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Greek Myths

John Cochrane has a superb op-ed in today's WSJ: "Greek Myths and the Euro Tragedy." Superb because he argues clearly and concisely that conventional wisdom on the subject of a possible Greek default, and how that might be really bad for the euro, is completely wrong.

"We're told a Greek default would imperil the euro. The opposite is true." A Greek default would only harm the euro if the ECB failed to act responsibly.

"A currency union is strongest without fiscal union." Giving investors the impression that other countries and the ECB itself stand ready to bail out profligate governments only creates moral hazard. Allowing Greece to default or restructure its debt would show the world that the ECB means business.

"... the euro's founders ... set debt and deficit limits. The problem is not that these limits were too loose. The problem is having them at all." The market is the best enforcer of limits on debt, not politicians. Those who borrow too much soon find that the cost of borrowing becomes prohibitive, and they then have no choice but to either reduce their spending or restructure their debt.

"We're told that a Greek default will threaten the financial system. But how? Greece has no millions of complex swap contracts, no obscure derivatives, no inter-twined counterparties. This isn't new finance, it's plain-vanilla sovereign debt." Those who read "Panic," the book I reviewed last week, will understand that this is a crucial point. The financial panic of '08 and early '09 was in large part driven by the market's lack of understanding of the risks inherent in complex derivative securities. In the case of Greek bonds, the risks are simple and straightforward.

"Letting someone lose money on sovereign debt is the acid test for the euro. If not now, when? It won't happen in good times, nor to a smaller country."

"The only way to solve the underlying euro-zone fiscal mess (and our own) is to slash government spending and to focus on growth. ... growth does not come from spending. Greece's spending over 50% of GDP did not result in robust growth and full coffers. At least the looming worldwide sovereign debt crisis is heaving 'fiscal stimulus' on the ash heap of bad ideas." This point is also crucial, as I have tried to point out before. Deficit-financed spending can never stimulate an economy, so slashing spending in order to reduce financing needs is not likely to kill an economy. It is likely, however, to improve investor confidence and economic efficiency, and those in turn become key ingredients for badly-needed future growth.

What this all means is that the market is likely overestimating the risks to Europe and the euro. The problem is not nearly as bad or intractable as the market seems to think.

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