Daily Archives: March 19, 2010

“Britain Not Part of Any Greek Tragedy”

By Marshall Auerback*

They certainly know what “schadenfreude” means in Germany. But the attempt by the German paper, Der Spiegel, to link the UK to the travails of Greece, takes the concept to a malicious and irrational extreme:

The British pound is tottering. The economy finds itself in its worst crisis since 1931, and the country came within a hair’s breadth of a deep recession. Speculators are betting against an upturn. Instability in the banking sector has had a more severe impact on government finances in Great Britain than in other industrialized countries. London’s budget deficit will amount to £186 billion (€205 billion, or $280 billion) this year — fully 12.9 percent of gross domestic product.

Sounds pretty, grim, especially given that Britain’s budget deficit is even higher than that of the “corrupt” Greeks, whom the Germans also seem so intent on abusing in print and punishing for their alleged fiscal profligacy.

But the article itself is rife with intellectual dishonesty. You cannot mindlessly conflate EMU states — Germany included — which operate with no real fiscal authority as sovereign states in the full sense — with countries, such as the United Kingdom, which fortunately has a government with currency issuing monopolies operating under flexible exchange rates (even though the British haven’t quite figured it out). And, as strange as it may sound, public sector profligacy at this time is preferable to Germanic style prudence, because as the private sector’s spending and borrowing go into hibernation, government borrowing must expand significantly to compensate. Even the French Finance Minister, Christine Lagarde, seems to understand that fact (and is taking heat from her German “allies” as a result). Her sin? She had the temerity to suggest that Berlin should consider boosting domestic demand to help deficit countries regain competitiveness and sort out their public finances. Noting that “it takes two to tango”, Lagarde suggested that an expansionary fiscal policy had a role to play here, not simply “enforcing deficit principles”.

Of course, that’s harder to do in the euro zone, given the insane constraints put forward as a condition of euro entry. As a consequence of these rules, the EMU nations cannot even run their own region properly. They have established a system which has consistently drained aggregate demand and brought increasingly high levels of unemployment to bear on their respective populations. In the words of Bill Mitchell:

The rules that the EU made up and then imposed on the EMU via the Maastricht Treaty’s Stability and Growth Pact were not based on any coherent models of fiscal sustainability or variations that might be encountered in these aggregates during a swing in the business cycle. The rules are biased towards high unemployment and stagnant growth of the sort that has bedeviled Europe for years.
Having conspicuously failed to deliver prosperity to their own countrymen, the Germans now see fit to lecture the UK (after taking out the Greeks, of course) on the grounds of Britain’s “crass Keynesianism” (in the words of Axel Weber, the President of the German Bundesbank).

There is no question that the UK has some unique features which make it more than just another casualty of the global credit crunch. It foolishly leveraged its growth strategy to the growth in financial services and is now paying the price for that misconceived policy, as the industry inevitably contracts and restructures as a percentage of GDP. This structural headwind will no doubt force the UK authorities to adopt an even more aggressive fiscal posture than would normally be the case. This is politically problematic, given that the vast majority of the UK’s policy makers (and the chattering classes in the media) still cling to the prevailing deficit hysteria now taking hold all over the world. But the reality is that the UK has considerably greater fiscal latitude of action than any of the euro zone countries, including Germany.

Let’s go back to first principles: In a country with a currency that is not convertible upon demand into anything other than itself (no gold “backing”, no fixed exchange rate), the government can never run out of money to spend, nor does it need to acquire money from the private sector in order to spend. This does not mean the government doesn’t face the risk of inflation, currency depreciation, or capital flight as a result of shifting private sector portfolio preferences. But the budget constraint on the government, the monopoly supplier of currency, is different than what most have been taught from classical economics, which is largely predicated on the notion of a now non-existent gold standard. The UK Treasury cuts you a benefits check, your check account gets credited, and then some reserves get moved around on the Bank of England’s balance sheet and on bank balance sheets to enable the central bank (in this case, the Bank of England) to hit its interest rate target. If anything, some inflation would probably be a good thing right now, given the prevailing high levels of private sector debt and the deflationary risk that PRIVATE debt represents because of the natural constraints against income and assets which operate in the absence of the ability to tax and create currency.

Unlike Germany, or any other EMU nation, there is no notion of “national solvency” that applies here, so the idea that the UK should follow Greece down the road to national suicide reflects nothing more than the traditional German predisposition to sado-monetarism and deficit reduction fetishism. A commitment to close the deficit is also what doomed Japan throughout most of the 1990s and 2000s, when foolish premature attempts at “fiscal consolidation” actually increased budget deficits by deflating incipient economic activity. Why would you tighten fiscal policy when there is anemic private demand and unemployment is still high?

Remember Accounting 101. It is the reversal of trade deficits and the increase in fiscal deficits, which gets a country to an increase in net private saving, ASSUMING NO STUPID SELF IMPOSED CONSTRAINTS along the lines proposed by Germany under the Stability and Growth Pact (which should be re-christened the “Instability and Non-Growth Pact”). Ideally, we want the deficits to be achieved in a good way: not with automatic stabilizers driving the budget into deficit because unemployment is rising and tax revenue is falling as private demand falters, but one in which a government uses discretionary fiscal policy to ensure that demand is sufficient to support high levels of employment and private saving. That in turn will stabilize growth and improve the deficit picture. Once this is achieved, any notions of national insolvency (or more “Greek tragedies”) should go out the window.

The UK can do this, even if its policy makers fail to recognize this. But not in the eyes of Der Spiegel, which warns that “tough times are ahead for the United Kingdom, so tough, in fact, that none of the parties has dared to say out loud what many in their ranks already know. At a minimum, Britons can look forward to higher taxes and fees.” And much lower growth if that prescription is followed.

We suspect that many in Germany and the rest of Europe understand this. So what other motivations are at work here? Clearly, calling attention to the state of Britain’s public finances and drawing specious comparisons to Greece in effect invites speculative capital to take its collective eye off the euro zone and focus it on the UK. Given that the alleged “Greek solution” proposed recently by the European Commission does nothing to resolve the country’s underlying problems, it behooves the euro zone countries to draw attention elsewhere before their collective resolve to defend their currency union comes under attack again.

And heaven forbid that the UK was actually successful (admittedly unlikely today, given the paucity of British political leaders who truly understand how modern money actually works). If Her Majesty’s Government spending actually managed to conduct fiscal policy in a manner which supported higher levels of employment and a more equitable transfers of national income (via, for example, a government Job Guarantee program) then what would be the response in the euro zone? Wouldn’t this cause its citizens to query what sort of bogus economic “expertise” that has been fed to them from their technocratic elites over the past two decades? The same sort of neo-liberal pap fed to the US courtesy of groups such as the Concord Coalition.

No question that public spending should be carefully mobilized to ensure that it is consonant with national purpose (not corporate cronyism). But the idea perpetuated by Der Spiegel that the government is somehow constrained by some self imposed rules with no reference to the underlying economy is comedy worthy of a Brechtian farce. Unfortunately, this particular German joke is no laughing matter.

*This post originally appeared on new deal 2.0

Greece Cannot Reduce Its Budget Deficit So Long As Its Neighbors Pursue Mercantilist Policy

By Yeva Nersisyan

When the 12 European Nations raced to embrace the single currency, euro, it was supposed to be a forward step in the process of European Integration, towards the United States of Europe. In retrospect, the euro has not only not contributed to deeper integration but is certainly close to undermining its foundations. The economic and debt crises have forced countries to resort back to their bitter past relations up to the point where Greeks are demanding that Germany pay WWII reparations.

Much has been said about Greece’s debt crisis with a few proposals on how it should deal with it. All of these eventually turn into proposals of how the Greeks should manage their own country. A recent article in the New York Times critically examines Greece’s pension system which has 580 occupations that qualify for early retirement at the age 50. Greece has promised early retirement to about 700,000 workers and its average retirement age is one of the lowest in Europe, 61. While the effectiveness or the reasonableness of the Greek pension system is beyond the scope of this blog, what is incomprehensible is how does a developed and politically sovereign nation such as Greece completely give up its domestic policy space, up to the point where it is told what to do about its pensioners, how to behave with the unions, what to do about public sector wages, etc? Politicians, rating agencies and media commentators somehow feel that they all have the right to give some advice on how the Greek government should manage their country. As long as we know, Greece is a representative democracy where the people elect their government and can demand that it do whatever it has promised to its population. It is up to the people of Greece, through the Greek government to decide what to do with their country, not to us, to you and especially not to the fraudulent and corrupt rating agencies and media commentators looking to make a career. Moreover, it sounds like Greece is simply trying to solve its unemployment problems by making people retire earlier. Prolonging the retirement age won’t do much to solve the problem, as the government will still need to spend to boost aggregate spending to create jobs for all those people.

Most commentators of course overlook the main issue which is that by entering the monetary union and divorcing fiscal and monetary authorities individual nations have given up their currency issuing capacity. So unlike the Untied States government that spends by simply crediting bank accounts, i.e. changing numbers on spreadsheets (see here), the Greek and even German governments need to have tax and bond revenues prior to spending. But euronations differ vastly in their ability to collect taxes and raise revenue through bond sales. The convergence in debt levels, interest rates and number of other economic variables among individual countries that was being predicted by mainstream economists never really materialized. Germany and to some degree France have remained the important players in the euro landscape reserving the right to dictate policy prescriptions to their less powerful southern neighbors. At this point, Greece largely depends on Germany to determine its fate. It is now similar to a developing country being told what policy to implement by the IMF, only in this case it’s Germany that has assumed the role of the IMF.

It is useful to recall the financial balance identity for analyzing what policy options Greece has (see here). The balance of the private sector (surplus/deficit) equals the balance of the government (deficit/surplus) plus the current account balance (surplus/deficit). In plain English this means that private sector savings (surplus) is financed by government deficit (an injection into private incomes and hence saving) and by the current account surplus (net exports are an injection into nominal income and hence saving). By entering the monetary union the euronations have voluntarily agreed to the debt and deficit constraints imposed by the Maastricht treaty. So what are the policy options for these countries under these self-imposed constraints? We know that the private sector cannot be perpetually in deficit; in fact the normal situation is for the private sector to try to save some of its income. The current account balance of Greece was -9.98% in 2009. If Greece only had a budget deficit of 3% (the Maastricht limit) then its private sector would need to run a deficit of 6.98%. If we want the Greeks to have a positive saving (>0) what needs to be true about the government deficit? Simple math will show that it has to be greater than 9.98% of GDP. So to balance its budget, either the private sector needs to go in debt (making bankers richer) or Greece needs to balance its current account and even try to achieve a small surplus which is neither desirable nor achievable.

But what happens when all euronations try to export their way out of their economic problems? Basically, they will have to revert to mercantilist-type beggar-thy-neighbor policies where each country tries to solve its growth and unemployment problems by exporting them to their trading partners. Germany has already taken this route which has allowed it to be a “role model” for “fiscal responsibility” and given it the “right” to criticize other countries which don’t follow it. But all the countries cannot be net exporters; some have to be net importers. Germany can only be a net exporter to Euroland if some other euro nations are willing to be on the other end of the transaction. France, Italy, Belgium and Spain are among the 11 largest export partners of Germany with each of these countries having a net deficit with it. It is the government or private deficit in these countries that’s financing Germany’s exports.

So what options do net importer countries such as Greece or Spain have to maintain their aggregate demand at a reasonable level? If sovereign indebtedness is not acceptable, the only thing left is private sector indebtedness which will eventually lead to a financial collapse as we have witnessed in the US, UK and elsewhere. And some countries such as Spain don’t even have that option as their private sector is already highly indebted.

To summarize, the problem is not Greece’s profligate spending, but rather the design of the European monetary system. It has been specifically created to divorce the monetary and fiscal authorities to make the monetary authority super independent from “political pressures”. It has tied the hands of governments restricting them in using their fiscal capacity to employ their labor resources and has forced the countries into sluggish growth, high unemployment rates, stagnating wages, cuts in social services, etc. They have been able to achieve low inflation rates though. What a fair trade-off! Moreover, as countries on the periphery approach the Maastricht debt limits, the markets start betting against the country’s debt forcing it to pay higher interest rates. And of course no mess is complete without the rating agencies which are “diligently” monitoring the debt and deficit situations threatening to cut countries’ ratings further exacerbating the problem.

If Germany wants to increase its retirement age and cut social benefits it should be up to the German public to accept it or protest against it. But foreigners shouldn’t be allowed to dictate this to Greece and other nations. If they are doing that, and successfully so, it means that something is wrong with the way the system is set up. It is time for Greece and other nations in the outskirts of Europe to push for a change in the institutional structure which is obviously dysfunctional.