The Debt Crisis

The FT articles by Otmar Issing and Ken Rogoff are required reading this morning: here and here.

(The new Vanity Fair article on Germany by Michael Lewis is also recommended but I do not have an online link.)

27 replies on “The Debt Crisis”

I thought the Issing made a lot of sense until i got to the last sentence in the article describing the euro as the “most successful project of economic integration in the history of mankind”. Who said the Germans don’t have a sense of humour?!

This morning has been unpleasant. DAX opened up 1.7%, then proceeded to hit 7% down at one point (-5% now), ie 8.7% negative swing in the space of an hour or so. No news, seems like some stopping out and some delta hedging of positions maybe.


Almost all treaties promising European fiscal discipline have been broken time and again. The worst example was delivered by France and Germany in 2002-03, when they violated the Stability and Growth Pact, and even organised a political majority against the application of its rules.

Any attempt to “save” monetary union via agreements which transfer sovereignty to a European level, where violations of fundamental treaties have become a regular event, lacks any logic. In the end it will only further alienate the people from Europe itself.

…to change the “no bail-out” clause ever more in the direction of a bail-out regime is not a step towards a democratically-legitimised political union. It is a move on a slippery road to a regime of fiscal indiscipline drowning hitherto solid countries in the morass of over-indebtedness.

This type of political union would not survive.


In the case of Europe, this involves very large debt writedowns in the smaller periphery countries, combined with a German guarantee of central government debt in the rest. In return, Germany will have to receive a disproportionate share of fiscal power in a more deeply integrated union, for at least as long as it is making substantial transfers.

We need not look beyond Ireland to see that Dr Issing makes a strong case against what would be perceived as a new form of colonialism.

We are good at finding scapegoats for our troubles and we would look east to Berlin.

Four years from the start of the crisis and baby steps have been taken in the area structural reform. Do not confuse this with what is tagged as ‘austerity.’

People may see virtue in change but as long as it doesn’t affect their applecart.

Of course the concept of the eurobond is alluring and it would be an ideal solution but unless the paymasters were to get deeply involved in the governance of debtor countries, how could it work?

The swastika would become a familiar sight at protests.

There are enough anti-Europeans in the population already to be willingly led by cunning narcissists, to a ‘promised land.’

Issing remains in the old nationalist Deutsche mindset, the fixation with rules, and wedded to the outdated ECB bible of the 2% – of which he was once a member of its governing council ……

Issing reading Rogoff is almost certainly spitting bricks at the idea of a wee modicum of inflation and debt forgiveness for peripherals overstretched on their borrowings from German banks – and like Dear Lorenzo has no notion that someone or some institution must monitor dodgy capital flows within the EZone …….. don’t suppose there is much point in mentioning EuroBonds in Issing’s company … but methinks without them, we will not have a canter on Rogoff’s 2nd Great Contraction …. but The Great European Collapse.

It might be useful to add George Osborne to the mix.

I also repeat here a comment I made on another thread.

Issing says;

“Almost all treaties promising European fiscal discipline have been broken time and again. The worst example was delivered by France and Germany in 2002-03, when they violated the Stability and Growth Pact, and even organised a political majority against the application of its rules”.

The FT says (in its editorial yesterday, 8 August);

“That makes it all the more important for the new economic governance regime to control the right things: growth must be given as much attention as fiscal rectitude, private balances as much as public ones, and sanctions must be automatic, not depend on the say-so of the big nations. The old stability and growth pact lacked all of these elements. That is why it failed”.

The French and German leaders agreed the following in Deauville which would effectively maintain the institutional situation (and, presumably, behaviour) which Issing condemns.

If the talk about the loss of sovereignty, political union etc. were true, a new treaty would be required. But the existing treaties provide the necessary competences. The UK could hardly agree otherwise. The two major players in Europe seemingly do not wish to use them. And they expect the markets to take what they say seriously!

As a non-economist, I find Rogoff far more credible than Krugman. Now, if we only had a magic wand!

P.S. A quote that I came across on an American blog (by Dickens).

“Credit is a system whereby a person who cannot pay gets another person who cannot pay to guarantee that he can pay”.

Its all very well criticising Rogoff but it seems to me that this is the approach that has to be taken if the Euro is to survive. With good leadership in the debtor countries this approach could be made work, particularly if the leaders can communicate the dire consequences of the alternative ie no Euro, bank collapses,no borrowing,massive cuts in current spending etc
The polical problem is that the one of the biggest vested interest groups in avoiding reality for as long as possible is our current governing and professional class who will have to accept very significant changes to their pay,pensions, benefits,accountability and competition when the “reality adjustment” is finally achieved.

@ Tom Paine

I like Prof Rogoff!

I agree with your sentiment and I have been saying ad nauseam that we should put reforms in place ourselves rather than waiting for the IMF or any other external party to do it for us.

I have advocated reforms of professional cartels as strongly as public sector reform.

I read a report on Monday that only one-third of UK private sector workers have company sponsored pension schemes, which is worse than in Ireland but is one example in both countries of the huge gulf between different sectors of society.

From Rogoffs article

“Too many decisions, for example the recent withdrawal of monetary stimulus by the European Central Bank and the US Federal Reserve have been predicated on overly rosy growth projections. Time and again, policymakers counted on rapid post-crisis recovery to help them avoid painful decisions on how to deal with badly overstretched private and public balance sheets, whether household debts in the US or sovereign debts in the periphery of Europe. Time and again, rapid growth did not materialise or – if there was a burst – did not last.”
This quote should be engraved into the walls of the rooms in dept of finance where they calculate budget projections for the next 5 years.

George Osborne policies is driving Great Britain straight into a new recession,he does not seem to be in the best position to give lessons.

@ Eamonn Moran

Hopes of a ‘rapid post-crisis recovery’ were soon dashed in 2009.

PIMCO and others were promoting the ‘new normal.’

Obama has been in office just 31 months and there was an argument that his initial stimulus should have been $2trn or more compared with about $800bn.

However, even with the latter level, ‘shovel ready’ jobs needed a lead time.

The severity of the housing bust, the bust consumer and Republican opposition made it difficult to do much more on the spending side.

About one-third of s/h house sales continue to be from foreclosures.

As for Europe, Germany accounting for about 27% of Eurozone output, has in fact grown faster than expected. As for the other countries, there wasn’t an expectation of ‘rapid’ growth.

Ding! Ding! Ding! Debt! Debt! Debt!. Well well, so at long last (after nine years) we start to see and hear the pennies and cents dropping onto the concrete paving.

The politicians have created and maintained this debt mess and they sure as hell do not wish to solve it, but they will be forced to – take some action. Better be able to hold your nose though.

If G-spending is 100 units and 10 or possibly 15 units of that is ‘borrowed’ rather than income from taxes. Then attempting any form of ‘austerity’ (raise taxes, cut G-spending, engage in less credit creation, borrow less) will result in an automatic decrease in Y (aggregate output), aka. ‘growth.

For many years now we have had ‘faux growth’ – mostly in services and debt. Now we have to pay, but guess what – we would have to borrow to pay down what we owe. You can only escape the debt trap if you can manufacture (domestically) something that you can sell for a profit.

I suppose we can be thankful that some bit of reality is beginning to seep in. Hope the decline in oil prices is long-lasting. We need lower energy and food prices – just to stand-still!

Brian Snr.

What a contrast in the two articles.

Issing tells us we shouldn’t start from here at all. The ECB should be given more independence- to sit on its ass presumably which is what he is suggesting. And its not ok to ‘bail out’ irresponsible countries but as bailing out bust banks gets no mention, we must assume that he supports the ECB for doing this.

Rogoff on the other hand is prepared recognise the now fatal damage caused by the lack of confidence in governments and institutions to deal with the crisis. He is absolutely right on this. A political class disconnected and insulated from the consequences of their decisions and lack of decisions. He is prepared to consider ‘solutions from outside the box’.

I know who I would want in charge of trying to solve this problem.

In any case, it is now too late to prevent a slide into depression.
No consumer in his or her right mind will proceed with consumption, particularly of large ticket items, given the sheer incompetence of western leaders to arrest the slide to depression.

Only a complete clearout of the present political non-leadership in western economies will allow the resolution of this crisis. But we are now facing a long term depression of maybe up to five years.
That is where the present generation of genius’ , with their fixation on failed ideologies and their complete capitulation to the large financial institutions, have lead us.

@ Michael Hennigan

The other night as we watched the ticker tape at the bottom of the TV screen warn of the impending downgrade of the US credit rating by S&P, my holiday companions and I arrived at a couple of conclusions; first, this might be the last year we will be able to afford a holiday that involves anything more than picking the weeds in the back garden at home and second, why don’t the rating agencies spare all of us the agony and downgrade all the world’s large economies in one fell swoop instead of picking them off, one at a time?
O.K., it might cause a bit of bother in that the world economy risks coming to a full stop for a while; but once all the major economies were downgraded to the same level it would be an even playing field again and the bond trading rules would have to change accordingly – if the cherished, self-styled perfect ‘market system’ is itself to survive in anything resembling its current form? Or are the same rating agencies who idiotically assigned a triple A credit rating to every and any rubbish financial product that came their way in the boom years intent on ensuring their own self-destruction?
Naive and simplistic, perhaps; but borne out of sheer frustration at the nonsense that’s going on. Over the past 48 hours I’ve heard a lot of commentary about how this is, at base, a political crisis and the markets are only responding as only the markets can to expositions of political weakness on both sides of the Atlantic.
To some extent this is obviously true. It’s arguable that liberal democracy, with its thirty years or so of blind faith in the ‘perfect market’ as the arbiter of economic affairs, has indeed reached a major crisis point.
Part of the reason for this may be that, post 1989 and the collapse of socialism, liberal democracy has faced no strong ideological competition and thus, no sense of threat. As commonly observed, practically all mainstream political and elite groups in western democracies moved to a common centre ground in terms of economic policy direction over the past two decades and became indistinguishable from one another in their faith in a ‘market’ that was left largely unregulated and allowed off to do its own thing. They separated their political market appeal from one another only by displaying dubious risk aversion on a range of issues from environment to energy production or commitment to certain models of social intervention, whilst the financial systems were let loose by common consent. Another part of it may lie in modern IT, whereby transactions that would have taken a day or two to complete even just a decade or so ago, may now be executed in microseconds based on computer models of how the world is supposed to work that, in themselves, may be inherently flawed since they cannot take account of the vagaries of real human behaviour – a sort of mindless ‘age of the machines’ that grips the world by the throat and that the messy and confused reality of democratic process can never keep pace with.
Seems to me there is a lot of analysis, from various perspectives, around over the past three years of this crisis. Much of it is brilliant and hugely informative, to the likes of me anyway; but I’m not convinced any longer that it’s all worth much more than a grain of sand. There are lots of good ideas too, it appears, from Eurobonds to new independent rating agencies. It may be unpopular to say so, but I’m beginning to feel sorry for our political leaders. The ‘markets’ demand instant solutions, but democracy, by its nature, cannot join the dots instantaneously to meet that demand. Most of all, there doesn’t seem to be any ‘big idea’ out there, good, bad or indifferent, around which the present system could rearrange itself. If there is, please enlighten me, because I obviously haven’t heard it nor understood it properly.
Meanwhile, I’m off out to do a bit of weed eradication and plant some winter vegetables. At least that way I can guarantee we might have something to eat for Christmas even if I’m hopelessly wrong about everything else.


Not to worry – the ECB will buy a few French and German bonds 😆

If they downgrade them all, apart of course from the Isle of Man and Guernsey, presumably the beauty contest would mean they’d have to upgrade them again straight away? (As they would be the best of the bunch and, you know, you have to have some AAA, right?). 🙂

13.21 Kenneth Rogoff, former chief economist of the International Monetary Fund, has predicted a grim outlook for the eurozone.
In an interview with Germany’s Der Spiegel magazine, the US economist warned that some EU countries are “fundamentally bankrupt” and should not have been accepted into the eurozone. He said:
Greece needs a massive restructuring plan, Portugal as well, probably Ireland, too. Ultimately, Germany has to guarantee all the central government debt in Spain and Italy, and that will be very painful. If Italy and Spain are to be kept in the euro area, then unfortunately the Germans will have to acknowledge that Europe is going to be a transfer union for some time to come.”

I cannot read the FT article but presume the quote from the Der Spiegal is along the same lines.
As other have indicated…I cannot see the Germans buying this.

It seems the Yanks are on our case….from an interview with Hank Paulson
On Dealbook
“Pretend for a moment that countries like Greece, Spain and Italy are our banks in 2008. They are close to insolvent. (And the actual banks in Germany, Britain and France that are supposed to be strong are horribly undercapitalized and are holding too much debt from countries like Greece, Spain and Italy — all countries that truly may not be able to pay it back in full.)

As Mr. Paulson told me, “The most pressing and significant problems in the global economy are unsustainable structural issues with regard to the E.U. — fiscal deficits and the structure of the E.U. itself.”

The big danger is Europe
By Robert J. Samuelson

There seem to be three other possibilities.

First, the European Central Bank — Europe’s Federal Reserve — tries to stabilize financial markets by buying the bonds of besieged debtor nations. It’s already bought Greek, Irish and Portuguese bonds; now it’s buying Italian and Spanish bonds. But where does this stop? The ECB is acting reluctantly, because it fears that excessive bond purchases (“monetizing” government debt) would unleash an inflationary flood of money. This approach is Muddling Through 2.0.

Second, the International Monetary Fund organizes a global rescue package worth trillions of euros. Europe’s debtor nations could borrow at low rates with long maturities. Once debt pressures were relieved, Europe could follow more pro-growth economic policies. But any package would have to be heavily financed by countries with huge foreign exchange reserves, meaning oil producers and — most importantly — China, with reserves of $3.2 trillion.

Third, some European nations could negotiate write-downs on their debts or default on them. Superficially, this seems a solution. But it would create other problems. Defaults would inflict huge losses on banks, insurance companies and pensions. Many European banks might collapse unless rescued. Who would rescue them? Confidence would plunge. A recession would seem unavoidable. Defaulting countries would also have trouble borrowing in the future.

@Bond Eoin Bond
The Dax volatility you mentioned earlier looks like being repeated on the Dow today.. Huge movement in the first 15 minutes.
I suppose we will have to wait on the Fed statement due out later to see the eventual outcome.

@ Veronica: Hi, nice to hear from you. This economic Regression (an actual re-set to earlier version) had its genesis back in early 1970s. In fact some historians assert that the real start-date was after WWI and the entire process is an enlarged and highly expanded reprise of similar, earlier economic eras.

Essentially a productive production economy begets, over time, a non-productive financial economy. The former makes things to sell, the latter creates debt – which grows! Outcome: insolvency and bankruptcy. But not this time – well so far, anyway.

Heroic efforts are being made by politicians to avoid at any cost to themselves, a write-down of the massive debt overhang which can never be paid back. Ever!

We no longer have cheap energy to fling around and crank-up a production economy which can generate a surplus. The east-asians can do this, but they are relying on us poor sods in the ‘west’ (include Japan with us) to buy their stuff. Using credit of course. This model has run out of puff.

I’ll leave it there. I am certain you can fill in the dots yourself. I’m off to the weeds myself. Pesky blighters.

Brian Snr.

Never a fan of Rogoff – his monetarist dogma is a product of a dollar centric financial era that now bears no resemblance to the pysical world.

First off Germany is not the Bundesbank and the Bundesbank is not Germany.
All states in the eurosystem are currency users not issuers – WE DON’T OWN THE STUFF.
So therefore to even think of fiscal reductions when it has remained static with respect to a previous hyperinflation in credit is retarded at best & corrupt ay worst.
Lets get down to the basic payments system – credit has reached near its theoretical limits , further credit production would add more to the malinvestment pot. , also the ECB do not want a default on any credit deposits in the Eurozone.
Therefore only fiscal spending can provide the money to pay debt , but it does not have to use debt – it can be cash.
But Goverments cannot produce cash………..
The ECB will destroy the remaining bits of Europe’s physical economy if they do not produce cash , they have done grave damage to Europe over the last 15 years , will they destroy the remaining bits to peserve the pristine nature of their ivory towers ?

@ Veronica

You don’t post very often, but every one of your posts is on the money. As you infer, politics is behind the economic curve. It’s up the the politicians to get their act together, and they will do, when there is no alternative.

Insofar as that process represents a proper reinstatement of democracy, and a rejection of plutcoracy, I say bring it on. I wouldn’t go about it the way they have done in Tottenham, of course, but it takes all sorts. Like you, I prefer gardening. Less sweeping up afterwards 🙂

@ Overseas commentator

I was not making any point regarding Osborne’s economic policy. I have no idea whether it is right or wrong for the UK. I was simply underlining the fact that the UK seems ready to contemplate a rigorous implementation of the reformed SGP while France and Germany, despite paying lip service to the idea, are not. The situation with regard to Germany now, however, seems to be changing, if the recent comments of the FDP Minister for the Economy are any guide. This suggests that the European Parliament’s position on the issue will be accepted when the so-called “six-pack” of legislative measures is adopted, probably in September.

The more general point that can be made is that there is a deplorable lack of understanding in the media and the economic commentariat generally, especially in Ireland, that the EU, and the sovereign states that make it up, constitute a democracy that is governed by and respects the rule of law.

As Brian G has shown in a number of posts by contrasting the texts of the recent statements by the ECB, France and Germany and the G7, a major negotiation has taken place. This has resulted in a still somewhat shaky outline of the necessary agreement on the respective roles of the ECB and the member governments in the joint creation of confidence. It will be copper fastened in the detailed text for the amended EFSF which, when it is agreed, one assumes will incorporate the changes already agreed in March.

As to Germany’s role in European affairs, I have no time for any discussion based on anything other than the assumption that the country behaves – since democracy was restored – as a normal sovereign state i.e. it defends it interests with the same determination as any other. The one peculiarity has been the fact that euroscepticism has not, until recently, been politically acceptable and Westerwelle, the feeble leader of the FDP, is now running for cover with fatuous remarks about needing “more rather than less Europe”.

An increasing number of the German electorate, if opinion polls are any guide, are waking up to the fact that the obdurate, foot-dragging, policy being pursued by Merkel is not, in fact, defending German interests but harming them. With the success of the ECB intervention in the secondary markets – and especially in the case of Ireland – any remaining shreds of credibility that she has are fast disappearing in an attempted retreat from what the French obviously thought had been agreed viz. the possibility of an increase in the size of the EFSF. This does not really matter. It is the general direction of sentiment in Germany that counts and this has, from what I can see, changed dramatically. Of course, I may be mistaken.

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