Eurozone: How to Drive an Economy in Reverse

By Warren Mosler

February 27 — The situation in Greece brings me back to the conclusion that merely resolving solvency issues in the Eurozone doesn’t fix the economy. Solvency must not be an issue, but if there is negative growth, solvency math simply doesn’t work for any of the Euro members.

Without growth in the Eurozone the resolution (for now) of the Greek crisis will simply result in the focus moving on to one of the next weaker sisters. As this happens the risk remains that other countries in trouble will ask for haircuts on their debt (similar to Greece) as part of their rescue. And that could trigger a general, global, catastrophic financial meltdown.

Follow up:
Monetary and Fiscal Expansion are Needed

My first order proposal remains an ECB distribution on a per capita basis to the euro member nations of maybe 10% of euro zone GDP per year to put the solvency issue behind them. Along with relaxed budget rules, maybe allowing deficits up to 6% of GDP annually, further supported by the ECB funding a transition job at a non disruptive wage to facilitate the transition from unemployment to private sector employment. I might also recommend deficits be increased by suspending VAT as a way to increase aggregate demand and lower prices at the same time.

Alternatively, the ECB could simply guarantee all national government debt and rely on the growth and stability pact for fiscal discipline, which would probably require enhanced authorities.

And rather than trying to bring Greece’s deficit down to current target levels, they could instead relax the growth and stability pact limits to something closer to full employment levels. And, again, I’d look into suspending VAT to both increase aggregate demand and lower prices.

Strong Euro First

However, all policies seem to be ‘strong euro’ first. And the ‘success’ of the euro continues to be gauged by its ‘strength’.

The haircuts on the Greek bonds are functionally a tax that removes that many net euro financial assets. Call it an ‘austerity’ measure extending forced austerity to investors.

Other member nations will likely hold off on turning towards that same tax until after Greece is a ‘done deal’ as early noises could work to undermine the Greek arrangements, and take the ‘investor tax’ off the table.

Like most other currencies, the euro has ‘built in’ demand leakages that fall under the general category of ‘savings desires’. These include the demand to hold actual cash, contributions to tax advantaged pension contributions, contributions to individual retirement accounts, insurance and other corporate ‘reserves’, foreign central bank accumulations of euro denominated financial assets, along with all the unspent interest and earnings compounding.

Offsetting all of that unspent income (private savings) is, historically, the expansion of debt, where agents spend more than their income. This includes borrowing for business and consumer purchases, which includes borrowing to buy cars and houses. In other words, net savings of financial assets are increased by the demand leakages and decreased by credit expansion. And, in general, most of the variation is due to changes in the credit expansion component.

Austerity in the euro zone consists of public spending cuts and tax hikes, which have both directly slowed the economies and increased net savings desires, as the austerity measures have also reduced private sector desires to borrow to spend. This combination results in a decline in sales, which translates into fewer jobs and reduced private sector income. Which further translates into reduced tax collections and increased public sector transfer payments, as the austerity measures designed to reduce public sector debt instead serve to increase it.

Now adding to that is this latest tax on investors in Greek debt, and if the propensity to spend any of the lost funds of those holders was greater than zero, aggregate demand will see an additional decline, with public sector debt climbing that much higher as well.

All of this serves to make the euro ‘harder to get’ and further support the value of the euro, which serves to keep a lid on the net export channel. The ‘answer’ to the export dilemma would be to have the ECB, for example, buy dollars as Germany used to do with the mark, and as China and Japan have done to support their exporters. But ideologically this is off the table in the euro zone, as they believe in a strong euro, and in any case they don’t want to build dollar reserves and give the appearance that the dollar is ‘backing’ the euro.

Three Reverse Thrusters in Use

This works to move all the euro member nation deficits higher as the ‘sustainability math’ of all deteriorate as well, increasing the odds of the ‘investor tax’ expanding to the other member nations – and that continues the negative feedback loop.

Given the demand leakages of the institutional structure, as a point of logic, prosperity can only come from some combination of increased net exports, a private sector credit expansion, or a public sector credit expansion.

And right now it looks like they are still going backwards on all three. And with the transmission in reverse, pressing the accelerator harder only makes you go backwards that much faster.

11 Responses

  1. Fabulous article, Warren! Took my understanding of MMT a notch higher.

    Under the heading “Strong Euro First”, 4th paragraph:

    … foreign central bank accumulations euro denominated financial assets,…

    Should that be “…accumulations OF euro denominated…”?

      1. @WARREN MOSLER,

        I know it’s just your way of making sure we’re paying attention.

        So if direct support of AD floats the economy, what factor MOST contributes to demand leakage and shortens the “float time” (velocity?) of the currency before it gets “tucked under the mattress”? Is there a “Domino Effect” involved?

  2. Warren,
    It is great to see that you are going to be on Nicole Sandlers show, I was the one that told her she should have you on, many of her listeners also chat in Thom Hartmanns chat room, maybe they will promote the idea of him having on his show also. Thom has Bernie Sanders on his show on Fridays and as you know Bernie has several MMT experts on his financial advisory panel, although from what he says, it doesn’t appear that they have quite gotten through to him yet. We all just need to keep trying to get the word out. I have learned so much from reading your site and have been horrified that so many people are suffering needlessly because of a few simple fallacious ideas! I applaud you for all your efforts in trying to help us all!

  3. “Alternatively, the ECB could simply guarantee all national government debt and rely on the growth and stability pact for fiscal discipline”

    This would still mean that austerity continues – I mean if they keep current deficit limits?

  4. In reference to Carney’s recent hedging:
    As far as I understand it, without taxes the private sector would never have fully accepted US dollars or US dollar denominated assets or paper money, in general.

    Taxes provide security that others will need dollars… pay their taxes. It helps reassure you that the guy who bought something from you with a dollar bill today will accept that dollar bill as payment when you buy something from him next week. Without this understanding, now largely obscured by the wide acceptance of a common unit of account, the private sector would not have easily or readily accepted the use and value of government currency.

    Along with legal tender laws, taxes help to give man the rationale incentives to accept the use of dollars as a common unit of account

    Taxes create a demand or value for dollars that would not exist otherwise. People obviously want dollars, but they want dollars to buy things, save, or invest. Taxes corrosively institute collective requirements that people summarily turn over X number of dollars to the government… it can, effectively, destroy them.

    Private sector ultimately ‘needs’ dollars to not only buy, save, and invest, but also to pay taxes. This additional ‘need’ “drives money,” in the sense that taxes serve as a valve by which government regulates private sector demand for the other three things.

    Am I on the right page people?

    1. getting closer.

      whatever the govt says it will accept for payment instantly has ‘value’

      if they said your old shoes could be used to pay $1000 in taxes, for example, they’d be worth that much.

      once the govt establishes a tax liability, and demands something for payment of taxes,
      seller of real goods and services wanting that thing in exchange make their case known.

      and once others see what can be bought for that thing, they too want that thing as a means for getting what’s offered for sale.

      read the 7dif?

      1. @WARREN MOSLER,

        Yeah, much simpler. I was trying to say that. I’ll forget the get the private sector to accept use/value of “fiat currency”.. thing. It’s “whatever the govt says it will accept for payment.”

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