Skip to content

The Eurozone is failing by reason of cannibalism

June 2, 2011

Listen to this episode

Joseph Stiglitz:

There needed to be more political integration to make the Euro work, that was very clear. And many American commentators on the Euro at the time said, optimistically, this was an unfinished project. There will be a crisis sometime down the line. The hope was that when that crisis occurred, there would be an effective response.

I think the general sense is that there hasn’t been. One of the reasons there hasn’t is that there are two very different conceptions of what went wrong. It echoes much of what I saw when I was chief economist of the World Bank and saw the bailouts in East Asia, Argentina, Latin America, and so forth. And there were two ways of describing those bailouts. One of them was they were a bailout of Mexico, or a bailout of Argentina. The other one is they were a bailout of Citibank, they were a bailout of American — Western — banks.

The true description from an economic point of view is very clear, and even a political point of view, they were a bailout of the lenders. They were a bailout of the big banks who had not done their job in lending. Every loan has a lender and a borrower. The person who is supposed to be more informed about the criteria of lending should be the guy who manages the risk, which is the bank. And these are the guys that consistently did a bad job.

Now partly it’s understandable. They were very politically connected. They were in the White House. They were in every government. So they knew that when things went badly, their friends in the White House would bail them out. And they were perfectly correct.

I was in the Council of Economic Advisers when the first of these began in the Mexican bailout. I said, “Why are we bailing out American lenders? Why are we using the name “Mexican bailout?” It’s not a bailout of Mexico. So the way you frame this is absolutely critical.

Then you’re asked the question, and you think about, What are the economic frameworks that are going to be necessary to make the European project work? The basic idea here is very simple. You have taken away two very important instruments of adjustment — interest rate and exchange rate. And you haven’t really put anything in its place. As an example, just to give you one of the ironies here. The worst manifestation of the crisis was Iceland. Iceland had a much worse crisis. But now they’re doing pretty well. You know, not great, but pretty well, because they had a flexible exchange rate and they restructured their debt.

What’s happened in Europe is they have not allowed it to restructure the debt. They’ve bailed out German banks, in effect. They’ve put the burden on Ireland and Greece and the other countries, which is beyond their ability to pay. It will happen. I mean, I think almost inevitably it will happen. Unless there is a real commitment of the European project. I don’t see that on the way.

Let me explain what I mean by that. Japan has a 200% — more than 200% — debt-GDP ratio. It’s not a problem. At least right now. If interest rates are 2%, 1%, a 200% debt-GDP ratio means you have to pay 2, 3, 4 percent of GDP to service your debt. Countries can do that. So, if there were a real commitment to have the European project succeed, interest rates would be low, the countries could repay, and there is no bailout. It’s just making sure that they can repay.

On the other hand, if you start trying to make profits off of the members of your family, which is what the German and other governments are doing. They’re quite proud about the fact. “We lent money to Greece at 5% or 6% and we borrowed at only one or two percent. Look it, we made several hundred millions of dollars of profits from our neighbors.”

This is a nice family relationship here. You make it … So if you’re going to charge 6% and you have a debt-GDP ratio of 150%, that’s 9% of GDP, it will go down the drain. And there will be restructuring. And they will have to pick up … the Germans will have to pick up the cost of restructuring the German banks, because there will be that kind of restructuring. And there should be.

So it’s really a political decision. Which of these alternatives Europe wants to go. Does it really believe in European solidarity, or does it want to have a restructuring.

Joseph Stiglitz giving us the framework to understand the past, present and future of the European situation.


The Great Recession lumbers on, met by the non-answers of monetary policy and austerity.

Some day Demand Side will begin the “I told you so” series. Not that we don’t remind our listeners how right we are as often as possible, but we need to remember that the low interest rates and other shoving of money into the pockets of the financial players has not worked, cannot work, and we predicted it would not work from the beginning. Likewise austerity. When there is too much unemployment and idle capacity, the answer is not to cut employment and reduce output, no matter how powerful the claimants to the income from that output are, nor how sophisticated the economic theories that suggest such a route is rational.

The starting point for prosperity is full employment of resources. The primary resource is labor.

Permit me a Nasrudin story. The Mulla Nasrudin is a famous folk character of Central Asia and Asia Minor, for whom there is no real comparable figure in the West. The mulla once decided to save money by reducing the feed of his donkey. Over time the donkey became more and more emaciated and less and less capable of carrying the loads required of him. Finally the donkey died. “Drats,” said Nasrudin, “I almost had him down to subsisting on nothing.”

What we are doing is no less insane, expecting to support our aging population, employ the millions of unemployed around the world, prepare for the impending climate crisis, and all the rest… How? By cutting back our spending on education, infrastructure, and employment. The planet is going to die and we’re going to say, “Drats. We almost had that debt paid off.”

But it’s worse than that, because the less we produce and earn, the less capacity there is to pay that debt and it actually grows in terms of burden. It is really no more complicated than that. The question becomes, “Where are we going to get the resources to employ our people doing the things that need to be done?”
The answer is, of course, from where the resources have migrated, into the pockets of the wealthy and into the coffers of the corporations. We need to – as quickly as possible – shift this – and not into the pockets of the poor, so they can spend on consumer goods and somehow generate demand for new factories, but into the investments for the future that employ the populations of the world. We can do it by providing investment opportunities for the investor class, opportunities that have a far more certain return than the McMansions they were so happy to invest in half a decade ago. Or we can do it by taxing them and directly shifting that resource to where it is needed.

The alternative is not muddle through to a more or less adequate outcome where the wealthy are secure in their wealth. That is not going to happen. THAT is the zero sum game. We need a positive sum game. The alternative is not more of the same monetary medicine. Although the Fed has proven it can write checks for useless financial instruments and put them on its balance sheet without causing inflation, that will change directly when checks are written for actual real investments that puts money into demand for real goods and services.

There is no muddle through. There is no arranging the real economy to fit the demands of the financial sector. There is only arranging our finances to meet the demands of the real economy.


Now let’s look at some observations from others

Paul Krugman

Under the title Is the ECB trying to provoke a financial crisis?:

…In Europe,… the pain caucus has been in control for more than a year, insisting that sound money and balanced budgets are the answer to all problems. Underlying this insistence have been economic fantasies, in particular belief in the confidence fairy — that is, belief that slashing spending will actually create jobs, because fiscal austerity will improve private-sector confidence.

Unfortunately, the confidence fairy keeps refusing to make an appearance. And a dispute over how to handle inconvenient reality threatens to make Europe the flashpoint of a new financial crisis.

After the creation of the euro in 1999, European nations that had previously been considered risky, and that therefore faced limits on the amount they could borrow, began experiencing huge inflows of capital. After all, investors apparently thought, Greece/Portugal/Ireland/Spain were members of a European monetary union, so what could go wrong?

The answer to that question is now, of course, painfully apparent… What to do? European leaders offered emergency loans to nations in crisis, but only in exchange for promises to impose savage austerity programs, mainly consisting of huge spending cuts. …

But … Europe’s troubled debtor nations are, as we should have expected, suffering further economic decline thanks to those austerity programs, and confidence is plunging instead of rising. It’s now clear that Greece, Ireland and Portugal can’t and won’t repay their debts in full, although Spain might manage to tough it out.

And there’s more, link online

On the other side are the bond vigilantes and the insolvent European banks, who must extract their full pound of flesh or the hysterical matrons of the market will … Will what? Take their money and put it … Where?

But there’s no doubt,

Here, courtesy of Calculated Risk is a relay under the title:
ECB Official says: “Orderly” Greek restructuring is a “fairy tale

Lorenzo Bini Smaghi, an ECB executive board member told the Financial Times in an interview that a Greek “soft” restructuring is a “fairy tale”.
“There is no such thing as an “orderly” debt restructuring in the current circumstances. It would be a mess. And I haven’t mentioned contagion – which would come on top.

“If you look at financial markets, every time there is mention of a word like restructuring or “soft restructuring,” they go crazy … “soft restructurings” “re-profilings” do not exist. They are catchwords that politicians have tried to use, but without any content.

I think that proves my point. Of course, there is orderly debt restructuring in that bondholders and the sovereigns can get together and come up with a reasonable write-down of the principle. What is not orderly is the exposure of the banks, and the ECB itself, to such an event. In particular, to the credit default swaps that nobody knows who has or who wrote or what, since they are under-the-table, oops, I mean, over-the-counter backroom bets.

The “contagion” is a catchword, not for any further deterioration of the sovereigns, but for the prospect of rational write-downs on other sovereigns that are likewise triggers for a credit default swap storm. As Stiglitz correctly describes it, this is a bailout of the bond vigilantes, the lenders, not the sovereigns.

Finally today, a few notes on taxation.

The Center on Budget and Policy Priorities observes that “simply letting the Bush tax cuts expire on schedule … would stabilize the debt-to-GDP ratio for the next decade.”

Mark Thoma comments “We are on the verge of trading tax cuts for the wealthy and spending on wars for large cuts to social programs (the budget hole the recession caused is helping to fuel the calls for austerity). Maybe that’s what we want, maybe not (and likely not if the polls are correct), but we ought to at least be more aware than we seem to be that this is the trade we are making”

What’s clear is that the radical and reckless tax cuts under W, combined with the wars in Afghanistan and Iraq explain virtually the entire federal budget deficit over the next ten years.

The great mass of the debt projected for 2019 is explained likewise by the wars and reckless tax cuts of W plus direct fallout from the financial downturn.

It would be cool if some of it were explained by our readying ourselves for the climate crisis or by educating our people or even by reeingineering our infrastructure.

But no, that would be too expensive.

Chart online

Elsewhere Lane Kenworthy is out with a piece examing the question:
Is Heavy Taxation Bad for the Economy?
A puzzle

Half a century ago, in 1960, taxes totaled about a quarter of GDP in Denmark, Sweden, and the United States. The tax take then began to rise in Denmark and Sweden, reaching half of GDP by the mid-1980s, where it has remained. In America it has barely budged, hovering between 25% and 30% of GDP throughout the past five decades.

It is Demand Side’s observation that the economic well-being of Denmark and Sweden has grown and surpassed that of the United States.

And we are in the first pages of Jeff Madrick’s book “The Case for Big Government,” which describes how America benefits when the government actively nourishes economic growth and deteriorates when free market orthodoxy dominates. According to the dust jacket, Madrick looks critically at how Republicans are cooperating with Democrats to engineer an era of stagnation and deterioration. Republicans in seeking to revive 19th Century principles and Democrats are abandoning the Great Society and New Deal principles. Quote Madrick paints a devastating portrait of the nation’s declining social opportunities and how the economy has failed its workers. Unquote

Happy reading.

Leave a Comment

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

%d bloggers like this: