Why Every Nation Cooks Its Books

03/09/2010 9:51 am EST

Focus: MARKETS

Jim Jubak

Founder and Editor, JubakPicks.com

As we see with Greece, lying can be a recipe for disaster. But for politicians, the advantages of deception far outweigh any rewards for honesty. (And are we ready for the bitter truth?)

Greece cheated on its national accounts in 2009. And that led to a budget crisis in 2010.

But that's not the important part of the story.

What makes this a crisis not just for Greece, and the euro and the European Union, is that everyone-from the Greek government and its accountants to the financial officials of the EU to the experts at international watchdog agencies such as the Organisation for Economic Co-operation and Development, or OECD-knew it.

And knew it for at least a decade.

It makes you wonder what other countries are cheating on their accounts. Or maybe we should ask it this way: "Is anyone not cheating?" We all know that the United States does. But so does China, that much-admired model-at the moment anyway-of economic management. Even the Canadians-yes, the Canadians- cheat!

The consensus view is that the world's books are in pretty bad shape. But the consensus view has a long history of ignoring problems until they bite it. Hard.

We're anywhere from a few years to two decades (closer to the former, I think) from feeling those teeth close in. (Especially if the economic recovery is going to be as profitless as I expect.) If we want to save ourselves from those chompers, it's time to face reality.

Building a house to withstand a 50-mph nor'easter doesn't make much sense if you live in hurricane country.

If everyone cheats, it's past time to look at some of the lies.

Perhaps you've had the details of the Greek budget crisis drilled into you until your head feels like you've had too much retsina. The Greek government projected a 2009 budget deficit of 3.75% in June and then 6% in the fall before conceding that the real deficit was going to be 12.7%.

What's less well known is that as early as June, economists and number crunchers at think tanks were blowing the whistle on the Greek budget figures. On June 24, for example, the OECD issued a report saying that the official target, at that point 3.75%, was spoiled feta and that a 6% deficit was way more likely.

A Membership Worth Lying for

Creative Greek accounting has a long history. In 1999, when Greece first applied for membership in the euro zone, it got turned down. Its budget deficit was way too large, and the country didn't have a chance in Hades of getting it down to the 3% maximum allowed under the rules of the European Monetary Union.

It was a different story when Greece applied again in 2001 and sailed into membership. What led to the amazing turnaround? Simple. Greece cheated.

The Greek government admitted it in 2004. (One of the advantages of the constant rotation of governments in Greece is that each party makes a practice of revealing all the dirty laundry of the previous opposition government when it takes office.)

In November 2004, Finance Minister George Alogoskoufis admitted that the budget figures the country had used to gain admission to the euro club were fudged. "It has been proven that the deficit had not fallen below 3% in every year since 1999," he told reporters.
 
Greek financial daily Naftemborikieven reported the exact size of the lie. From 1997 to 1999, the years that the European Union examined to determine whether Greece had met the 3% deficit maximum, the Greek budget deficit was 6.44%, 4.13%, and 3.38%. (Given what we know now, you're entitled to take even those figures with a grain of salt.)

At that time, Greece was looking at a 5% budget deficit-and rising as the country added cost after cost for the summer Olympics. Data filed with the European Union showed that the country had exceeded the 3% budget deficit maximum every year since 2000.

And the reaction from the EU?

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As best as I can judge, the reaction from the EU was a collective shrug. It was a done deal. European Commission spokesman Gerassimos Thomas said: "Greece's admission to the euro zone was done on the basis of the convergence report which was established at the time and on the basis of figures and the statistical methodology applied at that time. It wasn't in question at that time."

At this time, I'll bet there are more than a few officials and politicians in Brussels, Berlin, and Paris who wish that decision hadn't been allowed to stand at that time.
There isn't something in the air or water in Athens that makes Greek governments especially prone to cheating on accounting. The Greek governments might have had more motivation than most, but, for any politician, the rewards from cheating on the national accounts far outweigh the benefits of telling the truth.

On the one hand, cheating allows a politician to deliver goodies (jobs, subsidies, loans, rising real estate prices) without paying for them, and on the other hand, a politician can sleep well at night knowing the country is on a sound financial footing.

That's usually not even a vaguely hard choice.

Think I'm exaggerating? Then take a look at the finances of Canada, the extremely prudent US neighbor.

Or at least that's how the country is normally portrayed. (Being compared with the United States helps any country's reputation for financial rectitude, of course.)

Canada is in the midst of its own budget squabble.

The Conservative government has forecast that after going into the red in fiscal 2008-2009 by 56 billion Canadian dollars ($54.5 billion in today's US dollars), the budget will move back into balance by 2014. The Parliamentary Budget Office disagrees, however, and has issued a report saying the country faces a structural budget deficit that will result in annual shortfalls of CA$12.5 billion to CA$18.9 billion in each of the next five years.

The difference comes down to an argument about how fast the Canadian economy will grow once the global economy has recovered from the Great Recession in the United States. The Conservative government says growth will rebound to the pace before the global slowdown. (Canada's economy grew 2.7% in 2006.) The Parliamentary Budget Office, on the other hand, says economic growth in Canada will decline, averaging just 1.9% in 2009-2014 as a result of an aging population driving down the speed limit for growth in Canada's economy. In the next decade, the budget office says, the percentage of Canadians outside the work force will rise to 27% from 20% now.

Granted, a CA$56 billion Canadian deficit doesn't seem all that big, even when you say that it would be equivalent to a $600 billion deficit in the much bigger US economy. The US budget deficit for fiscal 2009 was $1.4 trillion. But Canada spent a decade reducing its debt-which peaked in fiscal 1997-1998 at $563 billion-to $458 billion in 2007. So even a small move back into the red seems a big step backward.

And many Canadian financial experts, even those who criticize the government's projections, remind Canadians that while the budget deficit is important, Canadian finances in general are just fine. Especially if you compare them with those of other countries. According to International Monetary Fund estimates, Canada's net debt will be just 31.3% of the gross domestic product in 2010. That compares with 117% for Italy, 72.9% for France, and 76.2% for Germany. Less than half the debt load of Germany, the poster child for fiscal conservatism in Europe?

So why worry?

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Oh, Canada, too?

But remember the thesis of this column? Everybody cheats.

Canadian politicians would like Canadians to focus on net debt because, given the structure of Canadian national and provincial finances, the measure understates the debt problem.

The problem is that while the finances of Canada's national government are in decent shape, the finances of the provinces are a horror.

The province of Ontario is the national basket case. In fiscal 2009-2010, the Conference Board of Canada projects, the provincial budget deficit will hit $14.1 billion. That would be the largest provincial deficit ever. The Conference Board projects that over the next three years, the provincial debt will grow by $56 billion.

The International Monetary Fund has a measure-gross national debt as opposed to net national debt-that captures some of this problem for countries such as Canada that delegate a big percentage of governmental spending to the provinces or states.

For a country such as France with a heavily centralized system of government finance (when Louis XIV said "I am the state," he could have been talking about Paris' dominance of government spending), net and gross debt loads aren't very different: Net debt in 2010 for France will be 72.9% of GDP, according to the IMF, and gross debt will be 82.6%. Same for Italy, where net debt will be 117% of GDP in 2010, and gross debt will be 120%.

But in Canada, because of the way that government spending is divided between Ottawa and the provinces, the difference is stunning. Remember that net debt was projected as just 31.3% of GDP in 2010. Well, the IMF projects gross debt at 79.3% of GDP in 2010.

Ottawa, you've got a problem-and one of a magnitude that isn't captured by the current debate between Liberal and Conservative politicians.

Now, I live in the United States, so I'm in no position to throw stones. Remember, everyone cheats.

The IMF projects that US net debt as a percentage of GDP will be 66.8% in 2010, more than twice that for Canada, and gross debt will be 93.6% of GDP, still almost 14 percentage points above Canada's.

And even the IMF gross debt numbers don't capture the full extent of the fiscal lie in the United States. A recent study pegs unfunded pension liabilities for the 50 states at somewhere between $1 trillion and $3 trillion, depending on the rate of return states will get on their pension investments over the next decade. And then there are all those off-budget liabilities such as Social Security and Medicare. These promises of future spending aren't included in budget calculations because they're "covered" by special trust funds with a source of revenue that is, supposedly, independent of general government revenue.

No politician in Washington wants to come up with a realistic estimate of the problem because that number would make it immediately clear that the dimension of the problem makes all the proposed "fixes" laughably inadequate.

And to be honest, we don't want to hear that message either. We'd salute the politician who told us the true extent of the problem briefly on the editorial pages of The New York Times and The Wall Street Journal, and then promptly vote him or her into retirement.

All this should make you wonder what games the Chinese government is playing with its budget and debt numbers. As noted earlier, it's in the self-interest of politicians everywhere-and the officials of the Chinese Communist Party are politicians-to promise everything and pay for as little as possible.

Everyone cheats, but everyone cheats differently. Coming Thursday: A look at the lies on China's books.

More from Jim Jubak:
Is China About to Start Exporting Inflation?
 
Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.

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