Monday, March 1, 2010

Greece and California

When the proposed currency unification of the members of the European Union was adopted I predicted it would fail. I was pleased to have been proven wrong - or so I thought. Now, I see I may have been right. As so often happens, the undrelying economic realities take longer than expected to assert themselves.

The underlying realities are these. A common currency implies a common monetary policy. By agreeing to adopt the same currency, the members of the currency union agree in effect to relinquish independence in monetary policy decisions. So France cannot adopt a more inflationary posture than Germany without straining the agreement. Whoever controls the supply of the currency will ultimately determine the degree of inflation. The ability of the independent states to create money to cover government deficits is removed.

In this way Greece is like California. California has no independent currency or central bank. When it runs a defiicit it can only cover it by spending less or taxing more. A third option is to go to the Federal Government to "bail it out." The Federal Government has its own exploding deficit. The difference is that the Federal Government can borrow money from the Federal Reserve System by issuing debt - as long as the Fed is willing to buy the debt or get the public to do so. The Fed can arrange the borrowing from the public (or foreign governments) if the Treasury is willing to sufficiently raise interest rates to make its debt attractive in these uncertain times, or (since high interest rates are unpopular) it can simply buy the debt by creating new deposits for the Treasury. This is commonly called "printing money." In this way, by adding to the Treasury's need to borrow, California can contribute to the policy dilemma of the United States.

California, with its huge deficits, is not the only perpetrator of profligacy. New York, New Jersey, and many other states, to various degrees, are guilty. By coming to the rescue of profligate states the Federal government forces those states who act relatively frugally and responsibly to shoulder the irresponsible consequences of the spendthrifts. Even more important, by so doing the Federal Government encourages irresponsible behavior and discourages fiscal responsibility.

I ardently hope that the decision is made not to come to the rescue of California, New York or any other needy state - even if this means the defaulting of state government debt and the crisis that will entail. Pay now or pay more later.

By the same token, the senior members of the EU should not bail out Greece - whatever the consequences. Greece today, Spain tomorrow and there is no visible end. Greece will not live up to any austerity conditions placed upon it and failure to stick to the tough love approach may well mean the end of the common currency that has worked quite well to date.

Obama wants America to be more like Europe - in health care, the environment, public transportation - and no doubt in hypocrisy too. The Europeans are contempruous of his admiration. They will not allow him to take away their reasons for hating America. Regarding California, as with most everything else, we should not be aspiring to be like them.

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