While speaking at the prestigious London School of Economics (LSE), Queen Elizabeth spanked the economics profession when she asked why so few economists had foreseen the credit crunch. Eight months later she received a formal response from LSE Professors Tim Besley and Peter Hennessy. Ten leading British economists then wrote a separate response emphasizing that Professors Besley and Hennessy failed to consider any deficiency in the training of economists.
Three Nobel Laureates along with the ten British economists “argue that economics have become largely transformed into a branch of applied mathematics, and little contact with the real world. The letter by Professors Besley and Hennessy does not consider how the preference for mathematical technique over real-world substance diverted many economists from looking at the whole picture.”[i] Interesting bit of self criticism.
The Queen was referring to the first of a two phase crash. First is the problem of worldwide bank insolvency. The second is the problem of worldwide government insolvency. Their genesis follows a common theme on parallel paths. Just like weak banks aren’t allowed to fail, but are instead merged into stronger ones under government supervision (sometimes with government money) resulting in the systematic weakening of the stronger banks. Over decades the whole banking system becomes weak and vulnerable to a single event pushing it to the edge of an avalanche-breakdown.
Governments have been doing this very same thing. They sell debt to cover the gap between what politicians promise[ii] and the maximum amount of taxes voters will tolerate. But politicians always promise more than the tax system can deliver. Historically, once over the edge, the strong governments prop up the weaker ones either by direct loans or guarantees to credit markets who have doubt on their ability to increase tax flows to support additional debt. Organizations like the International Monetary Fund (IMF) are organized to do exactly this. That Governments’ Credit ratings on existing debt also drop pushing up interest rates on existing debt, further squeeze budgets and threatens the viability of those promises and the political structure itself. On and on it goes with increasingly heaver debt loads, in both strong and weak countries alike; the strong propping up the weak; the strong slowly weakening; investor confidence waning.
Now the Greek situation. What can history tell us is the most probable next step? Note the following January8, 2009 headline “German bond sale’s failure signals trouble ahead”.
That sent shockwaves as Europe’s strongman Germany has trouble selling its bonds.
Will ECU bail out Greece really means will Germany bail out Greece. With Spain, Portugal, Italy, and maybe France, Belgium, Ireland rapidly approaching the Greece situation, and Europe’s strongman with problems of its own, it’s not too surprising Germany is resisting. Can she prop up them all?
Why Doesn’t Greece cut spending or increase taxes? The following March 11, 2010 Headline might offer a clue:
“Greece rocked by riots as up to 60,000 people take to the streets to protest against the government”
“It was the second strike in a week that brought the country to a virtual standstill, grounding all flights and bringing public transport to a halt”. The fuss? Budget cuts and tax increases.
Yesterday (April 29) Investor’s Business Daily Headline:
“S&P Cuts Spain As Greek Crisis Spreads In EU”.
There will always be a time when the strong aren’t strong enough to carry the weak.
Another answer to the Queen. These problems have been developing for decades and no one can say with precision how long this downward spiral can continue before investors run for cover and it all blows up. We only know it will eventually happen. She should have asked why so many politicians for so long were relying on short term political measures at the expense of long term financial stability? With reams of economic history to study, of course she knows the answer to that question.
Will members of the EU, once again, find a way to kick the can down the road or will they tackle this out-of-control spending monster head-on?
[i] “The ten economists uphold that the narrow training of economists – which concentrates on mathematical techniques and the building of empirically uncontrolled formal models – has been a major reason for the failure of the economics profession to give adequate warnings of the economic crises in 2007 and 2008.”
[ii] Few have limited their activities to the basics (requiring about 12% GDP) which are easy to cover with the tax base. Thus, the problem is the growth in entitlement spending. Many are about 50% or more of GDP.