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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
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