Euro surplus zero sum question

Piliger

Hi all,

A guy on a discussion was involved in elsewhere on the web posted the statement below about the Euro currency and how it works. I don't grasp how it is true or how it makes sense... but then I am just a business finance guy and may be missing a whole lot.

Could someone tell me if he is right or not and why ?



See, the Euro currency issuer - the ECB - only loans Euros into existence. That's the only means it uses to get them into circulation.
What this means is that savings across the economy sums to zero. Every Euro out there is matched by a Euro of debt. So if you want to have net savings, another has to hold the net debt. If an entire country wants to have net savings, another country must be in net debt.
That's what got Europe into this mess. When everyone tries to save Euros at once, countries with the strongest export sectors may succeed at saving - but if so it'll only be at the expense of those with weaker export sectors. The strongest save, the weakest dissave. Ultimately it proves unsustainable as there's only so much debt the weakest can take on before the whole system collapses.
The troika then impose austerity on the weakest, hoping that it'd help them save or become more competitive (despite that it'd damage the budgets of the strongest if they did). Problem is, it's still a simple tug of war - one can still only save at another's expense, and making the weakest pull harder isn't going to achieve a great deal. If they remain the weakest, they'll continue to run deficits. It's no general solution. The savings starved countries meanwhile undergo paradox of thrift which leads to negative growth and job loss.
What Europe needs is for the currency-issuer, the ECB, to allow the money supply to expand/contract with demand for savings. Normally, the currency-issuer is at the level of a government - the government simply runs deficits and/or surpluses as savings wax and wanes - satiating people's desires to save such that they spend suitably for high employment/growth. And, fortunately for these currency issuers, they are not in danger of running out of the currency they issue - even at high debt loads eg Japan. But the EMU has not even begun to address this problem today.

Rightwing

Piliger wrote: »

Hi all,

A guy on a discussion was involved in elsewhere on the web posted the statement below about the Euro currency and how it works. I don't grasp how it is true or how it makes sense... but then I am just a business finance guy and may be missing a whole lot.

Could someone tell me if he is right or not and why ?



See, the Euro currency issuer - the ECB - only loans Euros into existence. That's the only means it uses to get them into circulation.
What this means is that savings across the economy sums to zero. Every Euro out there is matched by a Euro of debt. So if you want to have net savings, another has to hold the net debt. If an entire country wants to have net savings, another country must be in net debt.
That's what got Europe into this mess. When everyone tries to save Euros at once, countries with the strongest export sectors may succeed at saving - but if so it'll only be at the expense of those with weaker export sectors. The strongest save, the weakest dissave. Ultimately it proves unsustainable as there's only so much debt the weakest can take on before the whole system collapses.
The troika then impose austerity on the weakest, hoping that it'd help them save or become more competitive (despite that it'd damage the budgets of the strongest if they did). Problem is, it's still a simple tug of war - one can still only save at another's expense, and making the weakest pull harder isn't going to achieve a great deal. If they remain the weakest, they'll continue to run deficits. It's no general solution. The savings starved countries meanwhile undergo paradox of thrift which leads to negative growth and job loss.
What Europe needs is for the currency-issuer, the ECB, to allow the money supply to expand/contract with demand for savings. Normally, the currency-issuer is at the level of a government - the government simply runs deficits and/or surpluses as savings wax and wanes - satiating people's desires to save such that they spend suitably for high employment/growth. And, fortunately for these currency issuers, they are not in danger of running out of the currency they issue - even at high debt loads eg Japan. But the EMU has not even begun to address this problem today.

The general gist of it is correct. However, the final paragraph is very debatable, I would side with European monetary policy over that of Japan/US, a disaster waiting to happen.

KyussBishop

Part of what the person is talking about is debt-based money; practically all of the money in our economy (and most fiat-money based economies around the world) is sourced from bank loans (contrary to conventional wisdom, banks create money when they extend loans - not even fractional reserve is true, the money is ultimately created from nothing), so for every Euro in existence, there is at least the same amount of debt (and thus, for every Euro in savings, at least the same amount in debt).

When you think about that for a moment too: Debt carries interest, making the debt grow bigger over time, so this means the net total of debt in the economy far exceeds the total amount of money (staying sustainable for a time, due to economic growth); here's a quick link giving some figures:
http://simonthorpesideas.blogspot.fr/2013/04/the-scale-of-eurozone-debt-and-money.html

This means it is impossible to pay off all debt, and if you try to, you will cause a massive economic depression due to deflation caused by the contracting money supply; we are actually experiencing something like this right now, because the drop in economic activity and the size of private debt, is forcing more money to go into paying down debt that would otherwise go into useful/stimulating economic activity; this is known as debt-deflation.

Right now, this debt is becoming ever more concentrated in the peripheral Euro countries, and austerity is holding our economies down, ensuring we are accumulating rather than paying off debt - I think the quote you have puts emphasis in the wrong place though: It's not the savings that matter, it's the private debt.


The last part of what the person alludes to, is I believe debt-free money; you can solve this problem by introducing money into the economy that is not based on debt, but this is disparaged as 'printing money' and as leading to hyperinflation, even though it is no more inflationary than the banks 'printing' (creating) money when they extend loans (that's a myth perpetuated, among others, to keep banks/finance in power over entire economies, by having a monopoly over money creation and by imposing debt even on governments)

It's a very heated topic (presently the most important topic in all of economics/politics in my opinion), but it's very valuable knowledge to have, so don't be deterred from reading up on or studying it further, by the (often very personal/condescending) attacks talking about it illicits.

Piliger

Thanks guys ... sorry about the delay in coming back. I'm going to study more about this this weekend

andrew

I can't really make much sense of the excerpt you posted. The author seems to be confusing a smorgasbord of concepts. First he talks about money creation being the creation of debt (it's a lot more complicated than that), then savings (savings usually equals investment, it has no relation to the amount of Central Bank money in the Economy), then the trade balance somehow fits into all of this.

But some of the things the author mentions do interact; this is what I understand the interaction to be: Savings usually equals investment, in a healthy economy. However, this is not the case now. There's a global savings 'glut', which means that there's more savings than investment. This glut has existed for a while. Anyway, these savings are floating about, searching for somewhere to go, and have been doing so for a while. For example, they (directly and indirectly) financed the the recent housing bubbles in many countries.

Within the Eurozone, one of the sources of these savings is Germany. Germany is a source because it is, and has been for a while, running a trade surplus. This means Germans sell more to the world than they buy from the world, so on net the country ends up with more money than it started with each year/period. Germans want to save this money, hence contributing to the big pile of money floating about. Why does Germany have a trade surplus? Because, among other reasons, the introduction of the Euro made German goods a lot cheaper for non-Eurozone people.

Some argue that this imbalance is screwing over other European economies. The lack of demand for their goods from Germans (because Germans aren't consuming if they're saving) is reducing their economic growth. In addition, the lack of demand for their goods, because people buy German goods instead, is also reducing economic their economic growth. So some countries want to see this imbalanced reduced, so that demand for European products is spread over more European countries and isn't centralised in Germany. A way to correct this imbalance would be for German goods to become more expensive, via inflation. So some people would like to see a period of relatively high inflation in Germany, such that German goods become more expensive on the world market. This could occur via the ECB using expansionary monetary policy, or if German people started consuming more goods.

Piliger

KyussBishop wrote: »

Part of what the person is talking about is debt-based money; practically all of the money in our economy (and most fiat-money based economies around the world) is sourced from bank loans (contrary to conventional wisdom, banks create money when they extend loans - not even fractional reserve is true, the money is ultimately created from nothing), so for every Euro in existence, there is at least the same amount of debt (and thus, for every Euro in savings, at least the same amount in debt).

So what you are saying is that no one really has any money. Everyone 'borrows' from someone else ... and this 'creates' money ?

When you think about that for a moment too: Debt carries interest, making the debt grow bigger over time, so this means the net total of debt in the economy far exceeds the total amount of money (staying sustainable for a time, due to economic growth); here's a quick link giving some figures:
http://simonthorpesideas.blogspot.fr/2013/04/the-scale-of-eurozone-debt-and-money.html

Except when money is borrowed and then lent on at a higher rate ? Wouldn't that balance against the debt owed ?

This means it is impossible to pay off all debt,

Do you mean it is impossible for EVERYone t [ay off all their debt ? or ANYone to do so ?
I do understand that paying off any debt in a short period of time sucks away money that could be recirculating and oiling the economy.

.... and if you try to, you will cause a massive economic depression due to deflation caused by the contracting money supply; we are actually experiencing something like this right now, because the drop in economic activity and the size of private debt, is forcing more money to go into paying down debt that would otherwise go into useful/stimulating economic activity; this is known as debt-deflation.

Ok .. I get that.

Piliger

andrew wrote: »

Savings usually equals investment, in a healthy economy. However, this is not the case now. There's a global savings 'glut', which means that there's more savings than investment. This glut has existed for a while. Anyway, these savings are floating about, searching for somewhere to go, and have been doing so for a while. For example, they (directly and indirectly) financed the the recent housing bubbles in many countries.

I had understood savings to mean money not being spent, but stashed in financial institutions and not being recirculated. But then again, those funds are actively being loaned elsewhere by those banks to spenders or new businesses or expanding ventures.... ?

Within the Eurozone, one of the sources of these savings is Germany. Germany is a source because it is, and has been for a while, running a trade surplus......SNIP

I do get the whole surplus principle broadly.

The biggest confusion I have about the original post I quoted is this Zero Sum Game thing WITHIN THE Eurozone ... that implies that all countries cannot be successful with their economies ....only some can at the expense of the others and that this locks some into heavy debt, imbalances permanently. I find this confusing.

KyussBishop

Piliger wrote: »

So what you are saying is that no one really has any money. Everyone 'borrows' from someone else ... and this 'creates' money ?

People have money, but:
1: When money is loaned out by a bank it is not sourced from savings (as is commonly thought), it is created from nothing (the internal operations within the banking system are complicated, but the end result is uncomplicated: money is created).
2: Something like 97% of money comes from bank loans, from money created out of nothing.

So, when you borrow from a bank, you're not borrowing from someone else (i.e. from someone elses savings), the bank effectively creates that money out of nothing - and yes, that's how almost all money is created.

Piliger wrote: »

Except when money is borrowed and then lent on at a higher rate ? Wouldn't that balance against the debt owed ?

If talking about a normal person doing this, that doesn't change the amount of debt vs overall money, it just means overall debt will grow even faster out of proportion to the money supply, because now you're taking added interest for yourself too.

The only ways to tip the balance of Debt vs Money, are:
1: Debt defaults/forgiveness/writeoffs (this is what eventually happens, and in my opinion, is a big part of what causes the business cycle - I think we will see more of this in the current crisis)
2: Creating money without debt, debt-free money. This is a very politically controversial topic, and I think it's the most important one there is right now.

Piliger wrote: »

Do you mean it is impossible for EVERYone t [ay off all their debt ? or ANYone to do so ?
I do understand that paying off any debt in a short period of time sucks away money that could be recirculating and oiling the economy.

Yes, it's impossible for everyone to pay off all their debts (though anyone, individually, can), as this would drain every single cent out of the economy

Even if you did that, there would still be debt left to pay off (and no money), because debt has grown far greater than the total money supply.


(Rest of post is skippable[noparse]:[/noparse])
Here is a very useful way of looking at the bigger picture of what's in the OP, using the 'sectoral balances' accounting identity (looks complicated, but is very intuitive once understood) - this is how the flow of money must be balanced in an economy:
(G – T) = (S – I) – (X – M)

G = Government Spending
T = Taxes
S = Savings
I = Investments
X = Exports
M = Imports

In addition:
(G - T) > 0 = Government deficit
(G - T) < 0 = Government surplus
(S - I) > 0 = Net private sector saving/surplus
(S - I) < 0 = Net private sector spending/deficit
(X - M) > 0 = Net exports/surplus
(X - M) < 0 = Net imports/deficit

Here's an interesting/useful image on what combinations of these you can have:


I have to caveat this though: That's based on economies where government is in control of its own currency, and we do not have that control in Ireland (but Europe as a whole does).

KyussBishop

Piliger wrote: »

The biggest confusion I have about the original post I quoted is this Zero Sum Game thing WITHIN THE Eurozone ... that implies that all countries cannot be successful with their economies ....only some can at the expense of the others and that this locks some into heavy debt, imbalances permanently. I find this confusing.

This (and international trade in general) is something I can find a bit confusing as well sometimes, even moreso when trying to work it out in the context of the Euro, which makes it even more difficult to figure out.

Yanis Varoufakis has done some excellent writing on the Euro crisis, though unfortunately I can't (offhand) find a good article on this exact topic; here is a semi-related one though:
http://yanisvaroufakis.eu/2013/04/12/germanys-continued-dependence-on-the-eurozones-stragglers/


My take on the Europe 'Zero-Sum' game, is that all of Europe is fighting for dominance over exports right now, to try and achieve an export-led recovery, and the reason this is Zero-Sum is because there is not enough worldwide Aggregate Demand to sustain exports for every EU country (because of the large drop in economic activity around the world, greatly reducing other countries imports of EU goods).

Germany is winning at this, at the expense of the deficit nations (and in my view, are holding the rest of Europe down with austerity, to keep it this way, to keep their advantage), because - among other reasons (and I've not read up on these reasons in detail) - it is the dominant Euro economy, and the currency union itself has been constructed around Germany (so tends to produce favourable results for Germany).

Germany has historically actually been running well below EU inflation targets if I recall correctly, while letting other (periphery) countries run at higher inflation rates to meet overall EU inflation targets (which Germany deserves blame for in my view, but again, I've not read up on that in great detail), which has helped stoke the debt-fuelled bubbles in the periphery, while keeping Germany with stable prices and strong exports.

Open to correction on many parts of that, but that's my (rudimentary) understanding of the situation with Europe and Germany.

Piliger

Thanks for those, KyussBishop ..... food for study in the next couple of days :-)

andrew

Piliger wrote: »

I had understood savings to mean money not being spent, but stashed in financial institutions and not being recirculated. But then again, those funds are actively being loaned elsewhere by those banks to spenders or new businesses or expanding ventures.... ?

Well, ideally savings are lent out, yes. But this can't be the case if there's little demand for savings, which is the case now.

The biggest confusion I have about the original post I quoted is this Zero Sum Game thing WITHIN THE Eurozone ... that implies that all countries cannot be successful with their economies ....only some can at the expense of the others and that this locks some into heavy debt, imbalances permanently. I find this confusing.

The idea that Economic growth within the Eurozone (or anywhere) is a zero sum game isn't true. It is never a zero sum game, ever. There is no accounting identity which says that x amount of growth has to be balanced out by y amount of contraction, or anything like that. The author's use of zero sum is completely wrong. What there are, are situations in which a country can induce economic growth at the expense of other countries, in the short term at least. For example, arguably the Euro was and is more beneficial for the German economy, than it was for other Eurozone economies. This doesn't always have to be the case though.

KyussBishop

andrew wrote: »

The idea that Economic growth within the Eurozone (or anywhere) is a zero sum game isn't true. It is never a zero sum game, ever. There is no accounting identity which says that x amount of growth has to be balanced out by y amount of contraction, or anything like that.

Indeed, economic growth is definitely a positive-sum game for everyone, and this is something that's useful to note in the context of the entire economic crisis around the world (which give some insight to what was posted in the OP, on international trade):
Countries are being encouraged to contract their private sectors with austerity (see the 'sectoral balances' bit I posted above: by definition, government trying to run more of a surplus with austerity, drains the non-government sector; unless they rely on credit/debt - which is already overextended), and to try and spur economic growth by increasing exports.

However, so many countries reducing public spending (reducing the flow of money into the non-government sector), is reducing worldwide aggregate demand, and that also is reducing the worldwide demand for other countries exports (World Exports = World Imports, so when countries are importing less, less countries can export too - or it becomes a race-to-the-bottom in valuation of exported goods or currency), and that is slowing down the growth of worldwide economies - so that's inherently self-defeating.

However (just for sake of argument), if there was a worldwide stimulus which was aimed at employing all of the unemployed, that would jump economic growth back up to 100% (without devaluation - because all countries do it simultaneously), and worldwide Aggregate Demand would be boosted as well, restoring the necessary amount of economic activity for achieving enough exports and domestic consumption, to achieve economic recovery (it would even start alleviating private/public debt problems too - but slowly).

Since this won't simultaneously happen though, countries must either devalue their currency in order to export more and increase economic activity, or must slash the cost of producing the goods (by slashing worker wages while keeping everything else in the economy just as costly - internal devaluation i.e. austerity - which is unsustainable due to unresolved public/private debt), or look at alternative economic policies for restoring full employment without significantly affecting the trade balance.


In this sense, the crisis is really more like: Many countries voluntarily deciding to reduce their economic activity by allowing so much unemployment, and refusing to compensate for this with devaluation (one way of increasing demand for exports and economic activity) or other alternative growth-boosting policies - this forces all other countries they trade with to also either reduce economic activity to match, or to engage in devaluation or alternate growth-boosting policies (because their exports fall)

It's pretty much a case of world economies sinking or swimming together (with economic growth being positive sum, and lack of it being negative sum) - and most are (due to bad economic policy/theory) voluntarily choosing to sink.