Jamie Dimon, CEO of J.P. Morgan (NYSE:JPM), recently made some interesting remarks on the Greek debt crisis. Not only does Dimon believe that Greece won’t default, he maintains that if it does, it will merely be a minor blip:
I don’t think [a Greek default is] going to freeze the capital markets of the world. We have had defaults around the world before — Russia, Argentina and Mexico — and they weren’t good events for global economies but they didn’t derail global growth.
My initial take on this is that either Dimon is somewhat naïve or he’s playing the role of the diplomat; something he has excelled at throughout his career. After all, part of Dimon’s great success is being the most politically savvy CEO of a major bank.
Let’s take the argument seriously in order to rebut the idea that Greece is merely “another Argentina,” because it most certainly is not. Too many politicians and too many bankers are treating the euro zone’s issues as an isolated series of sovereign debt problems and not an interconnected set of issues created by the flawed structure of the euro. That’s why this isn’t Argentina or Mexico, which were bankrupted by flawed economic and financial models. Say what you will about Greece, but Spain, Portugal, and Ireland are being sunk by the euro itself.
A Flawed Design
While I personally consider myself a monetarist, I do agree with a lot of the economic thought in both the Austrian school of economics and Keynesian economic theory. I would argue that all three of the major economic schools of thought are sound and hold considerable insight. There are some differences, but I do not view any of these three models as being majorly flawed in theory.
It’s when I see economic models that violate all three schools of thought that I get particularly worried. Take the conditions that helped create the US housing boom. There was something for any economist to dislike.
If you are an Austrian, you no doubt dislike all the government subsidies and interference in the housing market. If you are a monetarist, you can rightfully argue that the Federal Reserve was lowering interest rates in the early ‘00s right when it should have been aggressively raising them. This loose monetary policy helped fuel the housing bubble. Finally, if you are a Keynesian, you see a housing bubble coupled with a Congress and President that pump more money into the economy with excess government spending during a major boom. All together, it was a total recipe for disaster.
The euro zone is no different. From a monetarist perspective, it destroys the independent monetary policy of each sovereign nation, giving them no able to change money supply in order to react to observed market conditions. Milton Friedman would be appalled. In fact, Friedman predicted the euro zone would fail. It goes against the very core of modern monetary philosophy.
While Keynes was not alive when the euro was introduced, it’s hardly a stretch to say that he would have predicted its failure as well. Keynes was so concerned with trade distortions that when he proposed using the bancor as an international clearing currency (as opposed to the US dollar), he also wanted a current account surplus tax, so that currencies and trade could not become distorted. This is, in effect, precisely what has happened with the euro, with the wealthier “Northern Block” nations now running perpetual current account surpluses, while the PIIGS run perpetual current account deficits.
From the Austrian perspective, you can’t help but note that distortive affect on prices and trade the euro zone model is having. Germany and the “Northern Block” of Austria, Netherlands, and Finland all have perpetually undervalued currencies and undervalued assets. Moreover, they receive the benefit of artificially low interest rates. This creates artificially high demand for their exports, spurring economic growth. Meanwhile, the “Troubled Block” of Greece, Portugal, Ireland, Spain, and Italy has to deal with the precise opposite set of circumstances: Perpetually overvalued currency, overvalued assets, and artificially high interest rates.
In short, the euro zone was stirred up by an economic Frankenstein. It violates every mainstream economic model. Sure, there are benefits to having a single currency, including easier trade and travel within the euro zone, but that minor benefit hardly seems to outweigh permanent market distortions, constant deflationary pressures in the “Troubled Block,” and a lack of independent monetary policy.
Dimon might be correct that Europe can withstand a Greek default in isolation. But as argued earlier, this isn’t a mere “sovereign debt” issue. It’s a flawed currency design issue. And Greece is merely the first domino to fall.
One reason it’s been easy to wave this off as an isolated problem is the dysfunction of Greece’s economic model. Certainly, no one would ever point to Greece as the model of economic order, efficiency, and success. But that’s beside the point. Greece’s dysfunction and waste only explains why it’s the first domino to fall -- not why the euro zone itself is in danger of collapse.
No economic system is perfect, but Spain, Portugal, and Ireland have hardly been models of economic dysfunction over the past few decades. In many ways, they’ve been models of success, increasing their attractiveness for business and running sound fiscal policies. Yes, that’s the difficult part to explain away for those treating this as merely as “sovereign debt issue.”
Spain, Portugal, and Ireland have all been financially responsible in the near past and none had racked up considerable government debt through reckless spending. Their sovereign debt issues came as a result of economic collapse, which depressed government revenues severely. And those collapses were the result of the market distortions created by the euro. Now, due to a lack of independent monetary policy, none of these nations can recover.
America vs. Europe
People are very down on America right now and the housing bubble and subsequent bust certainly did a lot to erode faith in our system. But there’s a striking difference between how the United States and the euro zone have chosen to handle their problems that might reveal why the US model has prospered much more in the near past than the European model.
America has some very big problems, but let’s be frank: Nearly all nations have huge problems right now. While American politicians will continue to frustrate for the rest of our lives, there’s one major difference: American pols at least acknowledge the problems facing the US. You can fault them for dimwitted solutions, but our system no longer seems to be in complete denial.
That’s critical because issues cannot be addressed if people pretend they don’t exist. We certainly have issues with entitlement spending, a bloated defense budget, and underfunded pensions. But we acknowledge that they are problems, so there’s a mentality that we all have to work through them, even if the struggle to do so is very rarely anything other than ugly and painful.
Euro zone policymakers and bankers have not shown the same degree of awareness about their issues. And in truth, they might not be nearly as accountable as American policymakers. While the euro continues to cause economic destruction in Europe, euro zone policymakers keep acting as if the issue is reckless spending in the troubled nations.
If you’re a German politician, it’s easier to blame those lazy Spaniards or drunken Irish, rather than face that you are all entangled in a dysfunctional nightmare of an economic order. And the only way to remedy the situation is either to take the radical step of breaking everything up or give up your own nation’s sovereignty for a system that can actually function: Call it a “United States of Europe” if you will. But the latter seems to be a non-starter for the euro zone nations. And the former isn’t particularly desirable. So the alternative course is to pretend the problem doesn’t exist, throw a little bit of money at the “Troubled Nations” occasionally, make them agree to “cuts” in exchange for “your aid,” and hope it all goes away.
Except it won’t. The problem is the euro, which distorts prices and interest rates and creates economic carnage. And the problem won’t be fixed until the euro is fixed or dismantled.
A Greek default would not be the isolated incident that an Argentine, Mexican, or Russian default was in the past. A Greek default is only the beginning of the crumbling of an unsustainable economic order.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.