Wednesday, March 7, 2012

The Eurozone's two (killing) killer apps!

The Harvard professor Niall Ferguson wrote a book titled "The West and the Rest" where he defined 6 killer apps which allowed the West to dominate the rest of the world in the last 600 years. I will now explain 2 killer apps which have the very real potential of killing the Eurozone.

These 2 killer apps are:

The current account imbalances, and
the deposit withdrawals from national banking sectors (capital flight).

If all EZ-countries had balanced current accounts, there could be no cross-border debt. Today's problem is not the debt per se. Instead, it is the cross-border debt! If all of Greece's sovereign debt were held by Greeks, there would be much less excitement between Paris/Brussels/Frankfurt/Berlin.

A deficit in the current acccount (liquidity outflow of the country) must mathematically be offset by a surplus in the capital account (liquidity inflow into the country). Otherwise, the Balance of Payments wouldn't balance.

It is irrelevant whether deposit withdrawals are hoarded under mattrasses or transferred abroad. The banking sector loses liquidity and lost liquidity must be replaced. Since Greek savers withdraw their liquidity instead of increasing it, the lost liquidity must be replaced by someone else --- the ECB.

Is it really so difficult to see that current account deficits and deposit withdrawals must be financed through new loans from abroad? And that if one doesn't want to take up new loans from abroad or if one doesn't get new loans from abroad any longer, then something must be done about the current account deficit and deposit withdrawals? And that there is no other way to correct the situation?

If I could not make myself understood, please refer to Warren Buffett's tale on Thriftville vs. Squanderville. He explains it just so much better!

1 comment:

  1. WB leaves out a third party - the Finance Industry.

    Singapore reminds me of Thriftville, except it can't water or feed itself let alone feed Squanderville. It had to bootstrap itself with hard work, intellect, location, and the luck of being led by a benevolent far sighted Confucian Hakka man.