Saturday, July 16, 2011

On European Debt

[[Once again a political post]]

While the U.S. are involved in serious political fights right now, so is Europe. Interestingly, the European media cover the U.S. debt crisis only a bit, and the U.S. media almost completely ignore the European debt crisis.
What's also very interesting is that most articles in the U.S. say that Europe is clearly in decline right now. And most articles in Europe say that U.S. is clearly in decline right now.

Since quite some readers of this blog live in the U.S. I decided to make a post on the European situation. Of course, I'm just an interested non-professional. Remember that before you invest your retirement provisions. :)

Debt crises are only partly about facts; they are mostly about trust. In fact, trust is a fact. In 2010 the EU had a public debt of 85% and a running deficit of 6.4% of GDP. This is much, much better than the U.S., because EU revenue is 44% of GDP. Thus, only about 12% of the public spending is debt-financed, whereas 40% of U.S. public spending is debt-financed. Also, the EU has exported about 1.350 trillion € and imported 1.500 trillion € in 2010 which is way more balanced than in the U.S. (link)


Europe's problem is trust. And it is trust that makes the European crisis more dangerous than the U.S. crisis right now. Also, the European debt crisis is much more difficult to understand than the U.S. one - even for Europeans. But just like in the U.S. there are two basic positions. (Humanity is all about dualisms, isn't it?).

1) Just let the states go broke and save the banks when necessary.
2) Just introduce Euro-bonds so that all states pay for each other indefinitely.

Both positions are no solutions: they are ideologies.

If Europe allowed states to go broke, there is a high chance that the world would drown in flames for a decade and more as more and more banks and then nations needed to be saved while stopping the chain-reaction.
And for a nation to put the trust back into the banking system, it needs to be financially stable. Neither the U.S. nor the EU are anywhere financially stable enough to save a few hundred more banks right now.

On the other hand, while introduction of Euro-bonds would instantly solve the immediate problem, it would also bring along gigantic moral hazards. Greece could suddenly spend money that German tax-payers would need to pay - indefinitely. And the German taxpayers wouldn't be able to (de-)elect the Greece politicians that spend their money!
Moreover, while transfer of wealth is part of every nation, it requires an understanding of 'togetherness'; a common bond. The common bond is not sufficiently strong right now in Europe; mostly because we speak different languages and don't have visible political leaders.

What European and German leaders do right now is a middle course. A very dirty middle course! And I support that. If anything, you can blame politicians for not communicating their strategies to the constituency. But this very communication might actually make it harder or even impossible to go the middle course! Muddling through is what has to be done right now - unfortunately.


Europe will not fall apart due to this crisis. Just like the U.S. will not fall apart due to the tea party. Europe will eventually finish muddling through. Only then comes the really dangerous part! The European Union will have to become more resistant against debt crises. There are two ways to do that:

1) More integration: German taxpayers can elect the politicians that spend money in Greece and vice versa.
2) Separation: A northern EU and a southern EU.

I like (1) more. In the 21st century I want to be able to elect politicians that have global power. Unfortunately, (1) is also the less probable option. A lot depends on the next German and French elections! Major parts of the German opposition prefer (1) as well.

However, more likely is (2) and we can only hope that this process will be peaceful - especially in southern Europe that would suffer a drastic drop in wealth.


Of course, this is just the known unknown. Any revolution in China, war in the middle east (oil price shocks) or major terror attack can change the course of history and violently push us into the unknown unknown. It is going to become an interesting century! - just like the last one.

6 comments:

  1. Why should there be any debt crises? Unless there is a disaster or war, why run a persistent deficit? In the long run they only cost ever more, as banks demand interest on interest.

    I suspect that if these crises were not of their own making, the other nations would be more willing to help them out. Not that Greece or the other nations acted alone, the banking sector was all too eager to hide the problems.

    Somehow it always seems to go back to financiers hiding problems...

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  2. You say, "most articles in the U.S. say that Europe is clearly in decline right now. And most articles in Europe say that U.S. is clearly in decline right now."

    The sad/scary part is that all those articles can be correct at the same time. =(

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  3. The arguments in favour of government debt are usually based on the notion that governments can make more money if they borrow than businesses can.

    Consider - 1) a business borrows 10m to make widgets. After taxes, salaries and so on it makes 1m per year profit.
    2) a government borrows 10m to make widgets. It makes the 1m profit plus the corporation tax is profit the workers' wages taxes are profit and the cash spent in the shops gets taxed too. Plus it saves on welfare paid to formerly unemployed workers.

    because this theoretical example makes it so obviously sensible for governments to borrow this has dominated western capitalist economic policy.

    Unfortunately for ideological reasons governments in the modern west are very opposed to nationalised industry. There are some sound justifications as well as some not so sound ones.

    However the thinking that government borrowing = money fountains as if governments invested the cash they borrow into widget factories has not gone away.

    What they actually spend it on is services, welfare and pensions which is not directly profitable. So we dig ourselves into deeper holes while being assured that government borrowing is a Good Thing.

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  4. Stabs, in the short term, government borrowing is a voluntarily redistribution of wealth from the rich to the poor.

    In the long term it is an involuntary redistribution of wealth from the poor to the rich: compound interest.

    Thus, I am often surprised why the so-called left is so much in favor of gov. borrowing.

    In a short-medium, term gov. borrowing is a powerful economic boost.
    But it always comes at a long-term redistribution from the poor to the rich. Even if gov. eventually prints the money. In that case the poor also suffer the most.

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  5. Yes you're not wrong.

    I think part of the problem is that people are extremely bad at thinking through the consequences themselves. Partly it may be that many people have a phobia of maths and economics, so as soon as numbers are involved people switch their brains off and wait to be told what to vote for.

    What is interesting is that leader figures who people trust so rarely act in people's long term interests. Many of the politicians and government officials involved in building up public debt began as altruistic left wing students wanting to change the world for the better. (eg Tony Blair). What happens to them?

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  6. 1. Bailouts: I think bank bailouts were a massive mistake and repeating them would be insanity. Governments that were concerned about the consequences of large banks failing should have focused on those consequences, not on saving the banks themselves. Looking at the situation in the US, it seems a lot like bailing out the banks just delayed the problem a few years (while allowing the boards to continue to pay themselves tens or hundreds of millions for their "success"). If banking is a critical piece of public infrastructure (like roads, police and fire services) then the government should be running it; if it isn't then the government shouldn't be getting involved when businesses make bad decisions that cause them to fail.

    2. World Government: It would be nice to move towards a more world government, but I can't see how that will happen. In 2009 the world wanted to impose an insurance plan on banks to prevent another collapse/bailout. Canada was the holdout because our banks didn't fail. From the perspective of Canada, a huge shared insurance scheme would be like buying into group fire insurance with a bunch of known arsonists. I don't see how Germany would feel any differently about being co-governed by Greece or Ireland.

    3. Right and left and debt: In North America left and right are quite backwards in terms of deficits. Both Canada and the US had major budget balancing movements in the 90s, spearheaded by the Liberals and the Democrats, respectively. When power shifted back to the Conservatives and Republicans there was a massive run-up of budget deficits (or squandering of surpluses). Of course the public perception is that the right is fiscally prudent and the left is not, regardless of the facts.

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