The Greeks got it right when they voted No this past weekend. But Greece’s formal request for a three-year bailout is a step in the wrong direction. That’s because once debt reaches a certain limit, it is never going to be repaid. Living with a debt hangover is simply no way to live. Greece needs to wipe the slate clean one way or another.
More important, Greece matters because it is a model from which to learn. What is happening in Greece is very likely a portent of things to come.
We’ve seen it over and over again … the gradual slide into the abyss. And it’s always due to the same thing: debt.
In the movie Wall Street, Gordon Gekko famously exclaims, “Greed is good.” The same could be said of debt: “Debt is good,” except when it’s not. For the purpose of business investment, debt represents leverage. If you can earn more than your interest cost (the cost of capital), then your equity investment can earn greater returns. Similarly, when debt is to fuel investment, whether in new manufacturing capacity or a port that increases commerce, as long as the increased revenues exceed the cost of debt, debt is good.
Go back 100 years or more and almost all government served one of two purposes: fund a war, or to execute long-term investment (roads, bridges, tunnels, ports, libraries, etc.).
Today, more than 50 cents of every tax dollar in nearly every western country goes to fund some form of government entitlement program. As with most things, these programs started off small. During the course of several centuries the payments of pensions swelled and became disconnected from a sound purpose: investment, and instead became a tool with which to buy votes. Buying votes is a form of unproductive current consumption, not long term investment.
The same thing has happened in the private sector. It used to be that people borrowed money to invest in businesses and homes, but as western democracies evolved from agrarian to industrial to consumption driven, it became increasingly common for that consumption to be fueled by debt. In the United States, 70 percent of the economy is driven by consumers doing what consumers do — consuming. Today, governments all over the world borrow money to fund social welfare systems while consumers borrow money to fund vacations and everyday living expenses.
This brings us back to Greece. The “no” vote made sense because any accommodation it might achieve in terms of reduced interest rates or prolonged repayment terms won’t alleviate the hangover that condemns Greece to further pain and suffering.
Greece does need to reset. However, I’m not sure the Greek people understand what “reset” means. While Greece needs to reset its debt levels, it cannot simply start accumulating new debt to fund its social welfare system. Everything needs to be reset. Older people need to go back to work as Greece builds a new economy. For that, Greece has but two real options: tourism and low cost manufacturing. Tourism is already a major part of the Greek economy and Greece will be a relatively inexpensive place to vacation for many years to come. But Greeks will also have to go to work in factories because Greece can offer Europe a relatively skilled yet low cost place of manufacturing that is close to home. If Greece’s elders think that wiping the slate clean of debt means they are off the hook, they’re terribly mistaken. Pain for the elder generation is already a foregone conclusion in any scenario — euro or no euro.
The lessons of Greece should not be underestimated. Most of the western world is on the same path, just years, or in some cases, decades behind it. Nations whose economies are fueled by unproductive debt — both government and private — will not be able to avoid the same fate. Just do the math and ask yourself how it can be avoided.
In the United States for example, investment in bridges, roads and other infrastructure has dropped off dramatically since the end of the fiscal stimulus program that first started in the waning hours of 2008. Yet both government and consumer debt continue to grow. That debt is fueling current consumption, not long term investment.
All eyes should be on Greece, not because Greece itself matters. It doesn’t. Greece is just 3 percent of global GDP, and during the past five years, Greek debt has been systematically isolated from the rest of the world. The Greek crisis matters because it is a model from which to learn.
In the United States, Puerto Rico is about to go the way of Greece. Just as many Europeans are asking, “If Greece is allowed to default on its debt, won’t Portugal or Spain or Italy want the same,” the question in the U.S. will be, if Puerto Rico is allowed to default won’t Illinois or New Jersey ask for the same? Since Puerto Rico is not a state, some will even ask if we should simply kick it out of the US (like Greece and the Eurozone).
There are so many parallels between Greece and Puerto Rico, the EU and the U.S., that what ultimately happens in Greece matters in a very big way:
|Greece (any Eurozone country)||Puerto Rico (any US state)|
|No legal right to bankruptcy||No legal right to bankruptcy|
|Sovereign immunity from creditors||Sovereign immunity from creditors|
|No currency printing press of its own||No currency printing press of its own|
|Uses major currency (euro)||Uses major currency (dollar)|
|In debt over its head||In debt over its head|
|If Greece is forgiven debt, why not Spain||If PR is forgiven debt, why not IL or NJ|
|Can continue to use euro without EU consent||Can continue to use dollar without US consent|
|Parent (EU) is afraid of setting precedent||Parent (US) is afraid of setting precedent|
|Compromise means recurrence of problem in 3-5 years||Compromise means recurrence of problem in 3-5 years|
All Americans and Europeans should be keenly fixated on how things play out in Greece — and how they will play out in Puerto Rico, because both offer profound implications for the future of the US and European economies. It may be time for all leaders in the West to think about what a debt reset would look like at home.