The Greek debt crisis led some people to wonder why a common currency works in the United States but not in Europe. Then came the Puerto Rico debt crisis. Yet what happened in Puerto Rico actually shows why the dollar works when the euro doesn’t.
Normally, a country that finds itself with unsustainable debt can devalue its currency. This reduces the standard of living for the country’s residents but makes it easier for the government to pay off whatever debt it owes in the local currency.
Neither Greece nor Puerto Rico have that option since their currency is shared with other nations or states. As a member of the euro zone, Greece can threaten to leave, destabilizing the entire system, unless other members put up with its profligate spending. Greece isn’t the only one: Portugal, Italy, Greece, and Spain–the so-called PIGS–all seem to have unsustainable debts that threaten the euro.
Likewise, Puerto Rico is seeking federal relief (they’re calling it a “rescue,” not a bailout), but it has less leverage than Greece because if it somehow left the dollar zone, no one in the rest of the country would notice. But this isn’t the reason why the dollar works and the euro doesn’t.
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At heart, the main reason why the dollar works and the euro doesn’t is that every state has a constitutional requirement that it balance its budget each year. That doesn’t mean that states can’t go into debt–they obviously do whenever they sell bonds–but those debt must be backed by real income from taxes or user fees. In contrast, countries joining the euro all promised to keep their debts under control, but no one enforced the promises and debts of the PIGS went out of control.
When Puerto Rico became a territory, Congress insisted that it, too, have a constitutional requirement that it balance its budget. Specifically, the territory’s constitution states, appropriations for any given year “shall not exceed total revenues, including available surplus, estimated for said fiscal year, unless the imposition of taxes sufficient to cover said appropriations is provided by law.”
The problem arose because the constitution is written in English, but when translated into Spanish, “revenues” was changed to “resources.” As subsequently interpreted by Puerto Rican and U.S. courts, borrowing money became a “resource,” effectively wiping out any constitutional limit on debt (something John Oliver never mentioned on his show on Sunday). This allowed politicians to indulge in boondoggles such as the Tren Urbano. If Congress does rescue Puerto Rico, it should demand that this interpretation of the territory’s constitution be corrected.
So the euro zone could work–if every country in that zone passed a constitutional limit on debt and deficits. Likewise, the dollar would be a disaster if states were as free to run up deficits as Congress.
The Antiplanner wrote:
The problem arose because the constitution is written in English, but when translated into Spanish, “revenues” was changed to “resources.” As subsequently interpreted by Puerto Rican and U.S. courts, borrowing money became a “resource,” effectively wiping out any constitutional limit on debt (something John Oliver never mentioned on his show on Sunday). This allowed politicians to indulge in boondoggles such as the Tren Urbano. If Congress does rescue Puerto Rico, it should demand that this interpretation of the territory’s constitution be corrected.
It is my understanding that the electric power company, which is owned by the government of Puerto Rico, is significant part of the problem, as was documented by the New York Times earlier this year, How Free Electricity Helped Dig $9 Billion Hole in Puerto Rico.
According to the Times, the Puerto Rico Electric Power Authority gives away electric power to more than a few government agencies on the island.
Then, it went on a development spree, thanks to a generous —some might say ill-considered — gift from the Puerto Rico Electric Power Authority.
Today, Aguadilla has 19 city-owned restaurants and a city-owned hotel, a water park billed as biggest in the Caribbean, a minor-league baseball stadium bathed in floodlights and a waterfront studded with dancing fountains and glimmering streetlights.
Most striking is the ice-skating rink. Unusual in a region where the temperature rarely drops below 70 degrees, the rink is complete with a disco ball and laser lights.
What most likely would be the biggest recurring expense for these attractions — electricity — costs Aguadilla nothing. It has been provided free for years by the power authority, known as Prepa.
The consulting firm FTI Capital Advisors found that 288 governmental bodies on the island were delinquent in their power payments by $300 million. Among them were public schools, hospitals, low-income housing projects, a commuter train, the island’s water and sewerage system, and its highway authority, which operates traffic signals, toll plazas and highway lighting.
I never knew Tren Urbano existed. But after a short wiki read, I see it meets all the normal standards of over-projecting the future ridership of commuter lines – and thus justifying their construction. They run at about 20% of projected ridership – which, by some standards in the US – is pretty good.
“The rail system was officially inaugurated on December 19, 2004. After this date, free service was offered on weekends until April, 2005 when weekdays were added to the free service. Popularity grew quickly and by the end of the free period 40,000 people were using the train on a daily basis. By late 2005, however, ridership had fallen to 24,000, less than one-third of the 80,000 projection (and well below the projection of 110,000 for 2010”
One of those stupid promises we often hear this election year is quoted “I’m Gonna Break Up the Big Banks” *insert Audience applause and hooting*
The financial institutions at the heart of the 2008 crisis were not the very biggest banks? They were the government controlled lending institutions Fannie Mae and Freddie Mac that coerced (should I say forced) banks to give loans in the first place. That the U.S. banking system is far less top-heavy than its foreign counterparts? The largest banks in the world are Agricultural Bank of China, Industrial Bank of China, HSBC, Royal Bank of Scotland, BNG, Deutsche. The largest US bank is JP Morgan, 6th place on global index. The federal government rarely involves itself in capping the size of private businesses, even gigantic firms like Apple or Wal-Mart. From an investor perspective; would you invest in a company that’s legally prohibited from growing? Of course not. Even Sanders supposed bank busting bill; just four pages in all, makes no effort to grapple with that challenge. It simply directs the Treasury Secretary to identify said firms and somehow break them up with no real architecture as to how to do it. Second of all, government enforcing size limits on domestic banks would put the U.S. at a extreme competitive disadvantage in financial services. Local and Community banks can’t finance global megaprojects and megamergers, large banks can…and do. How are you supposed to finance major infrastructure projects, residential/commercial developments or capital intensive but critical services like oil pipelines, derricks, roads, rails, Construction equipment, tons of resources (concrete, steel, wire) without available credit. If JP Morgan hadn’t been big and strong enough to absorb the hemorrhaging balance sheets of Bear Stearns and Washington Mutual, we might well have endured a depression. Ditto if Wells Fargo hadn’t been big and strong enough to let Wachovia collapse into its arms. The world is also lucky Bank of America was big and (arguably) dumb enough to salvage Countrywide and Merrill Lynch from the jaws of death. The idea of splitting up financial behemoths as the best way to minimize risk? Some reformers think so. So do the small but well-organized “community banks” that tend to get their way on Capitol Hill; they’re the real back door lobbying arm of finance. The Bank bailouts are also a heavily quoted snippet among candidates, only the largest firms got ripped for taxpayer funded life support…what the media rarely revealed was that the smaller community and local banks got bailout cash too, for doing the exact same thing as their Wall Street counterparts
I obviously don’t understand enough about this, but don’t states and municipalities have huge issues along these same lines with pension funds? Feels to me like a significant amount of sleight of hand goes on to “back” those obligations with taxes or fees.
The dollar also does well because, like it or not, we’re the most stable economy in the world, and probably the only one that can ensure its own stability due to our massive military.
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So the euro zone could work–if every country in that zone passed a constitutional limit on debt and deficits.
” ~ anti planner
That doens’t address the problems of German exports, the regulations that have choked to death legal markets in Central and Eastern Europe, birth rates far below replacement rates, etc, etc.
The EU is dead. There hasn’t been and will not be a funeral. As an institution though it doesn’t work and will fade into history.