Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.
My comment, as now posted to Krugman's blog:
You say "the Portuguese macro story is harder to tell than those of Greece, Spain, and Ireland. ... There was a lot of private-sector borrowing, but it's not that easy to explain exactly why."

Maybe the Portuguese case will illustrate that the cause is exactly the same in all cases, and a structural flaw of the Eurozone.

The Eurozone was built on monetary parameters, both in the 1990 "convergence criteria" (inflation, interest rates, exchange rates, debt and deficit) and since its creation with the "Growth and Stability Pact" (public debt and deficit). Add to this the "Lisbon Agenda for Growth and Jobs" and the EU's outlawing of state-funded industrial policy ("Illegal State Aid Rules") and you have an explosive cocktail.

Portugal, like any other net importer within the Eurozone, needs to fund its GDP growth and its trade deficit. There's no way to do this but deficits and debt. If public deficits and debt are constrained, the private sector will have to accumulate deficits and debt. In the case of Portugal there is not a single "bubble" that can be blamed for it, so there's no clear-cut culprit. But the pressure for private indebtedness was inexorable. The alternative would have been a prolonged recession until the terms of trade with the Eurozone's net exporters (chiefly Germany) improved. Which Germany wouldn't have been very happy about - or the Portuguese people, for that matter.

So, the core flaw of the Eurozone is the same as that of Bretton Woods: no negative feedback loops on trade balances including the absence of floating exchange rates. Keynes warned about this at Bretton Woods but was spurned by the 1940's exporter of last resort, the US. Germany did the same to the Euro and continues to do it in its management of the crisis. China also in the ongoing "savings glut"/"currency war" kerkuffle with the US.

The fact that the Growth and Stability Pact only constrained public debt and deficit and not private debt meant that as long as economic stability reigned, European net importers would inevitably accumulate private debt (even France has a housing bubble, see the work of Jacques Friggit). For the private sector, supposedly, "the market would provide" but it obviously didn't. The market doesn't do feedback loops, it does bubbles and crashes.

As long the EU continues to refuse to acknowledge that it has an internal trade imbalance problem, the Euro will continue to see crises.

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010
by Migeru (migeru at eurotrib dot com) on Wed Jan 12th, 2011 at 06:27:48 AM EST
[ Parent ]
I posted before seeing this other Reader' Comment
People forget to mention that under the euro the deficit problems can only get worse.

Portugal had practically zero net foreign debt and a balanced current account in 1995 - when it started adapting its economy to the single currency. Convergence to the euro with a common monetary policy (meaning easy credit with low interest rates) completely transformed the situation in the following decade. Net Foreign debt is now about 100% of GDP and this is only the accumulated stock. In 2010 this stock has probably increased by some 10 to 12% of GDP, which is the estimated amount for Portugal's current account deficit last year.

The basic accounting identities tell us that a foreign deficit implies either private sector or public sector deficits - or both. It´s amazing yet revealing that the euro zone convergence criteria concentrated on only one variable of this identity (public deficits) while forgetting the other two. Thus a revolutionary process that eliminated monetary sovereignty for the participating states was founded on a misconception of basic accounting concepts!

Most of the Portuguese foreign debt is owed to banks in the core euro zone plus Spain. No wonder then that France and Germany are pressuring Portugal into accepting the intervention of the EFSF. This would mean Portugal would change creditors - not private banks anymore (they would have guaranteed payment of their credits via the EFSF) but a sovereign Euro zone fund instead. The French and German governments would thus be absolved from injecting hundreds of billions of Euros to save their imprudent, lending-happy private banks. For Portugal, however, this solution would be less than attractive: History shows that Sovereign Institutions, contrary to private creditors, typically refuse to accept haircuts.

Portugal is thus rightly resisting the pressure to accept the EFSF "support". She does not want to be pushed into an Ireland-style package that will crush her with an impossible-to-pay debt burden maybe for decades to come - while at the same time tying the country's hands under a fixed exchange rate, no sovereign money regime that implies any adjustments will have to come through a 19th century style deflation.

It's simply unbelievable that Europe has reached this low point of forcing absurd aid-and-austerity packages plus inflexible fiscal and monetary policies on heavily indebted euro zone member states. These recessionary policies can only lead first the periphery countries and ultimately the core euro zone countries themselves into an economic cul-de-sac.

There is no light at the end of the tunnel under the present framework. The European leaders must decide as soon as possible on one of two possible exit scenarios. Either full integration by implementing a single European budget with receipts and expenses at a level of about 30% of the Euro zone's GDP (admitting this is politically feasible)- or else get back to the old system of national currencies that served Europe rather well from 1945 to 1999, at any rate much better than the ill-conceived Euro project.

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010
by Migeru (migeru at eurotrib dot com) on Wed Jan 12th, 2011 at 08:44:32 AM EST
[ Parent ]
Doesn't seem too hard for Brazilians to understand three sector national accounting. But it seems impossible for the beneficiaries of the imbalances generated by ignoring this form of accounting to understand something that has been at the core of business practice for over half a millennium.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Jan 12th, 2011 at 12:33:18 PM EST
[ Parent ]
You can apparently be a former ECB Chief Economist and work for Goldman Sachs, and profess in public to not understand it
"With the failure to make sovereign states' fiscal policies consistent with the conditions for the single currency area, policymakers not only have weakened the functioning of monetary union, but have also called into question its very survival," Mr Issing declared.
As Upton Sinclair said, it is difficult to get a man to understand something, when his salary depends upon his not understanding it.

Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed Jan 12th, 2011 at 12:45:25 PM EST
[ Parent ]
I did have the Upton Sinclair quote in mind as I composed the comment. :-)

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Jan 12th, 2011 at 08:56:10 PM EST
[ Parent ]


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