Saving Greece, Europe, and the United States

Greece, Spain, Portugal, Italy, France, and the U.S. are close to bankruptcy, and they all have the same problems: profligate government, large trade deficits, and bewildered economists.

Moreover, the G8 statement was ruling out any real solution to the huge unemployment problems of the Southern Eurozone. All of the Eurozone countries with high unemployment rates have negative trade balances (as measured by current account balance divided by GDP), and all the ones that are doing well have positive trade balances. Furthermore, the worse the trade balance, the higher the unemployment rate as shown in the graph below.

This is not surprising from an economics standpoint.  Trade surpluses add to demand, while trade deficits subtract.  Also, when a country has structural trade deficits, attempts to stimulate demand through profligate government spending leak abroad.

In the chapter about mercantilism in his magnum opus (The General Theory of Employment Interest and Money), John Maynard Keynes explained what happens to trade deficit countries:

[A] favorable balance, provided it is not too large, will prove extremely stimulating; whilst an unfavorable balance may soon produce a state of persistent depression. (p. 338)

Spain, at 24.4% unemployment, has the highest unemployment rate in Europe.  Its problems stem not only from its trade deficits, but also from its foolish investment in green energy -- the same "growth" strategy that President Obama is emulating!  A study by Gabriel Calzada Alvarez and his colleagues at Madrid's King Juan Carlos University calculated that Spain lost 2.2 jobs in other industries for every government-subsidized green job that was created.  The problem is that renewable energy, being more expensive, wastes government resources while raising the overall cost of energy for local manufacturers.

Ireland is the only exception to the trade deficit rule.  Its 14.3% unemployment rate is due to the popping of its huge real estate bubble followed by the massive crony-capitalist bailout of its banks.  But it has a vibrant exporting industry, due to having the lowest corporate income tax on manufacturing of any eurozone country.  Ireland is suffering, but not as a result of its trade deficit.

But for all of the Southern European countries, the chief problem is their trade deficit.  By continually paying more for imports than they get for their exports, they gradually run out of euros, just as trade deficit countries under a gold standard run out of gold.

European political leaders think that the solution to the problems of Greece and the others is austerity -- cutting government expenditures.  The problem with that policy is that Greece and Spain are already experiencing depressions.  Election results in Greece (unemployment rate 21.7%) and France (unemployment rate 9.8%) prove that their citizens will not approve of a policy that requires a depression to correct the trade balance.

It is not an accident that the Northern European peoples have trade surpluses and the Southern have deficits.  Cultures where winters are longer and colder emphasize saving in order to survive.  And so with interest rates the same across the eurozone, the Northern Europeans saved and the Southern Europeans spent, and, inevitably, the Northern Europeans loaned money to the Southern Europeans so that the Southern Europeans could buy the Northern products.  The result was trade surpluses in the North and trade deficits in the South.

But loans from the North to the South can go on only so long.  Eventually, the South gets too deeply in debt to qualify for more loans and can no longer afford to buy more products than it produces.

A number of years ago, Prof. Milton Friedman, one of my (that is, Raymond's) mentors, predicted that the euro could not be sustained.  He recognized that a condition of its longevity was that each member had to earn as many euros or as much foreign exchange that could be converted into euros as it spent.  Not necessarily every year, but the deficit could not go on indefinitely.

The eurozone was a foolish thirteen-year experiment which was doomed to fail.  It is only a matter of time until Greece, Spain, Portugal, Italy, and perhaps France pull out of the eurozone in order to revive their economies.

Meanwhile, the United States is heading down the same trade deficit path as the Southern European countries.  Like them, we have massive trade deficits.  Like them, we have a massive budget deficit that is failing to reduce our high unemployment rate.

Although we do not share a currency with other countries, the emerging market countries produce a favorable trade balance for themselves and a negative one for us by manipulating exchange rates, imposing tariffs on imports from the U.S., and subsidizing their own exports.  American corporations are induced to build their plants offshore.

Almost all of the emerging-market central banks are following China's example of buying dollars and dollar assets, including stocks, bonds, and businesses, with the dollars earned by their trade surpluses with us.  These purchases push our long-term interest rates low -- even lower than our inflation rate -- which discourages Americans from saving.  We go farther and farther into debt to these countries to buy their products.  Eventually this system will collapse when countries lose faith in the U.S. dollar and we are forced to print dollars and undergo inflation to service our debt.

None of this is necessary.  There is a basic economic principle involved.  Balanced trade is way more important than free trade.  When trade is in balance, neither country is "beggaring its neighbor."

After the Southern European countries leave the eurozone and re-instituted their old currencies, they will still have the problem of how to achieve balanced trade.  There is a mechanism available to them: our invention, the scaled tariff.  This is a variable-rate single-country tariff that is imposed when a country experiences a significant trade deficit with another country.  The tariff rate rises as the trade deficit worsens, falls as the deficit improves, and disappears when trade is brought into balance.

We analyzed the scaled tariff in an article that was published in The Estey Centre Journal of International Law and Trade Policy.  It works like a change in the foreign exchange rate, except that it does not affect a country's trade with partners with whom it does not have a significant trade deficit.  And it provides the country imposing the tariff with foreign exchange revenues, thus easing its debt problems.

If trade-deficit countries enacted the scaled tariff, trade surplus countries would discover that they that must reduce their own savings rates in order to prevent unemployment in their own countries.  So they would run budget deficits and increase their money supplies and in all other ways possible encourage their own people to spend more on consumption, including consumption of imports.

The eurozone was a failed experiment.  It was based upon the hope that the countries of Europe -- and then, eventually, those of the entire world -- would come together in a free-trade zone with a single government.  Free trade works within the United States because people from less prosperous states move to states where there are more opportunities.  But in Europe, there are too many languages and too many cultural differences.

And free trade is not working internationally because some countries have ambitions and ideologies that encourage them to pursue mercantilist (i.e., trade surplus) policies.  The rapid growth of China during the past two decades has come at the cost of the U.S. suffering the loss of millions of manufacturing jobs.

Both world trade and the interdependence that is created through trade are important ingredients in world peace and prosperity.  But a successful trading system must be based upon balanced trade.

When trade is balanced, it can grow forever.  But imbalanced trade inevitably bankrupts the trade-deficit countries.  Then the entire trade system falls apart, as it is currently falling apart in Europe.

The authors maintain a blog at and co-authored the 2008 book Trading Away Our Future: How to Fix Our Government-Driven Trade Deficits and Faulty Tax System Before it's Too Late, published by Ideal Taxes Association.

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