Introduction:

If a nation runs a current account deficit which is smaller than the government deficit, then the domestic private sector (households plus firms) will have a surplus. If the external imbalance remains unchanged and the budget deficit is reduced, then the private sector’s surplus must decrease (or even become negative). To give an example, if the current account deficit is close to 11 per cent of GDP (as in the case of Greece 2009) and the budget deficit is 15.5 per cent, then the domestic private sector's surplus is 4.5 per cent of GDP. If the budget deficit is reduced to 10 per cent and the current account remains nearly unchanged, then the private sector, too, has to run a deficit instead of a surplus. This is a truism. Without saying anything about the endogenous dynamics, as a result it is always true. It is the way the economy is organized under modern conditions.

It is important to keep this truism in mind if we consider that one of the consequences of the recent financial and economic crisis has been that, starting in 2008, the public deficits in nearly all the countries of the industrialized world have increased dramatically. The rescue of the financial institutions after the breakdown of Lehman Brother has augmented sovereign debt up to a level where governments themselves depend on the financial markets’ willingness to give new credits and rollover the existing debt. Paradoxically enough the rescue of the financial system has not strengthened the position of democracy vis-à-vis the banking and financial institutions, but exactly the other way round: The parliaments are taken hostage and the financial markets seem to be in a stronger position than ever before. The above truism reminds us that the reduction of the sovereign deficit is not an isolated procedure, but it has enormous consequences for the economy as a whole, especially in countries with current account deficits. Since the outbreak of the crisis the pressure which the financial markets impose upon the national parliaments has increased enormously, especially in the countries of the European Monetary Union (EMU) with a current account deficit. Since spring 2010, when Greece had to ask for support by other EMU member countries, it is supposed that the austerity measures are accepted by the parliaments without resistance. As a consequence, governments which were considered to be too weak to implement the expectations of the markets – up to now Greece and Italy – have been replaced by 'technocratic' governments. At the same time democratic policy space has been restricted by the rules of a bizarre 'fiscal stability union' which the European Council put forward under the threat of increasing spreads. The paradox is that this strategy denies the most basic economic insights. It does not take into account a) that not only the world, but the European Union, too, is a rather closed economy, b) that a reduction of sovereign deficits, if it is not accompanied by a parallel reduction of external imbalances, goes necessarily at the expense of the private sector, and c) that the reduction of external deficits in one country requires a reduction of surpluses in other countries. How is it possible that the political leaders of Europe (and even some of their advisers) disregard the simplest economic facts? How is it possible that they oppose all proposals which are grounded on a sound analysis of the shortcomings of the architecture of the EMU? What pushes them to put the stability of the entire union at risk? In order to answer these questions we have to understand that the euro crisis today is not only – and not in the first hand – an economic crisis. This does not mean that misleading economic ideas about money, central banks, the role of fiscal policy etc. are not part of the story. But there is more than that. Politicians do not think and act primarily in terms of economic schools or theories. The thesis which I want to elaborate in this chapter is that the relation between the political and the economic sphere is a crucial dimension. In order to focus on this relationship I have chosen not to follow a purely theoretical, but a historical approach in the tradition of Karl Polanyi which is quite compatible to Keynes’ line of reasoning. A ‘Polanyian’ approach has the advantage that it allows one to take into consideration the historical background in which the imbalances developed.