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Europe made the Cowardly “Courageous Decision”

May 10th, 2010 No comments

Markets are happy about the European bailout of Greece’s bad debt, and they should be for two reasons. First, Greece will not be allowed to default on its debt, injecting some certainty into the market, and secondly, the Europeans have finally done something together politically.

However, in the long-term, they did the wrong something.

In the long-term, Europe has created a worse moral-hazard than the bank bailouts in the United States caused with its financial bailouts: a clear signal has been sent that politicians can bargain their way to political power by writing blank checks to public unions and other rent-seeking interests, and there will be no day of reckoning. Worse, the signal has been sent that, if you are a responsible, Prussian government that controls wage inflation, you will be forced to pay for the spend-thrift irresponsibility of your over-mortgaged southern neighbors. The lesson is clear: savers are suckers.

Europe should have looked at how the United States handles bad local governments…let them go bankrupt. By letting bad local governments go under, local governments in the United States can get out from under the bad decisions of previous governments and restart under firmer footing. Indeed, as Alabama has shown in recent years at the county-level, the threat of a bankruptcy by a local government is usually enough to bring creditors to debt restructuring, saving the county from needing to file.

By contrast, Greece’s government now lacks the power to force its creditors, particularly its government unions, to renegotiate its debts, since Germany and France stand ready with an open checkbook to bail them out.

The responsible course of action would be to let Greece default, or partially default, while protecting the somewhat more tenable positions of Portugal and Italy. Germany could have credibly said, “Greece lied; Portugal did not; we will protect honest governments.” Given the fungibility of the term, “honest government”, this would have been a position that would have made an example out of Greece while preventing a, “spread of the debt contagion”.

Europe has traded the long-term future of the Euro for short-term financial stability, and punted a much-greater day of reckoning some five to ten years down the road. Proponents will (mis)quote Keynes and say, “In the long-run, we are all dead.” I once heard Prof. Garrison quote another economist, “Keynes is dead, and we are stuck in his long-run.”

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