Serious Problems Emerge For The F-UK-De Group Of Countries

Well, I for one can’t help thinking that it’s now well time we all stopped getting carried away with the use of so many acronyms. Not only may one man’s meat easily prove to be another’s poison, it may even be that for some the entire meal will be so distasteful as to prove totally indigestable. And so it is with the latest set of proposals to appear on that diagnostic lab bench which has been hastily erected in the search for that magic “cure all” for the eurozone’s many ills.

Daniel Gros, in a well meaning, but I feel fatally flawed, move to get us all away from talking about some of the members of our own community as if they were PIGS, has decided to tell us that they are not pigs at all, they are merely GIPSYs. Of course, depending on which way you look at it, such forms of reference could be taken as a compliment (“you sure do eat like a pig”), or not, but stopping to think for a moment about the kind of controversy which has been provoked by the arrival of large numbers of Roma in Italy, perhaps telling the countries which lie on Europe’s periphery that the best way to conceptualise them is as a bunch of “gitanos” is not the best way to get reasoned debate going. Nor is it necessarily the best way to do this to tell the members of core Europe that they as things stand they are essentially F-UK-De. But there it is. That’s just how things are these days.

A Fiscal Adjustment Alone Won’t Work

Now, taking us back a bit nearer to that harsh and horrid reality, Daniel does in fact, in his ill-named Working Paper “Adjustment Difficulties in the GIPSY Club“, actually get to the heart of some very important matters, and really I thoroughly recommend everyone to read it from start to finish. The core of Daniel’s argument is, I feel, the extraordinarly obvious point that the kind of fiscal adjustment currently being proposed for some of the peripheral countries is going to have one, and only one immediate consequence: these countries are going to be sent off to the outer darkness of very, very (see his numbers) sharp GDP contractions, and these contractions run the risk of preciptating pre-Argentina 2000 type situations in one after another of the countries involved, since the contractions in nominal GDP are so large that they effectively take away with the one hand what was given (in the form of sacrfice) with the other, and will lead to a seemingly endless spiral of increases in the debt-to-GDP ratios, which will in turn lead to ever deeper short-term fiscal cuts, and ever stronger contractions, etc, etc.

As Daniel argues, the only way to restore competitiveness, and avoid the dreaded Argentine spiral is to carry out some form of internal devaluation:

“What can Greece do to escape the ‘Argentine’ vicious circle of higher risk premia and a worsening economic outlook? The only way to minimise the cost of the external and fiscal adjustments that are required to… make the situation sustainable is to make Greece more competitive and thus stimulate exports.”

“This can be achieved only by an across-the-board reduction of wages (or rather labour costs) in the private sector of between 10 and 20%. Cuts in wages of this order of magnitude will encounter fierce popular resistance. They could come about either at the end of an extremely painful process when unemployment has reached peaks never seen before or they could come much earlier as the result of an overarching national agreement in which the government, opposition parties and the social partners agree on what is needed in the light of present circumstances. Greece thus needs a concerted effort at the national level not just a government that pushes austerity measures through Parliament.”

So Why Are The Other F-UK-De?

The problem is, conceptualising this situation as one group of fiscally derilict countries having to be controlled by another group of upright and competitive ones does not give us a complete picture of the mess we are all in, as Gideon Rachman eloquently argues in his Dr Schäuble’s Torture Chamber post:

Behind the careful bureaucratic language, Schauble makes some amazing claims and proposals. Here are just a few.

“All eurozone members must return to adherence to the stability and growth pact as rapidly as possible.” This is just hypocrisy. I was living in Brussels when the pact was gutted the first time – because Germany and France were unable to keep within the 3% deficit limit.

Schauble also seems keen to resurrect the main feature that made the stability and growth pact lack credibility in the first place: the notion that countries that are running out of money need to be shocked back onto the path of virtue and prudence by being fined – a move that would obviously worsen their financial plight.

Basically, as Rachman argues, we all need to calm down a bit here, and get things rather more in persective. In the first place the Eurozone’s economies – as I keep arguing day in and day out – are all roped together via the system of current account deficits and surpluses.

This is a point France’s finance minister Christine Lagarde draws attention to in an interview in this morning’s Financial Times. As M. Lagarde says:

“[Could] those with surpluses do a little something? It takes two to tango,” she said in an interview with the Financial Times. “It cannot just be about enforcing deficit principles.”

“Clearly Germany has done an awfully good job in the last 10 years or so, improving competitiveness, putting very high pressure on its labour costs. When you look at unit labour costs to Germany, they have done a tremendous job in that respect. I’m not sure it is a sustainable model for the long term and for the whole of the group. Clearly we need better convergence.”

Well, let’s leave aside today the issue of whether or not convergence is a realitistic (or even a possible) objective for Europe’s economies given the large demographic mis-matches between countries, but still, Lagarde is on to something. What we don’t have is a situation where on the one hand we have everything for the best in the best of all possible worlds, while on the other we have a group of slouchers and forgers. This kind of thing makes for nice headlines, but it is far from corresponding to reality.

Another reason the F-UK-De group are in trouble if the GIPSYs wander off to the outer darkness, is that they will have issues to resolve in their banking systems, as the chart below reveals. German banks may have little exposure to Greek debt, but their exposure to Spain and Ireland is enormous.

In fact, the massive exposure of German and French banks to Portugal, Ireland, Greece and Spain offers part of the explanation as to why Europe’s biggest economies have been steadily moving to rescue their southern neighbors in recent days, according to a recent report from Societe General entitled “Shotgun Greek Wedding.” According to the report banks in Germany and France alone have a combined exposure of $119 billion to Greece and $909 billion to the four countries, according to data from the Bank for International Settlements. Overall, European banks have $253 billion in Greece and $2.1 trillion in the four countries collectively referred to as the “PIGS”.

“The exposure is enormous,” said Klaus Baader, co-chief European economist at Societe Generale in London. “The crisis in Greece isn’t Greece’s problem alone but a concrete problem for Europe’s whole banking sector. That explains the interest of finance ministers in stabilizing the situation.”

Defining Moment?

Gideon Rachman admitted that this one felt like a significant moment to him, and I am inclined to agree. We have two proposals on the table, and neither of them will work. In the first place simply treating the problem on Europe’s perifery as an essentially fiscal one will not return these countries to competitiveness, and will simply precipitate GDP contractions, and deflationary spirals, that will lead inexorably towards failure, defualt, and possibly exit from the Eurozone (which, in fact, Herr Schläuble seems to feel would be an acceptable outcome to all this).

On the other hand, A Germany (or a Japan) which is not able to maintain a substantial external surplus (which is the only way a country with their kind of demographic profile can attain headline GDP growth, since internal demand is long gone as a “driver”) since without a surplus and without GDP growth the implicit liabilities of ageing populations (via health and pension commitments) will become unpayable, leading to default (or a huge slashing of public welfare commitments) in these countries too.

Wolfgang Munchau also seems to think it is decision time. As he argues in his Op-ed in today’s FT, “Shrink the eurozone, or create a fiscal union“. I know which side I am on. As Joaquín Almunia once argued, people would need to be crazy to leave the Eurozone. So let’s get on with it, and go climb that hill which lies out there in front of us.

This entry was posted in A Fistful Of Euros, Economics and demography, Economics: Country briefings by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

37 thoughts on “Serious Problems Emerge For The F-UK-De Group Of Countries

  1. Good post, Edward. The Bloomberg chart shows a way overstated exposure to Greek loans for Switzerland, though. This is because EFG Bank Ergasias has a Swiss-based holding company. If you discount their loan book, the actual exposure of Swiss banks to Greece is quite immaterial, as per SNB statistics.

  2. Edward,

    I don’t know when Christine Lagarde gave that interview, but I suppose yesterday’s elections may have something to do with it. I think it’s a bit absurd to argue that convergence should be achieved on the lowest common denominator just because that pleases the political class in a number of countries. Maybe I’m too German in this respect, but given the political and economic costs of reform that Germany had to go through at the beginning of the decade (partly because of *external* pressure!), given the enormous windfalls in borrowing costs that were suddenly available to other countries because of a credibility transfer under the Maastricht regime, the current criticism of Germany for being too successful strikes me as a bit hypocritical.

  3. What I fail to see is why we cannot accept that the assumption that the Eurozone economies would converge was utterly wrong in the first place. The different philosophies on how to run an economy will not fade. They will stay and and given that, there’s only one solution: dissolution of the Eurozone. Either by Greece et al. leaving the Eurozone or by Germany and the countries of the former DM bloc doing exactly that. It will obviously cost a lot. But all these other proposals…debt union et al…are no good alternatives. Because they entirely rely on Germany feeding bill after bill, in addition to the bills Germany already feeds (think about the hundreds of billions Germany has given since 1990 despite the enormous costs of reunification). How long do you think German taxpayers are going to tolerate this? You cannot hold the Germans hostage forever by invoking its historical responsibility and ask for ever more payments. And neither can the German export lobby. Because at some point the hidden anger will result in the break up of Germany’s all-party-commitment to Europe (which by now means is representative for the German population) which would bring radical changes to Germany’s policy towards Europe. I don’t think anyone could reasonably wish for that. And I do see what a fiscal retrenchment of 9 % of GDP in 3 years will do to an economy already in recession. Certainly not a good idea. So let’s think about a realistic exit option for everyone. And while we’re at it, we could also think about breaking up all these oversized and much too powerful banks.

    By the way, there’s been another proposal by Schäuble concerning the creation of the EMF. The Bundesbank should give its gold to the EMF. Luckily, he cannot decide over that. And I must admit that -in my eyes- it would be nothing less than treason.

  4. Lagarde was very excellent in her criticism that the German competitiviness is built on the low wages – the famous German Lohnzurueckhaltung. This can not be a recipe for the whole EU, because the EU can not become a big IG Farben novum.

    In Germany there is a huge tradition of a low wage sector also after the IG Farben. This worked very well with turks and yugos in 60-ies and 70-ies. However, somewhere this will be exausted. Human ressource reserves in CEE are also exhausted. So there will be alot of problems faced by the German Rentners.

  5. Pingback: Tug o’ War Franco-German Style with Greece As The Center Line « Deep Thoughts by Professor Pinch

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  7. german companies don’t pay low wages, especially not in the manufacturing sector. Look at that chart

    verarbeitendes Gewerbe=manufacturing sector

    as you can see in the chart, the low wages are in the private service sector (right).

    That’s why I’m convinced that deflation in spain or greece won’t help, their wages are still significantly lower than german wages.

  8. I suppose some politicians somewhere must be sitting and thinking “Let’s see, leaving the Euro and devaluing hurts foreign Banks, while internal deflation hurts my voters. Boy, that’s a toughie.”

  9. But the Angela is now suggesting that spaniards must use the EU Structural funds to build their own Mercedes factory, the same size as in Germany, and start to produce their own Big Berthas in order to export to Germany.

  10. The consolidated exposure figures coming from the BIS are misleading (practically as misleading than the gross notional of derivatives report that is frequently touted in the press). It essentially takes the whole balance sheet of subsidiaries in a country and show it as liabilities.
    In reality, economic exposure is much lower for two reasons :
    – local subsidiaries rately enjoy full guarantee from the parent.
    – even when there is substantial funding from the parent (because of a loan to deposit ratio > 1), the controlling parent has large capability to pick and choose the best assets as collateral for such intergroup lending.
    If the SHTF, the parent mostly has to write off its equity participation, painful but far from deadly.
    In the case of Ireland, banking subsidiaries there are essentially portfolio companies that holds assets all throughout the world, not in Ireland (Ireland is just an attractive tax location).
    The size of exposures can certainly rock the boat and wipe off the equity of some Banks here and there with 1 EUR nationalizations, but certainly not endanger the financial system. The latter meme is just propagated by Bank bosses that want to keep their bonuses rolling. If GIPSI go down, it will be the end of the eurozone, but not the end of the world, nor the end of Europe.

  11. ‘Because they entirely rely on Germany feeding bill after bill, in addition to the bills Germany already feeds (think about the hundreds of billions Germany has given since 1990 despite the enormous costs of reunification). How long do you think German taxpayers are going to tolerate this?’

    To what extent is this reality and to what extend is this a myth?

    The situation between Germany and her peripheral ‘partners’ looks increasingly like the Wild West mining town caricature where the mine owner owns also the town, the Sallon, the Hardware and Grocery stores and the Bank.

    If the average German worker and tax-payer has not seen much good out of his sacrifices and his effort to increase his country surpluses via increasing competitiveness, its time for him to look his side of the border for the reason. German firms have been making good money out of Southern Europe which borrows from German Banks to finance import of German goods.

    Someone in Germany must be better off out of this deal. If it isn’t the average German, don’t blame your employers’ customers for that.

  12. Daniel,

    a good picture – it shows that the CEE does not get back from the EU even what they pay in.

  13. Generally these pictures showing net in and outs from the EU budget are very misleading. For instance, they do not show payments from the EU budget for quasi “common interest tasks”. Example – the Framework programm of 60 bn. Germany gets 30 bn from it, but this is somehow not shown in the balance. Despite the fact that this programm is mainly distributed by experts, officials, directors from Germany and mainly benefits German recipients. The CEE gets less than 1% from this programm.

    Other common programmes as EEN etc. etc. are also mainly benefitting German recipients because the distributors are mainly from Germany.

  14. @NikosR
    I didn’t blame the employers’ customers for anything. I just said they cannot ask for ever more money because they already DO receive a lot. They should stop seeing it as normal that other countries gift them money year after year. That’s it. How about starting to produce stuff that somebody would want to buy? A brief look into the Greek trade statistics for example reveals that the country does not only run an unsustainable trade deficit against Germany but also against the rest of the world. For some reason, this tends to be forgotten all the time. It’s not Germany’s fault that Greece has little to offer. I’m sorry to say that.

    You may take a look at this graph showing net benefits over the 2007-2013 period as planned by the EU:

    Here’s the briefing note for the EU budget which also contains the figures:

    Based on that, I’d say that Germany pumped at least €150 bn into the EU since 1990.

  15. To German,

    at the same time Germany is offering on the CEE market a lot of Chinese goods, which are, however, not more taxed with customs tax, if they enter through Germany. Milk powder with melanine leads, for instance.

  16. @ A German

    I don’t want to appear as saying that the Greek et al problem is solely a German creation. I just need to challenge the fact that a large percentage of the German population believes they have been channeling money to other countries just because they have been generous.

    Germany would be much worse off if it were not for the EU and the Eurozone. This is something Germans need to understand and stop moaning that much. What Germany did not succeed in doing in two World Wars, it managed to do through the EU and the Eurozone. I.e. create a large and largely protected market for itself. I say good for her, but please stop moaning about it.

    It’s no good looking just into the European structural funds transfers without looking into the greater economic relationship between Germany, German finacial institutions and German industry, and it’s partners. And btw that should include arms deals also.

  17. govs,

    Chinese goods imported via Hamburg are still chinese goods, your fixation with milk powder notwithstanding.


    you are making in your last post the standard pro EU argument used in Germany: Yes ,we are a big net payer but the exports to the rest of the EU are worth it. A conventional but from my perspective convincing argument.
    The net payer position as such is not a myth. 8.7 Billion is substantial and Germany has been a big net payer ab urbe condita.

    Now it is true that sometimes the sums payed to the EU are made even larger. And they have to be put in context: Per head the Netherlands and Sweden are bigger net payers.

    But the net payer position, sometimes grown in the telling is common knowledge in Germany. And that countries to our south and east are net recipient is also known.
    That is the background to same of the more negative reactions to the current greek crisis.

  18. “Germany would be much worse off if it were not for the EU and the Eurozone. This is something Germans need to understand and stop moaning that much. What Germany did not succeed in doing in two World Wars, it managed to do through the EU and the Eurozone. I.e. create a large and largely protected market for itself. I say good for her, but please stop moaning about it.”

    But Germany did not create a stable market with the Euro. We essentially created a bubble.
    It is true that the EU and the common market are to Germany’s advantage. Whether this is true for the Euro is doubtful.

    And it is of course not in Germany’s interest to force many southern trading partners into a deep recession as we are doing right now. But if you want to stay within the Euro there’s no other way.

  19. IM,

    milk powder sold by a mystical GmbH is a German export of Chinese milk powder polluted with melamin.

  20. ‘But if you want to stay within the Euro there’s no other way’

    Personally I’m one of those who advocate that joining the Eurozone was a really bad move in the first place. At least for Greece it was motivated by geo-political rather than economic judgement and I’m sorry to say that even those geo-political interests have not been served well. About the only ones who have really benefited from Euro entry have been the Banks and the importers of foreign (yes mostly German and Chinese) goods. BTW many of them used to be manufacturers and/or exporters before.

    Regarding what to do now I don’t feel either economically neither politically savvy enough to express an opinion about whether it would be better to stay in the Eurozone or make a run for our lives.

  21. And btw judging from the latest happenings in Eurogroup I don’t believe Germany is forcing Greece into a depression. I think she is forcing Greece to leave the Eurozone. I just hope that when that happens our government will have the guts to default as well.

  22. Will the government have a choice if Greece leaves? If debt remains to be denominated in Euro and, as I expect, the new Greek currency gets substantially devalued, Greece will hardly be able to service the debt. Or am I missing something here?

  23. I’m not sure what exactly you are saying. Fact is that if Greece exits the Eurozone (btw. no one seems to be sure if this means automatic exit from EU also), this has to happen together with some kind of debt ‘re-negotiation’. Of course this is not very welcome by DB or other such lenders is it?

    This is a Catch-22 for the whole of Europe and as long as the leading power in Europe continues to maintain its uncertainty about what to do next (see recent pro-IMF vs ant-IMF debate in Germany) all options for the Greek Government should remain open.

    The worse prospect for Greece (and I’m afraid the most probable one at least in the short term) will be for Greece to remain in the Eurozone while in the same time she turns to the IMF for lending rate support. This will just make Greece a new Latvia, only worse, and I’m not sure if this will be sustainable politically in the medium term.

  24. NikosR,

    the EU has already become the World capital of schizophrenia. EU2020 strategy provides for 3% spending for Science and Technology, but IMF has cancelled all this entirely.

    EU2020 asks to lower powerty, but at the moment Latvia is in a state in which it was during WWII. Never during the Soviet period even in the worst dreams we have seen something like that what we have today. Almost all rural schools are closed. Rural children are not educated at all.

    Last week a man died in the northern Latvia from hunger.

    People are walking on the streets with open wounds, missing eyes, ragging extremities.

    Greece has some hope, anyway, because the last package for Ukraine provided for much less severe austerity measures as Latvia had imposed on it.

  25. @Nikos
    I meant that the the Greek government may not be able to choose between defaulting and not defaulting if Greece leaves. After all, the new currency would plummet against the Euro. How is Greece than going to service Euro denominated debt?

    Isn’t the Latvian problem a home-made one? After all, you could give up the Euro peg…

  26. Oliver,

    therefore Greece has to default and massive bank restructuring will set in France and Germany.

    About Latvia – have you ever read about the problems with Latvian peg, contagion problems etc.? You are saying something silly. Like I would say Germans have elected Hitler because of extreme charming of this personality.

    Do you know about pressure built by ECB when Lithuania decided to move currency board from Central bank to independent institution as in Poland?

  27. @ A German

    That’s the idea. Now, let Focus and Bild do the calculation about the cost to German banks.

  28. Only a month ago, openly talking about exit from the Euro and defaulting here in Greece, people would take you for a fool. This is changing rapidly. Food for thought. It’s not only the German public who can influence things…

  29. btw, I was just reading that according to SIPRI, Germany has been the 3rd largest exporter of military material (after the US and Russia) for the period 2005-2009, with 11% market share. Guess who are the 2 best customers of Germany. Turkey with 14% and Greece with 13%. Again food for thought..

  30. @Nikos
    I’m a afraid to say that…but it’s possibly a lot easier to sell another bailout for the banks to the public than a bailout for Greece. It’s as simple as that.

    It’s true that the German arms industry massively benefits from the Greece spending spree? However, German arms exports certainly do not lie at the root of the Greek-Turkish conflict. It’s Greece’s and Turkey’s inability to solve their tensions that benefits the arms industry. And if they weren’t buying from Germany they’d buy from the US, Russia or France.

    I’m aware of the issues surrounding the peg. The smart thing would have been not to put it in place. I can’t help myself but many of the new member states let things happen to happen that they should never have accepted in the first place. I don’t care for the reasons but it appears that there’s no such thing as a free lunch. Everything comes with a price…

  31. You are speaking, dear German, just the next bullshit, and your morals are amoral. Your texts are so incompetent, so I am becoming impression you are just a typical product of the German Baumschule/Fahrschule/Tanzschule.

    The New Member States are OBLIGED to introduce the EUR, ohne wenn und aber. Since Baltic states have not used monetary policy already 8 years before 2004, and their currencies were pegged long time to: Estonia to DEM, Latvia to SDR, Lithuania to USD, it was just natural to refix it to EUR when entering the EU. It was widely accepted on both sides. The EU at that time was very hardly pressing the New Member States for EUR introduction. For Baltic States the terms were designed unrealistically stringent.

    What is the real problem – the absolute disintegrity, divergence and inconsistence of the EU policy determined by Old Member States. It is based only on the actual momentary situation. There is no continuity of this politics, no solidarity, no consequent realisation. Just a small change in the external situation and Angela is speaking 180º to what she said yesterday. This is the problem.

    Maybe the Soviet Union was really a bit old-fashioned and stagnating, but so silly was it not.

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