The euro-zone crisis has erupted again. As with all Greek tragedies, there are painful lessons for us all.
Once upon a time, in a distant land of heroes and villains, a King wanted his country’s football team to play in the top league. Taking the advice of his bigger and wealthier neighbours (and local public and private advisers), he borrowed lots of money and encouraged his citizens to do the same to buy new players. The King proudly asserted, “By boosting investment, being innovative, acquiring skills and improving infastructure, we will be more competitive at home and abroad. We will raise productivity and employment and generate sustainable growth. This approach will generate the wealth we need to pay back our loans and create a positive spiral of investment, wealth creation and higher living standards. We can match the big teams by buying the best players, scoring more goals, winning the league and becoming more popular”
Everybody wanted to lend him money for what seemed a good plan. The problem was his people didn’t have the culture to play as well as their rivals and his rivals were not going to sit back and just let him win the league. In the end, too much spending leaked to agents (external suppliers) and there was too much speculative consumption. Courtiers and others diverted funds into less than worthwhile schemes and the accumulated debt became a burden when the team stopped winning (forward economic momentum was lost). With income less than sufficient to service the debt, a negative spiral ensued. Poor tactics and team work meant too many own goals and losses. Backers got restless.
Each time the King had to buy more players (borrow more), he had to pay higher wages (interest rates) to do so. With a growing primary deficit balance, interest charges above the underlying economic growth rate and adverse valuation effects, the debt dynamics saw a ballooning of obligations to creditors – over 150% of GDP. Soon, the King’s problems became his neighbours’ problems too as his creditors realised they were holding dodgy IOUs unsupported by real scoring (earnings) potential.
The tragedy is that, when you aren’t winning (generating the income you need) and others are no longer willing to support your team (lifestyle), everybody loses: restructuring is the only way to repair your fortunes on the pitch (finances). One approach is to sell your best players (assets) to reduce the debt to manageable proportions but that probably means losing even more games if you haven’t got some bright, home-grown talent. (If you lose your job and can’t pay the mortgage, you have to sell up and downsize – anybody want to buy parts of a small Mediterranean country? You can only do that if there is positive equity i.e. you have assets to sell and your “fire sale” generates enough money to pair down the debt.) Unfortunately, the likelihood is that you won’t get back what you paid for your best players in the first place.
If it looks really desperate, you might just hand back the keys and walk away – the going into administration or ‘dump the currency’ option. This doesn’t relieve the pain much in the short term but may mean you can start again sooner with a different ground in a different league.
A third option is a full take-over by a new, rich owner … again, anybody want to buy a country. The King is dead – long live the King. European democracies are probably no longer in the business of directly taking each other over.
Anyway, the King resigns as team manager and moves what resources he has left to the mountains of central Europe – becoming a TV pundit on the game. His compatriots fail to form a new united team (government). The majority of citizens are too fed up with the never ending austerity that has been imposed and vote to stay away from matches, reducing income further.
Meanwhile, the big teams (foreign powers) who should not have let them into the league in the first place, are now suffering too. They insist, “we want you to stay in our league because, if you don’t, others might also fail and our business model (euro-zone) might collapse completely. If our lenders lose more money with you, we will have to cut back on credit at home and the whole franchise might shrink.”
To stay in the game, however, the King’s old country needs a re-distribution of funding or talent or both. They have to be allowed to compete and win some games. This means a full fiscal and monetary union based on mutual self-interest. You can not have one team winning the league every year (Germany). The talent and rewards has to move around through transfers of funding and investment (rebalancing of trade and public sector deficits and surpluses) .
In the near term, throwing good money after bad is never popular amongst the creditors – teams that are used to competing and not co-operating. The risk is that the downward path to relegation continues. The only question is whether the team goes by choice or is thrown out and, then, whether new owners can raise a phoenix from the ashes. Bottom line – the supply chain is only as strong as its weakest link. Break the chain or play the game -we are already in extra time and the penalties are coming thick and fast.