Citizens Concerned About Sovereign Debt Crises

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In the last example of Fourfold Problem-Solving we looked at How Buyout Funds Work as an industry on the microeconomics level. Today we’re going to look at national and global examples on the the macroeconomic level.

A national example of fourfold thinking

Macroeconomics is simply the “big picture” economics. At this point in time that usually means on the national or international level. Microeconomics, on the other hand, is anything below the national level, e.g., industry, households, regional and local governments.

The national level is where Americans can clearly see the downside of binary either/or thinking. We think we have two national political parties in this country; Republican and Democratic. The reality is that we have four parties:

conservatives          ultraconservatives

liberals                   progressives

Our ultraconservatives have pulled conservatism one way; now our progressives are pulling liberalism back towards its former place, and even beyond that into more progressive territory. Meanwhile, we have a liberal Democrat President who is trying to moderate the damage of that split, and traditionally conservative Republicans appear to be becoming more and more of a minority in Congress.

A global example of fourfold thinking

Most of the time, economists who use words rather than mathematics to express what they see tend to use twofold models. Foreign trade specialists, for example talk about exports and imports. On the national level macroeconomics specialists, such as Martin Wolf and other writers for the London Financial Times newspaper, talk about surplus and deficit countries, meaning countries with sovereign debt, e.g., Greece, and countries with a surplus, e.g. Germany.

Make no mistake, this is progress. Economists used to use one-good models. They used them in microeconomics for discussing what happens in a manufacturing establishment. And they based ideas of foreign trade on the notion that each of two countries produced only one good. Given the size of multinational companies such as those in the auto industry, and the complexity of international trade, that kind of simplification is no longer useful. The US trades with a myriad of partners, and 0ne-trick-pony manufacturers are now as rare as buffalo in this country. One-good nations are now rare too. And so are one-good economic models.

We’ve progressed, but only to binary models involving two polar opposites . Yet Martin Wolf did use fourfold thinking in one of his recent editorial comments about the crisis in the Eurozone. So let’s look at the basics of the financial crisis in Europe before we see what Martin Wolf says about it.

The Eurozone crisis

The Eurozone is now going through something very similar to the US financial crisis. Global banks overreached. When investment bank deals began to fall through and financial sectors in the Eurozone became shaky, the wrangling began over who was going to pay for the follies of those who bought and sold worthless investments in government bonds.

The holders of those worthless investments in sovereign debt would prefer it be the taxpayers who pay. The taxpayers don’t like that idea. Germany and other surplus countries in Europe, countries who hold a lot of the debt involved in the Greek debt crisis, prefer that Greeks pay the price. Greeks, who are a a strong unionist country have gone on strike. They are protesting in the streets the austerity moves being thrust onto their government and them by other EU countries.

I can’t blame the Greeks. Greece is predominantly a middle-class country. It does not have a preponderance of wealthy people it could even dream of taxing to pay its debts. Many of those debts have been facilitated by Goldman Sachs deals that were made with Greek government officials on an  “off-the-budget” basis. Those deals were invisible to the Greek people until the deals went sour in the global meltdown.

Worse yet, today’s Financial Times reports that a Greek government statistician is accused of altering his accounting method in 2009 to make it appear the Greek government had more of a deficit that it actually did. (“Athens statistics agency chief accused“). Greece is a country that has gone into debt by issuing bonds and by borrowing heavily from other countries. Today’s news threatens to derail a Eurozone-financed bailout loan that Greece needs to pay public sector salaries and pensions in January.

Once Greece got into hot water, a chain reaction began in Europe. Portugal, Italy, Ireland and Spain came under attack for also being deficit countries like Greece. Even France’s banking system has been tarnished by the crisis overseas. And Europe, unlike the United States does not have a strong central bank. The European National Bank does not have the resources to bail out even one of the Eurozone deficit countries.

Also, unlike the United States, the the debt problems within several Eurozone countries, even though different from one another in the details of how they came about, are all very real financial crises. These crises were not self-imposed by polarized political parties within any of the countries. Yes, we are a deficit country too in terms of our national budget, but we are have not yet come close to where our sovereign debt is worthy of being called a immanent crisis. We have time. Europe does not.

The polarization in the Eurozone arose when Greek sovereign debt became dangerously high. The polarization in Europe is between the have and the have nots, i.e., those private investors who “have” and are stuck with the bad sovereign debt (bonds sold by the Greek government along with derivatives sold by banks to “insure” those bonds) versus those taxpayers in Greece and other Eurozone countries who will “have not” if payment for that debt is taken out of their paychecks.

Martin Wolf’s fourfold thinking about the European Union crisis

Martin Wolf has used two pairs of opposites (fourfold thinking) in his editorial for the Financial Times, titled “How to keep the euro on the road“  These two pairs of opposites are: “stocks and flows” and “financing and adjustments”.

“Stocks” refers to the huge debt overhanging some European nations from their past actions. “Flows” represent the need to return to economic growth in the future. “Financing” and “adjustments” relate to ways to deal with the “stocks” (i.e., debt) and/or the need to create sustainable “flows” (i.e., growth) of income and expenditures for the future.

Wolf uses these four interrelated variables to consider how Europe can solve the crisis in the Eurozone as it faces illiquidity and insolvency right now for some of its members.

Unfortunately, toward the end of Wolf’s article where he discusses adjustments to flows, Wolf returns to the binary logic he’s been advocating for the past few years about countries with a trade “surplus” vs. countries with a trade “deficit’. He persists in thinking that “If external deficits are to fall, so must surpluses elsewhere.” In another article he wrote November 2, 2011 for the Financial Times,  “Creditors can huff and puff but they depend on debtors,” he frames international trade this way: “Since the world cannot trade with Mars, creditors are joined at the hip with debtors.”

In this second article Wolf is talking about creditors as countries which have a surplus in terms of their current account balances. Investopedia defines a current account this way: The difference between a nation’s total exports of goods, services and transfers, and its total imports of them. Current account balance calculations exclude transactions in financial assets and liabilities.” But it is financial transactions are precisely what has gotten Greece into trouble.

I really thought this kind of binary, simplistic “comparative trade” model in the field of economics would have left academia around the same time I did! I find myself disappointed it hasn’t.

Getting at the real problem

The real problem in the Eurozone that such dichotomous, binary thinking about current account balances of creditors and debtors glosses over the fact that there is a huge amount of toxic financial debt still floating around everywhere in the world.  Wolf doesn’t seem to notice that investment banks and shadow banks are lurking behind the massive fiscal debt that some sovereign nations have acquired. The real problem in the world right now is: “Who will pay?” Investors? Investment banks? Surplus countries’ governments? Or taxpayers in the deficit countries? That is the battle (literally) going on in Greece right now.

Investment banks who created the crisis have largely dodged the bullet so far, while taxpayers haven’t. Perhaps one reason some of the wealthiest Americans are reluctant to volunteer for the Buffet tax is that they know it could end up being a lot bigger than the current proposal. In addition, some of them are the investors who don’t want to take responsibility for Greece’s toxic debt in the first place.

The interesting thing about the US right now is that those conservatives who pay lip service to Adam Smith are supporting an economic system that would destroy the one Smith espoused. Smith’s world was one where money facilitated commerce and trade among people who had goods and services to offer each other. Our world is dominated by a gigantic gambling consortium that is in business only to make money. This is not what Adam Smith would have called, “The Wealth of Nations.” Yet investment banking is an industry that the US still leads the world in. And it is banks in the Eurozone and the US that hold much of Greece’s sovereign debt and the “insurance” (i.e., credit default swaps against sovereign debt) that are supposed to cover losses from Greece’s debts.

Greece, on the other hand, is a country that does not produce enough goods and services to pay for much of its debts. It has habitually borrowed too much and gone into sovereign default. And like all countries in the Eurozone, Greece gave up its power to control the rate at which its own currency is exchanged with other countries’ currency. Greece cannot devalue its currency in order to foster increased exports of the products it makes or to attract more tourists to the country.

Going towards a solution

The use of one pair of opposites, i.e., only two variables, to think about issues tends to lead to “either/or” thinking. Either/or thinking is polarizing thinking. When people use either/or thinking, they tend to take sides instead of engaging in problem-solving. Either/or thinking, in my opinion, is a trap. And in this case, dividing the Eurozone into surplus vs. deficit countries is too limited. So is talking about creditor and debtor nations solely in terms of foreign trade.

Wolf himself, in his article about keeping the “Euro on the road,” suggests that financing would come mainly from other Eurozone countries raising money from selling bonds for example, to help fund Greece, while adjustments refer to the austerity measures Greece is being arm-twisted to implement. These two variables have to do with cross-border exchange of debt in the Eurozone, while the two variables, creditor and debtor have to do with cross-border trade among Eurozone countries.

Fourfold thinking then can prevent getting to a stalemate; fourfold thinking is one way out of the mental traps we humans build for ourselves.

The Eurozone countries, as well as the rest of the countries in the world, all have at least four interconnected macroeconomic factors in play:

private debt         public debt    (as part of Martin Wolf’s “stocks)

exports                imports        (as part of Martin Wolf’s “flows”)

Rather than focus simply on trade, as Martin Wolf’s twofold thinking about “surplus” and “deficit” countries does, the current global financial crisis can be broken into four interconnected factors — debt, public and private; and foreign trade, exports and imports. Public debt here refers to sovereign debt of the countries in the Eurozone, while private debt refers to the individuals and institutions who hold Greek debt and derivatives.

Looking at an issue from more than two sides can change the way economics works. Looking at an issue from four sides can help break out of a box when two or more sides oppose each other on political issues.

With a fourfold model, we can see how the United States differs from the Eurozone. The US controls the exchange rate for its own currency, and we are now looking at increasing our exports as a way of dealing with our “flows,” i.e., our economic growth, problem. That, from what I can see, was what quantitative easing by the Fed was really all about; by buying back US government debt we sent dollars into the hands of private investors around the world. That kept the exchange value of our dollar low and fosters our exports to other countries. And we are at least attempting to deal with the private vs. public debt problem, our “stocks” problem, via taxation (or “tax reform”) as well.

The biggest question for the US is, can our political polarity be resolved far enough to deal effectively with our both our national debt and our trade deficit.

Follow Nancy Humphreys on Twitter @brucenomics