Economic doctrines and trends in fashion are both known to have limited shelf lives. It is as difficult these days to produce someone who wears bell-bottomed trousers as it is to deliver a die-hard votary of central planning. The recession in the western world seems to have squeezed the lifespan of the “big ideas” in economics even further. As the world economy teetered on the brink of a crisis towards the end of 2008, in the wake of the Lehman collapse, old-fashioned pump-priming came back with a bang. The ghost of John Maynard Keynes, the father of deficit financing, walked once again through the corridors of national treasuries as finance ministers spent their way out of the crisis.
The budget deficit in the US expanded from 2.7 per cent of GDP to 12.5 cent between 2006 and 2009; in the UK it went up from 2.7 per cent to 10.9 per cent. It suddenly became passé to talk about fiscal discipline; salvation seemed to lie in hefty government spending. But the affair with Keynes didn’t last long. Recent events in Greece and in other southern European economies suggest that this dalliance is turning out to be a liaison dangereuse. As investors begin to question the sustainability of fiscal overstretch (Greece has a national debt well in excess of its GDP), the inflow of external funds that helped bridge the fiscal gap has dried up, bringing the economy to the brink of financial collapse. The virtues of fiscal discipline are back in the creditors’ and policy-makers’ book of commandments. At least for now, it seems to be “exeunt Keynes, enter William Gladstone, progenitor of the balanced budget”.
While the experts place their bets on which economic ideologue will follow Gladstone in this parade of doctrines, there is a problem to be solved in Greece and the other economies of the so-called Club Med. The prospect of Greece making an exit from the euro might seem appealing, but is easier said than done. Getting the pre-euro Greek currency, the drachma, back in circulation (and finding international investors willing to hold this currency) will be no mean task. Eighty per cent of Greece’s debt is held by outsiders, and the risk of switching even a part of this debt to a revived drachma (and the worry that others, like Spain, could follow the same tack) could trigger a collapse in the market for southern European bonds.
The equally difficult question is whether Greece can or should adhere to the strict austerity measures that have been announced. Those who argue against excessive belt-tightening point out that it will end up compromising growth and hamper Greece’s ability to service debt. The counter-argument is that the global crisis has so permanently damaged the growth model (which relied heavily on a real estate and construction boom) that no degree of fiscal spending will prop up growth in a hurry. The bottom line is that there is no deus ex machina that offers permanent denouement or deliverance. Holders of Greek bonds will have to reconcile to the prospect of debt “restructuring”, a euphemism for a sharp haircut on their dues. If this is unavoidable, investors should bear the pain now instead of delaying matters and letting the problem metastasise.
