Mr Fine Suit comes to Europe
Once upon a time there were 11 prosperous merchants who lived in a land of peace and plenty. They decided to form a league that would work together for everyone’s greater good. But then a charming man in a fine suit came around with a tempting speech: “I love your project and trust your businesses. I will lend you money at a very attractive interest rate”. How nice, thought the merchants. Our customers will love us if we use the money we borrow to give them better deals.
All went so well that six other merchants were proud to join the league. Mr. Fine Suit seemed pleased. He reduced the already low interest rate on the loans. The merchants all planned to repay, but today was never quite right. Today, in fact, was always a good day to borrow more, while tomorrow always looked like a better day to raise prices.
Then one day Mr. Fine Suit changed his tune. “You know, you have a mighty nice little enterprise going here. But business is business, my friends. Interest rates are going to rise for some of you.” The merchants were angry, but what could they do? They promised to be more frugal, but still had to pay up. As the months went by, Mr. Fine Suit became more hostile. Just last week he came to the G-store, the most prosperous and prudent of all the merchants, with a really nasty threat. “You know, between us, I’ve never liked your stupid league. You’re much smarter than the rest. Leave the league and I’ll keep on lending you money at a low rate. If not, well, here’s a little reminder of what I can do.” He increased the interest rate by two notches before leaving the room with a menacing smirk.
The story is a parable of the euro zone debt crisis. The merchants are the member governments, the customers are the taxpayers and Mr. Fine Suit represents the banks, fund managers and individuals who lend to governments. These investors in government debt tend to think and act alike; just about two years ago their message to the euro zone changed from “We’re behind you all the way” to “Nice little monetary system you have here. It would really be a shame if something happened to it”.
The euro zone’s weaker members and the EU as a whole have responded to the threat with tougher budgets than were ever contemplated while investors were still friendly. But the investors have started to behave like an extortionist, demanding ever higher interest rates and threatening to withdraw funding totally. Even fiscally healthy Germany (the G-store) is now under threat. Of course, investors do not think of themselves as extortionists or even as malicious. They think of themselves as merely law-abiding professionals trying to protect the value of their investments, either by making sure the governments will be able to pay up or by selling before the governments default. But many sensible individual fears – “I don’t want to be caught out” – can add up to group menace – “You must meet our ever harsher demands – or else”.
The fable of Mr. Fine Suit could be elaborated to include the European Central Bank as policeman, but the addition would not change the moral: the mix of governments and financiers can easily become toxic. It has always been thus, at least as far back as the English King Edward III’s 1343 default which bankrupted the lenders of Florence. The political-economic logic behind these recurrent crises is straightforward. On the one hand, governments which are too weak to cover current expenses with tax revenues are bad credit risks. On the other hand, when previously supportive lenders suddenly turn against profligate governments, they look arbitrary and rapacious.
In recent years, these basic truths have been obscured by the widespread acceptance of a principle associated with the British economist John Maynard Keynes – governments should sometimes spend a little more than they take in to keep the real economy humming along. Even if the Keynesian principle is right, it justifies neither the imprudent deficits which Greece ran up after it entered the euro zone nor the ease with which it was able to borrow to fund those deficits.
In the euro zone, Mr. Fine Suit is now on the rampage. In the United States, he is still very friendly. But the stubbornly large American deficits – currently more than twice as high as the euro zone’s as a share of GDP – are a sign of political inadequacy. Like Edward III and the government of Greece, the U.S. government has consistently decided to spend significantly more money than it is willing to demand from taxpayers. Unless Congress finds a way to balance revenues and expenditures, sooner or later America’s Mr. Fine Suit will be coming around with a baseball bat.