A post by Edward Harrison
The Bloomberg video below is a bit sensationalist in my opinion. But it gets to the heart of the problem in Europe, namely Spain. Spain has an economy and debt which is an order of magnitude larger than Greece. That means that problems in Spain are more critical for the Eurozone than in Greece. But it also means that an EU bailout would simply not be feasible.
Watch the video and I will make a few other remarks below.
The first thing to realize is that government deficits are balanced by imports and private savings. I’m talking here about the financial sector balances, of course.
The chart to the left from the FT shows you that the collective financial balances in each individual Eurozone country must sum to zero. Where there is a government surplus it is matched by either the capital account or private balances. The same is true for deficits. Take Spain, for example. There, the government’s budget was in surplus in 2006 and it had a very large capital account surplus (the financial sector equivalent of a current account/trade deficit). This was matched by a substantial private sector deficit. By 2009, due in large part to an unprecedented housing bust, the government’s finances were in tatters. Look at the chart. This is matched by net private sector savings and a capital account surplus. The financial sectors must balance.
This brings me to the second thing to realize. Spain is to Germany as the United States is to China. In a fixed exchange rate environment, the U.S. is running an astonishing current account deficit while China runs an equally outsized surplus. Similarly, you can’t have Germany and Spain both running current account surpluses, unless the EU as a whole runs a current account surplus. This is something that Rob Parenteau ably gets across in a recent post.
So, if Germany (or the Netherlands) wants to be the export juggernaut and run a massive current account surplus, this has intra-EU ramifications. The most important is that Germany’s (or the Netherlands’) current account surplus (capital account deficit) is matched by current account deficits (capital account surpluses) in Spain (Portugal, Greece, Ireland and Italy). That’s how it works, folks. You sell more to me than I do to you and I get more cash than you do. There are always two sides to every transaction. It’s right there in the data.
The FT’s Martin Wolf is on to this and notes in his column yesterday:
In the short run, it is impossible to shift external balances quickly, particularly when domestic demand in the surplus countries is so weak.
Now Germany insists that every country should eliminate its excess fiscal deficit as quickly as possible. But that can only happen if current account balances improve or private balances deteriorate. If it is to be the latter, there needs to be a resurgence in private, presumably debt-financed, spending. If it is to be the former, there are two choices: first, current account balances must deteriorate elsewhere in the eurozone, entailing a move to smaller private surpluses in countries like Germany. Or, second, the overall balance of the eurozone must shift towards surplus – a “beggar my neighbour” policy.
In practice, the most likely outcome of such fiscal retrenchment would be a slump in countries with large external and fiscal deficits. Given the lack of competitiveness of such external deficit countries and the weakness of demand elsewhere in the eurozone, such slumps might become very long-lasting. The question is whether populations would put up with this. If not, political crises will emerge, with inherently uncertain consequences.
I would add to this by running a brief two-stage analysis of what happens under austerity (sorry, no charts yet). In stage one, we have the FT chart for 2009. Spain has an enormous budget deficit, which is offset by private savings and a capital surplus (more imports than exports). Germany has a smaller deficit and a capital deficit (more exports than imports) matched by a huge private sector savings.
If Spain is forced to run austerity measures as seems likely, in stage two, this shifts their government deficit markedly down. Given Spain’s poor labour competitiveness, sticky wage prices and inability to depreciate the currency, all of the adjustment falls onto the private sector in the form of reduced net savings (which could include larger debt burdens). But, the thing to realize is that total GDP in Spain is lower in this scenario, which means total imports are lower, which means Germany’s total export volume is lower. This is a deflationary scenario.
I know for a fact that Germany and Austria (another net exporter) are already cutting back their deficits, Austria via higher taxes. We see Ireland, Spain, Greece and Portugal doing ‘austerity’ measures to rein in government deficits too. Meanwhile, having seen the financial sector balances chart, you know that austerity means higher debt burdens in those countries, but also lower exports in Germany, which is also cutting back its own Government spending. So, austerity not only kills the Spanish economy and makes it prone to a debt deflation scenario, it also hurts the German export economy while they themselves are cutting back on government deficits.
What you have here is a perfect recipe for a double dip and a serious economic nightmare. Unless Germany can get its consumers to start spending more, Germany and the Eurozone are going to double dip, something Edward Hugh has already considered even before Germany’s crumbling export data were released.
Source
Germany’s eurozone crisis nightmare – Martin Wolf, FT
33 comments
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Spain is to Germany as the United States is to China,
Credit is to deception as the cock is to a vagina,
When your credit flows free and then it is plucked,
Austerity is ensured and the people are fucked!
Deception is the strongest political force on the planet.
have you been published yet?
Nothing ‘official’ Velobabe … I’m a self directed, free spirit, Renaissance man with a penchant for variety — jack of all, master of none … over the years I’ve developed a real hard on for the system, especially how it inhibits the spirits of all of us … writing couplets and free associational verse, for me, is a good way to bust out of the box of inhibition, and at the same time helps me crystallize my thinking … give it a whirl yourself … I would love to see some inner Velobabe …
It is always interesting to read such writing, since it seems to completely bypass the idea that there are a significant number of Germans that are thrilled that the idea of growth as the only measure of well being will be replaced by something else. This group is larger than the Green Party, though obviously, trying to fix a number is difficult. Especially as this type of thinking seems utterly alien to most Americans.
As a concrete example, the collapse of support for the FDP (losing roughly 50% of its support in its first hundred days as a government coalition party), with its avowedly pro-market stance, simply hasn’t registered. As another concrete example, the news that German CO2 emission sank almost 9% due to the Wirtschaftskrise was seen as a very positive benefit of reduced economic activity. A gain worth holding on to, actually, since for many Germans, it has always been clear that the only way to reduce pollution is to pollute less. Which means less growth, of course.
No one promotes less consumption because there is no money in it for corporations.
There is money in new gadgets though, either just for feeling good or otherwise, that let you consume the same but pollute less…maybe or mabye not, with the ony certainty that there will be other problems down the road arising from these new gadgets.
‘No one promotes less consumption because there is no money in it for corporations.’
Let me introduce you to the German word ‘Konsumterror’ – which originated at roughly the same time the Green Party began to form. Not everyone promotes more consumption – but don’t expect a media based on advertising to let you know just how many people do promote less consumption.
I would also argue that the cutbacks in the social ‘net’ (Hartz IV, anybody?) and the continuing uncertainty is likely to push up the savings rate rather than have this money available for consumption.
So, if the EU is successful in banishing swaps on sovereign debt, will the outcome of a double dip in Europe have a lesser impact globally?
I know Yves is a proponent of just banning swaps outright. I’m not, but I am moving in that direction over time. You probably saw the Rajiv Sethi piece which showed the asymmetric risk makes CDS a pretty heinous product.
http://rajivsethi.blogspot.com/2010/03/on-asymmetry-reflexivity-and-sovereign.html
But, right now the swaps talk is pure politics. Politicians are always looking for someone to deflect the blame onto to minimize damage. Swaps have nothing to do with the problems in Greece right now. So I don’t see much relationship between CDS and a potential double dip in the euro zone.
I’ve no doubt that swaps are not the basis of EU problems, but the “bets” that are the basis of these sovereign swaps have repercussions far beyond the local problems, and if they are anything similar to AIG’s losing bets the contagion could have global repercussions not limited to EU concerns. That leads me to believe that the EU would be doing all of us a favor if they banned these financial “WMD’s”. Since the US finds these instruments so appealing.
Ed says — “Swaps have nothing to do with the problems in Greece right now.”
BS on that Ed!
Swaps should go! All of these parasitic, overleveraged, non productive for society at large, voodoo, ‘credit’/’insurance’/’bullshit’ derivative products should be banned!
De-privatize the, ‘socialized’ banking for the wealthy ruling elite few, and socialize banking for the people. Make credit a public utility and rebuild the producing economy with direct funding by government. Fuck the fed, the imf, nafa, gatt, fico scores and all of those other self serving, parasitic, enslaving bullshit scams!
Strive for the “threshhold” Ed …
Excerpt;
“Jeffrey Friedman’s analysis of how Cioffi and Tannin clung to their beliefs in the face of mounting evidence to the contrary until the “threshold” was cleared and they finally threw in the towel is a perfect example of this phenomenon. In Ramachandran’s words, “At any given moment in our waking lives, our brains are flooded with a bewildering variety of sensory inputs, all of which have to be incorporated into a coherent perspective based on what stored memories already tell us is true about ourselves and the world. In order to act, the brain must have some way of selecting from this superabundance of detail and ordering it into a consistent ‘belief system’, a story that makes sense of the available evidence. When something doesn’t quite fit the script, however, you very rarely tear up the entire story and start from scratch. What you do, instead, is to deny or confabulate in order to make the information fit the big picture. Far from being maladaptive, such everyday defense mechanisms keep the brain from being hounded into directionless indecision by the ‘combinational explosion’ of possible stories that might be written from the material available to the senses.” However, once a threshold is passed, the brain finds a way to revise the model completely. Ramachandran’s analysis also provides a neurological explanation for Thomas Kuhn’s phases of science where the “normal” period is overturned once anomalies accumulate beyond a threshold.”
http://www.macroresilience.com/2010/02/17/natural-selection-self-deception-and-moral-hazard/
Deception is the strongest political force on the planet.
The eurozone is a regional example of a global problem. What is needed is coordinated action at all levels, but this requires leadership. The natural focus for such leadership is Washington on the global scale just as it is Germany and France in Europe. But there is no leadership. It is laughable to expect it from Team Obama or even the American political system in general. The same is true in Europe with Merkel, Sarkozy, and Brown. The result is that in the eurozone there is no European strategy, only a series of individual ones. But it is like the paradox of thrift: what makes sense at a smaller scale makes no sense, and is even highly destructive, at the macro-level. Europe needs to balance its accounts at a European level. To do otherwise is to allow Europe’s more powerful economies to operate at the expense of its weaker members, and this will inevitably lead to the destruction, not the construction, of European economic and monetary unity.
Well, your point is why we rid ourselves of the Articles of Confederation. Looking for the kind of leadership and coordination among actors without actual enforcement mechanisms won’t work during any kind of downturn. Everyone will be out for themselves.
Thats why globalized economies without corresponding changes in political structures never made sense. Elements of the Eurozone worked in the larger scheme of American Empire such as pushing West Germany and France together with the buffer states along for the ride, but moving beyond that things get dicey.
The problem is that Germany’s main competitor is China. German know-how is competing with cheap chinese labor. But as long as China artificially pushes its export by keeping the yuan heavily undervalued, Germany can’t afford to increase its labor cost without risking loosing most of its industry and becoming another Great Britain.
So one way out could be the threat of a import tax on Chinese goods into the EU (and the US). If China then revalues the yuan, there is room for higher wages in Germany. But if China doesn’t, we are in for a trade war which in turn might lead to a depression, the occurence of which we are trying to avoid in the first place …
One other idea to reduce the imbalances between Spain and Germany in the future could be something like “desertec light” – EU funds paying for German companies building lots of solar farms in southern Spain (where they are running out of water for intensive agriculture anyway; using solar updraft towers with extenive agriculture underneath the roof might work best) and distributing it north to EU countries. Problem: north of Spain lies France which has lots of cheap nuclear power …
Desertec light already exists in Southern Spain. In fact, Spain exports electricity to Morocco and France.
The problem is: European electricy grids are not interconnected enough. There are works right now to increase capacity on Spain-France electric interconnection, but it will take some years until energy exports to Germany via France have any macroeconomic significance.
But you are essentially right: that moment will come, sooner or later.
If the world needs cooperation by sovereing equals to be saved, the world is probably “fudged” on this issue as well as many others. The post-WWII structure was a result of a unique situation in 1944-45 where almost all the other sovereigns were destroyed, or in Germany’s and Japan’s case, about to be destroyed, and two of the surviving sovereigns, Britain and Russia, were very dependent on the U.S. And it was a population where the majority was more internationally minded and more concerned in a long-term interest in stability than any time before or since. Germany and China I guess believe we can all export to Mars. And instead of Roosevelt in 2016 we are going to get Palin/Cheney or Romney/Cheney. Yep, fudged we all are.
I am offended by the assertion that all the masses have to do is go consume and everything will be better. Over consumption is one of the problems that got us here and it is unsustainable besides.
I believe that the US can no longer sustain the consumption level it has had and that regression to the developed world average will muck with export and import balances everywhere. There seems to be no coordinated effort to come to grips with the fact that we cannot employ an increasing percentage of the world population….unless we return to the unsustainable marketing driven crap production, distribution and consumption model.
Unfortunately all the best minds are focused on continued rape and pillage of the world masses for the rich instead of sharing and getting along of humanity in general….or they have been eliminated over the years.
Bring on the evolution.
They are not the ‘best minds’ if they don’t get the big picture right.
Education today consists of instilling a sense of superiority and serves only to enlarge one’s ego so that one can transition flawlessly from being an ardent communist to a ruthless capitalist, or the other way around, in no time at all. The only common denominator with all these people is that they all are our ‘best minds.’
Great analysis, but one thing I think you should point out is that this is the real meat of Keynesian thought. His prescriptions have been completely bastardized, and the coming depression is going to be far worse than it has to be because policy is the exact opposite of what he said.
That said I believe a mild depression was inevitable anyway from too much debt and malinvestment, and see his ideas as a way to minimize the impact.
We are either in pre-depression or depression (the correct name for that should be waking-up).
So, this is what a historical time line should look like:
Predepression – Waking UP – Predepression – Waking Up – Predepression – Waking Up…
You can call Waking Up by another name if you want, Enlightenment, for it is during this time one sees clearly the decadence, the wastefulness and the idiocy of the preceeding Predepression period.
Wolf’s implicit assertion is that economics can overcome the laws of physics and solve a problem of permanence (lower demand) by shuffling the deck. In fact this is the halmark of Keynesian thinking and why everything written by the caste should be viewed accordingly. Wolf had an article up about savings (perhaps this is the same one) where he completely ignores externalities like savings on demand via the global QE regime (and yes I know what QE is).
“Austerity not only kills the Spanish economy and makes it prone to a debt deflation scenario”
Sadly Benron and his cohorts in the caste linger in denial: there will be no escaping the debt deflation unless of course you view it as the logical bridge to hyperinfation. Turning to fellow FTer (or is it Citi) Buiter’s rehtoric: the caste are a bunch of barbarous relics
Top European Union officials hit back on Thursday at criticism from Tim Geithner, US Treasury secretary, who has accused Brussels of pushing ahead with rules to regulate managers of hedge funds and other alternative investment funds that could be protectionist.
A spokesman for Michel Barnier, the new EU internal market commissioner who is responsible for financial services regulation and to whom Mr Geithner addressed his concerns, said that the EU decision to act on hedge funds was in line with a G20 decision to reinforce transparency in the financial system.
The biggest (issue) is the so-called “third country” issue – the access, and the terms on which this would be given, for alternative investment fund managers (AIFMs) from outside the EU to market to professional investors within the bloc. This was the issue that Mr Geithner raised and which has sparked fears of protectionism.
from:
http://www.ft.com/cms/s/0/3a2d919e-2d1e-11df-8025-00144feabdc0.html?ftcamp=Late_headline1/NL/USMar2010/Vanilla_geitnr/0/
The first thing to realize is that government deficits are balanced by imports and private savings. I’m talking here about the financial sector balances, of course.
The chart to the left from the FT shows you that the collective financial balances in each individual Eurozone country must sum to zero. Where there is a government surplus it is matched by either the capital account or private balances. The same is true for deficits. Take Spain, for example. There, the government’s budget was in surplus in 2006 and it had a very large capital account surplus (the financial sector equivalent of a current account/trade deficit). This was matched by a substantial private sector deficit. By 2009, due in large part to an unprecedented housing bust, the government’s finances were in tatters. Look at the chart. This is matched by net private sector savings and a capital account surplus. The financial sectors must balance.
———————-
A long time ago, people did not trade but grew their own food and paid government part of their harvest. What people did not eat became their private savings. And if it was a good government with few public sevants, it would also have some surplus.
In that world, you could have government surplus and private savings.
Edward Harrison, what happened to that world?
I commiserate with your viewpoint 100%. I don’t expect to live in the olden times ever again, but when everyone speaks about sectoral imbalances, no one qualifies the argument with “The reason that period to period GDP cannot fall is because …” other than that the economy cannot recess at all costs. I actually believe a lot of analysts believe the tail wags the dog. Consequently, we have a bunch of analysts preaching that since if government spending falls, the only other possible option is for the private sector to lever up and take on more debt, like a formula dictates reality. I hate that argument because I know when I pay down debt, I’m not asking whether or not the government is going to assume an equal amount of debt to counter my savings. I’m just doing what’s right for me. It’s only the analysts that come in and tell us that G has to do something that is right for me after the fact and I say fuck G and those analysts (Marshall in particular). Let’s do as Ed says and write this debt off and take some pain. True leadership would prepare the American people for some pain and get them through it as a nation.
Many people speak of the need to promote domestic consumption in Germany, but I haven’t seen anybody with a serious suggestion how to do that.
Here on the blog somebody mentioned more immigration, because immigrants would take on debt. But that is mostly non-sense. Unless they migrate into the social safety net (and thereby producing more gov’t debt), the effect is even to the opposite, as immigration lowers the negotiation power of workers.
Another issue was the promotion of house ownership. Unless people use more housing space, this has no effect at all. The people, who sell the houses will than have the cash, which they need to invest. Possibly this would even increase savings, as people would try to pay down their debt as fast possible. Of course house price increases have lots of other negative effects on the society and financial stability…
Wolfgang Münchau, with a bit more local knowledge, suggested income tax reform. But how does that help? Actually the Bundesverfassungsgericht has limited the maximum tax rate to 50%. The current maximum rate is 47.5%
So a major tax increase is basically impossible.
Of course this is probably not what he thought. But how does a tax reduction in the income tax increases spending. Most people, who don’t save anything pay as well little income tax. Most people with high taxes would just add to their savings, if they paid lower income taxes.
Of course lower taxes would have to be paid with something. So does he mean, a much higher deficit or cuts in spending (mostly transfers to people, who actually do spend the money).
Some people have suggested lower value added taxes. But in the short run, this would be just absorbed by the retailers. Nobody actually reduces prices and in the absence of meaningful inflation the non-increase in prices would not translate to higher buying power.
Then there is the possibility of massive infrastructure etc. investment. For sure something could be done there, but by far not enough to actually create so much demand to have large impact. And again the question is, how to finance it. Is it just a call for larger deficits?
I have my theory for why people don’t spend, but I have no easy cure for that. The claim by some people, that it is the increasing inequality doesn’t seem very reasonable, as in the UK, USA, France, Italy, etc. more unequal societies have current account deficits, so I assume a different reason…
However, I would be really interested in further opinions on which political actions could improve the situation.
So you think if Germany’s population increased 10% over the next decade, consumption would barely grow? Of course it would.
If you increase homeownership, people don’t save via bank accounts, but via homes. This leads to a wealth effect and higher consumption, since home prices tend to increase indefinitely if immigration is encouraged.
A bubble, as in Spain, or as in Germany in the 90s, must be avoided at all cost. But there’s also no point in bulldozing huge apartment complexes in East Germany, where immigrants could be injecting new life into the economy.
Another factor is Germany’s aging. People buy homes and take credit when young; Germans are too old (and getting older too fast) for consumption to increase. Which is another factor why immigration is so good.
Germany could also reduce its VAT and liberalise its non-tradable sectors: hairdressers’ surely should not need three years of education in order to open its own shop.
If these non-tradable services (e.g. hairdressers’, restaurants, etc.) were much cheaper (as they would with liberalization and immigration), people would use them every week, not once a month.
Results: increasing consumption, wealth and employment, and decreasing external competitivity at the same time, hence balancing its economy.
sending immigrants to east germany would hardly solve anything. People move away from there because there are no jobs (unemployment rate is 15%).
And second, immigrants from where? We already have 15 million migrants, mainly from Turkey and it remains questionable if that’s really a good idea because a not so small part lives from the german welfare state.
Migrant study
Poor, unemployed and without education
http://translate.google.de/translate?hl=de&sl=de&tl=en&u=http://www.spiegel.de/politik/deutschland/0,1518,629715,00.html
“Migrant study”
“Poor, unemployed and without education”
Imagine you are middle-class, employed and with education. Would you go to a country where immigrants are not welcome?
The end result: only the uneducated poor keep moving into that country.
You’ve got hundreds of millions of hard-working Latin Americans, Eastern Europeans, Africans and Asians, able to read in their native language, educated in engineering, medicine, etc. or with good manual skills, who would be able to work in the German manufacturing and service sectors as well as a German native after some years of experience.
Regarding Turkish third-generation poor and the lack of integration: well, Germany has one of the lowest social mobility in its education system among developed countries (see PISA). Manufacturing workers’ children don’t go to university; why would the children of the Turks?
hm, and what’s your theory? I like the theory from Thomas Fricke.
http://translate.google.de/translate?js=y&prev=_t&hl=de&ie=UTF-8&layout=1&eotf=1&u=http://www.ftd.de/politik/deutschland/:kolumne-thomas-fricke-viel-wind-um-wenig-wunder/50087373.html&sl=de&tl=en
http://www.ftd.de/politik/deutschland/:kolumne-thomas-fricke-viel-wind-um-wenig-wunder/50087373.html
First I should mention that it is as well unreasonable by now, to assume the reduced capital productivity due to the increased interest rates after the Euro introduction cause the CA surplus, because the return on actual investments has been higher in Germany than in many other EU countries.
However, there may be reasons, why an additonal premium is demanded by investors to put their savings to Germany.
1) Germans want to play it too save. So when they (we, I’m German, but I wouldn’t include me here) save, they prefer saving in very secure investments. This can never translate to equity, but only to ‘Fremdkapital’. But without equity, the corporations can only take so much debt on. Foreigners want a premium to invest in a foreign country, where they don’t know the situation so well as at home. This has changed in the last years a bit, but it is still very reasonable to assume a lot of home bias especially for equity for new and small companies. So Germany has an equity shortage, and a surplus of savings for riskless (or perceived as riskless) investments. So the savings move to the countries where there is more equity as collateral for credit.
This is consistent with the observation, that Germany has a lower net investment rate than France. The lack of demand in Germany is not just consumption, but as well a lack of investment. The IIP surplus is mostly held im bank credits, not direct investment, so in holdings, that are perceived as very save – Omas Sparbuch is essentially the bas for bank credit.
Another reason for capital fleeing Germany in my opinion is the severe political risk. And actually my opinion matters here, as I think, that many other Germans with high savings see the same risks.
Lafontaine last year suggested to disappropriate all entrepreneurs with more than one factory hall. Now while I don’t believe a gov’t with ‘Die Linke’ would go so far, there is a severe risk to the profitability of corporations, demanding a risk premium. But in an open market this leads to capital flight at least for some time.
The last thing is the question, why are people not more consuming.
Here in my opinion a strong social pressure not to show too much how wealthy you are plays are role. When the iPod came out, Germany wasn’t considered an important market at all. Simply for the reason, that Germans usually don’t by luxury products in masses. Even people who can afford a iPod just buy 20 Euro MP3 Players. Everybody buys at Aldi and not even Fride Springer has a driver, but drives herself.
So the savings doesn’t come from desperate wish to save, but basically from being unable to spend more than average income money in a socially acceptable way, that at the same time seems to give any personal gain.
While Germans do have different consumption patterns than other countries (e.g. less money for quality food and clothes, less importance attached to brands in electronics, etc.), I wouldn’t say they don’t love luxury products.
Just take a look at how many Audis and BMWs populate German Autobahnen. Statistically, many more than in other countries.
The problem with Germany is a lack of consumption and investment *growth* over the last decade, mainly related to a lack of general economic growth.
Lack of immigration, a rigid education system and an uncompetitive service sector (due to an unliberalized legal framework) are a huge part of the story.
Oskar Lafontaine is an outright hardline Communist, but I wonder if Germany wouldn’t be better off today had he imposed its opinion in the late ’90s and Germany had incurred in large deficits to support domestic demand and investment.
” Austria via higher taxes”
Well hooray for Austria. It’s always amazing how much Americans have bought the no-taxes ideology. Even the Americans who say that want to raise taxes, can’t bring themselves to raise taxes in a recession. It’s Laffers on the right and Keynesians on the left, or freshwaters against coastals, but they all share the same free-lunch philosophy.