Friday, November 11, 2011

Major Economic Reporting Breakdown at the New York Times

I sometimes carp about minor missteps, but this is big.  In a front page “explanation” of how the eurozone got into a sovereign debt crisis, there is criticism of myopic banks, lax regulators and spendthrift peripheral governments, but no mention of the fundamental underlying cause, the swelling imbalances between surplus and deficit countries in the currency union.

The Times reporters and editors need a refresher in introductory economics.  The fundamental identity that connects financial balances to a country’s international position is

BP + BG ≡ CA

where BP is the net savings of the private sector (income minus spending for households and firms), BG is the government's fiscal surplus or deficit, and CA is the current account balance (mostly trade).

Over the decade of the 00's, the peripheral countries were running ever larger trade deficits with the core countries, especially Germany.  At first these deficits were financed by private sector borrowing, but after the financial crisis hit private sector leverage froze, economies contracted, and governments stepped in to do the borrowing themselves.  Before 2008 the problem was too much borrowing in real estate, banking and other sectors; after it was too much borrowing by the government.  Yet, as long as the trade imbalances grew, one or the other was unavoidable.

(From a macro identity point of view, if governments had not increased their deficits post-2008, incomes would have collapsed.  This would sustain the identity by curbing imports on the right hand side, but would have allowed an economic freefall.)

So the real story, the one that the Times should have told, is about how the imbalances grew, why few noticed, and how the eurozone framework, with its utterly irrelevant “Stability and Growth” criteria, was unable to cope.

Skip the Times and get your news and views from the econ blogosphere.

Footnote: Nothing Greece and Italy do by way of budget policies or “reforms” can solve their sovereign debt problems.  They might as well sacrifice goats to the gods.  The only practical significance of the current political drama is that it will or won’t persuade the core countries to open the liquidity spigots, write down debts and resolve the banks.


Josephus said...

Dr. Dorman, thank you for being one of the lone voices in the wilderness on this issue. (Gotta' give some love to Kash Mansouri too.) I got Dr. Ewe Reinhardt of Princeton all worked up over this on the NYT Economix blog. The guy is supposed to be a knowledgeable authority on matters of political economy, yet he refused to entertain the notion that Germany's Eurozone mercantilism could be responsible for any part of this mess. Sometimes I feel like the world has turned upside down.

Steve Roth said...

You are absolutely correct here, but I think it's worth pointing out that you are not correct according to the definitions used in the National Accounts.

You say:

net savings of the private sector = income minus spending for households and firms

In the NIPAs,

Savings = Income - *Consumption Spending*

Again, you are absolutely correct. The problem is not with you, but with the national accounts.