Please explain this Economist article on the Euro.
September 19, 2011 7:02 AM Subscribe
Can you please help me understand this Economist article?
In particular, I'm confused by these passages. From where to where is money really flowing?
The ECB must declare that it stands behind all solvent countries’ sovereign debts and that it is ready to use unlimited resources to ward off market panic.
What exactly does this mean? The ECB would act as guarantor? Who exactly is providing this money? Is it being simply printed and bonds being purchased with that newly-printed money, or what? Where are these resources really coming from?
The sobering truth about the single currency is that getting in is a lot easier than getting out again. Legally, the euro has no exit clause. If Greece stormed out, and damn the law, as it might yet have to do, it would suffer a run on its banks, as depositors withdrew euros before they were forcibly converted into devalued new drachma. It would have to impose capital controls. Greek companies with international bills would risk bankruptcy, as they would suddenly be without the cash to cover them; and the pressure on other wobbly countries would increase. That is why we favour restructuring Greece, but letting it stay in the euro.
Why would Greece consider leaving the Euro? Why does that benefit it over and above simply defaulting on its sovereign debt? Why would "the pressure on other wobbly countries increase"? Would the average Greek citizen see inflation if that happened, or what, and why?
If, on the other hand, a strong country like Germany walked out of the euro, probably taking other strong countries with it, the result would be just as terrible. The new hard currency would soar, hitting German exporters. Turmoil in the rump of the euro zone would batter export markets just as the north’s firms became less competitive.
What's the turmoil here? Why would the north's firms become less competitive? What's the advantage to Germany in leaving the Euro?
German banks and companies, in a mirror image of what would happen in Greece, would suffer from the sudden devaluation of euro assets outside the new hard-currency zone.
English please?
And the rump might still break apart, as Italy or Spain would not want anything to do with Greece.
What's "the rump"? And what does it mean to say it could break apart, exactly?
In particular, I'm confused by these passages. From where to where is money really flowing?
The ECB must declare that it stands behind all solvent countries’ sovereign debts and that it is ready to use unlimited resources to ward off market panic.
What exactly does this mean? The ECB would act as guarantor? Who exactly is providing this money? Is it being simply printed and bonds being purchased with that newly-printed money, or what? Where are these resources really coming from?
The sobering truth about the single currency is that getting in is a lot easier than getting out again. Legally, the euro has no exit clause. If Greece stormed out, and damn the law, as it might yet have to do, it would suffer a run on its banks, as depositors withdrew euros before they were forcibly converted into devalued new drachma. It would have to impose capital controls. Greek companies with international bills would risk bankruptcy, as they would suddenly be without the cash to cover them; and the pressure on other wobbly countries would increase. That is why we favour restructuring Greece, but letting it stay in the euro.
Why would Greece consider leaving the Euro? Why does that benefit it over and above simply defaulting on its sovereign debt? Why would "the pressure on other wobbly countries increase"? Would the average Greek citizen see inflation if that happened, or what, and why?
If, on the other hand, a strong country like Germany walked out of the euro, probably taking other strong countries with it, the result would be just as terrible. The new hard currency would soar, hitting German exporters. Turmoil in the rump of the euro zone would batter export markets just as the north’s firms became less competitive.
What's the turmoil here? Why would the north's firms become less competitive? What's the advantage to Germany in leaving the Euro?
German banks and companies, in a mirror image of what would happen in Greece, would suffer from the sudden devaluation of euro assets outside the new hard-currency zone.
English please?
And the rump might still break apart, as Italy or Spain would not want anything to do with Greece.
What's "the rump"? And what does it mean to say it could break apart, exactly?
The article isn't written too well. It stems from this contradiction:
None of this will work unless the Europeans create a firewall around the solvent governments. That means shoring up euro-zone sovereign debt. Spain and Italy owe €2.5 trillion. What if the markets suddenly took fright over Belgium or France? Some have argued for a system of Eurobonds in which every country’s debt is backed by all. But the political oversight to ensure that high-spending countries do not fritter away other people’s money would take years to sort out—and one thing the euro zone does not have is time. The answer is to turn to the only institution that can credibly counter a collective loss of confidence on such a scale.
The ECB must declare that it stands behind all solvent countries’ sovereign debts and that it is ready to use unlimited resources to ward off market panic. That is consistent with the ECB’s goal to ensure price and financial stability for the euro zone as a whole. So long as governments are solvent and the bank sells the bonds back to the market after the crisis, this does not amount to monetising government debt. In today’s recessionary world, the ECB could buy several trillion euros-worth of bonds without unleashing inflation.
The article is trying to explain how to preserve a currency that is pegged to the collective prospects of several countries' economies and yet can't be damaged by any of those economies. Such a thing is not possible, of course, so the writer of the article dances around it by acting as if a central bank is an unlimited spring of stabilizing fund (you are right, it increases the money supply by printing and is an inflation risk) and deduces from this that countries like Germany leaving the jurisdiction of the ECB must necessarily become more troubled than they currently are troubled by the poorly performing countries sharing the Euro with them.
posted by michaelh at 7:27 AM on September 19, 2011
None of this will work unless the Europeans create a firewall around the solvent governments. That means shoring up euro-zone sovereign debt. Spain and Italy owe €2.5 trillion. What if the markets suddenly took fright over Belgium or France? Some have argued for a system of Eurobonds in which every country’s debt is backed by all. But the political oversight to ensure that high-spending countries do not fritter away other people’s money would take years to sort out—and one thing the euro zone does not have is time. The answer is to turn to the only institution that can credibly counter a collective loss of confidence on such a scale.
The ECB must declare that it stands behind all solvent countries’ sovereign debts and that it is ready to use unlimited resources to ward off market panic. That is consistent with the ECB’s goal to ensure price and financial stability for the euro zone as a whole. So long as governments are solvent and the bank sells the bonds back to the market after the crisis, this does not amount to monetising government debt. In today’s recessionary world, the ECB could buy several trillion euros-worth of bonds without unleashing inflation.
The article is trying to explain how to preserve a currency that is pegged to the collective prospects of several countries' economies and yet can't be damaged by any of those economies. Such a thing is not possible, of course, so the writer of the article dances around it by acting as if a central bank is an unlimited spring of stabilizing fund (you are right, it increases the money supply by printing and is an inflation risk) and deduces from this that countries like Germany leaving the jurisdiction of the ECB must necessarily become more troubled than they currently are troubled by the poorly performing countries sharing the Euro with them.
posted by michaelh at 7:27 AM on September 19, 2011
Who exactly is providing this money? Is it being simply printed and bonds being purchased with that newly-printed money, or what? Where are these resources really coming from?
It would be provided by the richer countries like Germany. It would come from taxes they collect from their citizens or from money they borrow using their superior credit rating.
posted by Paquda at 7:29 AM on September 19, 2011
It would be provided by the richer countries like Germany. It would come from taxes they collect from their citizens or from money they borrow using their superior credit rating.
posted by Paquda at 7:29 AM on September 19, 2011
Not an economist, not your economist, this is not economic policy advice: What exactly does this mean? The ECB would act as guarantor? Who exactly is providing this money? Is it being simply printed and bonds being purchased with that newly-printed money, or what? Where are these resources really coming from?
Since they mention "unlimited resources" yes, I think they mean printing money.
Why would Greece consider leaving the Euro? Why does that benefit it over and above simply defaulting on its sovereign debt? Why would "the pressure on other wobbly countries increase"? Would the average Greek citizen see inflation if that happened, or what, and why?
One tool for states with troubling amounts of debt is to inflate their currency and effectively reduce the value of their debts, but Greece can't do this because they don't control their own currency. If they left the Euro and established their own currency I think the average Greek would certainly see inflation in that situation and the transition to a new currency would probably be a huge mess as the Euro would be much more valuable than the "New Drachma" and imports would become very expensive. On the other hand, a default might end up having the same result: Greek leaving the Eurozone. The pressure on other states may increase as markets, learning from Greece, become less-willing to lend to other shaky countries.
What's the turmoil here? Why would the north's firms become less competitive? What's the advantage to Germany in leaving the Euro?
If the stronger Euro states are separated from the rest the value of the Euro relative to other currencies will increase, which is bad for exports as it is more expensive for other countries to buy your goods, which could mean increased unemployment. There might be political support in Germany for leaving the Euro as taxpayers see themselves as constantly bailing out their irresponsible neighbors but I'm not sure it would be actually economically beneficial.
German banks and companies, in a mirror image of what would happen in Greece, would suffer from the sudden devaluation of euro assets outside the new hard-currency zone.
I don't know what this means either.
What's "the rump"? And what does it mean to say it could break apart, exactly?
They're referring to the economically weaker euro nations like Spain, Italy, Greece, Portugal, and Ireland. Presumably right now their interests are aligned so they are something of a political power bloc but if Greece goes down the other nations may split apart, politically.
posted by ghharr at 7:32 AM on September 19, 2011
Since they mention "unlimited resources" yes, I think they mean printing money.
Why would Greece consider leaving the Euro? Why does that benefit it over and above simply defaulting on its sovereign debt? Why would "the pressure on other wobbly countries increase"? Would the average Greek citizen see inflation if that happened, or what, and why?
One tool for states with troubling amounts of debt is to inflate their currency and effectively reduce the value of their debts, but Greece can't do this because they don't control their own currency. If they left the Euro and established their own currency I think the average Greek would certainly see inflation in that situation and the transition to a new currency would probably be a huge mess as the Euro would be much more valuable than the "New Drachma" and imports would become very expensive. On the other hand, a default might end up having the same result: Greek leaving the Eurozone. The pressure on other states may increase as markets, learning from Greece, become less-willing to lend to other shaky countries.
What's the turmoil here? Why would the north's firms become less competitive? What's the advantage to Germany in leaving the Euro?
If the stronger Euro states are separated from the rest the value of the Euro relative to other currencies will increase, which is bad for exports as it is more expensive for other countries to buy your goods, which could mean increased unemployment. There might be political support in Germany for leaving the Euro as taxpayers see themselves as constantly bailing out their irresponsible neighbors but I'm not sure it would be actually economically beneficial.
German banks and companies, in a mirror image of what would happen in Greece, would suffer from the sudden devaluation of euro assets outside the new hard-currency zone.
I don't know what this means either.
What's "the rump"? And what does it mean to say it could break apart, exactly?
They're referring to the economically weaker euro nations like Spain, Italy, Greece, Portugal, and Ireland. Presumably right now their interests are aligned so they are something of a political power bloc but if Greece goes down the other nations may split apart, politically.
posted by ghharr at 7:32 AM on September 19, 2011
Best answer: Is it being simply printed and bonds being purchased with that newly-printed money, or what?
Yes, pretty much. The central bank, like all central banks, is in the business of "printing" money.* A declaration that the ECB "stands behind" European sovereign debt is essentially a declaration that they are willing to increase the money supply as needed to inflate away as much debt as is needed.
This hasn't really happened yet. Thus far, bailout efforts have all involved negotiating with individual governments to put up actual money, i.e. tax revenue, to buy bonds.
Why would Greece consider leaving the Euro? Why does that benefit it over and above simply defaulting on its sovereign debt? Why would "the pressure on other wobbly countries increase"? Would the average Greek citizen see inflation if that happened, or what, and why?
The problem here is that in most cases, countries that run into sovereign debt problems can use inflation to get themselves out of a hole. The thing about debt is that it's kept track of in currency units, and there's always the possibility that a sovereign country can simply increase the number of units available to make paying off the debt easier. Unless the number of units is controlled by someone else. Greece can't inflate away its debt right now because it doesn't have control over its monetary policy. If it did, it could introduce inflation to make servicing its debt easier.
Of course, this has negative consequences a lot of the time. Inflation is great for debtors but bad for creditors and investors, so a currency experiencing a lot of inflation discourages foreign investment. Sovereign default does too, but inflation is generally viewed as a less serious move than simply defaulting, so the consequences tend tend to be worse in defaults. Like, say 1789 France.
The benefit to the rest of the Euro is that now they've got one less shaky economy to deal with, making it that much easier to take care of what shakiness remains.
It's not entirely clear what difference Greek citizens might notice. Their fiscal numbers are in such bad shape that some kind of austerity was probably in the works anyway. Tax compliance is ridiculously low, and it's become apparent that there really are no reliable accounting numbers for what the government has done for most of the past ten-odd years. But it's possible that the austerity measures might not be as bad if inflation were an option.
What's the turmoil here? Why would the north's firms become less competitive? What's the advantage to Germany in leaving the Euro?
Because right now, the EU has been able to avoid inflation by simply having Germany buy bad debt with real money, not inflated money. This is great for everyone else, because it means that the Euro avoids a sovereign debt crisis for that much longer while not having to introduce inflation. But this is pretty sucky for Germany and the Germans, which wind up having to foot the bill for other countries who can't seem to get their fiscal house in order. Germany would arguably do a lot better on its own, as it needs PIIGS like a shark needs a lamprey.
Then again, this would have a result on Germany's exporters. As discussed above, inflation weakens a country's currency, making exports more expensive. So if Greece suddenly has a weak market, Greek demand for German products will diminish, and that hurts German firms that rely on exports. Whether or not the advantage from not having to pay other country's debts is greater or less than the cost of losing some access to foreign markets is an entirely open question, but the more Germany has to pay, the more attractive taking that risk becomes.
English please?
Right now, there are a number of French and Italian banks who are looking pretty shaky, because they own a bunch of Greek debt which is likely to become worthless in the near future. But if Germany were to walk out of the Euro, all assets denominated in Euros would look a lot weaker, and though German banks don't hold a lot of Greek assets, they do hold a lot of Euro-denominated assets.
What's "the rump"? And what does it mean to say it could break apart, exactly?
Probably the PIIGS. If Germany walked out, there would actually be very little incentive for the PIIGS to stick with the Euro either, as there would be very little help forthcoming other than inflation by the ECB, which might not actually work. The economically weaker countries might actually decide that it's worth it to go it alone, as they've got plenty of risk on their own, thank you very much, without being tied to the risk of other risky countries.
This is all painted with incredibly broad strokes, and there are probably people (paging Mutant!) who can spell things out in more detail. But that should at least get you started.
*Actually, that's just a metaphor. Actual physical currency is almost always produced by someone else. Rather, the central bank is responsible for the money supply, only a tiny fraction of which is actually represented by physical currency. But regulating the introduction of physical currency is one part of that.
posted by valkyryn at 7:33 AM on September 19, 2011
Yes, pretty much. The central bank, like all central banks, is in the business of "printing" money.* A declaration that the ECB "stands behind" European sovereign debt is essentially a declaration that they are willing to increase the money supply as needed to inflate away as much debt as is needed.
This hasn't really happened yet. Thus far, bailout efforts have all involved negotiating with individual governments to put up actual money, i.e. tax revenue, to buy bonds.
Why would Greece consider leaving the Euro? Why does that benefit it over and above simply defaulting on its sovereign debt? Why would "the pressure on other wobbly countries increase"? Would the average Greek citizen see inflation if that happened, or what, and why?
The problem here is that in most cases, countries that run into sovereign debt problems can use inflation to get themselves out of a hole. The thing about debt is that it's kept track of in currency units, and there's always the possibility that a sovereign country can simply increase the number of units available to make paying off the debt easier. Unless the number of units is controlled by someone else. Greece can't inflate away its debt right now because it doesn't have control over its monetary policy. If it did, it could introduce inflation to make servicing its debt easier.
Of course, this has negative consequences a lot of the time. Inflation is great for debtors but bad for creditors and investors, so a currency experiencing a lot of inflation discourages foreign investment. Sovereign default does too, but inflation is generally viewed as a less serious move than simply defaulting, so the consequences tend tend to be worse in defaults. Like, say 1789 France.
The benefit to the rest of the Euro is that now they've got one less shaky economy to deal with, making it that much easier to take care of what shakiness remains.
It's not entirely clear what difference Greek citizens might notice. Their fiscal numbers are in such bad shape that some kind of austerity was probably in the works anyway. Tax compliance is ridiculously low, and it's become apparent that there really are no reliable accounting numbers for what the government has done for most of the past ten-odd years. But it's possible that the austerity measures might not be as bad if inflation were an option.
What's the turmoil here? Why would the north's firms become less competitive? What's the advantage to Germany in leaving the Euro?
Because right now, the EU has been able to avoid inflation by simply having Germany buy bad debt with real money, not inflated money. This is great for everyone else, because it means that the Euro avoids a sovereign debt crisis for that much longer while not having to introduce inflation. But this is pretty sucky for Germany and the Germans, which wind up having to foot the bill for other countries who can't seem to get their fiscal house in order. Germany would arguably do a lot better on its own, as it needs PIIGS like a shark needs a lamprey.
Then again, this would have a result on Germany's exporters. As discussed above, inflation weakens a country's currency, making exports more expensive. So if Greece suddenly has a weak market, Greek demand for German products will diminish, and that hurts German firms that rely on exports. Whether or not the advantage from not having to pay other country's debts is greater or less than the cost of losing some access to foreign markets is an entirely open question, but the more Germany has to pay, the more attractive taking that risk becomes.
English please?
Right now, there are a number of French and Italian banks who are looking pretty shaky, because they own a bunch of Greek debt which is likely to become worthless in the near future. But if Germany were to walk out of the Euro, all assets denominated in Euros would look a lot weaker, and though German banks don't hold a lot of Greek assets, they do hold a lot of Euro-denominated assets.
What's "the rump"? And what does it mean to say it could break apart, exactly?
Probably the PIIGS. If Germany walked out, there would actually be very little incentive for the PIIGS to stick with the Euro either, as there would be very little help forthcoming other than inflation by the ECB, which might not actually work. The economically weaker countries might actually decide that it's worth it to go it alone, as they've got plenty of risk on their own, thank you very much, without being tied to the risk of other risky countries.
This is all painted with incredibly broad strokes, and there are probably people (paging Mutant!) who can spell things out in more detail. But that should at least get you started.
*Actually, that's just a metaphor. Actual physical currency is almost always produced by someone else. Rather, the central bank is responsible for the money supply, only a tiny fraction of which is actually represented by physical currency. But regulating the introduction of physical currency is one part of that.
posted by valkyryn at 7:33 AM on September 19, 2011
As to why Greece or Germany may possibly want to leave the Euro - In general, being part of a monetary union means that governments lose access to a key means of managing their economy - they no longer control money supply and interest rates, which is a tool which they use to moderate the delicate balance of inflation / growth. Arguably if Greece had not been part of the Euro they might have devalued their currency to make themselves more competitive and avoided getting into such a deep hole to begin with.
Also, in this case, being part of the Euro means that Germany is exposed to whatever risks Greece is bringing to the currency, and German taxpayers may have to put up some money to bail Greece out - understandably something they would avoid if they weren't part of the Euro in the first place.
posted by xdvesper at 7:35 AM on September 19, 2011
Also, in this case, being part of the Euro means that Germany is exposed to whatever risks Greece is bringing to the currency, and German taxpayers may have to put up some money to bail Greece out - understandably something they would avoid if they weren't part of the Euro in the first place.
posted by xdvesper at 7:35 AM on September 19, 2011
I'll try answering some:
Why would Greece consider leaving the Euro?
Because its new currency would be devalued against the Euro (and other currencies) making its exports more competitive.
What's the turmoil here?
Markets would not be kind to an EU without Germany (I mean, there's already a sovereign debt crisis - how bad would it be for Greece if Germany said 'sorry, we're leaving, look after yourselves'?)
Why would the north's firms become less competitive? What's the advantage to Germany in leaving the Euro?
Because as said a few sentences earlier, if Germany left the Euro, the new German currency would rise, making exports uncompetitive.
German advantage to leaving the Euro? Not much, based on what I said above. But Germany would no longer have to worry about bailing out the Greeks, which is the way many Germans see it. (Though a Greek default would hit German banks hard, so the benefit of leaving Greece to its fate might be a false one).
What's "the rump"? And what does it mean to say it could break apart, exactly?
What's left of the Eurozone after Germany leaves. In the article's analysis, it could break apart if Italy etc decided they didn't want to be in a currency union that included countries like Greece, but not countries like Germany.
posted by Infinite Jest at 7:36 AM on September 19, 2011
Why would Greece consider leaving the Euro?
Because its new currency would be devalued against the Euro (and other currencies) making its exports more competitive.
What's the turmoil here?
Markets would not be kind to an EU without Germany (I mean, there's already a sovereign debt crisis - how bad would it be for Greece if Germany said 'sorry, we're leaving, look after yourselves'?)
Why would the north's firms become less competitive? What's the advantage to Germany in leaving the Euro?
Because as said a few sentences earlier, if Germany left the Euro, the new German currency would rise, making exports uncompetitive.
German advantage to leaving the Euro? Not much, based on what I said above. But Germany would no longer have to worry about bailing out the Greeks, which is the way many Germans see it. (Though a Greek default would hit German banks hard, so the benefit of leaving Greece to its fate might be a false one).
What's "the rump"? And what does it mean to say it could break apart, exactly?
What's left of the Eurozone after Germany leaves. In the article's analysis, it could break apart if Italy etc decided they didn't want to be in a currency union that included countries like Greece, but not countries like Germany.
posted by Infinite Jest at 7:36 AM on September 19, 2011
As someone mentioned, being in the Euro means that a state doesn't have all of the macroeconomic tools available - there are limits on certain kinds of decisions. When those decisions seem to bump up against a state's culture and "force" it to make decisions that are "against our way of life" there's a perception problem - this is why people are demonstrating in the streets.
So even if Greece didn't want to USE the macroeconomic tools it theoretically could if it exited the Euro, leaving would send a powerful message to (gullible?) voters that no tight-assed Eurocrat is going to tell GREECE how to live... and what policies to pursue.
My pet theory is that Germany was much more exposed to the US financial crisis than it wants to admit publicly and that consequently Greece, Portugal and Spain may have even more leverage than they think they do, which will probably have the effect of keeping the Euro zone intact in the short and long term...
This theory holds or falls on how "fire walled" Deutsche Bank's US activities were from head office... but I'm quite ignorant of these details so my pet theory may be total bunk. (LOL)
posted by mikel at 8:17 AM on September 19, 2011
So even if Greece didn't want to USE the macroeconomic tools it theoretically could if it exited the Euro, leaving would send a powerful message to (gullible?) voters that no tight-assed Eurocrat is going to tell GREECE how to live... and what policies to pursue.
My pet theory is that Germany was much more exposed to the US financial crisis than it wants to admit publicly and that consequently Greece, Portugal and Spain may have even more leverage than they think they do, which will probably have the effect of keeping the Euro zone intact in the short and long term...
This theory holds or falls on how "fire walled" Deutsche Bank's US activities were from head office... but I'm quite ignorant of these details so my pet theory may be total bunk. (LOL)
posted by mikel at 8:17 AM on September 19, 2011
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Germany's in a bind; if they build a strong currency, value will cling to it, making their own exports too expensive to be competitive. So basically, the way I read the article, Europe is in a mess no matter what they do.
(I'm not an economist; can't you tell?)
posted by scruss at 7:27 AM on September 19, 2011 [1 favorite]