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Another Eurozone plan or two that skate around the edges

There was an article in UK Guardian last week (September 26, 2014) – Debt forgiveness could ease eurozone woes – which was interesting and showed how far the debate has come. The outgoing European Commissioner for Employment, Social Affairs and Inclusion, László Andor also gave a speech in Vienna yesterday – Basic European unemployment insurance: Countering divergences within the Economic and Monetary Union – which continued the theme from a different angle. While all these proposals will be positive rather than negative they essentially are not sufficient to solve the major shortcoming of the Eurozone – its design will always lead it to fail as a monetary system because they have not accepted that all citizens in each country have equal rights to avoid economic vulnerability in the face of asymmetric aggregate spending changes. That lack of acceptance means the political leaders will never create an effective federal fiscal capacity and the member nations will always be vulnerable to major recessions and wage deflation, which undermine living standards.

I have received E-mails recently and there have been some comments posted in relation to some blogs I have written on the Eurozone which say essentially that I unfairly bracket those who propose solutions to retain the euro but ameliorate the consequences of that retention as being either explicit or implicit supporters of the common currency.

Various justifications are used for arguing within the neo-liberal ‘tent’ for ad hoc solutions, which retain the euro and the fiscal constraints that are associated with it, including – political difficulties in challenging the very existence of the euro, unfairness to international creditors and financiers if the euro is abandoned by any particular nation, increased cross-border transaction costs, and other claims.

All of which have elements of truth. But a progressive position that argues from within the mainstream ‘tent’ inevitably becomes captured by the essential elements of the mainstream view even if the underlying ideology is rejected.

Time and again, we hear progressives arguing for more modest austerity in quantum or time elapse when the actual question is why have austerity at all. The danger of starting to outline a solution for the Eurozone without challenging the basic existence of the flawed currency is that only palliatives are offered which are so heavily compromised and constrained that they provide no lasting solution anyway.

In reviewing the 1971 memoirs by Lyndon Baines Johnson – The Vantage Point; Perspectives of the Presidency 1963-1969 – journalist David Halbertsam wrote in the New York Times – October 31, 1971 that LBJ, in full knowledge that the FBI Director J. Edgar Hoover had amassed a so-called ‘dirt file’ about politicians and public identities, that the President had said:

Well, it’s probably better to have him inside the tent pissing out, than outside the tent pissing in.

Progressives who think for pragmatic reasons they should be in the ‘tent’ rather than challenging the orthodoxy root-and-branch from outside the logic of the current ‘tent’ generally get nowhere and end up supporting, because it is politically easier to do so, outcomes that further entrench the orthodox hold on policy.

I think it is better to point into the tent and start the solution at the very basis of the problem and give the orthodoxy no chance of capturing the argument. From a strategic perspective, it is much easier, in fact, to force the debate into terrain the the mainstream is ill-equipped to deal with, than to dance around the edges of their world view and concepts.

The Guardian article was written by Bob Swarup, who is associated with the British Institute of Economic Affairs. He writes that the:

The eurozone debt crisis never went away. It merely acquired a misleading veneer of resolution thanks to grand promises, political chest-thumping and frazzled financial markets that were desperate to believe in happily ever after.

Which is easy to agree with.

The real economic health of the zone is poor and the large economies are stalled or going backwards, six years since the onset of the crisis.

With entrenched mass unemployment and rising poverty rates, it is no surprise that in Swarup’s words the:

Good Europeans are in decline while populism, nationalism and jingoism are les belles du jour.

The European Project, designed to bring lasting peace to the European continent is now being threatened by the insistence of the elites that a common currency should be imposed under conditions that make that common currency unviable.

Swarup also correctly concludes that “quantitative easing (QE) … is fast becoming a modern-day rain dance. QE is not a cure.”

While the mainstream have struggled to understand this point and in the early days completely mis-represented QE as somehow providing the banks with funds which they could lend out to stimulate the economy, more people are realising that it is no such thing.

It is a portfolio swap – bonds for bank reserves. Bank lending is not reserve constrained and banks do not lend out their reserves anyway, so how can it provide a stimulus effect?

Please read the following blogs – Building bank reserves will not expand credit and Building bank reserves is not inflationary – for further discussion.

Bob Swarup then comes to the essence of his argument:

Europe has a singular problem. It has far too much debt, and in a globalised world much of it is bound in a complex web, particularly among the weaker economies – namely Portugal, Ireland, Italy, Greece and Spain – and their main creditors: France, Germany, the UK and the US.

It is unclear what debt he is talking about. He mixes terms such as “foreign debt” and “sovereign bond market” in the same paragraph.

But I think he is talking about the government debt liabilities issued by the Member States of the Eurozone. Modern Monetary Theory (MMT) scholars would not call this ‘sovereign’ debt because those nations are no longer sovereign in their own currency.

They all use a foreign currency and issue debt in that foreign denomination. Such a government has to issue this foreign denominated debt if it spends beyond its tax revenue because it no longer has currency sovereignty.

A sovereign government is never revenue constrained because it is the monopoly issuer of its own currency. A fundamental difference that goes to the heart of the Eurozone problem.

I also note that his use of the geographic descriptor – Europe – is too general, given the huge divide in terms of the monetary system characteristics between the Eurozone members and the other European nations. The crisis is centred in the Eurozone for a reason.

Which then leads to the obvious conclusion that Bob Swarup is wrong to label the outstanding public debt as the Eurozone’s “singular problem”.

To see why ask yourself why Japan is not facing the same crisis as say Greece is. Japan has much large stocks of outstanding public liabilities than any of the Eurozone nations. Why isn’t its unemployment rate above 20 per cent? Why isn’t it in a constant state of recession?

The answer is clear – Japan issues its own currency, Italy doesn’t. That difference is the singular problem facing the Eurozone member states.

The lack of currency sovereignty is the ‘Causa Causans’ – the real, effective cause of the damage. The debt issues then become symptoms of that underlying cause.

The debt levels would be of no consequence if the nations issued their own currency.

The problem of a lack of currency sovereignty is compounded by the Stability and Growth Pact (SGP) rules that send clear signals to the bond markets that a nation that is hit with a nasty spending collapse sourced from anywhere and which is outside of their control, will quickly spiral into more or less permanent stagnation.

First, its growth collapses, then the fiscal deficit rises along with the public debt as the tax revenue shrinks with declining employment, then the bond markets realise the outstanding debt liabilities cannot necessarily be covered and as a result push up yields, then the maniacs in Brussels invoke the SGP, and spending is further wound back and the vicious cycle perpetuates until there is a full blown crisis.

That cycle of recession is intrinsic to the logic and design of the Eurozone with the SGP on top.

Equally, the net export mania that Germany attempts to impose on the Eurozone when it knows that it cannot possibly be a blueprint for growth for the nations in general (given the significant intra-European trade) is another symptom of what has gone wrong in Europe.

It forces nations, bullied into fiscal surpluses (or a bias towards them) to rely on sending excessive quantities of their real resources to other nations, which could have been used in the nation itself to further the well-being of the citizens, for income growth.

Given his focus on debt, Bob Swarup claims that:

Any solution that does not involve large-scale debt forgiveness is doomed to failure. In the 1920s, the Dawes plan – an ambitious scheme of credit easing to tackle the intractable debts left by the first world war – fuelled an enormous bubble that ended in the great depression, as the underlying reality of sovereign insolvency became clear. It also created a fertile political climate for the nationalism that ended so disastrously more than a decade later. Money is divisive when things turn sour.

Here is a solution for Europe that tackles the root cause.

First, there would be no need for large-scale debt forgiveness if the nations left the Eurozone and redenominated the outstanding euro liabilities into their own currencies. Such a nation could immediately stimulate domestic demand – for example, by announcing the government would offer a (reasonable) mininum wage job to anyone who would like to work on community projects.

The nation could always meet any redenominated debt liabilities in its own currency with no further credit risk.

What Bob Swarup actually means, and he just doesn’t want to admit to it, is that there can be no lasting solution for nations as long as they hang onto the euro as their (foreign) currency and are willing to live within the destructive constraints of the SGP.

The outstanding public debt liabilities under these conditions invoke credit risk and nations need assistance either from the ECB or via debt relief if they are to remain solvent – and – suspended in a more or less permanent state of stagnation.

That is the context of his solution.

Second, the real solution is not related to the outstanding public liabiliites but to the currency in use. The root cause of the Eurozone crisis is the euro and the baggage that surrounds it like the SGP. Get rid of that essence and the crisis disappears as growth resumes and deficits expand to meet the shortfall in total spending.

There is no doubt that Bob Swarup is correct in his assessment that “the system is saturated with debt, much of it bad” but any truly sovereign government can deal with a banking crisis with a stroke of the pen – immediately guarantee deposits, nationalise the failing bank, sack the managers and ensure they surrender any big payouts, and resume business as normal.

Currency sovereignty is very powerful. Nothing that is available or denominated in the currency of issue is beyond the spending capacity of the currency issuing government.

At present, even if there was debt forgiveness in the Eurozone, the next crisis is just around the corner when non-government spending next collapses. Then the nonsensical vicious cycle of rising deficits, SGP imposition, collapsing growth, rising deficits etc and rising political and social instability emerges again – all from the flawed design of the monetary system.

Zero debt, massive debt – the same dynamic will ensure stagnation is the norm.

Bob Swarup, unknowingly gives the game away with his last statement:

Without large-scale debt forgiveness, nothing will change. Rather, Europe will keep re-enacting the same tragedy of small decisions. Japan may have stoically endured two lost decades, but it is far more homogeneous and united. Europe is not.

Does he wonder why Japan is not remotely in the same position as the Eurozone nations? Hint: its all down to the root cause – currency sovereignty or a lack of it.

This point is clearly understood by the outgoing European Commissioner for Employment, Social Affairs and Inclusion, László Andor but his own particular ‘solution’ will also not suffice.

Andor proposes “introducing an automatic fiscal stabilisation scheme at EMU level” in the form of “a basic European unemployment insurance scheme”.

He cites increasing support for the idea from a “number of experts, think-tanks and policy-makers” but fails to mention that all the various supporting proposals accept the logic of the euro and the SGP.

The intent is sound – to elevate fiscal policy as an essential support to economic recovery.

He is correct in noting that “the unprecedented divergence in economic and social outcomes across the euro zone has called into question the ability of the European Union to achieve its core objectives as agreed within the Treaties, in particular balanced economic growth, full employment, social progress and the well-being of its peoples.”

Exactly the opposite is being created and the political classes are “losing people’s trust when it comes to ensuring broadly shared prosperity.”

He correctly concludes that the “main reason for these worrying developments is in my view not the lack of structural reforms, excessive red tape or insufficient global competitiveness of European economies” but “the incomplete structure of the monetary union … [an] … absence of financial instruments that would have supported countries without access to market financing and enabled a continuation of the economic recovery that began in 2010.”

Or more simply – the lack of a federal fiscal function to work, hand-in-hand, with the ECB as the currency issuer.

The ability to make automatic, countercyclical fiscal transfers between Member States using the euro would help resolve the vulnerability faced by nations who are like ‘states’ in a federation such as Australia or the USA.

When economic activity fell and unemployment rose, local spending would be aided by unemployment benefit payments to the nation from Brussels.

But such a scheme cannot usually meet the spending gap left by the decline in private spending. They just attenuate the collapse.

In a severe recession, discretionary fiscal deficits are required to provide the extra spending that is necessary to ensure growth continues and the employment losses are minimised. That capacity is not part of Andor’s proposal.

I considered this proposal in detail in this blog – A Brussels-run unemployment insurance scheme is no fiscal solution.

I won’t repeat the arguments here.

Andor’s idea is that the nations contribute euros to the scheme in good times and draw down in bad times. But that suggestion doesn’t relieve the constraints encountered by having to use a foreign currency.


There are any number of palliative care remedies being proposed by many individuals and groups about the Eurozone crisis.

None of them will solve the intrinsic problem which is the currency itself.

The only way to keep the currency is for the nations to agree they abandon pretensions to a separate destiny and refuse to tolerate massive regional variations in prosperity and put in place major fiscal transfer mechanisms that ensure the rich regions in Germany pay up to allow the poorer regions in Greece, for example, to come up to the same level of public infrastucture, employment and income growth.

That, in turn, would require the ECB to fund whatever deficits were required at the federal level (that is, a new federal fiscal unit is required) and the state level (the Member States).

That, in turn, would require the SGP be abandoned and preferably Overt Monetary Financing become the normal interaction between the ECB and the Federal treasury function, and filtering down to the Member State fiscal functions.

A federal unemployment scheme would be one element in that solution. But it is not the solution in its own right and to hold out otherwise is to just invoke more false dawns.

That is enough for today!

(c) Copyright 2014 Bill Mitchell. All Rights Reserved.

This Post Has 13 Comments

  1. Excellent article! However, I find the characterisation of the Euro as a foreign currency misleading. The Euro is a currency, where commerial banks have the monopoly of issuing it.

  2. Dear Bill

    Another economics blog that I read is Today they have an article about MMT, which is on the whole supportive. You may want to take a peek at it. It is written in German, but you can read that.

    Regards. James

  3. Beside of thanking you to take the time to look at our article I would like to add that we well aware that the Euro can function only if the ECB would fund whatever deficits were required at the federal level and in absence of that the only alternative is to have, eventually, sovereign defaults (“debt restructuring”).
    We offer a pratical solution (down to the detail of the law required to be passed by the Italian parliament) to stop the depression allowing an EU country to act without assistance from the ECB. We say that even inside the EU framework the Italian state can create its own money and finance a massive tax cut (albeit in a roundabout fashion). This would create a conflict inside the EU with Germany, but Italy would have the upper end and it would be up to Germany to make the decision to break up the Euro to stop us
    Note also that there is actually an advantage to create money by issuing tax credits inside the Euro because with Target2 the external deficit that 150-200 billions of tax cuts would create would be absorbed by the Eurosystem (Bundesbank forced to credit Bank of Italy).
    To create unilaterally money (“CCF-Euros”) inside the Eurozone framework would initially be something that minimize the “markets” (currency and bond) reaction and the inevitable crash of the bond market (yields are now between 1% and 2,3% even in Spain and Italy).
    I have no doubt that such policy would be eventually incompatible with the Eurozone structure and would lead at its implosion. But in Italy (and Spain, Portugal..) we have to do something NOW, we cannot wait and we need a practical plan to submit to the electorate to create money and cut taxes right now

  4. Giovanni has a point there IMO. The introduction of a tax-credit currency in Italy could well create an institutional crisis within the monetary union and bring the system to a tipping-point. This said institutional upheavel once it has started is hard to control and may also play in the hands of rightwing nationalists in Italy and elsewhere. Europe is in a big mess any way you look at it.


  5. Hi Larry,

    just sent the Flassbeck article to Bill. So perhaps you can get it from him.


  6. Bill, since Flassbeck came up, at some point it would be interesting to hear your take on his and Costas Lapavitsas’ diagnosis and proposed solutions of the eurozone crisis. As you surely know, they have supported a policy of maintaining upward wage-revaluations to level the competitiveness differences among member states instead of the current austerity + internal devaluation. Especially germany would have to wage-inflate in their scheme. One could surmise that for something like that to work would require some sort of coordinated incomes policy from member states.

    Also thanks for the interesting blog, much appreciated.

  7. Bill,

    have you done any in-depth analyses of the Japanese economy?

    Occasionally, when one argues in favour of fiscal deficits to stimulate demand and growth, people respond that they tried that in Japan over many years and it didn’t work. What would you say in response to that?

  8. for example, here is the economist Scott Sumner:

    “What facts in Japan caused Krugman to change his views on fiscal policy? The only new facts I see is that massive budget deficits in Japan extended over many years lead to the worst NGDP performance of any developed country in world history. What am I missing?”

  9. Hello Bill,
    As a newbie [being an architect/builder] to the world of monetary policy I only recently discovered MMT. But it is very persuasive! It’s about time our politicians stared to take note and amend their tired politically motived narratives.
    I have read and listened to much info on MMT but I have not yet seen anything about how it would work in a collapse scenario. By that I mean an “end of civilization” event, not just a deflation. Like all the other theories it relies on continual growth to work, which is not surprising. But is there a post on dealing with such an event?
    Collapse could take many forms, financial, resource depletion, climate change or a combination of those.
    Jim Rickards posits some likely troubles in this video, but there will be others;

    I also wonder if the gigantic debts we read about in the USA are factored into the MMT pantheon
    In the mirror image graph Stephanie Kenyon is fond of showing there’s no mention of the unfunded liabilities etc.
    Are they accounted for?
    John Doyle

  10. I seriously doubt that Krugmans point of view is ever made public. He used to be an academic but for at least the past 18 years or so he has mostly written or spoken for profit.

    With respect to the quote from Sumner: What elese would you expect of an economist brainwashed in the Chicago tradition.

  11. Scrap the Stability and Growth Pact and get the ECB to finance national deficits,aggressivley.Which would achieve the same thing as the nations re-adopting their own soverign currencies.
    Overt Monetary Financing

    The political attachment to the Euro is strong despite it’s obvious drawbacks.

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