The G-8 Meeting: No Aces, Just Jokers

The G-8 meeting on Thursday and Friday of this week will play like a B-grade horror movie. Ghouls--in the form of European debt crises--keep popping out of closets and lunging at the camera to scare the bejesus out of viewers. Greece's debt problems, thought to have been contained last year, are now revealed to be out of control again. All sorts of prominent officials and personages have insisted there will be no restructuring (i.e., default) of Greece's debt. This only reinforces the belief that there will be a restructuring, directly or indirectly, of Greece's debt. Portugal's debt problem recently lurched out of a closet and got a bailout package, making it the third domino to formally fall (Ireland was the second). Speculators are placing their bets as to whether Spain, Italy, Belgium or some other Euro bloc nation will be the next monster to pop up on the big screen. Northern European taxpayers are recoiling at all these horrors. But their leaders drag them inexorably toward more bailouts. The Euro bloc nations have, de facto, assumed responsibility for all sovereign debts of all Euro bloc members, although formal acknowledgement of this reality is less likely than Lance Armstrong admitting to doping.

It goes without saying that all European eyes at the G-8 meeting will turn to President Obama, accompanied by not really subtle suggestions that the U.S. finance a bailout of Greece (then Ireland, then Portugal and then the rest of the EU). The EU, as a whole, simply has too much debt to foster prosperity for the foreseeable future. As German and other northern European taxpayers assume more and more of the burden of the bailouts, their prosperity will suffer while Greeks protest to protect theirs. The Greek government is proceeding with asset sales to raise funds for paying off debt. But, unless it sells the Acropolis, these one-off asset sales won't reduce debt enough to stem the growing tide of red ink flooding over Greece's finances. Hence, European eyes turn westward for another Marshall program.

But President Obama has no cards in his hand. Today's American politics demand repayment of the federal government's debt, not some other nation's debts. Handouts for Europe wouldn't sell in salons in Manhattan, let alone living rooms in Iowa.

The Euro bloc doesn't have other potential benefactors. The BRIC nations are making noise about having a non-European selected as the next head of the IMF, sending a signal that they aren't overly enamored with seeing their capital contributions in the IMF directed toward financing the First World's luxurious (by BRIC standards) lifestyles. And once you get beyond America and the BRIC nations, no one else has enough wealth to help the Euro bloc.

The Euro bloc and America have no aces up their sleeves. They do have a joker--that the Federal Reserve and the European Central Bank print a lot of money. That would devalue the dollar and Euro, and make the sovereign debts of the United States and the Euro bleed away in the form of inflation. Devaluation isn't a strategy of the strong, but of the weak. The end result is that living standards in devaluing nations will drop. Thus, ordinary, taxpaying citizens will pay the price for the debt-fueled profligacy of the past decades.

Globalization, especially with the Internet and other aspects of modern telecommunications, allows ideas to spread really fast. That's good when they're good ideas. But when bad ideas spread, the result can be really bad. Beginning with over-indulgence in bank lending in Japan in the 1970s and 1980s, to the Federal Reserve's increasing reliance on price controls on credit in the 1990s and 2000s, to the Euro bloc's fiscal irresponsibility, the notion that prosperity can be achieved by financing consumption with debt spread like a prairie fire. But debts that finance consumption have an inexorable way of morphing into bad debts. Unlike transactional debts, such as the classic bankers acceptance, which resolve themselves when the transaction is complete, or business investment debt, which (hopefully) finances a productive enterprise, there's no happy financial ending that inheres in debt used for consumption. There are no necessary rational constraints on consumption, so ready access to debt for consumption can and will eventually produce a financial conflagration, immolating everything in its path.

The one thing that neither the Federal Reserve, the U.S. Congress, the administrations of Presidents George W. Bush and Barack Obama, the European Central Bank, or any of the governments of the Euro bloc nations has done is allow losses from the consumption rampage to be fully booked by the big banks. The institutions at the heart of the First World's financial system still hold vast amounts of dodgy debt that they aren't being forced to write down. Thus, accountability as a concept has died, and moral hazard is the order of the day. Governments no longer look to get rid of the problem; that would--horror--ruin some bankers. They just sneak around, scrambling for any way not obvious to taxpayers to brush the bad news under the carpet or kick the can down the road. This is costly.

The still extant stinky loans clog the financial system by restraining new lending and compelling central banks to print shiploads of money. The Fed's money printing is obvious--zero interest rates and QE2. The ECB's money printing is more subtle--it takes Greek and other sick countries' debt as collateral and lends against it, in essence giving more credit to yucky collateral than private lenders would extend. That's money printing by another name. Thus currencies are being devalued, and living standards in America and Europe lowered.

Expect upbeat pronouncements from the G-8 meeting. While differences between participating nations will be noted, they will also be downplayed while all national leaders put a rose tint on a debt dilemma with no exit.

There is in fact a way out--spurring economic growth and then taxing some of it to pay down the plethora of debt. Spending cuts large enough to close the gap aren't politically feasible nor are they sound public policy (unless one believes we should deprive the elderly of Medicare and close up the Defense Department). In America, growth has returned, albeit with high unemployment. The Republican majority in the House won't allow the only parts of the economy with the capacity to help more to pay down the debt--corporations and the wealthy--to bear an increased burden. So ordinary Americans are condemned to financial stagnation and high unemployment. And the Euro bloc's governance-by-panicky-crisis management precludes any logical continent-wide policies. It can only lurch from bailout to bailout, trying to confine the next ghoul popping out of a closet. The problem is, this isn't just a movie.