Herbert Stein (1916 to 1999) was a US economist who was influential in his time. Among his achievements, Stein was chairman of the president-guiding Council of Economic Advisers under Richard Nixon and Gerald Ford, was attached to the American Enterprise Institute think tank, contributed to The Wall Street Journal and taught at the University of Virginia.
Amid all his feats, Stein seems most renowned nowadays for one sentence he wrote in 1989. The sentence, which is famous because it sums up so much about economics in just nine words, is: “If something cannot go on forever, it will stop.” Another way of saying the same thing would be that days of reckoning do arrive.
Greece and its creditors are shuddering under this truth right now. Investors beware; Greece is not the only nation or otherwise running up against Stein’s law.
Greece’s collapse traces back in no small way to how the euro was created in breach of Stein’s wisdom. Europe’s monetary or currency union ignored that successful currency unions such as Australia’s are also fiscal, banking and political unions. Within the eurozone, Italy and Portugal are just two other countries on a debt trajectory headed straight for a Stein’s-law reckoning. Gross government debt to GDP stands at the default levels of 132% for Italy and 130% for Portugal, up from 115% and 96% in 2010.
What’s depressing about the eurozone is that the area’s largest creditor nation is on a collision course with Stein’s law. Germany’s economic outlook is clouded because any large economy whose exports amount to 50% of GDP (compared with 13% for the US) is inherently unstable for it relies on the health of others.
The economic model of advanced countries appears in danger of breaching Stein’s law in four, sometimes related, areas. The first is chronic fiscal deficits, which largely stem from governments promising to supply more services without imposing the higher taxes needed to pay for them. France, for instance, last posted a fiscal surplus in 1974.
The second area is that governments are overcommitted to paying for welfare programs that are expanding as populations age. In the US, for instance, social security and health now devour half the federal budget, up from an average of about one-third from 1965 to 2014.
The third problem is housing bubbles. Whatever the spruikers are saying, remember this longer-term truth tied to Stein’s wisdom; it would take unusual circumstances for housing to stay priced beyond the reach of younger generations as they appear to be now. (Excessive demand from foreigners may be one of these circumstances.)
Another unsustainable trait of the advanced economic model is its reliance on consumer debt. In Australia, the ratio of household debt to disposable income has jumped from 34% in 1977 to a record 154% now.
Australia is pursuing an additional breach of Stein’s law. Our 23 years of uninterrupted growth has been helped along by accumulating a record amount of foreign debt, the result largely of 42 consecutive years of deficits on the current account. Australia’s net foreign debt stands at a record 60% of GDP, a high ratio by global standards, and up from 30.5% in 1988.
Greece’s plight will no doubt remind policymakers everywhere of the insight that Stein crammed into just nine words. If Stein were to have added another nine, perhaps he might have drawn out his implicit warning by saying: “Problems solved sooner rather than later avoid bigger ones.”
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