The mercantilist model, competition between States and financial deficit

In accordance with the mercantilist model, competitiveness in international trade, aimed at achieving a surplus in the balance of payments, is to be pursued, with other conditions being equal, also by reducing wages. As well known, and proven, this model has generated severe trade imbalances, giving rise to a truly disruptive competition, within the European Union itself, strengthening Northern– central European countries and businesses, first of all Germany, and weakening Southern European countries and businesses, – as happened in Greece.

The implementation of austerity measures, in such weaker countries seems to be more functional to the recovery of the accounts receivable of exporting countries than to a true intention to support their actual social and economic development. Therefore, rather than a monetary tool for cooperation and development, the Euro seems an opportunity to be seized – an example is the competitive devaluation that the Deutsche Mark obtained subsequent to the Euro implementation – in order to achieve trade surplus within Europe, funding and liquidity for the Country's banking system[1] (through collections relating to trade transactions made by businesses) to be used, again within Europe, in favour of the banks of importing Countries, to foster their own exports to the latter Countries.

Today, the four fundamental freedoms provided for by the EU Law themselves, namely freedom of movement for people, goods, services and, most of all, capital, seem to have been very functional to competitive logics of a neoliberalism-based type, thus betraying the cooperation and solidarity between the EU Member States as, at least in theory, the Founding Fathers hoped for[2].

It is worth to briefly point out that the mercantilist model has the following features: 1) the State's active role for effective management of the country's economic affairs; 2) an essential function assigned to money for the country's wealth; 3) the achievement of trade surplus generated by exports that are higher than imports, thus resulting in the accumulation of financial reserves; 4) importing/use of generally low-cost raw materials and inputs (including labour), in order to increase the economic output.

Specifically, the different competitive strategies of foreign trade policies as implemented by the different EU Member States have caused severe monetary imbalances[3] between them, generating reciprocal financial deficit and surplus, resulting from intra-EU import and export transactions.

The deficit referred to herein is not yet the government budget deficit but the country's financial system deficit. Indeed, with a given money supply, imports cause a demand for credit by enterprises to the banking system, which, in its turn, because of the subsequent lower funding, has to increase its debt to foreign banking systems (especially to those that achieved financial surplus because of exports, to be used for lending that, where possible, would generate more exports, thus creating a “virtuous” circle for the exporting Country and a “vicious” one for the importing Country)[4].

These deficits in cash flows, in a sort of cascade reaction, have generated effects on single enterprises, on banks and on public financial resources. Positive effects for exporting countries and negative effects for importing countries[5].

Private debt (resulting from imports by enterprises and then transferred to the domestic banking system that has granted loans) becomes public debt when domestic banks become insolvent towards foreign banks of strong Countries, because of their poor liquidity resulting from a constant decrease in funding that becomes chronic in the countries that, once having made imports, cannot activate sufficient productive economic circuits that are fit to restore the absorbed resources. As it can be imagined, the insolvency of domestic banks causes serious problems, both inside and outside the Country. Therefore, in order to prevent the collapse of its economic circuit, the State engages in bailouts, thus increasing its own debt.[6]

Today, since the Euro area Member States have lost direct control over monetary power, their only way out is to increase their government debts, (however this comes at high interest rates due to the low attractiveness of their government securities – which, in its turn, is due to high country risk of the States experiencing more difficulties – with certain further loss of control over their government debt and certain exposure to sudden speculative attacks launched by large players in a deregulated market)[7], thus ending up in need of extraordinary financing measures to be implemented by international financial institutions (the IMF, the European Stability Mechanism (ESM), etc.) and having to a

ccept, in return for bailouts, demanding conditions for the restructuring of the state financial position, in the first place aimed at creating resources to be used to repay debts.

The price to be paid for such  austerity measures consists in cuts to some important social expenditure items such as healthcare, education, pensions, etc., which, today, are considered a “burden” for the economy[8]. The other solutions implemented in these scenarios typically concern the disposal or sale of State assets (including companies, through wide-range privatization plans).

These measures are implemented in order to “raise cash” and in accordance with the principle that a business-like and private-law-based management of assets and enterprises, constantly controlling expenses, would amount to an improvement for society. Yet, the outcome that can be seen today, quite a few years since the starting of liberalization and privation measures, seems to be quite in the opposite direction, with loss of jobs and increases in tariffs.[9]

Going back to the financial trends that result from relations between States and from the relevant role of the European financial institutions, perhaps it is worth mentioning the useless dispute, which was started in 2011 especially by some German economists and which seems to have caught both politicians and academics quite unprepared (which probably cannot be said for experts– sometimes fully-fledged technocrats – who are the only ones having a in depth knowledge of the operation mechanisms and, especially of the effects, of cross-border interbank payment systems).

In short, the European cross-border interbank payment system (for credit transfers resulting also from import/export transactions) called Target2, creates reciprocal debt (importing country) and credit (exporting country) relations of the respective central banks with the ECB that, in this case, operates as a clearing house. At the end, this complex mechanism results in an available amount of money on the exporter's c/a, with the available funds on the importer's c/a decreasing by the same amount.

From a strictly accounting standpoint, it is obvious that, based on this mechanism (Target2), it can be inferred that structurally-exporting countries achieve surplus with the “ECB clearing house” and, conversely, importing countries have deficits with the “ECB clearing house”.

This accounting consideration served as a basis for the above-mentioned economists to conclude that exporting countries would have accrued receivables from the European payment system amounting to their structural surplus.

This is a misunderstanding: actually, the central bank of the importing country destroys monetary base (with respect to the importer), whereas the central bank of the exporting country creates it (with respect to the exporter). If the ECB is the clearing house, the items recognized by the central banks are no more than clearing items that are to be offset. Indeed, it is to be pointed out that the Euro expresses a monetary union: even though retaining a very limited independence, a formal rather than a real one, in a number of aspects, including for interbank payments, the single central banks must be considered as part of the ECB.

The German academics' line of argument leads to a duplication of debt or credit, which, as demonstrated in this paper, is in its own able to transfer from the private scope to the public one, through the cascade effects that are typical of the bank debt circuit, because of pathological structural surplus or deficit[10] in the balance of trade. At the most, Target2 balances have the function of economic indicators.

The described scenario shows that (starting from financial and trade deregulation, financial and government debt crises are triggered)and prompts to wonder what role (active or passive) central banks must have today (vs. yesterday), as true reference institutions, in the economic and monetary field.


[1] The concept of “country system” used in this work is intended to summarize the clear alignment of industrial, labour, fiscal, financial, currency and other policies, all aimed at one or more objectives and, thus, featuring a high degree of planned interdependence.

[2] It is worth noting that the general prohibition of State aid, which EU treaties have set down to ensure equality of treatment in the EU territory of economic players, especially enterprises, and the authorization issued by the European Commission to depart from such prohibition, today seem to be a control tool given to strong Countries (and enterprises) – tendentially exporting ones – to the disadvantage of weak Countries (and enterprises) – tendentially importing ones. This is an ex post facto consideration that, obviously, does not pay homage to the probably genuine intentions on which the implementation of such control mechanism was based.

[3] It is obvious that liquidity (financial resources) are transferred from the importing country system to the exporting country system.

[4] The commercial strategies implemented by multinational or transnational enterprises do not usually follow the above logics, since, given their huge sizes and their subsequent contractual power, these enterprises do not fall within the jurisdiction orbit of the countries of original incorporation (for instance FIAT, now FCA, transferred its headquarters from Turin to the Netherlands and to the UK) to take advantage of those countries' legislations that are deemed more advantageous. Advantages mainly refer to tax legislation (but not limited to) – with scenarios of true tax competition between States that lower their tax rates – the so-called flat tax – in order, in the first place, to attract foreign capital. It is clear that, in practice, the choice to base a transnational enterprise in a given place rather than in another is affected also by other considerations, such as the cost of labour, the applicable environmental legislation (stricter or less strict), existing infrastructures, political stability, etc. Conversely, completely (or nearly so) irrespective of these variables are the choices of places where to base dummy corporations that, sometimes as a matter of a few mouse clicks only, are based in the so-called tax havens. It is easy to imagine that, in terms of geographical location and financial bodies used, also the management of financial resources by large transnational enterprises is likely to follow specific tax advantage and financial security criteria, also by basing in countries whose relevant legislations are fit to pursue the above objectives.

[5] For the sake of completeness, it is to be pointed out that the achievement of trade surplus is not in itself sufficient to generate structural financial surplus for the exporting country, since the liberalization of capital movements could foster the exit of the achieved trade gains from the State, especially when, for various reasons, the State's economic system is deemed unreliable by large economic players (in this regard, see the considerations made in Note No. 24 above).

[6] As today applied by Germany (mainly towards the other European countries) and by China (towards the world economy in its entirety), the mercantilist model leads the countries that effectively implement it to achieve financial surplus that can be used to provide loans mainly to importing countries. A good example of this is China, who holds a material portion of the USA government debt. It goes without saying that the “opinion” of the creditor State has a considerable weight on any restructuring decisions that the debtor State has to make. States having a trade surplus tend to implement restrictive domestic lending policies in order to control some variables (low inflation rate) that are essential for the mercantilist approach itself (which is based also, as stated above, on cost competitiveness).

The relations between the various Euro Area Member States often seem based on "non-aggression" tacit agreements, in order to prevent EU penalties from applying, afterwards, in case of non-compliance with, for instance, the limits recently set by the Fiscal Compact. A paradigmatic example that can be made in this regard is the repeated non-compliance by Germany with the set limit to trade surplus, which, in accordance with the EU legislation (the so-called Sixpack) shall not exceed, every year, a limit equal to 6% of the GDP (for the obvious purpose to prevent excessive financial deficit for importing countries, as explained above). In this case, rather than applying the set penalties, the European Commission issued a simple recommendation, with the tacit consent exactly of those (weak) countries hoping, as said above, that any future non-compliance by themselves with the budget deficit limits (deficit/GDP and debt/GDP ratios) would be met with the same soft treatment. It is clear that, in order to prevent any export surplus, Germany should have increased (or will have to increase) its domestic demand by implementing inflationary expansionary policies, which is in contrast with the adopted mercantilist model.

To complete this line of argument, it must be pointed out that a fair outcome might be seen in having the debt portion generated by such illegitimate export excess weighing on exporting countries, rather than importing ones, because exporting countries themselves have caused such debt to be generated by repeatedly, rather than occasionally, violating the EU regulations.

[7] The crisis resulting from the yield spreads of Government bonds issued by Southern European countries vs. the German Bund yield, which, once again, is the benchmark, is the result of the above-reported dynamics. The recent QE measures implemented by the ECB have included the purchase, even though on the secondary market, of Government securities, thus allowing the single States to lower the rates paid on issues. The effect has been a decrease (at least temporary) in the yield spreads of the various European Government securities vs. the German Bund.

[8] The State's ultimate purpose is thus betrayed and the State slowly and progressively stops being social and becomes, once again slowly and progressively, nearly a “large company” itself, where productivity is the main guiding principle in making decisions that impact on the community.

[9] Analyzing these scenarios it is difficult not to detect a trend that, for simplicity's sake, can, once again, be defined as “neoliberalistic”.

[10] A structural deficit in the balance of trade might not be pathological where the State, thanks to an internal virtuous circuit, which is difficult to achieve, can produce new wealth to a sufficient extent so as to offset outgoing financial resources.