Is Germany to blame for the euro crisis?

All the alternatives to eurozone ‘austerity’ involve redistributing more of Germany’s wealth to its neighbours. Giving the European Central Bank the power to act as lender of last resort to eurozone governments without limit will, via the new money created to do so, result in higher inflation in Germany. Schemes for debt mutualisation which propose to spread the debt of various eurozone countries among all members will be a boon for those with above average debt, like Greece, but less so for those with below average debt, like Germany.

Not surprisingly the Germans have been reluctant to embrace these schemes. Appeals to some shared European sense of identity have failed as this identity was a fiction in the first place. Another approach has been to mutter that Germany owes its neighbours because of the war. This approach has likewise failed as today’s Germans quite reasonably don’t feel the need to atone for what their grandfathers did.

But there is a more subtle, economically based argument that, partially at least, lays the blame for the euro crisis at Germany’s door. If this argument can be accepted then surely it is reasonable to expect Germany to cough up a bit?

The argument runs like this: with the assistance of Germany’s trade unions during the 2000s the Berlin government was able to hold down German wages. As a result German unit labour costs fell making German goods relatively cheaper than those produced elsewhere. As Philipp Bagus writes “Since the introduction of the Euro, Germany’s competitiveness, as measured by the indicator based on unit labor costs provided by the ECB, increased 13.7 percent from the time of the Euro’s introduction up until 2010. In the same period, Greece, Ireland, Spain, and Italy lost in competitiveness, 11.3, 9.1, 11.2, and 9.4 percent respectively”

The Germans were looking to sell and the PIIGS with their new, low, eurozone interest rates, were able to borrow the money to buy. Germany was, in effect, selling more than it was buying and lending the savings to PIIGS so they could afford to keep buying. Goods and loans flooded out of Germany and IOU’s flooded in. This showed up in the trade figures with Germany running a huge surplus offset by deficits around the Mediterranean.

By this theory Germany’s artificially depressed wages and consumption to some extent necessitated offsetting borrowing and consumption elsewhere. If Germany had allowed its labour costs to rise, so the theory goes, Germans would have consumed and imported more and PIIGS would have consumed and imported less.

It follows from this argument that Germany ought to let its wages rise which would have two effects: it would make the PIIGS more competitive by default and it would increase German consumption spending some of which, presumably, would be spent on goods or services produced in the PIIGS.

It is the same argument (most popular in the US) that is often made to lay the blame for the current mess at China’s door. If only the Chinese government would let the Chinese people consume more of the awesome output of the Chinese economy then American consumers wouldn’t have to assume this onerous burden on their behalf. The unsustainable debt and over consumption of the British, Americans, and PIIGS is necessary to balance out the saving and under consumption of the Chinese and Germans.

How valid is this theory? To some extent it reflects a prejudice against saving. In the current Keynesian climate saving is a dirty word; a reduction of the aggregate demand which supposedly drives the economy. But looking past this prejudice saving is vital to our economy. Without it there is no capital and without that there is no capitalism.

We must also remember that saving is simply an act of deferred consumption, an addition to tomorrow’s aggregate demand (conversely borrowing is the act of pulling tomorrow’s aggregate demand into today so the next time you hear someone wondering where all the demand went point them to 2000 to 2007 when the British public and government went on a borrowing binge). Few people save simply to admire their stack of fivers; they wish to spend tomorrow.

So as long as it reflects the actual preferences of economic agents, saving is a good thing. Here is the big difference between Germany and China. Whereas, in China, the full apparatus of totalitarian government exists to force its people to restrain their consumption (not that I support the Savings Glut Hypothesis) the same cannot be said of Germany. For all their cosy corporatism the German government and trade unions do not have the same sway over German workers as China’s Communist Party does over Chinese ones. That is not to say that they have none, but rather to suggest that German savings represent to a fair degree the preferences of Germans themselves.

The problem instead lies with what happened to these savings. Rather than funding investment which would yield an income in the future much of it was spent on current consumption and speculation in assets. In Spain and Ireland this flood of German savings produced a construction boom, in Greece it funded a ridiculously generous welfare state, and all over it funded a boom in retail spending.

For this the borrowers in the PIIGS and the banks in core eurozone countries who lent to them are to blame. But so, also, are the architects of a system which led both borrowers and bankers to believe (and we still wait to find out exactly how reasonable this belief was) that they would be bailed out by Germany if they ever got into trouble.

If the bankers and PIIGS want to keep accessing the wealth of German workers, the technical economic argument over trade imbalances might not fair any better than calling it modern day reparations.

This article originally appeared at The Commentator


Stop worrying about Greece leaving the euro. It won’t happen

Don’t call it a comeback

Stop worrying about Greece leaving the euro. It won’t happen.

I know that because Jean-Claude Juncker, head of the EuroGroup of eurozone finance ministers, said so.

I don’t envisage, not even for one second, Greece leaving. This is nonsense, this is propaganda”.

He assured us that the EuroGroup “will do everything possible” to keep Greece in the euro and had an “unshakeable desire” to do so.

Phew, so that’s all right then. And yet, and yet…I wonder.

Is Angela Merkel really willing to saddle her electorate with the burden of funding the welfare states of neighbouring countries which are more generous than anything found in Germany?

Are the Greeks really willing to keep cutting pensions and public sector pay and, occasionally, raising taxes at Berlin’s command?

If the answer to both of these questions is ‘no’ then Greece will exit the euro and it wont matter a damn what Mr Juncker says.

It could play out like this.

Greece could elect an anti-austerity government in the elections due on June 17th. They would refuse to enact the cuts demanded of them in return for the next tranche of bailout money. At this point the Germans could cave in and sacrifice their wealth for the greater good of the euro. But, assuming they don’t, Greece’s aid would be stopped.

The Greek government would now be faced with liabilities it couldn’t meet. Payments to bondholders or payments to employees and pensioners, one would go unmade.  It seems reasonable, since this would be an anti-austerity government, that it would be the bondholders who lost out.

This would be default. Greek borrowing costs, high enough to effectively bar Greece from capital markets and which would have risen even further on the withholding of the bailout, would skyrocket.

The Greek government, unable to borrow at any price, would be faced with the task of paying out in euros when it can no longer get hold of euros to pay out with. This is impossible. It would need to convert its liabilities into a currency it could get hold of, one it could produce at will. The drachma would be back and Greece would be out of the euro.

Without the restraining hand of the European Central Bank, the newly empowered Greek central bank would run the printing presses to produce the drachmas to pay its bills generating high inflation. The value of the drachma would tumble.

Some suggest that the drachma could plummet 40% below the euro before stabilizing. But the example of Britain’s recovery following its exit from the Exchange Rate Mechanism in 1992 is not an exact one; Britain replaced one monetary rule (exchange rate stability) with another (price level stability). It is not clear what Greece’s new monetary rule would be or if it would have one.

Let’s assume that Greece did adopt some new monetary rule following the devaluation of the 40 to 50 percent generally believed to be necessary to make Greek industry competitive again and get its economy moving. What would the effects be?

The wealth of Greeks held in euros would be reduced by 40 percent almost overnight. Ordinary Greeks would be impoverished on a massive scale. But the same would also happen to anyone who held Greek assets denominated in euros and this is where things could get nasty.

Foreign banks hold about €1trillion of Greek assets. If these were converted to drachma their value would fall by 40 percent. This would blow holes in the balance sheets of banks around Europe, particularly in France and Germany, but also in Belgium. Already short of capital these core country banks would hoard it, cutting back lending, triggering a new credit crunch.

There would be a new round of bailouts direct from euro member governments putting their already pressed finances under fresh pressure. Ironically, at a lower level, the Germans would find themselves in the position the Greeks find themselves in now. Renewed calls would be made for the ECB to be given the power to act as lender of last resort.

There is no guarantee it would stop there. As in 1992 the exit of one nation could prompt market speculation that others would follow, speculation that has a habit of becoming self-fulfilling. The prime candidate is Portugal whose borrowing costs would rise and Germany would be faced with the same question it had faced over Greece: whether to pay up.

After Portugal, Spain, Italy, Ireland and even France could all follow.

What are the chances of this coming to pass? The Greeks, for all the protesting and voting for anti-bailout parties, actually want to stay on the euro, the centre-right pro-bailout party is currently ahead in the polls.

And while the average German may not be keen on the idea of funding the early retirement of Greeks, leaders in the EU sometimes claim to be acting in the interests of some quasi-mythical entity called Europe rather than their national electorates.

Often this is just a cover for the most brazen kind of nationalist politicking but not always, the Germans sacrificed the Deutschemark after all.

It is possible that Merkel, who came under pressure at the G8 Summit to hand over billions of euros of German wealth to their neighbours, might just do so.

But what are we worrying about? After all, Jean-Claude Juncker says it can’t happen.

This article originally appeared at The Commentator

The sack of Berlin

Time for the return fixture?

Behind the current rebellion against ‘austerity’ lies the idea that we can carry on as before if only we can screw the money to pay for it out of someone else. But if the bond markets won’t continue to fund them, who do the anti-austerity activists think will?

The most popular answer is ‘the rich’, AKA ‘the 1 percent’. Musing on the Sunday Times Rich List recently, eccentric Labour MP, Michael Meacher observed that “the richest 1,000 persons…increased their wealth over the last three years by £155bn. That is enough for themselves alone to pay off the entire current UK budget deficit and still leave them with £30bn to spare.” Meacher clearly doesn’t know or doesn’t care how wealth works; the £155bn might not be in the form of cash but (more likely) in the form of assets which would have to be sold for cash which could only then be used to plug the deficit. However, there is no guarantee that these asset values would hold up if these 1,000 rich folks tried to sell £155bn worth at once.

But you also wonder how closely Meacher scrutinised this list. The top six on the list weren’t even born in Britain and attempts to expropriate their earnings so that our government can carry on spending could well see them skedaddle. Francois Hollande’s plan for a 75 percent top rate of tax will see a wave of latter day economic Huguenots flee France, taking with them the capital and entrepreneurial expertise that their religious forebears did when Louis XIV kicked them out.

But at the European Union level, for ‘the rich’ read ‘the Germans’. The backlash against EU austerity amounts to the argument that Germans should hand over more of their money to their Mediterranean partners.

There are two programmes which are widely trumpeted as being able to take the edge off European austerity. The first is the provision of liquidity by the European Central Bank. In practise this means that the ECB will begin printing money to buy the bonds of the squealing PIIGS, much like the Quantitative Easing carried out by the Bank of England. The effects are likely to be just as inflationary. The purchasing power of German incomes will be reduced to help out their Greek and Spanish neighbours.

The other is debt mutualisation. This essentially means that the debt of the eurozone members will be spread around more evenly. This is great if, like Greece, your debt is way above the average. It is less great if, like Germany, your debt is way below it.

Debt as a percentage of GDP

Source: The Guardian

But since the anti austerity activists are all about fairness how fair would it be to the Germans to have them fork out for everyone else? We hear that the “social fabric” of places like Greece, Spain or Ireland is tearing asunder but wasn’t that always the inevitable fate of a social fabric woven from easy credit and borrowed money?

Over the past decade, German workers, with the cooperation of their trade unions, accepted wage restraint and a rise of the retirement age from 65 to 67. As a result German unit labour costs fell by 16 percent between 1999 and 2007.

It was a different story elsewhere in the EU. With Germany running a current account surplus, it was sending capital abroad, essentially lending foreigners the money to pay for German goods, like a mini China.

This money flooded into the nations at the fringes of the eurozone who got German interest rates along with the single currency. And they knew how to spend it.

In Ireland, the boss of Dublin airport was awarded a salary double than that of the Chancellor of Germany. Government spending rose between 2000 and 2008 by 144 percent; welfare spending tripled. In Greece the public sector wage bill doubled. Pastry chefs and hairdressers were placed on a list of 600 professions deemed so “arduous and perilous” that they could retire at 50 on a state pension of 95 percent of their final year’s earnings.

So when you hear cries for the ECB to provide liquidity or for debt mutualisation, you are hearing cries for German workers to work till they’re 67 so Greek crimpers can retire at 50.

Sensibly you know that Angela Merkel will balk at turning her electorate into the galley slaves of Europe.

But then the EU and the euro have never been run on good sense. Between 387 and 455 tribes swarmed from modern Germany, across the Danube and carried off the wealth of Rome. The existential question for the euro is whether Angela Merkel will allow a return fixture.

This article originally appeared at The Commentator

Austerity is under attack


An end to the Broken Window fallacy

Austerity is under attack. Last weeks news that the UK has slipped back into recession was blamed on the government’s ‘austerity’ program. This weekends election of Francois Hollande to the French presidency, electoral gains in Italy for anti austerity parties, and chaos in Greece strengthen the hand of the so called ‘growth bloc’ which looks at the withering economies on Europe’s fringes and seeks an alternative to the tax rises and spending cuts of the austerity they hold responsible.

Across Europe it is being said that ‘austerity’ is not the answer. The choice is being as framed as austerity versus growth, as though riches are just a choice away. Sadly, and not surprisingly, it is not that simple.

When people say ‘growth’ what they really mean is increased government spending. But there is no connection between government spending and economic growth, if there were the Soviet Union may still be with us.

Indeed, for all the controversy about austerity across the west we see government’s borrowing and spending sums utterly unprecedented in peacetime.

Greece, with a national debt officially approaching 150 percent of GDP is going to run a deficit of 7 percent of GDP this year. The governments of Spain, Portugal, and France will all borrow around 5 percent of GDP this year. Britain, though, tops the lot. The British government will borrow over £120 billion this year, nearly 8 percent of GDP. The ‘cruel’ and ‘ideological’ cuts actually come in at a distinctly unaustere couple of percent.

In short, we are seeing massive borrowing and spending and our economies are still tanking. The argument that government spending = growth is plainly false. And with that the idea that there is a simple choice between growth and austerity disappears.

Anyone who after all this still clings to the idea that we can generate growth through increased government spending is suffering from some sort of hyper Keynesian psychosis; that we must push our deficits to 10, 15 or 20 percent of GDP, our debts to 150 or 200 percent of GDP. You could call this economic or suicide. If you were Monsieur Hollande you could call it an economic policy.

The ground upon which the ‘growth vs austerity’ plant has taken root was sown, to some extent, by those economists who pushed the idea of the expansionary fiscal contraction – the idea that the very act of cutting spending itself it would spur growth. But while budgetary balance might not be sufficient on its own for economic growth it is a necessary condition.

As countries borrow more and lenders come to doubt their ability to pay it back, the costs of borrowing increase. We’ve seen this with spikes on bond yields for governments in Greece, Italy, Spain, and Portugal during the euro crisis. These governments have had to pay more and more to borrow necessitating further spending cuts in other areas of government spending.

One alternative is to have the central bank buy the governments bonds with newly printed money. The European Central Bank has been doing as much of this as it can within its anti inflationary remit and seeks the power to do more. The Bank of England and Federal Reserve have been doing it lots and calling it Quantitative Easing. This has held down borrowing costs in both countries at the price, in Britain, of high inflation.

Inflation has been less of a problem in the US (on official figures anyway) but only due to the dollars status as global reserve currency which means that other nations will absorb almost any amount of dollars. Almost. The Federal Reserve’s monetizing of the debt is placing great strain on the dollar. The consequencesof a collapse would be catastrophic.

Either way, whatever people lose in austerity they will lose also with the inflation of the alternative, the decline in the purchasing power of their money. There really is no painless way out; no box to tick or lever to pull labelled ‘growth’ or anything else which will return us to the debt fuelled boom times before the credit crunch. As I’ve said before, as bad as it is, is as good as it gets.

The worrying thing about the anti-austerity backlash is that it indicates that voters still don’t really accept this. When asked if spending should be cut, taxes raised, and debt brought under control they generally agree in the abstract. But it seems they flinch from the reality of what this actually entails.

On official calculations, the debts of western countries are huge and growing. Unofficial calculations paint a much grimmer but probably more accurate picture. If even moderate attempts to slow the increase in debt – all austerity really promises in the short term – prove electorally unpalatable then western voters will be faced not with the bumpy landing of austerity but with the fatal crash of economic collapse. That, not debt fuelled growth vs austerity, is the real choice.

This article originally appeared at The Commentator

Money demystified: Stopping Keynes’s one man in a million


It’s on diversion

I’ve found that if I write an article about taxes, whether its avoidance or the 50p band, it’s likely to generate angry replies. But when I write about monetary matters, interest rates or Quantitative Easing for example, there is often a silence. Perhaps this is because few people share my interest in it, perhaps it’s because they think it less important than I do. Or perhaps, to borrow from Keynes, it’s because monetary policy works “in a manner which not one man in a million is able to diagnose”?

The textbook functions of ‘money’ are familiar to anyone with a smattering of economics; a medium of exchange, a store of value, and a unit of account. But each of these functions is entirely dependent upon money maintaining its value. If the value of the pound fluctuates it is no more useful as a unit of account or measure than a twelve inch ruler which kept changing length. Money which declines in value is a poor store of value.

Historically, when its value declines beyond a certain point people stop storing their wealth in money and trade it for commodities as quickly as possible. This acceleration in velocity of circulation exacerbates the decline in value and can trigger hyperinflation. And money which is rapidly losing value can cease to fulfill the function of medium of exchange if people refuse to accept it, legal tender laws or not.

So the value of money must be maintained for it to serve its functions and value is determined by supply and demand. Money is demanded for transactions, buying and selling. A few coin collectors aside, people do not demand money for its own sake but because they wish, at some point in the future, to exchange it for goods or services.

Under our present system money is supplied by the central bank. If people demand money to facilitate transactions why do central banks supply it? The motivations of the central banks who supply money are not the microeconomic ones of meeting transaction demand but macroeconomic ones which can change from time to time such as spurring GDP growth, decreasing unemployment, lowering inflation, exchange rate stability, or some combination of a couple of these. This is monetary policy.

Monetary policy is shrouded in mumbo jumbo but can be understood by anyone. Quantitative Easing, lowering the discount rate or the repo rate, Operation Twist, all of these monetary maneuvers executed by central banks essentially boil down to the same thing: the increase or decrease in the supply of money and credit to achieve some, one or two of the macroeconomic goals mentioned above.

When central banks reduce interest rates they purchase financial assets from banks with newly created money who then lend out some portion of this new money thus lowering interest rates. On the rarer occasions when they want to raise rates they do the opposite. Quantitative Easing is remarkably similar; it only really differs in that instead of buying short terms assets the Bank of England buys long term assets all of which, so far, have been UK government debt. Banks, in theory, then lend some portion of this new money out thus lowering these longer term interest rates.

There’s an obvious concern here. If money has to hold its value in order to fulfill its essential functions and if money supply is a crucial determinant of that value then won’t the tinkering about with the money supply affect its value?

But there’s another concern. Almost all the economic thinking upon which modern monetary policy is based models increasing the supply of money and credit as a once-and-for-all rise in everyone’s money holdings, proportionate to how much of the money supply they held before. This scenario is rather odd theoretically. If it’s true then monetary policy can have almost no traction and is pointless, all we will see are proportionate increases in price levels.

This line of theorizing is followed, it seems, simply to avoid thinking about the unpleasant consequences of monetary policy; the covert redistribution of wealth from the less well connected to the insiders and the permanent redistribution of wealth from those, like pensioners, on fixed incomes.

These consequences follow inevitably from the inclusion of time, an integral part of human existence and of sound economics as cause and consequence can only take place through time. If we include time we can look at how these expansions in the supply money of money and credit come about when central banks purchase assets from a bank. This bank now has money to lend out which it does. Its interest rates may fall but so will its borrowing costs (what it pays the central bank). As we see today, such action can lead to the sort of false profits which trigger multi million pound bonuses.

But there is a further benefit to these early receivers, these insiders. They receive this new money when prices are at the old level; it takes time for them to rise. As such, these early receivers are able to use new money to buy goods, services and assets at the old prices. However, as they spend this money and it is then spent by the second receivers, and then the third receivers’ etc prices are bid up. By the time the new money reaches those farthest from the monetary injection, the politically least well connected, often the poorest, the new money will have lost this power. They will simply face higher prices.

This is how monetary policy works. Central banks cannot create wealth but they can redistribute it. And the system confers a tremendous power upon those who exercise it. They are Keynes’s one man in a million and it’s in their interests, via mumbo jumbo, to keep it that way. Don’t let them.

This article originally appeared at The Commentator