Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.
Display:
The root of all evil in the Eurozone is the internal trade imbalances and the refusal to introduce corrective feedback loops. This is the same mistake made at Bretton Woods, and for the same reason: the largest economy and largest exporter putting itself at the centre of a fixed-exchange-rate system with no correction of trade balances.

If you couple structural trade balances and fixed exchange rates with the GSP's government deficit limits, you end up with huge pressure to increase private debt in net importers. Hence the credit bubbles in the periphery funded by credit from the core. This is inevitable. Otherwise you have a depression in the periphery as in fact it was not rising incomes that fuelled demand, but rising indebtedness.

In the meantime, the core country depressed real wages, ran higher public deficits and debts than the periphery, and cut social benefits. Meaning all the growth in the Eurozone went to returns on capital in the core country.

Eventually, something has to give, and it has.

So, what's the policy proposal to get us out the hole? To keep digging, apparently.

Contractive monetary policy to stave off non-existent invisible inflation monsters, retain the GSP, don't punish the core for its now excessive debt (now as well as over the last 10 years) but punish the periphery for its "automatic stabilizer" deficits (the same "automatic stabilizers" that were used as an excuse for smaller monetary expansion in Europe compared with the US). Refuse to introcude negative feedbacks in trade imbalances. Force deficit countries to accept IMF-style "rescues" rather than default on its debts to the core.

Brilliant.

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010

by Migeru (migeru at eurotrib dot com) on Fri Dec 24th, 2010 at 06:12:48 AM EST
[ Parent ]
Why is this? Why can't surplus core capital go somewhere else than into peripheral country debt (private or public)? Why can't it instead go into peripheral country equity, or outside the eurozone?

And why must debt explode in the peripheral countries with trade deficits? Why can't they instead reduce their equity holdings, or reduce their imports from the core?

These are not rhetorical questions: I really don't understand this, and ET discussion threads are the best seminar room I've ever been to. Lots of great stuff I've never been exposed to in ordinary seminar rooms. :)

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Fri Dec 24th, 2010 at 06:39:38 AM EST
[ Parent ]
And they are good questions to chew on.

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010
by Migeru (migeru at eurotrib dot com) on Fri Dec 24th, 2010 at 06:41:32 AM EST
[ Parent ]
Why is this? Why can't surplus core capital go somewhere else than into peripheral country debt (private or public)? Why can't it instead go into peripheral country equity,

There's basically four ways that could happen. Spanish firms could sell equity they hold in German firms. German firms can offshore production to Spain. German venture capitalists can seek to exploit promising business niches in Spain. Or German firms can buy equity stakes in Spanish firms.

The first option isn't really an option, because Spanish firms have no major equity stake in the German economy. And even if they had, why would they be inclined to sell it unless they were forced to? Shareholders in German firms have been the big winners in German policy.

Offshoring to Spain isn't going to happen either, for a couple of reasons. In the first place, any firm that is going to offshore is going to offshore to Eastern Europe or China. In the second place, the German reaction to offshoring would be to further depress domestic demand, further deflate prices and thereby force any business offshored to a €-zone country that was not prepared to follow Germany in a race to the bottom back into the fold.

And the problem for German venture capital seeking gains in Spain is that local Spanish investors are going to have an easier job of finding the good investments than ones operating out of Frankfurt.

Could German firms have obtained an equity stake in Spanish firms instead of lending Spain money? Obviously they could. And they probably did. But that isn't very much of an improvement - laundering the surplus into the secondary equity market would just be fuelling a stock market bubble instead of a real estate bubble.

By contrast, the way the debt was issued was that local Spanish banks made loans to Spanish households and businesses. The Spanish banks then went on the interbank market and borrowed regulatory reserves from German banks. Spanish households and firms then spent money back to Germany, forcing Spanish banks to borrow even more on from the German banks on the interbank market. Lending to other €-zone banks on the interbank market is virtually automatic, particularly when it is an interbank loan to cover a deposit transfer.

or outside the eurozone?

Because there is an intra-€-zone trade imbalance. If the surplus went out of the €-zone, the deficit countries would have to start borrowing outside the €-zone as well. Which would reduce to the current situation, but with a Chinese middleman between Germany and Spain.

Of course that might be politically easier, since you could then screw over the foreign middleman, rather than deal with the imbalances as a matter of internal policy. But I suspect that there's an upper limit to how long foreigners are willing to accept getting screwed over for the sake of internal €-zone cohesion.

And why must debt explode in the peripheral countries with trade deficits? Why can't they instead reduce their equity holdings,

In order to do that, surplus countries have to buy their equity. So this is simply a mirror image of your first question.

or reduce their imports from the core?

This one's actually the easiest question to answer.

All economic activity involves a proportion of imports. The precise proportion depends on how your economy works - what sort of raw materials you have, what sort of stuff you make, how your institutional structures are set up, that sort of stuff.

Reducing the percentage of your economic activity that depends on imports is hard, and takes time. One of the easiest ways to do it is to devalue your currency, but that option wasn't available. The second easiest option is to do hands-on import substitution policy. But that's illegal under EU rules.

So with no really desirable options for reducing import share, the only way to reduce total imports is to reduce domestic economic activity. That is, create an artificial business depression.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Dec 25th, 2010 at 05:01:53 PM EST
[ Parent ]
Plus, after Bretton Woods the US engaged in a massive programme of industrialization of Germany, the Marshall plan. They could just as well have said "we'll keep our surplus and you pull yourself up by your bootstraps". Or, even better, they could have implemented the Morgenthau Plan and actively deindustrialised Germany to turn it into an agrarian backwater.

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010
by Migeru (migeru at eurotrib dot com) on Fri Dec 24th, 2010 at 07:03:22 AM EST
[ Parent ]

Display:

Occasional Series