Sovereign Debt: A Modern Greek Tragedy - Audience Q&A, Part 1
Christopher Waller of the St. Louis Fed is joined by economists Fernando Martin and Christopher Neely to take questions from the audience. In this first half of the Q&A, participants ask about European tax collection, and what would happen to the Euro and the EU because of sovereign defaults or if Germany and other fiscally strong nations decide to leave the EU.
Part 1: Welcoming Remarks, Julie Stackhouse (5:44)
Part 2: The Ability vs. the Willingness To Repay Debt (14:45)
Part 3: Why Is Europe Having a Sovereign Debt Crisis Now? (8:19)
Part 4: Waking Up to the Great Shocks (6:20)
Part 5: Insuring Against Default and Higher Rollover Risk (4:54)
Part 6: Austerity Measures and the Real Default Threats (8:55)
Part 7: The Moral of the Tragedy (8:29)
Part 8: Q&A Part 1 (14:25)
Part 9: Q&A Part 2 (18:18)
Julie Stackhouse: So let's go ahead and see what's on your mind. Yes, sir, please. Thanks for turning your mic on.
Q: If Greece is kicked out of the Euro Zone or decides to leave, what do you see as the effects for Greece and the Euro Zone as a whole?
Christopher Waller: Put you right on the spot.
Fernando Martin: Thank you. Well, if they get out, they still have to solve their fiscal problem. So one thing that could happen is that once they have their currency back, they're probably going to inflate it right away. That's the politically less painful way of doing it, so that would be the prediction. Now, that doesn't mean it's easy. Right? I mean, inflation is costly. So it's just distributed like we're selling a different way.
Q: What if Germany leaves instead of Greece being booted out?
Christopher Waller: It's your turn.
Christopher Neely: My turn? Well, there is, in fact, a group of German economists who would like Germany to leave with a select group of what they would term fiscally responsible countries. And, you know, if you press them, for political reasons they'll even include France in that. But they're really talking about the Netherlands and Germany and whatnot. So in some sense, that would make a lot of sense. Because there isn't a way, as I understand it, legally to kick somebody out of the Euro Zone but you can leave. So a group of fiscally responsible countries could leave the Euro Zone and leave the heavily indebted countries to their own devices.
Christopher Waller: Question over here?
Q: In your slides you didn't show France in all of those slides—at least I didn't see them.
Christopher Waller: Yep. No, I used Germany as the benchmark. So the question was—I don't know if the mic was on—France was in none of the slides, was there some particular reason? Usually France and Germany have been very close. Germany is kind of viewed as the benchmark country. So I really just wanted one of the fiscally sound countries compared to the GIPS. But if I put France on there, France has had an increase in their spread to Germany as well. There's concerns about France's debt. They were downgraded this last year. We'll see what happens in the next couple weeks with the new government coming in. France is nowhere near these countries, but there's been a little bit of movement above Germany.
Q: I have a follow-up question. Our debt right now is trending towards $16 trillion. Right?
Christopher Waller: Yep.
Q: And our GDP is around 2.5 trillion?
Christopher Waller: No. About 15 trillion.
Q: Is it?
Christopher Waller: Yep. That's why the ratio is about 100 percent.
Q: Okay. And one last one. Turkey, do you think they will be the next member of the Euro?
Christopher Neely: No, I don't think Turkey will be allowed into the EU.
Q: What's keeping them out?
Christopher Neely: The Europeans don't want them.
Q: Is it political or monetary?
Christopher Neely: It's political.
Christopher Waller: I used to teach a course on the European Union. In Austria a few years ago when there was serious discussion about letting Turkey into the EU, this Austrian politician said we stopped them at the gates of Vienna in 1638, we're not going to let them in now. In the back?
Q: Being that there is so much political pressure to create and maintain the Euro, can you visualize a scenario where the debt prices get so bad that perhaps the European Central Bank decides to devalue the euro as being able to solve this problem?
Christopher Waller: Well, I think that the ECB is in a tricky position. I mean, they're trying to some extent solve liquidity problems in the financial markets. And I don't think their desire is to say, all right, let's just go. Because they have a constitutional mandate to keep inflation under 2 percent. So the rest of Europe would either have to throw that constitutional mandate out to allow them to do that. But that's what it would take. It would take the whole EU to say, okay, we're going to let the ECB do this. So unless that happens, they don't have any legal authority to do anything like that.
Q: Since when did that stop them?
Christopher Waller: No comment.
Christopher Neely: I have one comment on that. It's not as easy to inflate away debt as you might think, because a substantial portion of debt is short term and other debt is issued in the form of real bonds that depend on the price level. And so, you know, unless you're willing to accept very high inflation for a long time, it's difficult to get more than a decent chunk of your debt inflated away. And if you do that, you're going to pay the cost in higher interest rates for a long, long time.
Q: I've heard that the tax collecting policy in some of the southern European countries is just extremely inefficient and that's one of the reasons why they're in the trouble that they're in. Can you speak to what they're doing to correct that? Because I've heard in these countries tax avoidance is simply a way of life.
Fernando Martin: That's correct. But that's kind of a systemic problem that has been going on for a long time. So these countries basically adapted to the reality. So the recent crisis, when you see deficits going up, it's basically done by expenditure not by loss in revenue. In that sense, the U.S. is pretty special because as Chris was saying, our deficit was generated by both an increase in expenditure and a decrease in revenue. But those problems are longstanding and it's not really what triggered these current events.
Christopher Waller: Right. So I've heard numbers that about half of all the actual tax liabilities are collected on. How they quite measure that, I don't know. But whenever you get into kind of the hidden shadow economy, it's very hard to start measuring things. But as Fernando said, it is a problem in Greece but it's been going on for decades, it's nothing new.
Q: Is it just simply correcting that in some—you know, by using electronic transactions or a simple thing like using—could that help them immensely?
Christopher Waller: Yeah, I mean, and obviously if you said we're going to implement better record keeping, better enforcement, better all these kind of things that the U.S. does, you could actually reduce the amount of taxes that go unpaid. I always say, as Fernando was saying, if the Greeks were happy with this as a nation for many decades, that was kind of a political choice not to enforce it too hard.
Christopher Neely: By the way, Michael Lewis, he has some excellent anecdotes about such things in his book, "Boomerang."
Christopher Waller: Question in the back?
Q: How does the European Central Bank sell bonds? How do they finance themselves?
Christopher Waller: How do they finance themselves? They effectively make loans to banks on a regular basis and these banks pay them interest income. So that's fundamentally how they earn their income. They just provide loans, they charge interest, the banks pay the interest, that's how they do it.
Q: Second question. Is there a role for the International Monetary Fund in all this?
Christopher Waller: Oh, they've been in this from the very beginning. I think I had a slide that the IMF had put up $250 billion in May 2010, and I think there have been other calls for that. One of the issues currently is the BRIC countries—Brazil, Russia, India and China—are becoming bigger contributors, and they've had austerity imposed on them by the IMF. And it's like, you know what? It's our turn.
Q: As employees of the Fed, do you guys pretty much agree with Rogoff and Reinhart in terms of it not being sensationalized but just kind of the history that they write?
Fernando Martin: Well, let me see if I understand the question properly. So the main point of that book is basically that default is not something new, that it has been going on throughout history. And in that sense, I think we all agree on that. There's nothing new in the current crisis.
Q: But, you know, 90, 100 percent point that they were always making in there that you reached that point.
Fernando Martin: Ah, in that sense. You know, and they also make the other point which is lots of countries have defaulted with very little debt, and lots of countries have been doing fine with very high levels of debt. So I don't think there's anything magical about the particular number.
Christopher Waller: Yeah. I mean, I think that's true. That was one of the slides. Japan is at 200 percent and nobody's worried. It's really your willingness. And at the end of the day there's no magic number for willingness. To give you a rough example, people are very worried—and you may know—California may default on its state debt. Their state debt-to-GDP is about 4 percent. I mean, they could pay off all their debt with a one-year surcharge of income of 4 percent. Why are they not going to pay potentially their debt? They don't want to. It has nothing to do with they have a big debt burden.
Q: People like to point to Germany and their success as basically having a great economy based on their exports. And then the case has also been made that, well, the only reason they can export so much is because the Euro has such problems and the exchange rate is lower than it otherwise would be. So when people talk about some of the fiscally stronger countries leaving Germany's competitiveness to export problems if they were faced with a more valuable currency.
Christopher Neely: Germany has had a current account surplus for a number of years and even when the euro was much stronger. Certainly the value of a currency is going to affect the current account situation, but they've certainly had a current account surplus when the euro was much stronger.
Christopher Waller: Yeah, I mean, and Germans have been big—as Chris said—exporters for a long time. And one response is, you know, we can always have a weaker deutschemark. We don't need the Greeks to do that.
Q: Is it not true that a large part of the German prosperity has to do with exporting to other countries within the Euro Zone on a very favorable basis and that lies right at the heart of their considerable prosperity?
Christopher Neely: Yes, most of Germany's exports go to other countries in the Euro Zone. But I'm not really sure I understand what you mean about, on a favorable basis?
Q: Well, the point is that if they were to withdraw from the Euro, along with several other very strong countries, and the balance of the Euro Zone were to undergo a very substantial financial crisis as a result of the loss of the gravity of the German economy, French economy and so on, the question is is whether or not those countries would be in a position to absorb the exports from Germany.
Christopher Neely: The way that the big picture works now is that Germany has been running a current account surplus and these heavily indebted countries have been running current account deficits. And what that means is that Germany has essentially been lending them money to buy Germany's goods.
Q: Just like China.
Christopher Neely: So if these countries were to default on their debts and Germany would no longer lend them money, then, of course, Germany would no longer be exporting so many goods to them.
Q: That's the point.
Christopher Neely: Yeah. But, for instance, I don't see what good it does to Germany to send other countries goods and services that they're never going to get back.
Q: Well, I guess because they figure they're getting part of it back. And, you know, much as China figures to the degree that they're financing this country that it helps them obtain full employment and helps them expand their infrastructure and so on.
Christopher Waller: Well, I'll put it the way that one of my colleagues says. Germans work hard, they produce Mercedes, they send them to Greece, the Greeks send them a promise to repay, then they don't do it. I don't know who won on that deal. I don't think it was the Germans. In fact, the Germans could say, we're not going to send you the car, we'll keep it ourselves. We'll produce it and consume it ourselves. We don't need the Greeks to consume our cars. We'll consume them ourselves.