Austerity, The Savings Paradox or The Confederacy of Dunces

I recently wrote a post about the strength of the euro: what is it that keeps the euro so strong versus the dollar and other foreign currencies? The answer is, essentially, the ECB’s too much anti-inflationary policy. The following chart compares both the FED and ECB’s balances and shows that the FED is much more expansionist than the ECB.


The above mentioned doesn’t necessarily mean that the FED is right. But let’s see another issue: the following chart by Neville Hill at Credit Suisse:


We can see the effects of the austerity policy and the monetary contraction in the euro zone. On the left side we find the payment balances from the euro zone’s North and South areas. The South’s contractive policy performed the miracle of bringing external surplus to these countries. However, the northern countries have also increased their external surpluses!

The right graphic shows the surplus of the entire euro zone versus the rest of the world, which has increased. This means that everybody is increasingly saving more money –even wealthy people. So nobody consumes.

The thing is, the policy of austerity has been highly effective both in the worst-affected countries and in the thriving ones. That brings us to the following question: what kind of economic policy are we doing? Why do we have to undermine the euro’s economy so as to save the euro? It is obvious that the problem of public debt won’t be solved like this (see the chart below).


Reducing demand in all countries at the same time is a negative sum game. There may be some people happy about Europe having more external surplus than the US (who has deficit), and the euro being almost hand in hand with the dollar.

If only people just knew what the cause of their problems is! But they don’t know it. In the 1930’s, Europe threw itself into the arms of the communism/fascism. It was an authentic confederacy of dunces. But then, they didn’t know there were alternative solutions. It happens that people always choose the worst solutions, directed by those politicians chosen by them.

It is exactly what Wolfgang Münchau says to those who believe the southern countries’ external surplus is the ultimate proof that the adjustment is a success:

This judgment is profoundly wrong. It is true that the crisis countries have brought down their current account deficits. Italy and Spain are now running surpluses. Since Germany and the Netherlands have not brought down their current account surpluses, the eurozone as a wholehas moved from an almost balanced current account in 2009 to a surplus this year of 2.3 per cent of gross domestic product, according to the International Monetary Fund’s most recent estimates. The IMF puts the 2014 current account surplus at 2.5 per cent. In other words, the eurozone is adjusting at the expense of the rest of the world.

Judging the progress the euro zone has made on internal adjustments is hard as you must disentangle effects happening concurrently. You cannot arrive at a firm conclusion by just looking at the improvement in Spanish export performance, for example. The latest IMF World Economic Outlook included such an analysis, suggesting the internal adjustment was mostly cyclical, not structural. This is an important observation, buried in a subsection, itself hidden deep in the report. It essentially says internal adjustment is not really happening. The rise in the exchange rate ends the scenario whereby the eurozone pulls itself out of trouble by running large and persistent current account surpluses against the rest of the world.

Just to close, I’ll share with you this quote, to which I particularly subscribe:

In a monetary union adjustment is hard without any transfers and without a fiscal union. I know of no plausible plan how the euro zone can manage the dual feat of economic adjustment and debt sustainability within the straitjacket of official policy. And as long as such a plan does not exist, the crisis is not over.

About the Author

Miguel Navascués
Miguel Navascués has worked as an economist at the Bank of Spain for 30 years, and focuses on international and monetary economics. He blogs in Spanish at: http://

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