Retired Finance Professor, Michael Rozeff: Is Greece the Future of America?

From Lew Rockwell:

Greece has a sovereign debt problem. The bonds of the Greek government have been downgraded by a major rating service. Their prices have fallen sharply in the market. This means that the risk is high that the government will default on its sovereign debt.

The problem traces back to the earlier fact that for some years the government was able to borrow heavily at low interest rates. This means that it was able to sell its bonds at high prices. The problem arose because these market prices were too high.

The sovereign debt of Greece became overvalued due to central bank/banking system money inflation. This inflation, it should be strongly emphasized, originated in the fiat dollar system of the United States and the Federal Reserve.

The central banks of the world and the world money supply are heavily influenced by what the Federal Reserve does through a kind of multiplier effect, because foreign central banks respond to Fed inflation with inflation of their own. Ronald I. McKinnon explained this important process in his June 1982 article in the American Economic Review. We see it happening today when foreign banks have to inflate in reaction to QE2 in order to prevent their currencies from strengthening too much against the depreciating dollar.

The high bond prices encouraged the Greek government to borrow too heavily and to raise government spending. But since its spending was not productive, it didn’t produce high enough tax revenues to service the debt. In time the government faced the problem it now has, which is not enough tax cash flows or income to service the debt.

Monetary inflation, in other words, causes overvalued sovereign debt. This sets in motion larger government spending, higher debt loads, and an eventual fiscal crisis when tax revenues fall short of what is required to maintain government spending and service the debt.

This process goes on in addition to the business cycle effects, well-known in Austrian economics, that inflation produces. In keeping with the analogous finance literature on overvalued equity, I identify this process as one that involves agency costs of overvalued sovereign debt.

This process is only made worse when major lenders, such as large banks, have reason to believe that they occupy a privileged position and that their bond positions will be paid off by political means if necessary. These lenders then all the more become willing to buy overvalued sovereign debt.

This effect of inflation is important because of its broad applicability in an age of inflation. In particular, a number of other countries including the U.S. have followed the Greek path.

http://lewrockwell.com/rozeff/rozeff354.html