More Economic Geography

Caption: The European Central Bank in Frankfurt, Germany. Believe it or not, it's been even more useless since the Crash of 2008 than our central bank.

Image credit: ArcCan/Wikimedia

The other day I was discussing some of the reasons that there is a big difference between the financial problems of Eurozone members like Greece and Spain that are now heavily in debt, and the situations of American states that find themselves in economic distress. Today, Dean Baker discussed another one in the course of debunking another article in the Washington Post by one of their clueless economics reporters:

Hence we have Matt Miller telling us this morning about how resolving the euro zone crisis will require that German Chancellor Angela Merkel devise a plan for "apportioning pain."

Of course the opposite is true. The pain is wholly unnecessary and self-defeating. The obvious way out of the euro crisis is to require that the European Central Bank abandon its obsession with reinforcing its Maginot Line (its 2.0 percent inflation target) and instead act like a central bank. This would mean guaranteeing the debt of the crisis countries and supporting a higher inflation rate across the euro zone.

Matt Miller's Pain

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This failure of the European Central Bank to "act like a central bank" is another of the primary differences between what's going on in Europe and what's going on in America. In the U.S., the Federal Reserve Bank performs this function. Fed Chairman Ben Bernanke's Quantitative Easing (QE) policies are just another example of how this works. I don't know enough about the financial industry to hazard a guess about whether there is no other way the situation in Europe can be resolved. Still, I figure if QE could keep the lid on our banks' problems for this long, some similar program could handle the problems the Eurozone is having.

This is the basic problem - in a place like America or the Eurozone, it's not possible for all members to have a positive balance of trade. Money will tend to flow out of those countries or states that import more than they export. One of the things that helps ease that situation is that credit can flow into those countries or states. How that's being done right now in Europe is that big banks are lending money at exorbitant rates to the countries with a negative trade balance. In America, the states (via their banks) get this credit for next to nothing.

There are many reasons why the situations here and in Europe are different. It is foolish to suggest that American states, or America in general, is going to end up like Greece, with their creditors, in essence, threatening to break their legs if they can't come up with the cash. That's what's happening in Europe, but it's not going to happen here.

Our own path to economic ruin will be a somewhat different one, if we choose to go there.

UPDATE: Added a bit more to the discussion about where the money goes between net exporters and net importers. It wasn't clear before, probably because I thought it obvious which way the money goes. Still, if I'm bothering to explain, I should explain so people who don't think it's obvious can get caught up.