Can Pedro Sanchez save the PSOE?

Last month Pedro Sánchez Castejón was chosen to be the new leader of Spain’s center-left Socialist Party (PSOE).  El Pais called his appointment a “renewal” of the PSOE, buy although Sánchez seems to have been chosen mainly because he is too young and unknown to suffer from the revulsion most Spaniards feel towards the political establishment.

But as the PSOE’s new leader, look and without much of the baggage carried around by the older generation of leaders, Sánchez has an important choice facing him. If he expects to lead Spain and his party out of its current crisis, he must recognize that the crisis is fundamentally a conflict between the interests of Europe’s bankers and of Europe’s workers, and he must reengineer PSOE’s policies in favor of the Spain’s very anxious working and middle classes. If not, he will watch wistfully as Europe’s extreme right eventually takes control of the debate, either directly, or indirectly as the center-right parties absorb their arguments.

Throughout Europe, no less than in Spain, policymakers have refused to acknowledge the fundamental contradictions created by the euro just as, in the 1920s, they refused to acknowledge the fundamental contradictions created by the gold standard. Currency flexibility is one way an economy adjusts to volatility in growth and relative prices changes. When a country gives up control of its currency, however, volatility doesn’t disappear. Instead the adjustment accommodated by changes in the currency must now occur in some other way.

One common way is in the form of wage adjustments. Under a strict gold standard, countries with overvalued currencies usually adjusted by having wages fall relative to that of their trading partners, and of course the strongest impetus for falling wages was the unemployment caused by the expansion of foreign tradable goods sectors at the expense of the domestic. The volatility that could have been absorbed by the currency, in other words, was resolved mainly at the expense of workers.

Barry Eichengreen argued in Golden Fetters that the gold standard lasted so long during the 19th Century probably in part because the connection between the exchange rate and unemployment was not fully understood and, more importantly, workers were not sufficiently organized and enfranchised to protect themselves from the adjustment process that resolved currency imbalances. Because these conditions have changed, especially the latter in liberal democracies, this, he argued, is why we are unlikely to see a return to the gold standard.

But within the euro area, adjustment must take the same form as adjustment under the gold standard. Within Europe currency adjustments are not possible, and as a result Europe is forced into the classic gold standard adjustment when prices and wages are misaligned internally. With Germany having effectively devalued its euro during the decade after it was created relative to countries like Spain, for whom the euro is consequently overvalued, a misalignment of wages and prices must be resolved primarily in the form of wage and price adjustments, and this has meant, not surprisingly, that these countries would be forced into high unemployment until wages adjust.

The “correct” way to resolve internal misalignments would be for Germany to reflate domestic demand and raise domestic wages, but for a variety of reasons, at least some of which have to do with Germany’s determination to protect its banks from loan decisions made in the last decade, this is unlikely to happen without much greater pressure exerted by the peripheral nations. In order to protect the banks, who want a strong currency and for all debts to be either fully repaid or to be subsidized with transfers from the household sector, the brunt of the adjustment clearly will be borne by workers and an anxious middle class.

Put another way, Europe suffers from structurally weak demand largely because of structurally weak demand in its largest economy, Germany, and the result is that for many years Germany relied on excess demand from peripheral Europe to balance supply and demand. The 2008 crisis put an end to this form of balance by making it impossible for peripheral Europe to over-consume. Rather than resolve the problem by boosting demand in Germany, Europe’s solution is to reduce demand in the rest of the region (lowering wages reduces consumption). If Europe were a small economy, a surge in its current account might make up for this increasingly weak domestic demand, but Europe is too big to rely on external demand. It must rely on unemployment to “resolve” weak domestic demand.

Protecting the value of the currency and of international debt is usually characterized as behaving “responsibly”, but it comes with a cost. The policymaking elite, both on the left and the right, have been reluctant to make explicit the connection between the German policies, the euro, and domestic unemployment, preferring instead to blame misguided domestic labor polices, even though these labor policies long predated the euro crisis. This confusion affects not just Spain. Mario Draghi for example recently blamed “a lack of labour market reform and excessive business regulations” for Italy’s current failure to grow, as if these only became problems after 2008.

The rise of the fringe

Not surprisingly, this failure to address the root cause of the crisis has left European politics once again vulnerable to fringe parties. But while the extreme left does little more than act out publicity-garnering ways to express outrage, the extreme right has mounted a skilled and consistent attack on Europe’s monetary structure and on the banking establishment. Their attacks are not always rational – blaming foreign immigration, or the US, or China, for Europe’s problems suggests a pretty high level of confusion – but they have clearly taken sides.

This is why the extreme right has done so well throughout Europe, and will continue to do so, even eventually in Spain, at the expense of the major parties. Neither the PSOE nor the PP (the center right party in Spain) will revive Spain’s economy by behaving “responsibly”, given the intractability of the forces behind the economic crisis. Except in the very unlikely case that Germany vigorously reverses the wage- and income-suppressing policies implemented in the past two decades, Spain really has only two policy options, both very difficult.

Madrid can confound elite consensus and move aggressively to restructure Spain’s external debt while redefining its participation in the euro, for example by leaving the euro while committing credibly (i.e. with German support) to rejoin the currency union at some specified future date. In this case Spain will suffer a year of chaos before the reforms implemented, ironically, by Mariano Rajoy generate a return to rapid growth.

Alternatively Spain can continue to suffer many more years of high unemployment and, with it, a rising debt burden. The recent anemic improvement in the Spanish economy, announced with great fanfare, will do almost nothing to resolve either problem, especially with Germany and France weakening. Unemployment will stay high for many years and the combination of prolonged unemployment, emigration of many of the country’s best and brightest, weakened infrastructure, and a deterioration in the political landscape will ensure that Spain will be one of the sick men of Europe for decades.

For the PSOE to avoid irrelevance Sánchez must formally recognize that the policy failures accumulated over the past four decades, including labor rigidity and out-of-control corruption, although very real, are not the cause of the crisis. Spain’s high unemployment, excessive debt, and stagnant growth stem indirectly from policies implemented by Germany that forced down the GDP share of German wages while also reducing domestic investment. These policies created for Spain the same set of problems that simultaneously affected Portugal, France, and the rest of peripheral Europe.

Since 2001, with both consumption and investment declining relative to Germany’s production of goods and services, the only way Germany could avoid a surge in unemployment was with a surging current account surplus. The constraints imposed by the euro, which ensured massive German capital exports to the rest of Europe, allowed Germany to run this surplus, while its European neighbors, no longer in control of monetary policy and unable to prevent German capital imports which forced up asset and consumer prices, were forced to run the obverse deficits.

These countries had only two possible responses to German imbalances. First, low interest rates and surging capital imports from Germany could set off an unsustainable consumption boom and raise domestic costs relative to that of Germany, which they did before 2008. Second, Germany’s newly created manufacturing competitiveness would force German’s European neighbors to absorb the unemployment that should have afflicted Germany, which they did after 2008 once the consumption boom ran out of steam.

Their real commitment to Europe made it hard for policymakers to acknowledge that the crisis was caused by many of the policies, including the establishment of the euro, that seemed fundamental to European unification, and so they blamed domestic distortions, and especially high wages, for the crisis. Once the ECB declared its readiness to provide unlimited liquidity, and in spite of high and growing debt burdens and debilitating unemployment, Brussels declared that the euro crisis was largely behind us.

The crisis is not about bond prices

But while investors may be forgiven for thinking so, the European crisis is not about the price of bonds. The collapse in bond prices in 2008-09 reflected the very real fears of insolvency, and the fact that the European Central Bank has decided to provide unlimited liquidity to prop up bond prices has not resolved the insolvency risks at all. What is more, historical precedents suggest that the ECB’s resolve will only last until European banks, and especially German banks, have been sufficiently recapitalized (at the expense of households, of course) to recognize that many European countries will never repay their debts. Once they have the capital to absorb sovereign defaults, the appetite of Germany and other countries to continue funding unrepayable debt will fade away.

A recent piece by Barry Eichengreen and Ugo Panizza makes this contradiction clear. The authors show that countries like Spain can repay their debt only under implausible assumptions about the size of the fiscal surpluses needed to do so. As they write in a summary:

For the debts of Europe’s problem countries to be sustainable, absent restructuring, foreign aid or an unanticipated burst of inflation, their governments will have to run large primary budget surpluses, in many cases in excess of 5% of GDP, for periods as long as ten years. History suggests that such behaviour, while not entirely unknown, is exceptional. Countries that have run such large surpluses for such extended periods have faced exceptional circumstances. On balance, this analysis does not leave us optimistic that Europe’s crisis countries will be able to run primary budget surpluses as large and persistent as officially projected.

At some point, in other words, either the suffering countries of peripheral Europe will have to squeeze their citizens far more than is likely to be possible in a democracy, or these countries will have to restructure their debt with significant debt forgiveness.

The extreme right, and especially Marine Le Pen’s Front National, has engineered a frontal attack on the real source of the euro crisis. They recognized that policies that forced down German wages created the collapse in demand, and that the euro forces the rest of the region to compete with Germany by forcing down domestic wages which, paradoxically, will reduce overall demand in Europe even further. By leaving the European Union and regaining control of monetary policy, France will almost certainly see a decline in unemployment, a sharp improvement in its current account, and faster GDP growth.

French elites insist that Le Pen is not a threat because were she ever to become too powerful, the left and center would unite against her and prevent her party from winning any election. But even if they are right, they miss the point. The only way for the centrist parties to prevent a victory for the Front National may be by adopting most of its policies. As a recent article in Le Mode Diplomatique put it:

However the main reason [for earlier failure of the FN to take power] may have been Sarkozy’s adoption of staple FN policies: the promotion of a French identity; national preference in work, welfare and public service access; hostility towards low-income immigration; special crime laws for foreign-born migrants. Voters sympathetic to the FN saw Sarkozy as a more viable vehicle for their politics. As Le Pen Jnr put it: “The only thing that weakened the Front National was Sarkozy’s strategy of presenting himself as a kind of double of the FN.” Sarkozy saw that “the French people were turning more and more towards the option of the Front National. He managed to harness the force of that river and divert it to his own advantage.” She laughed. “But now the river has returned to its own bed.”

Europe’s policymaking elite refuses to acknowledge what is pretty obvious. Monetary union, as it is currently structured, forces imbalances in one country to affect neighbors within the union, and there is no mechanism for resolving the imbalances at the place of origin. Countries like France and Spain have no way to deal with policies in Germany that forced up the country’s national savings rate (by forcing down wages) while lowering domestic investment except by themselves lowering their own national savings, either in the form of an unsustainable consumption boom or a surge in unemployment.

Responsible bankers versus hungry workers

In this split between the “responsible” policymaking elite and the “irresponsible” anti-euro right, Europe is replaying one of history’s classic battles between bankers and workers. Throughout the 19th and 20th centuries (and indeed much earlier) debt and monetary crises have pitted one against the other. Sometimes the bankers win, as they did during Latin America’s Lost Decade of the 1980s, and the US in the late 1970s, and sometimes, although never without a struggle, the workers eventually win, as they did in the 1930s both in the US under Roosevelt and Germany under Hitler.

Whether the bankers are right about the long-term benefits of maintaining the course or the workers are right (and history makes clear that neither side is always right), by defending the currency and the sanctity of debt, elite policymakers throughout Europe have taken the side of the bankers. In order to protect the current monetary structure they have allowed worker unemployment to soar and uncertainty and fear to spread through the middle class.

But even if over the long term they are right to do so, the historical precedents suggest that the votes of the disaffected will go to whichever party, left or right, most vigorously takes up the cause of the workers against the bankers. If the center parties do not do so, as Roosevelt did in the 1930s, the extremists will. While Europe’s centrist policymakers refuse to address the root cause of the European crisis, and the extreme left expends its energy on theater and rage, the extreme right’s share of votes has risen and will continue to rise.

Pedro Sánchez has a choice. He can maintain the policies of “responsibility”, in which case he will cede leadership of the struggling working and middle classes to the racist and xenophobic right, with all the awful long-term consequence for Europe that this will entail, including a very low likelihood that the European Union will revive. Or he can seize leadership across Europe by demanding a meaningful debate across the continent on European debt and on the euro. This means among other things discussing ways of introducing currency flexibility as a more efficient way for relative costs in Europe to adjust, and it means recognizing very explicitly that much European debt can only be repaid in the form of a massive and unacceptable transfer of wealth from European workers to German banks.

Contrary to alarmists who see any step backwards as an existential threat to Europe, this debate would not mean the end of the dream of a unified Europe. It would simply mean conceding that Europe does not yet have the institutions needed for the currency union to survive, and that the capital, labor, banking and fiscal frictions that remain in place ensure that the flexibility eliminated by currency union will re-emerge in more destructive ways. There can be a successful European Union, and many of the changes that are needed to ensure success are likely to be relatively easy to implement, especially if they are part of an overall package that includes significant debt restructuring and forgiveness, but the current structure is not in place.

By undermining the irresistible pull of those who wish to destroy the union, a serious debate that recognizes the unbearable cost to European workers of the current structure might actually be the best way to save Europe. To insist that the current Europe is the only possible Europe does not make sense, and even many of Europe’s strongest proponents understand this, but to argue that the current version of Europe can evolve gradually in spite of the tremendous costs that must be borne by workers, especially in countries like Spain, may overstate the popular appeal of Europe and understate the extent to which political elites have overcommitted themselves to their creation.

The PSOE’s party elders did not choose him for this role, but if Pedro Sánchez takes the lead, in Europe as much as in Spain, and reopens the debate about the euro, acknowledging that the current structure does not work and defining with the help of hindsight what vulnerabilities must be addressed in a reformed European Union, the party’s new leader can halt the decline of the PSOE at home and reverse the ugly nationalism spreading through Europe. Spain and other countries suffering from high unemployment should unite and jointly put pressure on Germany to resolve its structurally weak domestic demand, and their excessive debt.

If however he continues to pretend that the crisis has been resolved by the ECB’s willingness to roll over Spain’s debt, which it will probably do only as long as German banks are insufficiently capitalized to recognize the obvious, he may find himself presiding over Spain’s and Europe’s swing to a nationalist right. In the battle between workers and the bankers, ultimately the workers will decide on who will determine policy.



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  1. Your analysis is brilliant and spot on, but I wonder why you are steadfast in not seeing a Hegelian development required here – the transformation of the exisiting Westphalian European nation states to the “United States of Europe”. Either in terms of pragmatism or in terms of answering the yearning of the Romantic core of Europe, it seems it is the only remedy. Your remedy of Spain leaving then rejoining or Germany or France doing similar will lead to at least intense local strife if not trans European strife. It is the re-emergence of fascism, the river returning to the bed.

    • Thanks, George, but I am only trying to work out the necessary economic consequences of European economic distortions. I leave the wider political implications to those who can do it better than me.

  2. What does ‘introduce currency flexibility’entail? I agree with the above comment, this is an excellent analysis but it leaves some specifics out.

    If Spain leaves and then comes back in, presumably at a lower value set on the Spainish national income vs the euro value than is currently the case will another country have to go out and come back in – or all the southern european copuntries go out for that matter?

    Would it not be better to have a three tier euro and put the various countries in one tier or another based on their employment stats? If you make a decision to put Spain, Italy, Portugal etc in the lower tier whose currency is set 40% lower than the top German tier euro and all debts are denominated in that currency, would that not be a workable solution? For example a Current Euro 200,000 debt becomes a 3rd tier Euro debt of Euro3 200,000 which after the changeover becomes a debt of 60% of the old Euro i.e. a debt of 120,000 in the old Euro1 value.

    That way you have your currency devaluation and partial loan write-off in the one package.

    • I think there are several ways flexibility can be introduced, David, and these will depend on a lot of factors which exceed the intent of this analysis. I think my main point is that the current “all-or-none” approach makes “none” an increasingly likely outcome. I truly believe that those hoping for a real and sustainable European Union must acknowledge that the current one is not that.

      • Indeed, let’s never forget that the ultimate goal of the European Union is not in itself to have a common market for the free exchange of goods and services, nor a common currency. It is to avoid – by a political system of permanent cooperation between nations – the repetition of bloody conflicts that have tended to occur throughout its history, mainly between England, Germany, France and Italy. In that sense, economic prosperity is simply a mean to an end. The problem now is that this mean is lacking badly. To the point that the end could at some stage be compromised as failure of the European Union (in particular with regards to the disastrous employment situation) leaves ample room for ill-meaning nationalistic movements.

        It is not clear that among the current team of European leaders there is even one that is up to the task. England has one foot outside almost since joining in 1973 and has mostly acted as a US agent to get rid of the European Community preferential trade clause and to drag the EU into successive GATT and WTO international trade rounds that have – in the context of high social regulations and safety nets in Europe dating from right after WWII – devastated its industry, its workforce and its finances. France is weak and confused. Germany is focused on winning the economic war, not just within Europe but globally. Italy is not standing for anything special. Spain is wounded.

        Not very inspiring unfortunately.

        • The EMU may very well end up in war again though. The world is so much different than what it was even 50 years ago. As you said, the UK is effectively a geopolitical puppet of the US while most of the European powers are weaker than they’ve been in centuries and it’s only going in one direction. We’re in a world where India has more geopolitical clout than any country in Europe including the UK. When was the last time that’s happened?

          There’re other factors we’ve gotta keep in mind as well, including factors like demographics and natural resources. Europe imports much of its natural resources and all of these countries are in secular demographic decline.

          I’d like to add one more point about the devastation of industry in these areas, which is that we’re entering a post-industrial world–particularly in the developed world which is already 80% of the way there. The dynamics of a post-industrial society are very different than that of an industrialized one. For one, the most important thing to have in the post-industrial world is human capital. This means that we’re likely to see large population declines throughout the entire world when countries hit the post-industrial stage. Due to post-industrialization, war has changed. War is becoming much more surgical and we’re already seeing the beginning of this shift with regards to the way the US is using drones. Eventually, I suspect we’ll start seeing strikes from space and with all sorts of unmanned vehicles where all of this will be driven by new technology.

          I think Germany might actually be one of the weakest countries in Europe, but it’s weakness is being hidden. Northern Europe is stocked with excess capacity and bubbles as well while all of Europe is ridden with debt. The European banking system is 3-4 times as large as the American one (relative to income) while the capital ratios are significantly less. Taken a 15 ft deep pool with a 15 ft diving board while halving the depth and tripling the height of the board. This is the situation that Europe’s in. Basically, Europe’s completely fucked.

  3. Regarding Pedro Sánchez, I have done some internet search to see if he has any clue on the dilemma that you have described so nicely. He has recently said, in relation with the latest growth estimates showing a stagnant european economy, that the “European Union needs urgently a policy change” but he does not explicitly signals the eurozone design and their imbalances as targets. Neither he aknowledges the debt problem except by saying that if he wins no more bank debt would be nationalized. It seems to me that Mr. Sánchez belongs to the political stablishment that is so reluctant to recognize the problems created by the eurozone design. I wonder that if someone in the PSOE would raise the questions you raise in this post would be inmediately considered an anti-euro outsider and would not have any chance to be elected as candidate of the left-center party.

    If I am rigth, and following your reasoning, we will se a surge of “fringe” parties and increased probability of disordered spexit, (grexit, itexit, frexit etc.).

    Besides, I would like to comment about your “is not about bond prices”. I agree with you and also with the opinion of Eichengreen and Panizza. But I would add that bond pirces have made (and are still doing) a lot of harm. Besides increasing the cost of government financing, higher interests rates in the periphery rises financial costs in periphery-based companies relative to core-based companies which in turn decreases competitiveness, which in turn adds more pressure to wages. Bond prices are not the cause of the crisis, but are the instrument that the financial stablishment has used to pressure wages down and in this way they have had an important role on how policies have evolved.

    • Of course interest rates matter, Ignacio, and if Spain were still paying 7% or more I doubt it would have lasted this long, but until businesses are willing, and able, to borrow at low rates, the ECB policy of rolling the debt over indefinitely won’t matter much to the economy.

    • As for Sanchez, my Spanish friends in government tell me not to hold my breath waiting for him to question elite consensus, but who knows? there have been many government heads who surprised once they were in government.

  4. Hi Dr. Pettis,

    I was hoping you could comment on Paul Krugman’s latest Opinion piece in the NYT, “Why We Fight Wars” in your next blog.

    I know this is an extremely sensitive subject for you, but I think it needs to be addressed by someone with credibility like yourself.

    My biggest fear is that once the music of a rapidly growing economy stops in China, leadership is planning on pivoting for political reasons by triggering a conflict with Japan and/or other neighbors, which obviously implies the US as well.

    As Dr. Krugman points out, that’s what it appears that V. Putin is doing in the Ukraine. And with his poll numbers up, this seems to support just such a move by China.

    Personally I think this would be a disaster for all involved, perhaps excluding top leadership in China. I think the world would benefit from your wisdom and view from a historical context.

    Of course I emailed you about this a few times years ago and understand that you may be unable to write something even in your gentile diplomatic terms and still reside in China. If that’s the case, I understand, although it would be unfortunate that truth may not be told until it’s history.

    Thanks for taking the time to read this.

    • The reasons for war vary, but much of the reason for war is over geopolitical fault lines. War is fought over key geographic locations, control of trade routes, control of supply lanes, and natural resources. Krugman doesn’t seem to understand that geopolitics, economics, and natural resources are all intertwined. Geopolitical systems co-develop alongside economic systems. For example, central banks were explicitly created for the purposes of funding wars and imperial expansions. Many statists take that to say that I’m saying central banks shouldn’t exist, which isn’t what I’m saying at all. If my enemy’s gotta a military and a machine that can fund wars in an instant, it means he can run my country over literally overnight. So I go and get a central bank where my government can start issuing government debt so that I can fight his armies and raise capital quickly if push comes to shove.

      Unfortunately, Krugman’s understanding of finance and balance sheets is so poor that he doesn’t understand any bit of my comment above. On top of this, Krugman has ZERO understanding of geography and completely overlooks its importance. For example, Krugman makes the claim that countries with higher populations than the US will eventually overtake the US in GDP and economic capacity. Of course, this isn’t the case because the US has two oceans on its Eastern and Western borders while having access to some of the most fertile land in the world that’s located in the Great Plains. Also note that the US has the world’s most advanced military with the world’s largest Navy and Air Force that effectively patrols the world’s oceans (and thus trade). It’s also of major importance to notice that the US also has a temperate climate and is the only country in the world that has access to two oceans and also has a temperate climate.

      Basically, what I’m saying is that a focus on economic efficiency means nothing if we don’t take into account geopolitical risk. I actually address this topic in the link below. It might be of use and help for you.

    • By the way, the US involvement in Ukraine may seem like it’s Russia that’s the aggressor, but that’s not the case. In reality, the US is the aggressor. The US has the world’s most rogue foreign policy and it’s not even close. The US props up and sides with the world’s most autocratic regimes (ex. Saudi Arabia) while claiming to support “democracy”. The only reason the US is involved in Ukraine at all is to undermine the Russian government and Putin.

      In the case of Islamic State, they’re getting large portions of their funding from places like Qatar, Saudi Arabia, and even Turkey (all of whom have been US allies over the past few decades). Also note that the second largest US oil importer is Saudi Arabia (after Canada).

      Krugman doesn’t really understand or grasp what’s going on and he’s way to politically biased to be taken seriously in this matter. Krugman’s completely blind to what’s actually going on in the world.

      • Suvy

        Aren’t you tired of these blanket assertions (i know I am), and isn’t your perspective a bit over-assumptive, based on fallacious, ideological, 19th century German (Kantian) Idealism. How in such a single breath can you assume so much. Is it a response to ideals progressed, versus, cold, on-the-ground facts, in a world far more complicated than the easily assumed better of our personal choosing. The world is replete with real danger. Your assertions as to Putin’s neo-imperial designs are ridiculous, your linking of Turkish, Saudi and Qatari actions (when there is grave problems between Saudi and Turkey, Turkey and Qatar, and on-again, off-again disagreements between Turkey and Saudi seem child-mindedly foolish.

        Turkey, in the recent period, and over the previous decade, was becoming more assertive as its European ambitions waned, Qatar and Saudi were on opposite sides of many recent conflagrations during the Arab Spring, Saudi Oil exports have more to do with the type of crude, as no two crudes are alike, and tight is giving sweet light, so Saudi sour is desired for the current refineries in operation.

        So where the US, as a large, long-term provider of global public goods, and a regional influencer toward stability has relations with three regional power brokers, who have recently co-operated and conflicted amongst themselves, and who are often on opposing sides, where the US has relations with these countries, you view it, from despair, despondency or paranoia the US a a purveyor of a rogue foreign policy.

        South Korea
        and many others have often not lived up to US expectations as to democracy, but each thrive as such now.

        Many other nations have not lived up to such, and don’t thrive, or do thrive.

        While it is important that Saudi is the 2nd largest supplier of oil, from external sources, to the US, it is rather more important that we not forget that more than 80%, up from 65%, of middle eastern exports go to Europe and East Asia. Again, some, with unsavory presents and histories, others who have evolved, but all who have a relationship or another with the US, if soft power gains, hiding, binding, norm entrapment and similar are tools used by them to progress agenda’s. Your notions are disappointing and superficial.

        • I’ve never read Kant and I don’t know what Kantian Idealism is.

          As for linking Saudi, Qatari, and Turkish intentions, the stuff I’m getting is the stuff that’s coming out of the European commission (in the third link I’ve attached, the German Aid Minister is the one accusing the Qataris). Here are some links you may wanna look at because you’re clearly buying the propaganda thrown out there by the West. I wish it were true, but much of it simply isn’t true.

          Also, the US isn’t a democracy, IT’S A FACTIONAL GOVERNMENT BY DESIGN! There’s a difference. Is each state having exactly two senators regardless of population democratic (note that senators were actually appointed by the state legislatures for half of US history)? Is having a requirement of 60 senators required to pass a bill through the filibuster democratic? Is the idea of federalism where states work autonomously so they can do their own thing democratic even if those in other states or the federal government democratic? The political structure of the US is actually halfway between an empire and a true democracy (Alexander Hamilton talks about this in one of The Federalist Papers BTW).

          “So where the US, as a large, long-term provider of global public goods, and a regional influencer toward stability has relations with three regional power brokers”

          HAHAHAHAHAHAHAH!!!!!!!!!! Please tell me how the US going into Iraq stabilized the region. This is total crap dude. I love the US with all my heart, but US foreign policy doesn’t create love towards this country. People across the world don’t really hate the people of the US (on the contrary, they love our culture and ideas about freedom), they (usually) hate the US political elite. The US has been THE most destabilizing force in the Middle East over the past few decades. Anyone that says otherwise hasn’t been watching and is politically blind. Just look at what’s happening to Gaza by Israel (who’s backed by the US), it’s just a modern version of ethnic cleansing. One of the Israeli military guys said that they should put up a concentration camp in Gaza, but Gaza IS a concentration camp. The Palestinian Arabs who’ve lived there for centuries have been displaced from their homes because of US support.

    • Suvy, actually Krugman has done important and interesting work on geography and economics. Many people may hate him for his politics (I don’t) but either way it isn’t helpful to ignore the fact that he is a brilliant and logical thinker.

      I think the main point in his article, Dave, is a reflection of what economists refer to as the “agency problem”. What is good for the shareholders (citizens) is not necessarily good for the managers (policymakers) because their incentive structures can be so badly misaligned. In that sense a “good” political system is one in which the incentives for both are correctly aligned. There is no great way of doing so, but democracies do it by giving the shareholders the right to expel the managers at regular intervals. It isn’t a terribly efficient system but, as Churchill pointed out, it seems to be a lot less bad than all the others.

      • With regards to democracies, what about the risk of groupthink leading to some crazy guy running the show. There have to be limits to democracies and having a strict parliamentary system can lead to major problems. Isn’t there a real issue with people running the show who have no skin in the game? I guess the advantage of an empire would be that an emperor has more skin in the game than a typical politician or bureaucrat.

        We shouldn’t underestimate the importance of having a system based on checks and balances along with the importance of constitutional limits. What’s the point in having a democracy if the majority can impose their will on the minority every single time? Surely, that can’t lead to good outcomes. We must keep in mind that Hitler and other dictators can be placed in power from democracies. There must be limits to protect our freedoms.

        I also think it’s really important to have decentralized institutions whereby many different ideas can be tried independently and autonomously. Having some politician/bureaucrat/central planner with no skin in the game making decisions for an entire country just seems dangerous. Wouldn’t it be better if you had individual states or provinces work independently while the federal or national government existed in cases of war or national emergency? Doesn’t that make much more sense than having a parliamentary system wherein the ruling party/coalition gets what they want basically all the time? Isn’t having that kind of a parliamentary system dangerous? This is why I think the factional type of government that exists in the US would be much preferable to the parliamentary kind that exists in the European world. Basically, countries that’re diverse enough to run decentralized federal republics would be better off versus running the parliamentary system seen in Europe.

      • “…, as Churchill pointed out, it seems to be a lot less bad than all the others.”

        I believe this to be one of the most cowardly, self-serving statements ever uttered. Imagine rationalizing something by saying that everything else is that much worse!

        Systems are designed by the few for their own benefit. No more need be said.

      • Professor, I don’t dislike Paul Krugman for his liberal politics which I always don’t find agreement. I also concur that he is a brilliant and logical thinker. The problem lies in his role as a Nobel prize winner writing a column for the liberal New York Times carrying water too exuberantly for the Obama Administration. Perhaps I am putting Nobel prize winners on a pedestal, but the Nobel gives Krugman a forum and credibility that other economists would never be afforded.

        I always thought you would have more agreement with Paul Krugman on economic affairs. You however appear to try to be apolitical in your writings and only present the issues, problems and potential solutions without any kind of overt political agenda.

  5. (REPEATING comment without URL links)

    Hello Michael,

    You wrote: “Countries like … Spain have no way to deal with policies in Germany that forced up the country’s national savings rate (by forcing down wages) while lowering domestic investment except by themselves lowering their own national savings, either in the form of an unsustainable consumption boom or a surge in unemployment.”

    I think you might be confusing what happened in the US (exactly as you describe) with what happened in Spain during the bubble years.

    Unlike the US, Spain did *not* lower its own savings rate. Instead, it absorbed the excess savings of Germany coming into its economy (i.e. Spain’s current account deficit) by raising its *investment* rate. You can confirm with the World Bank data,

    According to the World Bank data, household consumption in Spain went **down** from 59.7% of GDP in 2000 (when Spain joined the Euro) to 57.2% in 2008 (when the bubble burst).

    In addition, and by implication, the total national savings rate in Spain was *not* lowered at all between 2000 to 2008, as can also be verified from World Bank data

    So unlike the CAD-driven consumption boom in the US, what Spain had from 2000-2008 was an CAD-driven *investment* boom– although it may have proved to be equally wasteful & so ultimately unsustainable.

    Am I missing something? Please comment.

    • Hello Michael,

      Following up on my comment above, I would like to paraphrase your original writing to further explain my point to all the regular readers on this forum.

      A) You wrote: “Countries like … Spain have no way to deal with policies in Germany that forced up the country’s national savings rate (by forcing down wages) while lowering domestic investment except by themselves lowering their own national savings, either in the form of an unsustainable consumption boom or a surge in unemployment.”

      B) To my mind, what you MEANT to write was: “Countries like … Spain have no way to deal with policies in Germany that forced down the country’s aggregate demand (by raising the national savings rate (by forcing down wages) while simultaneously lowering the domestic investment rate) except by themselves either:
      (i) increasing their aggregate demand, in the form of an unsustainable consumption and/or investment boom, or,
      (ii) decreasing their aggregate supply by accepting a surge in unemployment.”

      In the face of the German surplus, what Spain did from 2000-2008 was (i) and what Spain did from 2008-2013 is (ii).

      Am I correct? Or am I making a mistake in my thought process somewhere?

      Please advise. Thank you.

      • Vinezi, I tend to throw all the deficit countries into the same basket and so sometimes need to be more precise in specific cases. By the way, you should look at total consumption, not household consumption (savings is GDP minus total consumption), but in Spain the two numbers tracked each other closely so your numbers are not directionally wrong.

        When the euro was introduced there was a decline in consumption as a share of Spain’s GDP which I attribute to a widespread perception of rising prices and the uncertainty surrounding the euro. At the time Germany was running deficits.

        Around 2003 is when we began to see the German current account surplus soar (I think it was in deficit until 2002) and the corresponding impacts on the rest of Europe. From 2003 to the crisis, in spite of weakness in the manufacturing sector, Spain did indeed see a rise in the consumption share of GDP, from 75.0% in 2003 to 76.7% in 2008 and 78.0% in 2009 (this is according to the World Bank data).

        Of course this decline in savings does not explain the full increase in the current account deficit which was caused, as you note, mainly by a surge in investment. Because of soaring real estate prices my sense is that much of this surge in investment occurred in real estate — certainly the case in the part of Spain where I live, which is still dotted with unfinished real estate developments and empty apartments everywhere. There have been lots of scandals in the newspapers about extravagant infrastructure too, so I assume plenty of money went into useless infrastructure, but I don’t have a breakdown.

        The key point, as you note, is that as German savings were forced up while German investment declined, the rest of the world, which mainly means Europe in this context, had to see investment soar relative to savings by an equivalent amount. Spanish savings declined slightly after 2003 — i.e. consumption increased — on the back of soaring asset prices, which made Spaniards feel wealthier, but the real “adjustment” was a surge in investment, much of which, in retrospect, was wasteful. Massive inflows of cheap capital often result in wasteful investment.

        This is why I don’t think we can blame Spanish foolishness for the crisis. There are more than enough idiocies in the Spanish political system to criticize the Spanish government, but the unsustainable post-2003 surge in the current account deficit was not one of them. This occurred because Spain had no way to prevent a flood of cheap German capital imports.

        Of course you can argue, and some people do, that “all” Spain had to do was to invest all this money intelligently and productively, but there are few cases in which a country has been able to invest such large and cheap capital inflows productively, and in every case I can think of the result was investment misallocation on a massive scale. At any rate if it was so obviously easy for Spain to invest German excess savings wisely, then why was it not equally obvious and easy for Germany to invest its rising savings wisely in rising investment? In fact, as you know, German investments actually declined. Spain was forced to do with German savings what Germany was not able to do, even as the expansion in Germany’s tradable goods sector came partly at the expense of Spain’s.

        Thanks for checking the numbers.

        • “…….By the way, you should look at total consumption, not household consumption (savings is GDP minus total consumption)……”

          You are correct. Mea Culpa. In fact, this raises a very important point: A lot of economists use Household Consumption as a convenient indicator for Total Consumption (i.e. Household Consumption plus Government Consumption), because they assume that Government Consumption is (a) more or less the same everywhere and (b) very small relative to Household consumption. This assumption can be very misleading when comparing ‘small-government’ countries like US with ‘big-government’ countries like Sweden.

          To see why, let us compare Household Consumption rates between US, Sweden and China:

          From the graph above, it may seem prima facie that Sweden has a severe under-consumption problem (like China) and that it is a grossly imbalanced economy (like China’s). But that would be a hasty and erroneous conclusion. When we look at Total Consumption (instead of Household Consumption alone) for the same three countries, we can see that Sweden is actually quite well balanced (unlike China) and has healthy consumption levels (unlike China):

          Obviously, the difference must lie in the Government Consumption levels (i.e. Socialism). Here are the data that show the massive scale of Swedish Socialism (high Government Consumption rates) relative to US or China:

  6. Thank you prof, i french so i have many points on witch i disagree with you. Even, if i totaly agree with you on current account surplus versus unemployment( actually you taght me that…).
    First you says that Mario Draghi want more reform to reduce the debt burden, actually what he want is a freer labour market before he unleash QE infinity.
    Second, you said that labor market failures was there longtime before the crisis, this is true but again what these people think it’s these failures witch leed to a massive debt burden and not just a surge due to subrime crisis. I also wonder why you just don’t think about default. In many European country debt burden is unsutainable.

    As a good student of your teachings i started few weeks ago to chase unsustainable debt over the world. Because you say that peope often mistake growth and debt i started to look at Korean miracle. I found on google stat a massive surge in M2 in 1997 until 2002 witch suggest me that Korea repay IMF with domestic debt. In the same time the groth rate declined. The economist seems on my side, what do you think?

    • I am not sure I understand, Cedric. I didn’t argue that that “Mario Draghi wants more reform to reduce the debt burden.” My point there is that he, like many others, sees the crisis as a consequence of inflexible labor markets, and I don’t. I think the timing of the crisis makes it clear that the crisis was a consequence of structurally weak demand caused by weak wage growth. This is why lowering wages is not only not the solution, but it will make things even worse.

      • “….My point there is that he, like many others, sees the crisis as a consequence of inflexible labor markets, and I don’t….”

        I think what Draghi meant was that inflexible labor markets in Spain caused costs (i.e. wages) and so prices (i.e. inflation) to rise faster in Spain than they did in Germany. After the introduction of the Euro, there was no way this could be handled by currency exchange rate adjustments, and so Spain became uncompetitive w.r.t. Germany. I believe this is the essence of Draghi’s logic.

        As you have yourself noted, Spain did have higher inflation (CPI) and a faster rise in GDP deflator than Germany under the Euro regime from 2000-2008. Here are the World Bank data:
        (1) Inflation
        (2) GDP Deflator

        A) So is Draghi’s logic correct? Was it the labor market inflexibility in Spain that caused the inflation-differential by a triggering a faster rise in wages in Spain relative to Germany?

        B) Or was it Germany that caused the inflation-differential by artificially suppressing (as a matter of state policy) wage-increases in Germany relative to Spain ?

        C) Or does the truth lie somewhere in between, such that both (A) and (B) are simultaneously true?

        Michael, would you please comment?

        • Read it from the man himself. Here is Draghi’s speech at Jackson Hole last Friday titled “Unemployment is the Euro Area”.

          Even if most of the substance is relatively ordinary, it is nevertheless an interesting text (including some footnotes, the first one in particular being as close as it comes an admission that QE has been ineffective to reduce under-employment in the US) because it is delivered by the guy in Europe who has the authority to act on monetary policy levers and the capacity to influence other aspects of economic policy.

          The speech touches on many of the themes that are being discussed here on this forum.

          However, the most telling I find is what is being omitted. There is no explanation of the crisis whatsoever. It simply comes in Draghi’s speech as “a negative shock to GDP”. Which just happened. Like that. Out of bad luck it seems. Don’t ask and he won’t tell is the usual modus operandi in this kind of exercise. Who needs a proper understanding anyway when one has “whatever it takes”?

    • ^^Cedric wrote: “…I found on google stat a massive surge in M2 in 1997 until 2002 witch suggest me that Korea repay IMF with domestic debt…….”

      I won’t comment on the credit expansion (M2/Nominal-GDP rising very rapidly) part of your assertion, but it is incorrect to say that Korea “repaid the IMF with domestic debt”.

      (1) Korea borrowed about 13 billion$ from the IMF in 1997-98 to handle the BOP crisis. Here are the IMF data:

      (2) As a response to the BOP crisis, Korea devalued its currency in 1997-98:

      (3) Using this devalued currency, Korea began to run huge current account surpluses (CAS) after 1998:

      (4) These CAS built up Korea’s foreign exchange (forex) reserves very rapidly after 1998 (and its forex reserves continue to rise to this day):

      (5) Korea repaid the IMF in 1998, 99 & 2001 from these forex reserves (i.e. from its CAS earnings).

      So the rapid credit expansion may well have something to do with the government forcing banks to lend in order to prevent GDP contraction (I don’t know) during the panics of 1997-98 & 2000-01, but it had little to do with repaying the IMF from 1998-2001.

      Do you disagree? Please let me know.

      • Because money creation means debt creation by banks. The surge in M2 in 1997 is at least strange. In the same time housold debt is rising.
        “In the wake of the 1997-1998 Asian financial crisis, Seoul encouraged banks to issue as many credit cards as possible so as to boost consumer spending, and by 2002 the number of cards in circulation surged 2.7 times to 105 million.” Reuters

    • Cedric

      Hopefully you do not disagree with Mr Pettis because you are French, but a person with a different viewpoint. I am quite sure that truth doesn’t have a nationality; or at least discussion of what might come near to truth.

  7. You had me right up until: “The “correct” way to resolve internal misalignments would be for Germany to reflate domestic demand and raise domestic wages”.

    Spain is a desperately poor country, living with delusions of first-worldliness. In the mid 1990’s when I lived there, it was considered an “emerging market”. And then suddenly it emerged. Not of course in the way that most nations emerge from agricultural modesty — no, Spain was different. It emerged by “virtue” of macro-economic diktat. It would be wealthy, because it was Europe. And Europe was first world, period.

    And with that, the banks opened their doors to a flood of credit which would of course never be seen again — as millions of Spanish households borrowed more than they could responsibly hope to repay.

    There is no “correcting” European economics at the German level without recognizing a troubling and far more basic fact: Spain is very close to third world in a great many ways. That it seemingly wears the trappings of the first world is not the point. The point is that what cannot be sustained, will not be sustained.

    Spain’s balance of trade is desperately lopsided. They continue to consume as if they are members of the club. And the only reason is, that the club allows this colorful guest to keep running up a large tab.

    • Jesuschrist! What a compendium of local color and prejudices.

    • Spain has not been a poor country, let alone a desperately poor country, since the 1970s at the very latest, Popo, and even then this was mostly in the south. Its balance of payments was “desperately lopsided” only after 2002-03. Before that it ran a large services surplus and a reasonable trade deficit, and it had a fiscal surplus before the crisis (unlike most of the rest of Europe, including Germany).

  8. in Spain there has been an extreme-left movement in the past European elections, ”
    Podemos” (we can) with 1.200.000 votes. It is currently the third force in Spain according to surveys. There is no significant equivalent to Le Pen’s extreme right party.

    • About Podemos, I have been also web-searching about their position on the monetary union and economic policies. They also seem not to have any clue about the problem that Pettis arises. More focused looks Izquierda Unida that in fact proposed an euro exit as a solution in 2012. So, I agree with Pettis when he says the left provides with demonstrations but not real answers in this particular and important issue.

    • Yes, so far most Spanish discontent has expressed itself more through the extreme left than the extreme right, perhaps because southern Spain, where the economy is worst, has historically been on the left whereas the right has been stronger in the north, and it also tends to be allied to socially very conservative elements, especially in the church. I don’t know much about Podemos (no one seems to) except that in the two long interviews I saw of their leader he explained copiously what he is against but didn’t explain what he plans to do. I would guess, however, that as the far right does well in the rest of Europe, it can only encourage the far right in Spain, and once the far right takes up the claims of the workers and attacks the bankers, which so far it hasn’t done, it will do well. In Spain there is a strong latent hostility to immigration which the far right can more easily tap into than the far left.

      • What you are missing here is that the Partido Popular IS the far right. They assume Franco heritage. All of the relevant far right people is hidden there, starting with Mariano Rajoy (which has written a paper about ethnic purity time ago).

  9. Given the intransigence of the parties involved, I agree with your analysis…..

    More as a thought experiment than a realistic possibility, I offer a one way to save the Euro: European city economies considered as football clubs. Everyone knows that when two teams are mismatched and one consistently trounces the other, it should be transferred to a new league.

    So. the most competitive economies are promoted up and out of the Euro into a separate league of cities with their own currencies, much like Singapore or Hong Kong.

    You could, for example, take the three biggest and strongest German metropolitan economies, like Munich, Stuttgart and Frankfurt. To them add the Ile-de-France (Metro Paris), the Netherlands’ “Randstat,” and finish off with Milan and (your choice) Barcelona or Madrid.

    Their reward is genuine competition, not the phony kind now used to penalize the rest of Europe. The reward of the “League of Left-overs”? Also genuine competition for the first time in a generation..

  10. I take this post as a proof of how screwed up Europe actually is. I can’t believe these countries actually ran the world from the 1600’s to until just 50-60 years ago. The ideology and thinking behind these countries is absolutely nuts. You’ve got either socialists on one side or fascists on the other and all of this is sponsored in the name of “democracy”.

    Just look at the foundation of the Euro as an example. The guys running the show knew that the nation-state needed to die, so they decided to create a unified currency. That makes no sense. If you wanted a geopolitical alliance to unite all of Europe, why the hell do you need a common currency? What kind of moron creates a common currency without creating a separate fiscal unit. If you do want some kind of a geopolitical alliance where Europe is together as one, you still need some kind of a fiscal unit, but why would you ever need a currency before a fiscal unit.

    On top of this, the unification is terrible set up that was designed to support “democracy” without ever talking about freedom. What kinds of morons set up a system that supports extremely democratic institutions (the US isn’t democratic BTW, it’s factional) without supporting basic free rights? Apparently, the only people dumb enough to do such a thing are people who’re dumb enough to think that a currency unification is necessary for a geopolitical alliance of a continent, but a fiscal alliance isn’t. There’s something corrupt and wrong about the ideology that runs Europe.

    • Suvy

      In the evolution of greater unions, monetary Union is the step before Political Union. So one might assume, in a world that involves much more than economics, and is comprised of more than the market (in present meaning, not enlightenment thought), that it was a stage, or step, toward greater union. A compromise on the road to such. Of course this is the first time, so many disparate groups, with histories, and legacies, and institutions of particular national origin tried to do this, so we can err on the side “trying something to see if it can be done”, with out, too much incredulity in our rather unimportant personal judgement.

      While these are important issues, and Europe faces difficult territory to traverse, they are in no way, as difficult as the paths that India and others need to walk.

      • Why do you need a monetary alliance before a political alliance? When the US formed, the US didn’t even have a monetary alliance initially and the monetary alliance came and gone throughout various points in US history.

        Clearly, to say that monetary union is necessary before political union is falsifiable by counterexample. The claim is invalid and WRONG.

        • This is typically the evolution, didn’t say requirement, but then why would one, in this day and age have a political without a monetary and fiscal union, and ultimately, how is that even possible, of course, the systems existent at the time of the US’s formation are a far cry from current circumstances to speak nothing of other factors:
          global population
          advance of technology
          speed of communication
          speed of transportation
          advances in storage
          use of natural resources
          integration of the global economy

          while a big supporter of History in Economics, I am not sure it would be terribly appropriate in this matter

          • What about risk? Connecting economies in the manner you’re suggesting increases all sorts of risks. I actually think we’re gonna be headed in the opposite direction.

            The reason you really had the developments in central banking and the creation of government debt was for war. In the 21st century, war’s gonna be a good bit different. Much of the fighting will be with drones and satellites while there’ll be battles in cyberspace. The advantages of centralization are starting to break down as the risks will be apparent over time. I think we’re certainly headed in the opposite direction as what you describe.

    • Well Suvy, you are a very high-spirited person. When you talk about Europe ruling the world from the 1600s until the 50-60 years ago, I think you have to make a delineation between Britain and Continental Europe. Britian was the leader of the world over those three and a half centuries. Not at all coincidental, the daughter of a British shopkeeper looked into the abyss called the European Monetary System (EMS) and said she would not give up Britain’s control over it’s own economy to Continental Europe. So I will give credit to Maggie Thatcher who stood up to even members of her own party over the fallacy of European Monetary Union. This divide also was a factor in her losing the leadership of the Conservative party in 1990 and thereby her position as Prime Minister. The rest is a bit complicated, but Britain got up and ran from the EMS two years later (1992) never to return again.

      I am 100% American with no British heritage, but I will give credit to British institutions and humanity for their contribution to the globe’s progress over those 300 plus years. Did they make mistakes in some parts of the world? Absolutely, but on the whole i think Britain has been a positive force in the world.

  11. Prof. Pettis,

    I hope you have this article translated to at least Spanish, if not also to other European languages… The English requirements to understand it are quite high.

    • I think it is going to be translated and reposted on the blog of one of the major Spanish dailies.

      • I have read the spanish version of this entry in Ernesto Ekaizer’s blog. Although the translation is awful the idea is clear. I hope it has some impact. I like very much the effort that Ekaizer has done reporting the economic situation from the beginning of the crisis. The fact that Ekaizer follows or reads your blog proofs, in my opinion, that his criteria for economic analyses has good bases.

  12. Wouldn’t it be easiest for everyone if Germany was “encouraged” to leave the Euro area.

  13. Agree with the need for flexibility to proceed with adjustments when necessary without throwing millions of people out of job. The current generation of European policymakers won’t acknowledge the Euro has failed to deliver on promises made, even if they understood how and why. To be fair, many people from the previous and current generation of leaders clearly foresaw the current difficulties. They have been marginalised ; and that is now history. In that sense, a new generation of leaders emerging is good as they can assess the (unfortunate) situation with a new pair of eyes. And let’s hope indeed that they can succeed before people’s despair brings extremists to power.

    But now that the lack of economic policy coordination within the Union (we can’t call that way two arbitrary rules of public debt below 60% of GDP and public deficit below 3% of GDP) and inappropriate and undemocratic institutions have produced this unfortunate situation, the solution(s) don’t seem so clear cut.

    1) Devaluation by “periphery” countries might indeed hurt German banks, though foreign losses might well be compensated by the boom of German domestic assets set off by the currency appreciation thanks to rapatriation and speculative inflows chasing whatever return is still available in these repressive days. In the mind of German political and financial leaders, may be the costs of that outcome are much more – both in amount and time – than just a one-off loss from devaluation of foreign holdings. That would be understandable. They have watched Japan sharp but brief financial boom followed by very long balance sheet recession since the 1985 Plaza Accord. Of course, the other side can force the German hand. But the “periphery” countries might simply end up swapping their deficit vis a vis Germany with deficit vis a vis someone else, just like the US swapped deficit vis a vis Japan with deficit vis a vis China after the Plaza and Louvre Accords. In other words, it is unlikely that European “periphery” countries can relax efforts to regain competitiveness to any great extent.

    2) Raising domestic wages won’t hurt German banks and might very well be the preferred option. And wages are indeed progressing in Germany and that’s good. The reason domestic wages don’t increase even further is that, like all large companies worldwide, large German companies have plenty of labor arbitrage opportunities available to them and under-employment is actually not low in Germany. Any amount of pressure from Spain, Italy, France won’t change that. In other words, it is unlikely that European “periphery” countries can relax efforts to regain competitiveness to any great extent.

    What a new generation of European leaders might do is indeed to change the governance of the Euro area, either by having fixed but adjustable exchange rates among countries (like under the ERM) or by having adequate and democratic federal institutions to pursue common tax and labor policies across the Union if there is a democratic desire to keep the Euro. But, despite being a huge task in itself, if it’s only that it won’t suffice. They also might push for a new world trade and monetary system which doesn’t leave so many labor arbitrage opportunities so wide open (for some mysterious reasons, European leaders are as committed to floating exchange rates outside Europe as they are committed to absolutely fixed exchange rates within the Euro area), with the resulting weakening demand trend and rising mal-investment and debt accumulation. That would be a welcome change from the current total absence of Europe on the international scene and in fact from the current total absence of any G20 members on this pressing issue of the world trade and monetary system (with Paul Volcker and more recently Mervyn King, it seems only retired officials who have nothing to lose anymore dare to speak up, and even in cautious diplomatic language).

    Best of luck to Mr Pedro Sanchez ! Even assuming he has the rest (insight, vision, courage, charisma, persistence), he will need all the luck he can have.

    • DvD wrote: “fixed but adjustable exchange rates among countries (like under the ERM)”. DvD even if I could agree with the concept “fixed but adjustable”, the ERM never could deal with the volatility we saw in 2008-2009. The Southern periphery will need to have very large devaluations to regain competitiveness which was not how the ERM functioned. Then you can bet France will question their participation. Once you have planted the idea of wide flexibility there is not much point to the ERM. Given that, the market will put extreme pressure on the outliers anytime they see overt weakness in any member’s economy. Different tiers within the Euro would just be a gimmick.

      The only true path to European Union is political. Frankly, I don’t see it with the current group of countries.

      • Most likely, you are right. To be credible, an ERM with narrow band is not very different from a single currency zone and should gather countries with an already high degree of economic convergence. This goes back, long before the Euro, to a series of mistakes by the European Union which all bear difficult consequences to the present day:

        – The first mistake was in 1973 to let England, Ireland and Denmark join without an explicit agreement by England that the purpose of the European Union was to be a full political alliance and not merely a free trade zone. This misunderstanding or lack of clarity has had lasting consequences and been the source of many unresolved ambiguities. Nearly 20 years after their entry, both England and Denmark have been dispensed from whole sections of the Maastricht Treaty on economic and monetary union in late 1991. This shows that the basis on which they initially joined was perhaps not so clear. (Already this “whatever it takes” idea to force each step even if not everything is right, hoping that things will resolve themselves over time).

        – The second mistake was to enlarge the European Union to too many countries. Between 1981 and 1986, Greece, Spain and Portugal joined. Austria, Sweden, Finland joined in 1995. Cyprus and Malta in 2004 and Eastern European countries later.

        Frankly speaking, the European commitment of countries like Ireland, Greece and Portugal is not so clear. You can’t help but think that they also saw in it a nice source of funds, supposedly to fund structural adjustements (we saw what happened there).

        In any case, as you alluded to, the European Union – and even the Eurozone – has been enlarged too much to be governable and have clear common goals.

        Frankly speaking, in addition to the 6 founding countries, the only other key one was England as it has been involved in major wars with either France or Germany over centuries. But here, the misunderstanding dates from 41 years ago.

        The weight of all these mistakes is being felt right now but you don’t hear anybody acknowledging them and making proposals to right them.

  14. Is it possible for any country to leave the Euro without triggering a cascade?

  15. “… means recognizing very explicitly that much European debt can only be repaid in the form of a massive and unacceptable transfer of wealth from European workers to German banks….”

    But surely banks, be they German or otherwise, are merely intermediaries. Banks can only give money to one group of people (borrowers; let us call them Group B) by taking money from another group of people (depositors, bond holders or equity holders; let us call them Group A).

    As you have yourself said so often, money is not wealth, it is merely a representation of wealth. Therefore, when the banks made the original loans, they took the wealth actually created by Group A and gave it to Group B on a temporary-use basis. Now you are saying that if Group B is asked to return the wealth to Group A, it somehow amounts to an “unacceptable transfer of wealth” from Group B to Group A.

    I don’t understand this. Perhaps I am missing something here?

    Yes, it would be reasonable to have a debate about how the pain of loss (default) should be distributed amongst or shared between reckless borrowers (Group B) and irresponsible lenders (Group A). But to say that merely asking group B to repay group A (whether in full or in part) is an “unacceptable transfer of wealth” seems to defy logic, as it is merely a reverse of the original “transfer of wealth” from group A, which actually CREATED that wealth, to group B, which thought (incorrectly) that it could find productive use for it.

    For example, when you say “…from European workers to German banks…”, what does “German Banks” here really mean? Who is on the Right-Side of the balance sheets of these “German Banks”?
    (1) Depositors (Mostly German workers, with small ones protected by German government)
    (2) Bond Holders (From all over the Euro Zone- Pension funds, Insurance funds, Retirees etc.)
    (3) Equity Holders (From all over the Euro Zone- Pension funds, Mutual funds, Middle-class Savers etc.)

    But surely, all of these, one way or another, represent “European workers” for the most part. The Pension funds, insurance funds, mutual funds etcetera and all merely representing “European workers”, are they not?

    So who do you feel should take the pain of default to avoid what you call “massive and unacceptable transfer of wealth from European workers to German banks”? Setting aside all sentimentality, Michael, could you please elaborate on this point from a rational angle?

    • There are a lot of ways to distribute the losses in the banking system — by liquidating government assets, by raising taxes on businesses, by forcing shareholders to absorb the losses, by taxing household income, by raising consumption or import taxes, by tolerating high unemployment in order to protect the value of the currency, by defaulting on creditors, including foreign creditors, etc. The losses are always assigned, but to whom and how is ultimately a political decision.

      • Dear Michael,

        I am a long time follower and owe you a great deal of practical understanding of monetary economics and balance sheets. This is my first post.

        I think Karim is spot on when he points to the vagueness of your statement re. the “transfer of wealth from European workers to German banks”.

        Karim is very correct to point out that the necessary transfer either way, by unemployment, by loosing his or her deposits, bonds or equity in banks or by higher taxes or by inflation, the German worker is going to bear the bill (not “banks”).

        Unfortunately (speaking as a German as you may have guessed), there will be no way around for the Germans to facing that the mistake has been done: Accepting too low wages and resulting under-consumption and miss-allocation of savings/capital to export driven industries and delivering goods by running up eventually noncollectable foreign claims, or even setting up this sorry monetary union without a stronger political and fiscal union to accompany it in the first place.

        At the same time I am skeptical that there is some responsible German politician who could explain this to the people of Germany to faciliate a controlled solition/resolution, and likely Germans will face it the stone hard way in the wake and fallout of the breaking apart of the EMU.

  16. Hi Michael,

    Another great post. In terms of Germany, I’ve always thought that too much emphasis is placed on the production & export side with less understanding of the role of domestic investment, the capital account and some of the effects of the removal of national currencies.

    As you stated above, Germany ran current account deficits during the 1990s, part of which in my view, can be explained through reconstruction of the DDR. However, at the time of the introduction of the euro (and of course, the time that the current account begins its upwards march) gross capital formation as a proportion of GDP drops by around five percentage points. Simultaneously, the removal of national currencies eliminated currency risk for the German financial sector.

    Do you think this increased the relative attractiveness of investment in the Eurozone periphery and that the growth in the capital account “enabled” higher current account surpluses?

    • Wen the savings rate is forced up beyond the requirements of domestic investment, excess savings tend either to flow into speculative investments at home, which can then set off a consumption boom, or they flow abroad, which allows the excess domestic production to be absorbed by foreigners. Kenneth Austin by the way has a great piece in the current Journal of P-Keynesian economics called “Systemic equilibrium in a Bretton Woods II-type international monetary system” that is highly relevant.

  17. As an Italian national, I found your post thoughtful, well argued and provocative. As to the latter, however, a friend of mine, a seasoned ex-politician, was literally outraged by your statement “…the workers eventually win, as they did in the 1930s both in the US under Roosevelt and Germany under Hitler.” He couldn’t admit that the workers “won” under Hitler, because Hitler did in fact betray the workers etc etc. After inviting my friend to quiet down and to come to his senses, I told him that I didn’d share his indignation and I saw your profane reference to Hitler as an admonition to all of those European policymakers (many of which purported to carry the legacy of the workers’ movement) currently engaged in vicious job-killing policies that, at the end of the day, workers tend to vote for those (be it Hitler or the devil) who put them to work.
    Did I read you right ?

  18. I think your friend may be a little too eager to feel indignant whenever he can. My point is that Hitler was able to collect votes from discontented workers and anxious members of the middle classes by attacking the bankers and the whole system of reparations which underpinned the global banking system. I don’t think this is a very controversial statement. I suspect your friend didn’t bother to read my article at all.

  19. Thank you for this article. I am in full agreement with your analysis. Unfortunately I have few hopes that Mr. Pedro Sánchez is anywhere near to understanding our economic problems. I have sent it to him through Twitter but I would be extremely surprised if he actually read it. His opponent in the recent party election, Mr. Pérez Tapias has acknowledged that he has received it and found it interesting. It is a shame that he lost. The political elites here are still in denial and firmly committed to the Euro project. I believe however that the main challenge to the system will not come from the far right but from a new left-wing party called PODEMOS ( They have been very successfull in the past European Parliament elections by becoming the third most voted political party in many regions coming out of nowhere. They are predicted to become the third largest political party in the next general elections according to opinion polls. Although populistic and demagogic, they seem to have understood that the problem is the euro and the debt and talk about “auditing” the debt to determine what part of it is illegitimate. In other words, they are implicitly talking about repudiation, which in my mind is a bad solution; they should negotiate a reschedule and partial pardon of the debt. Would you like to come to Spain to try to convince public opinion of your arguments? I am finding it extremely hard to convince PSOE supporters that we need to quit the Euro and renegotiate the debt. Congratulations on a good article.

  20. This is brilliant as far as European economy and politics is concerned. Every European politician should read this. I do not agree with the analysis of Spanish politics, howevr. One can hardly expect the parti of Felipe Gonzalez or Zapatero to ever drop the support of European bankers and elites, as thry have always done. Unlike france, the netherlands, or Austria, with fascist parties growing steadily over (at least) the last decade, fascism never has
    had the least political significance in Spain since the advent of
    democracy. Rather, it is an unexpected new movement, PODEMOS, which seems the only force able to balance the strugle between the elites and the working class. This is growing sponfaneously from well educated people well to the left of PSOE, and has managed 1 mil ion votes in the European elections even before becoming a regular policial partí, which is still not. The key points which harvest votes from all the social spectrum is the strugle against political corruption and financial elites.

    • I totally agree with Luis on the opportunity for PODEMOS. I find it tragic that the PSOE leadership is so blindly eurofanatic that their only proposal to get out of this crisis is that we need more Europe, which would be a plausible solution if it weren’t for the fact that Frau Merkel and Herr Schauble seem unwilling to discuss any alternatives to fiscal consolidation and structural reforms. Worst: the PSOE doesn’t seem go have a plan B for that moment in time when they realize that they will not get any sympathy from Northern Europe. What is extremely ironic is that Germany saw its debt pardoned in 1953. Together with the Marshall Plan that debt reduction led to the economic miracle in Germany. Spain was a party to that agreement. The Germans do not seem intent on returning any favors. This is a shame because they could save Europe, the Euro and their own economy.

      • But also the Central Europe against Southern Europe argument might be more than a diplomatic mistake. The struggle is working/middle classes against the elite. The same economic policy that is good for Spanish jobless people will be good for German minijob holders. THIS IS THE CRUCIAL ISSUE. All other European countries need something like PODEMOS to defend public resources. These are sold or spent in favor of the private sector everywhere in Europe!

  21. hi Michael, your analysis is spot on and an interesting read. how would you consider the role of austerity measure in such circumstances? the eurozone has, after all, been much of a welfare state and to a large extent values equity over efficiency. you think tight economic policies like those in China and Singapore will help?

    im writing from Singapore at . cheers

  22. I have had a few long conversations from peripheral Europeans about the Euro fiscal situation; the reality they face is as Michael describes it, that local firms cannot hope to compete without protectionism or some other competitive advantage; with free flow of capital and fixed currency this isn’t possible. Labour mobility is vapid at best with language and cultural barriers, even though the reality is many of a country’s elite are as productive as any other’s, but the infrastructure for them to succeed in their home countries simply isn’t there.

    What irks my colleagues is that, as “the elite” (ie educated and trained), they WANT to be and are capable of being, Germans, but cannot do so at home. An admonishment of the Euro would be seen as a victory of cultural superiority of the north over the south and would be seen as a step backwards. The bigger question I have is whether the gaps in productivity can be closed in any time period within the working lives of the “elite” from the periphery. That’s not a message many want to hear, not least those within the politically active circles of the popular mainstream political parties.

  23. “The time has come for France to resist Germany’s “obsession” with austerity and promote alternative policies across the euro zone that support household consumption, firebrand French Economy Minister Arnaud Montebourg said on Sunday.” per Reuters today.

    If France starts to put up a fight, I can’t see Spain and Italy trying to keep fighting to stay with the Euro. My guess (as Prof. Pettis has pointed out repeatedly) is we will see more and more statements from European politicians such as these due to the enormous political pressure building. Hopefully, leaders like Montebourg from mainstream parties will emerge before the extreme fringe parties gain popularity.

  24. I put the following as an example of the absurdity of austerity measures. I was in Lisbon in June. I went to the Opera House on a Sunday. It is a magnificent building, When I enquired, there were no performances that day ( Barcelona does a soprano with a pianist for tourists). When I asked if I could do a tour they said yes, there was a tour at 2pm. So I did a tour with 2 tour guides at 2pm . I was the only person on the tour ( it is an absolutely stunning structure). When I pointed out the website was not in English, hence why I was the only person on the tour(I stumbled on the tour by accident), the lady at reception said that because of austerity, they did not have the budget to do an English version of the website . The only version was in Portuguese. So 3 people were working on a Sunday, but no funds were available to tell any tourists they were open. Lunacy.

  25. Question on the subject of “resolved currency imbalances under gold standard (and no euro)” if Germany economy is stronger than Spain, the prices of German goods in Spain would go up to the point when they become prohibitively expansive for Spain. At the same time gold would flow from Spain to Germany and peso would go down with respect to mark. Why would unemployment in Spain necessarily go up at the same time?

    • John Stevens wrote: “….if Germany economy is stronger than Spain, the prices of German goods in Spain would go up to the point when they become prohibitively expansive for Spain. At the same time gold would flow from Spain to Germany …..”

      Under the Gold Standard (commodity or fiduciary money) consider the following two scenarios..

      (1) Assume the German economy is “stronger” (i.e. more competitive) than Spain.
      (2) As a result of (1), Germany runs a trade surplus against Spain (i.e. it exports more to Spain than it imports from Spain)
      (3) As a result of (2), gold flows from Spain to Germany on a net basis.
      (4) This accumulation of gold causes prices to rise (inflation) in Germany, even as the loss of gold causes prices to fall (deflation) in Spain.
      (5) As a result of (4), Germany loses its competitive edge w.r.t. Spain
      (6) As a result of (5), Germany’s trade surplus will vanish, and may even turn into a trade deficit, such that the net gold flow reverses direction and Spain regains some of its gold.

      (1) Assume the German economy is “stronger” (i.e. more competitive) than Spain.
      (2) As a result of (1), Germany runs a trade surplus against Spain (i.e. it exports more to Spain than it imports from Spain)
      (3) As a result of (2), gold flows from Spain to Germany on a net basis.
      (4) German MONEY-LENDERS take this net gold inflow as deposits from Germans and LEND it to either the Spanish government, or to Spanish businesses, or to Spanish households.
      (5) As a result of (4), there is NO accumulation of gold in Germany, and so prices do NOT rise (no inflation) in Germany. In Spain, there is NO loss of gold and so prices in Spain do NOT fall (no deflation).
      (6) As a result of (5), Germany MAINTAINS its original competitive edge w.r.t. Spain
      (7) As a result of (6), Germany’s trade surplus can continue as long as Spain (Government, businesses and/or households) continues to go deeper and deeper into debt to German money-lenders.
      (8) The only way to stop this cycle is to have a massive financial crisis.

      QUESTION: Which of these two scenarios played out under the Euro-standard (said to be similar to the Gold-standard)? Was it scenario (I) in which Germany had higher inflation than Spain and hence lost its competitive edge? Or was it scenario (II) in which Spain went deeper and deeper into debt, even as Germany maintained its competitive edge, eventually leading to a financial crisis?

      • I agree: if Germany shifted some of its manufacturing capcity toward domestic consumption and increased salaries and social spending then both Spanish and German workers would be better off. Merkel and Schauble seem to see foreign trade as a zero sum game and are fervent mercantilists.

      • Thank you for laying out so clearly the critical difference between the Gold-Standard (scenario I) and the Gold-Exchange-Standard (scenario II).

        The critical difference is that in the later case there is DUPLICATION OF CREDIT compared to the former case: the liquidity that arrives in the trade surplus country remains available there while it also returns and becomes available again to the trade deficit country where it is on-lent.

        This duplicate credit structure feeds itself on trade imbalances and tends to make them persist as long as the deficit country has no constraint issuing new means of payment, ie. new currency. That’s the only difference between the US and Spain (or other deficit country for that matter).

        This dual credit pyramid, overlaid on and mutually reinforcing with large trade imbalances, is the engine behind all great speculative bubbles … until such inevitable point where there are way too many financial claims on production compared to where real economic activity stands. Then, this fragile edifice of the duplicated credit pyramid – and all the claims that rank junior to it such as equities – comes crashing down. In general, the crash is even more explosive than the boom, ie. it is more concentrated in time.

        This was the main force behind the 1927-1929 speculative boom in the US (with the help of a little QE in 1924 and 1927 by the recently created Fed, buying bankers acceptance notes in absence of any Federal debt, to do “whatever it takes” to help England return to and stay at pre-war Gold parity – sounds familiar?), followed by the 1930-1932 crash and its negative feedback loop on the economy degenerating into depression. Bernanke got it completely backward: the Great Depression was not caused by not enough credit easing after it started but by too much credit expansion, duplicated in the US and Europe, before the crash. May be the lack of credit easing was an aggravating factor but it was certainly not the cause. Quite the opposite, actually.

        A fascinating book on this is The Monetary Sin of the West by Jacques Rueff published in 1972 and summing up his work throughout the 1960’s. It’s a real eye-opener. Here is the link:

        To Walter’s point below, such a system can work not only with Gold but with any currency internationally recognised as having reserve status. In the Scenario II example above, replace Germany by China, Spain by the US and Gold by the US$ an you have the current world monetary system. Then, replace 1927-1932 by 2003-2008 and you have the explanation of how and why the crisis happened. That the credit boom was directed to US subprime residential loans or to Spanish property development loans is only of secondary importance. Credit flows freely anyway and goes to shaky loans, hot commodities, fancy tech stocks or beautiful tulips depending on whatever is the mania du jour. And credit indeed duplicates in both debtor and creditor countries: see the credit boom in China from 2009? After having been lent to the US to finance the housing bubble (to help the US recover from the 2001-2002 recession), the same monetary reserves have been used a second time to finance China stimulus program (to help the Chinese economy recover from the 2008-2009 recession). And so the vicious circle continues…

        You can then appreciate the adequacy (or lack thereof) of “credit easing” policies as solution to the problem of the collapsing double credit pyramid. They may be necessary condition in the short term term but they are worse than insufficient in the long term, they are dangerous. They address the symptoms while making sure the causes persist. We are now 7 years after the beginning of the crisis and the same imbalances that caused it are still exactly in place. And global debt keeps growing relative to income. And equity and high yield markets are exuberantly reaching new all time highs. And income inequality and under-employment also. Talking about tougher bank regulation and supervision in the context of doing “whatever it takes” to keep alive the dual credit structure that could wipe out the banking system in a matter of weeks is simply laughable.

        That’s why the reforms of the international trade system (WTO) and the reform of the international monetary system with the introduction of an international reserve unit which is not also the domestic currency of a participating country (let’s call that Bretton Woods II) are inseparable. They are the two sides of the same coin. The purpose is the avoidance of meaningful trade imbalances and their prompt resolution in a cooperative manner should they appear.

        The US sees the role of the $ as the international reserve currency as a sign of prestige and strength. And for decades it seems to have been the painless solution for them to finance faster economic growth than would have otherwise been possible (the so-called “exorbitant privilege”). But, now that they are close to their debt capacity limit, it is really not in their best interest to pursue that road and to take the whole world with them to the bottom of the debt hole. Politically, giving up the $ as international reserve currency may be a hard sell for the US. But so was giving up Gold in 1933. It is really in the best interests of the US and the world.

        As for the Euro Area, joining such a BWII system, each country at a parity reflecting its own circumstances, the Eurozone will solve at once the difficulties created by the Euro without losing too much face as this would be done in the context of an international trade and monetary conference aimed at strengthening international cooperation and at resolving the imbalances that have affected them so severely. With less to fear from China in that system, Germany would be less intransigent vis a vis Spain.

        It is easily the best chance of resolving peacefully the global challenges of too low economic growth, too high debt, too high under-employment, destabilising income and wealth inequality and rising social and geopolitical tensions.

        The complete silence of economic and monetary policymakers from G20 countries on this pressing issue – individually or collectively – is really stunning! One has to wonder what’s behind their apparent refusal to consider such a solution and behind their insistence to instead take (consciously or not) large and increasing risks with the world economy, financial markets and, more importantly, with people lives and peace.

        Better Merckel and Draghi wake up than Le Pen taking care of it. Or is it going to be Pedro Sanchez saving not only the PSOE but the whole world?


    There is no such a thing as stronger economy. Germany runs a trade surplus because of policies initiated by the government.

    Your basic understanding of gold standard is totally confused. Under gold standard countries agree to sell say ounces of gold on request at a fixed a price in exchange of currency. So how could say peso go down with respect to mark when they are fixed?

    I strongly suggest that most readers, please obtain Prof. Pettis book “The Great Rebalancing” and read it before asking Prof. exhausting repeating questions. The book is available on “Amazon”.

  27. Prof. Pettis,

    I am wondering if you would consider the global dollar system an analogue to the eurozone insofar as the U.S. and occasionally other participants are forced to absorb excess savings on account of the Triffin dilemma and stimulus undertaken by foreign central banks.

    Are the political and economic dynamics different because the U.S. is solvent for the time being and its external debt is largely held by central banks?

    Should the Fed have kept injecting liquidity until more foreign central banks tightened to devalue the dollar, or has that process been adequately concluded?

  28. Michael, thanks again for your analysis and lucid exposition.

    Today the New York “Times” published a brief by Jared Bernstein, a senior fellow at the Center on Budget and Policy Priorities, summarizing a piece by Kenneth Austin, a Treasury Department economist, in the latest issue of Post Keynesian Economics, which is described as building off your work and that of Ben S. Bernanke (yes, that Bernanke).

    The piece criticizes the role of the United States Dollar as the world’s reserve currency.

    “. . . .what was once a privilege is now a burden, undermining job growth, pumping up budget and trade deficits and inflating financial bubbles. To get the American economy on track, the government news to drop its commitment to maintaining the dollar’s reserve-currency status.”

    It’s good to see your work reaching a wider audience.

  29. Hi Michael,
    Excellent analysis – concise and accurate. The fact that you are prepared to translate economic concepts into political realities is all too rare among academic economists – because of obvious pressures from employers and financiers – and hence all the more admirable. We agree on Krugman whose heart is certainly in the right place but his attachment to “scientific” economics just as certainly misconceived.

    Just one peccadillo, easily forgivable in a lengthy and brilliantly compendious piece is the bit where you say that “the workers won with Hitler”, against the bankers. Of course, it was still the haute bourgeoisie that “won” with Hitler after unleashing “the mob” against the organised working class already weakened by the intervention of the state machinery – police, paramilitaries and courts. (Friends who wish to pursue this may do no better than to peruse Charles Maier’s ‘Recasting Bourgeois Europe’ – I nearly went to study with this genius thirty years ago when he was at Harvard!) The brilliant bit in your presentation is to highlight the foolish tendency of left-wing reformist political forces to defend the indefensible rather than address the politico-economic reality, as they did in Italy before Mussolini and in Germany before Hitler – which is a deleterious political mistake that you avoid most perspicaciously. Again, great stuff! Ciao.

  30. Sorry for pestering, but I just thought of Tim Mason’s scholarly studies of the German and Italian working classes under their respective dictatorships now gloriously available on here is the link

    • ^JB: “Tim Mason’s scholarly studies of the German and Italian working classes under their respective dictatorships now gloriously available…”

      I could be wrong, but I think that it is a custom in the English language that once the word “glorious” has been used in a sentence, it must necessarily be accompanied by the words “heroic”, “revolutionary” and “reactionary” in that same sentence.

      I am not one to be bound to custom personally, but I thought I would try to modify the sentence above for the sake of those who might be so bound. To fulfill custom, it could be written as:

      “Tim Mason’s REVOLUTIONARY studies of the HEROIC German and Italian working classes under their respective REACTIONARY dictatorships now GLORIOUSLY available…”

      I request the VANGUARD of the MASSES on this forum to STRUGGLE to correct me if I am wrong.

  31. Question: Assuming that a lot of the spanish household and bank debt is already converted into national-public debt after a lot of bail-out activity by the taxpayers, would’nt be possible to write it off by the European Central Bank? Let’s say 25 % of the outstanding sovereign debt. This would lead to a devaluation of the euro, a surge in inflation in a similar way as when the peseta was the spanish currency. If Germany want to protect its banks, it could do it this way.

  32. In light of the outcome of negotiations between the Eurogroup and Greece (subject to final approval), the answer to the title question is quite simply “no”.

    The clear message from that outcome is indeed that the euro is an iron law: all debt accumulated as a result of intra-zone imbalances and economic policy divergence is fully due by the debtor country and, in case of unwillingness to make the necessary sacrifices, the Eurogroup and the ECB act as bailiff on behalf of the creditors to seize national assets and / or bank deposits, to the last in case of deflationary spiral lowering income faster than debt is amortized.

    So far, national political parties across the Eurozone member States believed they could weight on European economic and monetary policy. Some years ago, they even floated the idea of issuing Eurobonds jointly and severaly guaranteed by all member States. Several heads of governments and States have repeatedly tried to press Germany to give higher priority to domestic growth. The Stability Pact has been renamed the “Stability and Growth Pact”. We now know that these were sweet illusions. Reality has just appeared bluntly: to stay in the euro, the wage competitiveness of national economies (unit labor cost / labor productivity) must align with that of Germany. This requires a shock therapy in several countries, of which France might be the most critical due to its weight in the Eurozone and its prolonged drift in the opposite direction over the last 45 years.

    To escape austerity, there is no other way than to escape the euro. This is the implication – to meditate carefully – of what just happened with Greece.

    Said differently: if misalignments can’t be resolved through wage pressure in the less competitive countries, they will be resolved by currency realignment. In theory it should also be possible that the misalignments are resolved at least partially by wage increasing materially in the most competitive country, ie. Germany. But, in the current international trade and monetary system allowing labor cost arbitrage due to cross exchange rates not set at levels equilibrating cross trade balance, Germany knows full well it has little room to accomodate materially higher wages. So, most of the adjustment fells on the less competitive Eurozone countries, in the form of prolonged wage pressure or higher unemployment. This is a politically explosive cocktail.

    It is therefore likely that, sooner or later, the euro will break up. Not to be sad, for this is increasingly looking like the best case. In the worst case, this process of resolving the misalignments could lead to conflict in Europe, probably between France and Germany.

    Will history rhyme?

    • Germany is the most fragile country in the Eurozone and one of the most fragile in the world. Any sort of shift in the status quo could not benefit Germany while lots of shifts from the status quo could cripple Germany. The large the shift, the more vulnerable the German economy.

      With an extremely undervalued currency, ~50% of the German economy is exports. On top of this, the total assets of the German banking system are ~300% of GDP while the banking system has half the capital ratios as the UK and US. I’m also willing to bet that the German banking system is one of the largest holders of Peripheral European bonds, where the debts simply cannot be paid.

      • That’s part of the problem. Undervalued currencies are typically associated with rapid credit growth, in this case not domestically but externally to peripheral Europe. This is why I don’t think Germany can tolerate deb restructuring or formal debt forgiveness until banks are recapitalized or debt is transferred to the government balance sheet. This is what happened in the 1980s with Latin America. It wasn’t until US banks were sufficiently recapitalized, roughly around 1988, that they finally “discovered” the need for debt forgiveness. I would argue that Latin Americans suffered many years of unnecessary pain and US manufacturers lost an important client base during this time. It may be important to take the pain in order to save the banking system, but at least there should be a more open debate about it.

      • What I think is fascinating is that there are many people, and some with influence, that believe the German economy is a pillar of strength. They also believe Germany is the model for the rest if Europe.

        Of course, those of us here understand global trade mechanisms and know this is a fallacy. I actually fear Europe is killing the global economy.

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