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It is strange to think of a country like Greece as a lead indicator for what might happen globally. And maybe if things go badly enough in Greece, it will save the world from the same mistake.

The FT headline yesterday was "Greece warned to act quickly to rescue collapsing bond market". The article points out that public debt is set to rise to 124% of GDP next year. Ominously, it also notes that "Moody's will visit Athens this week".

It is clear what is meant by acting quickly - get the public sector deficit down by higher taxes and reduced public spending. No consideration is given to the fact that this policy is likely to weaken growth, thereby making matters worse on the fiscal front. The best way to get debt down is to foster growth, and yet the policies being forced on Greece (and Ireland and maybe others in the future) act in precisely the opposite direction. Partly by the actions of this week’s visitors who, lest we forget, were the people who decided that packages of sub-prime mortgages should have a AAA rating, we are implementing a depression inducing policy.

So far so bad, but is there an alternative? Fortunately there is. And it has already been tried in a limited way in some countries. It is quantitative easing – but with a twist. Greece should announce that it will embark on a program of buying its own government debt. But then once it owns enough of the debt, it cancels it. The debt disappears, nobody takes any losses, and you don’t have to wear the fiscal hair shirt at the wrong time.

People will worry about the inflationary consequences. It is printing money. But there are two strong reasons not to worry about inflation. First, it simply isn’t a factor in today’s world where lack of demand is the problem. Second, if it becomes an issue down the line then you can easily deal with it then by tightening fiscal policy and raising interest rates. You almost want to have the problem.

This isn’t just a policy for Greece. Few countries have public sector debt in excess of GDP, though Japan, Italy and Belgium do share that unfortunate position. But most developed countries are now running large deficits. So debt burdens are growing and the same pressures will build.

Maybe if Greece and Ireland suffer badly enough in the coming years we will learn the lesson that tightening fiscal policy in a weak economy makes no sense. And maybe that will save us from the next depression. Let’s hope so.

Disclosure: No related positions

Source: Greece: A Leading Economic Indicator?