Government Defaults in Greece & Puerto Rico: Are We Next?
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The Journal of The James Madison Institute Government Defaults in Greece & Puerto Rico: Are We Next? | Dr. Randall G. Holcombe he Greek government has been on had been fiscally irresponsible, promising the edge of defaulting on its debt their citizens more than they had the since 2010. A Greek default has been ability to finance. They were living beyond Tprevented only by a succession of bailouts their means. from the European Union (EU). The Puerto Despite the U.S. government’s Rican government did default on its debts reliance on deficit finance, it will not find in August 2015 because nobody stepped itself in the same situation of having to up to bail it out. These governments found default, as this article explains in more themselves in financial peril because they detail below. Even so, there are certain 12 | The Journal, Winter 2016 The Journal of The James Madison Institute hazards that can come with deficit finance countries have run deficits higher than 3 at the federal level. Moreover, some of percent of GDP, the level they agreed upon America’s state and local governments when the eurozone was formed. Greece could find themselves in the situation of and Puerto Rico are different only because having to default on their debts because they have already arrived at the point of of fiscal irresponsibility. A review of the not having sufficient revenues to repay factors that have led Greece and Puerto their debts. Their problems are the result of Rico toward default helps to illustrate what government benefits promised in the past, the risks are closer to home. with the costs of those policies pushed into the future. The Greek and Puerto Rican Fiscal Irresponsibility governments used deficit finance to live The governments of beyond their means. Greece and Puerto The Greek case Rico find themselves in “The financing of is especially tragic financial difficulty now government spending because European because of financial through debt is not politics has stood in irresponsibility in the the way of pushing the past. Government unique to Greece or Greeks to enact fiscally benefits given to citizens Puerto Rico. Deficit responsible policies. The are politically popular, spending has been best policy for everyone but taxes are not, so the norm in the United would have been for politicians, looking States since the 1960s, the EU to let Greece to build political and all of the eurozone default and handle its support, always have own problems in 2010 the incentive to offer countries have run rather than bailing it citizens more benefits, deficits higher than 3 out. While the Greeks without providing a percent of GDP...” were living beyond their sufficient flow of tax means, the message revenue to pay for the bailouts sent to the them. The result is increasingly generous Greek people was that they could continue government benefits paid to citizens, to do so thanks to EU support, rather than financed by government borrowing rather having to cut back to an expenditure level than taxes. Greece and Puerto Rico found at which they could sustain themselves. themselves in the position of having The bailouts occurred because of accumulated so much debt that they could the politics of a united Europe, despite the not pay it back. bailouts being economically unsound. One The financing of government of the political goals of the EU is to create spending through debt is not unique to a more European identity, so that people Greece or Puerto Rico. Deficit spending think of themselves more as European has been the norm in the United States rather than German, French, Spanish, since the 1960s, and all of the eurozone Greek, and so forth. From a political www.jamesmadison.org | 13 The Journal of The James Madison Institute The Journal of The James Madison Institute standpoint, the other EU nations would power to create dollars to pay its debts, not be acting European if they turned their but the United States government, whose backs on Greece. European politics led to debt is denominated in dollars, does have the bailouts, not sound economic policy. the power to create dollars, through the The Greeks were borrowing to Federal Reserve Bank, to pay its debts. If provide generous government pensions, the debt of the federal government were a bloated government sector with too to become as unmanageable as the debts many government jobs, and an expansive of Greece and Puerto Rico, the federal welfare state. Because the bailouts signaled government could call on its Federal to the Greeks that they could continue to Reserve Bank to create dollars to pay off its live beyond their means, the result has debts. Indeed, the Federal Reserve Bank has been another half decade in which the financed a large percentage of the deficits Greeks continued to do so using other the federal government has run since the people’s money. Puerto 2008 recession. The Rico, unlike Greece, is U.S. government can not getting a bailout, “While the ability to never run out of dollars, which will force Puerto create money to pay because it can always Rico to budget more create more. responsibly in the its debts insulates the When Greece future. In both cases, U.S. federal government joined the eurozone, reforms will be painful, from the threat of it gave up the ability because spending having to default on its to create its own cutbacks will be debts, money creation money, as did all of the necessary. Everybody brings with it the threat eurozone countries. If benefits when those Greece still had its own reforms are made of inflation.” currency, the drachma, sooner rather than and if it issued bonds later, which is why the denominated in bailouts worked against the long-term drachmas rather than euros, it would interests of the Greeks. have the power to create drachmas to pay off its debts. This is why there has been The United States Does Not Face the some discussion about Greece leaving the Same Risks eurozone and reestablishing the drachma. The United States government does If Greece had its own currency, it could not face the same risks because it has then create all the drachmas it needed to the power to print money to finance its repay its debts and avoid default. Greece deficits. The Greek debt is denominated would not be on the brink of default and in euros, and Puerto Rico’s debt is looking for EU bailouts if it had not joined denominated in dollars. Greece does not the eurozone. have the power to create euros to pay its While the ability to create money debts, and Puerto Rico does not have the to pay its debts insulates the U.S. federal 14 | The Journal, Winter 2016 The Journal of The James Madison Institute The Journal of The James Madison Institute government from the threat of having that the government’s currency loses all its to default on its debts, money creation value. This happened in Zimbabwe, where brings with it the threat of inflation. When inflation peaked at 80 billion percent per governments increase the quantity of month in 2008. The government quit money more rapidly than their economies printing money in 2009, and Zimbabwe are growing, the excess money bids up has been using other countries’ currencies prices. Many countries around the world since. In September 2015 it officially have inflation rates in the double digits, switched its currency to the U.S. dollar. including Venezuela with an annual Greece and Puerto Rico, because they did inflation rate of 68 percent, Ukraine with not have debts denominated in their own an inflation rate of 57 percent, and Iran and currencies, could not print money to repay Russia with inflation rates of 16 percent. their debts, but lacking the ability to do so The United States is not immune to double- has more positives than negatives, since digit inflation rates, having experienced it creates an incentive for governments to inflation rates of 11.3 percent in 1979, 13.5 be more fiscally responsible because they percent in 1980, and 10.3 percent in 1981. cannot inflate away their debts. So, the answer to Greece’s fiscal One of the ideas behind the problems is not to return to the drachma. creation of the eurozone was that because That just substitutes one problem it took away the power of national (inflation) for another (default). Inflating governments to inflate away their debts, away a government’s debts is another way it would push the member countries to for governments to live beyond their means be more fiscally responsible. This has not a little longer, but eventually, without fiscal worked for Greece, at least partly because reforms, inflation can become so rampant the other eurozone countries have shown Protestors during the 2015 Greek default. (Photo via CNN Money) www.jamesmadison.org | 15 The Journal of The James Madison Institute The Journal of The James Madison Institute a willingness to allow Greece to continue to be paid in the future, pushing the costs to live beyond its means. The fact that of those promises forward in time. In the United States cannot find itself in the California, Illinois, and many localities, same position because of its ability to the promises of past politicians are now create money to pay its debts only means coming due, and current governments that excessive deficit finance in the United are fiscally strained as a result. While the States will cause a different set of problems. United States government does not face the In addition to the threat of inflation, threat of default as in Greece and Puerto deficit finance means that an increasing Rico, several state and local governments share of government revenue goes toward do.