REVIEW & OUTLOOK
APRIL 12, 2010.
Greece's Debt Lessons
New York, California and Washington are on the same path.
European governments on Sunday moved closer to bailing out Greece, saying the country would be eligible for up to €30 billion in loans this year at about 5% interest from fellow euro nations if a rescue becomes necessary. This is one more attempt to assure credit markets in advance of a new auction of Greek debt on Tuesday, for whatever those attempts have been worth. Greece's debt agony is painful but it might do some good if the rest of the world—including Washington—heeds its lessons.
Athens remains in denial, thinking that its recent package of spending cuts should be enough to earn market support. The bond yields, says Finance Minister George Papaconstantinou, "don't reflect the real state of the economy, nor the efforts and results of what the government has done so far." King Canute also tried to command the tides.
The market message was delivered on Friday when Fitch, the credit rating agency, dropped Greece's debt rating to triple-B-minus, barely above junk status, citing in part "a deterioration in the outlook for economic growth." Greek industrial production fell 9.2% in February from a year earlier, according to Greece's national statistics office. And forecasts now have the Greek economy shrinking by at least 2% this year, even as the rest of the world has emerged from recession.
Athens remains in denial, thinking that its recent package of spending cuts should be enough to earn market support. The bond yields, says Finance Minister George Papaconstantinou, "don't reflect the real state of the economy, nor the efforts and results of what the government has done so far." King Canute also tried to command the tides.
The market message was delivered on Friday when Fitch, the credit rating agency, dropped Greece's debt rating to triple-B-minus, barely above junk status, citing in part "a deterioration in the outlook for economic growth." Greek industrial production fell 9.2% in February from a year earlier, according to Greece's national statistics office. And forecasts now have the Greek economy shrinking by at least 2% this year, even as the rest of the world has emerged from recession.
Hence the Fitch downgrade. Nobody doubts that spending cuts are needed and over time can contribute to reducing Greece's deficit. At a high enough price, Athens will also probably be able to roll over the roughly €22 billion in debt that's maturing this month and next. Investors have concluded that one way or another Europe won't let Greece default.
But the real reason for Greece's rising borrowing costs is the longer-term worry that the government lacks policies that would boost the crucial denominator in its deficit-to-GDP ratio. Investors are waiting for Greece to remember that austerity alone doesn't a vibrant economy make. Spiraling borrowing costs are only a symptom of Greece's trouble, not the primary cause.
Fitch's downgrade was a reality-check on this more fundamental growth problem. Chris Pryce, a director in Fitch's sovereign group, told us on Friday that, along with its high yields, Greece's austerity measures are "dampening demand in Greece" and "are taking money out of the economy." That sounds like a lament that Greece is too broke to afford a spending stimulus package, which it is. But it is also a policy of spend and tax that has brought Greece to this pass. Mr. Pryce is certainly right to look beyond Greece's budgets to its growth prospects.
To that end, it is some consolation that Athens is mulling a privatization plan and has proposed a gradual decline in its corporate income tax rate to 20% from 25%. The parliament would do well to approve the measure when it votes this week and make the cut to 20% immediate rather than phased in. The proposed steep hikes on dividend and capital gains taxes, on the other hand, are precisely what Greek firms don't need to lure more investors and get back to business.
While Greece's woes are still mainly Europe's problem, they should be a warning to Americans as well. Greece's predicament resembles that of New York and California, which are also struggling to pay their debts. The 2009 Washington stimulus helped those states postpone their day of reckoning, but that money runs out this year. Tax revenues have begun to rise again as the U.S. economy recovers, but those U.S. states also need to confront spending and pension commitments that are unaffordable in the long term.
As for Washington, it's worth noting that Greece's debt as a share of GDP is 113%. America's is now about 63%, a postwar record. But it is also growing fast, and the Congressional Budget Office forecasts that it will reach 90% by 2020 under Mr. Obama's latest budget proposals that will keep federal spending close to 25% of GDP. The recent historical average has been under 21%. Oh, and that 90% U.S. debt estimate includes the big tax hike scheduled for January, which CBO assumes won't retard economic growth.
Some on the American left argue that Greece's problem is that it joined the euro bloc and so can't devalue its way out of trouble. But the discipline of the euro is one reason Greece is having to confront its fiscal profligacy, and leaving the euro would only add to its financing woes. The Obama Administration may quietly assume the U.S. can devalue its way out of debt with easy money, but sooner or later the bond vigilantes will blow the whistle on that strategy and raise U.S. borrowing costs too.
Greece's predicament—like New York's and California's—is signaling loud and clear that the spend-and-tax economic model has hit the wall. The first lesson should be to stop the spending spree before it creates Greek levels of debt. The second should be to stop the tax increases that could slow the nascent U.S. recovery.
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