I like the way he puts it below:

“…if they actually cut back the deficit as fast as is being required they’re just going to go into appalling deflation.”

Goodhart Says Greek Deal May Collapse as Crisis Tests Euro

By Svenja O’Donnell and Andrea Catherwood

May 4 (Bloomberg) — Greece’s bailout “might collapse” and the nation’s debt crisis makes it “hard to see” how the euro will survive in its current form, former Bank of England policy makerCharles Goodhart said.

“If this financing deal should collapse, and it might for one reason or another, then there would be a question of what the Greeks could possibly do,” Goodhart said in an interview with Bloomberg Television in London today. “Default would be totally disastrous for them and leaving the euro would equally be disastrous.”

Euro-region ministers on May 2 agreed to a 110 billion-euro ($145 billion) bailout with the International Monetary Fund to prevent a Greek default, after investor concern sparked a rout in Portuguese and Spanish bonds last week and sent stock markets tumbling. The Greek crisis shows the need for more integration within the euro as a common currency, Goodhart said.

“It’s very hard to see how this is going survive this particular test,” he said. “The euro system has either got to have much more integration or parts of it will fall by the wayside.”

Standard & Poor’s last week cut Greece’s credit rating to the junk level of BB+, lowered Spain’s grade by one level to AA and downgraded Portugal by two steps to A-. Greece has now agreed to budget-cutting measures worth 13 percent of gross domestic product.

‘Appalling Deflation’

“If the current bailout is put in place, it will be enough to meet their immediate financing problems not only this year but for the next year or two,” Goodhart said. “The problem is that it doesn’t meet their adjustment problems. It doesn’t deal with the problem the Greeks, in part from having too large a deficit and too large a debt ratio, are very uncompetitive and if they actually cut back the deficit as fast as is being required they’re just going to go into appalling deflation.”

Greek 10-year bonds yielded 8.7 percent, about 566 basis points more than German bunds, as of 11:32 a.m. in London. That spread is down from as high as 800 basis points last week, the biggest gap since the euro’s introduction 11 years ago.

Should the deal fail, Greece “might do a kind of dual currency in which they use their scarce euros to meet their external commitments and in the meantime use an internal IOU, rather as Californian and some of the Argentinian states did, in order to meet their internal commitments” Goodhart said. “It would be a dual currency and the internal currency would fluctuate compared to the euro.”

Such an exercise would be “very messy,’ he added.

15 Responses

  1. Why is deflation appalling?

    This may be a naive question, but if stuff gets cheaper, why is it bad?

    1. Excellent question.

      It depends on what is causing deflation. In Greek case, it will be refusal to fund savings desire, leading to fall in AD, leading to loss of real output and higher unemployment. Credit will be paid down/written off and prices will fall to this lower credit environment (and raise real debt burned).

      If deflation is caused by productivity improvements, like in computers, it is not bad. Need to keep an eye on what baalnce sheet changes are happening and the why

      1. Fundamentally, there are three reasons why deflation is dangerous (much more dangerous than inflation at the same absolute level):

        1) because people always have the option of storing money under their mattresses for free, the nominal interest rate is floored at zero; therefore, deflation means that real interest rates can’t go below a a positive number which could be high enough to feed the desire to save, suppress the desire to spend/invest, and continue a vicious cycle;

        2) deflation undermines creditworthiness throughout the system because it is more difficult for borrowers to pay back loans in an appreciating currency; this further shuts down lending and investment;

        3) human beings seem to be resistant psychologically to accepting a cut in nominal wages, but this becomes necessary during a bout of deflation; rather than trying to cut nominal wages for everybody, employers take the easier route and lay off a subset of their employees instead; unfortunately, this is very inefficient and has plenty of additional negative effects for society and the economy.

    2. Yes, with deflation creditors benefit, with inflation debtors benefit.

      With lots of unemployment employers benefit, with no unemployment employees benefit.

      It seems to me that both scenarios benefit some, while hurting others. And so to call deflation bad implies taking sides, which isn’t objective, is it?

      1. Notice something though curious

        In both scenarios one side (creditors and employers) represents about 5-10% of the people while the other side (debtors and workers) represents about 90-95% of the people.

        Just sayin’

      2. That’s a one-off analysis.

        If unemployment rises, employers eventually face unsold inventories.

        A rising tide lifts all boats…

      3. Greg,

        any bond investor is a creditor. Any bank stock owner is a creditor. Pension funds, etc. all creditors, no?

        Any employee who’s also hiring is also an employer, no?


        price of unsold inventories gets lowered until those inventories get sold, no?

      4. Deflation caused umemployment means economy loses real output. So pie is smaller (even if you ignore distributional aspect between employer and employee).

        with respect to others, i do not think sticky wages is an issue here. issue is nominal debt burdens get bigger (real) in deflation just as ability to service them goes down. if society had no debt (all equity) than I do not think deflation would be big deal. non-debt deflation is good actually

  2. Deflation isn’t just stuff getting cheaper, it’s the price of labor getting cheaper. If wages go down, people will demand fewer goods and services, which results in wages going down, etc, spiral of doom.

    Perhaps Greece could short circuit that scenario and stay in the euro by just seizing all private savings and forcefully spending it. But that sort of starts to approach communism.

    1. “Perhaps Greece could short circuit that scenario and stay in the euro by just seizing all private savings and forcefully spending it. But that sort of starts to approach communism.”

      LOL. Well, yeah, that would be well on the way to communism. That’s sort of what Argentina did in early 2002 with dollar savings accounts, and it was a mistake.

      Undermining property rights and the rule of law is never a good idea. It is legitimate to default on hard-currency debt. That is a known and accepted risk. It is also legitimate to devalue your own currency (assuming you have one). But it is not legitimate to seize private property.

      It would do much more damage to the Greek economy than default would.

      1. I’m just proposing options, since the Greeks and Europeans don’t seem to want to do the obvious, 🙂

        Seems to me all hard currency systems are doomed to either default, devaluing (which pretty much means no longer a hard currency), or a communist revolution. I suppose they could attempt deflating by cutting wages and still keeping everyone employed, but has that actually happened in real life ever?

  3. Curious:

    Isn’t the empirical data clear enough on the benefits of inflation vs deflation?

    I can’t think of one (even mild) deflationary experience that was pleasant for an economy. On the flip side, economies have done well with even moderate to high inflation for lengthy periods.

    1. JCD,

      what’s “pleasant for the economy”? Bigger gdp number? Yes, inflation will do that, but what’s the point?

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