The Euro and the Economists

Spiegel Online International interviewed two German economists on the future of the euro.  One has an (incomplete) approach to a solution, the other still can’t see the problem.  The split between the two mirrors the split among politicians (although along different dimensions than the politicians), and the existence of the split is a demonstration of the lack of coherence in reaching a solution.  Which bodes ill for the euro and for the European Union.

The interview opens with this; I’ll cite one economist’s response, as the other is saying substantially the same thing I’ve been writing, and so he’s to a large extent preaching to the choir.

SPIEGEL: Mr. [Joachim] Starbatty, Mr. [Peter] Bofinger, can the euro still be saved?

Bofinger: …The highly indebted countries must be able to borrow at moderate interest rates so they don’t go bankrupt. This could be achieved with euro bonds. And if they can’t be implemented that quickly, the ECB has to stabilize the system. In doing so, it would not create inflation but would in fact avoid deflation.

Mr Bofinger is wrong on two counts, and his first error demonstrates his plain lack of understanding of the nature of the problem.  Disastrously indebted countries do not need to “be able to borrow at moderate interest rates.”  They’ll never be able to borrow their way out of a debt-based bankruptcy.  Disastrously indebted nations instead must stop borrowing altogether and reduce their debt through annual budget surpluses.  Moreover, budget surpluses achieved by taking money away from their citizens and so out of their economies in the form of higher taxes will only guarantee continued economic failure.  The borrowing must stop and the debt reduced through reduced government spending.  Secondly, throwing money at the problem via the ECB certainly will avoid deflation—by leading to explosive inflation from too much money chasing too few goods from too little production.

Bofinger goes on in response to another question:

German politicians have not acknowledged that these countries have already reduced their deficits significantly. Compared to 2009, deficits have declined in all of the crisis-ridden countries…. The markets haven’t even noticed this.

It’s true that the deficits have shrunk.  What the markets have noticed, though, is that reduced deficits means continued deficits which means still increasing debt for nations with too much debt already.

On Spiegel‘s question of EU-wide increasing yields on sovereign debt (which means it’s getting ever more expensive for governments to borrow), the two economists had this:

Starbatty: Because the trouble spots in the euro zone are not being isolated, the sparks are jumping over to the healthy countries. Everyone knows that if the weaker countries are to be rescued, two countries — Germany and France — will ultimately be doing all the heavy lifting. So the most important question is: How long are the Germans willing to pay? And how long are the French in a position to pay?

Bofinger: You correctly describe how the euro zone behaves today, with 17 different countries trying to address the problems individually. In fact, the real question is whether Germany can be everyone’s guarantor in the end. That’s why we have to turn things around and say: We will now act as a unit. If Italy can go into debt through euro bonds, it will always be able to raise money, even it has to refinance €300 billion ($400 billion) in debt next year.

Mr. Starbatty exposes the false premise of the fiscal union on offer: that the “weaker countries” should be rescued at all, and if so, by whom.  The German citizens are tired of being everyone else’s piggy bank, and the French, while slower to the realization, are rapidly losing their capacity, even as they remain (sort of) willing.  Bofinger, on the other hand, misses the problem altogether: the fiscal union both allows an Italy (or a Spain, or a…) to continue to borrow profligately, rather than bringing its debt under control, and it traps Germany (and France) into being the union’s piggy banks.

Here’s this exchange, also:

SPIEGEL: So are the euro countries too different to be welded together in a single currency, as euro critics have claimed from the start?

Bofinger: There are also big differences in productive capacity in the United States. The problem is that we in Germany have tried to become even stronger by holding back wages….

Starbatty: The mistake lies in the fact that the weak countries in the monetary union have not changed their policies. They have used the low interest rates to have a party….  …which is why we now have a large divide in the monetary union. Some are overly competitive, while others can’t keep up anymore.

Both economists have it wrong.  The variability in productive capacity isn’t the problem for cohesiveness.  The lack of common social and philosophical imperatives and the vastly differing views of the purpose of money are what make a cohesive fiscal union of all 17 nations impossible and that are pulling the 27-nation EU apart.  Separately, “overly competitive!?”  Only in the fantasy world of too big to fail does this contradiction make sense.

The interview goes on in this vein.  Without even an understanding of the nature of the problem, there can be no hope of a solution.  But let’s expand government (here in the form of more power to the ECB and a fiscal union layered on top of national governments), as one economist and a gaggle of politicians insist, anyway.

Read the whole thing.

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