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Money Talks

By Dr. Gregg Dimkoff
Professor, Grand Valley State University
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Greece is the cradle of Western civilization. We owe a debt of gratitude to its ancient scholars for their contributions to democracy, philosophy, plays and dramas, and teaching methods. The Greeks are teaching us another lesson today, a lesson about the consequences of living beyond our means.

After Greece’s economy entered a recession about two years ago, it tried to spend its way to prosperity. How did it get the money to spend? It issued government bonds. Does that sound familiar? It should – during the same time period, the U.S. Treasury issued more than $1 trillion of bonds to stimulate the U.S. economy.

Greece issued so much government debt that its ratio of debt to GDP rose from 14 percent to 115 percent. Greece’s politicians hid debt levels from the public until a new administration discovered the enormity of the borrowing. As soon as the actual debt levels became known, Greek bond investors around the world panicked. Bond interest rates rose sharply, investors weren’t willing to buy new Greek bonds, and the government didn’t have enough money to pay off maturing bonds. In effect, Greece was bankrupt.

The European Union jumped in to keep Greece on life support. Greece and other EU countries in danger of bankruptcy will get up to $1 trillion from the EU and the International Monetary Fund to keep them going. In return, Greece promised to cut its annual deficit from 12.9 percent to the EU’s goal of 3 percent by 2013. To do that, it must cut its government spending drastically and increase taxes big time.

The bailout is highly controversial. In essence, the EU is attempting to solve a debt problem by issuing more debt. EU countries in relatively sound economic health are paying for the excesses of its weaker members. That isn’t going over well with taxpayers in the financially healthy countries. It certainly isn’t going over well with Greeks. They riot in the streets every day, protesting higher taxes, cuts to government pensions, salary cuts to government workers, and in general, prospects for higher unemployment rates and a much lower standard of living for many, many years. The bill has arrived for their debt fueled excesses, and it isn’t pretty.

Those who are following the Greek financial crisis must be apprehensive about the parallels between Greece and the U.S. Both tried to spend their way out of recessions using unprecedented levels of government borrowing to do so. At the beginning of 2009, U.S. federal debt was $6.3 trillion. It now stands at $8.2 trillion, and the Congressional Budget Office announced last month that President Obama’s 2011 budget will generate another $10 trillion of budget deficits over the next 10 years. By then, the ratio of federal debt to GDP will be 90 percent, up from 40 percent at the end of fiscal 2008. The all-time high was 109 percent at the end of WWII.

We owe another debt of gratitude to the Greeks for teaching us a lesson about what the future might look like if we don’t take action to prevent our debt levels from soaring. One unknown is economic growth. If the U.S. economy experiences several years of strong growth, deficits won’t be as large as projected. If growth is less than the CBO projects, however, deficits will be even worse. To that end, we must tailor government policies to be pro-business and pro-growth (the two are the same). Businesses can be encouraged to invest in long-lived physical assets by introducing an investment tax credit. Productivity rises, and the benefits last years.

Government spending must be reduced from projected levels. That won’t be easy. No one wants to give up federal money — not the Post Office, not NASA, not Social Security recipients and not anyone else. Yet, either we make hard choices such as these or run the risk that other countries might someday force austerity measures on us.

Increasing taxes is another way to stave off crushing debt burdens. But who gets to pay more? In order for higher taxes to help significantly, even the middle class will have to pay considerably higher rates. Should we tax only businesses? Job growth will suffer, and ultimately, individuals pay most of those taxes through higher prices for goods and services.

There are no white knights to save us. It’s likely we’ll see a combination of reductions in government services, higher taxes and improved productivity over the next decade. If that doesn’t happen, we run the risk of defaulting like Greece.

Fortunately, there are enough differences between Greece and the U.S. to argue the U.S. can avoid Greece’s economic woes. Let’s hope both our politicians and citizens are up to the task. Because our country has a long history of solving its economic problems, there’s reason to believe we’ll get it right again.

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