Professor of Bruce C. Greenwald, Robert Heilbrunn Professor of Finance and Asset Management at Columbia Business School gave some very interesting interviews recently.
Prof. Greenwald is generally known for his value investing expertise, however in these interviews he offers us an different macro view on the euro-zone and the causes for the continuing world economy’s crises. I have made a limited transcript of the interviews.
International Trade Imbalances Are a Bigger Problem
Today there are some real problems in the world economy that have nothing to do with the financial crisis or unhealthy balance sheets.
The trade imbalances are at the heart of the economic decline and this is not a new phenomenon:
- Japan: for 50 years a net exporter, managing their currency
- China: grows through exports by keeping the Yuan at bay
- Germany: stays in the euro-zone keeping its exports too cheap
- Indonesia, Thailand, Malaysia and South Korea are since the Asian currency crisis (’97) running surpluses through a currency reduction of 50%
Adding up the surpluses of the oil exporters, there should be also various countries running deficits as all global trade accounts balance to 0.
A Short History of Deficits
Who runs these deficits then? Well after ’97 when Indonesia, Thailand, Malaysia and South Korea went from deficit to surplus, the deficits went to Mexico, Argentina, Brazil, Russia and we remember what happened to them around the turn of the century. They collapsed! Since then, they have all run surpluses.
During the 2000s the deficit running countries became the US and to a lesser extent the UK and the euro-zone. Financed by households living beyond their means, saving 0% and eating away household equity produced by the housing bubbles. Now the housing bubbles have deflated or stabilized and households are saving again, while demand has collapsed and everybody is adjusting.
The Difficulty in The Euro-Zone
Competitive Germany and the Netherlands are tied into the euro area with less competitive countries (Portugal, Spain, Italy, France etc.)
- When countries have significant deficits, it is extremely difficult to sustain full employment.
- Germany is in effect exporting any job problem it might have to less competitive countries in the euro area.
- These countries cannot protect themselves, because they cannot depreciate their currency
As long as Germany keeps running account surpluses, less competitive countries won’t have healthy demand growth. And as they cannot depreciate their currency they will have to make another fundamental change: lower real wages.
And Germany is not going to give away its economic power so easily. It has a very powerful manufacturing sector growing productivity at 5-7%. As domestic demand just grows 1% and globally it grows just 2-3%, they have to export. Otherwise manufacturing dies.
The Underlying Problem is The Decline of Manufacturing
The same goes for China, Japan, South-Korea etc. transmitting deflationary pressures overseas.
The underlying problem of global imbalances is the demise of manufacturing and the enormous vested interests in this economic sector. Governments try their best to protect manufacturing jobs by stimulating exports similar to the protection of agriculture in the depression years. However manufacturers are increasing productivity at a higher speed than global demand, leading to a significant deflationary pressure.
As long as the net exporters don’t find jobs in the service sector for their displaced manufacturing workers, there will be no solution for this crisis.
The other part of the problem is the dependency of deficit countries on external financing, where these countries are at the mercy of their external creditors. Living beyond their means becomes virtually impossible as long as they run a deficit and they have to become surplus countries without being able to depreciate their currencies.
So essentially, what is required from countries like Italy and Spain, is becoming more competitive than Germany through productivity gains. This is extremely difficult and probably not going to happen. The other painful way out is a decline in real wage rates which is a very difficult path, because households will feel real pain, losing their purchasing power.
The only way out is currency depreciation. This can be done the easy way or the hard way:
The easy way out:
- Germany, the Netherlands and Denmark (maybe France) leave the euro and appreciate their currency.
- The euro will fall, which will fix the problem for the uncompetitive countries.
- As the debt of these countries is denominated in euros, the burden becomes more bearable.
- Of course this scenario leads economic shocks for the leavers as exports will fall and their investments in euro will decline.
However prof. Greenwald sees this solution as the least painful and more orderly way to solve the problem as exits by the weaker countries will lead to defaults, serious recessions and even larger problems for German manufacturing.
Greenwald on Italy in Specific
Greenwald on the future of the US economy (But this could easily apply to Europe’s economy as well)