stuff i don’t get about the european debt crisis

All right – in general I don’t think I’m particularly dense, even in matters economic (though perhaps more so in that than other areas). But I’m confused about several pieces of the European debt crisis and comparisons that get drawn to American issues.

1.) I gather that one of the things that precipitated the crisis was Greece’s disclosure last year that its sovereign debt was about double what had previously been reported, is that correct? How did that happen?

2.) Krugman and others have pointed out that one of the differences between Greek/Italian/Spanish debt and US debt is that the Euro is not under the control of the Greek/Italian/Spanish governments. As such, they cannot really grow their way out of the crisis because their economies do not contribute all that much to the value of their currency, in stark contrast to the US.  In this sense, they participate like a “United States of Europe” in that each state can choose to issue bonds, but these bonds will be valued in a currency the value of which is not mostly in the state’s power. So does it follow that if North Carolina were suddenly to restate its balance sheet and disclose a lot more debt than previously thought, the dollar would be in crisis? If not, why not?

3.) Similarly: there are various places that use other countries’ currencies for various reasons. I believe Panama and some other countries maintain a one-to-one exchange rate with the USD; Equador, El Salvador, and East Timor apparently use it as official currency. For several years after independence Namibia used the South African Rand as official currency, and after that maintained a one-to-one exchange rate between the Rand and its Namibian Dollar; other countries in that region (Lesotho and Swaziland) use the Rand still. Why are these examples less of a problem than countries in the so-called “Euro Zone”? Since the Euro is a convertible currency, why couldn’t any country just decide, unilaterally, that its official currency would be the Euro? Why, in other words, does the ECB have sway over individual Euro-Zone countries?

Author: andrewperrin

University of North Carolina, Chapel Hill

3 thoughts on “stuff i don’t get about the european debt crisis”

  1. To the third point: they could (and indeed the Swiss basically did). But pegging your currency to that of another country/area (e.g., the USD or the EUR) has risks–ask the Argies ca. 2001.

    The yuan (rembini?) is pegged to the USD–but the peg itself has been changed as the Chinese economy grows stronger.

    Short version: pegging the currency works until it doesn’t. And countries that don’t change those pegs in a floating-rate world find imbalances growing.

    To the second, you missed the problem. If NC alone discloses a lot more debt, the dollar doesn’t go into crisis. If NC, TX, CA, NJ, NY, and CT do, it might be another story.

    Similarly, the EUR would survive the Greece problem if Italy (especially), Ireland, and Spain–not to mention France and Germany*–were doing well. (The currency drops slightly–same as the dollar would if NC were the only problem–and adjustments happen.)

    For the first issue, I’m told Goldman Sachs was involved in some way, and that some of the debt was “off-balance sheet.” But even independent of that, recall that most of the discussion isn’t about the absolute level of debt, but rather the debt/GDP ratio.

    If you need more social services (“safety net”), you need more spending (higher debt at the same tax levels). And if those people aren’t working, the things they used to produce don’t get produced (lower GDP).

    Raise the numerator, lower the denominator and the “debt ratio” increases–but not just because some of the debt used to be hidden. (As Krugman et al. note, several of the “trouble” countries had a Primary Account surplus before the Lesser Depression. The problem is lack of growth.)

    *If you think Germany is doing well, look at its major trading partners and revenues therefrom.

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  2. #3 is the easy one. Countries that can’t borrow in their own currency don’t go as deeply into debt as did the eurozone periphery. Implicitly, the bond markets seemed to have understood the eurozone as Germany co-signing loans, something that would not be true if Kreplachistan unilaterally pegged its currency to the euro. We had a good illustration of why with Argentina, which caused approximately zero problems for the United States in contrast to the nightmare Greece and the rest of the periphery is creating for the eurozone core.

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  3. In random order:

    To your second point, the main difference between the US and Europe is that North Carolina can run into trouble, but bondholders will still get their money back cause the states are federated and therefore all the other states foot the bill. I.e. their is joint responsibility between all the states of the US. Here in Europe, Greece issues Greek bonds not Europe Bonds. So if Greece goes bust, nobody will buy their bonds and so their finances are screwed. Germans aren’t liable for Greek and frankly don’t want to be! (For NC, they could still sell treasury bonds as the rest of the states would prop up their value and make them attractive to investors).

    To your first point: ‘creative accounting’. Let’s just say the Greeks knew they were in trouble, tried to hide it from the rest of the Europeans, but the EU knew and just turned a blind eye cause it knew that mentioning the problem would set off a debt crisis in Greece. Perhaps they should have said something earlier. Whoops.

    To your third point, I think the comment prior to mine elucidates it well. I’d just add that in addition to pegging currencies, there is a growing interest for Ireland to take on the British pound (were it no so politically detested). Like El Salvador became dollarized, this would add stability to the economy, but it gives control of monetary policy to the central bank which issues the currency (the Bank of England… which Ireland cannot control). This is why the ECB controls Euro countries. They gave up their power to change the value of their own currency in return for the stability of the Euro. Whoops again. Now the downside of a single currency has come to the fore with the likes of Greece and Italy needing to devalue their currencies to boost exports and increase growth, but not being able to cause they gave that power up with the onset of the Euro. In summary, if say Tunisia wanted to use the Euro as their official currency, there is nothing stopping them. The reason they will not is that they then hand over control to the ECB who do not care about the economic circumstances in Tunis. The ECB will also set interest rates. Is it really worth trying to get currency stability by using the Euro and in doing so giving up control over your interest rates and the power to value/devalue your currency?

    Long-winded I know.

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