The Greek Dog That Didn’t Bark

Europe, write Daron Acemoglu and Simon Johnson in Project-Syndicate here, has been captured by financial interest-groups and policy elites’ worldview.

“Europe’s policy elite – the people who call the shots at the national and Eurozone level – are in serious trouble. They have mismanaged their way into a deep crisis, betraying all of the lofty promises of unity and prosperity issued when the euro was created. The currency union mays survive, but, for millions of people, the euro has already failed in its mission of sustaining growth and ensuring stability. How did this happen?

The Greek, Portuguese, Irish, and Italian economies are reeling under fiscal austerity – with budget cuts and higher taxes as far as the eye can see. This policy mix will slow their growth, and that of the rest of Europe.”

By referring to the “policy mix” however, Acemoglu and Johnson avoid to mention explicitly that this mix includes not only fiscal austerity but also a seriously overvalued euro that hinders exports out of the zone and subsidizes imports, thus bestowing a permanent deflationary bias on European activity.

Anyway, they go on mentioning the “bigger issue”, that is the “debt overhang” that has forced European governments to pursue the elusive target dabt reduction through fiscal austerity. While commercial firms can deal with such problems by using the bankruptcy procedure, they write, European governments tend to shy away from it because, they claim, it would create havoc in financial markets as banks would suffer heavy losses (and that would trigger a domino effect in financial systems), and because the same banks have sold insurance against default (in the form of credit-default swaps) that, if activated, would inflict further crippling losses to them.

However, the authors note, Greece has been cutting the value of private claims by about 75% relative to their face value, activating in the process the credit-default swaps, but there is no sign of tumbling dominoes.

“Did the hell break loose? No.” So:

“Perhaps the risk that a Greek debt restructuring would cause a financial meltdown was always minimal, and quiescent markets were to be expected. But, in that case, why all the fuss?

The answer should be clear by now: interest-group politics and policy elites’ worldview. Even if the risk to the financial system was minimal, the impact on banks and bondholders was substantial. They stood to loose billions, and many financial-sector employees stood to lose their jobs. Not surprisingly, leading bankers lobbied against debt restructuring, both behind closed doors and publicly.  (…)

Even now, many of the losses that bankers should have faced are being shouldered by the public sector (No, read “by the taxpayers, JJR), including through various forms of direct support and the extraordinary and risky actions of the European Central Bank. The extent of subsidies in this sector is stunning and, under current policies, will only increase over time - thereby primarily supporting the lifestyles of the top 1% of people in very rich countries.

The Greek default has turned out to be the proverbial dog that didn’t bark. The lesson for Europe – and for the US –is clear: it is time to stop listening to what banks say, and start focusing on what they do. We must re-evaluate the distorted political economy of the financial sector, before the excessive power of the few imposes even larger costs on everyone else.”

I have nothing to add to that analysis except that I showed in my recent book, Euro Exit, that the euro itself was a scheme meant to boost the market power of the cartel of big, structural, debtors: the banks and the governments.

Now that it is clear for all that it is a failure, the business and political elites cannot find any kind of justification for it, except the apocalyptical threat of a meltdown of defaulting and then seceding economies – the dog that did not bark in the Greek default case.

It follows that we should stop listening to what governments say, as well as to what banks say.