The Euro Zone Race to the Bottom

By Warren Mosler

While the symptoms get continuous attention as they get threatening enough, the underlying cause – the austerity- does not.

The euro zone, like most of the world, is failing to meet its further economic objectives because of a lack of aggregate demand. And in the euro zone, the fundamental problem is that the member nations, as credit sensitive ‘currency users’ are necessarily pro cyclical in a downturn, much like the US states, and therefore incapable of independently meeting their further economic objectives.

So even as the euro zone struggles to address it’s solvency crisis that threatens the union itself as well as at least part of what remains of the global financial architecture, the underlying shortage of euro net financial assets continues to undermine output and employment, with GDP growth now forecast to fall to 0 with a chance of going negative in the current quarter. What this means is that without adopting an alternative to the current policy of applying enhanced austerity as the means of addressing the solvency issue, it all remains in a very ugly downward spiral with social collapse far less than impossible.

So yes, the solvency issue can continue to be managed by the ECB, the issuer of the euro, continuing to buy national government debt as needed. But that doesn’t add net euro financial assets to the economy. It merely shifts financial assets held by the economy from the debt of the national governments to deposits at the ECB. So it does nothing with regards to output, employment, inflation, etc. as recent history has shown.

In fact, nothing the world’s central banks do adds net financial assets to their economies. And much of what they do actually removes net financial assets from their economies, making things worse. Note that last year the Fed turned over some $79 billion in profits to the Treasury. Those profits came from the economy, having been removed from the economy by the Fed’s policy of quantitative easing, which the old text books rightly used to call a tax.

And meanwhile, the imposed austerity that accompanies the bond purchases does directly alter output and employment- for the worse. Additionally, for all practical purposes, there is universal global support for austerity as the means supporting global output and employment. So even if the euro zone gets the solvency issue right, with the ECB writing the check to remove all funding constraints, the ongoing austerity will continue to depress the real economies.

  1. badr says

    The Euro Zone will collapse sooner or later

  2. ann arky says

    Surely any system that relies on ever increasing debt has to collapse sooner or later. That applies to the world financial system. Perpetual growth is an illusion. Creating money out of money is hardly a sign of increasing GDP. House prices go up, the GDP goes up, what has changed?

    1. David Lazarus says

      I agree. After the debts have have been cleared, most likely by defaults and bankruptcy there need to be rules that restrict credit growth, especially residential mortgages. Without a credit bubble to worry about the economy can concentrate on rebalancing the economy. My fear is that politicians will not want to be seen to hold back the economy even if in the long run it is the best solution.

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