Does anyone know of a good, brief overview of the Eurozone crisis written by an expert?

I follow current affairs closely so I know a fair bit about the “news” of what’s been happening over the last year or two, but I’m struggling to get my head around the broader picture. Too often commentators tend to summarize the crisis as essentially being the result of “countries taking on too much debt”, which rings false as Spain had a budget surplus going into the recession and Italy still has a surplus in its primary budget. Alternatively they explain that countries are suffering the consequences of bailing out their banking systems, which again can’t be true for Spain because the Spanish banking system was well-regulated and required no bailouts, while the Icelandic banking system borderline collapsed and yet it’s recovering fairly nicely. The closest I’ve come to a genuinely enlightening explanation is on Paul Krugman’s blog, but obviously the nature of a blog means that he doesn’t provide a thorough overview, you just pick things up from him in bits and pieces.

So what’s the broader picture here? Expert economic opinion would be appreciated.

No one…??

If anyone can help you out here, I would think it would be Krugman. (Depending, of course, on your political views. Krugman has gotten increasingly political lately. Some, myself included, would applaud that.) On his blog page, note the sidebar on the right, where he has a list of past postings that he recommends reading to fill in the background. Have you noticed that, and gone there, yet?

His list of past blogs doesn’t seem to be particularly organized, though, as far as I can tell. I think it would have helped if he had listed them in a good order to read them, which he seems not to have done.

The Economist has quite a lot of articles about the crisis on its website, for example this recent one about Italy.

I can’t find a single article that gives a comprehensive guide, though.

I think the main problem is we’re still in the middle of things so it’ll take a while for the whole situation to play out and someone to make sense of it all.

Having said that I find some of the econo bloggers have done a reasonable job of making sense of it all. Here’s a link to Charles Hugh Smith’srecent take on matters for example.

I found Michael Lewis’s long articles on Greece and Ireland pretty interesting for a view of what things are like in two of the PIIGS companies, with lots of colourful anecdotes of the madnesses of the boom times which those countries are being called to account for. But his Iceland story is the best of all (even though it’s not strictly speaking about the Eurozone crisis).

When economies are fucked over by insufficient demand, there are a couple ways of fixing it. One way is borrowing money, the other way is making more money.

There is insufficient demand in Yurp.

Borrowing money? The debt load is already high and rising in too many countries. A big fiscal stimulus – borrowing a lot more money to build things and give to people – is not an option. Making more money? The countries in the eurozone do not have control over their own money. The European Central Bank is in Frankfurt, subject to stringent monetary union rules. This was in the belief that the Germans are a responsible people who would provide the credibility of low inflation for the euro, which would keep interest rates for places like Italy low.

Let’s talk about Italy for convenience. Interest rates in Italy are not low. The yield on Italy’s bonds are far too high now, because interest rates are not just about inflation, but also about perceived risk. When the economy is fucked over by insufficient demand, there are a couple ways of fixing it, and Italy has access to neither option. The debt load can be reduced, in real terms, by a bit higher inflation. The slack in the economy can be picked up by a bit more money bouncing around. Italy’s exports could get a boost from a bit of a currency devaluation compared to their neighbors. All of that requires flexible exchange rates and new money which they can’t make. The typical safety valve is gone. Instead of the pressure being relieved by the easing force of the currency, the pressure is building and building and building.

Italy can’t reduce the debt load through a bit higher inflation. They don’t have control over their own money. Italy can’t pick up the slack in the economy with more money bouncing around. They don’t have control over their own money. Italy can’t get an export boost from a slightly devalued currency on the foreign exchange markets. They don’t have control over their own money.

Interest rates are high enough now that they aren’t sustainable. There isn’t enough taxation coming in to meet the debts, and more taxes would depress the economy’s demand even further. That’s a notable vicious cycle of macroeconomics. A country with its own money could just print the money to pay off maturing debt. A big dose of inflation, sure, but if the fundamentals of the economy are strong enough – and they are – you don’t have to have a hyperinflationary case. But they don’t have control over their own money. The euro is a fixed exchange rate between all the eurozone members. In the old system, the Italian lira would lose value against the German mark, and things could potentially balance out. Italy’s euro, however, can not lose value against the German’s euro because it’s the same bloody euro. It’s 1 for 1 between Germany and Italy. That is, unless the system collapses.

There is fear that the system will collapse. And justifiably so. What can’t go on forever won’t go on forever.

If Italy were to break away from the euro, its “new lira” would depreciate rapidly in value against what was left of the euro. Well, that’s actually the new money that is needed. That would seem to provide the solution… except people holding money in Italian banks would suffer the effects of that loss of value. People wouldn’t want to lose a significant fraction of the value of their bank deposits overnight in that manner. And it’s not like the government can declare out of the blue, with no plan, that it’s done with the euro, thankyew. It would have to take some measures, think it out a bit. But that’s impossible, too, because the very act of announcing an intention to leave the euro would cause the biggest collective bank run in the history of the world.

Italy can’t tell the world it’s done with eurobucks without every single euro-denominated bank in the country, without exception, becoming insolvent. It would be the utter destruction of the Italian financial system. They’d have to declare a massive bank holiday, and shut down all transfers of euros/lira until the new system was in place. The flow of funds, the life blood of the economy, would seize entirely. There would be literally no access to Italian money. People would not have access to their funds for however long it took them to jury-rig a “new lira” system in place. No one knows how that would work.

So leaving the euro is not an option… That is, unless the mother of all bank runs happens anyway. If we’re already looking at the collapse of the Italian financial system, then hey, might as dig a new lira system out of the rubble.

All of this, by the way, could be avoided by more money from the ECB. If the central bankers in Frankfurt were doing their jobs correctly, instead of legally, then we could avoid the worst financial crisis ever. But as they like to inform us ad nauseum, they are bound by a sole “mandate” of price stability. The caretakers of the euro do not have the legal authority to save the euro. Those of us who tend to ignore the law and focus on the economics then call the ECB crowd a bunch of filthy pig-dogs. After all, we’ve read history books. The Bank of England ignored the law when it was necessary in the 19th century. Clear financial precedent there. It stands to reason this can be done again, right? Right? We can cite chapter and verse on the functions of a true lender of last resort all day long, but the ECB doesn’t listen.

They’re the only ones who can help. There’s already too much debt, which means this is a money solution, and yet the money people announce on a near hourly basis that they’re not legally authorized to help. What I’m saying here is that you should expect the mother of all bank runs in the not-so-distant future. There is no apparent will to avoid it.

And that’s the euro problem. Essentially. Every country has its own interesting wrinkles, the ins-and-outs could be explained in ten thousand times the depth, but bottom line is that they need more money, the countries need a reliable backstop, the banks need more funds to survive a massive run – in other words, they need a genuine lender of last resort – and yet the only institution with the technical ability to stop this mess refuses to do anything substantive about it. I tend to look at the end of the eurozone in its current form as a foregone conclusion, but I guess technically they still have time to change their minds. Technically.

In fact, their minds will be forced to change eventually. When the dominoes start falling and Germany’s own banks are next in line, the legal arguments will vanish. But by then, it will be too late to save the eurozone as it exists now, and similarly too late to avoid depression.

Thank you for that post, Hellestal (and thank you isaiahrobinson, for asking the question).

It’s an excellent post. I had a vague understanding of everything you just explained, but you’ve greatly clarified it.

What you’re saying doesn’t make me feel any better about the situation, but truth is what’s important here.

How difficult would it be to change the laws that they are being such sticklers about following? Is it even likely that they would want to? Are there some downsides to changing it that, at least in their minds, outweigh the current situation?

Ze Gehmans do not want to reward bad behavior. Moral hazard is the buzz word so fondly bandied about. They seem to look at this as a grand Morality Play, with irresponsible swarthy Mediterranean types screwing everything up, and Germany being asked to pay for it. This is not entirely true. Greece was the only genuine bad actor. As the OP noted, Spain’s government was as responsible before the crisis, and Italy… well, they were Italy, but things were basically okay. Even now things would be basically okay with lower interest rates.

I see no indication that the Germans are willing to fess up to all this. They’re going to have to pay, one way or another. The best way would be to eat a little higher inflation now, but good luck with that. They still have nightmares about men in lederhosen pushing around wheelbarrows full of marks. They hate inflation, and they’re not going to allow any for the sake of suntanned southerners who, they think, can’t live within their means. Spain suffers injustice to teach Greece a lesson. Bah.

My main hope at this point, I guess, is that the gargantuan bank run threatens everyone at the same time, so the Germans can no longer ignore the problem. They need to give the okay to the ECB to do what it takes. I don’t see them coming to their senses until the come-to-Jesus moment of having every one of their own banks on the verge of imploding.

Happy to be wrong about that, though.

Inflation would only work if the debt is in bonds that have long maturation periods. If the debt is made up of bonds that have short maturation periods, then it becomes impossible to inflate away the debt because bond buyers read newspapers too. The US over the last 20 years has been issuing more and more short term debt because the interest rates have been so low. If Italy has been issuing short term debt like the US then inflation would not help them much.
I agree that the ECB should be inflating the currency because this would cause wages to go down and find a new equilibrium with lower unemployment, because increased employment would help the Italian government by reducing the need for welfare and would slightly increase tax revenue.
I recommend this series of blogpost for understanding the Eurozone crisis I am not sure of the writer’s provenance, but the posts are clear and data-filled.

I agree about Michael Lewis. He’s very informative and entertaining. Here, for instance, is an article about how Greece got into trouble. Another piece about how Iceland got into a big mess. Also, his first book, Liar’s Poker, was where I first learned about collateralized debt obligations, which are part of the reason for the mess in the US.

And if the debt is in long-term fixed-interest bonds then the prospect of sustained inflation would cause the value of those bonds to fall sharply - which would bust banks all over Europe just as effectively as a formal default.

On top of that, once the markets started pricing in significant future inflation, the Italians could forget about selling bonds on the open market at 7% (which is about the maximum they can afford in the short term). Effectively the ECB would be committing itself to buying every Euro of debt the Italians (and the Spanish and the Portuguese and…) issued for the next several years, with the obvious risk that one or more governments would realise they could issue all the debt they liked and the ECB would have no option but to pick it up.

That is why the Germans are so insistent that the ECB doesn’t unlock the printing press until the governments accept EU (read German) “oversight” of their budgets. But (even if it was politically possible) making that legally enforcible would take years - and the EU no longer has years to sort this all out.

Okay, first, the value of the bonds is already dropping into a hole because of the risk of default. You can’t in any seriousness cite higher yields based on inflation, which would actually be balanced by increased revenues, while completely ignoring the reduction in yields from the elimination of the present risk of collapse. Second, and just as important, there are plenty of other assets on bank books that would increase in value with a better economy. When traditional loans are far more likely to be paid back, banks are in better shape. A good economy is good for banking.

Italy can’t afford seven percent at the moment because that seven percent is mostly based on risk. Inflation continues to be low, which means it’s an extremely high, unsustainable real interest rate. But if Italy were paying 7% in a period of 5% inflation (and I’m just offering an example here, not suggesting that 5% inflation is ideal), then the real rate would be an entirely manageable 2%. Italy would not in any way be dependent on indefinite purchases from the ECB. Simply untrue. Italy’s payments were manageable before fears of risk spiked rates, and they would be manageable if the risk went away again. More inflation means more (nominal) tax revenue, which can be used to pay higher nominal rates.

If the concern of the Germans were present sustainability, then that would be utterly ridiculous. Fiscal contraction without monetary easing contracts the economy – as we have seen again and again and again – which decreases government revenue, which makes the debt burden even less manageable. The only sustainable course is expansion, without the use of more debt.

The concern of future moral hazard is legitimate, but must be weighed against the impending financial catastrophe.

To take your first point, I was referring to the hundreds of billions of long-term Euro denominated debt currently on the banks’ books. If the market price of that debt falls significantly (and higher projected inflation would hit the price of all Eurozone debt, not just the PIIGS), the banks are bust in the short term regardless of their long-term prospects.

To take your wider point, your analysis depends on three assumptions:

  • Firstly, that monetary easing would lead to a rapid return to growth (rather than, say, a Japanese-style lost decade).
  • Secondly that any EU/ECB commitment to monetary easing and support for vulnerable countries is regarded as 100% credible (if there’s even a small suspicion that they may turn off the money taps, you get the default price and the inflation price).
  • Thirdly and most importantly, that the resulting inflation will be controlled and temporary. People are tossing around proposals for the ECB to print trillions of euros - enough to monetise a significant proportion of the Eurozone’s debt - while casually assuming that the effect will be “a few years of 5% inflation”.

To me, the quantitative easing cycle looks a lot like the infamous “stop-go” seen in post-war Britain - and that never turned out well.

I’d agree with your short-term conclusion - monetary easing (on an EU-wide scale) is the only way Italy and others are likely to get out of the current hole and the Germans are shortly going to face an explicit choice between allowing the ECB to print money, explicit bailouts or cutting the PIIGS loose.

My objection is to the view that this is all “pig-headed Germans blocking the obvious solution”. Neither the Bundesbank nor the ECB nor the German finance ministry is staffed by idiots - if they’re digging in their heels against expanding the money supply it’s because they see real downsides to expanding the money supply, not some atavistic memories of 1921.

I would highly recommend the columns of Martin Wolf of the Financial Times for a non-ideological view of the Euro problem.

True, I am making the assumption that the macroeconomics we’ve understood for most of the last century is valid. Now, maybe it isn’t. Maybe there’s some hole in our bountiful evidence. But this at least is an assumption I’m perfectly willing to stand by for the present.

Japan isn’t an exception. It proves the point. The Japanese raised interest rates, twice, when the price level was threatening to start increasing again, that is, when they were on the verge of having mild inflation instead of the deflation they preferred. They had their troubles in large part because the Nichigin made a deliberate choice for money contraction, a deliberate choice for price level decreases rather than returning to a sensible path of NGDP growth. The government pulled all manner of spending stunts, never bothering to check that the masters of money were pulling hard in the other direction whenever success was threatening to emerge.

The balance sheet means nothing on its own. Monetary base growth is not a reliable guide to the tightness or looseness of policy. You have to look at broader macroeconomic trends. Money is tight when nominal income growth is low. That’s been the case in Japan for nearly twenty years, and it’s the case in Europe now.

I don’t understand what you’re saying here with default price and inflation price.

I would agree entirely that the policy would have to be credible, but that’s true of any policy.

I made no such casual assumptions. I never stated a suggested rate of inflation, nor made any predictions on how long Germany would have to eat higher inflation. No mistake, Germany would have to eat higher inflation. No getting around that. But if a few countries break off? The devalued new lira/peseta/drachma/etc would force a devaluation of the old euro anyway. I’d suggest getting out your Great Depression books and looking back through them. Look at the chain reaction of devaluations. Look at the dominoes falling, one by one. Germany isn’t avoiding anything right now by being politically obstinate. They’re just playing a delaying game.

Or look at the Fed if you want to know how an expansion of trillions has led to a core inflation rate of… around 2%. It’s quite possible that we’ll be looking at another trillion coming up soon enough.

Demand. There’s not enough demand. The markets are clear as can be on this.

Even the most cursory look at their actions tells an entirely different story about the ECB.

They have an inflation target of 2%, and their own predictions say they won’t reach their legal target. That is rank incompetence. They’re happy to cough up legal justifications for their inability to act as lender of last resort, but they have no problem ignoring the law when it means inflation is lower than mandated. Their target is not sufficient to stop the crisis, and their effort is so substandard that they’re not even expecting to reach said insufficient target.

Appealing to their great knowledge/experience/deliberation is meaningless. There is no excuse for this, not legal or economic or anything else.

The BBC has a simple timeline.

The BBC’s Global Economy page has a load more information too.

Thanks for the discussion everyone. It’s been clarifying. Essentially it sounds like everyone here basically agrees on the fundamental dynamic of the problem, and you all seem to agree with the snapshot analyses I’ve read from Krugman as well. My only problem with Krugman is this:

This makes some sense to me. Krugman basically advances that point of view - “pig-headed Germans/ECB refusing to do the obvious solution”. He derides them as Very Serious People in suits who harbor ideological commitments to principles that are economically insane. Sometimes he’s 100% right in that type of analysis - he’s right to deride some of the supply-side advocates and gold-standard advocates in Washington in those exact terms, which the media never does - and the fact he was extremely sceptical about the Euro right from its inception gives him credibility on this issue, but he writes in such a stark, intemperate way that I’m always worried he’s grossly simplifying things. I will go and read those links on the side of his blog though to try and get a deeper understanding of the issue.

To be a bit more accurate, the duties of the ECB have been defined by a treaty. So, it’s not up to Germany to decide what the ECB can or can’t do. Even though Germany has been the main crusader for the cause of an ECB only in charge of limiting inflation, changing the rules would require the agreement of all the member countries, and not a mere agreement on a table’s corner in the middle of the night, but the signing/ratifying of an amended treaty.

The last time Germany had real experience with inflation was the 1920’s which lead to political destabilization and the ultimately the deaths of a hundred million people. So they have a national bias against inflation. Also the German economy went through a very prolonged period of struggle after reunification and recently had a 4 year period of slow growth and high unemployment from 2002-2005, they feel like they did the right thing and are being asked to bail out everyone who did not.
I agree with Hellestal that inflation is needed, but I don’t think it is the slam dunk that he does. Stagflation is a possibility, and macroeconomics is not a mature enough science that we can have certainty about what the inflation will bring besides lower wages and higher prices. But things are bad and getting worse and we need the central banks to fire every weapon they have at this.

Hellestal - I think we’re meaning different things when we talk about a “return to growth”. I don’t just mean avoiding a disasterous contraction, I mean a high enough long-term growth rate that the affected countries can expand their economies faster than their debts. Absent that, their long-term options reduce to five: explicit default, inflation that amounts to a default, devaluation (which means breaking the Euro), explicit bailout or ECB support on terms so easy it amounts to a bailout. From the German perspective, if it can’t prevent one of those five, general monetary easing is good money thrown after bad, or rather good money wasted delaying the inevitable.

Agree 100%. My objection is to the theory that you can generate demand in the long term (rather than a transient splurge of imports and inflation) by having central banks print money and governments spend it. Particularly in a mature economy where most of the low-hanging development fruit has already been picked.

You probably know more about economics than I do, but my reading of economic history is that simultaneous monetary and fiscal expansion (except as a short-term crisis response) produces inflation, not growth. If monetary expansion is required, governments have to hold the fiscal line (or, if you prefer, since a tight fiscal policy is unavoidable, expansionary monetary policy is essential).

But that leads us back to moral hazard. How do you make governments, who answer to voters, who hate austerity, stick to their budget plans when they know the central bank is bound to step in and save them? It’s too-big-to-fail with countries, and no-one’s found a good answer to that.