Athens goes on a Spartan diet

The last thing I want to do is write anything that might spook the markets, but I don’t think anybody will take my views on finance or economics so seriously as to spark a run on Wall Street. 

I say this because I just got back from Athens and I spent much of my travel time reading Liaquat Ahamed’s terrific book Lords of Finance: The Bankers Who Broke the World. Taken together, the trip and the book have reinforced my pessimism about Greece’s prospects of reversing its economic slide, and my concern that this situation will have significant negative repercussions elsewhere. The problem, as others know far better than I do, is that it will be very difficult for Greece to rescue its position despite the recent EU/IMF rescue package. 

In order to stave off default, Greece needs to trim its budget drastically (which means throwing people out of work or at reducng their incomes), while at the same time stimulating economic growth.  The problem is that it’s hard to do both at the same time, because cutting the budget (or collecting taxes more efficiently) reduces domestic demand and thus chokes off economic growth. And because Greece is part of the Eurozone, it can’t stimulate export-led growth by the normal expedient of devaluing its currency. (The sinking Euro helps globally, but not within the Eurozone itself.) Greece’s prospects for economic growth are further handicapped by conditions elsewhere in Europe: It will be hard for Greece to grow if the rest of Europe is stagnant. And if the government’s efforts at restructuring lead to widespread political unrest, then chances of robust growth are even slimmer.

And once the financial markets begin to realize all this, bond spreads will increase again and we will be back in the same soup we were in a few weeks ago. All of which leads me to conclude that Europe as a whole is going to be in difficult shape for quite some time, unless EU officials figure out a way to do a lot more than they have done so far.  And a double-dip European recession could trigger a double-dip recession here in the United States, which would have profound economic and political consequences (e.g., goodbye to Barack’s second term?).

Where does Ahamed’s book come in? His book is a history of international economics and finance in the 1920s — i.e., during the runup to the Great Depression — as seen through the lives and decisions of the four leading central bankers of the period: Benjamin Strong of the New York Fed, Montague Norman of the Bank of England, Hjalmar Schacht of the Reichsbank, and Emile Moreau of the Banque de France. A fifth figure — John Maynard Keynes — serves as the contrarian counterpoint to the other four.  It’s a gripping story — which Ahamed tells with great style and insight — and I took away three main lessons from it.

The first was the macroeconomic management remains an art and not a science, because success or failure often depends on mass psychology (what Keynes famously called "animal spirits") that few can foresee perfectly. Moreover, even well-intentioned officials inevitably operate with incomplete information and thus will occasionally make mistakes that appear foolish in retrospect but appeared justifiable (or at least no worse than other options) at the time.

The second lesson was that each of the main figures in the book enjoyed at least one period of dramatic success, in which they were hailed as a genius with an uncanny ability to manage financial affairs. You know, the same way people used to speak about Alan Greenspan.   Yet with the partial exception of Strong (who died at the relatively young age of 55, just before the Depression hit), each eventually made major blunders that helped produce and then compound the Depression, and did great damage to their reputations.   

The last lesson, however, may be the most important. The book reminds us that there are some situations where policymakers simply don’t have a lot of good options (see above re Greece). The four bankers’ efforts to manage the world economy in the 1920s were hampered by a host of structural conditions and orthodox beliefs, such as a fixed commitment to the gold standard, the enormous debts arising from World War I, the draconian policy of reparations imposed on Germany, and domestic financial institutions that were ill-suited to an era of increasingly global interdependence. 

So what worries me about Greece — and to a larger extent about Europe itself — is whether it is approaching a stage where there won’t be any levers to throw or buttons to push. If so, then it really will be a new world order, but not one that anybody should look forward to. But if my pessimism makes you uncomfortable, I can give you a good reason to disregard it. I may have been right about the Iraq war, but my track record as an economic forecaster is no better than what you’d get by tossing a fair coin, and quite possibly worse. Feel better now?