J-J ROSA's Blog

Euro-Crisis, Bargaining, and Unpredictability

2012-01-27T19:53:00.001+01:00

A good post in The Monkey Cage by political scientist Henry Farrel who compares the Cuban crisis competition in risk taking and the current euro crisis with the help of Nobel Prize winner Thomas Schelling’s analysis.

The risk of one actor going too far in the current game of chicken and thus precipitating breakdown by accident “is all the higher given the importance of market reactions in determining success or failure, and the inability to predict with even the faintest degree of confidence how markets might react to this or that move (it is clear from previous iterations of this game that the key political actors’ ability to model market reactions to their proposals is … limited).”

I came to a similar conclusion by a different reasoning in my book on the topic: there are so many different combinations of national strategies, and conflicting interests, in this oligopolistic game that predictability of the issue is nil. The only conclusion that seems to me reasonably likely is that the outcome will not be consensual. It will be arrived at by acute confrontation and partial or total breakdown, not by a new unanimous agreement.

Read the whole post here.

Eurozone About to Unravel

2012-01-17T16:51:00.000+01:00

"Is Europe About to Unravel?" asks Tim Duy here.
Excerpt:
“Even the illusion of political unity in Europe appears to be dissolving before our eyes. This, of course, should come as no surprise to anyone watching the European crisis unfold. The key problem always was the internal imbalances, a problem for which European policymakers have never offered a credible solution. They simply don't have such a solution in the context of a system of fixed exchange rates. I believe that currency devaluation is the only option that will change relative competitiveness in any reasonable timeframe and restore internal balance. But that option is unavailable for Euro members.

Lacking currency devaluation as a tool to resolve imbalances, European policymakers turned to fiscal austerity. That plan has failed, pushing nation after nation into ever deepening recession. With Greece going on its fifth year of recession, I imagine by now that Portugal, Spain, and even Italy now see the writing on the wall for themselves. Sadly, however, the alternative is exiting the Euro, which almost certainly means financial chaos for the Continent as a whole.

The Eurozone is like a roach motel. You can get in, but you can't get out.

Still, peripheral nations can only accept so much pain before the costs of being in the Euro outweigh the costs of leaving. And Italy is now sending Berlin a clear warning that such an endgame is approaching.”

My comment:

Except for the “you can’t get out” false assertion, Duy’s is an accurate description of the “euro error”. I disagree also on the idea that devaluation is unavailable for Euro members. Depreciation of the euro would be a good first step, even though it does not solve the problem of cross national prices divergence within the zone. But the latter difficulty could indeed be solved more easily by exits from the zone once the value of the euro vis-à-vis the dollar and other currencies has been seriously curtailed, and only a marginal correction of intra european exchange rates remains to be done.

Hierarchical, or Managerial, Capitalism

2012-01-16T10:43:00.000+01:00

John Kay endorses in a Financial Times column ("Business leaders of today are not capitalists") an analysis of contemporary “capitalism” that I developed in “The Second Twentieth Century: Decline of Hierarchies and the Future of Nations” (Hoover Press, 2006) and extended in an article in the French review “Commentaire” (“La crise des capitalismes hiérarchiques”, Hiver 2006-2007).

While in XIXth century capitalism “the economic and political power of business leaders derived from their ownership of capital and the control that ownership gave them over the means of prouction and exchange”, “the business leaders of today are not capitalists in the sense in which Arkwright and Rockefeller were capitalists. Modern titans derive their authority and influence from their position in a hierarchy, not their ownership of capital. They have obtained these positions through their skills in organizational politics, in the traditional ways bishops and generals acquired positions in an ecclesiastical or military hierarchy”.

What Kay does not mention however is that they often got their position through progress in the political system, and thanks to the support of the state hierarchy.

This system is still capitalist in the sense that managers need the consent of shareholders, even if it is only formal. But it is more accurately described as “managerial” (the power is detained by salaried managers), hierarchical, and corporatist (there is a deep collusion between political managers and business managers).

What Kay does not mention either is that, as I explain in my analysis, the extent of hierarchies in society is governed by the abundance or scarcity of information. As explained by Ronald Coase a long time ago, productive hierarchies (business firms) exist in order to economize on information, relative to a decentralized mode of production operating through individual craftsmen intensively using market exchanges (in the polar case).

And market exchanges are much more intensive in information than hierarchies, thus an increase in available information (a decrease of its cost) leads to a shrinkage of hierarchies and a development of markets.

The result is that in a period like ours, at a time when there is an extraordinary abundance of cheap information (the IT revolution), hierarchies tend to shrink while markets expand.

And this is the source of the present crisis of hierarchical, or managerial, or corporatist capitalism, a regime inherited from the previous period of high production and scarce information, extending from the last quarter of the XIXth century (the second industrial revolution) to the last quarter of the XXth century. This was the apex of the hierarchical capitalism, an organizational regime that produced the Rockefellers but also the Lenins and other totalitarian dictators, while empires expanded as never before.

The current trend is one of complete reversal of these organizational structures. And the problem for managerial capitalisms (and their managers) is how to get out of the previous system, and reorganize production, both public and private, along more markedly markets lines. How to break up big structures to bolster productivity again.

To conclude, there is one last thing that Kay does not mention: it is my book, even though it has been translated into English! Come on John, be a little more generous next time …

S&P’s Diagnosis

2012-01-16T09:31:00.000+01:00

Here it is, in a nutshell, as summarized by The Economist:

“According to S&P, EU leaders have misdiagnosed the euro-zone crisis. They have focused too much on tackling the increase in governments’ budget deficits, which is only part of the problem. As a result, they did not pay enough attention to the deeper causes of the crisis: the divergence in competitiveness between the euro-zone’s core of strong economies and its struggling “periphery” as well as the huge cross-border debts that stem from this gap. Reforms based solely on fiscal austerity could easily become self-defeating, notes S&P.”

They are perfectly right of course, and of course also fiscal austerity has already proved to be self-defeating (in Greece for instance). But the reason for this misdiagnosis of European leaders is that the fundamental problems of the euro-zone so well described by the rating agency are inherent to the very existence of a single currency, forced upon very dissimilar economies.

The financial mechanism resulting from the euro is by nature destabilizing: a single interest rate boosts activity and bubbles in countries that have an above average inflation rate, while it further depresses activity in those that have an under average inflation rate (probably resulting from under average activity level). The divergence is built in and cumulative.

Moreover, a single interest rate and structurally fixed (or suppressed) exchange rates boost capital flows from higher income countries towards lower income economies, the “huge cross-border debts” problem signaled above.

Realizing that leads inevitably to a disturbing diagnosis: the source of the problem is the euro itself, and thus what is required is a policy of euro exit. The governments concerned are not ready yet, politically, to face such a reality. A deeper crisis is needed before they do.

Big Mac and Currencies

2012-01-12T21:39:00.000+01:00

The Economist’s “Big Mac Index” of currencies’ over or under valuations is back in this week’s “Daily chart” here.

The Swiss Franc is the most overvalued currency relative to the US dollar (by more than 60 %), beating Norway, Sweden and Brazil. The most undervalued national currencies are those of India (by 60 %), Ukraine, and of Hong Kong. China comes fifth.

But why, oh why, are the intra eurozone real exchange rates over or under valuations not published? Given the current debate on potential euro exits it would provide a measure of relative competitiveness that could be compared to the conventional user cost of labor data.

Fukuyama on European Identities

2012-01-11T13:18:00.000+01:00

An interesting analysis of diverse European experiences in The American Interest.

France is best and Britain worst … for once …

Read it here.

Argentina 2001 versus Europe 2011

2012-01-07T16:51:00.000+01:00

The Argentine economy actually recovered quickly from a massive sovereign debt default in December 2001. Why could not some European countries do the same now?

Read John B. Taylor’s (of "Taylor's Rule" fame) post here.

Evans-Pritchard on 2012

2012-01-03T11:43:00.000+01:00

A view of the world, and of Europe, that markedly differs from all the official babble. Not really optimistic, to say the least, but plausible! I am not, however, able to attribute any appropriate probability coefficient, and even less a probability distribution, to these anticipations …

Read the Telegraph article here.

Political Malaise in the West

2012-01-01T16:27:00.000+01:00

“The West in political crisis has echoes of 1930s” writes Stella Dawson for Reuters, here.

Excerpt:

“The global financial crisis that began four years ago has morphed into a political crisis for United States and Europe.

… The shifting international economic order toward developing countries is nothing new. But it has been happening at a faster pace than expected, accelerated by what analysts have begun describing as Western democracy in crisis.

They see a government credibility problem in the United States and European Union, stemming from a perception that the political elite is too closely tied to the financial elite in the West, and their collusion caused the financial chaos of 2007 and 2008 and its messy aftermath, leaving the average citizen burdened with higher public debt, higher taxes, unemployment and austerity programs.”

My comment:

Quite true. But the problem predates the 2000s. It comes, in my opinion, from the globalization process of the last few decades. Not that globalization per se is a bad thing. On the contrary, it helped develop trade and specialization, thus increasing productivity everywhere. And anyway it is an inevitable consequence of the greater ease of transportation and communication (the information revolution).

But the increased mobility of factors (labor and capital) tends to reduce the fiscal power of territorial states through an increased competition between national governments. Thus a structural cut in public spending, a “downsizing” of states, was required, on top of the general downsizing trend affecting all hierarchical organizations, including commercial firms (see my co-authored paper on “the shrinking hand” on my website, to be presented next week at the American Economic Association meetings in Chicago).

Faced with these growing constraints most western states tried to cut their expenditures but did not succeed, not trying hard enough given the demands of their various electoral clienteles confronted with several financial and economic shocks. That’s why most governments came to rely more and more on debt to replace tax finance.

This changing financial structure of governments has produced two effects: first, politicians have come to rely more on the finance business and banks, which are channeling funds from capital markets to the governments treasuries. Hence the increasing collusion between demanders (governments) and suppliers (banks) of funds. And second, the new “capital structure” of governments, with less taxes and more debt, gives more importance to capital markets (the so-called “bond vigilantes”) and less to voters and taxpayers, hence the regression of democracy.

He who pays the piper calls the tune.

What is needed now, and urgently, is an across the board decline in public spending and in taxes on labor to stimulate supply at the same time. But this requires first a return to growth and a reduction of the bloated public debts (a public deleveraging). That’s why monetary policy and exchange rates are so important at this point. One has to remember that the first countries to exit the gold standard and devalue their currencies in the 1930s were those that returned to growth earlier than the laggards. Many analysts decried the “currency wars” then, but they were in fact currencies in search of new equilibrium prices.

However, as shown by several studies, a currency depreciation requires a cut in public expenditures to produce its positive effects. And there are no serious structural programs of government reform capable of stimulating supply (rather than just contracting demand, which is self-defeating) in view on either side of the Atlantic (except maybe the payroll tax reduction in the US, but it is temporary).

Hence the low ratings of politicians in opinion polls and their generally low credibility. Let’s hope nevertheless for some realistic fundamental reform proposals – at last – in 2012. Just the reverse of the New Deal is needed: a fall in the “churning”, inefficient from a redistributive point of view, public spending that taxes middle class income in order to ... subsidize middle classes, and a major cut of the taxes on labor (in order to raise wages,) instead of an increase in transfers and taxes (that reduce earned real wages). Also required is a shrinking of administrative and political hierarchies instead of an expansion of already excessive administrative employment, in order to reduce the overhead cost of government … Let’s call this a “second new deal”.

Becker on Euro Crisis and Euro-Bonds

2011-12-22T17:40:00.001+01:00

Here.

Feldstein Now Endorses My Euro Policy Prescription

2011-12-20T08:21:00.000+01:00

In May this year I send a copy of my recent book “L’euro: comment s’en débarrasser” to Martin Feldstein, as soon as it was published. In it I showed how the “Eichengreen sophism”, the claim that it was impossible for a country to exit from the Euro system because it would lead to a major depreciation of the newly re-created national currency, and thus to a catastrophic increase of the burden of previously issued euro-denominated debts, could be bypassed.

A depreciation of the euro exchange rate to the dollar (or the yuan) preceding the re-creation of a national currency (a euro exit) would make a major depreciation of the new currency, a new Franc for instance, unnecessary. Accordingly, no increase in the Franc value of the euro denominated debts would be entailed by a euro exit, and the “Eichengreen burden” would vanish.

Now Martin Feldstein, who previously advocated a temporary sabbatical for Greece from the euro, in order for that country to regain some external competitiveness, only to return to the fold of the euro system later on, advocates another type of solution in an FT op-ed titled “A weak euro is the way forward” (December 19, 2011). Basically he reproduces the analysis that I develop in my book. Looking for “the action that can shrink the current deficits of Italy, Spain and France without austerity, internal devaluations, or German expansionary policies” he finds a solution “in a lower value of the euro leading to an improved trade balance with countries outside the eurozone”. “Declines of the euro’s trade-weignted value will cause the exports of all eurozone countries to rise and the imports from outside the region to decline.”

How far should such a decline proceed?

“It is not clear how much further the euro would have to fall to eliminate existing current account deficits but it might take a trade-weighted decline of 20 per cent or more. That could imply a euro-dollar exchange rate below its initial value of $1.18 per euro.”

In my book I explain that a return to that parity would be necessary and that a return to the 2001 value of $0.85 would be even better, considering that the annual average growth rate of the eurozone at that time was a solid 4 per cent.

Is that target unrealistic? I do not think so. The euro lost about 25 per cent of its value between 1999, when it was introduced, and its lower bound of 2001. What is required today, after its 12 per cent decline since the beginning of 2010, is a further decline from $1.30 to $1.00 for instance (a 23 per cent decline) or even better to $0.85 (a 34 per cent decline).

How to obtain such a decline of the euro? My argument is that beyond money creation by the ECB, which the German government opposes, the growing doubts about the euro’s future effectively work to weaken the European currency’s value. And the further the delay in finding a solution to the current crisis, the greater will be the fall in value of the euro. Feldstein also cryptically notes that: “the recent momentum alone might cause that to happen.”

In conclusion, it is a pleasure that such a distinguished colleague finally comes to the same analysis that I proposed a few months ago. Of course it would have been more rewarding had he quoted my work and recognized that I originally suggested such a solution. But I trust knowledgeable readers in the blogosphere to make the necessary attribution, even in the American-centered world of professional economists.

How Debt Is Impacting the Current Slow Recovery

2011-12-18T09:15:00.001+01:00

In the US that is, because Europe is still heading towards recession, and possibly depression, due to the euro problem.

Mike Konczal posts a very interesting interview of Amir Sufi (University of Chicago Booth School of Business) in his “Rortybomb” blog. As he notes, Amir Sufi and Atif Mian (University of California at Berkeley) are doing the most interesting and important empirical work on what is going on with this Great Recession, or in other terms this great “balance sheet recession”.

They point, specifically, to the problem of the household balance sheet and how debt-to-income and leverage are linked to sluggish growth and employment. While in the aggregate leverage problems do not appear important, because for a borrower there is somewhere else in the economy a creditor, they consider that the borrowers’ situation is really critical because a massive shock can curtail their ability to borrow, and then they are forced either to default or massively pay back their debt burdens, so that, their wealth also curtailed, they have to cut drastically their consumption level. On the other hand the savers do not massively increase their consumption, despite the interest rate collapses, because of the zero lower bound on interest rates. In order to get the savers consume more, you need the interest rate to get really negative (which normally stimulates consumption), but it can’t get negative because of the zero-lower bound on nominal interest rate.

“The normal way you try to get real interest rates negative is through expected inflation, but the only way you can get expected inflation is if you force the current price level down, which is deflation. But the debt burdens are written in nominal terms. If you push the price level down, you get this vicious cycle where the borrowers cut their consumption even more.” This is the Fisher debt-deflation stuff.

To get out of it the only solution is not fiscal stimulus (pace Paul Krugman) but it is “writing down the debts of borrowers. That’s the number one policy that fixes the problem.”

European governments, and especially the German one, should think that over, I presume.

The whole post is well worth reading, here.

A Japanese Style Europe

2011-12-10T21:19:00.000+01:00

That’s the future awaiting the Eurozone according to Tim Duy. Excerpts:

“in short, I think Europe is rushing full speed to a Japanese outcome, with slow growth coupled with an appreciating currency. And ... that promise of slow growth and a strong currency will be what eventually tears the Eurozone apart.”

“When all is said and done, I am still amazed that the outcome of this summit is being described as a move toward fiscal union. It is not that – it is commitment to unified fiscal austerity, nothing more.

… In other words, the public sector will be engaging in massive procyclical fiscal policy as the recession intensifies. You have to imagine the end result is a substantial deflationary environment.

… that is truly sad given that deficits are not really the problem to begin with.

Why will the Eurozone fail? Because we still see nothing that addresses the internal imbalances between the core (largely Germany), and the periphery. That is a result of failing to commit to a real fiscal union. Such a union would include automatic internal fiscal transfers that are essential to maintaining regional economic stability. For example, economic distress in a US state results in an automatic relative transfer of resources via the decreased tax revenue from and increased transfer payments to that state. Lacking such a mechanism, a slow growth, hard money regime will increasingly ratchet up the levels of economic distress in the periphery. And eventually the costs of staying in the Euro will exceed the costs of exit.”

Precisely, as readers of this blog and of "Euro Error" (L'erreur européenne, 1998) already know quite well. The post is here.

Euro Crisis: From Bad To Worse

2011-12-09T13:57:00.000+01:00

The euro had already suppressed the national monetary exchange rate policy shock absorbers. Now today’s deal between European governments is intended to suppress the national budgetary policy shock absorber, essentially leaving each member country without any means for dampening asymmetrical shocks, at a time when the ECB is pursuing a non accommodating monetary policy for the whole zone.

Meanwhile, the disequilibrium real exchange rates between national economies that are at the origin of the problem still prevail and still diverge. Neglecting to address the fundamental problem of exchange rates and removing all the shock absorbers one after the other is a sure recipe for more difficulties to come on the way leading to depression.

The logical conclusion is that the coming eurozone recession will be deepening, aggravating budget deficits, and thus the euro crisis.

Call that progress if you want …

Austerität vs. Souverainisme

2011-12-05T18:28:00.002+01:00

According to Wolfgang Münchau (FT December 4) Angela Merkel and Nicolas Sarkozy are as far apart as they ever were.

Excerpts:

“Contrary to what is being reported, Ms. Merkel is not proposing a fiscal union. She is proposing and austerity club, a stability pact on steroids. The goal is to enforce life-long austerity, with balanced budget rules enshrined in every national constitution. She also proposes automatic sanctions with a judicially administered regime of compliance.”

“Mr. Sarkozy … while rejecting Ms Merkel obsession with austerity, … is not interested in a genuine fiscal union either. He is open to a eurozone bond and to the European Central Bank having the role of lender-of-last resort. I would surmise that this is because France would stand to benefit from both.”

While European leaders “understand the technical and legal issues well … I doubt they have ever understood the economic and financial dynamics behind the crisis. Their narrative, which reduces the crisis to a failure of fiscal discipline, is probably the reason why all their crisis resolution efforts have failed so far.”

My comment:

The point is well taken. But I suspect that the French and German governments stick to the “failure of fiscal discipline” theory because (a) the fundamental interests of France and Germany are conflicting, and (b) because, contrary to what Münchau believes, a correct diagnosis of the cause of the current euro crisis would point to the fundamental responsibility of the euro system itself: a non OCA (non Optimal currency area) which is also a non “ Optimal State area”, thus precluding any serious move towards a federal state, American way.

In my view, Ms. Merkel and Mr. Sarkozy are jockeying for position to avoid bearing the responsibility of a euro break up and try to gain some more time to persuade their public opinions that they did try everything to “save” the euro, so that when it finally breaks up none of them will have to take the blame.

Germany as a Geo-economic Power

2011-12-03T19:23:00.000+01:00

In the current crisis, German elites are doggedly pursuing a policy of “civilian power” (Zivilmacht) increasingly perceived in Europe as the continuation of Realpolitk by other means, writes Tony Corn in Small Wars Journal. Are we heading towards a “gentler, kinder German Reich”, but a Reich nevertheless?

“Demographically and economically, Germany is one third larger than either Britain or France. In the past ten years, this predominance has already been reflected in EU institutions, both quantitatively (Germany has the largest representation in the EU parliament) and qualitatively (the European Central Bank is a clone of the Bundesbank). But that’s apparently not good enough for Berlin, who has deliberately let the crisis move from the periphery (Greece and Portugal) to the center (Italy and France) in order to extract the maximum of concessions from the rest of Europe.”

Moreover, “Germany in the past decade has overtaken Britain and France as Europe’s main arms exporter” and is now “responsible for 47 percent of EU exports to China.”

“Germany is not only increasingly defining its national interest in economic terms, but also increasingly using its economic power to impose its own preferences on others in the context of a perceived zero-sum competition within the eurozone, rather than to promote greater cooperation in a perceived win-win situation.”

“German companies lobby the German government to make policy that promotes their interests; they in turn help politicians to maximize growth and in particular employment levels the key measure of success in German politics … Because much of this (German) growth has come from exports to economies such as China and Russia, where the state dominates business, (German) exporters are also conversely dependent on the German government.”

It is a typical mercantilist, Listian (from Friedrich List), policy.

“From 1871 to 1914, it is through civilian means … (mainly the 1879 alliance with Austria-Hungary) that the newly-created German empire proceeded to create in central Europe a greater informal empire known as Mitteleuropa. Even during the Great War, Germany’s main war aim was essentially to create a Europe-wide Customs Union (with a few annexations here and there). … And from 1940 to 1945, the uncomfortable truth is that Nazi Germany created a “Central European Economic Community” which, in many ways, anticipated the “European Economic Community” created by the treaty of Rome (1957).”

In short, common markets have been consistently used by Germany as an instrument of “soft”, “civil” power and dominance. And on top of the common market, since 1999, the strong euro managed by the ECB in the tradition of the Deutsche Mark has been instrumental in reinforcing the German economy while at the same time strangling the southern European and French ones. A shrewd strategic move.

The whole post here is serious food for thought.

Evans-Pritchard Is Right: Eurozone Monetary Expansion Is Required

2011-12-02T20:10:00.000+01:00

The eurozone badly needs monetary expansion and some inflation, that is, a depreciation of the euro as I advocated in my recent book. It is the first step to get out of the crisis.

Evans-Pritchard writes in The Telegraph:

“A near universal view has emerged that Europe’s crisis can only be solved by governments and fiscal policy, with varying views over the proper dosage of pain.

I beg to differ. This is a monetary crisis, caused by a jejune central bank that aborted a fragile recovery by raising rates earlier this year, allowed the money supply to collapse at vertiginous rates in southern Europe, and caused a completely unnecessary recession – and a deep one judging by the collapse in the PMI new manufacturing orders in November.

Needless to say, drastic fiscal austerity is making matters a lot worse. You cannot push two-thirds of the eurozone into synchronized fiscal and monetary contraction without consequences.

Note that five-years break-even spreads have dropped below zero for Italy, meaning that markets are now pricing in outright deflation. For a country with public debt stock of 120pc of GDP, that is a death sentence.

…

The eurozone economy is in imminent danger of crashing into deflation, bringing down the whole interlocking edifice of sovereign debt and distressed lenders.

…

This crisis can be stopped very easily by monetary policy, working through the old-fashion Fisher-Hawtrey-Friedman method of open-market operations to expand the quantity of money, ideally to keep nominal GDP growth on an even keel.

This does not solve the 30pc intra-EMU currency misalignment between North and South, of course, but it quite literally “solves” the solvency crisis for Italy and Spain. They would not be insolvent if the ECB had not driven them into depression by letting their money supply implode.

…

The bank can reflate Club Med off the reefs. It chooses not to act for political reasons because this means higher inflation for Germany. That is the dirty secret. Everybody must be crucified to keep German internal inflation under 2pc.”

The whole article here is a must read.

My comment: the lack of decision of the governments in the eurozone is not happenstance: it reflects this basic conflict of national objectives and requirements. It shows very clearly that one size fits none, and that the continental centralization of macroeconomic policy is terribly dangerous. That is, unworkable.

Crazy Ideas and Vested Interests

2011-12-02T13:27:00.000+01:00

Simon Johnson criticizes the notion that the European Central Bank could make a massive loan to the International Monetary Fund, which would then turn around and lend to countries like Italy. “This is a bizarre notion” he writes.

Instead, “the ECB should provide financial support directly to Italy, if that is the goal.

But that goal increasingly seems both to be the only idea of officials and the last failed notion of a fading era. More bailouts and the reinforcement of moral hazard – protecting bankers and other creditors against the downside of their mistakes – is the last thing that the world’s financial system needs.”

The whole post (about Too Big to Fail banks ad how to cope with them) is well worth reading, here.

Euro and the Confidence Fairy

2011-12-02T09:49:00.000+01:00

By Paul Krugman.

Excerpt:

“The idea that austerity measures could trigger stagnation is incorrect,” declared Jean-Claude Trichet, then the president of the European Central Bank. Why? Because “confidence-inspiring policies will foster ad not hamper economic recovery.”

But the confidence fairy was a no-show …

Read the post here.

Various Opinions About the Euro’s Future

2011-12-02T09:38:00.000+01:00

"A Freakonomics Quorum", here.

A mixed bag, of course.

More Plans to Save the Euro

2011-12-02T09:18:00.000+01:00

Is the “Great Dither” over? Can political centralization really proceed? here is Edward Harrison’s analysis for Credit Writedowns.

I am still skeptical. It seems more likely that some more time will be bought, and temporary hopes stimulated, until the next “last chance to save the euro”. The reason for being so wary of official discourse? It has been consistently false, and often deliberately so, over the past twenty years ... Remember the claims according to which the strong euro was good for growth and employment, that it would compel national inflation rates to converge, that it would protect national economies from economic and financial crises?

The Religion of an Increasingly Godless America

2011-11-25T10:26:00.000+01:00

An interesting post by Amanda Marcotte for Reuters.

Excerpts:

“Listening to the national discourse, one could be forgiven to imagining that America is becoming an ever more religious place. The amount of God talk in the public square has dramatically increased in a generation. Prior to the 70s, the concept of “the religious right” had barely existed, but now it’s a powerful lobbying force with multiple groups from Focus on the Family to Concerned Women for America, all sitting on more money than most liberal special interest groups could ever hope to accumulate.”

But:

“If you poll actual Americans, you’ll find that the trend is not towards more religiosity, but towards less. Much less, in fact.”

How come?

“The heightened emphasis on religion in politics is the death throes of the old order. … It’s only when (Christian) started to feel their power threatened (that) they become defensive, and in doing so, became much louder.” And the Americans are becoming more fond of the separation of church and state.

The Coming Euro Depreciation

2011-11-25T10:02:00.000+01:00

Simon Johnson agrees with the first step towards a solution of the euro problem that I suggested in my book, “L’euro: comment s’en débarrasser”. Namely, a substantial euro depreciation that would stimulate growth in the eurozone.

In his post for Project Syndicate on November 23, “Does Europe Have a Korean Option?” he writes:

“The obvious escape route leads through economic growth, which would reduce the debt-to-GDP ratio that make interest payments look reasonable. But the standard ways to stimulate the European economy are not available: fiscal policy is constrained by already-high debt levels; and the European Central Bank, fearing inflation, has kept a tight rein on monetary policy.

None of the other ideas on the European table, including various kinds of “structural reform,” will provide fast growth in the short term.

… A genuine devaluation, on the other hand, would work wonders for the real economy. The moribund Italian economy would spring to life if the euro fell by 30%, adjusted for inflation.”

Some observers wonder how the euro could be depreciated, given that it is a floating currency, the price of which is market determined. But Johnson explains the obvious:

“If the ECB agreed to loosen monetary policy or provide enough “liquidity” to support various bailouts, investors would fear inflation, weakening the euro. On the other hand, if the ECB preferred to let major countries, such as Italy, default on their debts, this would likely weaken the euro even further, as investors feared a contagion of defaults.

While depreciation would never be eurozone officials’ stated policy, it currently looks like all roads lead in that direction.”

There are major obstacles in the way of a conversion of the ECB to a loosening of its monetary policy: first the statutes of the institution that assign it only one aim, price stability. But also the German aversion to inflation, due not so much to a memory of the 1923 hyperinflation, but more to the re-export model of the German economy that rely on a strong currency and non increasing wages.

An increase of inflation would fuel wage increases in Germany and a depreciating euro would inflate the cost of buying intermediate industrial components from Central Europe and elsewhere, thus jeopardizing the competitiveness of German exports.

As a result it seems to me much more likely that the German government will stick with its “brinkmanship” policy leading to Greek and probably Italian governments defaults. Indeed, austerity programs (the shrinking of government spending), while necessary in the medium term, bring the southern economies closer to default.

As explained in The Economist article “Is this really the end?” (November 26), here:

“Add the ever greater fiscal austerity being imposed across Europe and a collapse in business and consumer confidence, and there is little doubt that the euro zone will see a deep recession in 2012 – with a fall in output of perhaps as much as 2%. That will lead to a vicious feedback loop in which recession widens budget deficits, swells government debts and feeds popular opposition to austerity and reform. Fear of the consequences will then drive investors even faster towards the exits.”

And it will lead to a major depreciation of the euro. It has started already with today’s temporary low point of 1,33 to the dollar, and one can only hope that it continues all the way to something like a 1 to 1 parity or even less.

This would alleviate the current pressure leading to a break up of the euro. But it is the only way out of the crisis and it would make the exit of individual countries from the eurozone much easier, avoiding the high cost of total collapse.

Germany’s Only Concern Is …

2011-11-23T18:49:00.000+01:00

... Germany! That’s what David Beckworth explains quite well today in a Seeking Alpha post. Meanwhile, the rest of the eurozone is marching to "Eurogeddon".

There are two possible explanations: either the German public does not fully appreciate the consequences for Germany itself of a severe recession or even an economic collapse in the rest of the zone, and believe they can rapidly force the other countries of the zone to become more “German-like”, or, in the case the eurozone breaks up, they expect to return happily to their “beloved Deutsche Mark with a relatively resilient German economy”.

My comment: Maybe the only solution for the coming crisis in a Europe completely lacking of any “affectio societatis” is to let Germany break free from the euro ….

Centralized and Undemocratic Europe

2011-11-20T15:00:00.000+01:00

Ross Douthat’s column on “Conspiracies, Coups and Currencies” in the New York Times is a must read: here.

What is now urgently required in Europe is a new polarization of political life: anti-federalist democrats versus centralizing technocrats. The main priority is to save the democracy, not the euro.

Euro: When Money Stops Flowing

2011-11-10T08:30:00.000+01:00

Felix Salmon (Reuters, Opinion) predicts a roller coaster coming in “The euro breakup thrill ride begins”.

He also quotes an unnamed EU diplomat that forecasts major political consequences: “This will redraw the map geopolitically and give rise to new tensions.”

Read the whole post here.

American and Chinese Realistic Views of Europe

2011-11-06T14:48:00.000+01:00

Jim O’Neill, the chairman of Goldman Sachs Asset Management, and Jin Liqun, the chairman of the supervisory board of China Investment Corporation, the country’s sovereign wealth fund, correctly diagnose, together, the two main weaknesses that plague the European economies.

O’Neill notes that members of the eurozone, in its present configuration, cannot hold together, and the more so if it were to put in place a single Treasury, as the French and German say they want to do. A eurozone finance ministry would induce Portugal, Ireland, Finland and Greece to pull out of the single currency. Anyway, only Germany, France and Benelux of the original joiners were the ones that were ideal for a monetary union (I personally doubt very much that this is true of France. But a “mark zone” makes sense, economically).

Jin Liqun on the other hand said, according to a Telegraph article , that:

“I think if you look at the troubles which happened in European countries, this is purely because of the accumulated troubles of their worn out welfare societies. … I think that the labour laws are outdated – the labour laws induce sloth, indolence rather than hard working. The incentive system is totally out of wack.”

Indeed, several American economists including Edward Prescott and Alberto Alesina have explained the rather low total hours of work of the European population compared to that of the US population as the result of higher and growing taxes on labour in European countries.

These are precisely the two causes of European low growth and unemployment that I diagnosed in my 1998 book “L’erreur européenne” (Euro Error, Algora, 1999) and in several subsequent papers.

But while the “euro error” is now widely recognized, even though its solution – euro exit – is still rejected by politicians and business leaders, the problem of the labour tax is not understood at all. In particular extremely few people seem to understand that the current extensive insurance coverage of health care, and the vertical redistribution of income by which high wages employees pay for a significant part of the health insurance of low wages ones, could be maintained but at a much lower labour tax level, thus encouraging more work and a higher income growth in most European countries.

This will be the next intellectual and political major debate following the structural redefinition or the collapse of the euro. The managers of big American and Chinese financial institutions seem to be more knowledgeable of these European realities than European politicians and business people.

Calomiris: Greece Should Leave the Euro

2011-11-04T15:15:00.000+01:00

Have a look at Bloomberg’s TV interview of Columbia University finance professor here.

Makes sense. Economists that do not depend for their career on European political authorities tend to agree ...

Kenneth Rogoff on the Surprising Strength of the Euro

2011-11-04T14:55:00.000+01:00

“Do the gnomes of currency markets seriously believe that the eurozone governments’ latest “comprehensive package” to save the euro will hold up for more than a few months?

The new plan relies on a questionable mix of dubious financial-engineering gimmicks and vague promises of modest Asian funding. Even the best part of the plan, the proposed (but not really agreed) 50% haircut for private-sector holders of Greek sovereign debt, is not sufficient to stabilize that country’s profound debt and growth problems.”

Read more of the Project Syndicate post here.

Greek Democracy

2011-11-02T07:51:00.000+01:00

Competitive politics, i.e. democracy, should bring out in the open available information. Here is a valuable contribution by Ambrose Evans-Pritchard (“Revenge of the Sovereign Nation” in The Telegraph), here

about the Europeans' so-called "rescue plans" supposedly meant to "save" Greece, but in reality pushing the Greek economy over the brink in order to try to save the euro.

Excerpts:

… “the Greeks are stripping away the self-serving claims of the creditor states that their “rescue” loan packages are to “save Greece”.

They are nothing of the sort. Greece has been subjected to the greatest fiscal squeeze ever attempted in a modern industrial state, without any offsetting monetary stimulus or devaluation.

The economy has so far collapsed by 14pc to 16pc since the peak – depending who you ask – and is spiralling downwards at a vertiginous pace.

The debt has exploded under the EU-IMF Troika programme. It is heading for 180pc of GDP by next year. Even under the haircut deal, Greek debt will be 120pc of GDP in 2020 after nine years of depression. That is not cure, it is a punitive sentence.

Every major claim by the inspectors at the outset of the Memorandum has turned out to be untrue. The facts are so far from the truth that it is hard to believe they ever thought it could work. The Greeks were made to suffer IMF austerity without the usual IMF cure. This was done for one purpose only, to buy time for banks and other Club Med states to beef up their defences.

It was not an unreasonable strategy (though a BIG LIE), and might not have failed entirely if the global economy recovered briskly this year and if the ECB had behaved with an ounce of common sense. Instead the ECB choose to tighten.

When the history books are written, I think scholarship will be very harsh on the handful of men running EMU monetary policy over the last three to four years. They are not as bad as the Chicago Fed of 1930 to 1932, but not much better.

So no, like the Spartans, Thebans, and Thespians at the Pass of Thermopylae, the Greeks were sacrificed to buy time for the alliance.

The referendum is a healthy reminder that Europe is a collection of sovereign democracies, tied by treaty law for certain arrangements. It is a union only in name.”

Excellent summary.

The Economics of Internal Devaluation

2011-10-28T22:03:00.000+02:00

Today’s post by Henry Kaspar for Kantoos Economics, here, is well worth reading.

Excerpt:

“Internal devaluation is tough. Assume Portugal is overvalued by 20 percent, and suppose it maintains its current speed of adjustment, i.e. – 0.9 percent per year. If unit labor costs for the average of the euro area continues to grow by just 0.8 percent annually, it will take 14 years until Portugal has restored a competitive position. Neither investors nor the Portuguese and wider European public will grant the process that much time.”

The punch line:

“there are few (if any) examples in history of heterogeneous countries that were able to tie their currencies together for long periods.”

Austerity + Fixed Exchange Rate = Policy Failure

2011-10-28T21:31:00.001+02:00

Read The Wilder View (Rebecca Wilder), here.

Mankiw on Four Typical Mistakes to Avoid

2011-10-27T10:03:00.000+02:00

Those of Zimbabwe, Japan, Greece and France. Here.

Krugman on the euro and rescue plans

2011-10-25T09:10:00.000+02:00

His recent post “The Hole in Europe’s Bucket” (Commentary, NYTimes) says it all.

Excerpts:

“Greece, where the crisis began, is no more than a grim sideshow. The clear and present danger comes instead from … Italy, the euro area’s third-largest economy. Investors, fearing a possible default, are demanding high interest rates on Italian debt. And these high interest rates, by raising the burden of debt service, make default more likely …

To save the euro, this threat must be contained. But … here’s the problem: All various proposals … ultimately required backing from major European governments, whose promises to investors must be credible for the plan to work. Yet Italy is one of those major governments; it can’t achieve a rescue by lending money to itself. And France, the euro area’s second-biggest economy, has been looking shaky lately …”

“What makes the story really painful is the fact that none of this had to happen … Britain, Japan and the United States … have large debts and deficits yet remain able to borrow at low interest rates. What’s their secret? The answer, in large part, is that they retain their own currencies, and investors know that in a pinch they could finance their deficits by printing more of those currencies. If the European Central Bank were to similarly stand behind European debts, the crisis would ease dramatically …

But such action, we keep being told, is off the table. The statutes … supposedly prohibit this kind of thing, although one suspects that clever lawyers could find a way to make it happen. The broader problem, however, is that the whole euro system was designed to fight the last economic war. It’s a Maginot Line built to prevent a replay of the 1970s, which is worse than useless when the real danger is a replay of the 1930s. …

The … European elite, in its arrogance, locked the Continent into a monetary system that recreated the rigidities of the gold standard, and – like the gold standard in the 1930s – has turned into a deadly trap.

Now maybe European leaders will come up with a truly credible rescue plan. I hope so, but I don’t expect it.

The bitter truth is that it’s looking more and more as if the euro system is doomed. And the even more bitter truth is that given the way that system has been performing, Europe might be better off if it collapses sooner rather than later.”

No further comment is necessary.

The Myth of Lazy Southern Europeans (Again)

2011-10-21T20:22:00.000+02:00

German officials shouldn’t be so patronizing with the “PIGS”. Read the post by Kash Mansori (The Street Light) here .

Why Britain is in Better Shape than Italy

2011-10-05T17:20:00.000+02:00

Here is Krugman on the advantages of having your own currency.

Meanwhile, the euro zone governments try to “save” the euro ...

Great Stagnation ... or Great Relocation?

2011-10-05T16:39:00.002+02:00

An interesting post in Noahpinion on why the center of gravity of economic activity and growth is shifting from the rich West, and especially the US, to emerging Asia.

While Tyler Cowen (Marginal Revolution) explains in his book The Great Stagnation that slowing income growth in the US is due to a slowing down of innovation and scientific discovery, Noah’s hypothesis is that growing income per capita in the East, multiplied by a very large population, makes for larger markets there that exert an irresistible pull on firms and economic activity away from the West. This is the “Great Relocation” thesis, and I find it rather persuasive.

Among the measures he suggests to reverse the trend I would support the idea of increasing the population through immigration and that of concluding free trade deals with other rich countries.

My criticism however is that much of Asia’s growth is simply due to the catching up of US income level phenomenon, and as such is a transitory phase that does not necessarily implies a fall in the American income per capita. That was already the case of Western Europe after the war, and then of Japan. And in these latter cases the catching up didn’t affect the leading position and continued progress of the US economy. This is not a zero sum game but a transition towards a new, higher income level, equilibrium for all. It only means that the acceleration of delocalization of low wages industries and firms create a need for new, high technology industries, that requires a high-quality economic environment, in the West.

So that, I would call the present transformation one of Great Reallocation (or Great Restructuration) rather than a Great Stagnation or a Great Relocation one. And in that perspective, the US entrepreneurs will find new products and processes to replace departed activities, sooner or later, but as in previous economic revolutions it is impossible for us to imagine them in advance. This is precisely the painstaking day-to-day job of innovators and entrepreneurs. It has been done several times in the past and it will happen again in the future.

Feldstein on the Coming Greek Default …

2011-09-28T13:17:00.000+02:00

… and France’s and Germany’s risky postponment gamble.

Excerpt:

“The markets are fully aware that Greece, being insolvent, will eventually default. That’s why the interest rate on Greek three-year government debt recently soared past 100% and the yield on ten-year bonds is 22%, implying that a € 100 principal payable in ten years is worth less than € 14 today.”

My comment: the best analysis of the current situation by the economist that clearly saw the future consequences of the euro as soon as projected, in 1992.

The complete post is well worth reading, here .

Greece on the Brink, Euro Should Fall Further

2011-09-24T14:22:00.000+02:00

Twenty-four centuries after History’s first sovereign default, that of ten Greek municipalities in the 4^th century BC (the creditor was the temple of Delos), the country is at the edge of a major default, five times the size of Argentina’s default in 2001.

The expected “haircut”, could be as severe as 80% of the debts’ amount. But it would still be manageable, as far as French and German banks, as well as the ECB, are concerned, because they are said to be able to weather this magnitude of losses, given the small absolute size of the Greek economy and thus of its debt, compared to the size of the whole European economy and of the banks themselves. Their shares have been savaged nonetheless, for fear of something worse. The real danger would come from investors’ reaction to a Greek default: many would be selling Italian and Spanish government bonds to avoid a similar amputation on their much larger holdings of these countries’ debt, thus making for a fall of bonds’ market values and a rise of interest rates, and further aggravating the state of these governments’ finances. Italian and Spanish haircuts would also inflict much larger losses on the European banks and that would jeopardize the financial system in Europe, and maybe elsewhere too.

Fearing this, European governments, under pressure from the US, appear now ready to issue more bonds (possibly Eurobonds, even though it is not significantly different from pure German bonds) in order to avoid Greece a default. And the ECB is ready to lend more money to the governments (a monetization of their debts).

The question is: while all this would be good for the banks, would it be good too for economic growth? Incurring more debts is not going to help European economies to deleverage, nor reduce the burden of their over-indebted governments. It would increase in fact the debt/GDP ratio. But monetization would help: is Mr. Trichet, finally, seeing the light and accepting a depreciation of the euro (which has already begun during the past week, the euro falling to less than 1,35 dollars)? There is still, however, a very long way to go to a value for the euro nearing equilibrium … (a one for one value to the dollar or even less in my opinion).

For Greece however, absent a very large depreciation of its currency, the drachma that is, after an exit from the euro zone, one cannot hope a return to positive growth even after default, but on the contrary a prolongation of the economic slump.

To conclude, remember that Japan tried the increased indebtedness policy strategy to get out of depression for a decade, thus avoiding the worse outcome, but accepted stagnation to this day. In a balance sheet recession, more debt is not the solution. A major realignment of exchange rates accompanied and caused by differential, and possibly massive, money creation is required. This is the common element between the 1930s required exit from the gold standard, and the present day required exit from the de facto Deutsche Mark standard. The later the exit, the later will be the return to growth.

Read a very interesting Bloomberg post covering the very wide range of possibilities here .

The Most Dangerous Decade

2011-09-19T18:12:00.000+02:00

A difficult transition awaits developed, corporatist capitalist economies: their problem is how to downsize both states and corporations to confront the competition of emerging economies in the new era of “small is efficient”.

Here is a lucid diagnosis posted in the CNBC’s blog:

“Robin Griffiths, technical strategist at Cazenove Capital, told CNBC that key markers, including the long-term low yields on U.S. Treasurys, indicate that the U.S. is in a depression not just a recession.

The bond market is clear and unequivocal in its message—this is a depression, not just a period of slower growth," he said, adding that a different approach was needed by developed economies to get out of the current mess.

History shows that what we need are small government, low taxes, and low regulation, but what we have is big government, big taxes, and big regulation, which is not going to work this time," Griffiths said.”

This is nothing less than a U-turn in economics conceptions and policies.

The European Debt Crisis

2011-09-18T10:29:00.000+02:00

An excellent post by Jeffry Frieden, Professor of International Peace at Harvard University, in Econbrowser, yesterday: “Europe’s Lehman Moment”.

Frieden explains that “Europe is in the midst of its variant of the great debt crisis that hit the United States in 2008. Fears abound that if things go wrong, the continent will face its own “Lehman moment” – a recurrence of the sheer panic that hit American and world markets after the collapse of Lehman Brothers in October 2008.”

Excerpts:

“most of the public discussions have been highly misleading. In Northern Europe, and especially in Germany, the tone has been one of outraged indignation. The high moral tone is misplaced. Certainly many Southern European banks and households, and the Greek government, borrowed irresponsibly; but German and other Northern European banks and investors lent just as irresponsibly. It’s not clear that there’s any real ethical distance between irresponsible borrowers and irresponsible lenders.

And most Northern Europeans also seem to believe that the bailouts have gone to lazy Southern Europeans. In fact, their purpose has been to shore up the fragile Northern European financial systems. German banks are among the weakest in Europe; some of them (especially the state-owned landesbanks) are effectively bankrupt. If they were forced to mark down their Southern European debt, they might well collapse in a heap, and the European financial system could grind to a halt.”

“In Europe as in America (in 2008, JJR), the real question is how the costs of this devastating debt crisis will be distributed. Who will pay – creditors or debtors? Taxpayers or government employees? German or Greeks? More realistically, what combination of sacrifices will be politically tenable, both across countries and within countries. The aftermath of every debt crisis sinks into conflict over who will bear the burden of adjustment to the new reality.”

Europe’s experience, however, differs from that of America’s because of the existence of the euro. While the United States went on a consumption spree financed by borrowing trillions of dollars from abroad, much of it going to the housing’s market, in Europe the ECB’s interest rates at “Northern” relatively low levels have been made available – due to the euro – to rapidly growing countries in Southern Europe that had previously had high interest rates, reflecting both their higher inflation rates and their past exchange rate risks.

It followed that for a decade, a group of countries on the edge of the Euro zone borrowed massively from Northern European banks and investors. In Spain, Portugal, and Ireland, most of the borrowed money flooded into the overheated housing market, while in Greece, it helped finance a continual budget deficit and a consumption boom.

This, I would add, even though Frieden does not mention the point, is a classical case of an artificially distorted price (here the “Northern euro interest rates” offered, due to the euro and the single monetary policy, to the more inflationary and more risky Southern borrowers that should have paid inflation and risk premiums) generating a massive misallocation of resources, and specifically a boom in borrowing that reached unsustainable levels. As in the U.S. case, the responsibility of the lenders is a major one: they made huge profits in providing excess finance to the South, just as the mortgage lenders in the U.S. were offered an excess supply incentive by the governmental regulations subsidizing housing finance.

Frieden rightly concludes that the very solvency of major European financial systems is at stake and that “this – not some abstract desire to extend a hand to the Greek and Portuguese people, or to save the euro – has been the principal reason for Europe’s ongoing debt bailout.”

But until now, these bailouts have not been enough:

“It seems clear that the Greek and Portuguese austerity measures will not be sufficient to allow the countries to service their debts; Spain seems on the verge of a similar slide into default; and even Italy is now at risk of going the way of the other debtors. Some or all of these debts will have to be restructured, the interest rates reduced and maturities extended. If not, there will be a wave of defaults whose reverberations will rival those of Lehman failure.”

What Frieden does not contemplate, however, is that the situation is made much worse by the existence of the euro, and the absence of a central government in Europe. The euro has destroyed, over a decade of existence, the competitiveness of the Southern economies that benefited mostly to German exports. It follows that the austerity policies intended to reduce the indebtedness of the South are applied to enfeebled economies, thus pushing them further towards contraction and default. Today, the U.S. economy is still paying the price of the credit bubble’s burst. But in Europe the price will be much higher if the Southern economies are not allowed to regain competitiveness through an exchange rate depreciation that would purge it from the large costs differentials relative to the rest of the world in general (due to euro overvaluation) an to the Northern ones within the euro zone, accumulated over a decade of euro membership. And that means both a euro depreciation, and, on top of it, specific national currency depreciations that imply a return to national currencies.

The euro zone is thus facing a worse challenge than the one to which the U.S. were confronted in the 2008 debt crisis, because not only the sharing of losses is at stake, but simultaneously a radical reform of the monetary constitution is required. While the U.S. economy if following a slow, uncertain path back to recovery four years after the crisis, the recession could be much worse and extend for a longer period in Europe because of the difficulty involved in accepting to acknowledge the reality of the euro’s failure, and of the responsibility of the single currency in the current crisis. What is required is nothing less than a reversal of the monetary empire-building of the last few decades. And I understand that this is a rather hard truth to swallow for the euro zone elites.

The whole post is well worth reading here .

Possible Outcomes for the Euro

2011-09-17T11:40:00.000+02:00

The Financial Times presents a very clear and pedagogical explanation of the consequences of a Greek default, leading to a possible euro exit and potential euro break up, here , including an interactive map describing the mechanism and the succession of events.

The emphasis is put on the “nightmare” that this scenario would represent for

Greek and other European citizens. As such, however, the presentation is unbalanced, first because it neglects to point the responsibility of the euro in leading our economies into this dead end, and second because the high cost of the alternative before us, i.e. higher taxes everywhere in Europe, leading to a deep depression and reduced levels of living for many years to come, is not mentioned at all.

As noted by Paul Krugman today in his blog, “The Conscience of a Liberal” (September 17):

“It’s astonishing how many European officials and unofficial wise men insist, with a great air of wisdom, that the euro crisis was caused by failure to enforce the stability pact — that is, limits on deficits and debt. How hard is it to look at the data and discover that Ireland and Spain appeared to be fiscal paragons on the eve of the crisis, with budget surpluses and low debt? Yet another triumph of the Very Serious narrative over easily checked facts.”

Indeed, the euro crisis is the result of a chronic overvaluation of the euro with respect to the inflation rates of several member countries, that destroyed their competitiveness and led to a negative cost of funds (the ECB borrowing rate minus the current inflation rate) in many countries, and, logically, to excess borrowing by the private sector and also by governments when the 2008-2009 crisis left them in need of a fiscal stabilization policy, absent any possibility of using the usual loosening of monetary and exchange rate policy to fight the downturn.

This is again the case today. The best policy would be one of substantial depreciation of the euro that appeared likely a few days ago, when its dollar value fell from 1,45 to 1,36, raising the hope that it would fall further to more reasonable values of about 1,1, or even better 0,9. But this was not to be and it returned towards 1,4 or 1,5.

The second shortcoming of the Financial Times article and of the governments’ official position is in the neglect of the consequences that “saving Greece and the euro” will exert on the economy. The defense of an overvalued euro will continue to depress the European economies (with the possible exception of Germany) while increasing taxes to subsidize Greece and other southern countries (by further transfers to their governments and banks), and simultaneously limiting money creation by the ECB, will make a deep recession more likely.

The real choice then is between disruption now (default and possibly early euro exit) and a durable depression and disruption tomorrow. Politicians having, like the rest of us, a preference for present wealth over future one, and thus for future losses over present ones, it is not difficult to forecast what alternative is most likely.

Given the recent policy choices of the largest governments within the zone, my guess is that they will try to consolidate the euro now by all means, “whatever the cost”, as they repeatedly pledged, that is, by increasing taxes at home and transfers to bankrupt governments, and dampening an already fledging growth to avoid the immediate turmoil and political costs of Greece’s and others’ bankruptcy. They again further the “kick the can” process for a few weeks or months, and by reducing temporarily the risk of an euro exit or break up in the near future they maintaining a high price of the single currency in the markets, and, in the process, lead their countries towards a depression in order to avoid the complete destruction of their political capital and the loss of the coming elections.

Trying to avoid economic turmoil and political losses they’ll get both economic depression and political turmoil.

Alesina and Giavazzi on How to Cut Deficits

2011-09-16T14:06:00.000+02:00

A good advice for deficit ridden governments.

Excerpt:

“The experience of Italy in the 1990s is consistent with three lessons that we have learned from examining examples of large fiscal consolidation in OECD countries with a government sector that accounts for well over 40% of GDP:

1. Only fiscal adjustments based on structural reductions in spending (as opposed to temporary cuts) can have a lasting effect on the debit-to-GDP ratio.

Tax-based adjustments simply keep filling the holes in the budget opened by automatic increases in spending.

2. Cuts to government spending have smaller recessionary effects than tax increases.

3. To the extent that spending cuts have a negative effect of output, this can be offset by enacting structural, growth-enhancing measures.”

My comment: I am not too sure about point 3, either about what they mean or if they are right in general.

Point 2 however is straightforward, but usually not understood by policymakers: since the welfare losses from taxes increase as the square of the marginal tax rate, reducing taxes in general exerts a powerful positive effect on production. The same for a tax cut that accompanies a spending cut, leaving the budget deficit unchanged. This is the expansionary effect of a balanced budget reduction (the inverse of the so-called “Haavelmo theorem” of the expansionary effect of a balanced budget increase, in an economy with much unemployed resources).

This effect should be especially strong in the European economies where overall tax rates are high (a discussion of which taxes should be reduced for maximum result is of course in order).

Accordingly, making one more step in the right direction, one should advise European governments not to try to reduce too hastily budget deficits (as Ms. Lagarde admonishes them) but to cut spending resolutely while cutting taxes even more, not less.

But maybe this is too complex for the limited economic understanding of politicians (and their advisers).

The Alesina and Giavazzi paper concerns Italy but the conclusions are also of value for other European economies. It is downloadable here .

Further reading: Alberto Alesina and Silivia Ardagna, “Large changes in fiscal policy: taxes versus spending”, revised October 2009, on Alesina’s Harvard website.

The Eurozone Double Dip is Almost Here

2011-09-09T14:17:00.000+02:00

That’s what Edouard Harrison* writes in Seeking Alpha.

Excerpt:

“The euro acts as a gold standard for individual euro zone members. As with the gold standard, euro zone members abdicated currency sovereignty in order to benefit from the price stability of the currency tie. Individual euro zone sovereign states are now currency users with limited policy space, meaning that a recession must be met with the deflationary response of pro-cyclical fiscal policy (budget cuts and tax increases).

Over the medium-term, this decreases demand and reduces economic growth. In a credit crisis, when private sector debt levels are high, debt deflationary forces of reduced output can lead to falling asset prices, debt distress, deflation and depression.

I see the procyclicality as one of the structural flaws of the euro zone; there is no federal agent to do counter procyclical budgeting during a recession. Thus, the euro zone business cycle will invariably be volatile, making current account imbalances a lightening rod for intra-European recrimination.

(…)

In the past few months, I have become negative on the euro zone’s chances of survival. I no longer believe the political imperatives for the euro zone will be enough to overcome the politics of this next downturn.”

* Edward Harrison is the founder of the blog Credit Writedowns (www.creditwritedowns.com) and is a finance specialist at Global Macro Advisors. Previously, Edward was a strategy and finance executive at Deutsche Bank, Bain, and Yahoo. He started his career as a diplomat and speaks German, Dutch, Swedish, Spanish and French. Edward holds an MBA from Columbia University and a BA in Economics from Dartmouth College.

My comment: Neat and concise summary.

A Simple Truth Beginning to Be Recognized

2011-09-09T08:44:00.000+02:00

By David Cottle on the Wall Street Journal’s blog “The Source”: “Leaving Euro Zone Isn’t Impossible”, here.

The author still exaggerates the difficulties of getting out, compared to those of staying in the zone. But most commentators now tend to get away from the Eichengreen’s fallacy that the participation in the eurozone is forever.

The End of Empire by Stealth

2011-09-08T07:53:00.000+02:00

A recent post by “Charlemagne” in The Economist (September 3^rd) describes “the end of Monnet”, the EU’s godfather.

“The French functionary believed in gradually unifying post-war Europe through discrete projects run by a caste of technocrats, with the end-point left deliberately ambiguous.” His method has gone far. Too far in fact.

By the time when the common market project – a classical free trade zone with obvious economic benefits for the protectionist and fragmented post-war European economies – was achieved, in the late 1980s, the caste of eurocrats led by the prototypical Jacques Delors launched a very different enterprise, that of a supranational public good, a single currency, meant to force a later political integration of several nation-states members of the European economic association. Instead of decentralization through market unification, the process became one of statist centralization without the explicit consent of voters. It was a process of technocratic empire-building by stealth.

The whole enterprise is now in shambles because you cannot manage a public good without a centralized political authority, a state in fact. And precisely at the moment when this statist project was launched, in the 1980s, the underlying prerequisites for its eventual success vanished. On the political ground, the integration of several independent states, quite difficult in itself, requires a common external enemy against which the fundamental public good of a common defense could provide the benefits of economies of scale and increased efficiency. But by 1991 the Cold War was over and the USSR had disappeared. Symmetrically, the US lost interest in the political unification of Europe. On economic grounds, the information and communication revolution of the 1980s (computers plus the internet) reversed the previous trend towards centralization and the advantage of large size, into a trend of general decentralization of large hierarchies, whether private or governmental, into smaller and more efficient units. In organizational matters small became beautiful, or at least efficient. Whereas in the 1970s the use of computers (and thus of efficient information gathering, storing and processing) was restricted by its high cost and limited availability to big organizations (large firms, state bureaucracies) it became available to every individual in the 1980s and 1990s, and instant communication worldwide became the rule. Hence the trend towards democracy, the counter example being found in information repression by Communist China and Middle East dictatorships. The organizational consequences of that revolution were devastating for the largest hierarchies (see my book “The Second Twentieth Century: the Decline of Hierarchies and the Future of Nations”, Grasset, 2000 and Hoover, 2006). Large and heterogeneous states – usually called “empires” – were the first victims, coming just after large and heterogeneous corporations – usually called “conglomerates”. Smaller and ethnically or economically fragmented states followed, such as Czechoslovakia and Yugoslavia, while separatist movements prospered everywhere. Small entrepreneurial firms multiplied. It was no time for large bureaucratic structures and empire building.

That mutation made the European process of multi-state integration obsolete overnight. It thus happened that the technocratic "empire-building by stealth" enterprise was doomed at the very moment it was launched, with the currency centralization as its first stage. It follows that the failure of the euro is not specific: it is just one example of the new trend towards general decentralization that characterizes the second twentieth century and the ICT revolution. It is in my opinion a durable trend.

In Europe, governments and banks tried to resist the trend by cartelization, and succeeded temporarily to avoid the downsizing necessity. Instead of reducing their excess capacity they could in that way temporarily increase it. But as a consequence they are now confronted with bankruptcy. The call for a “European governance” (read: a major step in political integration) is just plain wishful thinking and is no real option. The only solution now is to downsize these overblown technocratic structures and increase by this means the overall social efficiency (and level of living for the European populations) by returning to smaller and autonomous and competitive bureaucratic organizations, public as well as corporate. This is also the condition for a return to effective democracy, breaking away with the rule of technocracy.

Yes, this is the second death of Mr. Monnet.

Plus ça change …

2011-09-06T17:00:00.000+02:00

An interesting paper by Michael Sauga on the different designs and management styles of “transfer unions” (aka “federal states”): “Designing a Transfer Union to Save the Euro” (Spiegel Online). The author reviews several variants of such unions, and one historical episode stands out as a forerunner of current events.

Excerpt:

"In the mid-19th century, for example, France, Belgium, Italy, Greece and Switzerland established the Latin Monetary Union, a precursor of the European Monetary Union. The exchange rates among the members were set, and all members were required to accept the currencies of their partner countries. But Italy and Greece, in particular, took advantage of the rules of this union to take out high government loans, which they paid for in part by printing money. The other countries resisted the southern countries' inflationary policy, but then the monetary union fell apart in the mid-1920s.”

Read the whole article here.

When Will Euro Rioting Start?

2011-09-04T21:17:00.000+02:00

The question is raised by Bob Pisani (CNBC’s “Trader Talk Blog”). He summarizes an interview in the German newsmagazine Spiegel with economic historian Hans-Joachim Voth who studied the history of 28 European countries over the last 90 years and has come to the following conclusion:

1) “Austerity and anarchy are closely linked”

2) “Savings (budget cuts) amounting to just one percentage point of GDP are accompanied by social unrest. And when they reach two or three percentage points, it massively increases.”

Voth also gives the euro another five years before disappearing but says it is Germany that should quit the euro, not Greece. This is precisely what the former head of the Federation of German Industries, Hans-Olaf Henkel, has suggested in a Financial Times opinion, “A sceptic’s solution – a breakaway currency” on Tuesday August 30.

Read the whole CNBC post here .

Read also the complete Voth interview in the SpiegelOnline.

Excerpts:

“Spiegel: Wouldn’t abandoning the common currency sound the death knell for the EU entire project?

Voth: I believe that the consequences of ending the euro have been overstated. Not every dumb economic idea needs to be defended to the bitter end. Europe is infinitely more than the European Union, and the European Union is infinitely more than the euro.”

My comment:

1) Rioting has already begun in Greece.

2) Both Germany and Greece could benefit from quitting the euro … but also Portugal, Spain, etc.

3) Five years seems quite a long time given the deteriorating conditions of Greece, Portugal and Spain and the growing criticism of the euro in Germany. My guess would be that a radical move could be taken after the coming French and German elections.

4) In the meanwhile the only realistic policy would be to substantially devaluate the euro vis-à-vis the dollar, but with Germany staying in the eurozone to take its share of responsibility for the debasement of the external debts in euros, after benefiting from years of undervaluation of its “implicit DM” vis-à-vis other member countries within the zone.

5) Lastly, Voth sees a “southern euro” surviving with France, Italy and Spain, and maybe others, but he fails to recognize that the divergences between these economies would perpetuate the present euro problem. It would not constitute an optimal currency area either, and thus it will break down sooner or later. Sooner would be best.

The Sex Ratio, Gender Bias in Slave Trade, and Differential Polygyny in West vs East Africa

2011-08-26T15:31:00.000+02:00

A neat resource-abundance explanation by John Dalton and Tin Cheuk Leung, here.

Hat tip: Tyler Cowen.

Why Eurobonds Are the Wrong Solution

2011-08-24T13:22:00.000+02:00

Common sense (at last!) by an economist, Daniel Gros, ,here.

A Balanced Assessment of the Current Situation

2011-08-22T11:00:00.000+02:00

By Ambrose Evans-Pritchard in The Telegraph here. Closely reasoned as usual and thought provoking.

Are the 1930s Back?

2011-08-19T08:45:00.003+02:00

A frightening parallel in Kantooseconomics.com, here, especially regarding a comparison of the return to the gold standard (then) and the creation of the euro (now).

It is time to remember a forgotten lesson of the Great Depression. How to get out of it: (a) drop out of the gold standard, and (b) devaluate your currency by an adequate monetary policy.

The Economics of British Riots

2011-08-19T08:17:00.000+02:00

Read Posner and Becker on the topic here . The reasons for seemingly irrational behavior.

The Euro Endgame

2011-08-17T08:37:00.000+02:00

Mohamed A. El-Erian develops and analysis quite similar to mine (see for example my post of yesterday) for Project-Syndicate, even though his title is misleading, reflecting an ECB-centered preoccupation with its independence and future rather than expressing a concern for global welfare in Europe.

Excerpts:

“Whichever way you look at it, the ECB … is being forced into an endgame with three once-improbable outcomes. That endgame will play out in week and months, not quarters and years. (see my comments on the durability of cartels, JJR). …

The first is a disorderly breakup of the eurozone. …

The second is the one preferred by political scientists and European visionaries (he means “the politicians of the zone”, JJR): greater fiscal union … or, in blunt terms, German willingness to do for the eurozone what it did for Eastern Germany – namely, write large checks for years to come. (most unlikely, despite the "eurobonds" babble, JJR).

The third alternative is the one embraced by several economists. It involves creating a smaller and more economically coherent eurozone which would consist of core and near-core countries within a tighter fiscal union. … In the process, 2-3 peripheral economies would take a sabbatical from the euro. (See again my post on that. It is not a preference, but the logical consequence of the fundamentals of optimal currency areas theory, supplemented by politicians' preference for centralization, JJR).

Although the endgame is close, it is impossible to predict which alternative will prevail. … My sense is that politicians will opt for a weak variant of greater fiscal union, but that, ultimately they will fail to execute it for the eurozone as we know it today. … the coming endgame will be neither simple, nor orderly. (That’s precisely what I explained in my book, and in yesterday’s post, JJR).”

Additional comment:

El-Erian didn’t, however, mention a fourth alternative that we develop with two colleagues in today’s French daily Les Echos (for those of you who can read French look here: a major devaluation of the euro following a drastic cut of the ECB interest rates, that would stimulate all the economies of the eurozone, including the German one. It would buy some more time for politicians before they resolve to adopt the most likely shrinking of the eurozone into a DM-zone.

How Long Will the Euro Monetary Cartel Survive?

2011-08-16T15:16:00.000+02:00

A paper by Margaret C. Levenstein and Valerie Y. Suslow, “What Determines Cartel Success?” ( Journal of Economic Literature, March 2006 ), potentially provides elements of information that lead to an answer.

First, remember my analysis in a recent book, “L’euro: comment s’en débarrasser” (Grasset, 2011), of the euro as a cartel of currencies intended to maintain a high price of the jointly created substitute currency (the euro, which replaced the DM, Franc, Lira and other national currencies), in order for the big borrowers – banks, governments, and firms -- to lower the cost of the funds they borrow.

Second, read the abstract of the Levenstein/Suslow paper:

… “We conclude that many cartels do survive, and that the distribution of duration is bimodal. While the average duration of cartels across a range of studies is about five years, many cartels break up very quickly (i.e. in less than a year). But there are many others that last between five and ten years, and some that last decades. … Cartels break up occasionally because of cheating or lack of effective monitoring, but the biggest challenges cartels face are entry and adjustment of the collusive agreement in response to changing economic conditions. Cartels that develop organizational structures that allow them the flexibility to respond to these changing conditions are more likely to survive.”

Now the euro was born more than ten years ago, in 1999. It has obviously been submitted to cheating by many if not all of its member states, via the repeal of the “stability pact” and overborrowing by several governments that breached the quota limitations that are essential for a cartel to survive. It has faced entry by new members and its collusive agreement is confronted to severe and changing economic conditions.

But on the other hand it clearly developed an “organizational structure” in the guise of the European Central Bank, which, like all other central banks is an instrument of collusion and defense of the interest of financial institutions.

My guess is that this cartel is going to disintegrate, maybe to be replaced by a smaller, more homogenous one. Its life span is already respectable but it has an important comparative advantage over other cartels: the compulsory collusion organizer that is the ECB. So I would be surprised if it disappeared right now. I rather expect a protracted process of progressive disintegration (that could suddenly accelerate) by the exit of one country after another.

However, as I wrote in the book, the game with 17 players is too complex to allow a precise forecast, either regarding the scenario, or its timing. But right now the ECB has been compelled to renege also on its charter by bailing out a few overleveraged governments of the South. A policy which was strictly forbidden by the initial agreement. So watch out.

The Globalization … of Development

2011-08-16T08:49:00.000+02:00

Project Syndicate undertakes the publication of new, weekly series The New Global Economy in which senior officials from various countries, international business leaders, and economists will comment on a world in mutation.

Excerpt from the presentation:

“Ten years ago, rich countries dominated the world economy, accounting for two-thirds of global GDP. Since then, their share has fallen to just over half. In ten years, it could decline to a mere 40%, with emerging markets producing most global output.

The pace of this shift in economic power is unprecedented, and raises as many questions as it does hopes.”

Indeed, much has been said and written about the financial aspect of globalization, but the real aspects of the world economies’ rebalancing may be more important in the medium run.

Krugman on the ECB

2011-08-15T09:24:00.000+02:00

Europe needs more inflation, whereas the current ECB monetary policy is of the "one-size-fits-one" (i.e. Germany) category.

Read his short note here .

Europe (and Especially the Eurozone) Much Worse Off than the U.S.

2011-08-11T15:15:00.000+02:00

Have a look at Felix Salmon’s “Chart of the day” (Reuters). Both the chart and the comments are extremely clear, here.

The Brokers With Hands on their Faces Blog

2011-08-10T12:12:00.000+02:00

Here it is .

Soros on Euro Exit

2011-08-08T20:03:00.000+02:00

“The authorities are actually engaged in buying time. And yet time is working against them” he said in Vienna yesterday, according to Bloomberg.

“There’s no arrangement for any countries leaving the euro, which in current circumstances is probably inevitable,” he added.

Readers of this blog have been knowing that for a long time …

Great Recession or Great Contraction?

2011-08-05T21:08:00.000+02:00

Kenneth Rogoff claims in Project Syndicate that governments pursue the wrong policy recipe in trying to revive economic growth by fiscal policy or massive bailouts, which usually terminate recessions within a year, returning the economy to its long-run trend.

The current problem “is that the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation.” It is a typical deep financial crisis, not a typical deep recession. In the former, it typically takes an economy more than four years just to reach the same per capita income level that it had attained at its pre-crisis peak.

“Many commentators have argued that fiscal stimulus has largely failed not because it was misguided, but because it was not large enough to fight a “Great Recession”. But, in a “Great Contraction,” problem number one is too much debt. If governments that retained strong credit ratings are to spend scarce resources effectively, the most effective approach is to catalyze debt workouts and reductions. (…) the only practical way to shorten the coming period of painful deleveraging and slow growth would be a sustained burst of moderate inflation, say, 4-6 % for several years.”

My comment: I think Rogoff is completely right. But in the case of Southern European members of the euro zone the amount of cumulated debt and the deterioration of competitiveness are such that at least partial defaults and a return to flexible exchange rates are required. And anyway, an independent monetary and exchange rate policy would be necessary to increase inflation from 2% to the 4-6 % range, given the price trend and inflation aversion of Germany.

Explaining the Crash

2011-08-05T15:41:00.000+02:00

Many plausible causes have already been invoked for the current spectacular worldwide market crash: anticipation of a US double-dip recession, the Obama consent to a debt ceiling having the effect of cutting the macroeconomic stimulus too early, -- mostly in the US -- evidence that the European policy of helping Greece, Ireland and Portugal with more and longer term loans to alleviate the burden of their austerity programs did not produce the expected positive results, fear of contagion in sovereign bond markets engulfing Spain and Italy, lack of political leadership in Europe, and the excessively conservative policy at the ECB, -- mostly in Europe.

But all of these, and some others too, belong to the “guessing in the dark” category.

As “Buttonwood” writes in The Economist, the cause or causes may be what he defines as “non-economic”, but I think he means “non-macroeconomic”.

Excerpt:

“Some of the biggest falls of the last 25 years have been down (sic, but maybe he meant “due”?) to market dynamics, from program trading in 1987 to the LTCM crisis through August 2007’s quant blow-up to May 2010’s flash crash. We will find in a few days or weeks that someone was a forced seller.” (My emphasis).

Because, in the end, more sellers than buyers is the explanation to give whenever the markets fall. And that’s the only explanation that counts.

Let’s add that the reasons for selling should have been (a) global (because the Thursday crash was global), and (b) due to some unexpected news that led some large global investors to sell large quantities of stocks (including emerging economies’ stocks) and buy “safe” government bonds. Let’s wait for more evidence about who the sellers were, and why they felt compelled to sell.

Read the post here .

The Euromess as of August 3

2011-08-03T09:41:00.001+02:00

Paul Krugman sees “the whole eurozone … coming apart at the seams” (here) as investors fly from Italian and Spanish bonds, while Italy and Spain are too big to be “saved”, the Greek, Portuguese and Irish way, that is by North European taxpayers.

According to the Financial Times, yields on benchmark 10-year Spanish and Italian bonds reach 6.45 and 6.25 respectively. The premiums paid to borrow over Germany reach euro-era highs of 404 and 384 basis points (391 points in the latter case according to Bloomberg today). These yields and premiums are close to levels that pushed Greece, Ireland and Portugal into bail-outs. The premium on France’s bonds also reaches a euro-era high of 75 basis points.

Meanwhile the Swiss Franc approaches parity with the Euro and also gains vis-à-vis the US dollar, a clear sign of global financial worry. Today's interest rate cut by the Swiss monetary authorities is intended to check (efficiently) that rise but does not suppress the underlying cause.

The mounting crisis reflects the basic impossibility for southern European economies to avoid default on their debts with an overvalued euro while at the same time their governments aggravate the already severe recessions by deflationary macroeconomic policies (“austerity”) that stifle growth even more and thus further deteriorate public finances and increase (not decrease) the debt/GDP ratio. There is no way out in this direction. Partial default and currency depreciations – either of the euro and/or of newly re-created national currencies - are prerequisites for a return to growth.

The Fundamental Source of America’s Budget Deficit

2011-07-30T09:35:00.000+02:00

Martin Feldstein explains, in a remarkable Project-Syndicate post, why America’s budget deficit is so large.

Excerpts:

“America’s enormous budget deficit is now exceeded as a share of national income only by Greece and Egypt among all the world’s major countries.” It rose “from 3.2% of GDP in 2008 to 8.9% of GDP in 2010 (which in turn pushed up the national debt-to-GDP ratio from 40% to 62%.

(…)

To be sure, the current deficit of 9.1% of the GDP is due in part to the automatic effects of the recession.”

But according to the Congressional Budget Office, if the economy had been at full employment in 2008-2010, the budget deficit still would have increased by 3.2% of the GDP and even after the economy returns to full employment in the future the deficit will remain so large that America’s national debt-to-GDP ratio will continue to rise for the rest of this decade and beyond.

“The budget outlook in subsequent decades is dominated by the increasing costs of Social Security and Medicare benefits, which are projected to take the debt-to-GDP ratio from 90% in 2020 to 190% in 2035. Fundamental reform to these programs is the primary challenge for America’s public finances – and thus for the long-term health of the US economy.”

Read the post here .

Krugman on “Eurofail”

2011-07-29T09:08:00.000+02:00

“What the markets seem to be seeing is disaster on the periphery and the Japanification of the core. And I can’t say they’re wrong.”

Here .

The Latest (and Revised) Big Mac Index

2011-07-29T08:30:00.000+02:00

A “beefed-up” version of the Big Mac Index is now adjusted for the level of GDP per capita, the price of the sandwich in various countries being correlated to the GDP per person.

The change affects especially the measurement of overvaluation of Brazil and Argentina, and the measurement of undervaluation of South Korea, Mexico, Russia, China and India.

While the Chinese yuan is now close to its fair value against the dollar, the euro is substantially overvalued (36 % with the new versus 21% with the old index). This is not very good for the activity in Europe generally and it adds to the burden of the PIIGS by curtailing their debt servicing capacity: low growth means reduced tax receipts.

Have a look at The Economist here .

Greece Again: Acknowledging the Obvious

2011-07-18T09:01:00.000+02:00

Simple truths do percolate, in the end, through the political-media muddle. See for example today’s Financial Times article with the title: “Eurozone exit could restore Greek competitiveness”. Obvious from an economic point of view. But interesting nevertheless because it reflects the shift of emphasis of politicians’ aims, from the official motto of “saving the euro” to a recognition that some form of Greek default is already a fact, and that no durable solution, i.e. a return to growth, is possible for the Greek economy unless a major devaluation, i.e. an exit from the euro, is adopted.

That said, a warning is addressed to other potential defectors in the article’s subtitle: “But leaving the club may be much harder than it was to get in.” Obvious too: the membership in the currency cartel – I mean the “club” – has so deteriorated the Greek public finances and economy that the cost is already built in the current situation and has to be met by someone, foreign creditors, foreign taxpayers, and Greek workers and taxpayers. This is simply the characteristic of all political rents: they benefit a few in the present, and burden many others in many following periods.

Let’s keep in mind, however, that exiting the euro will produce a benefit, not a cost, to ordinary Greek wage earners and taxpayers.

From ERM to Euro: Creditors and Governments

2011-07-15T10:36:00.000+02:00

A useful reminder of the short history of the ERM debacle in the 1990s and a comparison with the current euro crisis, brightly summarized, is to be found in The Economist .

The best bird's eye view of the problem I have read so far.

Why Italy Is “Attacked”

2011-07-12T14:30:00.000+02:00

Nothing changed much in the state of the Italian economy and debt during the last few days, compared to let’s say one or two months ago. But suddenly “the markets” (as the press puts it) “attacked” Italy under the form of a fall in value of Italian bonds, and as a consequence of Italian banks and insurance companies that hold these bonds. Is it a sort of duel between these shadowy characters - speculators -and the Italian government (or the whole list of Euro zone governments)? Not at all.

There is, in fact, no “attack” against Italy, specifically. What happens is that the absence of any intergovernmental solution to the Greek problem (i.e. a massive bailout by northern taxpayers, followed by permanent transfers to the indebted country for the indefinite future, and possibly accompanied by a major partial default on the country’s debts) has progressively led, from one failed “plan” to another, investors worldwide to anticipate a Greek exit from the euro. This could in turn prefigure the most likely scenario for other over indebted members of the zone, penalized by the overvalued euro and unsustainable indebtness: exit now or accept the punishment of an unending recession.

For international investors the meaning of these developments is clear: the risk of the euro debts is rising (see Moody’s recent downgrades). Accordingly the required interest rate on euro instruments is also rising (augmented by a potential devaluation premium) and as a consequence the value of the euro debts is falling at the same time, as is the value of the euro in the currencies market. The more indebted the country, the higher is the required premium, Italy now catching up on Spain.

The inevitable exit of Greece from the euro zone will only confirm the soundness of this anticipation and will precipitate the fall of the euro, which already slipped from nearly 1.44 dollars last Friday to less than 1.39 today. This means, in other terms, that the markets incorporate in their valuations a partial default of debtors in euros.

A much larger depreciation is warranted if Greece exits the euro zone, but this will be good news indeed for indebted countries since it will amount to a corresponding reduction of the burden of their debts and a move towards the restoration of their international competitiveness.

A Short History of the Greek Debt Crisis

2011-07-06T09:17:00.000+02:00

Puzzled about the origin of the problem? Here is a useful reminder of what happened (a post in “The Denouement”). It lacks, however, an explanation of why it happened: a continuous deterioration of the economy’s competitiveness due to positive differential inflation in Greece versus other eurozone countries, a major continuous reevaluation of the euro versus the dollar (and yuan), the 2008 crisis striking an economy submitted to a restrictive (eurozone) exchange rate policy, and thus an accelerated recourse to the only policy instrument available to dampen the shock: budgets deficits and debt, all the more attractive since the interest rate was artificially lowered by the euro.

Nevertheless, have a look at the post here and especially at the list of major creditors of Greece, namely French and German banks and governments. It explains the current self-defeating policy followed by … er … the French and German governments.

A Great List of Books to Understand Economic and State Development

2011-06-23T15:10:00.000+02:00

From Chris Blattman here.

Nothing to add except to emphasize that « Nation building is a long and messy business » and that « War makes the state ».

Managerialism Rules in America

2011-06-23T14:29:00.000+02:00

A useful reminder, by Mark Roe, of his well-known analysis of modern American capitalism.

Excerpt:

“When it comes to capitalism vs. socialism, we know which side the US is on. But when it’s managers vs. capital-owners, the US is managerialist, not capitalist.”

A comment: Continental European systems are, of course, also managerialist, but on top of that they are corporatist, that is, are characterized by a deep collusion of business and administrative-political elites, an extreme version of that type of system being non-european but Japanese.

Read his post here.

For further references look here.

Krugman on the New Drachma

2011-06-20T14:36:00.000+02:00

Even though it has long been obvious that non-default is not an option, the European leaders and institutions pursue a strategy of delay with no solution in sight. Then,

“for Europe ex-Greece, the costs of delay are whatever delay does to reduce the amount that Greece will eventually pay its creditors. I think there’s a good case to be made that at this point demands for even more austerity are counterproductive, even in terms of creditors’ interests: the Greek economy is suffering long-term damage, the Greek political scene is being radicalized, and the chances of Greece just telling its creditors to take a hike while it devalues the new drachma are rising.” (Krugman’s blog in the New York Times, here).

Economic common sense indeed.

Dani Rodrik on Greece

2011-06-20T14:11:00.000+02:00

“When Argentina defaulted on its debt a decade ago, the country became a pariah in the eyes of foreign bankers and bondholders and was shut off from international financial markets. Yet its economy recovered quickly and experienced rapid growth thanks to a large boost in external competitiveness provided by a vastly depreciated currency. The lesson is that default can be the better option when the alternative is years of continued austerity.” (In the New York Times, here).

Perfect good sense, and I would add that default and devaluation is not only a better alternative: it is the only way to get the Greek economy out of the current mess and back to growth, and international financial markets after a while.

But then – illogically – Rodrik seems to deplore a Greek exit from the euro which would “unleash huge uncertainty about the rule of the game”.

Fortunately, he nevertheless concludes – correctly - that the current strategy of other European governments aims at “protecting German and other European creditors and bondholders while Greek workers, retirees and taxpayer (and also add German and French ones, JJR) pay the bill. This makes no sense economically, and will not work politically.”

I agree. But why did it take so long for most economists to recognize that an exit from the euro was the only durable solution for the Greek economy? One year ago it was already quite clear (see my May 5, 2010 interview in the newspaper Le Monde, downloadable on my home page).

The Hero of Fukushima

2011-06-18T13:30:00.001+02:00

A chilling account of what we now know, three months after the tragic nuclear accident, in a BigThink post, by Michio Kaku. Excerpts:

“1. After months of stonewalling and low balling figures, the utility finally admitted what many US physicists already suspected, that there was most likely a 100% core melt at all three reactors. Physicists in the West, given the meager data fed to the media by the utility, have run independent programs on their computers and have concluded that the accident was much, much worse than the government has been reporting. The new figures, although shocking, now agrees with assessments made in the US.

2. If 3 reactor cores suffered 100% core melts, then why didn't we have three China Syndrome type accidents? Why didn't we see three Chernobyl accidents happening simultaneously? The answer is that, at the very last minute, sea water was flushed into the three cores, stopping the melted uranium from melting through the entire containment structure and releasing vast amounts of radiation into the environment. The utility, however, resisted flooding the reactors with sea water, since it would reduce the reactors to junk, while the utility wanted to salvage the reactors for future use. Apparently, the reactor operator disobeyed direct orders. He was ordered to delay any plans to flush the cores with sea water. Instead, he did it anyway, going against his superiors. He should be considered a hero. Any delay back then might have led to an unimaginable tragedy.”

The punch line:

“Estimates for the clean up vary. Toshiba corporation estimated it would take 10 years. The Hitachi Corp estimated, however, that it would take 30 years. One nuclear engineer estimated that it might actually take 100 years. Remember that it took 14 years to clean up Three Mile Island, where there was no breech of containment. It has been 25 years since Chernobyl, and that accident still has not ended. So 30 to 100 years are not unreasonable guesses for the amount of time the cleanup will take.”

The Case Against the Euro

2011-06-16T12:38:00.000+02:00

Fernanda Nechio, an economist at the Federal Reserve Bank of San Francisco, presents a set of charts indicating that, according to one well-respected monetary policy rule of thumb (the “Taylor’s Rule” named for Stanford economist John Taylor) Europe’s central bankers have the wrong policy for the peripheral countries (the “PIGS”).

The rule says monetary policy makers should adopt a “tight” monetary policy when inflation is above its target or when the economy is above its full employment level, and a relatively easy monetary policy when inflation is lower than targets or unemployment higher.

According to Nechio’s calculations, the ECB is adopting the policy Taylor Rule says is optimal for the core states (the northern ones), but for the peripheral countries (that some call in a derogatory and unjustified way the “Club Med countries” implying –wrongly – that people there do not work) the current target rates are far above where the Taylor Rule would recommend. For these countries (Greece, Ireland, Portugal and Spain) the policy target interest rate remains deeply negative, which corresponds also to a much lower equilibrium exchange rate vis-à-vis the dollar and the yuan I would like to add.

As Nechio writes:

“From the inception of the euro to the 2008 financial crisis, the actual ECB policy rate was below the rate predicted by the Taylor Rule for the peripheral countries and more in line with Taylor Rule recommendations for the core euro-area countries. During the financial crisis in 2008, the peripheral countries fell into deep recession, which was followed by a debt crisis from which they have yet to recover. … These events reversed the historic pattern and positioned the ECB policy rate above the Taylor Rule recommendation for the peripheral countries.”

Let’s add that the depth of the 2008 recession in these countries has been magnified by the previous excess activity and speculation that the much too low (for them) interest rates fostered before the crisis. This is quite compatible with an Austrian view of the business cycle and the fault is that of the eurozone unitary monetary policy.

To summarize, the ECB’s actual rate has been either much too low for the economic health of the periphery (thus explaining the real estate booms in Ireland and in Spain before the crisis) or much too high after the crisis (thus accentuating the recession already severe in the periphery, and especially in Ireland, Greece and Portugal).

“In other words, if you are a country in the peripherals, the ECB’s monetary policy has been consistently wrong” writes John Carney in CNBC’s “NetNet” here.

The problem is that there can be only one monetary policy in a monetary union, and that one policy cannot fit simultaneously all member economies. At the limit “one size fits none” but here the monetary policy is aiming at the current conditions of the sole core (northern) members.

No wonder that Greek and Spanish citizens are in the streets in protest against their government budgetary policy which further restricts the economic activity (under pressure from the ECB, IMF and northern governments) and push their economies into a deeper recession at a time when ECB’s monetary policy is already much too tight for them.

The ECB’s inadequate interest rate policy exacerbated the bubbles in the periphery before 2008 and now it exacerbates the severity of the recession. It is a recipe for instability. Moreover the governments of the “core” resist any “haircut” for the creditors of the peripheral governments (mostly French and German banks, as well as the ECB) and insist on aggravating the amount of the debts of peripheral governments through more loans, ostensibly to “save them”, precisely when the capacity for repayment of these countries’ debt (the level of their GDP) is plummeting. Can you seriously call that “helping Greece”?

There is no way out of this mess other than a partial default on debts, and devaluation, that is an exit from the euro. This is what Argentina did in 2001, exiting the dollar zone and defaulting on a large fraction of its debts, with the result of a rather quick return to growth (within months) and a return also to international capital markets.

The current irresponsible policy of the “core” countries of the European Union, which consists in making Greek citizens pay for the euro disaster (and for their own banks), will only make matters worse. It will hasten secession from the eurozone, but fortunately for a better future.

The Nechio paper is well worth reading here .