Marshall Auerback: Are We Approaching the Endgame for the Euro?

By Marshall Auerback, a hedge fund manager, portfolio strategist, and Roosevelt Institute fellow. A version of this post appeared at New Economic Perspectives.

Forget about the S&P downgrade, which has had ZERO impact on the global equity markets. The downgrade was supposed to mean that it would be more likely that the US government would not be able to pay its debt than previously assumed. IF the markets took this warning seriously, then they would have attached a higher risk premium to US government bonds. Of course, the opposite occurred. US bonds soared in price. In other words, investors, both here and abroad, voted with money as loudly as possible that they view the US government debt as a very safe haven in a time of financial turmoil

So if it wasn’t the S&P downgrade which caused this downward cascade in the global equity markets, then what was it? By far, the most important factor currently driving the market’s bear trends is Europe or, more specifically, the future of the euro and the European Monetary Union. Systemic risk has migrated across the Atlantic to the euro zone.

And after the recent joke of a summit between German Chancellor Merkel and French President Nicolas Sarkozy, it appears yet again that Europe’s policy makers have comprehensively blown it. Their persistent reluctance to get ahead of the looming systemic ticking bomb at the heart of the euro project has reached the point where it is likely to doom the euro’s existence. Their repeated “rescue plans” (and equally fatuous statements about new committees and “euro solidarity”) can no longer mask the central problem, which is that countries with very different economies are yoked to the same currency in the absence of a fiscal transfer union which would otherwise facilitate growth, not ongoing economic depression and political turmoil.

Rather than attempting to stave off a double-dip recession by easing fiscal and monetary policy, the European Central Bank (ECB) has gone careening off in the opposite direction. The euro project is consequently being turned into a Hooverian instrument of economic torture from sado-monetarists, such as Jean-Claude Trichet, who see each bailout as a way for irresponsible nations to offload their liabilities onto their fitter neighbors, rather than considering the flawed institutional structures which created the need for these stop-gap measures in the first place. Interest rates have been raised, and member states have been forced into self-defeating austerity programmes which, by destroying growth, have made underlying debt dynamics even worse. It is hard to imagine a more tragic and self-defeating type of policy mix. It is 1937 writ large.

How long will voters in rich countries stand for this? Perhaps not much longer as the Germans in particular appear to have no stomach to withstand the costs required to save the currency union. So what is this problem at the heart of the euro project?

Let’s go back to first principles: it is important to recognize the difference between sovereign and non-sovereign currencies. A government with a non-sovereign currency, issuing debts either in foreign currency or in domestic currency pegged to foreign currency (or to a precious metal, such as gold), faces solvency risk. However, a government that spends by using its own floating and non-convertible currency cannot be forced into default, unless they willingly choose to do so (such as the US Congress almost prepared to contemplate during its recent debt ceiling negotiations). It is why a country like Japan can run government debt-to-GDP ratios that are more than twice as high as the “high debt” PIIGS, while enjoying extremely low interest rates on sovereign debt. A nation operating with its own currency can always spend by crediting bank accounts, and that includes spending on interest. Thus, there is no default risk in terms of a capacity to pay (as opposed to political WILLINGNESS to pay).

But as has been noted by many critics of the common currency project, the relation of member countries to the European Monetary Union (EMU) is more similar to the relation of the treasuries of member states of the United States to the Fed than it is of the US Treasury to the Fed. A country like Ireland is more like New York within the EMU than a sovereign state. This means it has little domestic policy space to use monetary or fiscal policy to deal with crisis. The upshot has been that in the face of the first large negative demand shock to hit the region, the nation states have quickly found they cannot use fiscal policy in a responsible way to protect its economy from rising unemployment and collapsing income. In a normal federation, the national government can always ensure the solvency of the constituent parts via fiscal transfers. In the legal design of the EMU, there is no such role specified and attempts by the member states to cushion the demand collapse quickly raised the ire of the Euro elites with the ECB leading the charge to impose austerity on errant governments.

In the US, states have no power to create currency; in this circumstance, taxes really do ‘finance’ state spending and states really do have to borrow (sell bonds to the markets) in order to spend in excess of tax receipts. Purchasers of state bonds do worry about the creditworthiness of states, and the ability of American states to run deficits depends at least in part on the perception of creditworthiness. While it is certainly true that an individual state can always fall back on US government help when required (although the recent experience of the debt ceiling negotiations makes that assumption less secure), it is not so clear that the individual countries in the euro zone are as fortunate. Functionally, each nation state operates the way individual American states do, but with ONLY individual state treasuries.

The euro dilemma, then, is somewhat akin to the Latin American dilemma, such as countries like Argentina regularly experienced during the time that they operated currency pegs. Given the institutional constraints, deficit spending in effect requires borrowing in a “foreign currency”, according to the dictates of private markets and the nation states are externally constrained. That’s why Ireland and Latvia are in a mess and suffer from solvency issues. It’s also why California suffers from a solvency issue or Italy or Spain. Not the US or Japan, which explains why the latter has been able to borrow money at around 1% for the past two decades, despite a public debt to GDP ratio about twice the US or the euro zone.

At this juncture, however, there isn’t enough time to create a “United States of Europe”, which is why the ECB has resumed its bond buying operations to put a floor on the bonds and alleviate concerns about the solvency issues of the individual nation states. The ECB has received a lot of criticism for this. In one sense, the criticisms are legitimate: The ECB is in effect playing a “fiscal role” for which they are ill-suited. They buy time by buying the bonds.

But the bond buying attacks the symptoms, rather than the underlying problems. And it’s fundamentally undemocratic: In taking up this role – by way of the ad hoc bailouts and secondary bond market purchases the ECB has become a sort of fiscal tsar unanswerable to any national electorate.

The hope is that by backstopping the bonds, the ECB can persuade the markets that countries like Italy and Greece are not insolvent and that these countries will resume funding them. Even with Italian and Spanish bonds now dipping below 5% recently, this has proved to be a fatuous hope because the contagion has now spread into core countries such as France. Europeans still have to get the institutional arrangements right and the ECB, as the sole issuer of euros, is the only instrument that today can play this role, albeit imperfectly, but there is a better way.

Immediate relief can be provided by the ECB, which should be directed to create and distribute several trillion euros across all euro zone nations on a per capita basis. This would not constitute a “bailout” as such as Germany (with the largest per capita economy) would be the largest recipient. Each individual eurozone nation would be allowed to use this emergency relief as it sees fit. Greece might choose to purchase some of its outstanding public debt; others might choose fiscal stimulus packages. While this might sound much like the current bail-out, in which the ECB buys government bonds in the secondary markets from banks (assuming the risk of a default by Greece, for example), the emergency package outlined here (first proposed by Warren Mosler) would be under the discretion of the individual nations.

Hence, the ECB would finance current government operations if national governments chose that course of action. And if they found that a country was abusing the privilege (for example, Greece being deficient in tax collection), it could withhold the payments until compliance was achieved. In effect, the sanction would be more credible as it would constitute the ECB withholding carrots, rather than beating up fiscally stressed countries with a stick and seeking compliance with a country already in dire economic straits. More significantly, the revenue sharing proposal would address the contagion impact, as the ECB could continue the distributions to other countries, even as it punished the “recalcitrant problem children”.

We emphasise that this does not address the problem of deficient aggregate demand, but does address the solvency issue, which is the main systemic threat to the euro zone right now (indeed, to the entire global economy). By persuading the markets that most of the euro zone is creditworthy, the risk of the markets shutting these countries down diminishes considerably. As these countries fund themselves on credible terms in the private markets, they can begin to grow again.

Of course, putting the problem in this context and putting out a figure that has a trillion euro handle on it, makes it harder to believe that it will be politically palatable to the ECB or its stronger creditor nations such as Germany. Which is why we think that our earlier suggestion might become the more likely endgame:

The likely result of a German exit would be a huge surge in the value of the newly reconstituted DM. In effect, then, everybody devalues against the economic powerhouse which is Germany and the onus for fiscal reflation is now placed on the most recalcitrant member of the European Union. Germany will likely have to bail out its banks, but this is more politically palatable than, say, bailing out the Greek banks (at least from the perspective of the German populace).

The question remains: do the Germans ultimately quit the euro to save Germany or do they take the view that their fate is too intertwined with the common currency and that departure imposes an even greater economic and political cost?

If the latter, the Germans have to be made to understand that core problem at the heart of the euro zone is NOT a problem of “Mediterranean profligacy”. Many people, particularly in Germany, express the view that the Italian, Greek or Portuguese governments (and by association their people) are to blame for this crisis – accessing cheap loans from Northern European banks, not paying enough taxes, not working hard enough, etc (this also seems to be a common view amongst readers of this blog).

One thing is clear from the remarks that continue to emanate from Europe’s main policy makers. They do not understand basic accounting identities. They fail to see any kind of relationship between their own export model and their trading partners.

For example, it is ironic (and more than a touch hypocritical) that Germany chastises its neighbors, like Greece, or its trading partners like the U.S., for their “profligacy”, but relies on these countries “living beyond their means” to produce a trade surplus that allows its own government to run smaller budget deficits.

It’s even more extreme within the euro zone in the context of the global economy. The European Monetary Union bloc as a whole runs an approximately balanced current account with the rest of the world. Hence, within Euroland it is a zero-sum game: one nation’s current account surplus is offset by a deficit run by a neighbor. And given triple constraints — an inability to devalue the euro, a global downturn, and the most dominant partner within the bloc, Germany, committed to running its own trade surpluses — it seems quite unlikely that poor, suffering nations like Greece or Ireland could move toward a current account surplus and thereby help to reduce its own government “profligacy”.

The ECB appears to suffer from the same conceptual confusion. They do not appear to make the connection between financial balances and nominal GDP growth -, as in, if the domestic private sector has a high desired net saving position (that is, seeks to save more than they invest, and either net accumulate financial assets or net reduce financial liabilities), nominal GDP growth will slow (or even contract) unless the fiscal balance is reduced, the current account balance is increased, or some combination thereof in sufficient size.

They seem to understand financial balances must balance ex post, and so the sector balances are interconnected. They do not appear to recognize the issuer of money and the creators of credit generally hold the key to the ability of sectors to deficit spend, and that deficit spending is required to generate the increase in income out of which new gross saving can occur. But with the chimera of “expansionary fiscal consolidations” getting revealed with Greece, Ireland, Portugal, and soon Spain all in recession, maybe we have an opportunity to connect the dots for more people on this.

What about the issue of laziness, corruption, poor tax collection, all of the charges usually hurled against the so-called “PIIGS” countries? To this we would simply ask, even if the “Club Med” countries are lazy and don’t pay taxes, why did this crisis come now? As Bill Mitchell has noted, these countries didn’t just become “lazy” when they joined the EMU. Why didn’t, say, the Italian government face insolvency prior to joining the EMU? The point is that it might be sensible if the Italian government could get the high income earners to pay more tax and it might be sensible to raise productivity but, as Mitchell has argued, none of these things are intrinsic to their crisis.

No, the problem is the Euro and it is a shared problem across the Euro zone. And this is what is beginning to dawn on the markets, as the contagion spreads from the periphery into the core.
Consider the chart constructed by the economist, Rebecca Braeu, of Standish Management:

The red line refers to Germany’s leading economic indicators – order books, exports, etc., and point to dramatically slower growth in the months ahead. Germany is in effect also a passenger on the Titanic, as Italian Finance Minister Guilio Tremonti recently noted. It might be in the first-class cabin, rather than steerage (or Irish stowaways, as the Germans no doubt view the former “Celtic Tiger”), but when the boat hits the iceberg, all passengers are affected.

Until now, the Eurocrats have either remained in denial about the mounting stress fractures within the system, or forced weaker countries to impose even greater fiscal austerity on their suffering populations, which has exacerbated the problems further. And there has been a complete lack of consistency of principle. When larger countries such as Germany and France routinely violated spending limits a few years ago, this was conveniently ignored (or papered over), in contrast to the vituperative criticism now being hurled at the Mediterranean profligates. The EU’s repeated tendency to make ad hoc improvisations of EMU’s treaty provisions, rather than engaging in the hard job of reforming its flawed arrangements, are a function of a silly ideology which is neither grounded in political reality, nor economic logic. As a result, a political firestorm, which completely undermines the euro’s credibility, is potentially in the offing.

And to judge from the flaccid statement that accompanied the conclusion of the Merkel-Sarkozy summit yesterday, it appears that even at this late stage, policy makers don’t get it, or just cannot summon up the political will for the huge conceptual leap forward required to save the euro. The Germans are paralysed politically and things are moving too fast for their policy makers to respond quickly. And their political leadership has neither leveled with the electorate in regard to the magnitude of the problem, nor the costs associated with ongoing punishments of the so-called profligates. Whenever a German political leader opens his/her mouth it is to announce bad news, like the recent statement by German Finance Minister Wolfgang Schauble that the German government was opposed to any increase in the EFSF’s resources, or the creation of a euro bond, even though such a move is essential for the medium-term stabilisation of financial markets.
At this juncture, then, it seems more likely that the Germans will try to save themselves by pulling out of the euro zone (and then they recapitalise their own banks, as they did following German reunification). They take the Benelux countries with them (which have already closely converged with Germany’s economy) and have a “Greater DM” bloc and buy the rest of Europe on the cheap with their newly reconstituted DMs.

The Club Med nations, such as Greece, Italy, and Spain are saved because the euro plunges and they get to export their way out of this. The euro becomes a soft currency country again and these countries go back to living with higher inflation, higher exports and probably a generally more comfortable way of life.

Interestingly enough, the country which really gets screwed in this type of environment is France which is neither a true “Club Med” economy, but has yet to undertake many of the structural reforms of its German counterpart which it is seeking to emulate. Its economy is more akin to that of Italy, but should it seek to become part of the “greater DM bloc”, then its industrial base will likely face a huge competitive threat from Italy. It could well be eviscerated. And the social reaction could be severe. Remember, the guillotine was invented in France.

As for Germany, the irony is that divorce from the euro zone will likely not prove to be the panacea that many in the country now think. As the newly reconstituted DM soars to Swiss franc type levels (the DM likely to be seen as a “hard currency” and a credible repository of savings flows), it is likely that German businesses will use their highly valued Deutschmarks to buy European assets on the cheap. Anschluss economics writ large. They will then move a large proportion of their manufacturing to other European countries, to take advantage of the cheaper labour costs, likely resulting in a lower standard of living for the average German worker. It will prove to be a form of fools’ gold for a large proportion of the German electorate, who will soon realize they were sold yet another bill of goods by their politicians.

In any case, there appear to be no happy outcomes here (although as my friend, Tom Ferguson always reminds me, “If you want to have a happy ending, go see a Disney film”). We therefore appear to be entering most dangerous time for Europe since World War II.

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  1. Tom

    Right on. I am German but it is no use talking to my fellow countrymen about the disaster that lays ahead for them unless they see the light. The older generation knows: Kohl, Schmidt understand, that an isolation of Germany in Europe can only lead to a repeat of the past. But alas Germany has grown fat and stupid after having been totally destroyed. Looks like another desaster is looming…

    1. KFritz

      In his introduction to “Magister Ludi” after Hesse’s Nobel Prize, Thomas Mann described the process between the end of WWI and the end of WWII as “the inevitable ruin of unhappy Germany.” Looks like it’s coming again.

    2. Jim

      Why do so many otherwise reasonable people continue to insist in the Euro? Why do they continue to doubt the collective wisdom of the electorate?

      Very similar to proponents of Congressman Ryan’s austerity pact in the US, which hopes to convert the Medicare program into a voucher program.

      Very unpopular in the states, yet, many on the Right insist that the American public is simply “fat and stupid”, and can’t realize that Medicare must be converted into a voucher program, providing significantly fewer services to senior citizens.

  2. Linus Huber

    I can agree with most of the analysis. The part that I am missing is the fact that it in actuality is another bail out of the banks. Simply stated, banks bought the bonds of these countries and they were obliged to evaluate the credit risks at that time. They misjudged those risks again and now everyone should again suffer for their incompetence. It is obvious that those countries in question will never be able to pay back those loans made to them. By delaying the actions of default (meaning haircuts in the size of 50-80%), banks are given the time to transfer the losses again to the general population. The ECB’s action is deplorable, they violate their own rules and should be presecuted for their braking of the law, or if their is no specific law, at least for breaking the spirit of the rule of law.

    The banks have been given an enormous important privilege to create money in form of extending credit. It is them who have to be made accountable when they do not act with care and diligence in regard to many economic aspects like systemic risks, country risks and so on. Their failure cannot continuously be the problem of the general population especially when considering how those bankers enrich themselves in the process. It is a stark violation of the spirit of the RULE OF LAW which the capitalistic system is based on. Until those bankers are not made accountable for their actions (it must include their private wellbeing to be effective), we will experience crisis after crisis.

    1. jake chase

      Suppose the problem is not the bonds issued by the peripheral countries, but the credit default swaps on the bonds? If the CDS on these bonds are a huge multiple of the bonds themselves, it is the US megabanks which are most endangered by the prospect of default. I have not noticed anyone writing about this and wonder why no one has.

    2. Marshall Auerback

      I think that’s right. There is a fundamental refusal to restructure the banks and write down the value of their holdings of, say, the PIIGS debt. I would certainly advocate protecting the depositors and nationalising the banks, many of which are likely insolvent, but this again appears to be a step too far for the ECB. So we get the endgame I predict in the piece, sadly.

  3. PDC

    Euro is a political project, disguised as an economical one. Politicians are slow in facing the economical implications and drawbacks of such a project, and do react only when the damage is already done. Local recession (i.e. for individual states like Greece) is probably unavoidable. Still, I do not think anybody is going to “divorce” from euro-zone, patches will be put in place (e.g. blue-red eurobonds) and eventually the economies of each state will adapt somewhat better to the common currency constraint, meaning that less productive countries will have to live a little bit more accordingly to their means. Huge fiscal transfers between different states would be very dangerous, as a matter of fact it is the only policy that could seriously enrage taxpayers and endager the Euro.

  4. Linus Huber

    By the way, it is very interesting, how the bank lobby is able to divert the attention away from their failure. Their influence on politicians is still enormous as the politicians are still acting in ways that will explore all possibilities to solve a problem without making them accountable. At least Merkel did ask a slight contribution by them but the terms were rather watered down.

  5. YankeeFrank

    Once again, thanks Marshall for a wonderfully clear and concise explanation of the current mess in Europe. However, as you point out, the “solutions” to this mess have some serious flaws. The real solution is to break up the EU and allow each nation to pursue its own economic path, with strong controls on international capital flows.

    Its amazing that we can put men on the moon and perform medical miracles yet somehow economics baffles us. But that is only because those who control the economic dialogue are corrupt and self-serving and don’t want simple and equitable economic arrangements. The lackeys of the global economic disorder are paid to obfuscate and dissemble (even when they, pathetically, don’t even know they are doing so — I am thinking of neoclassical and pseudo-Keynesian economists particularly) while the rest of us suffer under this “mysterious” and “fiendishly complex” system that somehow magically, in good times and bad, funnels rents and taxpayer funds to the capitalist class and enslaves most of the globe.

    In the long run the populace must become much more literate in matters of economics and finance, and we must move away from winner take all capitalist dynamics to ones that, while allowing for individual ambition and entrepreneurship, temper same with a strong ethic and compulsion towards the public good.

    All that being said, getting back to where we were in Europe and the US in the late-middle 20th century, but on a global scale, where nation-states functioned in a responsible democratic fashion without domination by a global capitalist cabal, would be a great start.

    1. Jim

      Economics baffles us because it depends so much on human interaction, and it’s next to impossible to model the human psyche.

      Much easier to model the laws of physics and arrive at the moon.

  6. Jessica

    By setting up the 3% criterion, was there an austerity bias built into the Euro? Softer than the “balanced budget amendment” often discussed in the US.
    We have all been so focused on the intra-Europe imbalances and the contradiction between a unified currency and separate national budgets. But if the Euro right from the start, also had a Hooverite bias built into it, that would explain why the crisis exploded the first time that Europe really needed stimulus spending.
    This is also implicit in Marshall Auerback’s proposal to print and distribute trillions of Euros to the national governments.

    1. Foppe

      I don’t think the 3% thing was that big of a hindrance.. The far bigger problem was the low inflation policy of the ECB, because it meant low interest rates, and therefore high demand for loans in the ‘periphery’, which were very safe to extend because the chance that people would default en masse (or devalue) would also be low. That and the undervaluation of the DMark/Guilder going into the Euro, I guess. Not sure what the effects were on the southern states; suspect it played a somewhat larger role there, though the rules were easy enough to circumvent.

      The 3% thing certainly was more problematic for Greece (with most of its rich evading), but the top tax rates are still relatively high (compared to the US) in most of Europe (though corporate tax rates are fairly low especially in the bank-heavy countries), so it hasn’t been too hard to meet that requirement (except for France and Germany, of course, who immediately flouted the rule).

      1. Jessica

        You are correct that it was not a problem during relatively good times, but is it a problem in a crisis. Didn’t both the US and China far over this level?

  7. Jessica

    Maybe others have seen it before, but “sado-monetarists” is definitely my nomination for new word of the day. Well put.

  8. ArkansasAngie

    “The hope is that by backstopping the bonds, the ECB can persuade the markets that countries like Italy and Greece are not insolvent and that these countries will resume funding them. ”

    Try to persuade … convince? What the hay!!!

    This pretend stuff has to stop.

    They are insolvent.

    Imaginary money thrown at imaginary problems.

  9. chris


    What if the tens of trillions in unregulated interest rate swaps maintained by banks (that are insolvent based on a realistic valuation of their assets/loans) are being manipulated to make it appear that U.S. Treasuries are a safe haven?

    I know, banks would never do such a thing although they did sell junk bonds with purchased triple A ratings didn’t they!

  10. Rodger Malcolm Mitchell

    The euro nations are monetarily non-sovereign. All monetarily non-sovereign governments, whether they be cities, counties, states or euro nations survive only by having money come in from outside their borders, either via exports or via inputs from another government. There are no exceptions to this law. ( )

    To date, Germany has survived on exports. When exports are insufficient, Germany will fail, as have the PIIGS.

    Rodger Malcolm Mitchell

  11. RSDallas

    I was with you until you said that each nation could allocate the funds as they saw fit, then I quit reading. These Nations are corrupt and find themselves in this current debacle because they are corrupt and have made promises in lieu of a vote that can not and will not be fulfilled.

    Simply put, they need to be allowed to fail. In the end, which I think is within 2 to 5 years away, this is what will happen. The same holds true for all of us in the United States. Debt does not go away. When is the world going to realize this. The debt has to either be paid or defaulted on PERIOD. We are experiencing the effects of kicking the can down the road for some 40 years and longer in Europe.

    It is mind boggling to me how the entire developed societies (Feds, Treasuries and Governments) are banning together to keep insolvent and deadbeat entities alive.

  12. Hugh

    As usual Auerback misses the point, and the point is kleptocracy. Throwing trillions of euros at European governments is supposed to make everything better, and it is to be sold on the dubious notion that it will be all OK if it is done on a per capita basis? This is the kind of facile plan that so discredits MMTers. These trillions are to go per Auerback to the governments and the governments decide how they are to be spent. Well, in a kleptocracy, they will end up in the hands of the kleptocratic elites, principally German ones. In this scheme, the PIIGS pay off all their debt to French and German banks or they enough to be able to pay off the rest. Meanwhile Germans, as in German kleptocrats, get a windfall on top of this. This is put forward as serious policy? Basically the French and German kleptocrats get all the money, and they go buy the rest of Europe (the PIIGS assets) with it.

    The analysis of the German exit from the euro is equally flawed. To ditch the euro is to ditch the European project. Why would the PIIGS want to share a common currency, once the political and economic rationales for it are gone? And yes, if the current eurozone breaks up, the debt to German and French banks is going to be written down or defaulted on leading to a need to recapitalize them. Who knows what all the CDS implications of this are? But if the Germans recapitalize their banks, where exactly is all this money going to come from for them to buy the rest of Europe? And recapitalizing banks is not their only outlay. Their export sector is going to be smashed between the high Mark and cheaper competing exports from the PIIGS and/or China. So again where exactly is Germany going to have all this money to buy up the rest of Europe?

    Indeed it is far more likely that the Auerback trillions of euros plan would provide the money for a buy up than a break up of the eurozone.

    From a kleptocratic perspective, these ideas are beside the point. The ECB is essentially the German central bank so what the ECB is currently doing is to all intents and purposes the German policy. And that policy is extend and pretend. The “extend” part is not, however, extending the life of the euro but extending the scope and duration of the looting. We see this in the push to austerity, to cut budgets, attack public employment and reduce social safety nets, and to sell national assets. This is not a sustainable approach. It fixes nothing, but then it isn’t supposed to. And yes, it will lead to a crash, but as I have said before while a crash is a disaster for us, for kleptocrats it is just another opportunity to loot.

  13. Hari

    Almost everything he says is accurate (similar to almost everything about MMT is good), EXCEPT for one glaring mistake that he makes here (and MMT’ers make in general) that will make the pracitcal policy implementation of their ideas a BIG PROBLEM. He says here, that the ECB can finance government if they chose that course of action and anyone playing truant would be “punished”. Alas, many WILL abuse this and there will be NO punishment (because everyone is having a good time, why bother trying to fix something). Similarly, fiscal deficit spending would indeed be effective IF the deficits were channeled for productive purposes and that, as we know, will NOT happen because the politicians and other self interests would usurp it for their own interests/asset bubbles/speculation and NOT for productive purposes.

    The problem lies in that “unless the unproductive uses of capital is punished” (with appropriate social safety nets to prevent a wholesale destruction of society. I am not arguing for liquidationist policy and every man for himself), people/citizens/self interest groups will NEVER learn. And the deficit spending (as proposed by MMT generally) and the ECB’s spending (proposed here specifically) WILL BE usurped for mostly unproductive purposes and the end result will be more speculation, more bubbles and the same denoument.

    As good as these ideas are in theory, they will FAIL in practice because they don’t teach discipline to use these deficits and the trillion Euro’s productively.

  14. gerold k.b. weber

    The Great Financial Crisis in the US and it’s propagation, subsequent bursts of European real estate bubbles (Spain, Ireland, GB), bailouts of financial institutions in Euro countries, and overall imprudent fiscal policy (Greece, Italy) led to a level of sovereign debt which cannot be refinanced in the market place at comfortable interest rates.

    Now everyone has recognized that Euro countries have no ready and willing lender of last resort able to hold the markets in check.

    Another urgent problem is high unemployment in many countries, creating dire situations for affected households, and testing the social cohesion.

    The MMT solution seems to be to establish a lender and a employer of last resort, and engage in massive deficit spending – without clarifying sufficiently the inflation risks down the road and probably without a good enough understanding of political economy.

    Being a citizen of Austria and to some extent sympathetic to MMT thinking, I nevertheless have some concerns.

    To begin with, class struggle as a root cause for extreme wealth and income inequality, financial capitalism, debt slavery, and lack of demand (see Foster’s and Magdoff’s ‘Great Financial Crisis’ and Michael Hudson’s work) are not sufficiently addressed by MMT theory and their proponents. One usually cannot find disaggregations of the household sector in wealth or income percentiles in MMT sectoral balance publications, or theories of the impact of wealth or income changes in this disaggregated groups on aggregate demand.

    Therefore, MMT proponents seldom propose concrete policies for redistribution of wealth or income.

    MMT proponents should balance their views and acknowledge that such redistribution is another valid solution for the creation of sufficient aggregate demand, full employment and price stability, even within an austerity paradigm. They would then be in the good company of Michal Kalecki (see his ‘Three Ways to Full Employment’).

    Also I would be delighted to see some scepticism on always increasing debt-to-gdp ratios on the part of MMT theorists, therefore enabling convergence of thought with intellectuals and economists proposing debt relief and/or deleveraging (Michael Hudson, Nouriel Roubini, Yves Smith, Nassim Taleb). Besides, proposing an increase of the debt-to-gdp ratio for already heavily indebted countries simply is a very hard sell, especially if further bank bailouts are financed with it.

    If our conclusion is that relying on yearly increasing debt-to-gdp ratios for keeping aggregate demand high and unemployment low is unsustainable in the long run (see i.a. the work of Steve Keen), then it is imperative to address class conflicts and means for the reduction of income and wealth imbalances, among them debt relief and write-offs. As a side effect, this would increase the pressure to tackle the TBTF problem too.

    Unfortunately economists of all sorts are of not much help to quantify how much redestribution would be necessary to rebalance for example the US economy (factoring out the foreign sector for a moment), and it looks as if there is a social taboo at work restricting such research.

  15. PBlacque

    You wrote: “the central problem, which is that countries with very different economies are yoked to the same currency in the absence of a fiscal transfer union which would otherwise facilitate growth, not ongoing economic depression and political turmoil.”

    Clearly you seem to think that a fiscal union could work. Could you elaborate on how that would work given the known and deep cultural differences across countries?

    I’m not so sure a Fiscal Union could work and I believe markets are realizing that… thus the uncertainty of the next step and the endgame… permanent bailouts or break up?

  16. Tim

    The single problem is that whether public or private, default is viewed as the end game by everyone. A final Death that cannot be recovered from for the institution and all related to it. Therefore nobody wants to do it.

    That assumtption is simply wrong.

    Debt is created for the assumed purpose that it will be transformed to productivity in the future. During times of excess the issuance of debt is innapropriate, and that innapropriately created debt never transforms into productivity, therefore the debt has only one choice: to return to its former state which is NOTHING. Default at a macro level is a harmless thing: that which was nothing returns to nothing; yet it is currently 100% taboo at a macro economic level.

    Only one direct correction on the article: High inflation is never comfortable to the general populous, deflation is. More people ate meat at the end of the great depression than the beginning. The majority of Japanese feel much more comfortable with their lot in life today than 1990. Mild to moderate deflation is only uncomfortable to the banks and the unemployed, which are an extreme minority of the populace.

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