What's Wrong with the Euro? (4)

Image credit. Continued from What's Wrong with the Euro (3)

Here is an alternative explanation of the European crisis, and, indeed, manifestations of that crisis all over the world.

Private Debt Is Driving the Crisis

We assume two factors to be the central indicators of economic activity: total demand and income.

Total demand and income are driven 

• by turnover of the existing money,

• by new money created by new private debt.

Private banks are by far the most ample source of changes in the money supply. In the UK, it is estimated that 97% of all money is created by the extension of private debt by private banks.

Also, existing money is relatively stable, whereas changes in new money can be rather volatile. 

Research provided by Steven Keen suggests that (the rate of change) in private debt determines employment: when private debt increases, money is available to fund economic projects that require additional labour input. When private debt declines, so does investment and hence employment.

Also, it transpires that unemployment is driving government spending, with the latter rising to handle higher unemployment, and falling when unemployment declines again.

Thus suggests that targeting government debt is targeting a symptom rather than the cause, which is a fall in (the rate of change of) private debt.

Responsive government spending (in addition to its being driven by unemployment) is called for, according to Keen, and has, indeed, helped to cushion the economy's crash in the US. Government spending resulted in slower deleveraging, helped avoid bankruptcies and encouraged people to resume debt financing. In Europe, countries prevented from responsive government spending had to suffer a more draconian and more enduring period of hardship.

Why Is Germany Different?

In Germany, private debt was on a falling trend for quite some time before the crisis hit. But then the question is, what was financing German employment if neither private debt nor government spending did it (preponderantly) ? 

The answer is: exports. Germany was running a trade balance of 7.5% of GDP, which is far higher than the government deficit allowed by the Maastricht treaty. 

Notably, looking at German statistics, there is no correlation whatsoever between government debt change and unemployment. The money that is financing employment is provided by earnings from exports, not by what is accomplished domestically. The money supply was growing despite a falling (rate of change of) private debt. Also, there was no housing bubble owing to a stable culture of house renting, based on low rents and a strong and safe status of renters vis-à-vis landlords.