If Pigs Would Only Fly

It may be all Greek to some, but New Zealand risks getting caught in the storm.

Listener: 3 April, 2010.

Keywords: Macroeconomics & Money;

It’s possible – although not certain – there will be a second phase of the global financial crisis, involving sovereign nations rather than financial institutions. To protect their citizens from the first phase, most governments increased their spending and cut taxes. That meant borrowing; in many cases, public debt levels are well above normal levels, and rising.

Borrowing requires a complementary lender. Because governments seem safer, many savers put their savings into public bonds – readers may have, via a financial intermediary. However, some country will have the highest relative debt, and (possibly another) one will be borrowing more than any other. Lenders are likely to become nervous about extreme cases, since their savings will be less safe there. To make up for their insecurity, they will want a higher interest rate, and measures in place to ensure their savings will be repaid.

So lenders will get some comfort if the economy is cutting its borrowing and its debt level. But that means the government will be reducing the protection it gives its citizens from the global financial crisis.

The balance between the power of the lenders and the power of the citizenry is complicated. Recall an old banking proverb: “If you owe your bank a hundred thousand dollars you have a problem; if you owe it a hundred million dollars it has one.” If a country has enough debt, then the lenders may have a problem, especially if the country threatens to default and either not repay any debt or repay it much later than it is due. Moreover, if one country defaults, those a little lower on the relative-debt list may join them – or be forced to, because increasingly anxious lenders refuse to roll over debt coming to maturity. It all gets very messy.

Countries do default or, at least, reschedule their debts more often than you might think. Among those that did in the 1990s were Brazil, Mexico, Russia and countries involved in the Asian crisis. (New Zealand never has.)

Currently, the focus is on a group of countries labelled “Club Med” or the PIGS (Portugal, Italy, Greece and Spain). They are southern members of the European Union and all are in the European Monetary Union (so they have no independent currency and are unable to use the exchange rate to help resolve any difficulties). They all have large government deficits and climbing public debt.

Greatest attention is being paid to Greece, which has the worst deficit and debt record. (In the recent past it has been lying about its financial figures, or using accounting tricks to hide them.) It wants to borrow around 13% of its GDP, plus past debt that has to be rolled over. The lenders are agitated, while the rest of the EU ponders what help it should offer, fearful that too much will set a precedent for bailing out the irresponsible. (In this case, the rest of EU really means mainly Germany. Many Germans do not care an olive for Greece; others think its welfare provisions – such as the age of entitlement for the state pension – are too generous compared with Germany’s.)

Recently elected Greek Prime Minister George Papandreou has promised to reduce the country’s deficit to 9% of GDP next year. That means some Greeks have to take a cut in their incomes, and that may also generate unemployment. It certainly has generated demonstrations and strikes – even some workers in the Greek treasury have walked out.

I can’t tell you where this will end for Greece – presumably in tears. But other countries are also under debt pressure – not only the rest of Club Med and not only in the European Union. New Zealand is well down the list, but there are fears that in a sovereign-debt-crisis phase of the global financial crisis, we may be part of the collateral damage.

How events will turn out depends on many uncertainties, so I also can’t tell you how we will be affected. But you can be sure a lot of thinking is being done about how to protect New Zealanders from the damage. Getting the deficit down and maintaining control of the national and government debt would be the most outward signs.