Month: December 2010

It's not just the Kiwi fruit.  Via Eric Crampton, Matt Nolan informs us:

On the surface there appears to be a lot in common with the Irish, Greek, and NZ economies.  All three have high net foreign liability positions, liabilities are highly concentrated through banks who are borrowing overseas, all three have experienced some form of housing boom and lift in consumption, and finally all three appeared to have a relatively strong fiscal position before the GFC before moving into fiscal deficits after the shock.  And yet (so far) while the Irish and Greek economies and banking systems have collapsed, New Zealand’s has been fine.

There are two major differences that have helped reduce the implied risk on our debt, making New Zealand much less likely to experience a bank run:

1. Our banking system is primarily foreign owned (Eric Crampton expands on why this is a good thing),
2. We have a freely floating exchange rate – combined with having much of our debt denominated in NZ$ this is useful.

Addendum: Matt Yglesias offers relevant comment.

The caveat about financial arrangements is important with respect to Germany’s apparent prosperity. Germany, like China, is less prosperous than it seems, because its surplus production is geared to sale for claims that cannot credibly be redeemed for what the country’s citizens would want should they exercise their option to consume.

That is from Interfluidity.  Is it a Keynesian point or an Austrian point?  You guess.

Drawing an analogy with the ill-fated Exchange Rate Mechanism (ERM) of the pre-eurozone era, Paul De Grauwe argues in a new CEPS Commentary that the creation of a sovereign debt default mechanism is a very bad decision that will make the eurozone more fragile by making financial crises an endemic feature.

The full (short) paper is here, recommended.  Excerpt:

[apart from Greece]…the root cause of the debt problems is to be found in the unsustainable debt accumulation of the private sectors. From 1999 until 2008, when the financial crises erupted, private households in the eurozone increased their debt levels from about 50% of GDP to 70%. The explosion of bank debt in the eurozone was even more spectacular and reached more than 250% of GDP in 2008. Surprisingly, the only sector that did not experience an increase in its debt level during that period was the government sector, which saw its debt decline from 72 to 68% of GDP. Ireland and Spain, two of the countries with the severest government debt problems today, experienced the strongest declines of their government debt ratios prior to the crisis. These are also the countries where the private debt accumulation was the strongest.

Once sovereign default is in play, De Grauwe predicts self-reinforcing downward spirals can  destroyithe eurozone.  His points are well-taken, but I would add a few observations:

1. To be a small country, and to "play with matches" without good fire insurance, is also a form of fiscal irresponsibility.  It is a more important form of fiscal irresponsibility than we had thought.  A'la Robert Eisner, the government's measured budget position is not the key magnitude for measuring its fiscal stance.  The three percent rule is partly to blame here, although a lot of countries couldn't even follow that.

2. The distinction between private and public debt ain't what it used to be.

3. Fiscal union was, is, and will remain a fantasy.  The best the eurozone could have done was to abolish national banking systems and have a truly European banking market.  It's too late for even that, though.