Spain’s’ only three options for recovery

Summary:  The Euro-crisis began in March 2010, and yet its causes and basic elements remain widely misunderstood — including, based on their public statements, by many of Europe’s leaders.  Here Prof Pettis gives a clear explanation of what’s happening, and of Spain’s only three ways out of this crisis.

Excerpt from “Three cheers for the new data?”

By Michael Pettis (Prof of Finance, Peking University)
November 12, 2012
Republished with his general permission.

Spain’s three options

Finally, and to turn away from China, we seem to be experiencing a renewed period of increased optimism over European prospects, but we should refrain from joining in. The optimism will soon fade. In the great debate over the economies of countries like Spain, we sometimes forget the simple arithmetic of economic rebalancing. This arithmetic, like it or not, severely limits the options open to these countries.

For many years, thanks partly to bad policies in Spain but mainly to aggressive attempts by Germany to achieve growth by forcing a trade surplus onto its European neighbors, Spain, and many other countries in Europe, ran enormous trade deficits. It is easy and popular to blame the greed of the Spanish and the stupidity of the government for the mess in which Spain has found itself, but the policies Germany put into place in the late 1990s guaranteed that Germany, a country that had run massive trade deficits in the 1990s, would run equally massive trade surpluses in the subsequent decade.

Because once they joined the euro the rest of Europe had no control over the value of their currencies and the level of their interest rates, it was inevitable that European countries that had joined the euro with higher-than-average levels of inflation would be forced to respond to German trade surpluses either by forcing up unemployment or by forcing up consumption, and so running the large trade deficits that corresponded to Germany’s trade surplus. No other choice was possible.

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The Fate of Europe has become visible. Only how and when the break comes remains uncertain.

Summary:   The last act of the EMU’s death throes has begun. We already knew the two possible endings: further unification or fragmentation.  Now we can see far enough to guess about when and how it will end.  Probably in a crisis, in which the odds of policy errors will be high — and the odds of unification are low.

“It is a national and imperative need to officially ask our partners in the EU for the activation of the support mechanism we jointly created.”
— Prime Minister George Papandreou, requesting a 45 billion euro loan from the Troika (EU, the European Central Bank, and the International Monetary Fund), 23 April 2010

A dream, perhaps soon to be real


  1. Summary of the Euro-crisis
  2. What will resolve the situation?
  3. What about the magic of Central Bank action?
  4. For more information

(1)  Summary of the Euro-crisis

Those words of Prime Minister Papandreous marked the beginning of the end for the European Monetary Union.  Now, two years later, it enters what looks like its final stage.  Here are forecasts about the next steps.  We cannot see the ending, but unification or fragmentation seem likely alternatives.  The current system is dying.

The European Economic and Monetary Union (EMU) was born on 1 January 1999 as a bold attempt to unify Europe by monetary policy as an intermediate step between a loose confederation and full political union.  Many experts said it would fail (see here for details).

The 2008 – 2009 crash exacerbated imbalances that had accumulated from the EMU’s flawed design (for details see the articles at the end of this post).  Each stage of the EMU’s death throes was a crisis, met by measures that were slow, late, incremental, and too small.  Each crisis larger than the previous in both euros and territory.

Each response was  known to be inadequate when made (despite the giddy applause greeting each new package).  Nothing more was possible. The leaders of the EU, ECB, and IMF — like ours — operate within narrow ranges of freedom.  Bold actions work only when a nation’s leaders and people will support them.  Europe’s elites and peoples want two incompatible things.

  • They want unification (to avoid war and control their destiny in a world of giants).
  • They don’t want what goes with it — the transfer payments (eg, as California taxes go to spending in Mississippi & New Mexico), the central control of spending (ie, by Germany), and the need to get along with one another.

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A note from Athens: Feeling on the ground has palpably changed

Summary:  The Greek people have locked themselves into a no-win dilemma since the first bailout in May 2010.  They want to stay in the Eurozone, but hate the pressures applied by EZ leaders as the necessary price for the aid that keeps them in the Eurozone.  Eventually the resulting damage will force them to leave, but the delay will weaken them — more unemployment, bankruptcies, capital flight, and social unrest.  They will crawl prostrate to a new future.  Today Megan Greene reports from the streets of this once-great nation as it sails to self-destruction.  It’s a powerful warning to America.


  1. A note from Nouriel Roubini’s visit to Greece
  2. The feature article:  Megan Greene reports from Greece
  3. About the author
  4. Other valuable recent articles about the Greek crisis
  5. For more information

(1)  A note from Nouriel Roubini’s visit to Greece

Excerpt from “Beware the Ides of March“, Nouriel Roubini, 28 February 2012 (subscription only):

I attended a public debate on whether Greece should exit the EZ; three-quarters of those who attended were against that option. One caveat is that most of the attendees were middle class folks who work in the private sector, speak English, are europhiles and blame the government and public sector for all of Greece’s problems. Lower-income individuals, employees of the large public sector and left-of-center voters have different views.

In my conversations with a large sample of private-sector businessmen — shipping magnates, other manufacturers, representatives of the financial sector — and members of the government, a similar view emerged: No one wants to even consider an exit from the EZ. Many forcefully argued — without any evidence — that Greece doesn’t have a competitiveness problem — despite data suggesting that unit labor costs rose by over 40% in the decade before the crisis — and blamed all of the problems of the private sector on the inefficiencies and tax burden of the public sector. Again, this sample of prominent Greeks is obviously as europhile as one could get, so can be regarded as somewhat biased.

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Europe has chosen a harsh future. All the paths for Greece lead into darkness.

Summary:  This week Europe’s leaders faced a choice somewhat similar and perhaps equally momentous as America’s leaders faced in 1787.  But this week they chose a path that looks punitive and short-sighted, pursuing European unification but likely to generate discord and eventually fragmentation.  Seldom does one act determine the future, but they might find it difficult to undo what’s been done this week.  The only certain result is much suffering and humiliation for the Greek people.  We can only guess at how this will work for Europe as a whole.


  1. The new bailout: the EU imposes Carthaginian deal on Greece
  2. For Whom the Bailout tolls
  3. Why are the EU member nations doing this?
  4. Lord Keynes explains the hidden truth behind this news
  5. For more information: posts explaining what’s happening and likely consequences

(1)  The latest bailout: the EU imposes Carthaginian deal on Greece

Greece passed their last easy exit.  Signing the latest bailout agreement (not yet done) leaves them no way to leave this highway to ruin, except by smashing through the guard rails and off the causeway.  Only fools commit a nation to a course of action without providing an emergency out — but Greece’s leaders have do exactly that.  We don’t yet know the exact terms of the deal, as it gains the necessary legislative approvals.  But these seem likely forecasts:

  1. Exchanging their existing bonds — issued mostly under Greek law — for bonds issued under creditor-friendly UK law both diminishes their sovereignty and makes the eventual default far more difficult.
  2. Exchanging bonds issued to private investors for loans from quasi-governmental agencies makes the eventual default far more difficult.
  3. Pledging their gold reserves eliminates a vital resource needed to buy imports during the default and devaluation process.
  4. Little, perhaps none, of the new money goes to the Greek people.  Rather it goes to banks and other Greek creditors.
  5. After this bailout, Greek sovereign debt will be almost twice GDP, with little hope for significant growth during the next few years.
  6. The EU demands severe restructuring of the Greek government, difficult in good times but perhaps impossible during the coming downturn.
  7. In exchange for bailing our EU banks, the EU imposes crippling austerity on Greece.  A long severe recession seems the best possible outcome.
  8. This occasion, like the dozen or so previous major summits, provides an opportunity for politicians to falsely claim “peace prosperity in our time” — but few economists concur.
  9. The coming months will further weaken Greece, so that the eventual necessary default and devaluation occur under conditions far worse than today’s.

Extreme outcomes seem likely, which might include depression (GDP already 17% below peak) and collapse of Greece’s political regime (probably not in the April elections, but in 2013 or 2014).  Contagion to the rest of Europe is a high risk, especially to Portugal, Spain, and Italy.

(2)  For Whom the Bailout tolls  (willl be updated)

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A look at the world as it is, not as we’re told it is

Summary:  The news media usually report accurately, more or less.  Often they prefer to act as stenographers for governments and corporations.  Sometimes the logical thread linking events — the narrative — is obscure, hidden in the noise.  Today we look at three examples of hidden history.

The world is not always as we’re told it is.  Here are three of today’s major stories, where the true narrative remains hidden — and we attempt to guess at the truth.

  1. The recovery in America
  2. The war against Iran
  3. Germany fighting to preserve the eurozone

(1)  The recovery in America

  • Public debt outstanding as of 31 December 2010:  $ 9,390,476,088,043
  • Public debt outstanding as of 31 December 2012:  $10,447,662,851,807
  • Cost of the recovery:  $1,057 billion.
  • The increase in GDP bought by that fiscal stimulus:  $561.2 billion

That does not mean the stimulus was wasted.  Imagine the recession that a balanced budget would have produced.  It does mean that cheering about a recovery is delusional; describing this as a “sustainable recovery” is doubly so.

Note: the public debt does not include treasury bonds bought by the social security trust funds, which are loans from the US government to the US government.

For more about this see About the January jobs report – mildly good news, but bought at great cost.

(2) The war against Iran

We can only guess at the plans of government leaders.  That’s understandable operational secrecy, not a conspiracy.  So what plan drives the intense propaganda drive demonizing Iran?  If Israel plans to attack, they’ve forfeited any hope of surprise. Logic and history are our only guides.

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Hot news! The wehrmacht failed to take Greece. Now Germany tries again, with a different method.

Summary:  Germany used it power over the European Monetary Union to institute a monetary policy that disproportionately benefited itself, to the disadvantage of the periphery nations.  Germany prospered, they lost competitiveness.  Now Germany acts to continue the game, attempting to force the losers to stay in the game.  Now it’s Greece’s turn to go under the hammer.  Will they comply or resist?


  1. The Financial Times breaks the story
  2. Update: The Greek government responds
  3. Update: Replies to Greece by the EU and the German goverment
  4. For more information about the European crisis

(1)  The Financial Times breaks the story

Call for EU to control Greek budget“, Financial Times, 27 January 2012 — Opening:

The German government wants Greece to cede sovereignty over tax and spending  decisions to a eurozone “budget commissioner” to secure a second €130bn  bail-out, according to a copy of  the proposal obtained by the Financial Times.

In what would amount to an extraordinary extension of European Union control  over a member state, the new commissioner would have the power to veto budget  decisions taken by the Greek government if they were not in line with targets  set by international lenders. The new administrator, appointed by other eurozone  finance ministers, would take responsibility for overseeing “all major blocks of  expenditure” by the Greek government.

Here is the “proposal” obtained by the FT.  Only fools would accept this insulting and contemptuous offer.

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Are Europe’s rulers copying the policies of Herbert Hoover in 1929, or the French Monarchy in 1789?

Summary:  There are two paths for Europe. The path it is on, leading to a painful future and fundamental change.  And the other path, with unknown risks and pain — but offering the potential for a better future.  The path chosen by Europe’s leaders reveals much about them.  The outcome will reveal much about Europe’s peoples.

Two major reports this week describe the perilous condition of the world economy.  Both are well worth reading.  Both raise serious doubts about the path that Europe is traveling.

The PIIE report goes into greater detail about treatment for Europe’s ills, giving the solutions recommended by our banking class — that dominate these discussions in the West.  Especially note two aspects, one recommended — and one omission.

(1)  Liquidate the people of the GIIPS and the institutions which serve them

The second ingredient is a far more aggressive program to reduce budget deficits and improve competitiveness in the periphery. These nations need to be highly competitive if they are to generate growth soon given the large risks overhanging their economies. This requires large wage cuts, public-sector spending cuts, changes in tax policy to attract investment and business, and stable politics.

… In a nation with a flexible exchange rate, adjustment is usually achieved with budget cuts and a sharp devaluation. Since euro area nations have forgone their right to devalue, they need to regain competitiveness through price and wage cuts, while even more sharply cutting budget spending. In essence, they need to increase volatility of their wages, prices, and budgets if they are prepared to forgo similar changes that could be achieved through the exchange rate.

The available evidence from the outcomes of the troika programs in Portugal, Ireland, and Greece, as well as the recently announced budget plans in Italy and Spain, suggests current policies will fail at this task.

… However, so far, there is little political will to take these necessary measures. Europe’s economy remains, therefore, in a dangerous state.

Boone and Johnson recommend very conservative policy changes.   Large cuts in wages,  Large cuts in public sector spending.  Changes tax policy to help the rich and businesses.  To be forced through by severe pressure from the nations of northern Europe and the institutions they control (eg, IMF and ECB).  Bismarck would consider these too far right-wing.

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