Monthly Archives: December 2011

“No People, No Problem”: The Baltic Tigers’ False Prophets of Austerity

By Jeffrey Sommers, Arunas Juska and Michael Hudson*
(Cross-posted from Counterpunch)
The Baltic states have discovered a new way to cut unemployment and cut budgets for social services: emigration. If enough people of working age are forced to leave to find work abroad, unemployment and social service budgets will both drop.
This simple mathematics explains what the algebra of austerity-plan advocates are applauding today as the “New Baltic Miracle” for Greece, Spain, and Italy to emulate. The reality, however, is a model predicated on economic shrinkage as a result of wage cuts. In the case of Latvia, this was some 30 percent for Latvian public-sector employees (euphemized as “internal devaluation”). With a set of flat taxes on employment adding up to 59% in Latvia (while property taxes are only 1%), it would seem hard indeed to present this as a success story.

THERE WILL BE BLOOD

By Marshall Auerback

Another week to go before the euro blows up, orso we’re told again for the thousandth time. More likely is that the ECB doesbarely enough to keep the show on the road, fiscal austerity continues andriots intensify on the streets of Madrid, Athens, Rome and Paris.  Like the film, “there will be blood” beforethere is any likely change toward a sensible growth oriented policy in the eurozone.

Given the travails of the euro zone, why has theeuro remained relatively robust?  Surely,a currency that is supposedly within weeks of vanishing should be tradingcloser to parity with the dollar?  Yet onecontinues to be struck by the divergence of opinion and actual marketaction.  For all the talk about the europossibly vaporizing by Christmas, it is striking that it remains stubbornlystable at around $1.34 to the dollar, substantially above the low of $1.20,which was reached in May 2010 (when predictions of parity with the dollar wererampant).

By the same token, we have a paradox on theother side as well:  every time itappears as if a solution to the problems posed by the euro look to be close toresolution, the euro strengthens. Perhaps this isn’t so odd, except that thesolution that virtually everybody agrees will work – namely, a sustained andmore holistic bond-buying operation taken up by the European Central Bank (ECB)– is said to represent a form of “quantitative easing” and aren’t we alwaystold that “QE” represents “printing money”, which should cause a currency to godown?  Isn’t that what all of theopponents of the Fed’s program last year were asserting?

Of course, in the case of the European MonetaryUnion, ECB President Mario Draghi insists that such bond buying will not takeplace in the absence of proper “sequencing”, by which he means agreed fiscalausterity first, bond buying afterward. The effect of the former will negate any potential impact of the latter,since the “inflation channel” (to the extent that inflation occurs at all) canonly come through fiscal policy.  Andcertainly, in the teeth of a severe recession, such cuts as those proposed bythe client state governments of Italy and Greece (along with a renewed assaultby President Sarkozy on the French welfare state) will almost certainlyexacerbate the profoundly deflationary pressures now operating in theeurozone.  Ultimately, this will surely have theresult of creating substantially more social instability and bloodshed, but itmight have little impact on the euro itself.

So what is actuallyhappening to the euro? Let’s take a step back from the panic talk. The mostrecent data from the COMEX suggests that speculators are heavily short euro andyet the currency has fallen less than 10% from its recent highs.   The question one might legitimately poseis:  at what point does the currentfiscal austerity produce higher deficits, which in theory should produce aweaker euro (as the euros become “easier to get”)?

I have been wrestling with this issue, and keepgetting back to a strong currency, even with increased fiscal deficits. Why? 


For one, the ECB’s bondpurchases in the secondary market are operationally sustainable andnon-inflationary.  When the ECBundertakes its bond buying operation, its debt purchases merely shift netfinancial assets held by the ‘economy’ from national government liabilities toECB liabilities in the form of clearing balances at the ECB. At thesame time, so-called PIIGS government liabilities shift from ‘the economy’ tothe ECB.  Note: this process does not alter any ‘flows’or ‘net stocks of euros’ in the real economy.


As Warren Mosler and I have argued before, so as long as the ECB imposes austerian terms and conditions,their bond buying will not be inflationary. Inflation from this channel comesfrom spending.  However, in this case the ECB support comes only withreduced spending via its imposition of fiscal austerity.  Mr. Draghi has now made this explicit and itis almost certainly the German quid pro quo for tacitly supporting a proposedexpansion of the Secondary Market Program (SMP).  And reduced spendingmeans reduced aggregate demand, which therefore means reduced inflation and astronger currency.   We also knowfrom an authority no less than the BIS (ironically, the same initials as “bloodin streets”) that banks cannot lend out reserves (see here – ), so increasing reserves in the banking system is NOTinflationary per se, as the Weimar hyperinflation hyperventilators continue towarn us. 

Now consider the trade channel: despite today’srapidly weakening economy (Europe is almost certainly in recession today), we are not seeing much deterioration in theeuro zone’s current account deficit. The Eurozone, in fact, seems to be apretty self-contained, and somewhat mercantilist economy, which displays far lessproclivity to import when the economy slides. So even though imports go down,so too do trade deficits, due to falling demand. Exports don’t fall and may infact go up in this kind of environment.

So that’s euro friendly.

As far as what happens if the ECB were to expandsignificantly its bond buying program in the secondary market, the notion thatthe euro would fall is akin to the reasoning that the dollar would collapse if itengaged in QE2. And if what is called quantitative easing was inflationary,Japan would be hyperinflating by now, with the US not far behind.

There is NO sign that the ECB’s buying of eurodenominated government bonds has resulted in any kind of monetary inflation, asnothing but deflationary pressures continue to mount in that ongoing debtimplosion. The reason there is no inflation from the ECB bond buying is becauseall it does is shift investor holdings from national govt. debt to ECBbalances, which changes nothing in the real economy.

But the question which persistently arises whenone advocates a larger institutional role for the ECB is  whether the ECB’s balance sheet would beimpaired, and the MMT contention has long been NO, because if the ECB boughtthe bonds then, by definition, the “profligates” do not default. In fact, asthe monopoly provider of the euro, the ECB could easily set the rate at whichit buys the bonds (say, 4% for Italy) and eventually it would replenish itscapital via the profits it would receive from buying the distressed debt (notthat the ECB requires capital in an operational sense; as usual with the eurozone, this is a political issue). At some point, Professor Paul de Grauwe isright:  convinced that the ECBwas serious about resolving the solvency issue, the markets would begin to buythe bonds again and effectively do the ECB’s heavy lifting for them. The bondswould not be trading at these distressed levels if not for the solvency issue,which the ECB can easily address if it chooses to do so.  But this is a question of political will, notoperational “sustainability”.

So the grand irony of the day remains this:while there is nothing the ECB can do to cause monetary inflation, even if itwanted to, the ECB, fearing inflation, holds back on the bond buying that wouldeliminate the national govt. solvency risk but not halt the deflationarymonetary forces currently in place.

Okay, so who takes the losses?  Well, presuming the bonds don’t mature atpar, no question that a private bank which sells a bond at today’s distressedlevels might well take a loss and if the losses are big enough, then banks inthis position might well need a recapitalization program.. And in this scenarioGermany too could take a hit, as does every other national government as theyuse national fiscal resources to recapitalize. And the hit will get bigger thelonger the Germans continue to push this crisis to the brink.

But that is a separate issue from the questionof whether the bond buying program per se will pose a threat to the ECB’sbalance sheet. It will not:  a big incometransfer from the private bond holders who sell to the ECB, which can build up its capital base via the profits it makes onpurchasing these distressed bonds.  So again, the notion of an ECB being capitalconstrained is insane.

By contrast, the status quo is a loser foreverybody, including Germany.  A broaderECB role as lender of last resort of the kind the Germans are still publiclyresisting, along with their unhelpful talk of haircuts and greater privatesector losses, actually do MUCH MORE to wreck Germany’s credit position thanthe policy measures which virtually everybody else in Europe is recommending.  Why would any private bondholder with amodicum of fiduciary responsibility buy a European bond, knowing that the rulesof the game have changed and that the private buyer could find himself/herselfwith losses being unilaterally imposed? The good news is that there finally appears to be some recognition of thedangers of this approach.  Per the WallStreet Journal:

“Ms.Merkel signalled on Friday that she is having second thoughts about the wisdomof emphasizing bondholder losses: ‘We have a draft for the ESM, which must bechanged in the light of developments’ in financial markets since theGreek-restructuring decision in July, she said after meeting Austria’schancellor in Berlin.

Austrian Finance Minister Maria Fekter, speaking at a conference in Hamburg onFriday, was more direct. ‘Trust ingovernment treasuries was so thoroughly destroyed by involving private sectorinvestors in the debt relief that you have to wonder why anyone still buysgovernment bonds at all,’ Ms. Fekter said.”


There are other issues which aremaking Germany’s position increasingly untenable, notably on the politicalfront, in particular the mounting strains between France and Germany.  Wolf Richter notes that virtually every leading candidatein the French Presidential campaign envisages a much more aggressive role forthe ECB going forward.  If ChancellorMerkel thinks she’s going to have a tough time now, wait until she ispotentially dealing with Francois Hollande, the French Socialist Presidentialcandidate, who is now ahead in the all of the polls, and who advocates a five-point plan which is anathema to Germany’sgoverning coalition:

  1. Expand to the greatest extent possible the European bailout fund (EFSF)
  2. Issue Eurobonds and spread national liabilities across all Eurozone countries
  3. Get the ECB to play an “active role,” i.e. buy Eurozone sovereign debt.
  4. Institute a financial transaction tax
  5. Launch growth initiatives instead of austerity measures.

As Richter notes, issues 1, 2, 3, and 5 are allnon-starters amongst Berlin’s policy making elites.  Even more extreme are the views of Socialistcandidate, Arnaud Montebourg, who has openly spoken of “the annexation of the French rightby the Prussian right.”

On the right, things are not much better.  French President Nicolas Sarkozy risks beingoutflanked by National Front leader, Marine Le Pen (whose father is Jean Marie Le Pen), who is adopting anexplicitly anti-euro candidacy, which isgaining traction as France’s new austerity measures continue to bite intoeconomic growth.   In his futile attemptsto maintain France’s AAA credit rating via increased fiscal austerity, Sarkorisks being hoisted by his own petard, as the likely impact of such measureswill be to take French unemployment back into double digits.  Paying obeisance to the shrine of Moody’s,Fitch and S&P via fiscal austerity is the economic equivalent of seeking tonegotiate a peace treaty with Al Qaeda.

True, Germany might well decide that enough isenough, that the ECB’s actions represent “printing money” and may thereforeinitiate a process of leaving the euro zone. But let us be clear about the consequences:  Were it to adopt this approach, Germany wouldlikely suffer from a huge trade shock, particularly as its aversion to”fiscal profligacy” would doom it to much higher levels ofunemployment (unless the government all of a sudden experienced a Damasceneconversion to Keynesianism – about as likely as a Klansman attending a Presidentialrally for Barack Obama) or reverting to its former policy of dollar buying. Itmight also affect the living standards of the average German as well becauseGermany’s large manufacturers originally bought into the currency union becausethey felt it would prevent the likes of chronic currency devaluers, such as theItalians, to use this expedient to achieve a higher share of world trade atGermany’s expense. Were they confronted with the loss of market share, Germanmultinationals might simply move manufacturing facilities to the new, low costregions of Europe to preserve market share and cost advantage or, at the veryleast, use the threat of moving to extort cuts in wages and benefits to Germanworks as a quid pro quo for remaining at home. Perhaps there would be blood in the streets of Berlin at that point aswell.

In fact, it is doublyironic that Germany chastises its neighbors for their “profligacy” but relieson their “living beyond their means” to produce a trade surplus that allows itsgovernment to run smaller budget deficits. Germany is, in fact, structurallyreliant on dis-saving abroad to grow at all. Current account deficits in otherparts of the euro zone are required for German growth. It is the height ofhypocrisy for Germans to berate the southern states for over-spending when thatspending is the only thing that has allowed Germany’s economy to grow. It isalso mindless for Germans to be advocating harsh austerity for the south statesand hacking into their spending potential and not to think that it won’treverberate back onto Germany.

Now, of course, GermanChancellor Angela Merkel may not consciously know all of these things.  In fact, she termed accusations of Germanyseeking to dominate Europe “bizarre”.  But it is clear to any objective observer that the political quid pro quo for greater ECB involvement indealing with Europe’s national solvency crisis is German control over theoverall fiscal conduct of countries like Greece, Italy, etc. Mario Draghi is Italian, but as Michael Hirsh of the National Journal noted in a recent tweet, the ECB head isplaying a German game of chicken: he is embracing exactly the strategy thatAngela Merkel’s political director, Klaus Schuler, laid out several weeks ago:holding out for fiscal union commitments from the weaker “Club Med”countries, in return for turning the ECB into a lender of last resort.  So whilst many Germans might think they want a smaller, more cohesiveeuro zone without the troublesome profligates, the policy elites in factrecognize that a “United States of Germany” under the guise of aUnited States of Europe, actually suits their aspirations to dominate Europepolitically and economically.  Which iswhy the outlines of a deal along the lines of increased ECB involved as a quidpro quo for greater German control of fiscal policy across the euro zone, isemerging.   It’s the equivalent of thegolden rule:  “He who has the gold,rules.” 
 It is high stakes poker, and one which willultimately lead to far more bloodshed, as my friend, Warren Mosler, aptly notedin a recent blog post:

Thereis no plan B. Just keep raising taxes and cutting spending even as
those actions work to cause deficits to go higher rather than lower.
Sowhile the solvency and funding issue is likely to be resolved, the relief rallywon’t last long as the funding will continue to be conditional to ongoingausterity and negative growth.
Andthe austerity looks likely to not only continue but also to intensify,
even as the euro zone has already slipped into recession.
So from what I can see,  there’s no chance that the ECB would fundand at the same time mandate the higherdeficits needed for a recovery, In which case the only thing that will endthe austerity is blood on the streets in sufficient quantity to trigger chaosand a change in governance.” (ouremphasis)

And by the way, thenotion suggested by some that this horrible dynamic could be arrested by theFed acting as a kind of global central banker of last resort is asinine.   As BillMitchell noted recently:

Asof today, the 1 Euro = 1.3294 U.S. dollars. So just purchasing the PIIGS debtto fund their 2010 deficits would have required the US Federal Reserve sellaround 347,024 million USD which is about 5.8 per cent of the US GDP over thelast four quarters. That is a huge injection of US dollars into the worldforeign exchange markets.
Thevolume of spending that would be required are even larger than the estimatesprovided here. That is, because to really solve the Euro crisis the deficits in(probably) all the EMU nations have to rise substantially.
Whatdo you think would happen to the US dollar currency value? The answer is thatit would drop very significantly. The word collapse might be more appropriatethan drop…At this point in the crisis, there is nothing to be gained by a massiveUS dollar depreciation and the inflationary impulses such a large depreciationwould probably impart. 

Blaming the Fed for afailure to backstop the eurozone’s bonds is akin to blaming a bystander for notstanding in front of a bullet when he witnesses somebody taking out a gun, andshooting another person.  The triggermanbears ultimate responsibility.  By thesame token, the euro crisis is a crisis which has its roots in the eurozone’sflawed financial architecture (no less an authority than Jacques Delors hasrecently admitted this ), and can only be solved by theEuropeans, specifically, the ECB, which is the only institution in theEMU that can spend without recourse to prior funding, due to the flawed designof the monetary system that was forced upon the member states at the inceptionof the union.  But Mario Draghi acceptsthe German political quid pro quo: in order to act, he will insist on greaterfiscal austerity as a necessary condition, which will perversely have impact ofdeflating these economies into the ground further and engender HIGHER publicdeficits.  Obviously this is one reason the Germans felt socomfortable in naming an Italian to the ECB. Trojan horses apparently don’tjust come in Greek forms these days. A Europe, where countries such as Italyand Greece become client states of Germany provides a much more effectiveoutcome for Germany than, say, trying to do the same thing via anotherdestructive World War.

MMP Blog #27: What about a country that adopts a foreign currency? Part One

By L. Randall Wray

A countrymight choose to use a foreign currency for domestic policy purposes. Asmentioned in a previous blog, even the US government accepted foreigncurrencies in payment up to the mid nineteenth century, and it is common inmany nations to use foreign currencies for at least some purposes. Here,however, we are examining a nation that does not issue a currency at all.

Let us saythat some national government adopts the US Dollar as the officialcurrency—accepted at public pay offices, with taxes and prices denominated inthe Dollar. Banks make loans and create deposits in Dollars. Government spendsin Dollars. While the nation cannot create US Dollars, it is clear thathouseholds, firms, and government can create IOUs denominated in Dollars.

Asdiscussed earlier, these IOUs are part of the debt pyramid, leveraging actualUS Dollars. Some of the IOUs (such as bank deposits) are directly convertibleto US Dollars. The currency in circulation is the US Dollar (US coins andnotes), but many or most payments will be done electronically. Check clearingwill be done at the country’s central bank, by shifting central bank reservesthat are denominated in Dollars.

Note,however, that withdrawals from banks are made in the form of actual US Dollars.Further, international payments will be made in Dollars (a current accountdeficit will require transfer of Dollars from the country to a foreigncountry). How is that accomplished? The domestic central bank will have aDollar account at the US Fed. When payment is made to a foreigner, the centralbank’s account is debited, and the account of some other foreign central bank’saccount is debited (unless, of course, the payment is made to the US).

Becausethis nation does not issue Dollars, but rather uses Dollars, it must obtain them to ensure it can make theseinternational payments and can meet cash withdrawals so that Dollar currencycan circulate in its economy. It obtains Dollars in the same way that anynation obtains foreign currency—because the Dollar really is a foreign currencyin terms of ability to obtain cash and Dollar reserves. Hence, it can obtainDollars through exports, through borrowing, through asset sales (includingforeign direct investment) and through remittances.

It isapparent that adoption of a foreign currency is equivalent to running a verytight fixed exchange rate regime—one with no wiggle room at all because thereis no way to devalue the currency. It provides the least policy space of anyexchange rate regime. This does not necessarily mean that it is a bad policy.But it does mean that the nation’s domestic policy is constrained by itsability to obtain the “foreign currency” Dollar. In a pinch, it might be ableto rely on US willingness to provide foreign aid (transfers or loans ofDollars). A nation that adopts foreign currency cedes a significant degree ofits sovereign power.

The Euro. The analysis in this Primer so far (with theexception of the previous subsection) has concerned the typical case of “onenation, one currency”. Until the development of the European Monetary Union(EMU) examples of countries that share a currency have been rare. They wereusually limited to cases such as the Vatican in Italy (while nominallyseparate, the Vatican is located in Rome and used the Italian Lira), or toformer colonies or protectorates. However, Europe embarked on a grandexperiment, with those nations that join the EMU abandoning their owncurrencies in favour of the Euro. Monetary policy is set at the center by theEuropean Central Bank (ECB)—this means that the overnight interbank interestrate is the same across the EMU. The national central banks are no longerindependent—they are much like the regional US Federal Reserve Banks that areessentially subsidiaries of the Federal Reserve’s Board of Governors that setsinterest rates (in meetings of the Federal Open Market Committee inWashington).

There isone difference, however, in that the individual national central banks stilloperate clearing facilities among banks and between banks and the nationalgovernment. This means they are necessarily involved in facilitating domesticfiscal policy. But while monetary policy was in a sense “unified” across theEMU in the hands of the ECB, fiscal policy remained in the hands of eachindividual national government. Thus, to a significant degree fiscal policy wasseparated from the currency.

We canthink of the individual EMU nations as “users” not “issuers” of the currency;they are more like US states (or, say, provinces of Canada). They tax and spendin Euros, and they issue debt denominated in Euros, much like US states tax andspend and borrow in Dollars.

In the USthe states are required to submit balanced budgets (48 states actually haveconstitutional requirements to do so; this does not mean that at the end of thefiscal year they have achieved a balanced budget—revenues can come in lowerthan anticipated, and spending can be higher). This does not mean they do notborrow—when a state government finances long-lived public infrastructure, forexample, it issues Dollar denominated bonds. It uses tax revenue to servicethat debt. Each year it includes debt service as part of its planned spending,and aims to ensure that total revenues cover all current expenditures includingdebt service.

When a USstate ends up running a budget deficit, it faces the possibility that creditraters will down-grade its debt—meaning that interest rates will go up. Thiscould cause a vicious cycle of interest rate hikes that increase debt servicecosts, resulting in higher deficits and more down-grades. Default on debtbecause a real possibility—and there are examples in the US in which state andlocal governments have either come close to default, or actually were forced todefault (Orange county—one of the richest counties in the US—actually diddefault). Economic downturns—such as the crisis that began in 2007—cause many stateand local governments to experience debt problems, triggering creditdown-grades. This then forces the governments to cut spending and/or raisetaxes.

To reducethe possibility of such debt problems among EMU nations, each agreed to adoptrestrictions on budget deficits and debt issue—the guidelines were that nationswould not run national government budget deficits greater than 3% of GDP andwould not accumulate government debt greater than 60% of GDP. In reality,virtually all member nations persistently violated these criteria.

With theglobal financial crisis that began in 2007, many “periphery” nations(especially Greece, Portugal, Ireland, Spain, and Italy) experienced seriousdebt problems and down-grades. Markets pushed their interest rates higher,compounding the problems. The EMU was forced to intervene, taking the form ofloans by the ECB (and even by the IMF). The US Fed even lent dollars to many ofthe European central banks. Nations facing debt problems were forced to adoptausterity packages—cutting spending, laying-off government employees andforcing wage cuts, and raising taxes and fees.

The nationslike Germany (also Finland) that largely escaped these problems pointed theirfingers at “profligate” neighbours like Greece that purportedly ranirresponsible fiscal policy. Credit “spreads” (the difference in interest ratespaid by the German government on its debt versus the rates paid by the weakernations; a good indicator of expected default is the spread on “credit defaultswaps” that are a form of insurance against default) soared as marketseffectively “bet” on default by the weaker nations on their government debt.

To put allthis in context it is important to understand that the Euro nations actuallydid not have outrageously high budget deficits or debt ratios, compared withthose achieved historically by sovereign nations. Indeed, Japan’s deficits anddebt ratios at the time were very much higher; and the US ratios were similarto those of some Euro nations now facing debt crises. Yet, countries that issuetheir own floating rate currency do not face such a strong marketreaction—their interest rates on government debt are not forced up (even whencredit rating agencies occasionally down-grade their debt, as they did earlierin the decade in the case of Japan, and threatened to do against the US).

 So what is the difference between, say, Japanversus Greece? Why do markets treat Japan differently?

The key isto understand that when Greece joined the EMU, it gave up its sovereign currencyand adopted what is essentially a foreign currency. When Japan services itsdebts, it does so by making “keystroke” entries onto balance sheets, asdiscussed weeks ago. It can never run out of the “keystrokes”—it can create asmany Yen entries as necessary. It can never be forced into involuntary default.

A sovereigngovernment with its own currency can always “afford” to make all payments asthey come due. To be sure, this requires cooperation between the treasury andthe central bank to ensure the bank accounts get credited with interest, aswell as a willingness of elected representatives to budget for the interestexpenditures. But markets presume that the sovereign government will meet itsobligations.

Thesituation is different for members of the EMU. First, the ECB has much greaterindependence from the member nations than the Fed has from the US government.The Fed is a “creature of Congress”, subject to its mandates; the ECB isformally independent of any national government. The operational proceduresadopted by the Fed ensure that it always cooperates with the US Treasury toallow government to make all payments approved by Congress. The Fed routinelypurchases US government debt as necessary to provide reserves desired by memberbanks. The ECB is prohibited from such cooperation with any member state.

From thepoint of view of the EMU, this was not perceived to be a flaw in thearrangement but rather a design feature—the purpose of the separation was toensure that no member state would be able to use the ECB to run up budgetdeficits financed by “keystrokes”. The belief was that by forcing member statesto go to the market to obtain funding, market discipline would keep budgetdeficits in line. A government that tried to borrow too much would face risinginterest rates, forcing it to cut back spending and raise taxes. Hence, givingup currency sovereignty was supposed to reign-in the more profligate spenders.

We will notexplore in detail this week what went wrong. Briefly, we can say that thecombination of fixed exchange rates and sectoral balances, as well as a bit ofdata manipulation and a global financial crisis created a monstrous governmentdebt problem that spread around the edges of the EMU, threatening to bring downthe whole union.

Since eachnation had adopted the Euro, exchange rates were fixed among countries withinthe EMU. Some nations (Greece, Italy) were less successful at holding downinflation (especially wages) and thus found they were increasingly lesscompetitive within Europe. As a result, they ran trade deficits, especiallywith Germany.

As we knowfrom our macro accounting, a current account deficit must be equal to agovernment budget deficit and/or a domestic private sector deficit. Thus,Germany could (rightfully) point to “profligate” spending by the government andprivate sector of Greece; and Greece could (rightfully) blame Germany for its“mercantilist” trade policy that relied on trade surpluses. Effectively, Germanywas able to keep its budget deficits low, and its private sector savings high,by relying on its neighbours to keep the German economy growing throughexports. But that meant, in turn, that its neighbours were building updebts—and eventually markets reacted to that with credit downgrades.

Unfortunately,some of these governments engaged in creative accounting–concealing debt—andwhen that was discovered, the finger-pointing got worse. The global financialcrisis also contributed to problems, as jittery markets ran to the safest debt(US government bonds, and within Europe to German and French debt). Burstingreal estate bubbles hurt financial markets as well as indebted households. Bankproblems within Europe also increased government debt through bail-outs(Ireland’s government debt problems were due largely to bail-outs of troubledfinancial institutions). The economic slowdown also reduced government taxrevenue and raised transfer spending. To avert default, the ECB had to abandonits resolve, arranging for rescue packages. Officials began to recognize that acomplete divorce between a nation and its currency (that is separation offiscal policy from a sovereign currency) is not a good idea.

Debt and Democracy: Has the Link been Broken?

By Michael Hudson

A longer version of the article will appear in the Frankfurter Algemeine Zeitung on December 5th, 2011
Book V of Aristotle’s Politics describes the eternal transition of oligarchies making themselves into hereditary aristocracies – which end up being overthrown by tyrants or develop internal rivalries as some families decide to “take the multitude into their camp” and usher in democracy, within which an oligarchy emerges once again, followed by aristocracy, democracy, and so on throughout history.
Debt has been the main dynamic driving these shifts – always with new twists and turns. It polarizes wealth to create a creditor class, whose oligarchic rule is ended as new leaders (“tyrants” to Aristotle) win popular support by cancelling the debts and redistributing property or taking its usufruct for the state.