Satyajit Das: The Real Debt Crisis is in Europe- Part 2 – “Europe’s Long, Long Goodbye”

By Satyajit Das, the author of Extreme Money: The Masters of the Universe and the Cult of Risk (published in August/ September 2011)

In the Long Term We’re All Dead

The European Union’s attempts to resolve the continent’s sovereign debt problems do not deal with issues of growth, intra-European financial imbalances and competitiveness. The only “initiative” was the vague plan for a massive public investment program, although no details of how it is to be financed were provided.

The call for greater public investment was accompanied by a familiar but contradictory insistence that all Euro-zone states adhere to agreed fiscal targets. Euro-zone countries except Greece, Ireland and Portugal must bring their budget deficit down to less than 3% of GDP by 2013. The need for many European countries to improve public finances is clear. But how greater belt-tightening and austerity would restore growth is not.

As EU targets are honoured in the breach rather than observance, they probably don’t matter anyway. Jens Weidmann. Bundesbank President and ECB council member, also identified the lack of incentive to correct public finances: “By transferring sizeable additional risks to aid-granting countries and their taxpayers, the euro area made a large step toward a collectivization of risks in case of unsolid public finances and economic mistakes. That’s weakening the foundations of a monetary union founded on fiscal self-responsibility. In the future, it will be even more difficult to maintain incentives for solid fiscal policies.”

The European model where Northern nations’ savings finance Southern spending providing a market for exports for countries like Germany was not questioned.

Given current productivity levels and cost structures, countries like Greece, Spain, Portugal and Italy are not internationally competitive at the current value of the euro. The competitiveness of these economies has also been eroded by the rise of other emerging market economies with lower costs. This has boosted demand for exports from Germany and other core EU countries and driven up the value of the Euro, further disadvantaging weaker members.

The common currency means that these nations cannot regain competitiveness through a significant devaluation. In his 1953 book, “Essays in Positive Economics”, Milton Friedman argued that adjustments were easier in a floating currency system because: “It is far simpler to allow one price to change, namely the price of foreign exchange, than to rely upon changes in the multitude of prices that together constitute the internal price structure.”

In the absence of flexibility in the currency, these countries are heavily reliant on structural changes, massive cuts in costs and increased productivity to enhance competitiveness. These measures will only work in the long run, if they work at all. In the meantime, the economy becomes mired in recession or low growth, high unemployment, falling incomes and deteriorating public finances. This is precisely at the heart of the current problems facing these economies.

The longer term options are clear. Europe must move to greater financial and economic union or restructure its monetary and currency arrangements. Greater integration will require sacrifice of national sovereignty, as fiscal policy, taxation and other national decisions are centralised. It will require financial “transfers” and support from the stronger Euro-zone economies to the weaker members.

The political, economic and social problems of such a strategy are formidable. German Chancellor Merkel has stated that she would not allow a union of automatic transfers from richer to poorer states: “This shall not happen according to my conviction.”

The alternative is a radical restructure of the Euro and Euro-zone itself. While the common currency will survive, weaker countries would leave the Euro, reintroducing their own currency – a considerable logistical challenge. The lower value of the new currencies, in combination with other measures, would help these countries regain competitiveness through the reduced domestic cost structures. The countries would gain added economic flexibility without the monetary and fiscal strictures of the Euro. Debt restructuring and a lower currency would potentially restore competitiveness and growth more effectively than successive rounds of ever more astringent austerity – the favoured and to date unsuccessful treatment.

The Panic Room

The EU’s reaffirmation of their commitment to do whatever is needed to ensure the financial stability of the Euro-zone, was initially greeted with relief. Similar “shock and awe” declarations a year earlier bought a few months of respite. This time celebrations lasted for less than a week as investors realised that the deal had not reduced the risk of financial contagion in the Euro-zone.

By Tuesday 26 July 2011, markets had become more circumspect and interest rates on Spanish and Italian bonds rose to levels seen before the bailout was announced. By early August, the pressure on European sovereign increased even further, compounded by the downgrade of the US sovereign debt ceiling.

Given the EU package still needed ratification by national governments, market panic forced the ECB reluctantly to re-commence it program to purchase European sovereign bonds to support the market.

In the background, arguments between the ECB and EU about who would guarantee these purchases continued. The ECB with capital of Euro 5 billion (being increased to Euro 10 billion) and individual Euro-zone central banks with capital of Euro 80 billion do not have the resources to stop the contagion.

There is also the question of how the ECB will finance the purchases. Should it choose to “monetise” its purchase (that is print money), the ramifications, both economic and political, would be profound. In essence, it is unlikely that the ECB can not resolve the crisis by its actions.

The Long Goodbye

The EU’s July attempts to resolve the European debt crisis was the latest in a series of missed opportunities. At best, the proposals buy time – a few months for banks to build a capital and loss reserves and beleaguered countries to undertake necessary reforms. On the most optimistic view, this will reduce the losses in any subsequent major debt restructuring. At worst, its sets up an even more dangerous crisis.

Continued uncertainty and volatility are likely. One market focus will be the periodic tests, which Greece and other countries need to meet, to receive funding. There is likely to be focus on the IMF’s ongoing participation, especially amongst emerging market nations who see the institution as having been exceeding soft on Europe when compared to the treatment of Asian and Latin American nations in previous crises. Disputes between the EU and the ECB, trying desperately to salvage its tarnished reputation, are inevitable.

Spain and Italy will be another focus of attention. The loss of access by the sovereign or banks to commercial funding at acceptable rates would intensify the problems. Unverified media reports already suggest that Italy may not participate in the next round of Greek funding because of its own financial positions.

Pressure on the credit rating or funding costs – initially affecting Spain and Italy but potentially extending wider to the European paymasters Germany, France and other stronger Euro-zone members – will exacerbate instability.

The continued acquiescence of the domestic voters and taxpayers cannot be taken for granted. In the indebted nations, protest against the harsh austerity and the financial egotists is likely to intensify. Resentment towards external interference and control of their economy will increase. Suggestions that the Finns sought the Parthenon and Aegean islands as collateral for a new bailout would not have engendered Greek gratitude for their saviours.

In the nations providing the bailout funds, taxpayers will become increasingly reluctant to finance their neighbours and more resentful towards the financial institutions successfully socialising their losses. Elections and changes in leadership will feed this uncertainty.

The game is all but over for the weaker countries – Greece, Ireland and Portugal. Vulnerable countries – Spain and Italy – are now being relentlessly hunted down. The stronger countries – France and Germany – no longer look secure, immune from the problems. It is time to admit that the “lifeboat” isn’t big enough for everybody and throw Greece, Ireland and Portugal out (read debt restructuring), concentrating efforts on salvaging Spain and Italy. Whether the EU have the stomach for this is difficult to tell, although self-preservation is a powerful motivator, especially for politicians. Whatever happens, the European debt crisis remains a key risk to the global economy.

Print Friendly, PDF & Email


  1. mmckinl

    1st qtr German GDP 0.1% … est 0.5% …

    Can there be any question that the EU is now in a double dip.

  2. Linus Huber

    A good summary of the EU’s problem. I may add that violating the principle of the rule of law, in this case of deciding to transfer bank losses to the tax payer, increases all risks to the point that politicians start to fear the result the next election will bring. They try to continue to make things as intransparent as possible in order to confuse the victims (tax payers). As the saying goes: IF YOU CAN’T CONVINCE THEM, CONFUSE THEM.
    It is similar when you start with a lie which requires the next lie for not being caught, and the next and next and so on. At the end you end up without any creditibility at all because, no matter what politicians say, people have a good instinct for what is fake. The only reason things do not fall apart is the fact that the population does not feel any of the results of today’s decisions as it always takes time for the transmission mechanism of serious financial implications to work its way into the daily life of the populace. By the time they realize what happened to them, it most probably will be too late and the damage has been done already. The anger will be as much greater at that time.

    1. Susan the other

      Europe’s Long Goodbye is the Cold War’s Long Goodbye. From 1945 on we, the US, were adamantly dedicated to making Germany the engine of capitalism in Europe. We justified any tactic. Now we see what comes of it all because the ill-gotten debt taken on by the southern EUROS collapsed their economies and their collapsed economies in turn collapsed Germany’s powerhouse economy. Nobody in Spain is buying a Benz these days. It was the same house of cards which capitalism produced here in the US. Debt fueled capitalism is a strange animal which feeds only on growth. Now there can be no growth because we have trashed the planet and we have to slam the brakes on as hard as we can. And our deceitful President goes on a tour of the Midwest and panders to our misery by saying we must all write our congress people and demand jobs. Why can’t anyone speak the truth? No one in Europe speaks it and no one here speaks it. Speak no evil.

      1. Jake

        The truth is that under a debt slavery system one side ends up with the cash and the other side the paper. Those that have the cash are the winners and those with paper are he losers. It is that simple. Just follow the cash. Are bonuses paid in ious are in cash? Are campaign contributions made in cash or warrents? The beauty of debt is that two of three sides fall. The trick is to be the third side. The vast majority of people will NEVER understand how the system works. So, get used to it. It will go on for ever.

  3. Blissex

    «The European model where Northern nations’ savings finance Southern spending providing a market for exports for countries like Germany was not questioned.»

    This is vendor financing, as usual the root of many evils, because of the incentives it gives.

    As always though more precise wording would help because «exports for countries like Germany» implies that all of Germany is exporting. No, what is happening is that vendir financing is a transfer of risk, and thus of wealth, within Germany, between two different groups with different political interests.

    «Milton Friedman argued that adjustments were easier in a floating currency system because: “It is far simpler to allow one price to change, namely the price of foreign exchange, than to rely upon changes in the multitude of prices that together constitute the internal price structure.”»

    MiltonF was as usual a cunning propagandists, because in this seemingly sensible piece there is a very, very big hidden agenda: changing the price of foreign exchange has a very large impact on the distribution of wealth and income between the internal and the external sectors of the economy.

    Both of the cases above are part of a general rule that most mainstream economists learn very early to avoid damaging their careers: never ever speak of the impact of economic events or policies on income and wealth distribution, even if that in the vast majority of cases is the big story.

    Because talking about the income and wealth distribution is doing political economy, instead of Economics, and thus is an attempt to restart the class war of the exploitative poor/workers against the productive rich/rentiers.

  4. financial matters

    At this point I don’t see how Italy and Spain can be salvaged under the current system. The game has changed with the ECB and other central banks taking too big of a gamble on buying up the high yielding bonds of the peripheral countries. They are now at the mercy of these peripheral countries but these peripheral countries can’t save them under the umbrella of the euro. The only way out that I see is for the sovereigns to go back to their own currencies, the sooner the better.

    1. Nathanael

      The depressing part is that it’s trivial to fix Europe given the power.

      (1) Print lots and lots of Euros.
      (2) Hand them out to the most socialist, spend-money-on-the-poor governments.

      Voila, problem solved. But the ECB is in the grip of hard-money fetishists.

  5. Blissex

    «The stronger countries – France and Germany – no longer look secure, immune from the problems.»

    But this whole story was never about the problem of Greece, Ireland and Portugal, it was always about saving the French and German banks who had lent to them.

    The industrial policy in the USA and Europe in the past 20-30 years has been as always to support immensely large TBTF companies as “national champions”, except that while once it was “what is good for GM is good for America” not it is “what is good for GS is good for America”, in other words national champions have been switched from manufacturing and unionized industries (bad) to FIRE and non-unionized (good) industries.

    As a result of this FIRE “national champion” companies have been allowed to compete internationally on leverage and fraud, with competitive lowering of the cost of money and of standards, as each national champion argued that in other markets competitors were allowed to be fraudulent and had lower capital costs because of higher leverage and lower interest rates.

    In the past governments cheated in internal competition by subsidizing the capital costs of their manufacturing champions and using competitive devaluations of the currency; now they cheat by subsidizing the capital costs of their FIRE champions with implicit risk guarantees allowing them to have ridiculous leverage ratios, and using competitive devaluations of standards.

    Since this has been done in Europe too, the leverage of European banks has reached the same ridiculously high levels of USA banks (I think that has remarked on this a few times) and European banks have been allowed (and probably even encouraged) to engage in vendor financing with a huge relaxation of lending standards.

    The underlying motivations as always are the huge underemployment problem in the First World (requiring the creation of lots of make-believe jobs supported by vendor financing) and the desire of many first world asset holders to cash out their assets in those low growth areas at the highest possible prices thanks to pump-and-dump policies.

    1. Paul Tioxon

      The EU has set of metrics that are snapshots of the Great Power’s, France and Germany, critical structures: a strong central government bureaucracy that collects taxes from the engorged merchants and business that grew fat from the intake of imperialism. Yes, it is all about France and Germany, who set up the standards that some nation states simply were doomed to live up, in times of discontinuity. It may have been a logical plan for glide path for development for states that have previously been little more than undeveloped territories of some greater power or empire. Greece, as it is repeated been reported, has no citizen culture of voluntary compliance to be taxed, and the state has not developed the professional cadre to enforce collection in the absence of voluntary compliance. Ireland has been at war with England since the 12 century, has no industry worth mentioning and has just begun to recover from the genocide of the 19th century. Portugal, has held out against incorporation into the greater polity which became the nation of Spain.

      All of these countries, have critical components missing which are the hallmarks of the modern nation state. But most of all, the nation building process, where by everyone comes together within the boundaries of the country and willingly accepts nationhood, as defined as having a strong central tax collecting government and the rest of nation building bureaucracy that uses those funds to further develop. A government without finance has no chance. To try to slap all of the nations of Europe together, pretending that they were all equal, and could all accept the standardized metric of debt to GNP, % of government spending as a part of GNP, etc. is to pretend that France is identical to Ireland, Germany to Greece, and so on. It simply is not true.

      The terms and conditions for acceptance needed more political parity than standards of democratic behavior such as free elections, parliamentary government, but to expect the finances of the economic and military powerhouses of Europe to demand the same of former colonies, and brutally subjugated nations, was just a masquerade for the continuance of dominance through other means. Now, the 2 Great Powers must live up to the social obligation any empire would make to defend its territories from attack, or risk losing empire. You can’t just have one market and one currency while the economy is good and expanding and without problems, you have to contend with the periods of discontinuity, from whatever reasons as well.

      Finally, taking the bits and pieces of a failed capitalism, and expecting different results is problematic. A bigger bag of chips in not a new product, it is just a bigger bag of the same old commodity. Structural changes to the political relations are the consequences to one market and one currency. If they are all bound by NATO treaty to fight and die for one another, should political integration and wealth transfers via a central European tax authority, as necessary during economic crisis be so hard to swallow? So yes, some sovereignty has to go, but did Ireland or Greece ever really have control over their national destinies for much of the last 1000 years anyway? And Germany and France also ran up against the limits of their sovereignty as well. Sovereignty may be absolute, but that does not mean unlimited. Consenting to participation in a larger limited sovereignty is a continuation of the absolute trait, which is all any nation possesses at all.

      1. tristus

        The purpose of the EU was to prevent another war between Germany on the one hand, and France, Britain and Russia on the other. Currently US hegemony supresses this possibility, but the tensions in central Eurpe are as old as rocks (see H. Kissinger’s 500 years diplomacy), and it’s no longer clear whether the US can sustain it’s global presence for much longer.

        Basically France, Britain and Russia were traditionally too weak to take on Germany each on their own, this is why you had the revolving alliances against Germany, and the continual attempts by France and Britian to prevent a unified Germany. Russia’s position has been more ambivalent. France is contiually existentially threatened by Germany, whilst Britain needs to keep the shipping lanes free and prevent a large army on the other side of the channel. This is why Britains less costly move is to support France against Germany.

        The EU was meant to solve this core problem structurally, by eventually dissolving Germany, but the bitch is that it would automatically also dissolve France and Bitian, who both wont do it. The other nations are just cheerleaders, spectators, parasites, beneficiaries, depending on the footwok in the dance between Germany and France.

        My personal hope for Germany is that this farce will end soon, and that the country will have the balls to reassert itself as the premier economic and military power in Europe, naturally against the wishes of Uncle Sam. But then we are back to the historic conundrum of finding a balance of power in central Europe which does not threaten the existence of France and Britain, and the peace of Russia. This can be achieved if Germany enters a strategic alliance with Russia and Japan, which would have the benefit of tying in the loose cannon Russia and building a counterweight to China. Of course it would mean that the US trusts Germany, which is unlikely.

  6. Blissex

    «the huge underemployment problem in the First World (requiring the creation of lots of make-believe jobs supported by vendor financing)»

    Where the First World includes Japan.

    An amusing aspect of this sad story has been that Japan tried the same strategy first and now USA/Europe governments are desperate to do exactly the same.

    Because I suppose they would be real happy to do as well as Japan has done, as it could be much worse (e.g. rise of fascist parties on the back of widespread unemployment).

    China is also using vendor financing but their goal is not just to create industrial underemployment to replace the even worse rural underemployment of hundreds of millions, but more importantly to induce foreign investment cratingf a new independent industrial (and financial) base for China which they did not have before.

  7. /L

    The big problem for the deficit countries is not so much so called competiveness, their big problem is the free fow of capital an primarily capital. Their big problem is that free flow of capital and of course also a “strong” currency do that they can’t curb excessive import so it balance with its export. It’s not that their export have gone down the drain it’s the import that have been excessive. Neither a sinking currency probably do much to boost export so it balance import in the short term, import will of course be demised by these measures but that will take an cruel toll on the domestic economy. Their long term “solution” is to climb the value chain ladder but that’s easier said than done.

    If now the crisis countries have taken measures before the crisis, aka harsh austerity to curb its populations ability to lend and import they would probably got lambasted for being unfair and conduct beggar thy neighbor policies. And of course domestic political suicide.

    The core problem is neo-liberal dogma on so called free trade where gods and capital can’t be curbed by those who is in risk of building huge foreign debt.

    1. Jim Haygood

      ‘The core problem is neo-liberal dogma on so-called free trade, where goods and capital can’t be curbed by those who are at risk of building huge foreign debt.’

      Agreed, a surge in imports was at the root of southern Europe’s problem, as the euro gave them ‘hard currency’ purchasing power.

      But the long-time objective had been to create a European free trade zone, and it still seems a worthy one. No one thinks the US would be better off with Customs posts at state borders.

      The euro zone’s structural flaw is fiscal autonomy coupled with monetary non-autonomy. Now it has become obvious that the Maastricht fiscal limits — 3% GDP deficit and 60% debt/GDP, to be enforced with fines — broke down and failed.

      A thought experiment: imagine a pre-1932, pre-Rooseveltian US, in which federal spending amounts to only 3 to 5% of GDP, with most spending occurring at the state and local levels (thus resembling Europe’s federal structure). Would today’s fiscal woes in California, Illinois and New Jersey produce pressure to break up the dollar zone?

      I don’t think so. But that’s a more of a cultural artifact, of a very mobile and geographically entwined population. State-level autarky is not seen as an effective response to crisis.

      But as Usgov’s credit and credibility deteriorate, states will have increasing incentive to secede, thus repudiating their share of Usgov’s debt mountain. Similarly, as the ECB turns itself into a garbage barge, incentives rise for European states to pull the plug on the ECB’s reeking meat locker of maggot-infested sovereign debt.

  8. /L

    Why is “monetise” public expenditures to save an economy that is clearly going done the pipe going to have disastrous ramifications while “monetise” private bank lending doesn’t. Of course we should by now have learned that central banks “monetise” private banks excessive pro cyclical debt expansion is the road to serfdom under the banksters. The later should by now be empirical knowledge.

  9. ccz

    “The European model where Northern nations’ savings finance Southern spending providing a market for exports for countries like Germany was not questioned.” Do the author think that German exports go to the PIIGS? Check
    “Given current productivity levels and cost structures, countries like Greece, Spain, Portugal and Italy are not internationally competitive at the current value of the euro.” Why UK exports and econnomy is stalling even with the help of a devalued pound?
    “The competitiveness of these economies has also been eroded by the rise of other emerging market economies with lower costs.” This has nothing to do with the euro adoption. This has everything to do with China joining the WTO. But if one compares wages of PIIGS and emergent nations… one can see that leaving the euro is not an easy medecin

    This has boosted demand for exports from Germany and other core EU countries and driven up the value of the Euro, further disadvantaging weaker members.
    The common currency means that these nations cannot regain competitiveness through a significant devaluation.” Ever read about the Kaldor paradox? Do you know that traditional sectors exports in Portugal are booming? They don’t care about Chinese competition, they compete on flexibility, on fashion, on fast delivery, they don’t compete on price as the winner factor.

  10. Jim Haygood

    ‘It is time to admit that the “lifeboat” isn’t big enough for everybody and throw Greece, Ireland and Portugal out (read debt restructuring), concentrating efforts on salvaging Spain and Italy.’

    My sentiments exactly, Professor Das. These little emperors have no clothes. But the European poobahs remain seated in the front row of the fashion show, oohing and ahhing at the silken finery as the models stride the runway starkers. Collective denial!

    This absurd pretense is all for the benefit of a powerful banking cartel, which has hijacked every one of the rich OECD democracies by taking over their central banks.

    Why vote for politicians, when you can vote by withdrawing your deposits? Toss the debit cards. Use cash, bust a bankster!

    1. jamienewman

      How about simply taking your money out of globalized banks and stash it in credit unions and locally owned savings banks and CDFI’s?

      1. Jim Haygood

        That would focus pressure on the TBTF banks, a worthy objective. However, the small deposit-takers would end up funding the TBTF leviathans through the interbank market.

        Converting deposits to cash deleverages the whole system. (We saw that movie during 1930-33.)

        In any case, shunning debit cards helps defund Visa and MasterCard’s heavy transaction fees on small businesses. Time to evict the bankster middlemen from local commerce.

  11. Jay B

    What happens when the credit crisis strikes?
    No rescue ahead of a credit shutdown in Europe appears likely or even possible given political conditions in Germany.
    A credit shutdown will give the German, French and ECB leaders room for quick maneuver. Won’t the ECB have to ride to the rescue? Won’t laws have to be ignored? What will German leaders want to achieve in that window of opportunity? Will the French agree?
    Isn’t this the likely focus of planning at high level talks now?
    That is the analysis I’d like to read.

  12. Sam B B

    Trade deficits are the root of all evil. The budget deficits are only one of the negative consequences of trade deficits. The US and Europe know it. There is no action on this issue because of widespread political corruption.

    1. CDS IS WMD

      Hmmm, don’t underestimate the Germans either… The Bundeswehr as a debt collection agency – ahem! Cynicism aside, a few observations keeping me awake at night:

      Don’t underestimate the resentment in the lower classes in Europe, particularly coupled with strong immigrational presence. Breivik and the UK riots do not seem entirely unrelated IMHO – Europe has never faced up to the problems it faces in demographics and the lack of successful intercultural integration, obviously glossed over in the boom, and now coming to the fore given austerity for some and bonuses for others.

      So what happens if the Depression really hits and there are 20-25% unemployment and Working Poor wages for the rest, with a triumphant top 1-3% of the population? If history is any guide, it suggests massive riots up to civil war and military dictatorships followed by inter-state war… Are we going to handle it better than our grand- and great-grandparents? Time will tell…

  13. Frank

    Don’t underestimate the Greeks. They have slow played their hand and have continued to be funded by the IMF and ECB and EU and have been extended cash and credit.

    What if the Greeks jump ship first and leave the EURO. Instead reneging on all debt and no restructure. They bring the drachma back. They get a clean balance sheet and don’t need to borrow from the IMF or ECB.

    Those institutions have no recourse. There is no collateral pledged. Yes, Greek will be temporarily banned from the credit markets. But in two to three years someone will finance them again? If history is any judge, absolutely.

    This will immediately have a financial impact on the EU/ECB and the other holders of the Greek debt. Especially the French Banks. Sarkozy and Merkel have had to have this discussion.

    I have to beleive that Greece, Ireland and Portugal have all carefully examined the odds of jumping before being pushed. But for now as long as they continue to receive new loans by giving vague promises of future austerity they can have it both ways. And give themselves time to print a new currency.

  14. Sungam

    One more thing to note is that the Euro zone already has a pact which is supposed to limit government deficits. Under the Stability and Growth pact all Eurozone countries are supposed to keep their budget deficit below 3% and their debt to GDP ratio below 60%. France and Germany have both been breaching the pact since 2003. Unlike Greece for example neither were sanctioned at the time.

  15. fajensen

    The continued acquiescence of the domestic voters and taxpayers cannot be taken for granted.

    Nobody within government cares about voters and taxpayers except about 1 month before the election date, which is every 4-5 years.

    When faced with an unpopular policy option, the government will just form a “broad coalition” with the “opposition” and ram whatever outrage they are plotting against the electorate through the parliament regardless. That is, if they cannot get the EU to do the dirty work.

    The coalition neutralises any vengeance from voters. Voting in the modern western democracy produces progressively less outcome, the youths in the streets of London already knows this, the workers will also learn – eventually.

Comments are closed.