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The flow of trade, the flow of capital and

the Eurozone: Guest post by Klaus Kastner

12 Oct

A few weeks ago, I began doing something which I hadnt done since my College days

I did some reading of and about John Maynard Keynes. Among others, I am just

finishing the book The Battle of Bretton Woods by Benn Steil. And I am amazed!

Two principal issues dominated the negotiations lead by Keynes on the UK side and by

Harry White on the US side, namely: the flow of trade and the flow of capital as a result

of a new monetary system.

Now I, for one, had not heard much about the flow of trade and capital as the Eurozone

evolved since inception. Instead, I seemed to always hear two principal themes: the

convergence of interest rates and the external strength of the Euro. Since both developed veryfavorably, the Euro simply had to be considered as a success.

It was only after Lehman that I began looking more closely at the world-wide flow of trade

and capital, albeit not within the Eurozone but, instead, between the US and the rest of the

world. And I was staggered by the enormous current account deficits which the US had beenrunning for years and decades. It seemed that the obsessive and no-fear-of-debt-having

American consumer had created jobs and wealth in the rest of the world and I started

wondering how long that could go on.

When the Greek crisis began erupting in late 2009, the first thing I looked at were Greeces

Balance of Trade figures since the Euroand I couldnt believe what I was seeing. Everyone

seemed to be worried about Greeces budget deficit and sovereign debt whereas in actual fact

it was clear that the Greek economy was essentially driving itself out of its value-generating

activities thanks to the Euro. And none of the discussions focused on that problem. Instead,

the logic shared by most everyone was that the budget would have to be gotten under control

and then everything else would automatically fall into place.

I was simply baffled how, prior to Bretton Woods, leaders would have understood that the

issues are trade and capital flows and, since the Euro, no one paid attention to them. All the

numbers showed the scary development since the Euro but no one seemed to deem them

important.

The dogma for the EU and Eurozone were the 4 freedoms, including the free movement of

trade and the free movement of capital. As long as that was assured, everything would be

fine. And now I read (again) that even Keynes was meandering on these issues at the time:

believing in the benefit of these freedoms but questioning their ultimate success at the same

time (I guess Keynes realized that Great Britain was not ready for completely free trade and

capital movement).

In retrospect, I think that Greece, for one, simply was not ready for the free movement of

trade and capital; certainly not after the introduction of the Euro. Furthermore, despite being a

great believer in the workings of free market forces within an adequate policy framework, Iam beginning to wonder whether the completely free movement of trade and capital is a

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workable proposition within the Eurozone in its present structure (which is why I recently

gave up hope that the Eurozone could survive in its present structure).

The opposite to free movement of trade and capital is not necessarily the control of trade and

capital. I, for one, believe that the Eurozone, in its present structure, needs a managed flow

of trade and capital whereby the management takes the form of incentives. I rememberreading, back in my College days, about the concept of infant industry protection. The idea

is that one cannot expose an economy to world-wide competition if that economy is not yet

ready to compete. In the case of Greece, I am not even sure that a return to the Drachma

would change all that much in the shorter term. Ok, Greece would immediately become a lot

cheaper (more competitive) in foreign currency terms. But being cheap alone doesnt

automatically build up a productive capacity. That requires a long term economic

development plan.

I dont see the operational challenge of a Grexit as unsurmountable at all. If handled well, a

one-week bank holiday (at the most) should suffice for that. But I dontbelieve that, in a

redesign scenario, it is the weaker countries which should leave the Euro. It would be ofgreater benefit to the weaker countries if the stronger ones (Germany & Co.; i. e. the North)

left the Eurozone. That would leave the South with a cheaper currency relative to the North.

The South would become more competitive pricewise and its Euro-denominated debt would

devalue relative to a Northern currency.

That, however, is guessing. What is not guessing is the realization that the free flow of trade

and capital, combined with a common currency, has deprived a country like Greece of its

productive capabilities and until that issue is properly addressed, the losers of the Euro-

structure can have little hope to ever utilize their economic potential.