Wednesday, September 28, 2011

Feldstein's simplistic world view

Europe’s high-risk gamble

Sep 27, 2011 10:33 EDT
By Martin Feldstein
The opinions expressed are his own.
The Greek government needs to escape from an otherwise impossible situation. It has an unmanageable level of government debt (150% of GDP, rising this year by ten percentage points), a collapsing economy (with GDP down by more than 7% this year, pushing the unemployment rate up to 16%), a chronic balance-of-payments deficit (now at 8% of GDP), and insolvent banks that are rapidly losing deposits.
The only way out is for Greece to default on its sovereign debt. When it does, it must write down the principal value of that debt by at least 50%. The current plan to reduce the present value of privately held bonds by 20% is just a first small step toward this outcome.
If Greece leaves the euro after it defaults, it can devalue its new currency, thereby stimulating demand and shifting eventually to a trade surplus. Such a strategy of “default and devalue” has been standard fare for countries in other parts of the world when they were faced with unmanageably large government debt and a chronic current-account deficit. It hasn’t happened in Greece only because Greece is trapped in the single currency.
Comment: At least when it comes to the euro, Feldstein obviously can't go beyond simplistic textbook analysis. He lacks completely any insight what the euro is about. He neither has the historic understandig nor does he possess the imagination to foresee the true consequences of his suggestions. In this respect, of course, he is not alone. I guess this is what makes him so popular in his profession, unfortunately so.

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