A few thoughts on the euro crisis

by John Quiggin on May 10, 2010

I’m rushing to prepare to go into a lockup to write reports on Australia’s government budget, brought down tomorrow, so this post is a bit scatty, but it might raise some points for discussion regarding the European debt crisis.

  • First, a general observation. In a typical bailout, the biggest beneficiaries are not debtors, but creditors. So creditors ought to be “bailed-in” and made to bear some part of the cost
  • The Greek case is misleading, in implying that government profligacy is the primary cause of the crisis. In most cases, the problem is the same as in earlier rounds of the crisis, most obviously in Iceland – bad loans by private banks which their national governments feel impelled to rescue, but can’t afford to
  • The idea that the euro precludes devaluation as a way out is a relatively minor part of the story. Given that debts are denominated in euros, devaluation to improve the trade balance would be only marginally effective. The real effect of the eurozone so far, has been to raise the stakes regarding default.
  • Resolving the crisis requires a couple of measures at the European level – monetary expansion by the ECB – co-ordinated action to strengthen government revenue, both by an acceleration of the attack on tax evasion and by discouragement of tax competition within the eurozone


The reasoning on my first point is straightforward. The debtor has the option of default, and the typical bailout offers terms that are better than default, but not much better. Among other things, this reflects the fact that the rescuer (a national government bailing out financial institutions, or the IMF bailing out governments) has to consider the impact of an easy-terms rescue on future negotiations. By contrast, the creditors are unambiguous winners if default can be prevented. The Greek rescue is a case in point. As I said in comments, the big winners are the banks that lent to Greece. That’s not to say they are winning at the expense of the Greeks (except to the extent that the original loans were offered on deceptive terms). The losers are the citizens of the countries that are doing the bailing out. Unsurprisingly, these are mostly the domiciles of the creditor banks (though a commenter points out that the burden sharing is unequal – French banks are more exposed, but the German people are paying more)

On the second point, I haven’t checked the data as closely as I should. But it’s my impression that most of the possible defaulters went into the crisis with reasonably sound public finances, and that the explosion in deficits is more due to the cost of rescuing the domestic financial sector than to the usual processes by which budget deficits increase in a recession. Comments on this would be appreciated.

Similarly, on the third point, I’m arguing from impressions rather than a full understanding. But it seems to me that the willingness of the Greek government and (despite the demonstrations) most people, to accept fairly drastic measures is in part due to the recognition that default would almost certainly entail exclusion from the eurozone, and probably from other beneficial aspects of EU membership.

Finally, the discussion I’ve seen suggests that if tax evasion in Southern Europe were brought under control, the fiscal crisis would be resolved, at least in the long term. But that clearly requires more action against the largely Northern European jurisdictions that continue to facilitate evasion – Switzerland, Liechtenstein, the Channel Islands and so on. They’ve been giving ground gradually, but now the case is much more urgent than it was even a year ago.

{ 9 comments }

1

Tim Worstall 05.10.10 at 12:47 pm

“In a typical bailout, the biggest beneficiaries are not debtors, but creditors. So creditors ought to be “bailed-in” and made to bear some part of the cost”

Absolutely true, but that makes it a default (if even a partial one) which is a political non starter in EU circles.

“But it’s my impression that most of the possible defaulters went into the crisis with reasonably sound public finances, and that the explosion in deficits is more due to the cost of rescuing the domestic financial sector than to the usual processes by which budget deficits increase in a recession. “

Not entirely convinced, not for Portugal anyway:

http://www.nakedcapitalism.com/2010/04/was-greece-rescue-futile-and-is-portugal-next.html

“Brussels admitted last week that Portugal’s external accounts have switched from credit in the mid-1990s to a deficit of 109pc of GDP. This has been caused by the incentive structures of EMU itself. “The more broadened access to credit induced a significant reduction in the saving rate, while consumption kept growing faster than GDP. This development led to an increase in Portuguese indebtedness,” it said.
The IMF’s January report said “The large fiscal and external imbalances that arose from the boom in the run-up to adoption of the euro have not been unwound, resulting in the economy becoming heavily indebted and growing banking system vulnerabilities. The longer the imbalance persists, the greater the risk the adjustment will be sudden and disruptive.” The IMF noted the “heavy reliance” of banks on foreign wholesale funding, equal to 40pc of total assets….

Yes, Portugal’s public debt will be 86pc of GDP this year against 124pc for Greece (EC estimates). That is small comfort. Giles Moec from Deutsche Bank said Portugal’s private debt reached 239pc in 2008: Greece was 123pc. Total debt levels matter. The last two years have taught us that private excess lands on the taxpayer one way or another. For Portugal, the figure is now is in the danger zone above 300pc….”

2

otto 05.10.10 at 1:14 pm

“if tax evasion in Southern Europe were brought under control”

Isn’t this sort of asking the impossible given the incentives etc that firms and individuals face in these countries? A bit like saying, if the mafia in Palermo was brought under control… These problems are enormously difficult. At the very least, I hope we have an alternative solution just in case tax evasion in Southern Europe is not brought under control.

3

yoyo 05.10.10 at 1:50 pm

Many solutions seem the detail who might be paying for it (austerity cuts), but i have not see who are the major holders of the bonds are. Some mention of ‘northern banks’ but is it really held as capital ie shareholders of the bank? If so, it seems that in the last bank crisis, in the Great Depression, a significant amount of rentier class holdings were wiped out. This time, I would guess the owners aren’t really ‘bankers’ as such, as obnoxious as Goldman frat boys are, but a more diffuse group of upper middle class professionals with large 401ks?

It seems like who the real recipients are of these handouts ought to be clarified.

4

alex 05.10.10 at 3:03 pm

My impresssion was certainly not that Greeks evaded taxation by moving their money to Switzerland; they seemed to evade it by just not paying.

5

mds 05.10.10 at 3:36 pm

First, a general observation. In a typical bailout, the biggest beneficiaries are not debtors, but creditors.

Indeed. This should be a completely banal observation, yet somehow it’s eluded practically everyone. Even “debtors” has been elided to mean individual low-income Greek citizens who bear the brunt of “austerity measures,” or at best a government that wasn’t in power when the loans were made. Not that a change in government should automatically mean a repudiation of the prior administration’s debts, but all the finger-wagging at the irresponsibility of a government that was in opposition until recently is getting to be a bit much.

It seems like who the real recipients are of these handouts ought to be clarified.

This is another good point. I seem to recall some talk during the Iceland debacle that it was a good idea for, e.g., the UK to put the screws to Iceland because of all those British pensioners, local governments, etc, who had a stake in the outcome. Banksters who made obscene profits in the run-up to the collapse were often making them off of being the bundlers and brokers of debts rather than creditors. That said, a great many such firms were nonetheless caught standing when the music stopped. So I doubt it’s either / or.

6

Oliver 05.10.10 at 7:19 pm

Yet Spanish public debt is low and banking regulations were very strict. As far as Spain is in trouble, it is so because its prospects for growth are bad. That however is a results of its loss of competitiveness caused by the Euro.

7

hix 05.10.10 at 8:20 pm

Anybody knows if the holiday homes in Spain are counted as assets of foreigners in Spain and if yes if they are accounted at purchasing price?

Spain has a worse international investment position than Greece as percentage of gdp:
http://en.wikipedia.org/wiki/Net_international_investment_position

I fail to see how any of those countries including Greece should be unable to pay back the debt. Even the worst, Portugal just owes one years work. The higher interest rates that even solid Italy has to pay arent so much an inability to pay risk premium as an unwillingness/inability of the governments to get their hands on the assets of the citicen. Thats where the problems with bailouts start. The more of the debt is hold by foreigners, the less likely it becomes that the debtor societies get their act together.
Things get especially problematic when the bailout is paid by those evil Nazis that stole our gold and forced us to buy their overpriced submarines etc. Scholars at the global dominating English speaking elite Universities will be fast to jump at the rethorical support, slash out papers that describe how its all the fault of China and Germany anyway. Explain that all those countries with the foreign debt really had no choice because …. meaningless bla bla bla bla, similar to the one that was used to explain how the US current account deficit was all no problem, rather a sign of strenght in the past…., to justifiy how its ok for rich nations to default . To close the left flank, there will be talk about how harsh the bailout conditions were to Greece, talk about human suffering, increasing suicide rates, shorter life expectancy. . Poorer Greece, already quite efficient indoctrinated with xenophoby already will be up in arms against the foreigner. Meanwhile the Greek upper class finally gets a chance to use that nice new Yacht, get away from the unpleasant noise in Athen, maybe make a longer boat trip to Singapore, make sure everything is fine with ones trust there.
A focus on gdp as such is misguided. The important aspect is the ability to export goods and services. That ability to pay foreign debt isnt much hurt by a gdp that contracts because people stop eating out or stop paying men to run arround with guns .

8

Walt 05.10.10 at 8:49 pm

Ah, yes, the Greeks are rioting because they can no longer eat out. Which, if you’ve had a really good gyro, you can’t blame them.

9

Alex 05.11.10 at 6:26 pm

The idea that the euro precludes devaluation as a way out is a relatively minor part of the story. Given that debts are denominated in euros, devaluation to improve the trade balance would be only marginally effective.

Well, in a different sense, the euro does preclude devaluation as a way out. Because if, say, Spain hadn’t joined the euro in the first place, then its debt wouldn’t be dominated in euros.

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