Euroconfusion

by John Quiggin on November 17, 2010

Most of the discussion I’ve seen of the financial crisis as it affects the eurozone seems to me both confused and confusing. A country outside the eurozone and without the “exorbitant privilege” of being able to sell lots of debt denominated in home currency has three options when it runs into debt trouble: default, depreciation and dependency.

Default is the straightforward solution, but it involves a big loss of face, and unpredictable long-term costs. Depreciation doesn’t directly improve the debt position, since debts are in foreign currency, but by making exports cheaper and imports dearer it helps a country to trade its way out of difficulty, without the need for a reduction in domestic prices and wages. Finally, there’s the option of dependency on an outside rescuer, normally the IMF. This has been the most common solution, but the IMF always demands a price (in terms of policy “reforms”) that makes a rescue only marginally more attractive than default.

A eurozone country doesn’t have the option of depreciation. In return, however, it has two dependency options, calling on either the IMF, or the European Financial Stability Fund. Since the EU would like to keep the IMF out, a distressed debtor can expect slightly better terms from the EFSF.

The default option isn’t affected, except in the same way as any kind of behavior viewed as discreditable affects membership of any club. A government that defaults on its debts might be thrown out of the eurozone, but then again it might be thrown out of the OECD, and the eurozone might expel a member that facilitated tax evasion.

The big question is whether the EFSF will work. That’s certainly challenging, but it still seems like a better bet for debtor countries than going it alone. And of course, there’s more commonality of interest than is often supposed because any bailout benefits the creditors, usually French and German banks

{ 67 comments }

1

Lemuel Pitkin 11.17.10 at 2:53 pm

You’ve left one off: Depression, or rather, contraction of domestic demand. That is the most common response — you free up additional foreign exchange to service the external debt by reducing consumption, investment and public expenditure. That’s what’s usually happening in cases people attribute to depreciation. The belief that it’s exchange-rate induced expenditure-switching is a misconception that arises from two prejudices of econoists: that aggregate income is fixed, and that price signals reliably guide behavior in the short run.

In fact, though, if you look at e.g. the Asian crisis of a decade ago, you will see that exchange rates played a distinctly secondary role in the big improvement in the current account position those countries needed to service their debts when capital inflows stopped. The evidence for this is that (a) in Korea, Indonesia, Thailand, etc. there was a big reduction in imports but little or no increase in exports, and (b) the decrease in imports tracked domestic expenditure closely, but in most Asian countries showed little or no correlation with currency movements.

In general, the beginning of wisdom in international economics, IMO, is the recognition that short run trade flows are driven much more changes in income, than changes in relative prices.

2

Lemuel Pitkin 11.17.10 at 2:57 pm

Also, I’m curious why you think the EFSF might not work. As long as we are just taking about small countries like Greece, Ireland and Portugal, what would stop it from working?

3

john b 11.17.10 at 3:01 pm

the eurozone might expel a member that facilitated tax evasion

For heroic values of “might”, perhaps. I don’t see Luxembourg or the Netherlands being blackballed any time soon…

4

Richard J 11.17.10 at 3:35 pm

Any of the Benelux countries, really. Though Luxembourg doesn’t really have much reason otherwise to exist, having initially failed at, and now become obsolescent for, its original purpose of stopping France and Germany going to war.

5

zamfir 11.17.10 at 3:44 pm

The belief that it’s exchange-rate induced expenditure-switching is a misconception that arises from two prejudices of econoists: that aggregate income is fixed, and that price signals reliably guide behavior in the short run
Yes.

6

Francis 11.17.10 at 4:06 pm

Lemuel, contraction as applied to a government means you keep servicing debt and instead spend less on other priorities. Contraction in the private sector means a reduction in aggregate demand ( see, eg, the US). It seems from your comment that you’re conflating the two.

7

Lemuel Pitkin 11.17.10 at 4:21 pm

Francis,

I’m not conflating anything. I am (like John Q. in the original post) considering a situation in which the public debt is denominated in foreign currency, so dealing with debt trouble without default or dependence on outside assistance requires *both* increasing the share of public expenditures going to debt service, and increasing foreign-exchange earnings. Depreciation is one way of achieving the latter goal, as John Q. says. My point is that the more usual and reliable way is to contract aggregate demand, in both the private and public sector, as a means of reducing imports and freeing up foreign exchange earnings for debt service.

And of course none of this (as John Q. also points out) applies to the US, since our government debt is denominated only in our own currency.

8

john c. halasz 11.17.10 at 4:50 pm

@2:

EFSF is “structured” to boost its credit and lower its cost, so the actual amount available is only a portion of the ostensible amount. Also, the very countries that are in trouble are also supposed to be pledging a proportional share of its funding. Like a lot of these financial “rescue” operations,- (remember MLEC?),- it has an air of tautology, repeating the very mechanisms that cause the trouble in the first place. And, of course, the point is not to bailout the trouble economies of debtor countries, but to bailout the money-center banks at public/tax-payer expense all round.

9

Lemuel Pitkin 11.17.10 at 4:54 pm

the very countries that are in trouble are also supposed to be pledging a proportional share of its funding.

That might be an issue if a much larger country, like Spain or Italy, was in need of rescue, but I don’t believe more than a trivial share of the funding comes Greece, Ireland and Portugal.

And, of course, the point is not to bailout the trouble economies of debtor countries, but to bailout the money-center banks at public/tax-payer expense all round.

That may well be true, but it’s a separate question from whether it will work.

10

john c. halasz 11.17.10 at 5:06 pm

@9:

Well. yes, that was kinda the point of “structuring”, though if Spain and Italy are bailing out the others, their own fiscal position is effected, und so weiter.

“Will it work?” For what? And no.

11

Tim Worstall 11.17.10 at 5:16 pm

Well, Spain is pretty much next in line, so dealing with it through the EFSF only works if it doesn’t get as far as Spain. And with 20% unemployment, 40% youth unemployment and a property collapse every bit as appalling as Ireland’s, the idea that Spain isn’t going to be a problem looks remote.

Edward at a Fist Full of Euros has been looking at this over the past year and he’s not hopeful at all: there are what appear to be some really horrible banking problems in there related to mortgages.

But I think there’s a much larger problem here: akin to the distinction for a bank of being illiquid in the face of a run or actually being insolvent.

If it is just akin to liquidity, if the markets just need to be pacified, the national debts backstopped for a few years, then possibly it can be worked through. But if it’s more akin to insolvency, then I don’t think it can be.

Of course, a country isn’t going to be insolvent in the same way a bank is, this is only an analogy. But if it is true that wage/productivity levels are out of whack between the PIIGS and the Germanic core (which I think is true, certainly for Spain, Portugal and Greece) then there’s no real way out of this in the medium term unless there’s a fall in real wages in those countries compared to the Germanic ones: or a large rise in productivity of course. Neither of which are really easy things to do: they’re damn hard to do in fact and both would involve wholesale restructuring of aspects of the economies.

Living in Portugal, as I do, I certainly cannot see anyone being able, in the face of both strong unions and a resurgent left, being able to either shake up the labour market or persuade said unions to be as cooperative as the German unions have been over the past decade. It might be highly desirable that these various things happen: but I don’t think it’s in any way politically possible.

I’m still with my view from the mid 1990s, the euro simply won’t work because it’s just not close enough to being an optimal currency area.

12

Francis 11.17.10 at 6:17 pm

Lemuel: I seem to be more obtuse than usual. I see that a reduction in aggregate demand leads to a relative increase in exports, but how does this put the home government in a better position to service its foreign debt? Why is it the case that an inrease in privately-held foreign currency denominated assets make the government’s obligation easier? (I would have thought that the reduction in domestic demand would reduce the government’s tax stream and made debt service harder.)

13

Stuart 11.17.10 at 6:20 pm

I’m still with my view from the mid 1990s, the euro simply won’t work because it’s just not close enough to being an optimal currency area.

Presumably the US $ simply won’t work either due to the massive variations geographically that are equal to the variations across the eurozone.

14

ejh 11.17.10 at 6:21 pm

Dear me, it’s looks like we’re all paid too much again. Well I never. I really didn’t see that one coming.

15

Chris Bertram 11.17.10 at 7:26 pm

I suppose Stuart’s point there is a sarcastic one, but it isn’t clear to me that this isn’t right. Large parts of the US would presumably benefit from being able to devalue relative to the coasts, set different interest rates etc. (Ditto for the north of England, Wales, Scotland wrt sterling).

16

P O'Neill 11.17.10 at 7:43 pm

Although the optimal currency area arguments are well-known, this recent op-ed by Uri Dadush & Moises Naim lays out the US versus Europe comparison in current context very well.

17

Myles SG 11.17.10 at 8:35 pm

the decrease in imports tracked domestic expenditure closely, but in

You do realize that the causality of imports being a function of domestic expenditure in the short term is a definition of macroeconomic theory, right?

It’s complete tautology. You can’t say “well it tracked demand but not currency rates” because if it didn’t track demand it couldn’t very well track currency rates at all, either. In fact if it didn’t track demand then we’ve got nothing to work with here.

18

Henri Vieuxtemps 11.17.10 at 9:00 pm

I don’t like the WSJ piece linked in 16.

“…Greek and Italian labor costs, for example, have risen by more than 25% relative to Germany’s since they adopted the euro a decade ago” – what does it mean, exactly? Does it mean that Italian labor costs are 25% higher than German? I doubt it.

Anyway, sure, centralization and uniformity increase stability. Until they don’t anymore, and then the whole big thing folds like a house of cards.

19

Tim Worstall 11.17.10 at 9:09 pm

“Presumably the US $ simply won’t work either due to the massive variations geographically that are equal to the variations across the eurozone.”

Noooo…because the eurozone variations are greater than the US ones. Quite aside from the US having a Federal Treasury, the E zone has larger differences in productivity, languages alone make labour less mobile etc.

The US$, as an optimal currency area, didn’t work for a long, long, time. It’s still arguable whether the UK is one even now. The EU?

No, it isn’t one, and without central fiscal and taxation policy, won’t be one for a long time to come.

20

jon livesey 11.17.10 at 9:20 pm

“Does it mean that Italian labor costs are 25% higher than German? “

No, it means relative to productivity. Italian wages aren’t 25% higher than German ones, but when you count lower Italian productivity, labour costs per widget are X% higher than in Germany. Is X actually 25? Well, when you remember Italy includes Sicily as well as Milan, it could be.

21

Chaz 11.17.10 at 10:00 pm

Another objection to that editorial in 16: They talk about our (California’s) balanced budget rule as a good thing. In fact it is a straitjacket that has forced the state to lay off employees and postpone spending, worsening the recession. And those aren’t even structural adjustments; we will bring the spending back just as soon as revenues allow. The only good the rule has done has been to keep our accumulated debt down, which is nice for the bondholders because we probably won’t default (unless our balanced budget requirement forces us to!).

Imagine if Greece prohibited itself from running a budget deficit. Why, then they might as well default, because they couldn’t borrow money anyway.

22

mpowell 11.17.10 at 11:45 pm

Isn’t the big difference between the US and Europe fiscal union? I’m a little surprised anyone would ignore this.

23

vimothy 11.18.10 at 12:44 am

Pity that we seem to have arrived into the back to front situation where the left is more attached to the (euro) gold standard than the right, but hey ho.

24

Lemuel Pitkin 11.18.10 at 2:50 am

see that a reduction in aggregate demand leads to a relative increase in exports,

No, it leads to a decrease in imports. (Which does of course mean an increase in *net* exportsd. Maybe that’s what you meant.)

but how does this put the home government in a better position to service its foreign debt? Why is it the case that an inrease in privately-held foreign currency denominated assets make the government’s obligation easier? (I would have thought that the reduction in domestic demand would reduce the government’s tax stream and made debt service harder.)

The government has two problems: First, there has to be sufficient foreign exchange available in the country for servicing the debt. And second, that foreign exchange has to be claimed by the government. Reducing imports helps with the first problem, not the second. but that’s the important one for this discussion. If the government lacks the fiscal capacity to borrow or tax its own private sector sufficiently to service its debt even if there’s no balance of payments problem for the country as a whole, then it wouldn’t be able to handle its debt even if it were all denominated in the local currency.

Your point in parentheses is valid, though. So the cut in public expenditure will typically be larger, maybe much larger, than the immediate increase in debt service payments. These crises can be really catastrophic.

25

Chris Bertram 11.18.10 at 8:28 am

#22 – yes. Unless you can persuade German taxpayers to support people in poorer parts of the Eurozone (including welfare systems etc). Since persuading one sort of Belgian to support another sort of Belgian is already impossible, this looks far fetched.

26

Tim Worstall 11.18.10 at 9:22 am

Fiscal union (akin to the US Federal govt redistribution) is indeed a possible solution.

What I’d love to know is, has anyone worked out quite how much of this there would need to be?

It would necessarily be the “rich” countries of Northern Europe sending money south (and east). So how much would they have to send?

And, given that said “rich” countries already have some of the highest tax rates in the world (whether marginal or as percentages of GDP) how much higher would they have to go?

Are we talking about sending 0.5% of GDP? That’s less than the current EU budget. Or are we necessarily talking about 5%, or 10%, of GDP? Given our starting point (the State already spending/redistributing 40-50% of GDP in Northern Europe) does anyone think such tax rises viable?

Note that I’m not talking about bailouts of the current debt. Rather, what level of geographical redistribution would be needed to make fiscal union work?

Anyone know?

27

Zamfir 11.18.10 at 9:44 am

Tim, I am not sure how much needs to be a permanent stream, at least from monetary stability POV. Important for the monetary union are fluctuations in the flow, so that for example a local increase in unemployment is partially compensated by a temporarily higher transfer inflow.

I don’t know if it is politically feasible to have such transfers set up in way that gives a long term average flow close to zero. And of course it would require a partial transfer of policy setting to Europe too. People won’t pay for unemployment benefits if they have no say in reducing that unemployment.

28

Shining Raven 11.18.10 at 10:06 am

Henri @18 and jon livsey @20:

Indeed, German labor costs per unit produced are much lower than those in other European countries. But that is not really the fault of the other European countries, it’s the fault of the Germans, and it’s making everybody worse off. The 25% figure seems about right.

Labor costs per unit have increased all over Europe pretty much in line with productivity, as it should be. Only in Germany did they rise much more slowly (starting during the 90′s already), this was achieved mainly by badgering the unions with supposed problems in international competitiveness of German industry (“German wages are much higher everywhere! How can we stay competitive?” – True, but productivity is much higher as well, so that overall Germany is very competitive, as evidenced by the low labor costs per unit – and the trade surplus.).

The effect is that Germany is “world champion” in exports, and there is a huge trade surplus, but the Euro is not appreciating against other currencies, because overall Europe does not have much of a trade surplus, only Germany as such.

This has a lot to do with the problems of Greece, for example. We Germans out-compete the Greek on unit costs and manage to export a lot to them, with the profits not going into German consumption, but to investors, who lend the money back to Greece to finance its imports…. Because of the common currency, obviously the Greek can not depreciate their currency against Germany’s to restore balance…. We are not going to get out of this without a rise in German wages and hence German consumption – or the severe contraction of consumption in the debtor countries, which is going to hurt everybody including Germany.

(This point of view is for example put forward by the economist Heiner Flassbeck, who’s the Director of the Division on Globalization and Development Strategies at the United Nations Conference on Trade and Development (UNCTAD). Also put forward by the chief economics writer of the German Financial Times, Thomas Fricke, but I could not find a good reference in English for this analysis.)

29

Alex 11.18.10 at 10:19 am

Ahem.

30

Shining Raven 11.18.10 at 10:25 am

Sorry, slight mistake, that should be “Labor costs have increased all over Europe pretty much in line with productivity (keeping labor costs per unit approximately constant)” – not “Labor costs per unit have increased….”.

The point is that wages over most of Europe have increased with productivity, so that wage earners got a share in the productivity gains, whereas in Germany the wages have increased much less, leading to falling costs of labor per unit when compared to other European countries, thus improving Germany’s relative competitiveness – to the detriment of German wage earners and everybody else.

31

Shining Raven 11.18.10 at 10:43 am

Alex @29: thank you for the link, of course the point is made much better that I could have done it.

Sorry that I was not aware of the reference – I am not a regular reader of “A Fistful of Euros”.

32

Henri Vieuxtemps 11.18.10 at 11:11 am

Shining Raven, the dynamics you describe seem like a very mild version of the China-US model: much cheaper to produce stuff in China, currency peg, low consumption in China, export stuff to the US, buy US debt, etc.

But it’s not nearly as severe as Chimerican imbalance, because, after all, there is labor mobility between Germany and Greece, they have compatible labor and environmental laws, comparable safety net, etc.

And for German labor unions to be successfully badgered as you described, they really have to feel German first and labor second, and perhaps that’s going to change little by little.

33

John Quiggin 11.18.10 at 11:20 am

@Lp #1 Of course, you are right. Implicit in my discussion of devaluation is the base case (what might in other contexts be called the default option) where the policy is to drive down prices and wages sufficiently to generate a trade surplus.

And I should have mentioned the obvious option, that of Euro-inflation, as recommended by the IMF and half-adopted by the US Fed in QEII. Rather than repudiating particular bad debts, this imposes a uniform loss on all investors. My feeling is that the ideal solution would involve some default/repudiation of particularly egregious deals (eg the GS deals to hide Greek debt) along with some general inflation.

34

Shining Raven 11.18.10 at 12:13 pm

Henri,

yes, to some extent it is very similar to the US-China trade imbalance. In that case, of course, there is a standard answer to the problem: remove the currency peg….

As for labor mobility between Germany and Greece, yes, a little, I guess, but it is certainly not sufficient to offset the problem. And Germany itself still suffers from quite a bit of unemployment, since internal consumption is not there, since wages are still too low.

With regards to the badgering of unions: It has been conventional wisdom for I don’t know how many years here in Germany that German labor costs are too high and German companies can only survive if the German workers show some restraint in their wage demands.

This view is almost uniformly held through most of the major media, and shows up in political speeches and commentary constantly. There are lots of “contracts” between employers and unions where the employers promise to forgo layoffs in exchange for no increase of wages. So the unions very often feel closest to the interests of one company first, not so much German first, before everything else.

35

hix 11.18.10 at 2:40 pm

“And of course, there’s more commonality of interest than is often supposed because any bailout benefits the creditors, usually French and German banks”

We already had that theory with Greece. In the Greek case it turned out Germany was underrepresented as lender and France about average, which made any bailout a rather bad deal even for France and a horrible one for Germany. Thats not how the EU ticks. I know that just asumeing that the EU is a German French conspiracy is the way to go in the English speaking press, but its still very wrong.

36

Lemuel Pitkin 11.18.10 at 4:06 pm

Of course, you are right. Implicit in my discussion of devaluation is the base case (what might in other contexts be called the default option) where the policy is to drive down prices and wages sufficiently to generate a trade surplus.

I’m glad we agree. Except, I’m not sure we do.

In the case I am describing, prices don’t necessarily fall at all. Wages probably do, but that’s only a minor factor. What happens is that output and employment fall. This leads to a sharp drop in imports even if relative prices do not change at all. I believe — as e.g. Joan Robinson argued — that short-term trade adjustments almost always happen through AD-driven changes in the level of output and income, *not* changes in relative prices, which still seems to be what you are thinking of.

Alex’s AFOE post is very good. But he doesn’t make the distinction quite as clearly as I would have liked between income- and price-mediated trade shifts. It is certainly true that if German workers were paid more, they would consume more of, among other things, vacations in Greece, improving Greece’s balance of payments; and if Greek workers were paid less, they would consume less of, among other things, German consumer durables, also improving Greece’s balance of payments. It is not true (or anyway much less true) that if German workers were paid more, German consumer durables would become more expensive and people would consume Greek vacations instead, or vice versa.

Among other reasons for this, (1) relative prices don’t always move with relative costs (profit margins often adjust instead, especially in the short run); (2) in the real world there is not much of what Paul Davidson calls “gross substitution,” i.e. price signals are mainly effective within relatively small sets of similar goods ; and (3) relative prices show a strong tendency to revert in the middle run, before whatever substitution might happen has time to take effect. To spell out the second factor a bit more: Greece’s problem vis-a-vis Germany isn’t that German manufactures are cheaper, but that Greece doesn’t manufacture most of the goods that Germany does at all; changing relative prices won’t help that.

The idea — pushed by Krugman among others — that Greece would be fine if it could just devalue, is contradicted by decades of experience in the developing world. In fact, the realistic alternatives are (1) government-stabilized capital flows from Germany to Greece forever (everyone dismisses this as impossible, but it’s what would happen in a fiscal union; it’s also been the position of the US for the past 30 years, and may well be for the next 30); (2) a systematic industrial policy to develop a wider range of tradable-goods sectors in Greece; or (3) permanently slower growth in Greece relative to Germany.

37

Norwegian Guy 11.18.10 at 5:42 pm

Pity that we seem to have arrived into the back to front situation where the left is more attached to the (euro) gold standard than the right, but hey ho.

Is this really the case? And where? My impression is that the Euro is mostly backed by neoliberals. And that the left is opposing it. Though there might be differences in space and time, and between different examples of “left” and “right”.

38

hix 11.18.10 at 8:00 pm

/sign me up for neoliberal then.

Opposing anything the EU does or joining the EU in general is very left, which makes Ludwig Erhard , the FPÖ, Ukip etc lefties and me neoliberal.

39

Norwegian Guy 11.18.10 at 10:15 pm

No, there are certainly people backing the Euro that are not neoliberals. But I don’t consider, say, Paul Krugman a neoliberal either, and he hasn’t been that supportive of the Euro. And in the Swedish Euro referendum in 2003, it was clearly the left wing that was most opposed, especially the Left Party, the Greens, and people on the left of the Social Democratic Party. The supporters mostly ranged from the leadership of the Social Democrats and rightwards. And it is clear enough from the statistics which social classes voted for, and which classes voted against (members of the trade unions) joining the Euro.

40

jon livesey 11.18.10 at 10:26 pm

Shining Raven: [Concerning who is responsible for the persistence of the productivity gap in the Euro area.] Yes, I agree and have made much the same argument myself. In this case I was just answering a factual question. A lot of problems would be made easier if Germany would simply allow internal demand to rise more or less in line with its export success, but I am afraid that we are dealing with a country that has very strong folk memories, plus a Chancellor who seems dead set on defending “german success” at all costs, no matter what that costs the rest of Europe.

41

jon livesey 11.18.10 at 10:33 pm

Hix “I know that just asumeing that the EU is a German French conspiracy is the way to go in the English speaking press, but its still very wrong.”

I think you are loading this statement by the use of the word “conspiracy”. The main thing I have noticed that has changed since about a year ago is that up to the end of 2009, polite people always talked about the Euro-area, and polite people refrained form talking about it as being German-dominated. In fact, such talk often invited broadsides.

But if you fast-forward to today, it is as if the Euro-area no long exists as an actor, and all anyone talks about is what Germany will do, what Germany will allow, what Germany will pay for, and so on. We even see Euro-area policy being held up for weeks at a time so that some election for dog catcher in Middle Saxonistan doesn’t go against Merkel’s wishes.

So, no conspiracy, but maybe because no conspiracy was needed, since anyone could see that sooner or later a crisis would arise in the Euro-area that needed gobs of cash to fix, and only Germany has the gobs of cash.

And as for France, well every organ grinder needs a little monkey. If it amuses the French to think they are Germany’s co-equal, good luck with that.

42

Lemuel Pitkin 11.19.10 at 1:47 am

Jon Livesey-

Do you think that e.g. the big shareholders of Irish banks are unhappy at the prospect of a European bailout? It may be that day-to-day authority within the Euro area is right now being exercised mainly by the Germans. But do you really think the majority of the business and financial elite elsewhere in Europe disagrees with the main thrust of EU policy? (Of course they’ll disagree with details.)

43

John Quiggin 11.19.10 at 7:21 am

hix, can you elaborate on your claim? I haven’t seen new data, but an older analysis like this
http://www.piie.com/realtime/?p=1521
suggests that French and German banks were the main lenders to Greece, and that French banks lent relatively more (I remember you stressing the latter point which is one reason I wrote “French and German”). My impression was that the same was true more broadly, though presumably British banks are more exposed to Ireland.

44

John Quiggin 11.19.10 at 7:23 am

LP, I take your point, but I think you’ve oversold it. Depreciation has proved at least somewhat effective in resolving balance of payments problems, and it gives precisely the price effects of depression without the quantity effects.

45

a 11.19.10 at 10:12 am

“French banks lent relatively more”.

John, the table you refer to is misleading. The large exposure in the table given to French banks comes from French banks owning majority shares in Greek banks (Credit Agricole owns Emporiki Bank, Societe Generale has a little over 50% of Geniki Bank). The table then counts the exposure of these Greek banks to Greek debt, which is enormous because the Greek government has stuffed its banks with its debt. The exposure of the French banks is limited, however, to their equity in the Greek banks. Obviously, in normal circumstances, the French banks will inject money into the Greek banks to cover losses. On the other hand, if the Greek state were to default on its bonds, the French banks will just walk away from their investment, leaving them with a far, far lower loss.

46

Alex 11.19.10 at 11:22 am

Does anyone know if “Anstaltslast” exists in Irish law? And why the hell do I have to ask this damn question, when it’s about the first thing anyone would seriously want to know?

47

Tim Worstall 11.19.10 at 11:29 am

“Does anyone know if “Anstaltslast” exists in Irish law?”

Having looked up what it actually means, if you mean that owners must always ensure that there’s enough cash to pay corporate debts, well, yes and no.

Yes in the sense that if there isn’t, then the company must declare insolvency. No in the sense that there is still limited liability, in that maximum losses to shareholders are their shareholdings.

All of which would be fine except the Irish Govt has guaranteed all of the liabilities of the Irish banks…..

48

Richard J 11.19.10 at 11:35 am

UK company law certainly criminalises trading while insolvent. AFAICT, Irish company law pretty much starts (for obvious historic reasons) from UK law and has, oh, 80-odd years of parallel evolution, but not trading while insolvent is one of the longest-standing principles.

49

P O'Neill 11.19.10 at 12:23 pm

Does anyone know if “Anstaltslast” exists in Irish law? And why the hell do I have to ask this damn question, when it’s about the first thing anyone would seriously want to know?

Alex, I was stuck on this question in the AFOE thread because I can’t find a clear definition of what it means. I’ve seen both the definition used by Tim and a more specific one referring to a state guarantee to an entity (e.g. KfW) that it will always have sufficient funds to operate, the so-called “maintenance obligation”. Our Irish ministers love to toss around the Latin legalisms to confuse people so they may too eagerly grasp the German ones too.

50

hix 11.19.10 at 1:00 pm

Those Greek numbers loook different if one includes non Eurozone lenders:
http://www.spiegel.de/wirtschaft/soziales/bild-691559-57832.html

As for the Euro in general. Americans naturally hate the Euro, thats besides the point. European ones werent enthusiastic either. No one in his right mind wanted Greece within the Euro for economical reasons. That was always known to be an implict transfer payment to Greece, albeit of a larger smaller sice.

51

Shining Raven 11.19.10 at 1:10 pm

jon livesey: I am not sure if it is so much German “folk memory” (there are really not that many people left who have experienced hyperinflation) as more of a neo-liberal propaganda campaign. As I said before, it really is conventional wisdom here in Germany that wages are too high (where the comparison is always made in absolute terms), and this point is made in the popular press by politicians, journalists and spokespeople for the industry all the time. This is advantageous to industry when it comes to wage negotiations, so there are many (short-sighted) people with a vested interest of keeping this view alive.

There is very little talk of increasing internal consumption, and indeed even the German unions have only recently begun to make this argument explicitly. I think union representatives where somewhat reluctant to use it, since it really goes against their old strategy of securing jobs by deferring pay raises, in which they became in a sense complicit with the employers and adapted their framing of the issue.

Making the macro-economic argument implies for the unions to admit that their old strategy of securing jobs by lowering pay failed, and I believe they were somewhat loathe to admit a mistake.

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hix 11.19.10 at 4:31 pm

Now neoliberals are responsible for corporatism? Always getting better :-).
Corporatist wage restraint is a classical strong labour party strong union Keynsian strategy. Just saying.

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John Quiggin 11.19.10 at 7:29 pm

@hix and a

These points are useful correctives, but I don’t think they undermine the general point that bailouts aren’t simply a matter of (the citizens of) prudent eurozone countries paying to bail out (the citizens of) reckless borrowers in order to save the euro. Rather, most of the redistribution is within countries, from ordinary citizens to bankers and the aim is to save the banking system not the euro.

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Lemuel Pitkin 11.19.10 at 8:33 pm

On 53, I agree with John Q. completely. If there’s a conspiracy in the Euro system, it’s not by “the Germans” but by the economic elite of the continent as a whole, to do an end-run around national politics that still favors the organized working class more than in the rest of the world.

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piglet 11.19.10 at 9:02 pm

“Paradoxically, despite this grim picture, it is actually Europe that should be envious of California.”

What nonsense passes for economic analysis in this country is just beyond the pale.

American firms have restructured faster: U.S. GDP has declined by only 1.2% from the second quarter of 2008 through the second quarter of 2010, while European GDP fell by 3.2%. Meanwhile, since bottoming out in the second quarter of 2009, investment in the U.S. grew by 23% through the second quarter of this year, compared to a rise of 8% in the EU.

Great. So how are the employment numbers looking? Abysmal. Not to mention that California and many other states is gutting its higher education system, trying to fill its budget gap by 50% tuition hikes and the like. Americans are living in a fantasy land and the deeper the crisis the more they are hiding from reality. The depth of the American crisis has little to do with GDP numbers. It is the decimation of the middle class, and the gutting of the economic arrangements that have historically supported it, that is worrying. The US is two countries, a tax haven for the super-rich and an underdeveloped country with crumbling infrastructure, structurally unable to invest in its future, for most of the rest. Tens of millions of Americans still imagine themselves as middle class members but they aren’t any more. They have fallen off the ladder and nobody is going to help them back up.

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piglet 11.19.10 at 9:03 pm

That was of course in reference to “Europe Needs a California Dream”.

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piglet 11.19.10 at 10:50 pm

Isn’t the big difference between the US and Europe fiscal union? I?m a little surprised anyone would ignore this.

But the US “fiscal union” is weak. It’s one of those fiscal systems where a person’s – especially a rich person’s – tax liability dramatically varies with the zip code, and wealthy Americans can and do move to relative tax havens. As a result, public infrastructure and services vary from place to place at least as much as they vary between EU countries. It always surprises me how people mistake the United States for a unified country just because they all wave the same flag. It is not.

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Lemuel Pitkin 11.19.10 at 11:24 pm

public infrastructure and services vary from place to place at least as much as they vary between EU countries.

Piglet, this really isn’t true. Most government spending in the US is by the federal government, and that’s flat or modestly progressive in its geographic distribution. Similarly, it’s not really true that “tax liability dramatically varies with the zip code” — again, most taxation is federal. And in general, the high-income jurisdictions are also the ones with the highest and most progressive taxes — the rich do *not* relocate to tax havens. (Which is something we should be happy to point out.) There’s just no comparison between a federal government in the US that spends over 15% of GDP, and an EU that spends maybe 1%. It may be true that the US fiscal union is weak compared with some individual European countries (tho even there it depends on the country); but it’s very, very strong compared with Europe as a whole.

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Sev deMonterey 11.19.10 at 11:25 pm

LP “The idea—pushed by Krugman among others—that Greece would be fine if it could just devalue”
I think he says better off, not fine. He appears to be increasingly of the mind that they, perhaps others, may be forced off the Euro. http://krugman.blogs.nytimes.com/2010/11/18/this-is-the-way-the-euro-ends/

Piglet “California and many other states is gutting its higher education system, trying to fill its budget gap by 50% tuition hikes and the like. Americans are living in a fantasy land and the deeper the crisis the more they are hiding from reality.”
I agree, and think the coming year or two will be increasingly grim. State and local budget cuts are really just beginning. At the Federal level, who knows?

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piglet 11.19.10 at 11:54 pm

It may be true that the US fiscal union is weak compared with some individual European countries (tho even there it depends on the country); but it’s very, very strong compared with Europe as a whole.

US federalism is weaker than any EU country I know of; only Switzerland (which is of course not an EU member) is somewhat comparable although even there it’s a mixed bag (tax rates can vary dramatically even between neighboring towns but then there is also some sort of fiscal redistribution). Of course when the US is compared to the EU, nobody would deny that the EU is less integrated (it was never intended to be otherwise). But the fact remains that the US as a country is characterized by extreme social and economic disparities based on geography. Public infrastructure in the US not just varies from place to place but the tendency has moreover been towards massive defunding.

“Most government spending in the US is by the federal government” – yes and most federal spending is military spending. Public infrastructure is mostly funded at the state and local level, especially education of course where disparities are infamous. I don’t just mean the disparity between Mississippi and Massachusetts but perhaps more importantly the decline and decay of American core cities, which no European country would allow to happen.

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Lemuel Pitkin 11.20.10 at 12:52 am

US federalism is weaker than any EU country I know of; only Switzerland (which is of course not an EU member) is somewhat comparable

OK.

Of course when the US is compared to the EU, nobody would deny that the EU is less integrated

I thought that was exactly what you were denying at 57. I guess I misunderstood.

Public infrastructure in the US not just varies from place to place but the tendency has moreover been towards massive defunding.

I think the latter part of this statement is by far the more important. The essential point about public infrastructure and (many) public services in the US isn’t that they vary so much from state, but that they’re grossly inadequate everywhere.

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Jack Strocchi 11.20.10 at 5:28 am

John Quiggin @ #33 said:

These points are useful correctives, but I don’t think they undermine the general point that bailouts aren’t simply a matter of (the citizens of) prudent eurozone countries paying to bail out (the citizens of) reckless borrowers in order to save the euro. Rather, most of the redistribution is within countries, from ordinary citizens to bankers and the aim is to save the banking system not the euro.

Where was the German housing bubble then? It seems that some country’s bankers are more reputable than other country’s bankers.

No wonder German bankers sound so snarky these days.

More generally, whilst Pr Q’s story about the European Sovereign Debt Crisis (ESDC) is true as far as it goes, it leaves out much. Therefore his theory of the ESDC leaves much to be desired.

Specifically, the ESDC is not merely a story of private financial agencies (Wall Street and the City) running amok, although that happened. Its also a story of how public fiscal agencies lost the plot, failing to practice counter-cyclical prudence and adding fuel to the housing bubble fire.

The Greek sovereign debt crisis was NOT the result of a real estate bubble pushed by unsound lending practices. TBS, the Greek banks are getting a bail-out, but that is a consequence, rather than a cause, of the general debt crisis. Since the slump, property prices there have mostly traded sideways or sagged slightly. Nothing terribly out of the ordinary.

Most of Greece’s national debt is government debt. It is suffering a fiscal-foreign crisis brought about by poor management of its budget combined with a down-turn in its export-dependent economy. That is, the Greek state is the “reckless borrower”, acting on behalf of its “citizens”. No doubt in cahoots with GS to cover its shabby audit trail.

More generally the whole story of the GGC is not a simple Bad Private Banks v Good Public Treasuries morality tale, although there is a fair bit of that. It is a story of how public fiscal policy reinforced private financial practice accross a whole range of economic activities eg In the US, Fed, GSEs, HUD. And in the EU, the PIIGS countries have all been fiscal profligates well before the housing bubble went bust.

Of of the interesting paradoxes is that British banks are deeply in the whole to the PIIGSs countries. So any EU bailout of PIIGSs is effectively a bailout of the UK. Rather as any US bailout of Wall Street was essentially a bailout of Goldman Sachs.

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Jack Strocchi 11.20.10 at 5:46 am

Have a look at this chart showing the snchronized deficits of the PIIGSs countries and the UK (okay wikipedia but its consistent with authorised sources). It shows that the whole Eurozone was heading into major deficit as early as 2007, which was before the US housing bubble burst.

So something was nasty cooking in the EU after the mid-naughties, or at least the reckless and feckless parts of it, well before Wall Street’s shenanigans started to really upset the boat. Sure there was reckless credit practices to finance property bubbles in the Meditteranean and North Sea states. But there were also structural fiscal deficits which the GFC has greatly amplified.

In a way the US and EU both face similar problems of “uneven development” for their diverse sjurisdictions and demographics. Plus a banking class (Wall Street & City) that is out of control. Thats proving to be a headache for policy makers on both sides of the pond.

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Tim Worstall 11.20.10 at 10:18 am

“yes and most federal spending is military spending.”

Not even remotely true.

Military is the majority of the discretionary budget, yes ($660 billion of $1.3 trillion) but there’s another $2.1 trillion of mandatory spending (Social Security, Medicare and Medicaid are each, individually, of the same order of magnitude as defence spending).

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IM 11.22.10 at 1:00 am

It shows that the whole Eurozone was heading into major deficit as early as 2007, which was before the US housing bubble burst.

Well, no. Actually it shows the Eurozone and the EU as aggregates moving into a balanced budget in 2007, from 1.5% or so to a 0.5% deficit. Spain had a surplus, Ireland a balanced budget, Italy was diminishing her deficit and only Greece was as usual in trouble. So 2007 only one country in this chart shows a public deficit problem: Greece.

Very much not a debt problem that started in the public sector. Of course it has arrived there now. But then you could say that Spain is the Florida and Ireland the Nevada or Arizona of Europe.

But in Florida there is Social security and Medicare and the DOD and NASA who all keep the federal government money flowing.

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piglet 11.22.10 at 4:44 pm

“Military is the majority of the discretionary budget, yes ($660 billion of $1.3 trillion) but there’s another $2.1 trillion of mandatory spending (Social Security, Medicare and Medicaid are each, individually, of the same order of magnitude as defence spending).”

Social Security shouldn’t be counted as government spending at all. Other countries count their retirement system separately and not part of the state budget. Remember what triggered the dispute was the comparison with the EU and the claim that US federal spending evens out regional differences, in particular with respect to “public infrastructure and services”.

The essential point about public infrastructure and (many) public services in the US isn’t that they vary so much from state, but that they’re grossly inadequate everywhere.

No I think the geographic disparity is significant and there’s a lot of literature to confirm that, e.g.
http://newswire.uark.edu/article.aspx?id=15081
http://www.kansaspress.ku.edu/drepla.html

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hix 11.23.10 at 6:39 pm

Read some numbers yesterday, the biggest Ireland creditor is the Uk )-:. Now, go try to spin that into a the Euro is evil theory.

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