European Fiscal Union may be Closer.

[innonimatu]

My main argument is that wage depression in Southern europe is inevitable and -at least right now - beneficial because it suppresses consumption.
In my opinion the root cause of all this is that consumption in many European nations didn't fit productivity and resulted in said service and consumption driven economies (basing on housing and retail booms etc.).

That's too simplistic an explanation. The original problem, the economic (I won't go into political responsibilities just yet) cause of the crisis, was misallocation of investment, and there were two different kinds of it. In some cases investment was allocated not to satisfy national demand but to satisfy speculative cross-border demand. The housing boom of Spain is one possible example: most of the financial capital came from outside, and the future expected demand was supposed to come from there also. A gamble which went wrong. But in most cases foreign capital fueled consumption because there was nothing else profitable it could fuel. And because capital which enters a country as a loan must almost by definition be spend (or lend back) abroad, that which was consumed was imported. It all (capital floes and trade flows) must balance in the end. So trade deficits had to rise if banks were not prevented from lending. Because so long as they had capital available from abroad they'd borrow it and lend it out inside the country. And EU rules prohibited states from curbing or even directing those bank loans.

Now, you can complain that if only those countries had borrowed for importing productive assets it would all have been sustainable. But... could both the demand and the preference for productive assets exist to the scale where all that available capital offered to and by the banks would be invested that way?
No. Because no one else was buying. Why would people buy productive assets? To produce. What for? To sell, mostly. Which is only profitable if you aren't being undercut in your prospective markets. Sure, there were possible productive investment, and there were some productive investments made. But no way could the scale of the flood of capital which followed the monetary union be employed that way. The only way to avoid the problem would have been to prevent most of those loans from being taken in the first place. And here we should look more carefully at your graphs (thanks for collecting those btw) of the current accounts for some of those deficit countries. I'll get to it shortly.

What German and Dutch and French capital did to the Southern Europeans it did not do to the Poles and Czechs and Slovaks etc. simply because they refused to spend said capital on consumption maintained by imports. Much of the capital that moved there was actually invested.

The scale of loans directed there were much smaller in scale. Today Poland's external debt is what 1/10th of that of Spain? In particular, their banks had access to loans only at higher rates. Which was good for them. They could absorb a large portion of those as productive investment, because the lenders who demanded higher rates also were more concerned that there be a productive application for the funds, capable of paying those rates. For everything there is a saturation point, and that includes foreign loans and even "foreign investment", typically but erroneously presented as always a good thing.

Both the people and the politicians of Southern Europe wanted the monetary policy and monetary strength of Germany but refused to accept the public sentiments and economic policy that has to come with that monetary policy.
They have to do the following: Embrace wage equality, embrace sustainability (translation: low growth) embrace policies and taxation that favors labor, saving and investing over consumption.

Sorry, but it is entirely false that these public sentiments were supposed to come with monetary union. I mean, why would anyone sign up for a monetary union if a condition to carry it out was "low growth"? That's the absolute opposite of what the union was sold on! And how are governments supposed to control consumption if they can't control their banks and the capital flows of their countries? Only by reducing wages to the point where it is clear even to the dumbest banks that any consumer lending will be too risky. But that doesn't add up with favouring labor in wages! If you truly favor labor (something which Germany clearly has not been doing!) you get higher consumption.

My point here is that economies are demand driven. Southern Europe and only Southern Europe can control how much capital it pulls from the north and how it it allocated.

How?
Could the southern governments have nationalized all banking and have them refused foreign loans? And forbidden foreign banks from coming up and offering loans? Nope, the EU forbade that. In fact, integration into the EU was the excuse used to privatize banks in my country, a disaster in the making which I remember quite well.
Could it have slapped customs duties on imported goods to inflate their prices and reduce demand? No.
Could it have raided VAT and prevented people from going abroad to buy in a country with lower taxes? No.
Could they have raised those and other taxes to curb consumer spending? Yes, theoretically, but imagine how well it would have gone: "you see, we must raise taxes because of this euro thing we just got the country into, without asking you people in any consultation, btw." Politically, it was impossible: the EU and the Euro were sold on the promise of better living conditions, and even with those (delivered through increased but unsustainable lending) the EU had its new treaties rejected in several national referendums. Before its present obvious crisis.Also, what would those governments do with the extra tax receipts? If they redistribute or reinvest it in unproductive stuff, it's the same (macroeconomically) as if they hadn't collected it. If they invested it on enterprises capable of actually producing and exporting goods (to avoid those trade deficits) they'd be held in violation of the competition rules of the EU!

Yes, lets have a look at Portugal in all its pre-Euro glory:

...and Spain...

...and, of course, Greece:

That's current account balance starting in '67.

So, what did we see?

I see three graphs that back my blaming of the new institutional arrangements of the Maastricht Treaty and the Euro for the huge increases of the current account deficits of those countries.

The euro didn't come into being in 2002. Not even in 1999 when the exchange rates were fixed. The whole mad project started being implemented in 1993 with the treaty and became irreversible, with most of the the participants obvious, by the mid-90 when the membership criteria was settled. And, because capital flows within the EU had been "liberalized" back in 1990 this was all it took for the cross-border lending inside the future eurozone to take off. Which was politically encouraged, as it was seen then as a validation of the monetary union project: "you see, we're already having an impact, this thing is gonna work".

Then there are two possible consequences of that negative trade balance: Either you have your currency depriciated (which ends the consumption spree and makes the growth go poof) or you have a significant inflow of foreign capital - most likely in the form of private debt, which ends the consumption and corrects living standards and trade balances.
All the Euro did was to eliminate that choice.

No. What the Euro - and in fact we should say instead the Maastricht Treaty where it and EU wide capital deregulation were cooked up - did was to enable those trade deficits in the first place. Before things could get a little unbalanced and then it'd be time to settle the accounts back - some pain, but doable, especially as states still had available the whole usual rage of policies any sovereign state has. Now? Well, frankly the mess is such that no one seems to know what to do.

 

[Ayatollah So]

The only unusual thing here is that the PIIGS can't adjust (i.e. reduce) their consumption (i.e. living standard) the "normal" way (via devaluation of their currency).

That's a damn big "only" thing.

 

[Verbose]

To my thinking convergence of the Eurozone economies will happen, or things will fall apart. How either of these is achieved can apparently vary though.

The fundamental problem to me remains one of poor econimic growth in the Eurozone. And for me the important feature of the situation really is that even Germany hasn't managed much growth at all, and it's supposed to be the "model country" here, in which case everyone is deep in the cacky. Adopting some kind German recipy here can't help propel any of the now indebted nations out of their predicament. And would most likely cause a direct economic depression, which considering the size of the economy involved is more than likely to go global. And no one really wants that.

Then again, I suppose things might also work out just by getting enough security harness on the debt situation to stop the worst market jitters, then the ECB inches inflation up a bit, and Germany again allows wages to rise at a rate faster than the rest of the Eurozone, which preferably now is very hawkish on reining in that kind of thing. The value of the Euro depreciates, the PIIGS do get some overdue economic and administrative overhaul, and Germany starts acting less like the Great Attractor within the Eurozone, and things might get a tad more balanced. It would hardly amount to more than muddling through, and would probably cause a Lost Decade as far as serious economic growth is concerned, but perhaps it just might stave off actual depression?

 

[Leoreth]

Then again, I suppose things might also work out just by getting enough security harness on the debt situation to stop the worst market jitters, then the ECB inches inflation up a bit, and Germany again allows wages to rise at a rate faster than the rest of the Eurozone, which preferably now is very hawkish on reining in that kind of thing. The value of the Euro depreciates, the PIIGS do get some overdue economic and administrative overhaul, and Germany starts acting less like the Great Attractor within the Eurozone, and things might get a tad more balanced. It would hardly amount to more than muddling through, and would probably cause a Lost Decade as far as serious economic growth is concerned, but perhaps it just might stave off actual depression?

I think that's exactly what's going to happen. I don't think it'll amount to a lost decade, but certainly we will have to pay off mistakes that were made at the conception of the monetary union. I prefer paying them off by slower growth for some years instead of a complete crash now.

 

[Marla_Singer]

It would hardly amount to more than muddling through, and would probably cause a Lost Decade as far as serious economic growth is concerned, but perhaps it just might stave off actual depression?

Seriously, don't you have the feeling that the two last decades were already lost for Europe?

I mean, what do we have to regret? Current unemployment and growth figures aren't really more terrible than the european average since 1990. We're so addicted to the English speaking financial press that we behave as if we were in the US!


Sorry but I prefer some tough times that offer us a fresh new start than to keep going endlessly the same logic which has failed since the 1980's : unemployment, sluggish growth, debt.

 

[Marla_Singer]

I think that's exactly what's going to happen. I don't think it'll amount to a lost decade, but certainly we will have to pay off mistakes that were made at the conception of the monetary union. I prefer paying them off by slower growth for some years instead of a complete crash now.

The euro is not the cause of the crisis. Lehman Brothers bankrupcy is.
You're all brainwashed by the WSJ, that's just insane!

 

[Cutlass]

The euro is not the cause of the crisis. Lehman Brothers bankrupcy is.
You're all brainwashed by the WSJ, that's just insane!

Wasn't Lehman either. Though both Lehman and the Euro definitely are contributing causes. But it really goes far deeper and is spread far wider.

 

[Verbose]

Seriously, don't you have the feeling that the two last decades were already lost for Europe?

I mean, what do we have to regret? Current unemployment and growth figures aren't really more terrible than the european average since 1990. We're so addicted to the English speaking financial press that we behave as if we were in the US!


Sorry but I prefer some tough times that offer us a fresh new start than to keep going endlessly the same logic which has failed since the 1980's : unemployment, sluggish growth, debt.

Me? I'm still kind of cheezed over what a complete dud the bold pronouncements of European Council meeting in Lisbon in 2000, about how in the coming decade the EU needed to become the most competitive knowledge-based economy in the world. http://www.consilium.europa.eu/ueDocs/cms_Data/docs/pressData/en/ec/00100-r1.en0.htm

Actually accomplishing it might not have been to realistic, but what we got was an abject failure. So yes, in that respect I do agree with you that the EU has experienced a "lost decade", for the most if not all. Get back to that, and have some lean years in the process, fine. It's just that we don't need "tough times" for the sake of, well, tough times... This is not morality play after all.

Because the experience of the last decade varies quite a bit. I doubt the former eastern bloc EU members consider it too bad. And I'm in Sweden, and we definitely have had a far, far better decade in the 00's than in the 90's, despite the last bit of it being off. From a Swedish perspective it's been less unemployment, less debt, and robust growth.

 

[Leoreth]

The euro is not the cause of the crisis. Lehman Brothers bankrupcy is.
You're all brainwashed by the WSJ, that's just insane!

When a bridge collapses in a storm, the cause of the collapse is the storm, but that it isn't properly constructed is also a factor.

 

[Marla_Singer]

When a bridge collapses in a storm, the cause of the collapse is the storm, but that it isn't properly constructed is also a factor.

But the bridge still holds.

Financial markets aren't happy, but it's not because we failed to make them happy, it's because we didn't want to. It was easy to satisfy them, we only needed to print money. And after 4 months of debate, we considered it wasn't in our interests and we decided not to.

So yes financial markets are pissed, but they only represent short term interests, not long term. And meanwhile, the17 countries of the euro area together will have in 2011 a public deficit representing less than half of the 2011 US public deficit.

 

[Leoreth]

I don't argue the Euro has failed. I argue it has flaws.

And the Eurozone governments tried all the time to make the investors "happy". The thing is, investors don't want to be happy. They either want their investments to be sufficiently safe or sufficiently profitable. A lot of time was wasted by trying to regain the investors' "favor" while changing little that accounted for the factors I've mentioned.

 

[Mise]

If you don't want to have to worry about what the bond markets think, don't borrow from them. Simple as that.

 

[Leoreth]

Of course. Didn't want to make it sound as a critique of bond markets, quite the opposite.

 

[kronic]

The euro is not the cause of the crisis. Lehman Brothers bankrupcy is.
You're all brainwashed by the WSJ, that's just insane!

No, I'm afraid you're wrong. Lehman may have been the trigger but the underlying problem is that balance of payments, or the current accounts, of many Euro countries totally went out of control following the Euro introduction, dividing the Eurozone in a group of producing and a group of consuming countries.

I can only say it again. For me, the insane misallocation of capital that started when funding costs in Europe began to converge (mid 90's) explains a lot of the story. It made investing in Southern countries as cheap as in the so called core while offering higher returns and that way fuelled a big investment and consumption boom in countries like Spain. When it became evident that this boom was not matched by advances in productivity and a broadening of the industrial base, the bubble popped and money started to flee the countries. There's a big capital flight going on in France, too. The great convergence in bond rates reversed and suddenly Southern countries started to fall into depression while the former sick man of Europe (Germany --> >10 % unemployment, three years without any growth, multiple breaches of the stability pact etc. in the first half of the 2000's and many sluggish years before) NOW does relatively good. It's no coincidence. The source of this is thus relatively simple: We had convergence in the cost of funding but no convergence at all (rather divergence) in the ability to provide goods and services for international (and national) customers. And that obviously was caused by the Euro. The difference for the Southern countries when compared to the pre-Euro era is significant though: They can't support their economy through devaluation.

A chart that illustrates the convergence of funding costs:

If the Eurozone is to survive, there's only one solution: The gap in competitiveness must be closed and it cannot be done by inflating German wages the same way as in Southern countries during their boom as Germany wants (and indeed must) stay competitive on markets outside the Eurozone as well. I fully understand that the path of internal deflation is politically and socially unacceptable for Southern countries. I know how painful it was for Germany to deflate but this time deflation will be even harder for the Southern countries as they will have to deflate against a country that won't inflate much. That is indeed the dilemma.
For now, the current account deficits of those countries are funded through the Eurosystem, i.e. mostly the German and Dutch central banks. The Bundesbank alone has automatically piled up of more than €500 billion in claims against Southern central banks over the past three years. Claims that of course are not backed by any assets and thus could be wiped out overnight. This has to stop. Germany is essentially giving away products in exchange for promises that can't be kept.

Eurobonds are, in my opinion, no solution. The only thing they'll do is taking us back to the pre-2007 Euro years: convergence of funding costs without convergence of the 'real economy'. Not only will it cost the German government dozens of billions per year (some German economists say €50 billion, i.e. about 1/5 (!) the size of the federal budget), it will also lead again to the same misallocation of capital we had before. It will fuel another boom not supported by the real economy in Southern countries and put the German economy at the brink of collapse. I fully expect German politicians to go down that road for idelogical reaons, driven by their guilt complex, and let Germany commit economic suicide. But this is not smart. Not for Germany, and not for Europe either. If we get Eurobonds, we'll discuss Eurozone breakup again in a few years - when the German economy cracks over the weight of sponsoring the Eurozone. I am certainly not ready to go down that path.


*Sinn et al.
@The Germans - Did you watch Sinn's presentation over the Euro a few weeks ago? I'm not a big fan of him but I think he's spot on the Euro issue. 2 hours worth of listening:

Link to video.

 

[innonimatu]

And I'd like to add that for the debt problem there is only one possible outcome, which is default. The banks and governments of several countries will have to default, and the longer that is delayed the greater the default will be. And either the euro, free trade, or free flow of capital must go.

In the meanwhile the position of both creditor and debtor countries within the EU only worsens by delaying it.
Debtor countries are letting their companies and wealthy individuals move capital out and halt all investments there, which will make their situation when the default happens (vital imports must be financed somehow) much worse.
Creditor countries will have their institutions take even greater losses, needing larger adjustments in their own economies to make up for those.

All of this has political consequences: the greater the troubles when those defaults happen, the greater the odds that the EU and even a few political regimes will be target of public anger and become salvageable.
In the meanwhile several players outside the EU are laughing all the way to the bank. The Euro, which was salvageable in 2008, is pretty much doomed now, the european banks likewise, and an Europe engaged in an internal race to the bottom in asset prices is now selling off its better industries cheaply to outside competitors, after having already voluntarily sacrificed its "less technological" ones already on the altar of free trade. And they still think they can fix unemployment just by reducing wages!

 

[Mise]

Of course. Didn't want to make it sound as a critique of bond markets, quite the opposite.

I was agreeing with you

 

[kronic]

The German statistics office today released the first estimates for 2011 GDP growth: +3 %

The interesting thing is that for the first time in many years, private consumption (+0,9) and business capital expenditure (+1,1) each contributed more to growth than trade (+0,8).

But it is also said that the economy likely started to contract in the 4th quarter of 2011. Detailed Q4 figures will only be available next month but it's estimated that GDP was about 0.25 % lower than in Q3.

Budget deficit came in at -1 % of GDP.

 

[innonimatu]

And at the other end of the EU:
The Greek parents too poor to care for their children

Greece's financial crisis has made some families so desperate they are giving up the most precious thing of all - their children.

One morning a few weeks before Christmas a kindergarten teacher in Athens found a note about one of her four-year-old pupils. "I will not be coming to pick up Anna today because I cannot afford to look after her," it read. "Please take good care of her. Sorry. Her mother."

In the last two months Father Antonios, a young Orthodox priest who runs a youth centre for the city's poor, has found four children on his doorstep - including a baby just days old. Another charity was approached by a couple whose twin babies were in hospital being treated for malnutrition, because the mother herself was malnourished and unable to breastfeed.

Cases like this are shocking a country where family ties are strong, and failure to look after children is socially unacceptable - and it's not happening in a country ravaged by war or famine, but in their own capital city.
[...]
"Over the last year we have hundreds of cases of parents who want to leave their children with us - they know us and trust us," Father Antonios says.
[...]
One woman driven by poverty to give up her child was Maria, a single mother who lost her job and was unemployed for more than a year. "Every night I cry alone at home, but what can I do? It hurt my heart, but I didn't have a choice," she says.

She spent her days looking for work, sometimes well into the evening and that often meant leaving eight-year-old Anastasia alone for hours at a time. The two of them lived on food handouts from the church. Maria lost 25kg. In the end she decided to put Anastasia into foster care with a charity called SOS Children's Villages. "I can suffer through it but why should she have to?" she asks.

She now has a job in a cafe, but makes just 20 euros (£16) a day. She sees Anastasia about once a month, and hopes to take her back when her economic situation improves - but when that might be she has no idea.
[...]

The European Union, bringing starvation to Europe country by country... Thus union thing really is working, isn't it? And the Euro thing really unleashed a new decade of prosperity and happiness, didn't it?

 

[Traitorfish]

We'll be having a bit of a whip-round, I think, see if we can't get those Greeks the guillotines they so sorely need.

 

[Lone Wolf]

Snip

Extremely informative, thanks.
I learned a lot from this thread about the reasons of the EU crisis. An informative thread in OT, what a wonder .