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Europe's crisis is caused by its institutional failure to confront two recycling problems: A debt recycling problem and a surplus recycling problem.

  • The debt recycling problem emerged after the Crash of 2008. Banking losses, following the implosion of the market in securitised derivatives, led to increased government deficits which in turn (aided and abetted by the panicky credit rating agencies' downgrades) caused (i) doubts on the capacity of some peripheral countries to fund their debt, and (ii) uncertainty on the capacity of banks exposed to the stressed governments' debt (on top of pre-existing holdings of toxic debt) to survive under the strain of a hypothesised sovereign default. The rest, as they say, is the sad history of the euro crisis.

  • The surplus recycling problem has been a permanent feature of the eurozone from its very inception. Its nature is simple: In every currency union there will always co-exist regions (or member-states) that are permanently in surplus with the rest and others that will be deficit regions. Given that the deficit regions cannot devalue as a means of keeping their deficits in check, some mechanism must exist by which the surpluses are recycled from the surplus regions and into the deficit regions not as fiscal transfers but as productive investments that lessen the divergence and help with cohesion. The eurozone has always lacked such a surplus recycling mechanism (click here for a paper that explains this argument fully).

These two problems, or challenges, are not being addressed by the European Union, the result being a euro crisis that is spiralling out of control. The debt recycling problem is causing a vicious cycle between the government debt crisis and the banking losses crisis. Meanwhile, at a time where growth is more needed than ever, the debt recycling problem is highlighting, and boosting, the surplus recycling problem. The trick is how to deal with both problems at once. It is a trick that the Modest Proposal for Resolving the Euro Crisis (put together some months ago by Yanis Varoufakis and Stuart Holland) is well suited to perform.
(Focus on the surplus recycling problem and how it's a currency problem)

Economics is politics by other means
by Migeru (migeru at eurotrib dot com) on Mon May 30th, 2011 at 05:21:40 PM EST
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