Does Europe threaten world recovery? Lessons for the US

On 12th November 2013 Economists for Peace and Security convened a workshop in Washington DC to discuss Jobs, Investment and Rebuilding America: An economic and national security agenda. In that forum we heard Jason Furman, Chair of the Council of Economic Advisors, deliver a passionate speech in defence of social security and welfare provisions against the encroachments of austerity and debt fetishism. In that same context I was asked to address the question: Does Europe pose a threat to US and global recovery prospects? Here is an audio of what I had to say:

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    • When will you ever get the simple fact that for Germany to have a trade surplus, others must have deficits. In the case of the GIPSIFs huge deficits over a prolonged period of time. So who is to blame, hm? The buyer who lives beyond his means or the producer of competitive stuff?

      Besides, the stuff that the buyers purchase is mostly vendor financed, thanks to the idiotic Target 2 system, backstopped by the German citizens who were never asked if they want to participate in this crazy scheme. They had and have no choice. The buyers had and have – they could simply live within their means.

    • @VSS

      What exactly gives you the idea that Target2, a payments clearing system and nothing else, is backstopped by the German citizens?I have noticed that you have consistently brought TARGET2 to the discussion to prove that somehow Target2 exists so that the southerners can “import for free” but now moving one step further and claiming that German Citizens backstop Target2 is absurd seriously.

      For start, Target2 is a settlement system just like Fedwire in the US.It is comprised by the National Central Banks of the eurozone members and it serves the purpose of settling crossborder payments between eurozone members.Every CB has a Target2 account at the ECB and whenever they credit or debit these accounts their counterparty is always the ECB.
      So for example if I buy something from you ,say for 1000 euros, and pay you with my deposits at Alpha Bank, the Bank of Greece would debit Alpha Bank’s reserve account with 1000 euros and its Target2 Account with 1000 euros. BundesBank would credit its Target2 Account and Deutsche Bank’s reserve account.This would by definition create a deficit of reserves at the Greek Banking System and an equivalent surplus of reserves at the German Banking Systems.

      At normal times such imbalances were corrected through interbank lending e.g. Alpha Bank would borrow the missing reserves from Deutsche Bank that had excess reserves, and it would pay the interbank interest rate.Since the interest that Deutsche Bank would receive on its excess reserves if it left them deposited at the ECB would be smaller than the interbank rate, it would have an incentive to go to the interbank market and find a bank to lend its excess reserves.
      And that is actually what has been happening during the whole period from the adoption of the euro until the crisis.That’s the reason why TARGET2 balance sheet was not so large.

      As the periphery banks started getting under stress and in danger of bankruptcy, Northern Banks deemed preferable to let their excess reserves sit at their reserve accounts earning less interest instead of lending them to risky southern banks.

      To get back to the example,since Alpha Bank is now unable to find the needed reserves at the Interbank Market, it receives an overdraft from the Bank of Greece that is ALWAYS secured with adequate collateral.At the same time the Bank of Greece debits its own Target 2 account and as long as the balance is negative it must pay interest to the ECB at the MRO rate.

      If the Bank of Greece was not allowed to be involved in such an intervention, this would create problems for the ECB in its attempt to establish its targeted interest rate level since it would be the equivalent of not letting the quantity of reserves to float in order for their price to reach the desired by the ECB level.And that is precisely the reason TARGET2 exists.It’s a tool that allows the ECB to maintain control of the interest rates at times when the interbank market is not functioning properly.

      This would be solved by a unified banking union.The fact that such a union does not exist is another flaw of the architecture of the common currency yet AGAIN you try to point fingers to others and even claim that somehow you are backstopping the scheme.

    • I did and the problem with the author is that he has a strange idea about reserve balances.
      Again consider my example above.
      I buy something from you with my very own money (i.e. I didn’t borrow it).This involves a transaction between my bank and yours.Banks ALWAYS settle these transactions with reserves.That’s the sole use of reserves.After this transaction is over my bank is short on required reserves.It can either obtain them from the interbank market (from a bank that has excess of reserves such as yours) or else the local Central Bank is obliged to offer them provided that the bank has adequate collateral to post.

      Where do you as a German Citizen fit into this?What was asked from you for this to happen?
      And why do you call that financing of southern countries while I clearly wasn’t financed by anyone but myself in the above example?
      TARGET2 does not help someone that has no money to earn a free lunch.
      This becomes even more clear if you see that if I move my money from a Greek to a German bank this would too require Bundesbank’s TARGET2 account to be credited and Bank of Greece Target2 account to be debited .
      Does moving my money from one place to another require someone to finance me?
      Have a look at this article:

      There’s one specific risk it mentions in the end:
      “However, central banks in the core countries face one specific risk that can be traced back to the TARGET2 imbalances, and this refers to the possibility that a country might decide to leave the Euro area. In such a scenario, the net claims the remaining central banks have acquired vis-à-vis that country reflect a genuine risk that would not exist without these imbalances. This could in the extreme case of a total break-up of the Euro area, and assuming that the peripheral central banks could not repay their liabilities, mean that the losses would materialise on the Bundesbank’s balance sheet.”

      While this is true, Bundesbank’s balance sheet would show losses, I have to add that this does not necessarily mean that it’s a burden for German taxpayers.Unless ofcourse you have a problem with a currency issuer issuing new money and want to pay a tax instead.

    • @ Crossover

      Apparently the machine translation of Prof. Sinn’ text was not clear enough to explain to you what is really going on with Target 2. I with my rather limited command of the english language and economist terminology can’t do this either. So, sorry.

      Just a remark. You argue ‘..the possibility that a country might decide to leave the Euro area…’ and in the next paragraph you argue ‘…problem with a currency issuer issuing new money…’

      Greece to leave would be more logical, and of course better for Greece, but I myself have no problem with Germany leaving this dysfunctional currency union. As I did repeatedly express in Yanis’ blog.

    • @VSS

      Professor Sinn is since years known for his ideas on Target2 and there have been critics on his views ever since.Nothing new here.If it is difficult for all the “professor Sinns” out there to understand reserve accounting, then that is their problem.After all that’s not the only thing mainstream economists are unaware of.

      Target2 is nothing but a clearing system.And a clearing system is not able to finance deficits.Furthermore since the accompanying assets and liabilities are recorded in the balance sheets of central banks, it is hard to imagine why any potential losses should pose a threat to government budgets.Central Banks being currency issuers, enables them to operate even with negative equity to eternity.Only self-imposed constrains would require an injection of new capital with taxpayers money.
      So whether Bundesbank’s claims on other Central Banks pose a real risk or not is more of a matter of politicial decisions rather than anything else.

  • The last thing a normal person in Ireland needs is a growing world economy.
    A growing world and European economy would further centralize economic commerce.

    The world is collapsing because the village , market town etc has been destroyed so that financial centers could earn interest from a physical economy with limited medium of exchange (also as to subsidize corporations on a vast inhuman scale) ………………..I have just listened to Ben Bernanke asking teachers to make people more dynamic in this strange world we live in……(its strange because monetary activities dictate physical activities and not the other way around)
    Normal people cannot operate at this scale without being crushed…the “dynamic people” who somehow get the remaining scarce credit in their bank accounts (via any means at their disposal) don’t add much to the society either – infact given the probability they must beg , borrow or steal to be successful its likely these new strange monetary creatures subtract from society….but gentle Ben wants people who believe in his debt based system.
    People who train to be better hamsters.

    European institutions will not save you – they are at the heart of this darkness……need I remind you Ireland went into immediate deflation after 1979 when it joined this larger banking union.
    This is a very long term project – a market state project and Europe is at the center of it.

    The solution is simple and always the same – Fiat Kings must rise up and totally destroy banks fiat power.

    Otherwise you remain a pet within their glass cage….a source of wry amusement.

  • I was pleasantly surprised to hear you proclaim that “Greece is dead”, even at a workshop where economists understand the unsaid qualifiers of this statement.

    Do you think it proper, next time you appear on a Greek tv station, to repeat this proclamation (properly phrased and qualified of course, as it applies to a general audience) and to raise the question of *coordinated* breaking up the EZ or at least proclaim that Greece consider exit options, if EZ policies do not change?

    If not, why?

    • The US does not just issue currency…..its double entry shit – very very different

    • Huh? The whole world uses double entry book-keeping I’m not sure where were you going with this.

    • Could it be that double-entry book-keeping, while precious for corporations and households, is meaningless in the macroeconomic sphere?

    • It could very well be meaningless (though I have reasons to disagree) but I don’t see how that makes any difference to the fact J. Galbraith highlighted: US as an issuer of its own fiat currency cannot default on its public debt.

      Whether we use double-entry book-keeping or any other framework to account for this debt has no practical impact to this fact.