Like giving a credit card to a college student. The Euro Zone crisis is a symptom of flawed systems design
This is a discussion of the design of economic systems, the factors for success and the reasons for their demise.
The blog post is unfinished... and needs a lot of work.. But it will get there over time.
What is causing the systemic problems in Europe?
What is an economic system?
An economic system is a system for producing, distributing and consuming goods and services. We all contribute to the system
How are economic systems supposed to work?
Cash and financial management is not easy. As an entrepreneur/business owner & manager, I work with my controller and directors to forecast our income and expenditures, cash flow, pipeline bi-weekly to ensure we can meet our obligations to the people, families, vendors that we depend on and are responsible for. We don't dwell on the numbers but know them well enough to understand our current position and come up with reasonable forecasts and strategies to manage future positions. Even though we work in an environment of almost full transparency we make mistakes. This process ensures that the mistakes do not risk the near and long term viability of our business.
Sovereign Nations should run like businesses
National finances should be no different. Nations, like individuals and business, have income and expenditures. They have to manage cash and credit facilities. They set budgets, decide on strategic investments, set targets for discretionary funds, forecast returns etc. Typically, the minister of finance, central bankers, and policy makers are responsible for managing these things. The public has a role in selecting elected representatives make policy on our behalf.
The policy that they make should be rational, and in theory should lead to economic, and cultural growth that is steady, predictable.
Policy makers are not dimwits. Why do crisises emerge?
Most policy makers are smart and their intentions are pure. They studied in great schools, often have incredible credentials. They generally understand the basic financial principles like if you spend more than you make, you to take on debt. If you keep taking on debt, eventually the costs of servicing debt become too much to bear, and a nation will default.
That Damn T-shirt cost me $5 Grand!
The current crisis reminds me of a much more personal crisis that I experienced in University. I remember it clearly. Walking through the student centre I was wooed by credit card companies that were setup offering free t-shirts for credit card applications.
I remember walking up to the table, filling out the application, and receiving the free t-shirt. I wonder now if I would have done so knowing that that free t-shirt would end up costing me thousands in late and interest fees.... but I digress.
I remember receiving the credit card in the mail and thinking WOW I finally have credit, I'm an adult, I can manage this.
And manage I did. What I learned is that the extension of credit did not necessarily mean credit worthiness, or reflect my ability to pay those debts.
Creditors were giving students, like myself, access to credit that they couldn't possibly repay if fully leveraged. They encouraged us to spend and then punished us heavily for managing credit poorly... and all I got was a lossy t-shirt.... well and an inflated standard of living for a short period of time.
Systems rely on assumptions and models. These assumptions often dictate whether a system will succeed or fail.
It's clear that the economic crisis in Europe was not caused by credit card companies wooing nations with swag... on the other hand, I don't think it's that far off.
The European Union and Euro Zone offered lesser economies of Southern and Eastern Europe something that they had never been able to achieve themselves. A standard of living on par with Germany, France and the rest of Northern Europe. All it would cost was their Monetary policy. Achieving European standards would take time and money but would be paid for by increased economic integration between member nations, freedom of mobility (goods and people), decreased transaction costs, and all the other efficiencies derived from being part of a larger unit.
The equation simply didn't work out.
Southern and Eastern European economies invested heavily in political, social, economic systems to bring their standards up to Northern European standards. They adopted European employment standards and overnight the costs of everything from newspapers to employment shot up. The cost of a espresso in Rome became the same as the cost of an espresso in Frankfurt, and Athens, and Lisbon and so on.
Southern and Eastern Europe (which up until recently had been cheaper european alternatives to the North) all of a sudden lost their competitive edge. The cost of producing goods in Germany was now effectively the same as producing goods in Spain, yet Germany offered better quality and capability. On the other hand, producing goods in places like Turkey (and other near shore alternatives) was now relatively much less expensive and those near shore alternatives offered similar quality products as in Greece and Spain. Investment slowed in southern and eastern Europe and flowed to alternatives.
In the meantime, investment continued, governments missed targets, ran deficits, hid deficits, and today we have the Euro zone crisis.
We could point fingers at creditors, but the creditors simply provide the means to make poor decisions. (it's like going to Vegas and blaming Steve Wynn for your hangover and loses). They cannot be held accountable for poor policy decisions.
We could blame national leaders, but let's face it... they were playing with a stacked deck. No chance they could possibly win. Utopia within reach, the terms of a deal agreed to (forced investment), what choice do they have but to try and achieve the vision? A vision they believed in.
We could blame the citizens (often depicted as lazy and entitled). But they never had a chance, or a say for that matter. Which is probably the most frustrating part of the collapse. They were along for the ride and sold a bag of goods.
The blame has to be on the Euro zone system architects. The architects of the system made poor assumptions, poor judgements, were arrogant and created a system destined to fail.
When countries like Cyprus and Greece joined the Euro zone they inherited European standards without European income. Like giving a credit card to a university student with no, or limited income. Disequilibrium in spending and income can only last so long. Default is inevitable.
Clearing the $1,000 debt of a college student is incredibly different from clearing the debts of a whole continent.
Over leveraging has a very painful and inevitable outcome, de-leveraging at the mercy of the creditors. In the end everyone gets a haircut (including creditors), often at the expense of the people. As always the most vulnerable suffer the most.
In the case of Cyprus, the unprecedented action of creditors, and their raid on the bank accounts of citizens should be an eye opener to everyone.
It's an example where citizenship and participation mean partnership. It's an example of accountability for the actions of democratically elected policy makers. They make poor decisions, the country goes broke, we as citizens are responsible.
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