"When the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals.
We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues"

( JM Keynes, "Economic Possibilities for our Granchildren" 1930 )

Thursday, May 6, 2010

European Ants and Grasshoppers

The narrative of the Greek (and probably Spanish, Portuguese… ) bailout is accompanied by the reaffirmation of a border line within the EU, a line between relatively stable, prosperous countries and their weak and “spendthrift” partners. Now, as “the party” (i.e. irresponsible spending) is over, the former are being asked to rescue the former and so on. In many respects, the narrative resembles the tale about the hard working Aunt and the Grasshopper*....

The apparent soundness of the narrative overlooks basic economic principles. First of all, there is nothing special in existence of debtors and creditors, that is a normal characteristic of a modern credit economy: For each Grasshopper “spender” there MUST be an "Aunt" lender, for each “irresponsible” country there must be a “responsible” one that is willing to pay the bill.

Second, it is not that bad to have a spender country besides you:Since economic prosperity of nations is measured in terms of production, the very existence of foreign “spenders” ( or even credits ) contribute to the prosperity a country as an outlet for the rich country production. The debt is considered as an asset, so the rich country becomes richer.

Now, lets check out some graphs to analyze who really benefits from the debts. Since Germany is the quintessential “responsible” country, the analysis focuses on German figures

Definition : External balance of goods and services/ Gross domestic product (output approach)

As can be easily noticed from the above graph, since the beginning of the century, the external trade has contributed up to 6% to the German GDP, in other words, German jobs and their relative prosperity relies on external consumers ( otherwise they would be forced to reduce prices or not to produce). It should be noted that such situation cannot last forever, or at least for a huge country like Germany.

And who are these clients?

Source: Bundesbank

The main clients for the German surplus are the partners in Europe 15, a phenomenon that became crucial after the introduction of the Euro (and its predecessor, the ECU). Needless to say, the excessive European excessive consumption was financed by Capital transfers or debts accumulated along the whole decade and the Euro was a main catalyst for that process

How the Euro is linked to the unbalanced trade and debts between European countries? The Euros , the monetary union involved not only the adoption of a common currency but the adoption of similar interest rate. These rates are always a compromise , they are adequate for some countries and might become inadequate for others (too high or too low)

Lets see the evolution of interest rates at the EU compared to the inflation rates:

Source: OECD

As can be seen, since the introduction of the Euro, the short term interest rate set by the BCE was very low, and practically with only two years of real positive ( interest – inflation) in Spain due to its higher inflation. That low and negative interest rates were the drive for a consumption and real estate “Fiesta” which brought about a huge indebtedness of the Spanish economy. Needless to say, the spending frenzy was funneled to purchase foreign products, including Germany´s.

Summarizing: The actual debt problem owes its existence not only to the spending habits but also to the structural weakness of the “prospereous” economies which managed to evade recessions by injecting liquidity and debt to their partners. The conclusion is that the responsibility for the debt crisis is common and therefore the cost of the bailout should be shared by all the Union and not only by the citizens of the countries which are sinking in debts. In other words, in the end we are all A bit of aunts and a bit of grasshoppers ....

* The Ant and the Grasshopper, is a fable attributed to Aesop, providing a moral lesson about hard work and preparation.

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