Gianpaolo Rossini - 26/01/2012

In the EU Monitor of the influential Deutsche Bank dated 26th October 2011 Thomas Mayer states that “under the surface of the sovereign debt crisis and that of the Euroland banks there is an equilibrium of the members’ balances of payment caused by unbalanced real exchange rates … which generates transfers of resources channelled by subsidised credits from the creditor countries towards the debtors. These transfers do not have explicit political support and can lead to the implosion of the Euro if they are protracted.” Germany is starting to realise that the problem of Euroland does not lie in the public accounts (those of Greece, Ireland, Spain, Portugal and Italy) but in the imbalances in the balances of payments. If for Greece in 2010 there are weaknesses in the public accounts besides those with abroad, for Ireland, Spain and Portugal the public accounts are in better conditions or not far from the German ones. However, these countries present a high foreign debt specular to a high foreign credit of Germany and the Netherlands. However, Mayer’s discovery of the centrality of the Euroland members’ foreign accounts already starting from 2010 is belated. And above all there are still errors of evaluation in Mayer’s analysis and in Germany’s stance in late-2011. In order to understand better, let’s suppose that Spain has a current account deficit of 1€ with Germany because it imports for 2€ and exports for 1€. Up until 2010 this deficit was funded by Germany that accepted Spanish financial activities in return (as well as real activities such as properties). The Spanish interest rates are close to the German ones and the money supply in Spain does not suffer from the foreign deficit. In 2010 things changed. Faced with the same 1€ Spanish deficit now the Germans are trying to acquire Spanish financial activities (or capital) only for 0.50 €. How is this sudden imbalance in the Spanish foreign balance of payments bridged? By means of a transfer from the Spanish central bank that siphons off 0.5€ from the circulation in Spain and cedes it to a German bank or to the Bundesbank. By means of this transaction the money supply in Spain decreases and it increases in Germany. The positive positions (assets) of the German banks grow at the Bundesbank and of the latter at the ECB, while the opposite occurs for Spain (as the ECB statistics say). All this makes the interest rates in Spain rise and makes them fall in Germany, which ends up lending 0.5€ indirectly to Spain at a higher rate than what the saver can obtain in Germany. On this 0.5€ Germany gains a clear benefit. There is a transfer of income (from capital) from Spain to Germany, while before 2010 that was not the case as the rates in Germany and Spain were aligned. The increased interest rates put investments to a severe test (hence growth) and the public accounts. If, moreover, the Spanish taken by a lack of confidence in their country take 1€ of capital into Germany, the Iberian balance of payments reaches a deficit of 1.5€. The active position of the Bundesbank at the ECB increases to 1.5€ with a further expansion of the mony supply and a decrease in the interest rates in Germany while the opposite occurs in Spain. The transfer of resources from Spain to Germany leads to Germany growing and makes it enjoy an “exorbitant privilege” due to the fact that the Spanish savers put their savings cheaply into Germany which, by means of the ECB and the financial market, lends them back to Spain at far higher rates. This is the opposite to what is argued by Thomas Mayer, who wrongly claims that Germany is financing the imbalances of the southern European countries at convenient rates. If only that were the case! If so, we would be in less trouble than we are now. Unfortunately, it’s the countries of southern Europe that are funding at convenient rates. Lower than the ones made by the ECB, public spending and private investments in Germany. Up until 2010 Germany funded the Spain’s foreign deficit at market rates, but not at subsidised rates, as Mayer claims. That is, it has copied what China and Japan have been doing for the USA for the past two decades. The Italy case At the end of 2010 Italy had an active position at the ECB (3.5 billion), less than Germany’s, but better than that of France (- 28 billion). This is the result of good foreign accounts and the success of Tremonti’s tax shield. From May 2011 a hole was opened in our balance of payments owing to the flight of capital often concealed in commercial transactions. Germany’s active position has grown in the ECB while Italy’s has worsened in a specular manner (going in 6 months from + 3.5 to -103 billion). So we are providing low-cost saving obtaining in return funding for the public sector at exorbitant rates. In short, an enormous transfer to Germany comparable in terms of the sheer size to war compensation. Implications Two ways to put an end to this. The Eurobonds. All the countries pay the same interest rate with the issue of European public debt bonds. Or else a strong monetization of the debt by the ECB. It already does this for the banks but do not, owing to the institutional rigidity derided across the English Channel and across the Atlantic Ocean, for the States. The initial policy invoked over two years ago by Tremonti and Juncker would have avoided the Greek disaster and the ensuing crisis. It remains valid but it is more difficult and politically hardly sustainable in Germany, where a villainous media campaign has made it unappealing. The second policy should be undertaken immediately and pushes the Euro up to more realistic quotations seeing the balance of the purchasing power between Euro and Dollar should be at an exchange rate of around one-to-one. However, it is still necessary to align the real exchange rates inside Euroland with the opposing policies between countries with foreign payments deficits and countries with a surplus. The former are doing this in a rigorous manner with a major cutback in expenditure. Those enjoying a surplus are doing nothing. And this could make the Euro implode, because those who cut expenditure will get caught up in a recessive spiral.

Gianpaolo Rossini
(University of Bologna)