The global surplus bogeyman recycling mechanism

It’s becoming almost a standard narrative that actually the crisis was not caused by the Greek’s overborrowing, but instead by inadequate demand in Germany, needing involuntary demand for Germany’s exports to stabilise Germany, a demand that later wreaks havoc.

Before this takes hold too tightly, I think it’s worth remembering basic open economy models of trade, in which current account surpluses arise naturally, and improve everyone’s lot, if they are related to the relative demands and supplies for future consumption, and relative returns.

Thus, as a mature economy, with scope for future income growth limited, and an aging one, with demand for saving higher to provide for old age, it would be natural for capital to flow to countries engaged in a process of catching up levels of average factor productivity in Germany, where marginal returns are higher.  Like Greece for instance.

In such a world, policy could shut off this intertemporal trade, but at great cost to both parties.

Part of the standard narrative is that this pernicious German saving was aggravated and helped along by the creation of the Euro, which, because of the weakness of the other countries, meant that German exports were overvalued.

The counterpoint to this is that nominal exchange rate regimes should not matter for anything much, intertemporal trade included, beyond horizons of 5 years or so.  Certainly not at the frequency of 2 decades, which is what some of the versions of the evil savings hypothesis deploy.

All is not quite so simple, of course, in the real world.  For the welfare improvements long- term current account surpluses and deficits to be there for the having requires that parties on either side of the trade understood the relative income profiles correctly, and also correctly understood the risks around them.

In the case of Greece and the other catch-up countries, it’s plausible to think that there ought to have been great uncertainty about just how far, given existing institutions, or plausible assumptions about how they would evolve, Greece’s income per head would catch up.  And that it was easy, in the early phases of that catch up, to guess the end point wrongly.  And we know now that there is much evidence, not least hindsight, that risks were not correctly priced in, or, if they were understood, were understood to be the business of someone else [in the case of mysteriously narrow spreads on EZ peripheral sovereign bonds].

Seen this way, the appropriate response is not radical and far-reaching intervention to prevent countries that want to save from saving, but mechanisms to tackle market failure in risk bearing and risk pricing.  Which is what, slowly and clumsily, is going on.

All that said, there are lots of problems with and puzzles for the basic toolkit on which those insights [they aren’t mine] are built.  But it should take more to displace it than simply the assertion and global recycling of the story of an evil capitalist saving bogeyman.

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6 Responses to The global surplus bogeyman recycling mechanism

  1. > radical and far-reaching intervention to prevent countries that want to save from saving

    Question. I am not an economist and I am puzzled by seeing savings and spending usually presented as polar opposites.

    Yet in the spending equation C + I + G + X, the (I) can be considered a form of savings.

    When I look at the European situation, the problem doesn’t seem to be that there are too much “savings” but that not enough of the savings are invested in the weaker regions (perhaps because the central bank is making keeping savings as idle reserves too attractive relative to investment in weaker economies).

    But surely if this was true, economists would be pointing this out in chorus. What am I missing?

    • Hugo Evans says:

      I think you are partly correct that this is a flow of funds issue between Euro regions. In a sovereign national economy total income = total expenditure, C+G+I+X =C+T+S+M. We say I is the accounting identity of S. They are the same thing viewed from different angles.
      But this says nothing about how that comes about. For a Keynesian S=I in a closed economy because I creates a flow of income the residual of which after C we call S. S precedes itself as I.
      Rearrange to get national accounting identities, with C cancelling; (G-T) + (I-S) + (X-M) = 0
      If German firms and households are to accumulate NET financial claims on other sectors (save) and their gov’t refuses to run a matching deficit (because of austerity) then in an open economy X-M must be positive when viewed across =, that is there must be a current account surplus with the external sector. If the external sector uses a different currency then German S in this scenario must be held in that currency, unless their CB creates a backdoor deficit by swapping foreign currency for new Euro. If the external sector (Greece et al) uses Euro then S is automatically repatriated via Target 2. But the S only happened because Greek C created it following German I. After 2010 German banks stopped lending this Greek C back as German I (a form of vendor financing) and Greek S also drained abroad until ELA was exhausted. This is why there will always be a country like Greece in the Euro and why throwing Greece out won’t solve their problems, and why people are looking for ways to suppress German S.

  2. Mic says:

    I think this is far to simple. Firstly: In your description a current account surplus is a matter of a – how ever conducted – rational decision of a collective entity. It is not. It is not evern a matter of markets and international economics. Secondly: The surplus arose naturally? Forgive me that is totally wrong!

    In case of Germany, it was a matter of politics (Hartz I-IV). And it is still a matter of politics and power (Max Weber). Against resistance of other status groups German exportindustries are getting their way. In consequence: there is a unbelieveable amount of distribution from the broader society (and foreign areas) to the German exportindustry, their management and their shareholders. Noone is “saving” for a demographic turnover or something like this. It is just a question of wealth creation; a more complicated mechanism to “beggar your far (other countries) and near (home economy) neighbor”.

    If it is about market failures, it is a question of power! And I don’t think that economics is the right framework to conduct an adequate approach to that question!

  3. Peter K. says:

    I don’t understand. Don’t the policymakers of Germany (and China for instance) allow their economy to increase a certain amount of aggregate demand per year (via the inflation target) which is related to workers’ income? Aren’t the critics suggesting that the Germany allow a larger increase in demand, income and inflation?

    What would be the “fair” amount of numbers and what are the actual numbers? Germany’s inflation is certainly low. Yellen suggests for American workers, 3-4 percent wage gains are normal with a 2 percent inflation target.

  4. nanikore says:

    “But it should take more to displace it than simply the assertion and global recycling of the story of an evil capitalist saving bogeyman.”

    Risible and largely inane typecasting.

    But you do make the important point, which is actually what these people are probably actually trying to say. The Eurozone periphery needs structural reform if German savers are going to invest their capital there (which they would like to do, because it would get a higher return, as well as go to people who need it.) This is probably the big argument for political and fiscal integration in the Eurozone – it would involve reform of institutionally weak states. The momentum for this however was lost in events related to the expansion of the EU. But I hope you are right that, even if clumsily, something like this is actually going on.

    Fiscal integration and institutional reform with the Euro in the Eurozone is the way to go, not Krugman’s historically ill-informed ISLM devaluation prescription, which at best, will return Greece to its pre-Euro days.

  5. John says:

    Why should nominal exchange rates not matter beyond five years? I can think of a rather obvious counter example: cheap Chinese exports. The Chinese practice of subsidizing their exports through a weak nominal exchange rate resulted in a transfer of wealth from various Chinese economic actors to foreign consumers who bought the cheap goods. This monetary regime lasted for more then five years and the trade surplus was persistant. When the subsidy ended there wasn’t a clawback of the benefits of the subsidies to consumers.

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