Sunday, January 15, 2012

On the mis-diagnosis of the Eurozone's crisis

According to S&P, EU leaders have misdiagnosed the euro-zone crisis. They have focused too much on tackling the increase in governments’ budget deficits, which is only part of the problem. As a result, they did not pay enough attention to the deeper causes of the crisis: the divergence in competitiveness between the euro-zone’s core of strong economies and its struggling "periphery" as well as the huge cross-border debts that stem from this gap. Reforms based solely on fiscal austerity could easily become self-defeating, notes S&P.

So writes The Economist, and thus confirms the writings in this blog of the last many months. Let me restate my point: the budget deficit and sovereign debt are not Greece's foremost problems. Greece's foremost problem is her foreign debt caused by her current account deficit! Or rather: her foremost problem is the continued requirement of significant funds inflows from abroad because of the continued current account deficit!

A budget deficit can, theoretically, be financed domestically (Japan finances much of its budget deficit domestically; so does the US). A current account deficit can only be financed with money from abroad.

A budget deficit tends to stimulate the domestic economy by pumping money into it. A current account deficit withdraws money from the economy by paying for imports and it de-industrializes the domestic economy (unless the imports are primarily capital goods for investment purposes).

A country's foreign debt represents the savings of other countries which those other countries have lent to the country. If Greece were not using about 500 BN EUR of other countries' savings, there would be much less hectic between Paris-Brussels-Berlin today. If Greece had zero savings of other countries (i. e. zero foreign debt), I doubt that many other countries would care very much how Greece handles her budget deficit.

It is clear by now that other countries no longer want to lend their savings voluntarily to Greece. Furthermore, Greeks are transferring their own savings abroad (capital flight). Thus, while the present financial squeeze on the state may be painful, it is very manageable when comparing it to the horrrendous financial squeeze which Greece will find herself in once the funds flow from abroad comes to a halt. No more cars, motorcycles or smartphones? Not quite, but quite a bit less!

The necessary medicine has been outlined here many times before, and I repeat the most important steps:

1. Reduce dependence on foreign funds by reducing the current account deficit.
2. Substitue imports of consumption goods with new domestic production.
3. Promote exports by allowing Special Economic Zones where exports can be produced competitively.
4. And, finally: attract foreign investment, attract foreign investment and, again, attract foreign investment so that the need for loans from abroad can be reduced.

Greece, if she acts cleverly, could transform herself into the role of a trendsetter who explains to the surplus countries that the best way to help the Greek economy is to help it to develop on its own (instead of killing it with exports to Greece). The price which the surplus countries would have to pay for that is less exports to the Periphery. That would appear to be a very reasonable price to pay when comparing it to the alternative of losing 3-digit BN EUR loan amounts.

Does Greece want to go down into history as the country where the collapse of the Eurozone began or would she prefer to become the country which served as the prototype for the solution of the Eurozone's economic imbalances?

If I were Greek, I would opt for the latter!

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