Greece and the European Debt Crisis

MS. SUSAN PAGE

10:06:54
Thanks for joining us. I'm Susan Page of USA Today, sitting in for Diane Rehm. She is in Maine for a station visit. World leaders gathering in France for the G-20 summit were already reeling from Greece's announcement it would put its rescue package to a popular vote. Then came news that Europe may have already slipped back into a recession.

MS. SUSAN PAGE

10:07:17
Joining me in the studio to discuss the latest on the eurozone debt crisis and it's implications for Greece, the eurozone, and the U.S. economy: Fred Bergsten of the Peterson Institute for International Economics, Desmond Lachman of the American Enterprise Institute, and David Wessel of The Wall Street Journal. Welcome to "The Diane Rehm Show."

MR. DAVID WESSEL

10:07:37
Thank you.

MR. C. FRED BERGSTEN

10:07:38
Good morning.

MR. DESMOND LACHMAN

10:07:38
Thank you.

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10:07:38
We're going to invite our listeners to join our conversation later in this hour. You can call our toll-free number, 1-800-433-8850, or send us an email at drshow@wamu.org. Or find us on Facebook or Twitter. Well, David Wessel, you've been on the phone on your computer until just a moment or two ago on the latest of what's happening in France. Bring us up to date.

WESSEL

10:08:03
Well, it's almost -- I'm almost afraid to answer the question because in the five minutes we've been sitting in the studio, who knows what may have happened. But, basically, the -- in the last 24 hours, the prime minister of Greece decided to put the whole question of whether Greece should stick with the austerity or not to a vote. This upset everybody else in Europe. And they told him, if you're going to do that, the question has to be, are you going to stay in the eurozone, the common currency, or not?

WESSEL

10:08:34
It looks like his government is not going to survive. It looks like a new government will be in place, run by a caretaker, a technocrat named Lucas Papademos, who is -- has been at the European Central Bank but is now -- or was visiting at Harvard, although, apparently, he's on a plane on the way to Greece. So part one is they're trying to straighten out the Greek situation. And the reason this is so important is not because Greece is big, but because what happens in Greece doesn't stay in Greece.

WESSEL

10:09:05
And so they're worried about the implications for the other European countries. Meanwhile, today at the same time, the new president of the European Central Bank, Mario Draghi, an Italian, presided over his first meeting of policymakers there. And to the surprise, but relief, I think, of a lot of people, he decided to cut interest rates a little bit to try and help the European economy weather this very, very, very on storm.

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10:09:33
So Americans might say, wow, you're a great place to visit, but why should I worry, as an American, about what's happening in Greece? Fred, should Americans be worried about this?

BERGSTEN

10:09:44
Americans definitely need to be worried. There are at least two big reasons. One is that Europe is the biggest component of the world economy. It's bigger than the United States. If Europe goes into recession, as now seems quite possible -- could be pushed further in that direction if this financial situation there implodes -- it'll weaken the whole world economy, weakens our exports, weakens the earnings of our firms, weakens our own economy.

BERGSTEN

10:10:05
The second reason is financial transmission. U.S. banks and some other lenders have a lot of credit outstanding in Europe. If there were widespread financial difficulties in Europe, if Greek default led others to default at the extreme, that could be very bad news for the U.S. financial system, and it would weaken our whole economy further. So there are at least those two big reasons why all this affects the United States in a serious way.

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10:10:30
And, Desmond, this is not exactly what the French had planned for the G-20 summit now about to begin. They had thought this would be, instead, a demonstration of how Europe was getting things under control.

LACHMAN

10:10:43
Right. I would agree with you that this couldn't be a worst nightmare for France running this G-20 meeting, that the whole euro project looks like it's really unraveling. It looks like the Greek government, as David said, is about to fall. It's difficult to see how Greeks avoids a hard default. And I think that what's interesting is that the French and the Germans are now talking about the possibility of Greece exiting the euro, which wasn't on the table a little while ago, that right through the surprise as they've been saying, no devaluation, no restructuring of the debt.

LACHMAN

10:11:22
First, the debt restructuring comes on the table -- they talk about a 50 percent voluntary reduction. Now, we're looking as if it's going to be a hard default. And now, they're raising the possibility that Greece could leave, and they're trying to put a brave face on it, that the rest of the Europeans could do very well without Greece. I think that they're underestimating the contagion that we're going to see from Greece. Already this morning, we saw Italian bonds spreads -- rise to the highest level that they've done in the past 10 years, which isn't a good sign.

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10:11:57
You said that we could see a hard default. What does that mean?

LACHMAN

10:12:01
What it basically means that we get a disorderly default instead of the banks actually saying we agree to a write-down of the debt. We could say, we could get a situation where Greece simply says, we're not paying, and what's more, we're not paying you something like 70 or 80 cents on the dollar.

LACHMAN

10:12:19
Greece has got a big advantage in the debt situation in that Greece's debt is covered by Greek domestic law, so the private creditors just don't really have much recourse if Greece were to take unilateral action of that sort. The private creditors, at least, the only remedy they could get would be in a Greek court, and the Greek court would be enforcing Greek law.

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10:12:44
Fred?

BERGSTEN

10:12:45
I'm a lot more optimistic than Desmond. He is right that there are a lot of risks, and they've been accelerating here in the last couple of days. But this whole European crisis has evolved over the last two years like the traditional "Perils of Pauline." There have been, time after time, where it was expected, including by Desmond, I might add, that things were going to fall apart. They have not done so. The Europeans, kicking and screaming, complaining all the way, have, at the end of the day, always done the right thing.

BERGSTEN

10:13:14
They've provided enough money to get through the crisis of the moment. They have not gotten ahead of the crisis, that's to be sure. They have not assured everybody that they're going to take care of it long run. The cacophony of voices out of Europe confuses the markets, creates enormous volatility. But the bottom line is that all the Europeans, all the big ones -- the French, the Germans, et cetera -- are so committed to European project that I predict they will do whatever is necessary to see it through.

BERGSTEN

10:13:42
It is conceivable that Greece might default and get kicked out. I doubt that. I think when the Greek people face the choice of sticking with the current economic reform program or leaving Europe, being kicked out, not just at the euro but at the European Union, they'll choose to stay in and take the bitter medicine. But even if they did, the eurozone sticks together, and I think the other countries, vis-à-vis the contagion fear -- the Italians and others -- will be so horrified by the demonstration effect of Greece getting kicked out that they'd actually buckle down and do better.

BERGSTEN

10:14:13
So I come out on the opposite end and think that I'll get, yet again, one more big crisis. Europe will prevail, and the euro will proceed. And it may even get ahead of the curve for the first time.

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10:14:26
So, David, where do you stand on this? Is this just one more in a series of crises that get met in the end? Or is this something that's potentially more perilous?

WESSEL

10:14:35
Well, I think even Fred would agree, it's potentially more perilous. The question is, are we yet at the moment analogous to the day when the House of Representatives rejected the Bush, Paulson, Bernanke, Geithner plea for money for the banks, the $700 million TARP Program? You may remember, they voted it down then. Then they saw the reaction in the markets, and they basically scurried around and voted it out. And it's...

BERGSTEN

10:15:03
It's three days later.

WESSEL

10:15:04
Right. It's pretty clear that Europe needs a really big scare in order to do what's necessary. What I don't know is, is this scare enough? It's pretty darn scary, but it is enough to really force them to do it? And the problem is that when you wait until the last minute to do things, when you need a really big crisis for the politicians to be heroic and do things that people don't like, you sometimes over-wait. You wait too long. And I don't know whether they've waited too long.

WESSEL

10:15:34
They certainly are not ahead of the crisis. The question is, is all the stuff going on right now in Europe enough to get them to do what needs to be done? Or does it have to get even worse before they do that?

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10:15:44
And is there a significant United States role at this point? Are we basically watching to see what happens?

LACHMAN

10:15:52
We're really watching to see what happens. We can't really provide much in the way of money. We're taking the position that the Europeans have enough money to fix the situation. But the real problem is that money can't fix it. We can't fix this by throwing more money at these countries. Basically, these countries are insolvent, that they have to write down their debt by a big amount to get back to viability. And, worse yet, they're locked in a fixed exchange rate system, which doesn't allow them to devalue their currencies to get an export boost.

LACHMAN

10:16:30
So what you've really been seeing on what has been the course of this crisis is that the IMF has come with the recipe of real austerity that has driven these economies deep into the ground. And what they're coming back now and saying, if you want more money, you've got to do more austerity. So in the case of Greece, what we're seeing is what economists would call austerity fatigue.

LACHMAN

10:16:53
And if you look at what's occurring in Germany, what you're getting is you're getting bailout fatigue, that the German public doesn't want to provide more money to keep this thing going. So my view is that it's only a matter of time before this fractures because of real, deep-seated fundamental problems.

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10:17:13
And not just austerity fatigue increase, but austerity revolt. I mean, you see these demonstrations in the street, the strikes. I mean, that clearly is -- or is that why the Greek prime minister called a referendum, (word?) Fred?

BERGSTEN

10:17:28
Oh, sure. Greece is the only one of the European debtor countries where there has not been agreement with the program by the opposition as well as the governing political party. It's very interesting that in all of the other countries -- Spain, even Italy, Portugal, Ireland -- both sides of the political street or all sides have been in support of the program and have put their minds to supporting it. In Greece, the opposition, very opportunistically, has claimed they could negotiate a better deal. That's fallacious.

BERGSTEN

10:18:00
And the European leaders have now made that clear. So the choice, really, is the current program or nothing. I just wanted to add on your point about the United States, two things the U.S. can do and has done: One, the U.S. has really been in the trenches pushing the Europeans very hard to do more. It's not just watching. It's pushing them very hard for the reasons I said before, the impact on the U.S. itself.

BERGSTEN

10:18:21
But, secondly, if there is a need for additional money, the United States still has a leadership role in the International Monetary Fund and can promote or certainly accept a big IMF addition to whatever the funding the Europeans put up. That was done in the original bailout programs. It can be done again.

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10:18:39
We're going to take a short break. Stay with us.

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10:20:02
Welcome back. I'm Susan Page of USA Today sitting in for Diane Rehm. With me in the studio, David Wessel, economics editor of The Wall Street Journal, he's the author of, "In Fed We Trust." And Desmond Lachman, a resident fellow at the American Enterprise Institute, and Fred Bergsten, he's director of the Peterson Institute for International Economics. And he's author of, "China's Rise." We're going to take your questions in just a few moments. You can call our toll-free number, 1-800-433-8850. Our phone lines are now open, or send us an email at drshow@wamu.org.

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10:20:37
Well, we've already gotten several emails along this line. This particular one comes from Les (sp?) who writes us from Brattleboro, Vt. He says, "What right, if any, do Merkel and Sarkozy have to tell Greece it cannot have a referendum, determine what question should appear on their referendum as one is held? Greece is supposed to be a sovereign nation of free people led by its elected leader. Isn't this Franco-German bullying of Greece overstepping the bounds of the E.U. mandate?" Well, what would you say, David?

WESSEL

10:21:04
Well, I think that's important to realize that the individual countries in Europe, the 17 countries, did surrender some of their sovereignty when they agreed to share a common currency and have a common central bank. And the tension now is they didn't quite work out how much of their other sovereignty that they surrendered. And they agreed in a treaty -- Greece lied to get into the union. They agreed in a treaty to limit their deficits, so they -- that -- they're already over that hurdle.

WESSEL

10:21:35
The second thing to say is, you remember that when Washington, D.C., the city got into trouble and when New York City got into trouble, they got bailed out -- Washington by the federal government, New York by the state of New York. And when you get bailed out, you give up the right to manage your own affairs. And in both those cases, basically, trustees were appointed to oversee the city's finances.

WESSEL

10:21:58
And so what's going on here is that Greece needs money. France and Germany have money. France and Germany say, we're not giving you unlimited amounts of money unless you agree to play by our rules. And Greece really has only two choices, to say yes or to leave the euro and leave the European Union, perhaps, with all the consequences therein.

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10:22:20
You said Greece lied to get into the E.U. What did you mean?

WESSEL

10:22:24
I think it's generally accepted that there were certain requirements you had to meet in order to become part of the euro, to show the currency about what your government finances were. And with the benefit of hindsight, it looks like Greece cooked the books, that they really didn't meet the criteria. People may have known this in Europe and winked and looked the other way. But with the benefit of hindsight, they did not meet the criteria going in.

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10:22:47
So thinking about -- if, in fact, Greece leaves the eurozone, this is a real possibility, right? It's entirely -- it's possible that Greece will do this. First of all, what will that mean for the eurozone? Does it survive? Does it -- what kind of implications are there for that, Desmond?

LACHMAN

10:23:02
Well, the serious damage that Greece can do to the eurozone is not pay back its debts. If it doesn't pay its debts in a big banner, if it does default to the tune of something like 70 or 80 cents on the dollar, that would be devastating for the European banking system. The ECB itself over the past year and a half...

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10:23:23
The ECB being?

LACHMAN

10:23:24
The European Central Bank has surprisingly articulated the idea that, where Greece to default, what you'd get is you'd get contagion to Portugal island, Spain, possibly to Italy as well. And then the European banking system would, in the words of the European Central Bank, have its Lehman moment. Meaning, that it would be similar to the crisis that the United States had in the banking system in 2008, 2009.

LACHMAN

10:23:55
So the issue really, in terms of where the eurozone is going, is, will Greece have what I'd call a hard default? And I'm afraid that I think that the likelihood of that is rather great. Then you get the banking system in Europe having difficulties. They then have a credit crunch and then the signs of recession that we're already seeing in the core countries. We're seeing an abrupt slowdown in growth in France, Germany, Italy that turns into a recession, and then it makes it already very complicated for all countries in the union to stay within the discipline of a single currency.

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10:24:37
Fred, do you agree with that?

BERGSTEN

10:24:38
There's no doubt in my mind the euro would survive the exit of Greece. Greek is -- Greece is 3 percent of the economy. It's a very small share of anything relevant in Europe. So the euro would clearly go on. Some few would be better off without a weak sister like that in it. The real question, the one we addressed before, what would be the demonstration effect on the rest of the eurozone?

BERGSTEN

10:25:05
If Desmond is right and a Greek exit led to significant risk that other countries would also exit, particularly big ones, Italy and Spain, then the whole project would be at risk. My prediction, as I said, is the opposite, that the horrific example of Greece leaving -- particularly, if it defaulted as well -- would force the others, basically, to pull up their socks and live with the programs.

BERGSTEN

10:25:33
Now, Ireland and Portugal are already doing it. Spain is largely doing it. The only other big question at the moment, I think, is Italy, which also has internal political change probably going on over the next few weeks and months. But I don't think there's really any risk to the future of the euro. Desmond's right. A hard default would lead to a lot of problems for banks within Europe.

BERGSTEN

10:25:54
But, remember, they've already agreed to take a voluntary write-down to 50 percent. Well, 70 or 80 would be worse, but not so hugely worse, I think, that it would have any devastating effect on the financial system. And again, the European Central Bank, my prediction, will do whatever is necessary. The European governments are already poised to recapitalize the European banks, so they'll be in better position to deal with any losses they would take, such as a Greek default. And so, I think, that side, while messy to be sure, could also be handled.

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10:26:27
David.

WESSEL

10:26:28
I just want to emphasize how hard it is to predict what's going to happen and how uncontrollable this has become. So I think Fred's scenario is plausible, and even likely, but I keep thinking about what was going on here in the fall of 2008 in just one little example. So the authorities let Lehman Brothers fail. They thought the markets were ready for it. They claim now, after the fact, they didn't have the legal authority. And they thought they understood what would happen afterwards.

WESSEL

10:27:00
It didn't really occur to very many of them that any money market fund still had a lot of loans out to Lehman Brothers. One of them did. It was unable to pay back its depositors at -- or its investors at 100 cents on the dollar, and that led to a cascading effect. So why this is so frightening is that you can't assume that everybody will do the logical thing. It will act in the collective self-interest.

WESSEL

10:27:27
Every day brings some new development where some politician in some small country decides to test the system, some revolt from the members of Anglo-Americans ruling party. Lord knows what goes through Berlusconi's mind during all this stuff. I think we probably don't want to know. And so that's why it's frightening because it's new, it's unpredictable, it's out of control. And this is the biggest economy in the world, as Fred put it, playing with fire.

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10:28:00
And it comes at a time when, certainly, Americans and, I think, probably citizens in the developed world around the globe do not have a lot of faith that their government will do the right thing.

WESSEL

10:28:10
Absolutely. It comes in a bad time for two reasons. One is the one you said, that across the world, there's a loss of confidence in government, in business elites and everybody else. And, secondly, the rest of the world isn't doing so great either. In case you noticed, we have 9.1 percent unemployment. We're not in a position to absorb a blow from a deep European recession the way we might have been, say, in 2006.

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10:28:33
So we talked about what Greece leaving the eurozone might mean for the eurozone. What's it -- what would it mean, do you think, for people in Greece, for Greeks, who have been so alarmed by some of the austerity measures that they are facing -- have already taken and are facing ahead?

LACHMAN

10:28:50
Well, I think that what one really wants to keep in mind is what's been going on in Greece with IMF-imposed austerity, that the Greek economy over the last two years has contracted by 12 percent. Just to put that into perspective, in our great economic recession, we only contracted by 4 percent, and we though it was a disaster. Their economy has declined by 12 percent, that the unemployment is already at 16 percent.

LACHMAN

10:29:17
What they've got ahead of them, with the Germans and the French imposing additional austerity in these kind of circumstances, is if they stayed that course, they've got many, many years of real suffering. In those kind of circumstances, you look for alternative routes. And a case that comes to mind is Argentina. In 2001, everybody said, if Argentina leaves its fixed exchange rate with the dollar, the sky would fall. Argentina will sink into an abyss.

LACHMAN

10:29:51
And what actually turned out is Argentina had a very good decade. Subsequently, they had one or two bad quarters, and then they had some hope of growth through a depreciated currency that allowed them to have a real export boom. I'm not saying that that cost is without risk. But the cost of Greece sticking with these kind of policies is really just offering them many more years of hardship. And it doesn't surprise me at all that the people are in revolt and that the country has basically become ungovernable.

BERGSTEN

10:30:27
There are all sorts of interesting comparisons. Another is Latvia. Latvia had the biggest recession of any country in Europe, 2008, 2009. It took a 25 percent decline in standard of living. It took that willingly, with effective and aggressive policy responses. And now, only two to three years later, it's again growing. The government that did it has been reappointed to office not once, but twice. So there are all sorts of different comparators.

BERGSTEN

10:31:01
The truth, as David said, is we don't know which way it would go. But the cost to Greece, I think, of leaving the eurozone will almost certainly be worse than going through with the adjustment programs that they've already started.

WESSEL

10:31:15
To go to your question, Susan, about what does it mean to the U.S., I think that there's one sort of strange side effect to the U.S. So the United States government, for all its problems and for all the dysfunction that we talk about in Washington, is able to borrow huge sums of money at very, very low interest rates. And the only reason, in my opinion, it's able to do that is it's become the world's tallest midget, that the rest of the world is such a mess that global investors are willing to put money here.

WESSEL

10:31:47
And the concern I have about that is that that takes the pressure off us to get our own affairs in order, to figure out what do we do about our long-term deficit problem, to figure out what do we do to quicken the pace of growth here, to deal with short-term and long-term threats to our future prosperity. And so I think we're kind of living in a false -- with a little bit of false security now.

BERGSTEN

10:32:10
Susan, one quick comment on that. I agree with everything David said. The U.S. may need a humongous crisis to get its own act together. But when you say the rest of the world is not doing well, that's not right.

WESSEL

10:32:21
Fair enough.

BERGSTEN

10:32:21
Half the world is the emerging markets and developing countries led by China, Brazil, others. They are growing at more than 6 percent on average, more than 8 percent in China. They're keeping the world economy at an average growth rate of 4 percent. So it's the rich, so-called advanced countries that are doing badly. But the half of the world that's emerging and developing is doing very well, thank you.

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10:32:42
I'm Susan Page, and you're listening to "The Diane Rehm Show." We're taking your calls, 1-800-433-8850, and reading your emails. Let's go to the phones and take a caller. Greg has been holding on. Greg, hi. He's calling us from Lexington, Ky.

GREG

10:32:59
Thank you very much for taking my call. In addressing the European crisis, when you have one set monetary policy and different fiscal policy, it's basically a recipe for destruction. This whole situation that -- we talk about the contagion. I think it's important to realize that this pathogen that is infecting the planet originated in the United States. And the fallout that's being experienced in Greece and other countries is a direct and, in some cases, an indirect result of that.

GREG

10:33:35
But this is becoming a Gordian Knot in conjunction with what's going to come down, that, basically, these austerity measures are nothing short of what Britain and France gave Germany at the end of World War I with the Versailles Treaty. And I don't think that some of these countries you mentioned are going to survive these dramatic changes where, basically, a generation is sacrificed.

GREG

10:34:03
I think that you're going to see more revolts. I think you're going to see cities burning. And I think it's something that even though the United States with the Treasury secretary printing the money, giving it to Bernanke, giving it to the banks at zero percent -- we're not out of the woods on this, by far, yet.

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10:34:22
All right. Greg, thank you so much for your call. Fred.

BERGSTEN

10:34:24
I think the first point the caller made is critically important. About 15 years ago, the Europeans decided to create something that they called Economic and Monetary Union. They succeeded in creating a monetary union pretty comprehensively, with a single currency, a single central bank. However, they did not create an economic union -- no common fiscal policy, no common regulatory regime, no economic governance mechanism.

BERGSTEN

10:34:52
So Europe is a halfway house. They knew that. Outsiders knew that. It was assumed that, after the monetary union got going, there would be a kind of forward momentum, and they would complete the circle. Well, they didn't. In the last decade, the world was booming. Their economies were doing well. There was no pressure to advance. Now they've gotten caught in this halfway house.

BERGSTEN

10:35:13
So the real question is whether the monetary union will collapse and they'll wind up with nothing -- that would be the demise of the euro -- or whether they will be driven by the crisis to complete the economic union, move toward true fiscal cohesion with economic governance institutions. My strong guess and prediction is the latter, that, in fact, coming out of these two years of crisis already is enormous institutional evolution in Europe moving them toward a complete economic union.

BERGSTEN

10:35:43
But that's going to require amendment of treaties, amendments of constitutions. It'll take five years or more. It's not going to come out of this crisis. But that is the existential question. And it's true: Europe has to go one way or the other. It can't stay in this middle.

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10:35:55
But Greg had a second point as well, predicting cities burning, a generation sacrificed, arguing that it's basically not sustainable for democracies to undertake this kind of pain.

LACHMAN

10:36:06
Right. I think I would really agree with the caller that the basic problem is, as he's mentioned, these countries gave up monetary flexibility. They gave up the ability to move their exchange rates. What the basic problem is for these countries is they didn't play by the rules of the game. For 10 years, they ran enormous budget deficits. They got very large public debt problems. And the essence of the problem right now is that if you try to cure those problems with fiscal austerity, you drive the economies deep in the ground.

LACHMAN

10:36:44
When you drive those economies deep in the ground, you lose tax revenues, and you have to do even more fiscal adjustments. So you get in a negative cycle, and that produces a lot of hardship, as we're already seeing in Greece, and it does lead to social breakdown. And I think that port countries like Portugal are probably going to be next in line.

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10:37:04
The Associated Press has just moved a story that reports a spokesman for Greece's government says it is prepared to discuss an opposition demand for the creation of a transitional government to approve the latest bailout deal and secure the next installment of rescue loans for the country. And the government spokesman said, we are ready for serious discussion on the conservative opposition proposal.

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10:37:24
Of course, the prime minister has scheduled a confidence vote on his government for tomorrow, not clear if it will survive. We're going to take another short break. When we come back, we'll go to the phones again, 1-800-433-8850, and we'll read some of your emails. Stay with us.

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10:40:02
Welcome back. I'm Susan Page of USA Today, sitting in for Diane Rehm. With me in the studio this hour, Desmond Lachman from the American Enterprise Institute, David Wessel from The Wall Street Journal, Fred Bergsten from the Peterson Institute for International Economics. Now, if the Greeks actually go to a coalition government, which is the implication of the AP story that has just moved on the wire, does that mean they would not have this referendum that has so shaken things, Fred Bergsten?

BERGSTEN

10:40:33
Almost certainly not. The objective of the referendum was to get a domestic political consensus in support of the adjustment program that's necessary to keep Greece and the euro and to keep its recovery going. This would be an alternative and a much healthier one because it would happen much more quickly. If the opposition party joins with the governing party, as they suggest they will, and support the rescue program, then you've got a unified political underpinning in Greece so that the government, with the support of the opposition now, can face down the domestic political opposition.

BERGSTEN

10:41:11
As I said before, that has been the case in every one of the other European debtor countries: Ireland, Portugal, Spain, Italy. In all of those, there has not been a domestic political battle over this. It's still been hard to implement some of the rules, some of the new changes. But the domestic politics have not flared over this. And in Greece, it looks like, now, they may join the parade.

BERGSTEN

10:41:33
That would be a huge step forward in enabling Greece to conform with the creditors demands and get with the program and move on and, I think, significantly restore market confidence that the whole European rescue program goes forward.

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10:41:47
So, David, problem solved?

WESSEL

10:41:49
Well, I don't think the problem's solved. I think we take an inch -- a step away from the edge of the abyss. But I think it does illustrate a point that Fred made earlier, which is -- so, basically, France and Germany said to the Greek, listen, you -- you're playing with fire here. You're not going to allow it to have some kind of mealy-mouthed referendum just for your domestic political purposes. You have to decide. Euro, in or out.

WESSEL

10:42:10
The prospect of that may have forced the Greek political system to come together. It's an example of what Fred was saying, that, when confronted with the really existential question, they may actually back away.

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10:42:23
Desmond.

LACHMAN

10:42:24
I think that if one does get a transitional government, what that would be -- it would be a short holding operation, so they get the next disbursement from the IMF and E.U. But it's very difficult to see that this will not shortly be followed by elections where the people will have the ability to vote. I think that what's of concern is that the opposition in Greece has got a very, very different vision from the government as which way to go. They believe that spending cuts are really driving Greece into the ground, that Greece should stop those kind of austerity measures, instead, that Greece should engage in supply-side tax cuts, which would promote growth and boost revenues.

LACHMAN

10:43:11
I'm not sure that the IMF or the European Union would see it the same way as the opposition. But the opposition -- I would be very surprised if they're in a coalition for a long period of time. I would see them being in a coalition simply as a bridge towards an election where the matter can be trashed out. And that election would make a referendum totally redundant.

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10:43:35
And echoes in that debate from some of the politics we hear here in the United States. Fred Bergsten, we should note that what's in front of Greece is not only austerity measures, also some structural reforms.

BERGSTEN

10:43:47
Yes. Austerity is, of course, a big part of what they have to do. They've been living beyond their means to the tune of 20, 25, 30 percent, so they do have to tighten their belts, no doubt about it. But even more important, certainly for their longer run economic viability, is structural reform. Greek citizens can retire and start getting pensions before they're 50 years old. They've got to reform the pension system. They have labor laws that are very rigidly blocking entry into lots of professions by qualified people.

BERGSTEN

10:44:19
So they don't get anything like the productivity growth that they should. They've got to open up their labor markets. They've got to make it easier to fire people, which is now almost impossible, or else companies will never hire people and start creating jobs again and investing in Greek-productive activity. So there's a whole series of structural reforms that Greece needs that is -- as Desmond said, that's supply side, that's pro-growth. Those things take time to play out.

BERGSTEN

10:44:48
They have to be coupled with the short-run austerity. But they're not only critically important economically. They give hope for the future. And if those things are done, then the country has something to look forward to. Incidentally, it's the same in some of the other European debtor countries. That's very much the set of issues in Italy, to some extent in Spain. Those other countries have been starting to move.

BERGSTEN

10:45:08
Greece has to have that component to the program. And that'll help sell it domestically and make people, like in Latvia that I said before, willing to take pain for at least an interim period.

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10:45:19
Let's go to Newtown, Pa. and let Frank post a question or make a comment. Frank, hi. You're on the air.

FRANK

10:45:25
Yeah. I'd like to know the U.S. exposure to the Greek debt. You know, Obama, when the banks are in trouble, he runs over there, and he's going to promise them all kinds of money. We've got college loans up to our neck, those kids who can't pay. We've got a housing problem in this country. Why does he run around and cater to the banks? They did it in '09. Again, why are they doing it now?

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10:45:56
All right, Frank, thanks so much for your call. So, David, has President Obama offered financial assistance to the banks here to help bail them out?

WESSEL

10:46:04
No. In fact, when the Europeans decided they wanted money from outside, it was kind of symbolic that they went to China and not to us. So I don't think the U.S. is going to put any money into this thing except, as Fred said, if the International Monetary Fund gets involved. I think the caller -- underlying the caller's question is this widespread sense in the U.S. that somehow, during this whole financial crisis, which is -- seems to be one long series of agony-ridden Sunday nights before the markets open, that somehow the government feel it necessary to bail out the banks and they don't bail out the people.

WESSEL

10:46:48
I think that's a very understandable reaction to a situation where the government basically decides, and they will eventually in Europe, that financial system is so important to the functioning of the whole economy and to everybody's well-being that they'll have to bail them out. But it's hard for people to understand why the banks get bailed out and the homeowners and the student loan borrowers don't.

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10:47:03
And Frank's original question was, what's the exposure of U.S. banks to this eurozone crisis? What's your answer to that?

WESSEL

10:47:09
The exposure to Greece is very, very small. But as we've seen, it may infect the rest of Europe, and we've apparently lost one financial firm already, this MF Global firm in New Jersey run by the former governor of New Jersey, John Corzine, the former Goldman Sachs CEO and the former everything else. So the problem is that it's the indirect exposure that some U.S. bank have -- our money market fund lent money to some French bank that has a lot of exposure to Portuguese or Italian or Spanish debt.

WESSEL

10:47:42
And it's that house of cards. You can't quite see where the bodies are buried -- can't think of any more metaphors to mix in one sentence -- that worries people. So it's very hard to measure. But Fred said at the beginning -- and I think he's absolutely right -- we are vulnerable here. It's not -- we are not in a position to weather a collapse of the euro or collapse of the big European banks without some pain here.

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10:48:04
Well -- and, in fact, if Europe slips back into recession, we have our own very weak recovery going on here. Would that push us back into recession, too, do you think, Desmond?

LACHMAN

10:48:15
Yeah, it almost certainly would, that the channels would be if there's a weak Europe, we don't have a market to export to. If Europe has a little banking crisis, it means that the euro would depreciate against the dollar, which means that we have trouble in third markets. But I think that it's the financial market linkage that is most serious.

LACHMAN

10:48:37
I totally agree with David that United States' banks don't have much exposure to Greece, but United States money market funds, together with banks, have huge exposure running into trillions of dollars to the French, German banks, which, in turn, are exposed to the Greeks and Portuguese and the islands of the world. So we might not have direct exposure to those countries, but through our exposure to the banks, we've got indirect exposure which would be of deep concern if Europe were not to succeed.

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10:49:12
All right. Frank, thanks very much for your call. Hope that answers your question. Let's go to Jeff. He's calling us from Chapel Hill, N.C. Hi, Jeff.

JEFF

10:49:17
Hi there. Hi, Sue. Thank you for taking my call. Appreciate it. And I appreciate a lot of the comments going on, you know, in this time of, I think, great need around the world. But I think everybody sort of -- a lot of people are told, in a way, to look at it, I think, in a wrong way. And it's almost -- if I could use, like, Desmond there, he uses the word contagion like Giuliani used the word terrorist. And it's meant to put people on the other side of the veil, you know, in front of us, instead of looking behind the curtain.

JEFF

10:50:01
Now, what's behind the curtain I find very interesting because there is this Canadian Globe newspaper that has an online article on theglobeandmail.com, and what they have is simply said Iceland determined that it was under no legal or moral obligation to underwrite the reckless behavior of its commercial banks whose assets soared to 10 times gross domestic product. Now, you have 13 million...

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10:50:38
Now, Jeff -- I just interrupt -- that is, of course, a question. This question of Iceland has come up in a series of callers and some emails. And I wonder, is that, in fact, something Greece could look to? Is that something the world could look to as an example of the path ahead?

LACHMAN

10:50:52
Well, I think that Iceland did decide not to pay its debt, and what they did decide was to let their currency float. And off to some difficulties, Iceland has been doing reasonably well. So that is an example that countries could follow. I would agree totally that when countries like Ireland guarantee all of the banks deposits, when they don't let people who've lent to the banks take haircuts and they assume that on the taxpayer's role, that is a huge mistake, and got a country like Ireland deeply into trouble.

LACHMAN

10:51:31
You know, so there are huge mistakes that have been made by many of these countries, but the end result is that they're in a very difficult situation. They're in the straightjacket of the euro, and it's difficult for me to see how they avoid a deepening in recession, which is going to cause a lot of social and political problems for them.

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10:51:49
And when you say take a haircut, what does that mean?

LACHMAN

10:51:52
Take a haircut is a euphemism for being hosed by the person who borrowed the money from you, that instead of their paying you 100 cents on the dollar, they decide to pay you 30 cents on the dollar.

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10:52:04
All right. Jeff, thanks very much for your call. Let's go to Orlando, Fla. And I'm hoping I'm going to say your name right, Trinikerov. (sp?) Is that correct?

TRINIKEROV

10:52:11
Yes. Yes. Good morning and thank you for giving the opportunity. I'm going to be a little less politically correct. I think that Greece's problem is, like, they never learn. They are the remnant of an empire that failed because of greed and because there was absolutely no way to contain it, because of their many war that they wage around the world. But, coming back to Europe, I like to compare Europe with the French Revolution.

TRINIKEROV

10:52:40
The 1 percent controlled the means of the 99 percent. And just like Marie Antoinette had the guts to say, let them eat cake, they are telling the world the same thing. And the world is no longer the group of people that used to live in the (unintelligible), you know? The education and the way the electronic media has, you know, enlightened and opened, so people are more in tune of what is happening simultaneously all over the world.

TRINIKEROV

10:53:06
And I think that all these (word?) of greed and corruption in industry, if they don't pay attention, we are going to have anarchy like one of your speakers said because enough is enough.

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10:53:17
Right. Well, thanks very much for your call. I'm Susan Page. And you're listening to "The Diane Rehm Show." David, would you like to respond?

WESSEL

10:53:23
Well, I think -- I want to mention two things that the caller said that, I think, are worth keeping in mind. One is that there is a big widening of the gap between winners and losers in our country and in other countries. And to the extent that that continues, it is breeding a lot of resentment among people, and we see it manifested in different ways at different times. I think it had something to do with the Tea Party revolt. And the Republican Party here clearly is motivating some of the Occupy Wall Street Wall stuff. So the legitimacy of the system is being called into question.

WESSEL

10:54:00
The second thing is that, you know, the caller and a number of other callers has -- have thrown around the French Revolution and Versailles and all that, and I think we got to give ourselves a little more credit than we're giving ourselves. Nobody is talking about Germany invading Greece, right? We are not talking about turning this into World War III. And 60 years ago, when these kind of things were going on, we were. And so we should give ourselves a little bit of credit. We have a lot of problems, but we are trying to resolve them through peaceful means. And that is not insignificant.

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10:54:37
Here's an email we have from Dennis. He writes us from North Carolina. He writes, "I heard the E.U. or ECB" -- that's the bank -- "has asked China for over $1 trillion to assist in handling the situation. Does this represent a major shift in economic prowess from West to East?" Well, first of all, what would -- what is the -- what does Europe want -- what role does Europe want China to play going forward?

BERGSTEN

10:55:01
Part of the big rescue package that the Europeans announced only a week ago was an expansion of the resources of their bailout fund, the European Financial Stability Facility, and they created a component of that called a special investment vehicle through which they could borrow money from people outside Europe to augment the resources available to finance the Greek rescue and possibly other country problems, bank capitalization, the whole range of things they're doing.

BERGSTEN

10:55:33
Once you set something like that up, you follow Willie Sutton. You look around and say, where's the money? Well, the money is obviously in China. China has foreign exchange reserves of $3.2 trillion. It's been validly unhappy with the way it has to invest that money -- U.S. Treasuries, which pay virtually no interest and in a currency that's in decline -- so the Chinese have kind of put out the word that they're willing to look around for alternative investments.

BERGSTEN

10:56:01
Naturally, the Europeans got on the plane, headed for Beijing, asked them if they would do it. The Chinese, of course, were playing it coy, saying we're going to be very cautious. We'd have some quid pro quo, but that's certainly a possible contribution to the outcome.

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10:56:15
And here's a new report from the Associated Press writing out of Athens. It says, two officials close to the Greek prime minister say he has scrapped his plan to hold a referendum on the latest European debt deal -- that was previously predicted on this program...

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10:56:29
...after the main opposition leader said he would back it. That's all the time we have. I want to thank our panelists for joining us this hour. Fred Bergsten from the Peterson Institute for International Economics, Desmond Lachman from the American Enterprise Institute, David Wessel, economics editor of The Wall Street Journal. Thank you all.

WESSEL

10:56:46
Thank you.

PAGE

10:56:47
I'm Susan Page of USA Today, sitting in for Diane Rehm. Thanks for listening.

ANNOUNCER

10:56:54
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