Tuesday, October 11, 2011

Why Should Oregonians Care About Greece?

I received an e-mail from a reader about the Greek and EU situation and, in particular what it will mean for Oregon.  I can only give some general thoughts, but let me first start with a bit of a primer (the letter writer clearly understands the situation well so this is for those that don't).  This is all a bit of an over-simplified synopsis and please feel free to add/subtract/comment.

When the Euro was created there were a lot of observers (like myself) that wondered how you could possibly make a system work where monetary policy was aggregated to the European Central Bank (ECB) but fiscal policy was left to the member countries.  Having your own currency is an important constraint on fiscal mismanagement for if you become overly indebted, investors start to flee and dump your currency thus devaluing it.   The devaluation of the currency has the effect of making imports more expensive, but making exports more competitive, but it also have the effect of easing debt burdens because it tends to spark inflation (along with the high interest rates that arise as a result of how much the government has to offer to borrow money).  There is also an incentive problem: when Greece adopted the Euro, they suddenly could borrow money much more cheaply than they had previously been able to, and so they borrowed.

The solution to the fiscal v. monetary policy problem in the Euro zone was strict guidelines on fiscal management.  Which is fine as long as everyone plays fair.  Greece did not.  In essence the Greeks cooked the books and hid massive government debts for years.  When the extent of the malfeasance came to light, suddenly Greek bonds (government debt) were a much more risky assets than was thought to have been the case.  Unfortunately the exposure to Greek debt among European banks, already rocked by the banking crisis of 2006, is very high.  Already Greek bonds have been downgraded, meaning they do not count the same against banks' reserve requirements, and the moment the Greek government starts to default on its debt they become essentially worthless.  So teetering European banks already struggling to re-capitalize will be at risk and it will be 2006 all over again.  Not to mention that a default in the Euro zone would do damage to the Euro itself and that there are other EU countries that are in pretty bad shape that could get walloped if Greece defaulted and spooked investors.

So this is why this is a true global crisis, not just a problem for the Greeks.

Now, what does this mean for Oregon?  Nothing directly but a lot indirectly.  A massive European crisis with failing banks and defaulting countries would once again send the global economy into a tailspin just as the US centered banking crisis of 2006 did.  Though we largely bailed out banks and kept the system from collapsing and whether there is enough collective will in the EU to do the same is the $24,000 question of the day.  I think, in the end, the answer is yes as German banks are pretty badly exposed as well to Greek debt and Germany is the linchpin in all of this.

Anyway, such a collapse would hurt the US economy and thus Oregon.  Trouble for a major trading partner and market for our goods would hurt the US and Oregon.  Even though a lot of our trade is with Asia, much of it ends up in consumer goods that ship globally.  Asian trade is a buffer for Oregon, certainly, but I don't think it would be enough for Oregon to escape the effects of a European crisis.  In addition, an already difficult credit situation would be made worse by the European banks plight. So that will affect the US economy and thus the Oregon economy.

My e-mailer also asks about the muni bond market.  Here I think it is hard to know what will happen.  US muni bonds are under duress right now due to the recession's impact on state and local budgets and the massive pension obligations that are locking up big slices of muni budgets all over the US.  I don't think Greece will affect this market directly, but will indirectly if it causes another US recession.  Capital, however, has been flowing in to the US as a safe harbor so this might have a countervailing force.

So there you have it, my off-the-cuff observations on why even Oregonians should care about what happens to Greece.

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