By James Kwak
So, as everyone knows, the ECB came out yesterday with its latest plan to stem the creeping European sovereign debt crisis. This one involves potentially unlimited ECB purchases of sovereign debt, so long as its maturity is less than three years (presumably so that the ECB can pull the plug within three years on non-complying governments) and the country in question agrees to comply with fiscal policy reforms (i.e., austerity).
I don’t have any particular ability to forecast whether this will succeed or fail. My inclination is that it will succeed for a while and then turn out to be insufficient, for the reasons that others have identified. Central bank bond-buying will enable governments to borrow money at manageable yields, so their national debt will not spiral out of control solely because of climbing interest rates. But to bring debt levels down will require actual economic growth, and more austerity—even if it isn’t quite as austere as that imposed on Greece in the past—will not generate growth. In addition, the ECB’s promise to “sterilize” its bond purchases—I believe by selling other assets to raise the cash for bond purchases, so the net effect will not be to create money—means that this is not a particularly expansionary form of monetary policy.
This is as good an occasion as any, however, to ask a question I’ve been wondering about for, oh, years now. Every discussion of the European crisis includes the following domino theory (although no one calls it that anymore, for reasons I’ll get back to): If Greece leaves the Eurozone, that proves that it is possible to leave the Eurozone—or, put another way, that the powers that be cannot keep the Eurozone intact. If people realize that it is possible, then bond markets will bet even more heavily against Spain and Italy, which will force them to leave the Eurozone, which would be terrible. Hence Greece cannot leave the Eurozone.
The reason no one calls this a domino theory anymore is that the original domino theory was thoroughly discredited. Remember the fall of Vietnam? Do you remember the ensuing communist takeover of the free world? No, because it didn’t happen.
It seems to me that the current version of the domino theory, where Greece plays the role of Vietnam, rests on a logical flaw. The premise is that (a) if Greece leaves the Eurozone, that implies that the powers that be (Germany, the ECB, the IMF, etc.) are incapable of preventing any individual country from leaving the Eurozone. This ignores two other obvious logical possibilities. One is that (b) the powers that be might have the ability to protect any country they choose to protect, but might decide that Greece is not worth the trouble. The other is that (c) the powers that be might have the ability to protect some countries that are not in such bad shape as Greece (Spain and Italy come to mind).
For whatever reason, the powers that be have chosen to embrace the domino theory, calling the euro “irrreversible,” among other things. In practice, this means that they have staked their credibility on keeping Greece in the Eurozone. And having committed themselves to this position, they have ensured that should Greece leave the Eurozone, it will be interpreted to mean (a) rather than (b) or (c). In other words, by embracing the domino theory, they have made the domino theory more likely to actually be true. Which means that despite yesterday’s announcement, the future of the euro still depends on the ability of Greece’s incompetent, unloved political class to continue imposing austerity on its people.
The Baseline Scenario 
Crushing austerity on the Greek people is not going to ever work, that much is clearly certain. Greece doesn’t have the economic wherewithal to repay its’ massive debt. The situation is ridiculous, and Greece should default, in my opinion.
And James, your last paragraph revived the logic of that great college-era book by Joe Heller, CATCH-22.
I’ll repeat, and enhance, some remarks that I made quite a while ago
in reply to Mr Johnson’s Warnings of Doom a few months back..
Let’s suppose I am a proprietor of one of Germany’s celebrated
medium-sized industries; my firm produces trucks, or machine
tools. I know what benefits the Euro has brought me.
I have been able to sell my goods all over the Euro zone,
without worrying about tariffs erected against my goods.
And I have been able to bid for my supplies and raw materials all
over the Euro zone, without having to worry: “that factory in Spain made me a good offer; but should I take it? I need delivery in 6 months,
but who knows what the peseta-Dmark exchange rate will be then?
Perhaps I’d better buy a Credit Default Swap” !! ?? !!
So, when this Euro system, which has brought me so many benefits,
suddenly gets in trouble, I, with other sensible German manufacturers,
quickly go to Merkel and tell her: “For goodness’ sake, we must do
whatever it takes to keep the Euro going! We want our prosperity
and our advantages, which the Euro has brought us, to persist!”
And these businessmen would put ads in all the German papers etc.
Why doesn’t that happen? I suspect it is because there are German
(and other) _bankers_, who are saying: “Hey, perhaps our profits
in buying and selling money are about to take a big upswing? Let’s
push for the dissolution of this horrible Euro, and return to
the era of all separate currencies. People with Dmarks often have to
get pesetas, and vice versa, and with every such transaction, W E
M A K E A P R O F I T ! !”
“Now,” continue the bankers, “how shall we do this? obviously we
drive up the prices of bonds issued by the weakest countries first;
split them off from the Euro. Greece is probably our best bet;
we’ll get the drachma re-instituted, and then we’ll go after either
Spain or Portugal.”
I have been asking friends in Germany, and elsewhere in
Europe, for months. But they are not economists and
they shrug: “Ich weiss nicht” ‘Je ne sais pas.”
Are the Germans as smart as the Chinese? China gets rich by selling
the U.S. masses and masses of stuff(the clothes I wear,
the computer I type on). And, to make it easy for the U.S. to keep buying stuff, the Chinese buy huge amounts of our U.S. deficit,
so this business can keep going. If the Chinese can do this with us,
why can’t Germany do this with the Greeks?
Finally, George Soros, a Hungarian-American who made his
billions (partly) by running down the English pound, and is
therefore an expert at this kind of banker game, has an article
about all this in the latest New York Review of Books.
Best wishes,
Alan McConnell, in Silver Spring MD
Hi Alan, good stuff, as usual.
Germany grumbles over bond plan, but, what else is new?
Jens Weidmann in an aside in a recent interview said as to the reasons why Greece must be kept in “not all of them economic”. That’s all he said but since I have been suspecting all along how important it is that Greece is located opposite Turkey and that she seems to be allowed to keep up her buying of military stuff at pre-crisis rates that resonated strongly with me.
http://www.spiegel.de/international/europe/spiegel-interview-with-bundesbank-president-jens-weidmann-a-852285.html
While politics and economics often go hand-in-hand, their cause and effect theories do not flow in the same direction.
Thus basing your comment above on a political domino, which was effected by an external side effect of economics — our inadvertent introduction of free trade, which helped to change the long term results, which were strengthend under Clinton; is not the same as a country that joins a group of countries with free trade to start out with that then affects governments and centrally based economics.
The lines of cause and effect are pointing in opposit directions. Though the solutions are almost the same — increase free trade. But there is an external factor of an aging population that needs to be addressed.
> This ignores two other obvious logical possibilities.
More than that! Aliens might descend and gift Italy and Spain with advanced technology that saves their economy. China might give them all their treasury bonds. All the bondholders could suffer simultaneous amnesia and just forget what they are owe. &Etc.
Are you really sure you are right in accusing people of a LOGICAL flaw, ignoring obvious LOGICAL possibilities? On the face of it, that’s a pretty arrogant sounding criticism and would be helped if you could have cited one specific offender.
Is there not the tiniest chance that the people who have you puzzled (for years now, you say!) are disagreeing with you on likelihoods, not what is logically possible. That for instance they might indeed concede that, as a matter of logic, it would be possible for the rest of Europe to intervene to save anyone but as a practical matter don’t think that’s particularly likely in the circumstances they are imagining? Or that eople aren’t really saying that grexit MUST logically lead to a spexit, just that they believe it substantially increases the chances? (And curious, would you disagree with that?)
Alan McConnell wrote:
“Let’s suppose I am a proprietor of one of Germany’s celebrated
medium-sized industries; my firm produces trucks, or machine
tools. I know what benefits the Euro has brought me.
I have been able to sell my goods all over the Euro zone,
without worrying about tariffs erected against my goods.
And I have been able to bid for my supplies and raw materials all
over the Euro zone, without having to worry: “that factory in Spain made me a good offer; but should I take it? I need delivery in 6 months,
but who knows what the peseta-Dmark exchange rate will be then?
Perhaps I’d better buy a Credit Default Swap” !! ?? !!”
First there were no tariffs inside the EU / Eurozone even before the creation of the Euro. And you can export to Denmark, Poland or the UK without worry about tariffs even though they don´t use the Euro. They´re member countries of the EU after all.
Second there were already attempts to create a stable European Monetary System to reduce fluctuations between currencies. And companies today import supplies and pre-products from (EU) East European countries even though they´re not Eurozone members.
Third with the introduction of the Euro it was suddenly more profitable (and assumedly less risky) for larger German banks to make loans in and to other Eurozone member states.. Why loan money to your mid-sized company in Germany when you can loan the money to another Eurozone country at a slightly higher interest rate? So the investment rate in Germany went from one of the highest before the Euro to one of the lowest in the Eurozone during the early 2000s.
Combined with that is the fact that real interest rates (interest rate – inflation rate) for investment loans were usually lower in Germany before the Euro than in most European countries. A competitive advantage that compensated partly for the higher wages in Germany. With the Euro introduction that advantage / compensation vanished. Leading to stagnating wages in Germany for most of the 2000s.
And finally fourth. In Germany the large (multinational) banks and companies are the big supporters of the Euro. The mid- and small-sized companies became a lot more skeptical in the last 2 years. That´s at least what their Association publicly says. Simplified (by me) they´re saying that all these rescue programs will cost a lot of money. That means sooner or later higher taxes. Large multinational companies can use their subsidiaries in foreign countries to legally minimize their taxes. You, with your family owned mid-or small-sized company in Germany, don´t have that option. So unlike large companies and banks, you´ll end up paying the higher taxes. And because the large companies will evade them, yours will be even higher. Reducing your competitiveness.
In summary, German large (multinational) companies and banks were and are the big profiteers of the Euro.
Mid- and small sized companies were initially hit and only profited later on. And that profit only came because they regained their competitiveness. Meaning stagnating wages for employees in Germany. And by now these companies are fearing higher taxes in the future reducing their competitiveness once again.
The losers for most of the 2000s were the ordinary German citizens.
And we know who the winners were, the zombie banks scattered across the continent. These banks are insolvent and need to be shuttered.
@Brenda, “..Though the solutions are almost the same — increase free trade….”
Increase free trade among whom? Aging populations have everything they need – and that’s being carried off by looters quicker than would be normal if there was rule of law or a real country – so I guess you are talking about GLOBAL economic interests – weapons, drugs, slave labor – the billionaire class, right?
With the Middle Class in USA already skinned alive to support the Middle East Welfare Queen – what “trade” do the 20-40 years olds have? Computer viruses?
Plutocrats are trading freely, already, no? How much more freedom do THEY need? Walk in the door, shoot everyone, and then walk away with the coveted stuff? Even THAT kind of “free trade” is regularly conducted!
Old age and treachery win over youth and skill. Watch out for the “aging” when they get off their “depression meds”….
A while back I heard of a story of any ONE born after 1991, belong to the technological devil. Now all things considered, it seems to be coming true.
My compliments to Detlef for his cogent and informative post.
(Can I speculate that he is a German national based with a
German banking firm here in the US?) I found especially
interesting Detlef’s claim, in the section after his “Third”,
that companies in say Spain needing loans would rather
get it from a German bank. I don’t see why this is so; my
feeling would be that with the Euro all Eurozone banks would
be in competition with each other, and we know that banks,
like other firms, although giving lip service to competition
really don’t like it. But I may be missing some subtlety here!
Detlef has caused me to do a little work. I have looked at
what Der Spiegel has had to say; one recent article therein
indicates that they consider Prof Sinn a crackpot, whereas
Prof Sinn gets and Op-Ed in the NY Times, presumably as
an indicator of German public opinion. Also, Der Spiegel
has just published a version, in German, of George Soros’
article I mentioned in my previous post. The BBC, in its
RSS feed, also mentions the Soros position.
Finally, it seems that the fate of the Euro may be decided
in Karlsruhe, by the German Constitutional Court.
I hope that Detlef will respond to give us his further
point of view.
Best wishes,
Alan McConnell, in Silver Spring MD
Words mean Nothing. Deeds define the metal of a man and nations. Any idiot can brute pilie of steaming pile of unmitigated caca, fictions, myths, hollow promises, and patent naked lies. We should have learned this terrible truth from the fascists in the bushgov. Note bushtheidiot bruting the hilarious fiction that the “fundamentals of the economy are sound” weeks before the impact worst economic crisis since the great depression crushed the global financial system. Despite the confident bruting – lie is and will always remain a lie!!! The fundamentals of the economy were quite certainly terribly UNSOUND! The markets today are based on fictions, myths, and patent lies, – NOT fundamentals. Regardless of the absurd irrational exhuberance of the den of vipers and thieves on Wall Street and the illogical pricing of hollow promises – the grim reality is that all the kings horses and all the kings men cannot put to toxic global financial system back together again. Ashes, ashes, all fall down.
Burn it all down!! Reset!!! It’s the only viable option!
Same with Draghi! Promises are one thing – actions and actual deeds are something entirely different!