Posted by: Dirk | February 27, 2015

V for Varoufakis – the video

After much vilifying in the German media, this video is a welcome change. We should get used to Varoufakis as the first in a long succession of Greek finance ministers fighting a political fight against the German finance minister. Given that Greece reaches a primary surplus of 4.5% and keeps it there – no country has even come close to achieving this – and a zero growth rate on average (sorry, but I think that is a realistic assumption) Greece’s government debt will fall below the 60% declared the maximum of “just right” by the Maastricht Treaty in 2039! Lots of fun for the media and the politicians? I don’t think so. Europe is on a slippery slope, even if Greece stays in the euro. Apparently, Greece will not reach the 4.5% primary surplus after the most recent negotiations, just as France and Italy will not hit their targets this year. European nations have given away their sovereignty and now they find out the hard way that Germany has taken over. Admitting this is difficult for those parties that supported the euro, but the realization will be made. It is obvious.


survey from Italy was published some days ago which asked people what they think about the euro. The results were not surprising, with many people saying that the euro made life complicated and should be abandoned (= against the euro). It is interesting to take a look at the dynamics at the party level:


30.5% of Italians are against the euro, but the social democrats of PD are relatively happy with it. Voters of other parties are not so happy with the euro. The situation in France is similar, with only 12.3% of PS voters being against the euro while on the extremist right (FN) the percentage is 47.%.

Social democrats all over Europe have invested a lot of political capital in the euro. Recently, the Greek social democrats scored less than 5 percent of the vote in national elections. In Spain, Podemos is set to overtake the Partido Socialista (which is social democrat) in the next elections.

The longer the trouble with the euro continues, the more likely it is that social democrats in Europe will be relegated to the status of a minor party, or so it seems.

figure 1-6
Source: Economic Report of the President, 2015

Posted by: Dirk | February 16, 2015

Money and Credit – a €-pean Perspective

I have written a book (in German) on money and credit with a special focus on the euro zone. It was published by Metropolis in December 2014 and is available through the publisher, Amazon, and bookstores everywhere. There is a companion website in which I post comments about twice a month. You can download chapter 2’s section on money creation by commercial banks for free. Among other things, I discuss the mechanics of monetary policy, fiscal policy, money creation by commercial banks from a balance sheet perspective and apply these insights to the euro zone.

Posted by: Dirk | February 13, 2015

Stark vs Horn: exchange of ideas on money in Germany

Yesterday, both Jürgen Stark of Deutsche Bundesbank and Gustav Horn, who is connected to the unions, voiced their opinion on the euro zone crisis – Stark in the FT (paywall), Horn in Die Zeit (in German). It was very interesting because apart from the fact that they do not agree they use completely different styles to address the readers. In short, Horn relies on persuasion:

Um eine Erkenntnis kommt man deshalb nicht mehr herum: Das Vorhaben, durch hartes Sparen die Schulden zu reduzieren, war von Anfang an zum Scheitern verurteilt. Denn es beruht auf zwei gravierenden Denkfehlern, die in den vergangenen Jahren immer offenkundiger zu Tage traten. Auf den ersten Blick erscheint die Strategie durchaus plausibel: Wer spart, hat weniger Schulden. Das kann jeder Privathaushalt unmittelbar nachvollziehen. Deshalb wurde ja auch die schwäbische Hausfrau zur Ikone der Sparpolitik erwählt.

He attacks the idea that you reduce a country’s debt through thrift (the Swabian housewife). He tries to persuade readers that what is right for a single household is wrong for all households (=the economy). Not everybody can save more, because my expenditures are someone else’s income. That someone cannot possibly save more if I reduce his income by spending less (and saving more). Contrast this with Stark’s text:

Years of mismanagement and failure to observe the rule of law have led to increasing budget deficits and mounting debts. Risk premiums soared. [..]

Such reforms are painful. But they are necessary in order to return to a solid growth path. [..]

Keynesian thinking has never played such a large role as in Anglo-Saxon countries. German thinking is founded on “ordoliberalism”, an approach arising from the recognition that markets need rules to be set and enforced by government.

This is a mixture of misrepresentations and ideology. First of all, Spain and Ireland ran budget surpluses for the years before the crisis, not budget deficits. Here is Ireland’s and Spain’s government debt year by year from 2003 to 2007 (in 2008 the crisis hit and debt went up):

year – Ireland – Spain – Greece

2003 – 30.1 – 47.6 – NA
2004 – 28.3 – 45.3 –  NA
2005 – 26.2- 42.3 – NA
2006 – 23.8 – 38.9 – 103.4
2007 – 24.0 – 35.5 – 103.1

The data for Greece was apparently taken out of the database because at the time Greece played some financial tricks that it learned from Goldman Sachs. Spiegel reported in 2010:

Goldman Sachs helped the Greek government to mask the true extent of its deficit with the help of a derivatives deal that legally circumvented the EU Maastricht deficit rules. At some point the so-called cross currency swaps will mature, and swell the country’s already bloated deficit.

Greece was the odd man out anyway, since the other crisis countries – Ireland and Spain – had very low levels of debt that were sinking from 2003 to 2007. At the same time, Germany got letters from Brussels because its deficit was too high!

Stark then mentions reforms that are painful but necessary. I think there is now enough proof to conclude that austerity policies did not help to increase growth. They were started in 2010, and none of the countries has seen a rebound. The euro zone has entered deflation territory and demand remains weak.

Last but not least, the remark about cultural difference and that Keynesianism did not take root in Germany. This again is a remark that is ideological and does not explain anything. Ideas are not German or American or, in the case of Keynesianism, British. If I remember correctly, Keynesian ideas were very popular as late as 2009. Let’s have a look at the speech of Jürgen Stark from June 2009, when he was still executive member of the board of the ECB (my highlighting):

Fiscal policy measures

Let me now turn to the fiscal policy reaction to the economic crisis. Fiscal authorities in the euro area have demonstrated their willingness and capacity to act rapidly and in a coordinated manner in exceptional circumstances. It is important to distinguish between measures intended to support the banking sector and fiscal policy measures aimed at stimulating demand. [..]

In addition to providing financial support to the banking sector, euro area governments reacted forcefully to counter the negative impact of the financial turmoil on the real economy. Besides the operation of automatic stabilisers, which provide a significant cushion to the euro area economy by way of lower tax revenues and higher spending on unemployment benefits, the discretionary use of fiscal policy helped to mitigate the effects of the global economic downturn.

So, let me put that into proper context. When Germany in 2009 was on track for -5% GDP growth, discretionary use of fiscal policy helped to mitigate the effects of the downturn. However, in 2010-2015, when there has been no downturn in Germany but still downturn almost everywhere else in the euro zone, than discretionary use of fiscal policy cannot and will not help to mitigiate the effects of the downturn. Quite the opposite: discretionary use of contractionary fiscal policy is supposed to mitigate the effects of the downturn!

Theories are intellectual entities, and have no national bias. Of course that does not mean that the Bundesbank, which mostly follows monetarism (at least the political leadership does), is “neutral” when it comes to theory. But I would argue that this focus on monetarism is not the result of intellectual insight but rather intellectual closure. After all, the monetarists have lost one fight after the other without discarding the idea that the central banks control reserves and banks lend those reserves to the private sector whereas other central bank, like the Bank of England, have discarded these views.

If the FT would be demanding fact checking, then the article by Jürgen Stark would not have gone through. Budget deficits of the crisis countries only went up after the crisis started to hit Europe, not before. Hence there cannot be any causality running from budget deficits to the euro crisis. Also, claiming that reforms that deliver only pain but no increase in welfare should be continued without explaining to the public how they are supposed to work leaves the reader with the impression that the text is an ad hoc justification of bad economic policies.

I think that Horn does the right thing here and discusses the paradox of thrift in order to explain to the public what the problem is. After all, the paradox of thrift is taught to undergrads in macroeconomics courses and the Wikipedia entry is good enough that the lay reader can understand the problem:

The paradox of thrift (or paradox of saving) is a paradox of economics, popularized by John Maynard Keynes, though it had been stated as early as 1714 in The Fable of the Bees,[1] and similar sentiments date to antiquity.[2][3] The paradox states that if everyone tries to save more money during times of economic recession, then aggregate demandwill fall and will in turn lower total savings in the population because of the decrease in consumption and economic growth. The paradox is, narrowly speaking, that total savings may fall even when individuals attempt to increase their savings, and, broadly speaking, that increase in savings may be harmful to an economy.[4]

Posted by: Dirk | February 12, 2015

Swedish Riksbank goes negative

The Swedish central bank has announced a negative repo (main policy) interest rate of -0.1%. Here is the first paragraph of their press statement:

There are signs that underlying inflation has bottomed out, but the situation abroad is now more uncertain and this increases the risk that inflation will not rise sufficiently fast. The Executive Board of the Riksbank has therefore decided to cut the repo rate by 0.10 percentage points, to -0.10 per cent, and to adjust the repo-rate path down somewhat. At the same time, the interest rates on the fine-tuning transactions in the Riksbank’s operational framework for the implementation of monetary policy are being restored to the repo rate +/- 0.10 percentage point. Moreover, the Riksbank will buy government bonds for the sum of SEK 10 billion. These measures and the readiness to do more at short notice underline that the Riksbank’ is safeguarding the role of the inflation target as a nominal anchor for price setting and wage formation.

I find it strange that the Swedish government does not use fiscal policy. According to the National Debt Office, the debt as of December 2013 stands at only 35% of GDP. Sweden is not part of the euro area and hence does not face constraints from the Stability and Growth Pact. Sweden has been running persistent current account surpluses and would not have any trouble with the balance of payments if it would expand domestic demand. Inflation-targeting as a central bank strategy seems to continue its long fall. Let me end with an excerpt from one of the intellectual giants of Sweden, Knut Wicksell (1898):


Posted by: Dirk | February 12, 2015

Benjamin Franklin on “Paper-Currency” (1729)

As Europe struggles with its currency – well, at least parts of Europe – it might be interesting to take a look back at the history of the United States of America, back when they were part of the British Empire. There is a text by Benjamin Franklin from 1729 titled “A Modest Enquiry into the Nature and Necessity of a Paper-Currency“. Here is an excerpt:

There is a certain proportionate Quantity of Money requisite to carry on the Trade of a Country freely and currently; More than which would be of no Advantage in Trade, and Less, if much less, exceedingly detrimental to it.

While this reminds me of the quantity equation, it nevertheless tells us that pragmatism ruled on monetary issues. The monetary circulation can fall short, can exceed the level at which trade of a country would carry on freely and currently, or can just be just right. Franklin correctly recognizes that the circulation of money is needed to carry on “the trade of a country”. One wonders what he would say in a situation like this (data from ECB):


The right hand graph shows that loans to other euro area residents are negative since 2012, which means that the private sector is repaying loans. On a net level this destroys deposits as banks get deposits back that they created when the loans were originally made. Franklin would definitely not been happy about this development of the paper-currency! He recognizes correctly:

Yet if Money grows scarce in a Country, it becomes more difficult for People to make punctual Payments of what they borrow, Money being hard to be raised; likewise Trade being discouraged, and Business impeded for want of a Currency, abundance of People must be in declining Circumstances, and by these Means Security is more precarious than where Money is plenty.

That, I think, is a very good description for the euro area. It is not a country, but it is a currency area, and usually countries and currencies match one to one. It was a big experiment to have one currency for many countries. It seems to end because the politicians in control are not willing to bring about “a certain proportionate Quantity of Money requisite to carry on the Trade of a Country freely and currently“, which could only be done through fiscal spending, it seems.

The monetary circuit in the euro area is not enough to carry on European trade. If it can’t be expanded because of political reasons, than Europe will not be united but fragmented. This would be frustrating, but the US went through some currency regimes before it established a solution that was working. It would not be a scandal to recognize that the institutions of the euro are flawed and that we need reform.


Flassbeck economics points out that the Greeks have a problem and quotes the ECB:

The Governing Council of the European Central Bank (ECB) today decided to lift the waiver affecting marketable debt instruments issued or fully guaranteed by the Hellenic Republic. The waiver allowed these instruments to be used in Eurosystem monetary policy operations despite the fact that they did not fulfil minimum credit rating requirements. The Governing Council decision is based on the fact that it is currently not possible to assume a successful conclusion of the programme review and is in line with existing Eurosystem rules.

This could mean that Greek banks have a problem. They use Greek government bonds as collateral for loans from the ECB. These loans create deposits at the Greek central bank, which banks could then exchange into cash. No more from February 11th:

The instruments in question will cease to be eligible as collateral as of the maturity of the current main refinancing operation (11 February 2015).

This is basically what was done to Cyprus. Greek banks are doomed if they cannot produce any more euros in cash. If – and that is a big if – Greek banks would have to close, than it probably does not make much sense to open them up again with Greece being a member of the euro area. The Greek government might as well decide to introduce a new currency. However, as El Publico reports, the Greek banks have been authorized to use €10 billion in emergency funds. The Greek government concludes that there is no liquidity problem. Frances Coppola points out that Varoufakis has seen this ECB policy coming six month ago, as an exchange on Twitter shows. The coming weeks should feature a discussion on whether the ECB is allowed to cut liquidity provision to a member state government. I would tempt to think that it is not within the mandate of the ECB to cut off some banks in one nation. Here is what the ECB says about itself (my highlighting):

The Treaty provisions also imply that, in the actual implementation of monetary policy decisions aimed at maintaining price stability, the Eurosystem should also take into account the broader economic goals of the Union. In particular, given that monetary policy can affect real activity in the shorter term, the ECB typically should avoid generating excessive fluctuations in output and employment if this is in line with the pursuit of its primary objective.

On a side note: the Greek government’s suspension of talks with the troika is supported by the statement from the European Court of Justice in mid-January:

Thus, in the event of the OMT programme being implemented, the ECB must, if the programme is to retain its character of a monetary policy measure, refrain from any direct involvement in the financial assistance programme that applies to the State concerned.

One wonders what kind of construct will replace the troika. European institutions dictating policy to member countries will not increase the image of the European Union, especially if they force countries to give up on public goods like health care, education, etc. The political survival of the EU is more uncertain than ever, it seems.

Posted by: Dirk | February 5, 2015

Foreign debt reduction requires net exports

Jürger Kaiser has published a paper at the German socialdemocrats’ foundation FES in 2013 in which he takes a closer look at the London Debt Agreement of 1953, in which Germany’ foreign debts were reduced roughly by half. Everybody realized that repayment of foreign debt would only be possible if Germany would have a net export – or current account – surplus:

»Germany’s ability to pay depends not only on the ability of private and governmental debtors to raise the necessary amounts in DM without inflationary consequences, but also on the ability of the national economy to cover the debts out of the current trade surplus. (…) The examination of Germany’s ability to pay requires the investigation of a variety of problems including: (a) Germany’s future production capacity with particular consideration of the production capacity for export goods and the ability to substitute the products currently imported. (b) The possibility of selling German goods abroad. (c) The probable future German trade conditions. (d) The internal fiscal and economic measures in Germany required to ensure an export surplus« (Auswärtiges Amt et al., 1951: 64).

Related to this is Monday’s news about Germany current account surplus as reported by Reuters:

Germany’s current account surplus is likely to have hit a new record of $285 billion (£189.31 billion) in 2014, beating China once more, its Ifo think-tank said on Monday in a report which may fuel criticism that Europe’s biggest economy is not playing its part to reduce global imbalances.

German policy makers should understand that they face two options here to allow other euro zone countries to achieve net exports. The first option is reducing incomes there until other euro zone countries reduce their imports so that they are lower than exports. The second is increasing incomes in Germany through higher wages and more government spending so that German imports rise and this pulls up exports of other euro zone countries to the level of their imports and beyond.

What is not logically consistent is to defend net exports of Germany and complain that other countries that are part of the euro zone cannot repay their debts.

Former German finance minister Peer Steinbrück (socialdemocrat) has given an interview to tageszeitung’s Ulrike Herrmann. It was very revealing. Since the interview was published in German, let me translate a few phrases and put them into context. Comments are open, so if you think that I mistranslated or put the extracts out of context, voice your critique! The first snippet comes in response to Herrmann quoting Varoufakis, who said that the Greeks can’t pay anyway.

P.S.: I have a clear understanding of what an unconditional debt cancellation will do to the debate in Germany. Populist parties would be enthusiastic about this help for their electoral campaigns.

So, let’s be clear about this. Politically, the socialdemocrats can’t let a debt cancellation happen because then populist parties would steal their (the socialdemocrats) votes. Steinbrück, when asked the first time if a (partial) debt cancellation for Greek would not be on the agenda, answered: “No, they already hat two cuts”. He also complains that a cut in Greek debt would hit European tax payers.

The case for not accepting a Greek hair cut rests on two pillars (I can’t find a third or a fourth):

  1. the ruling coalition government of Germany would lose votes
  2. European tax payers lose money

The second reason is something which can be circumvented if the ECB buys sovereign bonds and then accepts the losses on those bonds by letting equity fall into negative territory. Whereas private banks with negative equity are closed down, this is not the case for central banks. They can always create new deposits for participating banks because they are running the accounting system. Marking up the deposits that a bank has at a central bank is not depending on the equity position of the ECB. (If you do not agree: what is the actual equity of the ECB and do you really think that other people look at that value?)

The Federal Reserve Bank, for instance, has bought up lots of treasury bonds. The effect is that the treasury pays interest to the Fed, which books this as a profit. Central bank profits usually are returned to the Treasury, hence the Fed will transfer the money back to the Treasury. Sovereign debt problem solved, interest rates under control. This is modern sovereign money. The ECB, by the way, can do the same and does so with quantitative easing (although for different reasons). This does not create inflation, because money is moved from the governments account to the central bank and back (it’s not the same money, by the way). No goods are purchased, no services bought.

So, the only reason why the German government does not accept another debt cut for the Greek government is political, if Steinbrück is to be trusted. He is a member of parliament, so he’s still part of the club. European politics 2010-14 was driven by campaigns of misinformation (the lazy Greeks, Club Med, etc.) and maybe 2015 we can have an open and honest debate about the mess Europe is still in. Of course, politicians will continue to maximize votes, but then it is the public which needs to be educated. It would help tremendously if the media would rethink their point of view. The recent interview by the BBC with Greek finance minister Varoufakis is a case in point. The anchor from the BBC seems to be an angry woman, angry about the Greeks and their behavior:

It is very nice to see Varoufakis counter the full court press that the BBC anchor plays. Informed sources already wrote in 2013 that 77% of the bail-out money went to the financial sector and not the general population. The Greek crisis is not about the Greeks living by spending our money. It is about the European banks lending money to the Greek government, which was not able to repay in 2009. Instead of finding a solution right then and there, politicians decided to kick the can down the road, while the Greek government bonds had two hair cuts and were moved to public institutions where now 90% of them seem to be. So, European politicians created the huge potential costs for taxpayers. Potential costs that did not exist in 2009.

Last but not least, remember that austerity was imposed on Greece through the troika, which helped to create a fall of GDP by some 25%. Of course the debt-to-GDP also went up because of the loss of output. So, to a significant extent austerity policies imposed by the troika are indeed the reason why now with the diminished output Greeks cannot repay their foreign debts.

The drama of Greek debt is a political drama. The troika was invented during the crisis. Austerity was never a threat before the crisis happened and was imposed because the European Commission wanted it, not because it had to. These were political decisions, and they were not based on macroeconomics textbooks. Expansionary austerity and the confidence fairy where stories invented on the go, without proper theoretical foundations (and not mentioned in macroeconomics textbooks). It is about time to stop T.B.T.F. (too big to fail) and T.I.N.A. (there is no alternative) and rethink the whole episode 2008-2014. Learning from mistakes is hard, but it must happen.

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