Great Leap Forward

MMT AND THE EURO: Current Account Imbalances and the Euro Crisis Part 2

Last week we looked at the claim that MMT has ignored current account imbalances among EMU members. That turned out to be fallacious. We went on to examine the claim that the Euro crisis is a simple balance of payments problem. That, too, is fallacious. If the EMU had been designed properly, it would not matter whether some member nations ran current account deficits—much as many US states run current account deficits. Instead, the problem is that the EMU separated the currency from fiscal policy—all the members adopted the Euro, but each was separately responsible for its own fiscal policy. Further, and this is the point to be explored in detail here, each was responsible for dealing with its own banks should a financial crisis hit.

Warren Mosler had long argued that a very likely path to a Euro crisis would come from a bank failure. With no equivalent to Washington to come to the rescue, each individual nation would have to bail out its own banks. That would add to government debt, cause interest rates to spike, and lead to a run out of banks that could not be stopped. Except by the center—the ECB—which was not supposed to do anything of the sort.

Think about that. When US banks start falling like dominoes, who do you call? Not the Secretary of the Treasury of the State of North Carolina! Nay, you call Uncle Sam and Uncle Timmy and Uncle Ben. Please, Uncles, can you spare, say, $29 trillion dollars to bail us out? (

When Irish banks started failing, who did they call? Well, not Fritz in Frankfurt. Let’s see. Total Irish debt was right about ten times Irish GDP (give or take a Euro or two) thanks to the most profligate bankers the world has ever seen. (The US only managed five times GDP—pikers!) Irish bankers had never seen a bad loan they didn’t like. So they politely asked the nice guys in the Irish Treasury to please, please, take over all our bad debts or the economy will crash. And recalling the potato famine, the government took them all. That busted the budget and the government delivered the famine, anyway.

Sergio (Remember him? This is a response to his argument that MMT’s predictive success is “spurious”—see last week’s blog.) sees all this as a current account imbalance. Those Irish and Icelander consumers just bought too many imports. Living the high life up north.

OK, here’s Ireland’s sectoral balances:

Before the GFC hit, we observe that the Irish government is following the neoliberal advice, running budget surpluses. It also has some very small current account deficits (shown as positive because the graph plots the mirror image capital account surplus). Both of these are “leakages” from the circular flow of income that has to be offset by an injection in the form of a private sector deficit. Now, you can, I suppose, blame profligate Irish consumers for their deficits or you could just as easily blame the government for its surpluses.

In any event, up to 2007 there is nothing that would cause a mainstreamer to worry about Ireland—and it is no secret that mainstreamers thought Ireland was the model of success. But boy-oh-boy did she blow up. Was it the miniscule current account deficits? No. It was the indebtedness of the financial sector—the bank bad loans. Certainly matters were made worse by indebted consumers, with debt fueled in Ireland (as in many other places) by a real estate bubble. But it is a massive stretch to claim that Ireland’s problems resulted from runaway current account deficits. Ireland could have run a continuous current account balance and she still would have exploded—see below.

In response to the banking crisis, the government blew up its budget trying to bail-out the financial system. In truth (as I’ve written about elsewhere) this was an act of Irish charity to save central Europe’s banks; the smart thing to do would have been to default on all the external debt and nationalize the banking sector. (Some say that would have been illegal within the framework of the EU; so be it!) I won’t go into the Icelandic crisis but exposing the banking problems in both Ireland and Iceland as well as the links between “periphery” (and even non-euro) banks and the big banks in the center was the opening salvo of the Euro crisis. Suddenly the banking emperors had no clothes.

And as the Irish government’s budget blew up, investors took a close look at their portfolios of Euro government debt and realized they were exposed to huge risks, too.

Of course, as economies slowed down, most of the other Euro nations also had deteriorating budget balances; and many also found it hard to sell exports. Germany—as Jan Kregel had long ago predicted (see the blog last week)—continued to do very nicely, thank you, as the whole Euro system was constructed to its benefit. It was the low cost producer and the safest place to park Euros. The rest of Europe marched its way toward oblivion.

Here’s Italy, which after the fall of Greece, Portugal, and Spain is expected to be the next shoe to drop:

If Italy were a sovereign nation, it’d be hard to see the problem. Small current account deficits, positive domestic private sector surplus (except in the earliest two years of the GFC) and moderate budget deficits that offset these. No worries here, right? There aren’t many sovereign nations in the world that look a whole lot better to a mainstreamer—only “beggar thy neighbor” mercantilist nations like Germany will have domestic private and government budget balances “better” than this. And yet Italy is experiencing a bank run, high unemployment, imposed austerity and speculation that it will default on its government debt. It might even be forced to leave the EMU. How could anyone—let alone an Italian economist—attribute Italy’s problems to profligate consumption of imports? Heck, back in the bad old days before the EMU (when Italy had its “high” inflationary Lira) it actually ran current account surpluses. It was the set-up of the EMU that killed Italy’s exports—exactly as Jan Kregel had predicted.

France? Well, it is not in the dire straits of a Greece or Spain, but it is talking austerity and there are rumblings of problems even there. Strange. Until the crisis hit it had very small current account deficits; yet it always had significant private savings. If you wanted to point your finger at anything, it would have to be the government deficit–that is, if you did not understand that sectoral balances must, well, balance. Budget deficits exploded as the private sector retrenched and tried to boost savings to deal with all the uncertainty. Given the current account deficit (which grew, but not all that much) the budget had to move to deficit.

Note also that as in the case with Italy, France ran current account surpluses until it adopted the Euro. So, again, Kregel had this correct: the set-up of the EMU favored German exports. And yet it is highly misleading to claim that the current crisis is just a payments imbalance. Rather, it is necessary to understand why the EMU suffered from a design flaw and as well to understand the Godley sectoral balance in order to understand why a current account deficit matters: given a balanced private sector account, a current account deficit necessarily implies a budget deficit. And the EMU was set up to punish budget deficits. That was the whole idea behind delinking fiscal policy from the currency. It was flaw by design.

There’s an interesting story that fits well across most of Euroland. Budget deficits and government debt were small relative to GDP all the way up to the GFC—if these were sovereign nations certainly small enough that no concerns should have been raised. Take a look:


While most countries violated Maastricht criteria, the ratios were not high for sovereign nations. Lest you think that Italy and Greece were always beyond the pale, recall that Japan keeps interest rates at about zero with a debt ratio of 200%. So the MMT argument is that as individual sovereign nations, there was no question of government solvency among any of these nations. But by joining the EMU, suddenly solvency of every one of them was thrown into question. Following Charles Goodhart’s papers in 1996, 1997, and 1998, MMTers had long compared these debt ratios to those of US states. We argued that from the get-go  they were all orders of magnitude too high for nonsovereign members of a monetary union—five times, and more, higher than debt ratios of US states. It was a question of when, not if markets would recognize this.

As Keynes remarked, markets can remain irrational a lot longer than you think they can—and in this case they did. We expected interest rates to diverge earlier than they did (this was a topic of several pieces by Stephanie Kelton in the early 2000s). But when the crisis hit, interest rates finally did diverge:

In our view, the “convergence” period in the mid 2000s was the period in which markets were remaining irrational—either not recognizing that EMU states were like US states and hence vastly over-indebted, or markets were presuming that the ECB would backstop the states even more securely than Uncle Sam backs US states. Finally the divergence that we expected to be “rational” returned in 2008. The convergence was an aberration; the divergence is “normal” for states that can become insolvent.

Recall from last week that Kregel had predicted that the Euroized union would not become a major net exporter to resolve the “race to the bottom” deflationary internal dynamics. (And recall that Germany’s mercantilist policies would impart an EMU-wide deflationary force as other nations would cut demand to hold wages in check in order to compete with low German labor costs. This internal pressure could be offset only if EMU members could find external demand.) For completeness, let’s see how well that prognosis held up:

We can see a strong cyclical movement of the balances—as government budgets move toward balance, a recession is created which restores budget deficits that also move the private sector sharply back to surpluses. But formation of the EMU really had no discernible impact on the overall current account balance. Again, there is no story to be told here—exactly as Kregel predicted. The Euro area continues to run small current account surpluses (with a small deficit only in 2008 when global growth turned downward) that are not sufficient to overcome the internal deflationary dynamics. Something like three-fourths to 80% of all the current account surpluses run by EMU members are due to those of Germany—which sucks demand (mostly) out of its fellow members. This is why most EMU members suffered chronic high unemployment even before the GFC.

To summarize the point about sovereignty, let me quote from a 2001 piece by Warren (just two years into the euro experiment):

“The euro-12 nations once had independent monetary systems, very much like the US, Canada, and Japan today.  Under EMU, however, the national governments are now best thought of financially as states, provinces, or cities of the new currency union, much like California, Ontario, and New York City.  The old national central banks are no longer the issuers of their local currency.  In their place, the EMU has added a new central bank, the ECB, to manage the payments system, set the overnight lending rate, and intervene in the currency markets when appropriate.  The EP (European Parliament) has a relatively small budget and limited fiscal responsibilities.  Most of the governmental functions and responsibilities remain at the national level, having not been transferred to the new federal level.  Two of those responsibilities that will prove most problematic at the national level are unemployment compensation and bank deposit insurance.  Furthermore, all previous national financial liabilities remain at the national level and have been converted to the new euro, with debt to GDP ratios of member nations as high as 105%, not including substantial and growing unfunded liabilities.  These burdens are all very much higher than what the credit markets ordinarily allow states, provinces, or cities to finance.”

Note how Warren mentioned the problem with bank deposit insurance—individual euro nations were responsible for their own banks. Warren went on in the same piece:

“Since inception a little over two years ago the euro-12 national governments have experienced moderate GDP growth, declining unemployment, and moderate tax revenue growth.  Fiscal deficits narrowed and all but vanished as tax revenues grew faster than expenditures, and GDP increased at a faster rate than the national debts, so that debt to GDP ratios declined somewhat.  Under these circumstances investors have continued to support national funding requirements and there have been no substantive bank failures.  Furthermore, it is reasonable to assume that as long as this pattern of growth continues finance will be readily available.   However, should the current world economic slowdown move the euro-12 to negative growth, falling tax revenues, and concerns over the banking system’s financial health, the euro-12 could be faced with a system wide liquidity crisis.  At the same time, market forces can also be expected to exacerbate the downward spiral by forcing the national governments to act procyclically, either by cutting national spending or attempting to increase revenue.”

Ok, an economic slowdown would widen deficits and force government to tighten procyclically—slowing growth and actually worsening budgets. That recognition then led Warren to a series of questions about the behavioral and policy responses:

“The inherent instability can be expressed as a series of questions: 

*Will the euro-12 economy slow sufficiently to automatically increase national deficits via the reduction of tax revenues and increased transfer payments?  

*Will such a slowdown cause the markets to dictate terms of credit to the credit sensitive national governments, and force procyclical responses?  

*Will the slowdown lead to local bank failures?  

*Will the markets allow national governments with heavy debt burdens, falling revenues and rising expenses the finance required to support troubled banks?  

*Will depositors lose confidence in the banking system and test the new euro-12 support mechanism?  

*Can the entire payments system avoid a shutdown when faced with this need to reorganize?”

We now know the answer definitively: in every case the EMU response increased instability. The bank runs are now in full force. The Target 2 mechanism that I discussed a couple of weeks ago has softened the blow but actually increased the potential for massive defaults. It is worthwhile to look at Warren’s conclusion from a decade ago:

“Water freezes at 0 degrees C.  But very still water can be cooled well below that and stay liquid until a catalyst, such as a sudden breeze, causes it to instantly solidify.  Likewise, the conditions for a national liquidity crisis that will shut down the euro-12’s monetary system are firmly in place.  All that is required is an economic slowdown that threatens either tax revenues or the capital of the banking system.  

A prosperous financial future belongs to those who respect the dynamics and are prepared for the day of reckoning.  History and logic dictate that the credit sensitive euro-12 national governments and banking system will be tested.  The market’s arrows will inflict an initially narrow liquidity crisis, which will immediately infect and rapidly arrest the entire euro payments system.  Only the inevitable, currently prohibited, direct intervention of the ECB will be capable of performing the resurrection, and from the ashes of that fallen flaming star an immortal sovereign currency will no doubt emerge.”

And that gets us to the final problem with focusing on the current account balance. By construction, the capital account balance is the mirror image of the current account since the flows of goods, services, and factor payments have to be “paid for”. But as I said, that is a very tiny fraction of “capital flows”. If a German bank makes a mortgage loan of 100K euros to a Spanish resident to buy a house, there is no capital flow record as nothing was imported (factor incomes get reflected in current account balances, but financial transactions themselves do not). But just as a current account deficit gets a nation indebted, so do financial transactions. With real estate bubbles all over the US, Australia, the UK, and Europe a lot of this kind of cross-border indebtedness was created. Again, if one focuses on imbalances of current and capital accounts, all this will be missed.

Further, what has really exploded over the past couple of decades is financial institution indebtedness—“banks” owing other “banks” (many of these are what Paul McCulley called “shadow banks” which are not technically banks and are not regulated or backstopped to the same degree; arguably it really was the shadow banking sector that blew up the globe). As I’ve discussed, Minsky saw this as part of the transition to “money manager capitalism” while others named it “financialization”. No matter what it is called, it created huge risks that a relatively minor problem in one institution could spread quickly throughout the whole global financial system.

And that, folks, is precisely what happened in 2007. It is still happening. It will not stop until all the big financial institutions are shut down. But that is a topic for another day. (My gosh, is there anyone alive who still believes these institutions are solvent? They are held up by nothing but fraudulent accounting built on pervasive fraud.)

One of the goals of European integration was to free up labor and capital flows, removing barriers so that factors of production could cross borders. Indeed, that was a primary reason for adopting the single currency. Whether or not that was a good idea, and whether or not it worked, is a topic beyond our scope. What is important in the context of the current crisis is that it enabled banks to buy assets and issue liabilities all over Euroland—which they did with abandon. Their risky and fraudulent activities were fueled by the deregulation and desupervision of banking contained in the Basel Accords, which allowed European banks to partake in the same dubious schemes that Wall Street’s banks pursued. And because of the way the EMU left all responsibility for crisis response to individual members, a crisis was sure to bring the down the whole house of cards.

This is, of course, what got Irish banks into trouble, as they ramped up lending across Europe, growing their liabilities to multiples of Irish GDP. Then, when their bets went bad, the Irish government had to bail them out, boosting fiscal deficits and government debt into uncharted territory. Again, this was a design feature of the EMU and the European Union more generally:  banks were freed to run up massive debts that would ultimately need to be carried by governments that, because they had abandoned currency sovereignty, were in no position to bear the burden.

That brings us to the growing run on banks. Again, this results from a Euro design feature because it enables bank depositors to costlessly shift euro deposits from one bank to another anywhere in the EMU. This is enabled by the “TARGET 2” facility (Trans-European Automated Real-time Gross Settlement Express Transfer System). Any depositor of a Spanish bank can move deposits to a German bank. Such a shift requires that the central bank of Spain obtain reserves that get credited to the central bank of Germany. If deposits tend to flow from the periphery nations, their central banks go ever more deeply in hock to the ECB to obtain reserves that accumulate in the account of the Bundesbank.

Now, moving deposits to German banks is a sure bet: if Germany leaves the EMU depositors will get appreciating Marks, and if Germany remains in the EMU, depositors have the safest euro deposits available. Why take a risk that Italy or Spain or Greece will leave the EMU, default on euro-denominated deposits, and redenominate them into a depreciating currency? Even in the best case scenario, the country that leaves the EMU will honor its euro debts only in domestic currency; in the worst case scenario it might not honor them at all. And while it is conceivable that Germany could refuse to honor euro deposits held in its banks by citizens of nations that leave the EMU that would seem to be a low probability. After all, Germany will want buyers for its exports—so why not honor the deposits, even if they must be converted to marks with the death of the EMU?

Of course, a currency union really must have something like a TARGET 2. In the US, depositors can shift deposits about and from the beginning in 1913 the Fed guaranteed that bank deposits clear at par. While we have District banks sprinkled around the country, it makes no difference whether a bank happens to be headquartered in South Dakota, New York, Missouri, or California. We settled the question about dissolution of the Dollar Union back in the days of the Civil War. So, no matter how much the crazies in Alaska or Texas might fantasize about it, there is a near zero probability that President Obama will have to face the dilemma ably handled by President Abe Lincoln.

In a financial crisis, troubled American  banks may not be able to obtain reserves for clearing in the fed funds market but that is why we have a Federal Reserve System to act as lender of last resort. The Federal Reserve District Banks around the country are protected by the Mother Hens in Washington—the US Treasury and Fed Board of Governors stand behind them to ensure par clearing among regions and to recapitalize District banks if that should ever become necessary.

Private banks are free to accumulate debts of local and state government—and they can find themselves in trouble if these governments default on their debts. But there is no plausible scenario that these governments will leave the union and redenominate debts in another currency. If the governments default, and if the banks holding those debts become insolvent, then we’ve got the US Treasury and the Fed to resolve the private banks, too. Both the Fed and the Treasury can get stuck holding bank liabilities that cannot be covered by the debtor banks. Other creditors of failed banks can also suffer losses. But the Dollar Union will stand and only extremely inept policy by the Fed and Treasury would allow a run to develop on banks in one region as depositors shifted to banks in another. While incompetence cannot be entirely ruled out, it is extremely difficult to envision anything like what is going on in the EMU happening in the US.

The European TARGET 2 facility works much like the US par clearing system except that instead of District banks that are members of the Central Bank, we have member Central Banks without the same degree of central responsibility to support them. Will Greece’s Central Bank get recapitalized by the center? I wouldn’t bet on it. And who will recapitalize the ECB if that becomes necessary? That is why policymakers are concerned about the flows of reserves and the growing indebtedness of member central banks to the ECB.

The EMU bank runs should accelerate in coming days, as remaining periphery depositors decide to take the safest bet by shifting deposits to German banks. And if that does happen, TARGET 2 ensures that the ECB will be stuck with trillions of euros of potentially uncollectible debts due to all the reserves it has been lending to central banks that have to finance the run to German banks. It all essentially comes down to the links and the design flaw: free “capital” flows, a single currency, and no central fiscal authority. Only the ECB stands between the EMU and disaster—a reluctant guarantor at best.

Some mainstreamers continue to see the GFC as a result of current account imbalances—the “excess global liquidity” thesis. See for example: (This is similar to the views of Sergio albeit his are without the loanable funds theoretical background.) Many orthodox economists ironically adopt something close to a “loan pusher” argument: the excess global saving pushed interest rates down, leading to excessive borrowing by debtor nations that consumed beyond their means. Although the framework is somewhat different from the current account imbalance story, the conclusion is the same: too many imports flowing to heavily indebted profligate consumers. This can be supplemented with the mercantilist story—Germany is also guilty because it pushed cheap exports onto the importers.

As I have tried to make clear, there is something to that but it is far too simple. The EMU could easily have self-destructed even with no current account deficits anywhere. And the US does not self-destruct in spite of current account deficits everywhere (internally and externally). The original MMT critique—dating from the earliest formation of the EMU—helps us to understand the difference.

Some critics have said that MMT just got lucky—the clock passes 12:00 twice daily. They claim MMT just threw out a bunch of predictions of crisis and happened to get one right. Actually, we got both of them right: the GFC that started in the US (thank you Goldilocks!). And the one underway in Euroland. The descriptions of the design flaws and as well of the likely processes that would unfold in crisis proved to be correct.

Other critics say that MMT was not the ONLY approach that got the prediction(s) right. OK that is fine—welcome aboard to join a small club. Those who got it right deserve to play on the main stage right now. Let us then see the analyses that led to the predictions. Perhaps there are several that appear to describe the processes that led to crisis, including non-MMT approaches. So much the better! Global economic processes are extremely complex and I would not be surprised to find other plausible stories.

It might not be possible to distinguish between rival stories based on our current understanding. But at least we can eliminate some failures: Efficient markets hypothesis, Rational expectations, Real business cycle, and all versions of Monetarism can be thrown out. The scope for approaches to economic analysis has been narrowed but not necessarily to a universe of one.

The economist’s work is never done. Who thought it would be?


56 Responses to “MMT AND THE EURO: Current Account Imbalances and the Euro Crisis Part 2”

barfJuly 17th, 2012 at 12:26 am

the two massive problems that are going to be exposed because of this financial catastrophe are France's nuclear policy (which will have to be wholly supported by the State should the EU start fissuring) and more importantly the Continent's insurance industry with all the "guaranteed rates of return" which made sense in the 70's, 80's and to some extent with the introduction of the euro the 90's into the 2000's…but now represent a clear and MASSIVE financial ala AIG in the USA. Except that "Europe has about 4 or 5 of those" to the USA's one. Munich Re, Swiss Re, Allianz, Axa and Generali come to mind. Here's an oldy but a goody:

EugenRJuly 17th, 2012 at 5:48 am

"Watching the PIIGS borrow & spend themselves into bankruptcy & then bailing them out is both immoral and irresponsible." is a painful issue and so also the key issue. It is obvious, that if to be pragmatic, and acting for better economic future, Euro has to be saved for any price, yet there is this disturbing moral question so nicely said by Paul-NJ. But, not all the sovereign debts are the same. Greece behaved criminally from the first moment it entered into the Euro Zone, but then they pay a very heavy price for it, what other punishment can we expect? Spain is a different story, it has a crisis due to the collapse of its real estate industry. Such a collapse happened in the past, happens, and will happen. If not the restriction printing money, they could have solved it by themselves, i wouldn't see here a moral question but rather structural one, that has to be solved. The same with Italy and the rest of the P.I.G.S.
But there is an other moral question, that does have to be considered, and it is the question of the commercial banks. How come, that this proud institutions, claiming professionalism and excellence, failed so much? They did not know when they borrowed Greece about 500 milliard Euro,that the real GDP of Greece, without the loans they gave, is about 150 milliard Euro. It is enough to look into some chart in Google to understand that this is the case. viz.
That shows clearly how low is the Greek and Portuguese capacity for savings, if added to it the current account deficit: viz.….
It is obvious that long time before 2008 not Greece and not Portugal had the capacity to pay back debts, since they have to come from some savings.The managers of commercial banks, who approved these loans, should be asked for explanation of their misjudgment, and it should be publicized, to prevent same misjudgments in the future?

EugenRJuly 17th, 2012 at 5:50 am

It is time Europe put aside its fractionation and bloody history. When the Euro was created, everybody know that it cant work in the rules it was created in, but most of the countries went for it, believing, it is a step forward. But then the shortsighted populist politicians, supported by people easily provoked by populists,started to paddle against the unification. The arrogant Irish, the proud Scandinavians, and the conservative British,all of them has forgotten the lesson of WWII. Hopefully the crisis will teach them all, that the only way is the common way. If due to tendency of the Europeans to compete and not cooperate, the only way to advance unification is by economic crisis and some moral concession and sacrifice, let it be so.

ggmJuly 17th, 2012 at 6:21 am

I read Hamilton's piece as well as the Wray article which Hamilton excerpts and all of the subsequent comments on both sites. Ultimately, I agree with Wray's accounting. Brad Keoun also posted an excellent rebuttal to Hamilton in the comments. I'm not saying that Hamilton is on the Fed's payroll, but one could easily draw that inference based on his strange insistence on minimizing these backstops.

However, this is really off topic.

DiranMJuly 17th, 2012 at 6:31 am

It was criminel to put Greece in the Eurozone in the first place, but this was an act of collusion between EU and Greek policy makers. Indeed. Lucas Papademos, who certainly knew everything about the dubious process and fudging, was rewarded by a position on the ECB. Indeed later the EU forced him upon Greece as PM to 'save' the situation. Papademos, of course, only made the mess worse by agreeing to a program that is unworkable, etc. In short, the biggest criminals are the EU political elite and their policy maker friends who created and perpetuate this monstrosity of a currency union, compounding the mess and making the losses larger and larger as they continue to dither and obfuscate. A true hero would close down this currency union and minimize losses before it collapses in disorderly dissolution!

DiranMJuly 17th, 2012 at 6:36 am

There is never been a 'unification' of Europe without repression and force: Napoleon, Austro-Hungarian Empire, Soviet Union and now European Union. The European Union is causing massive pain and suffering to millions of Europeans by this forced currency union generating massive economic dislocation in a giant economic prison. Read the article above carefully to understand how this works and the consequences! Sooner or later people will opt for their political and economic freedom and fight to break out from the yoke of Brussels tyranny.

DiranMJuly 17th, 2012 at 6:39 am

Why are European policy makers so deaf and incompetent in basic economics? I suppose that this is a replay of the Soviet Union where ideology and political ambition are the driving forces. History shows how Europe self-destructs time and again with ideology.

Neil WilsonJuly 17th, 2012 at 8:43 am

"Hopefully the crisis will teach them all, that the only way is the common way"

Actually it teaches the opposite. That the common way is not the only way and probably isn't the best way.

Better a co-operating bunch of smaller agents.

RamananJuly 17th, 2012 at 1:27 pm

"If a German bank makes a mortgage loan of 100K euros to a Spanish resident to buy a house, there is no capital flow record as nothing was imported (factor incomes get reflected in current account balances, but financial transactions themselves do not). But just as a current account deficit gets a nation indebted, so do financial transactions"

Correction needed.

If a German bank resident in Germany makes a mortgage loan of 100K to a Spanish resident, it is recorded in the financial account of the Balance of Payments. (capital account in the textbook terminology, financial account in official terminology).

Also, current account deficits increase the *net indebtedness* of a nation, whereas financial account transactions by themselves *do not* increase the net indebtedness. There's a difference.

Ireland did have high current account deficits. According to the IMF WEO September 2011, these were from 2005 onward till 2009: 3.5%, 3.5%, 5.3%, 5.6% and 2.9%.

More importantly, an analysis of the external sector also needs to take into account revaluations of assets and liabilities vis-a-vis nonresidents. So, Ireland saw huge revaluations against her favour and this cause its net indebtedness to rise to 100% of GDP.

"Now, you can, I suppose, blame profligate Irish consumers for their deficits or you could just as easily blame the government for its surpluses."

A relaxation of fiscal policy by Ireland before the crisis would have caused the domestic demand to grow faster – deteriorating the external sector more and bigger trouble. The relaxation would caused the gap between private income and expenditure only temporarily to reduce – but with higher private expenditure would have led to a more dangerous outcome.

RamananJuly 17th, 2012 at 1:36 pm

Or if the "German bank" is resident in Spain, no financial account transaction as you say but needs to be specified that it is resident in Spain.

Anyway second part about net indebtedness (current versus financial account transactions) holds.

SchofieldJuly 17th, 2012 at 7:27 pm

Neil Wilson

"Hopefully the crisis will teach them all, that the only way is the common way"

Actually it teaches the opposite. That the common way is not the only way and probably isn't the best way.

Better a co-operating bunch of smaller agents.


Absolutely right. Outside of the fiscal policy space argument imagine the scenario if the EMU countries had adopted a balanced trade policy between member countries as an aim and requirement of the Maastricht Treaty with timetables attached. This would have constrained Germany's irresponsible mercantilist policy towards its fellow EMU members.

TomJuly 17th, 2012 at 7:46 pm

You're still missing the basic distinction between the euro, a national fiat currency, and a foreign or gold-backed currency.

The euro is similar to a national fiat currency in that euros can be issued in unlimited quantities. Eurozone national central banks have considerable leeway to issue large amounts of euros in a crisis, and they have done so at paces much greater than US quantitative easing relative to their national GDPs.

However the euro is similar to a foreign or gold-backed currency in that in a crisis within part of the Eurozone, euros are exported from the crisis-hit countries to the countries still deemed safe. This is similar to the exporting of dollars from Argentina in its crisis, or to the redemption of currency for gold and exporting of gold during the Great Depression. If a Eurozone country were fully depleted of base money euros, its banks would be unable to honor withdrawals. This is the speeding train that Spain and Greece are running in front of.

The notion that this is all about the solvency of the national governments is very misguided. If Spain or Greece had national currencies when credit bubbles of similar scale collapsed, the interest rates on their government bonds would have rapidly escalated. Solvency comes down to the real resources that you can command, not to the quantity of currency that you can issue. From the investor's point of view, default and devaluation are two weapons in the same counterparty's left and right hands.

FDO15July 17th, 2012 at 8:08 pm

Here's what I'd like to know. MMT says the government doesn't ever really have nor doesn't have money. They don't spend tax dollars. It's all just credits and debits in spread sheets. So why do you complain about bank bailouts then? They're not spending taxpayer money. In the case of the Fed's $29 trillion loans they just credited bank accounts temporarily and then erased them later. Even the capital injections came from nowhere. The money didn't come from tax payers. So what's the big deal? Under MMT we should be able to bailout everyone and still have money left over the afford full employment.

Why do you guys feel the need to contradict yourselves left and right? Could it be because your entire theory is filled with inconsistencies that render the entire thing wrong?

Jose GuilhermeJuly 17th, 2012 at 8:21 pm


If a German bank lends to a Spanish household, then Spain is exporting an IOU.

How come this transaction does not increase Spain's indebtedness? The IOU will presumably have to be paid off by "Spain", right?

One other point:

Let's say, for the sake of simplicity of argument, that the Spanish current account is at balance.

Then – there having been no goods, services, or transfer transaction – you should have an increase (plus sign) in Spain's capital balance, and a decrease in the official (foreign) reserves balance.

But in this case, there is no foreign exchange involved – both countries use euros – so what happens to the "foreign" reserve account?

I think these are key accounting issues, without an understanding of which the euro crisis cannot even be properly analyzed.

Yet these issues are typically not clarified, even in debates among supposedly learned economists.

It is as if mathematicians could not agree on definitions!

Will you then – as someone whose knowledge of these issues is recognized by no less a personality than Marc Lavoie – help clarify them for the interested but definitely not academic public?

Jose GuilhermeJuly 17th, 2012 at 9:08 pm

If Spain, Greece had national currencies they could have their central bank setting rates on national currency public debt at any level desired.

Of course, that would not be so with foreign currency denominated debt.

RamananJuly 17th, 2012 at 11:42 pm


There are terminologies which are proper and agreed upon. For reference see the IMF's guide on Balance of Payments.

Its best to avoid "exporting IOU" etc and simply call exports exports and financial account transactions by the same name.

Regarding your question on transaction on the financial account, it increases Spain's assets and liabilities simultaneously. So the example you give doesn't increase Spain's net indebtedness.

More properly and practically, the German bank has a branch in Spain and is considered a resident in Spain and hence this transaction – if done directly at the resident branch – doesn't even appear in the balance of payments.

However the branch is a corporation and it is profitable and is controlled by a main branch in Germany. When this starts making profits – such as by receiving interest payments – it appears in the balance of payments.

If the branch repatriates profits to the parent, or if it retains earnings – both appear in the current account and there is a second entry in the financial account.

Regarding the financial account broken into financial account and official settlement account: (with a zero CAB), changes in the financial account resulting in changes in official settlements change the composition of the international investment position but do not change the net indebtedness.

Jose GuilhermeJuly 18th, 2012 at 1:40 am

“When this starts making profits – such as by receiving interest payments – it appears in the balance of payments”.

So when the Spanish real estate market collapses the German bank reports a loss on the loan and that loss then appears in the BOP?

That would explain why Ireland’s modest current account deficits suddenly translated themselves after the housing crash into a massive net international indebtedness position, I suppose.


Jose GuilhermeJuly 18th, 2012 at 1:44 am

Oh, I almost forgot: the “exporting IOUs” expression came straight out of an old edition of Samuelson’s textbook. 🙂

LRWrayJuly 18th, 2012 at 2:19 am

Oh, Hi again Phil, FiDO, Anon, and so on. So now you have moved on to Theme Names–Audited last week, now Not a CPA? Keep trying, you'll come up with a clever one. We've got all your ISPs now so we can immediately identify you.

The issue you try to raise is dated. All this was dealt with months ago on GLF. It is not really so much accounting as adding, as in 3+5=8. You might get a different number, maybe 6? Your math might be different but no one has found an error in our math. And I note the Fed has recently released a study using our methodology of adding up.

But keep trying, you just might hit on something clever.

LRWrayJuly 18th, 2012 at 2:23 am

FiDO: I like you best with this alias. Much better than Anon, Phil, Audited, and Not Uh CPA. Your comments bite!

Not a big deal if you think the Fed's role ought to be to bail-out Real Housewives of Wall Street! Of course Uncle Sam can afford it. That has nothing to do with the complaint.

LRWrayJuly 18th, 2012 at 2:28 am

Right Ramanan, twist the words to make your point. Then backtrack. Again, Ireland's problems have little to do with current account imbalances.

LRWrayJuly 18th, 2012 at 2:30 am

right jose: if they had their own sovereign currencies, the interest rates would be whatever they chose. that is just basic understanding of sovereign currency with central bank as price setter. ie Japan, US, UK

RamananJuly 18th, 2012 at 7:06 am

I thought your whole double-post was twisting words.

"Oh balance of payments doesn't matter … but it matters because … but it doesn't matter! "

Btw, you present yourself as a dissenter: "imbalance, what imbalance". You should realize that the position is mainstream and orthodox. In neoclassical economics, imbalances don't matter. But they matter so they blame the government for not setting markets free.

Yours is not twisting it to sound heterodox.

RamananJuly 18th, 2012 at 1:43 pm


Yes losses in Spain will hit Germany's net asset position.

Modest current account deficit? 5.6% deficit is hardly "modest".

The countries with good current account were Germany, Luxembourg, Netherlands, Belgium, Austria, Finland (check the IMF's World Economic Outlook data section) if you want to look at it that way!

Btw, not that "exporting IOUs" is wrong. Just that it has a potential to create confusions so better avoid it – that's what I meant.

Jose GuilhermeJuly 18th, 2012 at 5:58 pm


Thanks for your answer.

I said Ireland’s CA deficits had been modest in the sense that compared to the enormous (negative) net international investment position of the country those deficits look tiny indeed.

I suppose this discrepancy is a result of the massive post – bubble writedowns in the real estate market.

IMO, this demonstrates it is not enough to look at CA deficits. A country may seem to be relatively “balanced” in its foreign accounts, and the markets may buy that story. Then suddenly a bubble in the RE or financial sector bursts and pop – we find out the country was in a risky external position, after all.

And when or if this happens being monetarily sovereign is a big advantage. Just compare the situations today of Iceland and Ireland after being submitted to a similar shock in 2008.

The only rational advice to any country considering abandoning the power to create its own money should thus be: be careful what you wish for!

nopeJuly 18th, 2012 at 9:38 pm

"Oh balance of payments doesn't matter … but it matters because … but it doesn't matter! "

Um, no that's not what he has said at all. Now you're really twisting things. I think that should be pretty clear to everyone.

Jose GuilhermeJuly 18th, 2012 at 9:38 pm


Thanks for your answer.

I said Ireland's CA deficits had been modest in the sense that compared to the enormous (negative) net international investment position of the country those deficits look tiny indeed.

I suppose this discrepancy is a result of the massive post – bubble writedowns in the real estate market.

IMO, this demonstrates it is not enough to look at CA deficits. A country may seem to be relatively "balanced" in its foreign accounts, and the markets may buy that story. Then suddenly a bubble in the RE or financial sector bursts and pop – we find out the country was in a risky external position, after all.

And when or if this happens being monetarily sovereign is a big advantage. Just compare the situations today of Iceland and Ireland after being submitted to a similar shock in 2008.

The only rational advice to any country considering abandoning the power to create its own money should thus be: be careful what you wish for

RamananJuly 19th, 2012 at 1:13 am


Yeah but don't give the impression that it has low CA deficits.

Let me offer an analogy. I claim smoking reduces lifetime. However there is nothing preventing a smoking/nonsmoking person from blowing himself up. Does that prove smoking doesn't matter?

So there is a clear distinction between which countries ended in trouble and which didn't.

So bringing in Ireland – not sure what it proves. It has a huge net indebtedness to the rest of the world due to the external sector. The creditor nations have far less trouble. Btw, many Euro nations' bill rates such as 2y are turning negative! And the hugely indebted nations (indebted to the ROW) are in trouble.

(Btw, Ireland's analysis is even more complicated by fact that it is a center for SPVs).

EA Nations strictly cannot make a draft at their NCB. However, this reason alone doesn't tell a story. To tell a story you need to see what went on. A simple look at the public debt (which is roughly the cumulative fiscal deficits +/- technicalities) does not give an answer. See my graph here which compares public debt versus net international investment position for EA nations

You could claim the Euro Area would have blown up anyway but that's just theoretical. It's not a story of how events happened and so on.

At any rate, the post completely fails to take into account Ireland's international investment position (and hence its external situation).

LRWrayJuly 19th, 2012 at 3:39 am

No Ramanan: your whole story is counterfactual. Your claim is the problem is current acct deficits. Not giving up sovereign currency. But they gave up sovereign currency and blew up. Alabama is not blowing up. States all across the US have massive current acct deficits.

You bait and switch all the time. You twist words all the time. You attack, and never make a positive contribution to any discussion. My point was clear: German banks make loans in Spain that indebt Spanish homeowners. Never shows up in current account deficits. Spain can have a balanced current account and still blow up due to debt. You have no answer to that so you twist words and say that if a German bank in Germany makes a loan it does show up in capital acct. So what? Beside the point. And if it ever happened it is a small part of the story.

All your posts are just framing. Attack, then hide behind a retreat.

LRWrayJuly 19th, 2012 at 3:44 am

Agreed. Ramanan's whole business model is based on twisting words on very minor points to divert attention. It is all framing. To try to build a fog of confusion over points that are actually very clear. He then thinks he wins even as he backtracks away from the points he made.

LRWrayJuly 19th, 2012 at 3:48 am

I am a dissenter from wrong analysis. Thirlwall's Law (that you implicitly use behind all your posts) is applicable only to gold standards, and somewhat to Bretton Woods. We left those before you were born. Get over it. Like it or not, we are not on gold or BW. We've got "modern money", "soft currency", "fiat money", "sovereign currency"–whatever you want to call it. I could care less what is "heterodox"–if it is wrong, I leave it behind.

RamananJuly 19th, 2012 at 5:46 am

Well I never claimed giving up sovereignty xyz is good. I have quoted Godley's articles in various places including my blog to highlight this.

The point is that there is a story on how the crisis played out starting from 1999. Your theory that its simply giving up the power to make a draft at the central bank does not explain why Luxembourg is in less trouble and why Greece is in more. For that you need to bring in the current account balance. Unfortunately despite your victory dance, you hardly ever discussed this before 2010.

No bait and switch. Keep accusing. Typical.

"Never shows up in current account deficits. Spain can have a balanced current account and still blow up due to debt."

But Spain did not have a balanced current account. Why do you always bring fantasy into the discussion? Germany is not in as much trouble as Spain!

It's crystal clear – the debtors are in trouble.

"All your posts are just framing. Attack, then hide behind a retreat."

As usual, replies full of accusations. Hardly ever seen you debating with me in a logical manner.

RamananJuly 19th, 2012 at 5:55 am

Well I thought you also used Thirlwall's Law in your paper about Mexico!

We had a balance of payments constraint earlier and we still have a balance of payments constraint. My view is as straightforward as that despite your attempt to make it look as if I switch!

In the Euro Area, the balance of payments constraint becomes more pronounced because exchange rates are locked irrevocably and that governments do not have the ability to use the central bank overdraft leaving it with little powers to protect itself.

The 2008 crisis has highlighted how nations with a sovereign currency (your terminology) went to the IMF for funds. Yet it isn't sufficient for you to change your incorrect views.

Funny the idea was advocated by Milton Friedman (who even proposed to make official intervention in fx markets unconstitutional) and has pushed nations into agreeing on free trade.

There's so much neoliberalism there, but you don't see it!

LRWrayJuly 19th, 2012 at 11:45 am

Debate with you? You hide behind an alias. You jump in and attack then go away and hide. Who knows who you are? Or if you even exist? Where's your CV? I've gone to your website which typically has some charts from some official publication and then a bit of analysis of the charts. It never rises to the level of analysis that could serve as the basis of a debate. Nor do your comments that are always over some little nit-picky point. What position do you hold that is worth debating? If you've got one, come out of the closet, write it up, publish it, and lets have a debate about it. I have no idea what point you are trying to make now beyond your belief that the EU crisis is all due to balance of payments problems. I have shown that is quite superficial and highly misleading. We can envision a number of other paths to crisis due to the way the EMU was set up. For example, a bank crisis, which can happen with balanced current accounts–the example I was providing.

LRWrayJuly 19th, 2012 at 12:44 pm

Ah, another drive by. Timing is everything, isn't it Ramanan? Ireland's foreign balance was +4% 2003.1; +3% 2004.1; +0.4% 2005.1; +0.8% 2006.2…………….Positive current accounts! After 2006 the balance moved into persistently negative territory as spreading crisis hurt US growth, until end of 2008 when Ireland managed a couple of qrtrs of positive current accts.
But, yes, I'd say that 5.6% negative balance is perfectly sustainable for a sovereign currency-issuing country that floats. I've explained why in numerous published pieces. Thirlwall's Law does not apply in the case of floating sovereign currencies.

RamananJuly 19th, 2012 at 3:19 pm

Unsure what your data source is:

IMF WEO September 2011. Table A11 – Appendix.

2004:minus 0.6
2005: minus 3.5
2006: minus 3.5

The trouble is that its not a choice that most governments can manage to truly float without incurring debt in foreign currency. Those debtor nations who do are US, Canada, UK with very high acceptance in international markets. Others such as Sweden (and Canada) have improved CAB since 2000s.

The trouble is 5.6% doesn't remain 5.6% it rises forever if fiscal policy alone is used.

Thirlwall's Law is empirical.

PJ PierreJuly 19th, 2012 at 5:45 pm

This is the strangest complaint yet! A's don't come from anywhere, teachers cant run out of A's, so who cares if they award them to there favorite (undeserving) students? Points at the ball game don't come from anywhere, why does it matter if the scorekeeper grants a few (unearned) help his favored team over the hump? Give me a break, seriously?

LRWrayJuly 19th, 2012 at 8:28 pm

I repeat: I'm amazed you think a serious "debate" can take place in the comments section of a blog. If you are prepared to actually debate over the causes of the Euroland crisis–rather than just take driveby potshots like a Troll–then lay it all out. Come out of the closet. Author a serious piece. Disclose your framework; lay out your methodology; tell us your theory; support it with data and argument. Persuade us. Driveby is not persuasion.

I suspect you cannot and will not do that. On the surface, I do not believe you have any explanation–just a handwave at an "empirical" "Law" that somehow current acct imbalances rise "forever". I think that is a highly ridiculous position, especially given that the "Law" was based on Gold Standard empirical evidence. It will be very hard for you to defend it, methodologically and theoretically and empirically. I could be wrong. Let us see. I'll wait.

nopeJuly 20th, 2012 at 12:06 pm

I think a lot of people who comment on MMT blogs are full of confused ideas, both those who are in favour of MMT and those that are not. But MMT itself is coherent, I think. Give me one good example of a "confused MMT idea".

nopeJuly 20th, 2012 at 12:12 pm

"The 2008 crisis has highlighted how nations with a sovereign currency went to the IMF for funds."

You mean Mexico.

nopeJuly 20th, 2012 at 12:29 pm

The UK has had current account deficits for decades, and a banking crisis, but hasn't run into the trouble faced by eurozone countries. Gilt yields are ultimately under the BoE's control. Clearly the main problem is the way the eurozone is set up.

"The trouble is that its not a choice that most governments can manage to truly float without incurring debt in foreign currency."

That's quite an interesting point I'd like to know more about from an MMT perspective.

nopeJuly 20th, 2012 at 4:56 pm

Ouch. Every time FDO15 pops his head above the barricades these days he gets it slapped right back down again. It's got to be hard, and painful, being that dumb.

RamananJuly 20th, 2012 at 8:34 pm


You are right. Blog comments is not the best place for serious debates. It's useful however to directly pinpoint. Of course, it's no substitute for academic writing.

What you ask me to do is not kid's play. It involves a lot of things but I am serious about my macroeconomics and monetary economics to know it well. I am in no hurry however. Knowledge cannot be hurried. But of course, I like international monetary economics and will definitely say something solid.

To answer your point straight on what you think is ridiculous – just have a look at Australia's balance of payments. It's net investment income is already highly negative (A$53.76bn in 2010-11 on net liabilities of around A$800bn – the negative NIIP – at the end of the period) and only sustained due to some positive net exports in recent times.

If it were not for net exports, this would keep rising even more and due to the magic of compounding, add to net indebtedness and will lead to ever rising payments only to require correction at some stage.

You could argue that it could continue forever, but at least there's a logic to the above – if net exports aren't positive, the current account imbalance rises forever.

If a nation has a gdp 100 and exports 25.6 and imports 20 it means to sustain imports at 20, exports of 25.6 is required which is not guaranteed considering fierce competitors like Germany are out there. The exports are also limited by the demand in the rest of the world. To make this even more complicated, if the nation wants to grow faster, it will be importing higher on which the government has no control in the absence of direct import controls. So in addition to fiscal policy, more is needed but such measures are somewhat of a taboo under GATT.

Hopefully, for now, lets not debate on this example and end this here for now.

Thanks again for engaging. Peace for now.

RamananJuly 20th, 2012 at 8:39 pm

"If a nation has a gdp 100 and exports 25.6 and imports 20 it means to sustain imports at 20, exports of 25.6 is required"

Oops. Typos. Should be read:

If a nation has a gdp 100 and imports 25.6 and exports 20 it means to sustain imports at 25.6, exports of 20 is required

LRWrayJuly 21st, 2012 at 4:03 am

Yes this would be easy to blast apart but I won't do it. Just remember, there are 3 balances in the sectoral balance. I don't need to say more. You will be proven wrong by the forthcoming empirical evidence on Australia but we will need to wait decades because the euro-type crisis you predict for Australia will not happen. Will Australia have a crisis? Yes. But it will be a sovereign country type crisis, not a Euro crisis. Australia will not have to abadon the australian dollar and it will not kick any region out of its dollar union. Anyone who understands sovereign currency will understand what I mean by this. Your math examples are completely irrelevant.

LRWrayJuly 21st, 2012 at 8:37 pm

Oz, like the US and UK is a sovereign nation that issues its own floating currency. Its sovereign govt faces no solvency constraint so it CAN deal with any crisis that arises; the only question is WILL IT which mostly boils down to politics. What kind of crisis? A financial crisis, like the US and UK crises–homeowners are overindebted and paid too much for housing; their banks are holding loans that will never be repaid. This can happen regardless of the current account balance. I am not ignoring the fact that these countries DO have current accont deficits, and that shows up all else equal as bigger private sector deficits–which then eventually lead to retrenching and economic slowdown and then the stuff hits the fan and you get a financial crisis. Throw in money manager capitalism which means massive indebtedness WITHIN the financial system that blows the whole thing up even worse. BUT, and this is a big but, these nations are NOT like nonsovereign Euro nations. They do not have to turn to anyone to resolve their problems. They've got the financial wherewithal to deal with the problems.

ollyJuly 22nd, 2012 at 12:18 pm

Why do you think so many countries (with their own currencies) took part in the Fed's currency swaps during the 2008 crisis?