Tuesday, October 29, 2013

The Economic Consequences of the Euro

The above title is paraphrased after John M. Keynes' "The Economic Consequences of the Peace". Paul A. Volcker wrote the introduction to the edition of the book which I just (re)read and he started by saying: "I read (skimmed may be a more accurate description) John Maynard Keynes' book as a student... Well, here I am almost thirty years older, more than eighty years after the book was written. In reading the book - really reading it this time - I am struck not just by the felicity of Keynes' prose and the passion of his concerns but by the relevance to the world in which we live".

Well, I am more than fourty years older than when I first read (skimmed) the book and now I have reread it - really reading it this time! And I can only totally agree with what Volcker said in his introduction.

Greece is now into the fourth year after the First Memorandum. There have been endless discussions about Greece's sovereign debt since then. The debt in absolute terms; the debt as a percentage of GDP; the sustainability of the debt; the need to restructure it; perhaps the need to forgive it; etc. etc. The discussions which Keynes described as being at the center of the Versailles Conference reminded me of the discussions about Greece since 2010.

Keynes, after resigning from the Conference, developed a revolutionary common-sense approach to the issue of German war reparations in his book: instead of devoting all the energies to the question of how much Germany should pay, devote some energies to the question of how much Germany could pay and how Germany's capacity to pay could be increased!

Keynes devotes a long chapter to the question of "Germany's capacity to pay". In it, he doesn't talk at all about the German budget and the potential of a budget surplus. Instead, he talks about the German economy as a whole and its capacity to achieve a surplus in its external accounts so that this surplus could be used for war reparations.

As a non-economist, I need to make the following caveat: Germany at the time had a local currency and to pay off other countries it needed to have surpluses in foreign currencies. Whether or not the same applies to Greece as a member of a currency zone is not quite clear to me. However, what seems clear is the following: if an economy owes money abroad and if it has the intent to pay off those debts, it will either have to generate external surpluses or sell domestic assets abroad.

Keynes beautifully takes the German trade balance apart to show the potential (or lack thereof) which Germany had to increase exports and/or decrease imports. He concludes that section by saying that "It is for those who believe that Germany can make an annual payment amounting to hundreds of millions sterling to say in what specific commodities they intend this payment to be made and in what markets the goods are to be sold. Until they proceed to some degree of detail, and are able to produce some tangible argument in favor of their conclusions, they do not deserve to be believed". Wow! That's the elegant British way of telling someone that he doesn't know what he is talking about!

The rest of the world (mostly EU banks) had transferred, from 2001-10, 283 BEUR (net) to Greece, the entire country, in the form of loans. Since then, I would guess that another 50-100 BEUR (net) was transferred. Much of Greece's foreign debt is now held by official institutions. And now those official institutions tell Greece that they want some of their money back. That is understandable.

What is absolutely not understandable is that no one seems prepared "to say in what specific commodities they intend this payment to be made and in what markets the goods are to be sold". Not to mention the question whether the Greek economy has the capacity and resources to produce those commodities in the first place.

Keynes not only analyzed the capacity of the German economy but he also devoted thoughts to the possibility that this capacity could be increased: "If the Allies were to 'nurse' the trade and industry of Germany for a period of five or ten years, supplying her with large loans, and with ample shipping, food, and raw materials during that period, building up markets for her, and deliberately applying all their resources and goodwill to make her the greatest industrial nation in Europe, if not in the world, a substantially larger sum could probably be extracted thereafter; for Germany is capable of very great productivity".

Well, I am not going to argue that Greece could ever become the greatest industrial nation in Europe but what I have criticized heavily since the beginning of this blog is that no one - no one at the EU level and certainly no one at the level of Greek leadership - no one has been making a long-term economic development plan which would outline the optimization of the Greek economy's potential for the next generation. Well, not quite. McKinsey presented its Greece Ten Years Ahead report over 2 years ago. I cannot judge whether their recommendations would have been the answer to all questions but they certainly didn't get much attention.

There is no way that one can draw water from a dried-out well unless one first dumps water into it, which doesn't appear to make sense. Instead of wasting time with senseless activities, one ought to devote one's energies to fixing the well. Any banker who has ever been involved with a troubled borrower knows that the only way to eventually get one's money back is to make the borrower strong again. One can, of course, squeeze the borrower to the tilt and liquidate as many assets as possible. That way, one will get some money back but one will never get all the money back.

Lest I be misunderstood: I am not saying that the rest of the word should simply "supply Greece with large loans" (Keynes) and wait for miracles to happen. Those miracles won't happen by themselves. What is absolutely necessary (and has been necessary from day 1 of the crisis) is to put together a long-term economic development plan for the Greek economy. A plan which builds on existing capacities of the Greek economy as well as identifiying new capacities to be developed. The primary responsibility for putting together such a plan lies with Greece. However, any such plan - if it is to stand a chance of being successful - needs to be embedded in an overall European economic environment, if not even a world-wide environment (particularly China in the case of Greece). This is why the EU should feel equally responsible for working out such a plan together with Greece.

I fear that "supplying Greece with large loans" outside the concept of a long-term economic development plan stands a high chance of eventually ending up as wasted money. Throwing money at a problem without having an overall concept for using it wisely tends to fall into the category of "We don't know where we are going but the faster we drive, the sooner we will get there!"


  1. This is an excellent post whose point is well noted.

    However there are greater ills within the Eurozone than just Greece. After all if it was just Greece that is the problem, then why is it that Eurozone member after Eurozone member fall like dominoes (the latest casualty is Slovenia)?

    The following post by Professor Bill Mitchell hits the nail on the head.


    Simply put, the point of production is consumption. There is very little sense in export-driven mercantilist strategies. Such a strategy de facto means that you suppress your demand, and somebody else exceeds his' (relative to his productive capacity).

    The current under-utilization of resources within the Eurozone is tragic. It's wasted potential. More so, it is wasted potential that is reflected on human tragedies (poverty, unemployment). The Eurozone has every means in it's disposal to put these resources at work. That it doesn't do so because of vague ideological constraints is unforgivable. Unforgivable

    The Eurozone is such a big area, it has so much productive capacity. Why not just produce what we need and consume it ourselves? Why ship it abroad for others to consume? Why have a current-account surplus? A simple balance would do. Then we could consume more and be happier.

    The euro is a free-floating currency. This means that as the Eurozone's current-account increases, so does the euro's value (vis-a-vis the currencies of it's trading partners). This undermines the Eurozone's precious export-led strategy, and a new round of demand suppression must ensue. This is ridiculous. Personally, I want out. The Germans can have their surpluses and eat them. I'd rather eat tangible stuff.

  2. Klaus, your plan looks theoretically feasible. But in practice Greece will not get it's act together and the EU will not be in a position to resolve in time the Euro crises. So the outlook is disturbing...


  3. Slowly, but gradually, the world is waking up towards the macro practices of the mercantilists.


    This isn't the first time the Americans speak out. I only remember too well when in a G7 summit Timothy Geithner suggested that current-account surpluses should be no more than 4% per GDP, a suggestion which was shot down by Germany and China (who else?).

    Germany and China can't win this game. Either they will contribute to the rebalancing, or others will do it for them. The recent spat over the US debt ceiling was such a warning which was wrongly interpreted as dysfunctional US politics.

    The phobic policies of the Eurozone deficit nations, who always succumb to the will of the Germans, are obviously disappointing. But if the politicians won't change, then the citizens will change the politicians, as in the case of France and Marine Le Pen.

    1. Klaus
      I'm happy you do not suggest supplying large loans to Greece without a plan, I would not supply money with a plan, I would not even supply them if the Greek had made the plan and therefore had ownership. I am trying not to be ironic or obnoxious, but, Greeks cannot (will not?) work to a plan. Be realistic, look at projects here, big or small (the Olympic Games, works on your house) not only were they not carried out in accordance with the plan, there never was a plan. Greeks are opportunists; they are also so smart that they do not need to plan. Deep inside you know it, you also know that no sane nation(s) would finance the plan; they would (rightly so) claim that the money would be used for corruption and consumption. Regarding your "fixing the well" so Greece can pay back their debt, I think most Europeans have realized that Greece will not pay back their debt, I also think that the well is so contaminated that no amount of fixing it will do the job.
      I have just read the Fifth Activity Report from the Task Force for Greece; it is a sad story about competent experts making slow progress in reforming a failed nation that do not want to be reformed. They make progress, not because of the assistance from Greek politicians and civil servants, but in spite of their obstructions.
      It makes me wonder why so many well-meaning people try to save the Greeks from themselves and their ways. The majority of the Greeks do not want the help, they tell us in sooo many ways to go home and mind our own business (but to leave the credit card here), I suggest that we please them and do so (not the part with the credit card though). No more moral or nation building, it is too expensive for Europe, and painful for both parties.
      The ECB and the national banks can then keep the loans on their books for as long as they find it politically expedient. Europe can get along with the more important job of salvaging the good parts of EU (not the EURO).
      The greeks can wait for the Messiah they tell each other will come nexr week: The Eurobonds, the gold in the mountains, the Russians, the gas in the oceans, the Americans, the solar energy, the Chinese, the German elections and forming of government, the well-educated and innnovative Greeks, their geopolitical position, the Greek diaspora, the TAP gas connection, the comming presidency of Greece in EU, the German war reparations, etcetera. None of these "saviors" require any efforts on the part of the Greeke nation, but, "Keep Talking Greece".
      PS. Should the Greek nation then vote for a 5 year detour (delay) in their progress via a SYRIZA government, then, by all means, that is their constitutional right.

      Have a nice weekend, Lennard

    2. Lennard
      As I was reading your little tirade against Greece and Greeks, I felt sure that there would come a punchline at the end and that the punchline would say something like:

      "...on the other hand, I still love Greeks and Greece!"

      Are you sure that, deep down, you didn't feel like saying something of the sort???

    3. Klaus
      The reason for my tirade about (not against please) the greeks is that I love them, 35 years love and (frequent, on and off) coexistence does no go away overnight. I firmly believe that continouing the present "co-operation" between Greece and Europe will cause wounds that will not easily heal, if at all. I therefore suggested that the parties seperated, not necessarily divorced, the alimony being the Greek debt. That may not be generous enough for some, but we also have to consider what Europe can afford, and that poorer people than the Greeks will contribute to that alimony.
      A separation will allow the parties to decide if they wish to establish a new different relationship, and what kind. It will allow the parties to reflect on the compatibilities of their values, morals, cultures and systems. To contemplate if the parties will have mutual benefits from a future partnership. To ponder who they are, where they are and where they want to go. Not who they would LIKE to be, or where they would LIKE to be, but the truth (there we go again, KNOW THYSELF).