WASHINGTON -- Watching the battle play out between Greece and Europe's financial leadership, observers in the United States might wonder how it is Greece got itself into this mess. Could such a thing ever happen here?
No, it could not. The reason lies in the different structure of the United States and the European Union, and has led to much confusion in the United States, as politicians have warned that if this or that policy isn't enacted, America could become “Greece on steroids.”
The key difference is that the United States has its own central bank -- the most powerful one in the world. Greece, meanwhile, does not. And while the states of the United States are genuinely united -- a common banking system, common federal budget and common political system -- the eurozone is a federation of countries with a common currency that, in the face of crisis, must largely fend for themselves.
When countries’ economies slow down, they have two sets of tools at their disposal: monetary policy (adjustment of the money supply) and fiscal policy (adjustment of government expenditures). Central banks fill the demand gap of a recession by printing currency, and governments do it by spending more than they save.
But in a monetary union of many countries, like the eurozone, the largest and most powerful countries, like Germany, can use their outsized influence to secure a monetary policy that works for them. Those same policies may be counterproductive for other countries with different economic needs. If Germany is concerned about inflation, for example, it may be inclined to raise interest rates, which would be devastating for the economies of countries struggling with high unemployment.
And if a monetary union does not have a corresponding fiscal union, troubled countries also have limited fiscal policy tools to stimulate their economies. While fiscally centralized governments can transfer money from one part of the country to another, separate countries that run out of money in an especially severe recession must either cut back dramatically, beg their richer neighbors for help -- or, as in Greece’s case, a combination of both.
Let's consider an example: Varoufakis compares Nevada and Greece
In April, Greece's then-Finance Minister Yanis Varoufakis traveled to Washington to meet with President Barack Obama and Christine Lagarde, the managing director of the International Monetary Fund, one of Greece's creditors. He also sat down with The Huffington Post for an interview, and we asked him why austerity has survived in Europe as the consensus of most elite politicians and bureaucrats, whereas in the United States, it had its moment but has since become somewhat discredited.
Consider, said Varoufakis, what would have happened to the state of Nevada if the United States operated as the eurozone does.
"Suppose that in 2008 the United States was structured as the eurozone was. Well, take the great state of Nevada. Its banks went bankrupt, its real estate and construction sector went under," he said. "Imagine if the state of Nevada had to bail out the banks of Nevada, pay unemployment benefits, which were skyrocketing, and have no central bank standing behind it. Let me simply suggest to you that the great state of Nevada would become insolvent in one day.”
The nightmare scenario Varoufakis describes is exactly what happened to Greece.
Just as Nevada and a handful of other states bore the brunt of a burst housing bubble driven by Wall Street, so too did Greece suffer the worst effects of European banks’ casino lending. To be sure, until 2008, the Greek government took on loans it could not pay off -- and hired Goldman Sachs and other Wall Street firms to help cover it up. But it takes two to tango: German and French banks in particular lent to Greece despite knowing they were making risky bets. In fact, German and French banks had so much bad Greek debt on their books that when it looked like Greece was going to go bankrupt in 2010, European leaders feared that allowing the country to default would be an economic catastrophe for the continent. They were worried it would open other euro nations up to speculative attack, setting in motion a chain reaction to unravel the euro.
But Europe’s fiscal and political divisions made the action they took to address their concerns far more complicated and less effective than it could have been -- and far less beneficial to Greece itself. What might be a standard transfer between fiscally united states required the eurozone to take extraordinary measures. And the lack of political unity within the euro area meant that the powerful eurozone nations were inclined to choose the measures that accommodated their domestic needs first and Greece’s economic needs a distant second.
Bailout funds went to the Greek government, but were destined for the banks
So rather than take the politically unpopular step of bailing out the big banks directly, the German-led eurozone used the Greek government as a conduit for the funds. In 2010 and 2012, the eurozone nations, together with the IMF and the European Central Bank (ECB), provided Greece with rescue loans totaling 240 billion euros. But the vast majority went toward paying money the Greek government owed its creditors, which were initially mostly big banks. Then, in March 2012, European governments bought out the remaining Greek debts on banks’ books at a discount.
Whether Greece’s creditors were private or governmental, however, as of January 2015, just 11 percent of the troika’s bailout loans had gone toward funding its government. The rest went toward debt repayments.
“The effect of these bailouts was to shift debt from the shoulders of privateers to the shoulders of taxpayers,” Varoufakis explained. “This is something that our parliament opposed when it was happening. We’re against it. We thought that it was a terrible deed. And we even demonstrated in the streets against those bailouts.”
But for the German-led eurozone, the benefits of Europe’s stealth bailout were twofold. By bailing out the big banks through Greece and then buying out those banks’ debts, Europe both reduced risks of financial contagion from Greece and allowed its leaders to scapegoat Greece for what would have otherwise been an unpopular policy. European leaders convinced their publics that Greece’s slacker behavior was to blame for the bailouts, not their own failure to regulate their big banks -- or forge a closer fiscal and political union. They told their constituents that Greece was, at best, a welfare queen in need of discipline; at worst, they called it a “cancer,” unworthy of membership in the currency union.
All of the Greece-bashing had an impact. From Finland to Spain, angry European taxpayers wanted their pound of flesh from Greece.
And did they ever get it. Since 2010, Greece has implemented one of the most dramatic fiscal adjustments in modern history. In 2014, it boasted the largest cyclically adjusted, primary budget surplus in Europe. To get there, Greece’s government has raised taxes and cut spending dramatically. It employs 30 percent fewer government workers than it did in 2009; pensions have, on average, been cut by 40 percent.
A broad array of economists believe this fiscal austerity has devastated Greece’s economy. In the years since Greece implemented its creditors’ austerity policies, its economy has shrunk by almost one-third, and adult unemployment remains above 25 percent.
Greece’s budget tightening would not be as much of a drag on its economy if it had monetary stimulus at its disposal. By devaluing currency, a country can boost its exports and domestic consumer demand. Iceland, for example, was able to recover economically despite a massive fiscal contraction because it had its own currency and could print as much of it as it wanted.
But Greece is on the euro, and the European Central Bank, which controls the euro, has not afforded Greece anywhere near enough stimulus. During much of the recent economic recovery period, the ECB’s cautious monetary policies reflected the inflation concerns of Germany.
Unlike its counterparts in the United States and Great Britain, the ECB raised interest rates twice in 2011, which is believed to have contributed to the continent’s double-dip recession -- and hit struggling economies like Greece’s especially hard.
Leaving Greece behind
Now that the ECB has turned on the monetary gas, Greece has not shared in the gains. In January, the ECB refused to include Greece in its quantitative easing program, because it says Greece owes it too much money.
In negotiations between Greece and its creditors, many experts also say the ECB has acted as an enforcer for Germany rather than a lender of last resort. That is because in addition to controlling the eurozone monetary policy, the ECB has served as a deposit insurer for troubled banks in Greece and other struggling nations -- the European FDIC. But critics note that the ECB has effectively abdicated its role as a source of deposit insurance at strategic moments to get Greece to concede at the negotiating table. Most recently, the ECB capped emergency liquidity to Greek banks in late June ahead of the Greek referendum, forcing Greece to impose capital controls that have kept its banks closed to this day. Now that Greece has reached a highly concessionary agreement with its international creditors that surrendered most of its financial sovereignty, the ECB announced that it will resume the emergency lending.
It would be one thing if this at least allowed to Greece to pay off its debt. But even for the eurozone, it has been penny-wise and pound-foolish. Because Greece’s debts have grown faster than its economy, the IMF now projects that Greece will need a massive debt write-off if it is ever to emerge from the new bailout program and finance itself on the private markets again.
So going back to Varoufakis’ hypothetical: Imagine a similar sequence of events happening to Nevada. It would be as though, instead of the stimulus and the federal safety net, Nevada just got TARP -- and then immediately had to start paying the tab for Wall Street banks.
It sounds crazy.
But if Nevada were part of the eurozone it would have been hammered in the same way. "If [Nevada] had to go to the international markets to borrow, those borrowings, those funds, would come with austerity strings attached by the IMF. That would crush the state of Nevada completely," Varoufakis said. "So austerity has staying power in Europe because we lack the automatic stabilizers you have in the United States. If we had them it would have died also. It would have been a passing phase."
Why couldn’t that happen to Nevada?
Instead of begging the IMF or wealthier independent countries for money, however, Nevada simply benefitted from the “automatic stabilizers” that come with fiscal unity. Federal programs that normally support Nevadans, like Social Security, Medicare, Medicaid, food stamps and unemployment insurance, are built to accommodate greater demand. That means that greater outflows from the federal government to Nevada during the recession replaced some of the income lost from layoffs elsewhere. It prevented Nevada’s acute recession from becoming a Great Depression.
We do not often think of them this way, but these “automatic stabilizers” are enabled by hidden transfers from wealthier American states to poorer ones. According to an analysis of government data by WalletHub -- which combined several metrics, including the ratio of federal spending to the amount a state pays in federal taxes -- states like New Jersey, Delaware and Illinois subsidize states like South Carolina, Maine and Mississippi. Nevada is somewhere in the middle: it tied Michigan for 16th least dependent on the federal government.
In addition, partisan gridlock notwithstanding, the relative political unity of the United States meant there was strong public pressure to enact special fiscal and monetary stimulus policies that provided economic relief nationwide. On the fiscal side, the federal government passed an $800 billion stimulus package. That put money in people’s pockets and in state and local government coffers with a combination of spending projects and targeted tax cuts. And the federal government picked up the tab for bailing out the banks.
An analysis by The Huffington Post of White House data shows that Nevada received nearly $1.6 billion in federal stimulus dollars.
On the monetary side, unlike the ECB, the Federal Reserve has kept interest rates at or near zero since 2009. It also kept credit cheap for American businesses and consumers by buying trillions in private assets in an unprecedented program known as “quantitative easing.” Advocates who want the Fed to do more, by tying interest rate hikes to wage growth, for example, do so knowing it might benefit some parts of the country more than others.
Economists Mark Zandi and Alan Blinder estimate that the stimulus alone increased U.S. GDP by 3.4 percent in 2010 -- keeping the unemployment rate 1.5 points lower than it would be otherwise.
Evidence suggests that the stimulus package, and other measures, worked in Nevada too. Unemployment peaked in Nevada in November 2010 at 13.7 percent, and its unemployment rate has been dropping ever since then. As of June, official unemployment in Nevada was down to 7 percent.
Is the eurozone doomed, then?
It depends what is meant by "doomed." The eurozone is unlikely to unravel in the near future, if only because the costs of leaving the eurozone remain very high. It says something about the real or perceived risks of leaving the currency that the leftwing Greek prime minister Alexis Tsipras was willing to agree to Greece’s worst austerity package yet and surrender Greece’s financial sovereignty rather than face the prospect of leaving. In the near term, a Grexit would cause untold economic damage as the value of people’s savings plummeted and the cost of essential imports like food, oil and medicine skyrocketed. Tsipras apparently judged the risks to be too high.
But the eurozone has lost its moral and political credibility. It does not speak well of an economic system if the main reason people are in it is because the alternative might be worse. That has the capacity to prevent it from expanding in the future, and is already inspiring a wave of extreme political movements within its borders.
The Greek crisis has exposed the contradictions at the heart of the currency union: It was always a political idea awkwardly implemented through monetary means. Joining European nations under a common currency was meant to be the next logical extension of the European Union, formed to bring peace to the continent after World War II. As many warned when the eurozone was created, though, yoking countries with very different political and economic policies to the same currency could deprive them of much-needed flexibility during economic downturns. The resulting economic instability would exacerbate the very political divisions the union was meant to heal.
Nobel Prize-winning economist Milton Friedman summed it up presciently in a 1997 essay.
“Political unity can pave the way for monetary unity,” he wrote. “Monetary unity imposed under unfavorable conditions will prove a barrier to the achievement of that unity.”
Some European leaders appear to be heeding Friedman’s advice after the fact. They are renewing their efforts to unite Europe politically and economically to bring it into line with the monetary union.
“I think this is one of the lessons” of the Greek crisis, said Peter Wittig, the German ambassador to the United States, at a press briefing on Monday. “We have got to learn how to harmonize even better our fiscal and economic policies in the future.”