Saturday, July 30, 2011

The Fundamental Source of America’s Budget Deficit

Martin Feldstein explains, in a remarkable Project-Syndicate post, why America’s budget deficit is so large.


“America’s enormous budget deficit is now exceeded as a share of national income only by Greece and Egypt among all the world’s major countries.” It rose “from 3.2% of GDP in 2008 to 8.9% of GDP in 2010 (which in turn pushed up the national debt-to-GDP ratio from 40% to 62%. 
To be sure, the current deficit of 9.1% of the GDP is due in part to the automatic effects of the recession.”

But according to the Congressional Budget Office, if the economy had been at full employment in 2008-2010, the budget deficit still would have increased by 3.2% of the GDP and even after the economy returns to full employment in the future the deficit will remain so large that America’s national debt-to-GDP ratio will continue to rise for the rest of this decade and beyond.

“The budget outlook in subsequent decades is dominated by the increasing costs of Social Security and Medicare benefits, which are projected to take the debt-to-GDP ratio from 90% in 2020 to 190% in 2035. Fundamental reform to these programs is the primary challenge for America’s public finances – and thus for the long-term health of the US economy.”

Read the post here .

Friday, July 29, 2011

Krugman on “Eurofail”

“What the markets seem to be seeing is disaster on the periphery and the Japanification of the core. And I can’t say they’re wrong.”

The Latest (and Revised) Big Mac Index

A “beefed-up” version of the Big Mac Index is now adjusted for the level of GDP per capita, the price of the sandwich in various countries being correlated to the GDP per person.

The change affects especially the measurement of overvaluation of Brazil and Argentina, and the measurement of undervaluation of South Korea, Mexico, Russia, China and India.

While the Chinese yuan is now close to its fair value against the dollar, the euro is substantially overvalued (36 % with the new versus 21% with the old index). This is not very good for the activity in Europe generally and it adds to the burden of the PIIGS by curtailing their debt servicing capacity: low growth means reduced tax receipts.

Have a look at The Economist here .

Monday, July 18, 2011

Greece Again: Acknowledging the Obvious

Simple truths do percolate, in the end, through the political-media muddle. See for example today’s Financial Times article with the title: “Eurozone exit could restore Greek competitiveness”. Obvious from an economic point of view. But interesting nevertheless because it reflects the shift of emphasis of politicians’ aims, from the official motto of “saving the euro” to a recognition that some form of Greek default is already a fact, and that no durable solution, i.e. a return to growth, is possible for the Greek economy unless a major devaluation, i.e. an exit from the euro, is adopted.

That said, a warning is addressed to other potential defectors in the article’s subtitle: “But leaving the club may be much harder than it was to get in.” Obvious too: the membership in the currency cartel – I mean the “club” – has so deteriorated the Greek public finances and economy that the cost is already built in the current situation and has to be met by someone, foreign creditors, foreign taxpayers, and Greek workers and taxpayers. This is simply the characteristic of all political rents: they benefit a few in the present, and burden many others in many following periods.

Let’s keep in mind, however, that exiting the euro will produce a benefit, not a cost, to ordinary Greek wage earners and taxpayers.    

Friday, July 15, 2011

From ERM to Euro: Creditors and Governments

A useful reminder of the short history of the ERM debacle in the 1990s and a comparison with the current euro crisis, brightly summarized, is to be found in The Economist .

The best bird's eye view of the problem I have read so far. 

Tuesday, July 12, 2011

Why Italy Is “Attacked”

Nothing changed much in the state of the Italian economy and debt during the last few days, compared to let’s say one or two months ago. But suddenly “the markets” (as the press puts it) “attacked” Italy under the form of a fall in value of Italian bonds, and as a consequence of Italian banks and insurance companies that hold these bonds. Is it a sort of duel between these shadowy characters  - speculators -and the Italian government (or the whole list of Euro zone governments)? Not at all.

There is, in fact, no “attack” against Italy, specifically. What happens is that the absence of any intergovernmental solution to the Greek problem (i.e. a massive bailout by northern taxpayers, followed by permanent transfers to the indebted country for the indefinite future, and possibly accompanied by a major partial default on the country’s debts) has progressively led, from one failed “plan” to another, investors worldwide to anticipate a Greek exit from the euro. This could in turn prefigure the most likely scenario for other over indebted members of the zone, penalized by the overvalued euro and unsustainable indebtness: exit now or accept the punishment of an unending recession.

For international investors the meaning of these developments is clear: the risk of the euro debts is rising (see Moody’s recent downgrades). Accordingly the required interest rate on euro instruments is also rising (augmented by a potential devaluation premium) and as a consequence the value of the euro debts is falling at the same time, as is the value of the euro in the currencies market. The more indebted the country, the higher is the required premium, Italy now catching up on Spain.

The inevitable exit of Greece from the euro zone will only confirm the soundness of this anticipation and will precipitate the fall of the euro, which already slipped from nearly 1.44 dollars last Friday to less than 1.39 today. This means, in other terms, that the markets incorporate in their valuations a partial default of debtors in euros.

A much larger depreciation is warranted if Greece exits the euro zone, but this will be good news indeed for indebted countries since it will amount to a corresponding reduction of the burden of their debts and a move towards the restoration of their international competitiveness.  

Wednesday, July 6, 2011

A Short History of the Greek Debt Crisis

Puzzled about the origin of the problem? Here is a useful reminder of what happened (a post in “The Denouement”). It lacks, however, an explanation of why it happened: a continuous deterioration of the economy’s competitiveness due to positive differential inflation in Greece versus other eurozone countries, a major continuous reevaluation of the euro versus the dollar (and yuan), the 2008 crisis striking an economy submitted to a restrictive (eurozone) exchange rate policy, and thus an accelerated recourse to the only policy instrument available to dampen the shock: budgets deficits and debt, all the more attractive since the interest rate was artificially lowered by the euro.

Nevertheless, have a look at the post here and especially at the list of major creditors of Greece, namely French and German banks and governments. It explains the current self-defeating policy followed by … er … the French and German governments.