Home > Uncategorized > Must Europe become a transfer union?

Must Europe become a transfer union?

In my last post, I argued that Greece would be sustainable if not for the Euro.   However, the Euro itself is unsustainable (if for no other reason than that politics within the Eurozone will tear it apart)–this later point being much more conventional.   The question then becomes what exactly can be done to save the situation, is it worth it and who exactly is going to pay for it.   As with the previous post, I think I’m more-or-less on my own against the conventional wisdom.

My thinking is that the Eurozone could be saved (in theory) and it wouldn’t even require a transfer of real resources to the periphery.

Follow the money

The way to start thinking about these issues is to just follow the money–before and after the crisis.   Following the adoption of the common currency, the Euro-periphery began running large current account deficits.   I like to think about the current account as the change in the consolidated balance sheet of a nation’s private/public sector.   If Honda were to sell a car in the United States, they would presumably have (say) US$20,000 from the sale.   Let’s follow that money.   The sale obviously increases the US imports from Japan, but the story isn’t over; Honda must either 1) buy an US$-denominated asset  (i.e. treasuries or real estate)–this increases the indebtedness of the US relative to Japan and so the current account deficit–2) buy US-produced goods/services (for example, vacations in Hawaii)–this increases US exports to Japan 3) Honda trades those dollars for Yen–in which case the purchaser does one of these things.

The point is that the money flow from Japan to the US is possible only to the extent that Japanese Firms, Households or Government purchase American assets.   Now looking back at Germany and Greece, it is clear that the Housing bubble in Greece is a direct manifestation of the German current account surplus–they are two sides of the same problem.   The fact Germany’s current account is still in surplus (while the eurozone’s as a whole is in deficit) means that money is still flowing to Greece today.

Real transfers and financial transfers

At this point, I’d like to muddle the issue by distinguishing between real and financial transfers.   Pre-bust, Germany was sending Greece real goods (BMWs, for example) and it was funding that transfer (as above) with loans, it turns out, which Greeks would not be able to repay.    In other words, there was a (rather large) transfer of wealth from Germany to Greece pre-crisis.

This is a big deal.   I argued before that the problem with the Euro is politics.   Pre-crisis there was in essence a massive transfer of wealth from Germany to Greece.   This situation was popular.   Hmmm.   So what’s going on?   For one thing, Germans likely expected to be repaid one day.   More pertinent, though, is that the pre-crisis situation resulted in a large expansion of effective demand for German products and hence declining unemployment in Germany.   This is old hash, really; its the same reason that China keeps kept its exchange rate undervalued.   What gets missed, though, is that the flow of cash and the flow of goods go in the same direction–financial transfers and real transfers happen together.

Money-constrained or Supply-constrained

I’ve been trying to explain for years now to my very-Tea-Partyish dad how Keynsian Macro works.   I finally (I think) made some headway last month when I suggested the following intuition.   There are three “regimes” of macroeconomics separated by the most constraining resource in the economy; 1) a Malthusian regime; constrained by the supply of a non-reproducible natural resource, such as land–this I argued matches most closely with most people’s intuition 2) a Classical regime; constrained by the availability of reproducible resources such as machines and people 3) a Keynesian/monetarist regime; constrained by the supply of money.    The last being the only one we, as a society, truly have control over since money is not actually a resource.

Greece hasn’t run out of land (any more than before the crisis, surely), it hasn’t run out of people–not with 25% unemployment.   What it has run out of is money.   Here’s the thing.   Germany wants to be repaid.   Repaying Germany is the same thing, ipso facto, as selling Germans more things made by Greeks.   Greeks selling more things to Germans means more Greeks employed selling things to Germans which in turn means more revenue for Greece and hence an easier time for Greece to repay the Germans!

It’s a self-reinforcing and self-sustaining loop.   It is not a transfer from Germany to Greece, it is a transfer from Greece to Germany.   It is the opposite of austerity as it is currently practiced.   The problem–the only problem–is how does one get this started?   As pointed out ad-nauseum, normally a nation would devalue its currency in this sort of situation, but that’s impossible while Greece is on the Euro.

Whatever is done, it is a transfer from Greece to Germany

I wish I could say I knew how to solve the current euro-mess within a politically realistic institutional-reform path.   I think the ECB has the power to target the current account deficit directly, although I can’t blame people for worrying about re-inflating asset bubbles (I tend to think of it as inflating Germany’s assets to match the inflation of Greece’s assets).   Whatever you do, though, its a transfer of wealth to Germany, not a bailout for Greece.

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