Debunking the Causes of the Eurozone Crisis

Yves here. One of the major focuses of the INET conference in Paris was the Eurozone crisis. The live broadcast of Nobel prize winner Joe Stiglitz’s interview of Yanis Varoufakis attracted over 50 million viewers.

Another event widely anticipated among conference attendees was a panel on the last day of the conference, Saturday, featuring Hans Werner Sinn, a well-known and particularly vocal defender of the orthodox German view of the Greek crisis, that Greece had been a profligate borrower that needed to take a big dose of austerity medicine. The other panelists contested various aspects of Sinn’s thesis, but the most striking and effective contrast came from Servass Storm of Delft University, who summarized a devastating paper that shredded conventional wisdom on the roots of the Eurozone crisis. I’ll present a post on the paper proper later this week.

Lee Sheppard was gracious enough to recap the panel, which was notable also by virtue of Sinn toning down his normally forceful views, although in the Q&A section, he became more heated. It is worth noting that Sinn advocated the idea of a temporary exit from the Eurozone for Greece (how does that work, exactly?) with Greece getting relief (aka subsidies) for essential imports like pharmaceuticals.

By Lee Sheppard, contributing editor of Tax Notes International

The purpose of the euro was to push down labor costs in Europe by making prices transparent using a single currency. Germans were especially keen about this “benefit” of the single currency. Hans Werner Sinn of Munich University is arguably correct that the Club Med countries did not do what they were supposed to do in getting their acts together by reducing costs to become competitive.

However, an unexpected thing happened when the euro was created. Yields on sovereign and private debt went lower, enabling more borrowing by Club Med countries. Some countries had too much private borrowing and some countries had too much public borrowing.

To Sinn, who appeared before a skeptical audience at INET, it doesn’t matter how the capital flowed into the country. Excessive foreign borrowing pushed up wages and had a detrimental effect on competitiveness. He argued that the Club Med countries should act like Ireland and take the pain in exchange for bailouts. Wrong relative prices explain the euro crisis, in Sinn’s view.

Veal Milanese is really Wiener schnitzel. Yes, northern Italy is very productive. Italy’s tradable sector is roughly the same size as its non-tradable sector. But Italy on the whole has low productivity, low education attainment, a bad business environment and high labor costs. Italy has low R&D spending and low levels of tertiary educational attainment. Italy is not good at enforcement of contracts or tax collection. Things are getting better, but they are still not good, according to Dominic Lombardi of CIGI.

Lombardi defended Italy’s reputation for profligacy and not getting it together. He argued that Italy did not spend or borrow too much. There were capital account surpluses every year except 2009 and 2010. Italian sovereign debt only increased when Italian GDP collapsed. If growth in the European Union had been average, Italian sovereign debt would be only a hundred and fifteen percent of GDP rather than a hundred and thirty percent. Roughly 30 percent of Italian sovereign debt is held by foreign holders. So he argued that it was contagion and risk aversion that pushed up sovereign yields in Club Med.

Will Greece ever become competitive? Sinn insisted that every country can become competitive. But it is hard to see what areas Greece can become competitive in or indeed what tradable sectors it has. “Greece will never make it in the eurozone,” Sinn said. It would be best for them to temporarily exit, according to Sinn.

Servaas Storm of Delft University saw no statistical proof that capital flows inflated wages in Club Med. Wages don’t explain current account numbers because they are too small to affect them and are not transmitted in prices. Rather, what he called the “banking glut” of debt buildup produced artificial growth at the time. And that borrowing was not used productively. It went into Spanish houses.

Even if Greek labor costs were to be reduced to rock bottom, non- cost competitiveness would still be more important, according to Storm. Direct labor costs are just not that large a component of final goods costs. The truth is that Club Med is not technologically intensive. Storm argued that non-price competitiveness, like technological innovation, is more important than cost competitiveness.

Storm called the eurozone crisis “a huge tragedy and a disgrace.” He argued that structural reform is a euphemism, and cause poverty and dislocation. Internal devaluation will not help. It is causing unemployment, in his view. Mission-oriented public investment would be more helpful. “Europe need to wake up from a deep slumber of a decided opinion,” said Storm, quoting John Stuart Mill.

Should Germans be required to take their holidays in Greece? Sinn argued that quantitative easing would produce price realignment in the form of inflation in Germany, provided Club Med countries don’t borrow more and do become competitive. Andrea Terzi argued that there should be monetary stimulus to enable people to buy their own output.

Weren’t the eurozone capital flows just vendor financing to enable Greeks to buy Porsches? Storm noted that much of the borrowing was not used productively. Sinn claimed that a third of the funds borrowed by Greece flowed back out into private bank accounts (note this figure is contested; nearly 90% of the bailout funds went to banks, and not to Greeks, but Sinn may be looking at a longer time frame). Andrea Terzi of Franklin University (Switzerland) pointed out that neglect of infrastructure does not show up in budget numbers, so you need to drill deeper into the actual uses of funds, and not just the gross level.

Keynes said that real outcomes are shaped by monetary decisions, Terzi noted. (Greece and Portugal had violent revolutions in the 1970s.)

Is the lingering stress all really a monetary problem and attributable to the failure of the European Central Bank to monetize? “Behind every penny of savings is a penny of debt,” according to Terzi. “Savings need to be funded.” Savings equal government debt plus private that plus foreign debt. “Debt is high when EU rules say so,” Terzi argued. Thus the crisis was caused by lack of credit. Because government has to create money for people to spend, savings are not the way to correct capital flows in a monetary economy.

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  1. James Levy

    We all know the dominant narrative is nonsense. It’s been demonstrated to anyone who has eyes to see and ears to hear. If you marshaled every piece of evidence and presented it to the bankers, politicians, and media moguls with links, footnotes, and a dancing bear they would choose to disbelieve it anyway and go on spouting the same nonsense.

    We were all taught, and the better the education the more rigorously we were taught it, that what “wins” arguments is a combination of facts and logic organized around an elegant rhetoric. It’s how every intellectual and scholar showed off in graduate school. But power does not respond to such arguments. In his book on the Confederate Army (to continue a theme we’ve been exploring lately) Glatthaar demonstrates that the dominant ethos in the South was the Might Makes Right–the idea was that ideas were personal, and the attitude was “I’ll whip any man who says I’m wrong.” This is how the rich and powerful relate to “truth.” It’s a personal claim much like a claim on property, and like a claim on property it is worth fighting over. You don’t bow to a better argument backed by evidence. You stand by your claim until someone comes along powerful enough to knock it out from under you.

    I, for one, am no good at this game. I’m wedded to the old systems of learning and knowledge that I was educated in and believe to be enlightening and true. But we had better not run around pretending that the game is one thing when it is another.

    1. hunkerdown

      If I ever find myself in the same room as you, I’d be pleased to shake your hand. “All you need to get people listening to you is to announce the correct answer” is a noble lie.

      Now, one might ask why pretty much everyone below local-elite level is intentionally taught to use weapons that are so ineffective and easy to turn against their user, unless the fix was in from the start.

    2. Calgacus

      Which side won the Civil War? As Lincoln said at Cooper Union, and as the war showed – “Right makes Might.” “Power” does respond to – bow down to, grovel before – such arguments – one just needs patience and a sense of humor to see it.

      1. Knute Rife

        Won the war and lost the peace. The problem is that Might Makes Right is the norm; Right Makes Might requires a societal focus that burns itself out. After the war, the North had other things to do. Reconstruction was a half-hearted effort and significantly co-opted by secessionists from the start. In 1877 even that charade was ended, and Might Makes Right became the only law in Dixie for 80 years.

  2. No one in particular

    I think Sinn is right (in so far) as relative prices are concerned. And they need to change (and are too sticky downwards and over time in reality) if relative productivity changes. The big debt glut caused in the periph caused by lenient regulation disguised the real issue – as long as one region has a higher (relative) productivity growth than another, relative prices have to change – constantly. [i.e. wages in the lower productivity area need to fall, this can be done by external or internal devaluation – regardless, but it has to happen: the euro is build on the fallacy and folly that fixing the relative prices/wages by introducing an inflexible currency unit will abolish these relative price adjustments and wishful thinking galore that all participants would be “beamed” to the higher Northern European livinng standard without hard graft].

    And facilitating these unavoidable adjustments inside a currency union without transfers/aka gifts is politically much more difficult, as permanent nominal wage reductions are inevitable to compensate for lower productivity. [a pipe dream to think Germany with her 27% share can pay for a similar living standards for the remaining 60%]
    However, we are long past the stage were any technical argument counts, because the euro and his “saviours” have long left reality behind them, this stupid currency union was aliviated to “religion” and belief too long ago. Only a forcefull and involuntary reacquaintance with hard economics facts will shatter this belief and the euro – too late and too costly. And the Germans know what they are talking about – they were the first to see the stark difference between outcomes driven by “supply and demand”, i.e. constantly adjusted relative prices in the West, and centrally planned, not adjusted socialist muddling through in the East, when the wall came down. They still suffer from and pay for it.

    1. JTMcPhee

      As far as I can see, economists can’t settle on what “money” is or how it works, or agree on what “wealth” is or how it’s created or destroyed. My untutored sense is that even though people are starving in China, my mother’s argument for cleaning all the good, nutritious food off my dinner plate, there is “enough to go around” of all the stuff that matters to ordinary people — food, shelter, clothing, energy sources that don’t pollute, even “health care.” Enough to provide a “modest competence,” , assuming any ability among us to share at all, that “Golden Rule” stuff.

      Latest expectation management and Narrative Bite is that because Markets and Competitiveness, anyone with a modest competence, and maybe even with Freud’s main sine qua nons, “Lieben und Arbeiten,”, needs to just accept that their wages and wealth will be stripped to a minimum, maybe not as in Greece and Nigeria and so many other places, not even enough to live on. That’s a statement about who,a very few it turns out, has the power to force impoverishment and its diseases on others while sucking up all the wealth, not about what is possible and much less about what is “right,” another notion rendered debatable by those who dictate the framing the rest of us have to try to live with.

      Where’s an economist’s kind of proof that it’s “not possible” to build decent sustainable system? They’ve got all the complex justifications and models that support the other thing in all its tentacular parts.

  3. craazyman

    Just curious if Outis Philalithopoulos attended and/or was on any panels. I recall seeing his work published here in the past. Was he there to defend academic choice theory in the face of aggressive questioning by world renowned economists? It’s not an assignment! just a question. :O -The Human Monkey Who Can Talk

    Did anybody there know what “competitiveness” means? Or is it sort of like pornography, nobody can describe it but everybody thinks they know it when they see it.

    1. craazyboy

      On the soccer field, the Olive Team ties the BMW Team. Non EU teams aren’t allowed on the field, of course, and the BMW Team members all have good German names.

      1. craazyman

        If Team Olive lets Team BMW win 34-0, they should get some recognition for generosity! it’s not fair to say they weren’t competitive. Yes, they lost, but they lost in a way that is almost an act of love. LOL Doesn’t that count too?

  4. Rodger Malcolm Mitchell

    The problem with the eurozone is this: Nations surrendered the single most valuable asset any nation can have: Their Monetary Sovereignty

    Not having Monetary Sovereignty, the euro nations are unable to control their own money supply. It is a firm rule of economics that a monetarily non-sovereign nation must have money coming in from outside its borders — a trade surplus — if it is to survive long term. It cannot survive solely on tax dollars.

    By contrast, a Monetarily Sovereign nation (the U.S., UK, Canada, Australia, China et al) can survive and grow forever, even with a net trade deficit.

    Thus, the euro is built on the false premise that all euro nations can have a trade surplus, and they are doomed to fail. I predicted this in a 2005 speech, when I said, “Because of the Euro, no euro nation can control its own money supply. The Euro is the worst economic idea since the recession-era, Smoot-Hawley Tariff. The economies of European nations are doomed by the euro.”

    There are two, and only two, solutions for these nations:

    1. Merge financially as a “United States of Europe,” where some central source provides money as needed

    2. Re-adopt your own sovereign currencies.

    All else will fail.

    1. Knute Rife

      Yes, the sovereigns do not have currencies, and on the flip side, the currency has no sovereign. The whole arrangement was set up to fail. How do we fix it? By hardening the currency through austerity, of course! That’s always worked so well to head off deflation. But wait, there’s more! Let’s impose austerity unevenly, inflicting it most harshly on the regions and classes that will be hurt the worst and be able to defend themselves the least. I’d say we learned nothing from the 1870s, but the Serious People who make all the decisions in fact learned the lessons perfectly, which is why every few years, when parts of the underclass start getting uppity, the Rich and Powerful and their lackeys dress this quatsch up as a sure cure for all economic ailments and hard-sell the snake oil to the detriment of the rest of us.

    1. hunkerdown

      At its root, it’s the gamification of masochism. Would that someone had put the pointed question to him, “Why compete?”, just to watch the chronically useless justify their Great Chain of Being.

  5. Ignacio

    The game of assigning blames still going on, and of course the “club med” as usual suspect. Bullshit. Imbalances among eurozone countries are not the result of profligate vs austere, but the result of a mercantilistic game of exporting demand.

    1. financial matters

      “And here is the paradox: all the policies proposed to increase growth of incomes and generate fiscal surpluses ultimately have a negative impact on income growth. Keynes called it the paradox of saving; here, it is the paradox of euro survival. Historically, deflations have produced financial crises just as easily as inflations. While Germany pleads for more political control and integration, the EU may disintegrate through political reaction to prolonged stagnation.”

      Demand can be stimulated by providing anti-austerity measures in the form of food, medicine, employment, education and shelter which would also have an equalizing effect. And there are plenty of environmentally friendly and socially useful projects.

      1. MyLessThanPrimeBeef

        I think it’s more a case of demand being met (already there, yearning to be met), instead of demand being stimulated (a starving man needs not be stimulated).

        And those in power can live happily ever, even with their austerity, that is, leaving current austere overall government spending neutral, by taxing the rich, just saying no to corporate bailouts/welfare, and reducing military budgets.

        1. financial matters

          Yes, more a case of empowering demand by providing good employment opportunities and services (medicine, education, legal). And change the corporate bailouts/welfare into better retirement security such as doubling social security.

  6. susan the other

    Thank you for the links to Varoufakis et al. I enjoyed his discussion with Stiglitz and then went on to a discussion in 2011 about his book Global Minotaur. He traces the financial crisis to the way the world economy unfolded after 1971 allowing Wall Street to effectively mint its own money in complex securitizations. A pyramid that managed to extend the great wealth recycling mechanism (the American minotaur) that Bretton Woods created. This analysis rang true to me because I had read stg about FDR not wanting to stimulate production to get the US out of the depression because the factories could create more than enough goods just running half time and FDR didn’t want to make the depression even worse by over supply. But after the war, America realized that it could produce its brains out and sell it all to Germany and Japan via the Marshall Plan etc. Then, in 1971, we no longer had a surplus to recycle, (having bankrupted our own system?) and we made the decision at that point that we would just recycle other countries’ surpluses and keep on truckin’. That we would run on deficits. And Germany and Japan et al sent all their profits back to Wall Street for reinvestment, etc. And our financiers took a substantial share of that flood of money and financialized the world with their newly minted securitizations. Creating a “pyramid.” Varoufakis was too politic to call it a Ponzi. And the rest is recent history. In 2008 the minotaur died from gorging itself. And what we need is another way to recycle surpluses according to YV. Because surpluses create wealth. In all this very interesting analysis by Varoufakis, and lots of other people looking to jump start the world’s economy, I never hear mentioned the great reality we face. The destruction of the environment precludes these old industrial/manufacturing/trade solutions. We need a minotaur that doesn’t recycle the wealth of mindless production (what exactly is that wealth?). We need a minotaur that reclaims the environment. We could feed it for centuries and it could redistribute the money almost like the old minotaur. But nobody ever approaches this very serious stuff.

    1. Chauncey Gardiner

      Re: … “I never hear mentioned the great reality we face. The destruction of the environment precludes these old industrial/manufacturing/trade solutions. We need a minotaur that doesn’t recycle the wealth of mindless production (what exactly is that wealth?). We need a minotaur that reclaims the environment. We could feed it for centuries and it could redistribute the money almost like the old minotaur. But nobody ever approaches this very serious stuff.”

      You do, STO. I think you underestimate your own level of influence.

    2. AQ

      America realized that it could produce its brains out and sell it all to Germany and Japan via the Marshall Plan etc.

      Half the team uses this to explains the post WWII years of growth and income distrution, and by extension why it can’t work anymore, (it’s because the rest of the world was destroyed and we exported to them) and the other half says that we sold our products to ourselves. Exporting products to the destroyed world was rather low overall. Is there a definitive resource for this somewhere?

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