Greece Today, America the Day After Tomorrow?

As the markets tumble, and even a big, fat bailout from the EU and the IMF may not be enough to save the Greek economy and keep it within the Eurozone, the question on everyone’s lips is ‘who will be next?’ If Greece were knocked out of the Eurozone, Portugal and other smaller, weaker economies would feel the wrath of the markets and, if they too fell, where would the cascade of dominoes end? It is the fear of a chain reaction that could blow the Eurozone apart that is driving the EU’s big hitters to consider the rescue of a country whose economic woes are largely of its own making. Other countries, without such (albeit reluctant) friends, may too have cause to worry.

As we write, Twitter is alive with claims and rebuttals from the Conservative and Labour political parties, respectively, that Britain’s spiralling public debt means that it could be next. Putting the UK’s public finance problems in the same category as Greece’s is, of course, an exaggeration but a necessary one for the Conservative politicians trying to blow a hole in Prime Minister Gordon Brown’s (already weakened) reputation for economic competence before May 6th’s General Election. But even if these claims are overstated, it doesn’t mean that British government debt, or the venerable pound, is safe – with most polls predicting a hung parliament with no one party in control, the risk is that a coalition government will find it harder to administer the bitter fiscal medicine that is required, sending the markets into jitters.

While this stuff of nightmares is keeping politicians awake on the eastern side of the Atlantic, America’s leaders have no such worries about the dollar (even though US government debt is already above 70% of GDP, which is higher than Britain’s and only a little less than the Eurozone’s). Why? Because the dollar’s position as the global reserve currency makes it ‘too big to fail’.

This may be good news for the US economy in the short term, but the future of the dollar should really be causing more sleepless nights in Washington. Look at Europe’s problems again – membership of the Euro had allowed Greece and other spendthrift nations to keep borrowing without taking any heat from the markets. Until now. Similarly, in the run up to the credit crunch and crash of 2008, the dollar’s position as global reserve currency allowed America to keep borrowing cheaply from the rest of the world. By insulating the US economy from the operation of the laws of economic gravity, the dollar’s privileged position therefore helped to stoke the credit bubble to such enormous proportions, making the resulting crash worse than it otherwise might have been.

This situation cannot go on for ever. The dollar’s dominance was inevitable at the end of the Second World War, when the US economy generated nearly half of world GDP and America was the world’s creditor. In those days, when the US was capitalism’s hegemon, the French Finance Minister (later President) Valery Giscard d’Estaing could only chunter about the ‘exorbitant privilege’ bestowed on the US economy by the dollar’s unique status. Today, when the US share of global output is nearer 25% (and even lower at purchasing power parity exchange rates) and is the world’s debtor, other countries can do more than moan and some are actively looking for ways out of this perverse situation.

This doesn’t mean there necessarily will be any immediate dumping of the dollar. The problem for China, and other creditors, is the old lender’s dilemma, updated: if America owes you a billion dollars America has a problem, if America owes you $2 trillion, you’ve got a problem. Yet this shouldn’t be a cause of complacency in Washington. In The Road From Ruin  we show how Britain failed in the 19th century to see the dangers inherent in the Gold Standard, the global monetary sytem it had created, until it was too late. America should take heed of this lesson.

We agree with Nobel prize-winning economist Joe Stiglitz that global financial reform is desperately needed. America and China’s co-dependence on the dollar is an opportunity for them to call other countries together to make a grand bargain to create a new global reserve system. Yet the temptation is to put off such tough decisions until it is too late. That is what Greece did. Does America really want to follow that example?