Friday, November 28, 2014

The Euro’s Latest Reprieve

NEW YORK – Like an inmate on death row, the euro has received another last-minute stay of execution. It will survive a little longer. The markets are celebrating, as they have after each of the four previous “euro crisis” summits – until they come to understand that the fundamental problems have yet to be addressed.

There was good news in this summit: Europe’s leaders have finally understood that the bootstrap operation by which Europe lends money to the banks to save the sovereigns, and to the sovereigns to save the banks, will not work. Likewise, they now recognize that bailout loans that give the new lender seniority over other creditors worsen the position of private investors, who will simply demand even higher interest rates.

It is deeply troubling that it took Europe’s leaders so long to see something so obvious (and evident more than a decade and half ago in the East Asia crisis). But what is missing from the agreement is even more significant than what is there. A year ago, European leaders acknowledged that Greece could not recover without growth, and that growth could not be achieved by austerity alone. Yet little was done.

What is now proposed is recapitalization of the European Investment Bank, part of a growth package of some $150 billion. But politicians are good at repackaging, and, by some accounts, the new money is a small fraction of that amount, and even that will not get into the system immediately. In short: the remedies – far too little and too late – are based on a misdiagnosis of the problem and flawed economics.

The hope is that markets will reward virtue, which is defined as austerity. But markets are more pragmatic: if, as is almost surely the case, austerity weakens economic growth, and thus undermines the capacity to service debt, interest rates will not fall. In fact, investment will decline – a vicious downward spiral on which Greece and Spain have already embarked.

Germany seems surprised by this. Like medieval blood-letters, the country’s leaders refuse to see that the medicine does not work, and insist on more of it – until the patient finally dies.

Eurobonds and a solidarity fund could promote growth and stabilize the interest rates faced by governments in crisis. Lower interest rates, for example, would free up money so that even countries with tight budget constraints could spend more on growth-enhancing investments.

Matters are worse in the banking sector. Each country’s banking system is backed by its own government; if the government’s ability to support the banks erodes, so will confidence in the banks. Even well-managed banking systems would face problems in an economic downturn of Greek and Spanish magnitude; with the collapse of Spain’s real-estate bubble, its banks are even more at risk.

In their enthusiasm for creating a “single market,” European leaders did not recognize that governments provide an implicit subsidy to their banking systems. It is confidence that if trouble arises the government will support the banks that gives confidence in the banks; and, when some governments are in a much stronger position than others, the implicit subsidy is larger for those countries.

In the absence of a level playing field, why shouldn’t money flee the weaker countries, going to the financial institutions in the stronger? Indeed, it is remarkable that there has not been more capital flight. Europe’s leaders did not recognize this rising danger, which could easily be averted by a common guarantee, which would simultaneously correct the market distortion arising from the differential implicit subsidy.

The euro was flawed from the outset, but it was clear that the consequences would become apparent only in a crisis. Politically and economically, it came with the best intentions. The single-market principle was supposed to promote the efficient allocation of capital and labor.

But details matter. Tax competition means that capital may go not to where its social return is highest, but to where it can find the best deal. The implicit subsidy to banks means that German banks have an advantage over those of other countries. Workers may leave Ireland or Greece not because their productivity there is lower, but because, by leaving, they can escape the debt burden incurred by their parents. The European Central Bank’s mandate is to ensure price stability, but inflation is far from Europe’s most important macroeconomic problem today.

Germany worries that, without strict supervision of banks and budgets, it will be left holding the bag for its more profligate neighbors. But that misses the key point: Spain, Ireland, and many other distressed countries ran budget surpluses before the crisis. The downturn caused the deficits, not the other way around.

If these countries made a mistake, it was only that, like Germany today, they were overly credulous of markets, so they (like the United States and so many others) allowed an asset bubble to grow unchecked. If sound policies are implemented and better institutions established – which does not mean only more austerity and better supervision of banks, budgets, and deficits – and growth is restored, these countries will be able to meet their debt obligations, and there will be no need to call upon the guarantees. Moreover, Germany is on the hook in either case: if the euro or the economies on the periphery collapse, the costs to Germany will be high.

Europe has great strengths. Its weaknesses today mainly reflect flawed policies and institutional arrangements. These can be changed, but only if their fundamental weaknesses are recognized – a task that is far more important than structural reforms within the individual countries. While structural problems have weakened competitiveness and GDP growth in particular countries, they did not bring about the crisis, and addressing them will not resolve it.

Europe’s temporizing approach to the crisis cannot work indefinitely. It is not just confidence in Europe’s periphery that is waning. The survival of the euro itself is being put in doubt.

Read more from our "Sticking with the Banking Union" Focal Point.

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    1. CommentedBakhodur Rakhimov

      Dear readers,
      I had a sudden feeling/thought the other day after constant reading of the Business section in the International Herald Tribune: it's simply should be renamed to CRIME section!!! Almost the entire selection of articles is about banks' (the financial sectors' or people related to them) fraud,cheat, greed, bailouts,speculations,bets,investigations,lawsuits ...and the list goes on with no end in sight. And it's all in the name of markets and money. How come our moral sentiments became so corrupted and we ended up in such a commercial, moneyterised society?

        CommentedGary Marshall

        Then you should stop reading the newspapers, or believing what you read in them.


    2. CommentedDaniel Gomes

      It's amazing the amount of misinformation theses days.
      In particular a certain group of people which started with Anglo-saxon conservatives with which now misinformed Germans with supremacist complexes have formed a strange alliance.

      Such alliance founded on their completely unfundamented belief that their austerity recipe will make the world a better place when every single bit of evidence and history shows the complete opposite.

      Now these strange German allies, chose to add another set of principles to this one concerning the virtue of austerity. Namely the hail to hypocrisy and amnesia together with a generous portion of decades old supremacist believes.

      Lets see...

      It was not in such a distant past that German financial sector (and regulators) joined ranks with their Anglo-saxon deregulation jihadist to crater the world economy through widespread thievery and stratospheric amounts of irresponsible speculation on the U.S. subprime market.

      A very little publicised fact was that German banks were on the first line of major delinquents in the U.S. subprime speculation crisis.

      And lets remember that at this time southern European banks had relatively healthy balance sheets and even the so called Spanish property bubble showed no signs of unsustainability.

      As matter of fact in all the splendor of their arrogant ignorance, the members of this alliance are completely oblivious to the laws of supply and sustained demand .. Yes Spanish population increased 10% during that period, whereas unless you know something i don't, Spanish territory apparently did not increase a single inch.

      Now.. for their destroying the economy the financial sectors of these strange allies, were rewarded with the mother of all bailouts and transfer their toxic assets to the U.S. and European tax payer.

      And lets remember that there were government controlled banks involved and a lot of tax revenue from this speculation which was not socialized throughout Europe.. only the debt and toxic assets.

      But lets see how unbelievably enormous is this hypocrisy and how much German debt and toxic assets were socialised into the balance sheets of U.S. and Europe taxpayers.

      For example... through programs such as the Fed the buy-back of toxic assets:

      Or the hundreds of billions of cheap money against worthless collateral

      Because German financial system was the one cut off from the markets in 2008-2009

      Unfortunately only data from the Fed is available because the ECB is only accountable to the German-French clique.

      Now with no shame whatsoever, Germans still top up this amnesia with further claims of the financial discipline of their government's accounts when the eurostat numbers show clearly that German debt and budget defict are no better than Southern europe until the collapse of the economy in 2008 and the wave of German austerity pushed southern europe into the abyss:

      German public debt:,10,12,24&y=geo&unit=0&language=en&pcode=tsieb090&plugin=0

      German budget deficit:,10,12,14,24&y=geo&unit=0&language=en&pcode=tsieb080&plugin=0

      The rest is history..

      1. German and U.S. financial systems were being rescued from the abyss they created, by the tax payers of Europe and U.S.

      2 meanwhile the smaller more vulnerable countries had to pile huge amounts of debt due to the collapse of tax revenue, increase in social welfare expenses and last but not least as part of the worldwide agreement to bring back the ecnomy from the crater created by the likes of Deutsche.

      3. The revered ratings agencies told periphery crountries "oops.. i don't like your balance sheet anymore and i'm going to effectively cut you off from the credit markets."

      4. ECB and Fed awashs banks with cash to absorb the risk that these banks had taken in the sovereign debt of periphery countries thus allowing them to get rid of these assets with o concern for the interest spiral it caused.

      5. Banks took that money and bought German bunds because market panic triggered by ratings agencies distorted the markets to the point in which the country which was about to fail 5 years ago is now considered the only safe investment in Europe.

      Hope this was informative for those people who believe in the superiority of their financial discipline.

        CommentedMoritz G€d1g

        Sounds like blaming others for own faults. You are right in many respects but it is not like Greece for example did not cause it's problems. Mr Merkel might be making it hard for them now, but they are the ones to blame. As a German I want to see reform progress for the money I know I have to continue to give them.

    3. CommentedMATTHEW M

      I am amazed at this sites lack of really addressing the obvious- out of control global finance. Where do we start: 1) JPMorgan cooking its books and the $2B hedge loss that some estimate will be north of $9B. 2) LIBOR rate rigging - why is anyone surprised as central banks have been artificially manipulating rates/markets for a long time - current S&P gains are primarily linked in the last few years to FED easing - same with LTRO in EU 3) HSBC "apologizing" for money laundering 4) JP and HSBC RICO suit on silver market manipulation and on and on.

      We witness Barclays executives committing suicide, PFS head attempting to take his own life, and one has to ask is a mass seppuku of banking executives or the current increased spate of lawsuits amongst financial players (the inevitable self cannibalization) the only remedy to clean up the toxic and corrupt banking sector.

      Unfettered, unhinged and irresponsible banks that are engaged in a massive fraudulent feeding frenzy that is bankrupting whole countries. The increased debt loads all related to massive bailouts to banks that have inept and corrupt executive teams.

      This is the core problem. We need to pull back the corporate veil, (executives, incestuous Boards, auditors, and lawyers) and expose where all the warts are.

      Regulation is sorely needed. A global come to Jesus meeting is sorely needed: declaring all CDO/CDS null and void is a great starting place. And then onto those that took the risk bearing the losses rather than the continued socialization of the losses on the backs of the world's people.

    4. CommentedAndré Rebentisch

      What you call "virtue" is another word for trusted governance, also known as pacta sunt servanda. Now, from a EU Treaty perspective we are in a state of exception because member states were prohibited to finance each other. Trusted relations are more important than the current interest rates, but you could argue that interest rates reflect the current level of trust. The longer it takes governments to meet their obligations the harder it gets for them to restore trust. Without trust no Eurobonds.

    5. CommentedJuergen Goebel

      Hello Mr. Stiglitz,
      if I got you right, your main hypothesis is:
      More debt leads to more growth, which leads to higher tax revenue, which leads to a lower debt burden.
      This sound like a very easy and pleansant way to go.
      Unfortunately, the times of strong growth have come to an end, at least for the Western world. Peak oil, for example, lies behind us.
      Moreover, there must be an approriate basis for growth. One necessary part would be a reasonable public service. Unfortunatley, there is none in Greece.
      I believe that the German people have good reasons to become tired of the Euro. The recovery measures are unlikely to be successful, but at the same time they destroy our political institutions, because our politicians have to break promise after promise to take them.

        CommentedMoritz G€d1g

        I doubt that that is what Mr. Stiglitz ment.
        Instead of more debt there is also higher taxes.
        What he said is that the current economy of Greece is not able to pay back it's debt.
        "growth could not be achieved by austerity alone"
        Greece must first start collecting it's taxes properly and raise the productivity of it's administration.

    6. CommentedGabriela Meissner

      I still don't understand why people think that Ms. Merkel is really interested in solving the crisis. I think that she is only interested in winning the next elections in 2013, and therefore she does and says what a felt majority of people in Germany wants to hear.

    7. CommentedGordon Tolleson

      The problem is not understanding the problem, the problem is implementing the solution when soverign countries unlike the "states in the USA" will not give up their soverign rights to unelected official in Brussels.

      The Euro was design originally to make this the solution in the end, but it is not working. While we tend to blame Germany for the Euro's woes we tend to forget the soverign countries overspent and nothing more. They are fiscally constrained and cannot print. Germany is the largest contributor to all of these bailout schemes.

      What makes absolutely no sense to me is Spain must borrow at 6% to loan Italy at 3% and vise vera. This is not going to work at all and anyone stating it will is off their rocker. Math does not lie.

      I think Europes biggest problem to be honest is when they made last minute swaps subordinating all bond holders making them take a loss. The Euro politicians came out of their meeting and immediately announce they would not do this again. The ECB will do it again if they get into trouble. So now they are paying for the mistake.

      Just today Finland and Norway will not approve the new funds unless eveyone else is subordinated to this new scheme. Bottom line to me currently is broke nation loaning money to broke nations borrowing at 6% to loan to others at 3% is never going to work. A fiscal and governmental Union is not going to happen this year.

    8. CommentedLuke Ho-Hyung Lee

      We have developed numerous “job-killing machines” in the real market (or supply chain process) through the use of IT and networking technology over the last 20 to 30 years of the Modern Information Age. These machines have significantly contributed to the shift to a more efficiency-oriented supply side environment by killing jobs and have altered the whole economic environment. Strangely, it seems nobody has recognized this yet, and no expert has considered this at all in his or her public ruminations about the economy.

      Without first replacing those job-killing machines, can we change this worsening course of the employment situation and revitalize the economy? That is, can we solve the current economic crisis only with the old economic policies or stimulus plans? I believe it to be impossible in most existing market or supply chain processes. That’s the real problem.

      I would strongly suggest you see this article: “Job-Killing Machines in the Modern Information Age”

    9. CommentedGary Marshall

      Hello Mr. Stiglitz,

      My. My. How far from reality you reside!

      The great Keynesian system is coming to its Waterloo, I do hope. And all the great Keynesians can do is find fault with irrelevant or extraneous issues.

      All those people who contribute here can only offer the same tried and failed remedies of the past: more government expenditure funded by borrowing.

      Sadly, the Euro does not afford nations the freedom they once had in printing up and squandering all that Federal money. With the Euro, the money has to actually be borrowed, not from the former and always availing national central bank, but from the financial markets.

      And what a wonderful instrument the Euro is. And if all these Keynesian beliefs in government expenditure creating wealth were true, Greece would be among the wealthiest of European nations. But it isn't. So either Keynesian beliefs are wrong, or the Euro is at fault.

      And Mr. Stiglitz, beholden to his dear flawed, corpulent, hideous, wasteful, corrupt, money addicted, slothful child, faults the Euro.

      How much folly one finds in erroneous belief.

      Well, its not the death of the Euro. Its the death of modern Keynesian economics and big, corrupt, and wasteful government.

      And once your Keynesian child finishes puking green slime all over your fine Nobel prize, perhaps you might read through the proof below. Find the true flaw, which seems a bit of a challenge for you, and collect $50,000US.

      It shouldn't take you too long.


      The individual European countries have the means to remedy their current problems with ease. And the means to that end is contained in the little proof below for the abolition of Taxation, which novelty may be absurd on the face of it, but not so when examined.

      If you or anyone can find the flaw in this proof, I shall be more than happy to give the reward of $50,000. None have yet been successful. Perhaps because so few have tried.

      Its not the end of Europe or the world, but a new beginning.



      The costs of borrowing for a nation to fund public expenditures, if it borrows solely from its resident citizens and in the nation’s currency, is nil.

      Why? Because if, in adding a financial debt to a community, one adds an equivalent financial asset, the aggregate finances of the community will not in any way be altered. This is simple reasoning confirmed by simple arithmetic.

      The community is the source of the government’s funds. The government taxes the community to pay for public services provided by the government.

      Cost of public services is $10 million.

      Scenario 1: The government taxes $10 million.

      Community finances: minus $10 million from community bank accounts for government expenditures.
      No community government debt, no community
      government IOU.

      Scenario 2: The government borrows $10 million from solely community lenders at a certain interest rate.

      Community finances: minus $10 million from community bank accounts for government expenditures.
      Community government debt: $10 million;
      Community government bond: $10 million.

      At x years in the future: the asset held by the community (lenders) will be $10 million + y interest. The deferred liability claimed against the community (taxpayers) will be $10 million + y interest.

      The value of all community government debts when combined with all community government IOUs or bonds is zero for the community. It is the same $0 combined worth whether the community pays its taxes immediately or never pays them at all.

      So if a community borrows from its own citizens to fund worthy public expenditures rather than taxes those citizens, it will not alter the aggregate finances of the community or the wealth of the community any more than taxation would have. Adding a financial debt and an equivalent financial asset to a community will cause the elimination of both when summed.

      Whatever financial benefit taxation possesses is nullified by the fact that borrowing instead of taxation places no greater financial burden on the community.

      However, the costs of Taxation are immense. By ridding the nation of Taxation and instituting borrowing to fund public expenditures, the nation will shed all those costs of Taxation for the negligible fee of borrowing in the financial markets and the administration of public

      Gary Marshall

        CommentedMoritz G€d1g

        Gary M. does not like to pay his taxes so he had the idea that the government could simply pay him for financing the common expenditures.

        CommentedGary Marshall

        Hello Ignorant Prince,

        I forgot to add that the public expenditures will be made with an eye to costs and benefits. If the costs of the expenditure are greater than benefits, the expenditure will not be made. Otherwise it will.

        If costs of borrowed money run at 5% and benefits run at 8% of invested capital, then it should be a go.

        So why would anyone have to pay for public expenditures when they pay for themselves?

        For example, access to clean water could be accounted a worthy project with good returns. Dirty or disease laden water can cause a community grievous harm. The local hospital may be overrun with patients suffering all sorts of water borne maladies. The medical costs, lost work days, etc could be erased with a modest investment in purifying the water.

        Simple cost and benefit analysis. If the cost to the community of water borne diseases are $5 million, and construction costs of a water filtration plant $1 million with $1 million in annual expenditures, is this not a valued return to the community? Is it inflationary?

        No because the community now has $3 million per year to go and spend on other items, perhaps better healthcare, better education, a larger home.

        Imagine a shareholder in some company that must issue bonds to raise capital for some major and designedly profitable investment. Suppose he does not wish to buy the bonds and forgoes the offered interest, while others, some not even shareholders, do.

        Is this shareholder a free rider? Is he a free rider because he does not wish to obtain interest, but would rather just enjoy the increased value of his share in the company's new enterprise?

        Perhaps he does not wish to profit twice for a very good reason. Perhaps he holds bonds and earns greater interest from some other concern. Perhaps all his money is tied up in shares of various companies.

        In short, the expenditures by government will pay for themselves with returns sprinkled throughout the nation. Otherwise, they won't be made. Certainly, some investments will fail, but most will generate good returns, and a few spectacular returns.

        I hope this answers your question.

        Gary Marshall

        CommentedGary Marshall

        Hello Ignorant Prince,

        And why would the free rider problem enter into this matter?

        The government is interested only in obtaining revenue for its expenditures. It offers bonds with a market determined interest rate. The bondholder is enriched with interest, as would any bondholder.

        The government obtains its money and makes those needed public expenditures.

        What does the free rider have to do with any of this? That problem so prominent in the system of Taxation disappears when it is abolished.

        So perhaps you had better explain yourself so that I may better respond to your query.

        Gary Marshall

        CommentedIgnorant Prince

        Dear Gary Marshall,

        I admire your tenacity but before posting your opus magnum again I suggest you google "free rider problem" and consider the implications of your proposal. Appropriately, also see Greece, Italy.

    10. CommentedKevin Lim

      Stiglitz's central complaint seems to be that the EU needs to "get real" about the disconnect between the ideal of economic integration and the reality of the little details getting in the way (tax competition, the perceived stability of German banks encouraging capital flight etc)

      In all fairness, the EU cannot "get real" about itself without committing suicide. There is simply no democratic mandate for sweeping political and economic changes needed for greater integration. Even in the boom times getting a new treaty passed was an exercise in frustration. Brussels was a byword for byzantine lawmaking divorced from reality. So you can only imagine what would happen if the leaders tried to sell more "Europe" to their citizens now.

      That being the case, this half-cocked quasi-integration rife with unresolved questions and inconsistencies is already the best of all possible worlds. Methinks the leaders of the EU already know this, and their plan (if you can call it that) is to simply bumble along in the hopes that global growth will eventually pick up again so they can then get back to their usual business of pretending everything is OK.

    11. CommentedStéphane Genilloud

      This is indeed troubling. If the financial markets ask for a 5bp premium on Spanish bonds, why do Spanish people leave their money in their banks.
      As soon as the possibility of a Greek (or Portuguese, or Spanish) gained a reasonable likelihood, most capitals would have been supposed to flee (and thus, to trigger the collapse).
      It looks like there is some confidence that the ECB will come to rescue in the last moment. But then, a question remains, why this 5 bp spread?