Greece needs to leave the euro: Part I

I wrote this comment in reply to a great article published by Martin Wolf in the FT today (6/3/2015) which you can find here 

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Good article, but in my humble opinion some misconceptions.  

First, Martin Wolf makes the point that the euro area is not an OCA.  As my research has clearly shown (see my Bank of Finland discussion paper on this issue published 2 years ago  http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Pages/dp2013_33.aspx), Greece does not have, and never did have, business cycles (or any other cycles for that matter) that are synchronous with the rest of the euro area.  It is simply not a good fit with the rest of the euro area, without (according to the OCA theory) there being sizable offsets which consist of fiscal transfers and much higher labor mobility.  And this is the case both ex-ante, and ex-post.  So, given this empirically proven stylized fact:

Second, the Greek government is simply wasting it's time and energy negotiating something that will not result in any long term membership of the euro - it will just be "another shot of medicine to help the dying patient".  I understand that the fact that the Greek government is actually negotiating is a necessary political pre-requisite to leaving the euro, but let's not drag this sorry Greek tragedy on any further than needs be, as this just prolongs and likely exacerbates the suffering of the Greek people.  

Third, Martin Wolf says that this will have a profound effect on the euro area and reverse the integration dynamic.  Well, hmmm, Greece is a little country the size of the State of Rhode Island in the context of the US - so it's not as if Spain or Italy were leaving. The euro area is 16 years old - and so its longevity won't depend on one small member deciding to leave early on it's evolution.  Also, the UK leaving the EU would have a much bigger impact on the integration dynamic than Greece leaving the euro area. 

Lastly, Wolf clearly wants Greece to stay inside the euro when he says that "This must be seen as a long game".  I mean how long do you want this game to be?  Governments simply don't think long term as their time horizons are short term or medium term at best. So the Syriza government really has the choice of alienating it's supporters and signing up to something that it promised never to sign up to, or pulling Greece out of the euro, which will create some chaos to begin with unless they have a proper plan B in place.  

If I were the Greek finance minister right now (which thankfully I am not), I would be furiously planning and comparing different strategies for a euro exit, as inevitably, that's what is the most likely outcome here.  

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Now in part 2 of this blog, which will come out in the next couple of days, I will outline what I think the options are for Grexit.

The Ladder of Escape (in US Budgetary Politics)

On Tuesday I was in London for a day of culture - something I rarely get in my current home town of Corpus Christi. So in the morning I ended up at Tate Modern to see the Joan Miró exhibition.  Miró was a staunchly nationalist Catalonian painter who lived through the upheaval of the Spanish Civil War and when he moved to France in 1938 to escape it, got caught up in the beginning of the 2nd World War as Germany planned and then enacted it's invasion of France.

That morning I had been happy to hear about the deal struck thousands of miles away in DC between the two main US parties, what I didn't realize was that the "Ladder of Escape" theme that runs through so many of Miró's paintings was really what was going on in the negotiations in DC that had just been finalized.  In Miró's paintings the "Ladder of Escape" (seen in red and black disappearing upwards) acts not only as the restlessness of a perpetual émigré but also the idea that you can escape from reality into an abstract fantasy world, as Miro did in terms of his art being a sanctuary from all the terrible things going on around him.

As the FT makes clear this morning in an excellent review of the agreement "forged of necessity" by Robin Harding, the spending cuts are post-dated to when either the current raft of politicians have been voted out of office or when economic circumstances will have changed considerably so that in a new Congress the current agreement can safely be ignored. Hence although the media stated that markets fell today because of high levels of Italian government debt, I think the truth as to why markets plunged yesterday is probably much closer to home.

Of course, the reality of dealing with budgets is not pleasant - cuts have to be made and whole sections of the population have to be asked to carry an increased burden, but ultimately at some point down the road that is what must happen.  The question is "when"?  So I can see the temptation in front of the politicians - specify that most of the cuts will happen in the future and appoint a committee to make the cuts that need to be made now, and then climb up the "Ladder of Escape".  Larry Summers (in the FT) has also noted that these spending cuts are agreed relative to a baseline, but there is no reference to any baseline in the agreement, so no doubt this can be interpreted quite a few different ways, an omission that might have been intentional to help get it passed and on President Obama's desk in time.

That is certainly not to say that I favour the UK approach of the Conservative/Lib Dem coalition.  Their policy is basically to hike sales taxes and slash government services and departments, as well as downgrading public sector pensions considerably, while also cutting the number of University places available to this year's intake and dramatically increasing tuition fees. Economic growth is almost non-existant in the UK and the country could very well slip into recession later this year. But I would say that I like the fact that there are both spending cuts and tax increases (what Obama calls a "balanced approach") despite the fact that the timing of the UK policies are just too rapid. I think what needs to be emphasised to the American people though is that new taxes will have to be raised if they are to begin to properly address the problem without gutting the welfare state or the military - that is just the reality, and even conservative economists like Robert Barro agree on this point.

Now in these blogs I have maintained all along that the US would be slowest to come out of the 2008/2009 recession because it had the catalyst for the global downturn, and would probably need most stimulus. But now that the stimulus is virtually complete it does not seem exactly the right time to enact some draconian pull-back, but obviously it does compel the administration to explain to the markets how it plans to get it's fiscal house in order down the road. And therein lies the main problem - its policies of increasing taxes on the rich to pay down some of the debt was just not grounded in political reality, given the emergence of the tea party and the pledge that the Republicans had taken to Norquist's association. So all the adjustment had to come on the spending side, and that just isn't going to happen quickly given the fact that we're still dealing with 2 wars, and a housing market that is still in decline in many parts of the nation.

There are several important questions that come out of the brinkmanship we experienced over the weekend, and one of them must be whether it would have been better not to reach an agreement that is more fantasy than reality, and then to have faced the consequences, rather than sign something that clearly lacks credibility.  No-one wanted a default, but there again running a sensible fiscal policy requires some reality checks on all fronts, not just that of taking a surgical knife to government spending.

So back to Miro again and while Miro was exiled from his beloved Catalonia to France (Paris) he painted what for me was the best picture in the Tate Modern exhibition - that of a "Still Life with Old Shoe". Here ordinary objects become fantastical - you can see the vivid colors surrounding everyday objects like an old shoe, a piece of bread, a knife in a potato and a bottle of wine. I think the point Miro was also trying to make is that when you face extreme pressure, the ordinary things in life matter a lot, and garner extra meaning. I can't imagine what analogy one might make for the budgetary mess here, but I'll be pondering that over the next few days!

Certainly though if you happen to be in London before September 11th, I would definitely recommend you take some time to see this fascinating exhibition!