Tuesday, December 28, 2010

2011, the Year of All Dangers for the Euro

A quick look at the graphics gallery from the Spiegel Online (The Euro Crisis in Numbers) highlights the problem.

The amounts of government bonds coming due in 2011 will be peaking in Portugal, Spain, and Italy, and will reach short term new highs in Ireland and Greece: here, here, here, here, and here.

Further rises in bond rates are to be expected in the above countries, weighing even more on budgets and economic activity, increasing the demands for financial transfers and thus the tensions between the zone members. Add to that the 2011 elections in Germany and the prospect of the 2012 elections in France and all the elements of a deepening crisis appear to be present.

Monday, December 27, 2010

The Excess Supply of PhDs

From The Economist:

“A PhD may offer no financial benefit over a master’s degree. It can even reduce earnings”.

I wonder if that means that a destruction of human capital is taking place in the course of prolonged studies. A quick look at the sorry state of the excess production of new economic articles in peer-reviewed journals may lend credibility to that conclusion.

Read more.

Friday, December 24, 2010

The European Quandary: Michael Spence

I liked his clear and condensed analysis of the EU's central problem in a recent Project Syndicate post:

“Europe struggles to find a solution to its deficit and debt problems by treating them with short-term liquidity fixes whose purpose is to buy time for fiscal consolidation and, in the absence of the exchange-rate mechanism, some kind of deflationary process to restore external competitiveness. Success is by no means assured, and the most likely outcome is a sequence of contagion events and a broader loss of confidence in the euro. The core issue is burden-sharing across bondholders, citizens of the deficit countries, the EU, and, indeed, the rest of the world (via the International Monetary Fund).”

Sunday, December 19, 2010

Euro Defaults or Euro Exit?

“Far from being irrational, markets are quite right this time to be concerned about the current crisis in the euro area” writes Elena Carletti, a professor of economics at the European University Institute un Florence, in Bloomberg.com.

As an alternative to sovereign default, she comments, a country could simply leave the currency union. “This would also need to be done quickly to avoid massive capital outflows. A government would have to redenominated overnight all contracts into a new currency, presumably at a 1-to-1 ratio with the original euro amounts. There would still be a market-determined exchange rate between the new currency and the euro.”

Would the following depreciation of the new national currency increase the burden of the foreign held government debt? Not necessarily.

“Most emerging-market sovereign debt was written under U.K. or New York law. In the euro area, much of it is under domestic stature. In Greece, about 90 percent is subject to local legislation.”

Presumably the euro denominated debt could be redefined as a national currency denominated one. But anyway, in my opinion, an exit by a single country would be much more costly both to the economy of that country and to big European banks if not preceded by a coordinated, and substantial, depreciation of the euro that would make a large devaluation of the new national currency unnecessary. And in any case, as I see it, (partial) default (or “restructuring”) and exit are not alternative solutions but could well prove to be complementary.

Sunday, December 12, 2010

Differential Effects of British and French Colonization

The case of Cameroon that was divided between Britain and France following the German defeat in WWI, to be reunited only much later, at independence in 1960, highlights the effects of colonial rules and legacies on present day economies.

A new research by Alexander Lee ad Kenneth Schultz of Stanford shows that rural households on the British side still have, today, higher levels of wealth and are more likely to have access to improved sources of water (a locally provided public good).

They remain cautious, however, about the relative importance of the factors that can explain these differences:

“The exact origin of the British advantage are impossible to determine with certainty, but we hypothesize that it is caused by a combination of ‘hard legacies’ (lack of forced labor, more autonomous local institutions) and ‘soft legacies’ (common law, English culture, Protestantism). The relative role of these two types of influence is a fruitful topic for future study.”

Read more, here .

Hat tip: Laura Freschi (AidWatch).

Friday, December 10, 2010

How Ants Solve the Shortest Path Problem

A Scientific American article reports the results of a new study of the techniques used by ants to quickly find routes in a changing maze that could be useful to systems engineers.

“In the wild, ant scouts deposit pheromones along the trails between food and the nest. Nest mates then follow the trail, laying their own pheromones, amplifying the markings along the path. Because the pheromones gradually evaporate, longer trails--on which ants are spread more thinly--carry lower pheromone concentrations than short trails. Since pheromone strength is what draws an ant to follow a specific path, longer trails that have weaker pheromones are abandoned in favor of shorter ones. (…)

Many computerized systems, such as those that route telephone calls through busy networks while minimizing connection times, already solve shortest path problems by deploying virtual ants that explore all possible routes in a system and deposit virtual pheromones on each route they travel.”

This technique however implies that when a new obstacle blocks a well traveled path they should turn around and go all the way back to their nest along the most traveled path, in order to start a new search.

The study reported in the Journal of Experimental Biology, shows that Argentine ants (Linepithema humile), do not just retrace their steps when presented with a barrier--as might be expected. Instead, the ants begin a localized search that seems to take into account the direction in which they were planning to go.

The discovery indicates that Argentine ants use more than just the simple trail pheromone to find their way. "The individual ants appear to have internal compasses and odometers that allow them to guide their search," says Chris Reid, a behavioral biologist at the University of Sydney in Australia, the lead author of the study.

David Broomhead, director of the Centre for Interdisciplinary Computational and Dynamical Analysis at the University of Manchester, UK, adds that "it would be really interesting to see if we can get a computer to do what these ants are doing."

Hat tip: Big Think.

Slavemaker Ants Are Von Neuman-Morgenstern Rational Agents

Ants enslave the strong not weak report Ella Davies in BBC Earth News (November 8).


“Slavemaker ants prefer to target the strong over the weak when seeking new servants, researchers have found.
Ants were observed actively choosing to attack larger, better defended colonies over smaller, weaker ones.
Scientists suggest that the intelligent ants identify strong defences as a sign of a strong population.
By conducting fewer raids on strongly defended targets, the slave-making ants actually limit the risks and come away with the most pupae to enslave.”

The reason is, according to a research conducted by Sebastian Pohl, a biologist, and his colleague Susanne Foitzik, a professor of behavioral ecology, both at Ludwig Maximilian University (LMU) in Munich, Germany, reported in a recent issue of the journal Animal Behaviour, that it is essential that scouts make the right decision about suitable raid targets or "host colonies" without being discovered and attacked.

"Losing a single (scout) worker might very likely be synonymous with losing half of the colony members," Mr Pohl told the BBC. Therefore, a smaller number of scouting events and subsequent raids present the lowest risk to the slavemaker colony. However, the colony still needs new slaves to be able to survive to the next season.

From their behaviour, researchers suggested that the scout ants associated strong colonies with high numbers of pupae and a high benefit. The tactic of fewer raids on stronger targets consequently offered the best risk to benefit ratio.

My comment: This behaviour is typical of Von Neuman and Morgenstern rational agents! In other terms they maximize expected, risk-adjusted utility in an uncertain and dangerous world.
Now if ants can be that sophisticated, why couldn’t human beings be at least as rational?

Monday, December 6, 2010

Schumpeter, Information, and the Great Recession

Mike Mandel ( Innovation and Growth) believes the information economy recession that started with the beginning of the current century and explains the depth of the “great recession”, is over now.


“Is the long information sector job drought finally over?

(…) our information industries have mostly been shrinking from 2000 until very recently. This was one of the great disappointments of the past decade, and one of the big reasons why the 2000s were an economic disaster. (…)

Here are the numbers: In 2000 the information sector employed 3.6 million workers. By 2007, just before the recession started, the number was down to 3 million, and in 2009, the information sector had shrunk to 2.8 million. That’s a 23% decline in 9 years. By comparison, the whole private sector is only down about 2% over the same stretch.”

My comment: I, too, believe that the unusual severity of the current recession results from the downside of the extraordinary innovation cycle (a Schumpeterian one) that started in the mid-1970s. The heated debate about the efficiency (or inefficiency) of macroeconomic policy (mostly in the US) is due to the fact that the marked slow down of information innovations and related investment opportunities, that sustained the remarkable growth of the 1980s and 1990s, precludes a vigorous pick up in investment and growth. Government deficits and money creation can damp down the recession but cannot by themselves generate a new expansion comparable to that of the previous two decades.

Growth in consequence will stay sluggish until the next innovation wave (that may be already be under way without our knowing it …). Most commentators have been focussing the analysis on the financial sector that indeed contributed to amplify the crisis, but financial excesses themselves had their origin in the perspective of unusual (and highly uncertain) real returns in the new technologies, just as in the booming 1920s. That's also why, following a similar path, we often find the present situation so similar to that of the 1930s.

Saturday, December 4, 2010

How to Quit the Euro Zone

The euro debate is evolving along a well-known path. Individuals and governments confronted to major difficulties tend to start with a denial: the problem does not exist. Then the conservatives claim: yes, there is a problem but not as serious as what you pretend. In the third stage, they recognize that the problem is serious indeed, but a radical change is impossible, they maintain. In the fourth stage, the radical change becomes possible but horribly costly. And in the fifth stage, no real change having been tried, it proves eventually even more costly to maintain the existing system than to opt for a radical break with the past.

The third stage has been dominating the debate for about three years since the American economist Eichengreen claimed that he had found the definitive argument against a break-up of the Euro: it would unleash the “mother of all financial crises” since it would lead to bank runs that would destroy the banking systems in Europe and possibly elsewhere.

Now, interestingly, The Economist is proceeding to stage four in its December 2 edition, with a paper titled “Don’t do it: The euro is proving horribly costly to some. A break-up would be even worse”, here and also here.

But the analysis is seriously flawed. Here are some excerpts from the paper, and a different and critical point of view in favor of an exit.

“A break-up might happen in one of two ways. One or more weak members (Greece, Ireland, Portugal, perhaps Spain) might leave, presumably to devalue their new currency. Or a fed-up Germany, possibly joined by the Netherlands and Austria, could decide to junk the euro and restore the D-mark, which would then appreciate.

In either case, the costs would be enormous. For a start, the technical difficulties of reintroducing a national currency, reprogramming computers and vending machines, minting coins and printing notes are huge (three years’ preparation was needed for the euro).”

But remember that at the time of the launch of the euro, the official claim in the deluge of publicity aimed at the public opinion of future member countries, was that these costs were small, or even negligible. And keep in mind that the national central banks are still in place and working today so that no new institutions are needed to recreate national currencies.

“Any hint that a weak country was about to leave would lead to runs on deposits, further weakening troubled banks.”

As I explained previously, the “Eichengreen impossibility” does not hold if there is a large euro depreciation prior to the exit of new national currencies. In that case no further depreciation would be needed for these new currencies, or in some cases a minor depreciation would be enough.

“That would result in capital controls and perhaps limits on bank withdrawals, which in turn would strangle commerce. Leavers would be cut off from foreign finance, perhaps for years, further starving their economies of funds.”

Really? Are currency union exits always leading to durable economic and financial catastrophe? Is that what happened to the following countries that chose to exit from a currency union: Bahrain (1973), Bangladesh (1965), Barbados (1975), Botswana (1977), Cape Verde (1977), Cyprus (1972), Dominican Republic (1985), Ghana (1965), Guatemala (1986), Ireland (1979), Israel (1954), Jamaica (1954), Kenya (1978), Kuwait (1967), Malta (1971), Mauritania (1973), Mauritius (1967), Morocco (1959), New Zealand (1967), Nigeria (1967), Pakistan (1949), Reunion (1976), Singapore (1967), South Africa (1961), Tanzania (1978), Tunisia (1958), Vanuatu (1981), among many others, including the countries that regained their independence from the Soviet Union since 1991 in Eastern Europe and Central Asia, and, last but not least, Argentina.

“The calculation would be only slightly better if the euro escapee were Germany.”

Not true. In that case, if the euro becomes the currency of the southern European countries, it will depreciate substantially, thus alleviating the cost of exiting from it, as explained above. While a “euro-south” would not be viable since it would present the member countries with the same “one size fits none” than the present euro, it would be a useful transition for the euro countries that today need a depreciation most, to exit in an orderly manner, and without an unbearable increase in the external debt due to a large depreciation of the national currency vis-à-vis the surviving euro.

“Again, there would be bank runs in Europe as depositors fled weaker countries, leading to the reintroduction of capital controls. Even if German banks gained deposits, their large euro-zone assets would be marked down: Germany, remember, is the system’s biggest creditor. Lastly, German exporters, having been big beneficiaries of a more stable single currency, would howl at being landed once again with a sharply rising D-mark.”

Not true if the euro, whether still including Germany, or without Germany, is sufficiently weakened in foreign exchange markets before the exit of national currencies.

The punch line: Stage five may be closer than we think.

Thursday, December 2, 2010

Pro-euro Eichengreen Joins the Euro-criticism Bandwagon

Kevin O’Rourke (The Irish Economy) has translated Eichengreen’s paper in today’s Handelsblatt.


« I’m probably the most pro-euro economist on my side of the Atlantic. Not because I think the euro area is the perfect monetary union, but because I have always thought that a Europe of scores of national currencies would be even less stable. I’m also a believer in the larger European project. But given this abject failure of European and German leadership, I am going to have to rethink my position.
The Irish “program” solves exactly nothing – it simply kicks the can down the road. A public debt that will now top out at around 130 per cent of GDP has not been reduced by a single cent. The interest payments that the Irish sovereign will have to make have not been reduced by a single cent, given the rate of 5.8% on the international loan. After a couple of years, not just interest but also principal is supposed to begin to be repaid. Ireland will be transferring nearly 10 per cent of its national income as reparations to the bondholders, year after painful year.
This is not politically sustainable, as anyone who remembers Germany’s own experience with World War I reparations should know. »

My comment: It is easy to blame politicians now that things are turning so wrong, as correctly forecast from the start by euroskeptic economists, but wrongly denied by pro euro promoters, among whom Eichengreen and the (ECB funded) CEPR clique in Europe. But the current difficulties were unavoidable, independently of the quality of European leadership, given a strong macroeconomic shock, and that conclusion was well known long before the launching of the euro. Thus, shouldn’t economists who consistently advocated the creation of the euro, applauded politicians for doing so, and fostered illusions about its sustainability for years, consistently misleading the public opinion, share a large responsibility for the coming disaster?

Furthermore, Eichengreen also recognizes, belatedly, that (a) austerity further deteriorates the economy and the fiscal position of countries that adopt it, and (b) a depreciation of the euro is absolutely necessary and would improve the Irish situation. An analysis that the readers of this blog have been exposed to for quite a while.

« Nor is the situation economically sustainable. Ireland is told to reduce wages and costs. It must engage in “internal devaluation” because the traditional option of external devaluation is not available to a country that lacks its own national currency. But the more successful it is at reducing wages and costs, the heavier its inherited debt load becomes. Public spending then has to be cut even deeper. Taxes have to rise even higher to service the debt of the government and of wards of the state like the banks.
This in turn implies the need for yet more internal devaluation, which further heightens the burden of the debt in a vicious spiral. This is the phenomenon of “debt deflation” about which the Yale economist Irving Fisher wrote in a famous article at the nadir of the Great Depression.
For internal devaluation to work, therefore, the value of debts, expressed in euros, has to be reduced. »

As explained in this blog, a large enough depreciation of the euro would then permit an exit of national currencies from the euro straitjacket without the apocalyptic consequences that Eichengreen has predicted, even pretending – wrongly again - that it was just « impossible » to exit from the European currency after entering the zone.

By the "rethinking of his position", Eichengreen is just the first to try avoiding a well deserved blame. Let's wait now for Wyplosz, Giavazzi, Pisani-Ferry, Sinn, and other euro supporters including in particular almost all the French economists, to try both to totally reverse their long held dogmatic position while avoiding at the same time a total loss of credibility. Quite a challenge, indeed.

Theories of What Causes Economic Downturns

Macroeconomists should use all five of them, alternatively or as complements to each other claims Brad DeLong, in order to explain current events. A much needed pragmatic and empirical-historical approach.

Missing in his list, however, is the Real Business Cycle explanation relying on technological shocks, unless he considers it a part of the Austrian theory.

Friday, November 26, 2010

The Best Hope for the Survival of the EU

It is the non-survival of the Eurozone, according to “Worthwhile Canadian Initiative: A mainly Canadian economics blog here .


“If a firm defaults, you can: arrange a takeover; close it down and sell off its assets; write down its; or convert its debt into equity. If a country defaults the first and second options are unlikely. Most commentators are talking about debt write-downs.

A debt write-down raises a number of questions. How big a write-down? Would it be the same for Greece as for Ireland? Should private debts all be written down by the same amount, and by the same amount as sovereign debt? Who decides? How long will it take to decide? How many countries and banks go bust while they are trying to decide? It would be a very nasty argument.

A better option would be to convert the country’s debt into equity. That is essentially what happens when Ireland (say) re-issues the Punt, and converts its Euro debt into Punt debt. (For “Ireland” read “Greece”, Portugal, Spain, Italy, whoever” throughout).

Sure, the law says that it has to pay Euro debt in Euros, not in Punts.But the law also says the debt must be paid in full. And if we are talking about write-downs, we have already admitted that the law will be broken.”

My comment: good food for thought!

Thursday, November 25, 2010

Economic Fundamentals Strike Back at the Euro

As I wrote earlier, here, what happens to the euro is a perfect illustration of Herbert Stein’ Law: “If something cannot go on forever, it will stop”.

Now after years of denial and obfuscation by European politicians, businessmen, and economists, reality simply strikes back: one money fits none, and moreover it provides perverse incentives to borrowers while aggravating macroeconomic disequilibria.

Continental commentators, and especially economists, are busy trying to operate a complete turnaround in their assessment of the situation: the number of those who pretend to have forecast the present difficulties a long time ago is growing rapidly with the deteriorating euro outlook.

But, in France for instance, if I remember well, only four economists consistently and clearly criticized the enterprise from the start (and even before the creation of the euro) and continued to do so during all the following years: Alain Cotta, Gérard Lafay, Jean-Pierre Vespérini, and myself, following the lead of Martin Feldstein in the US. All the others either loudly applauded to the initiative or hedged their bets by forecasting some difficulties but that the governments would easily solve with more “coordination” and a centralized, federal, “European economic governance”.

Now to obtain a more truthful view of the current problem, have a look at non-continental media:
Ambrose Evans-Pritchard , “The horrible truth …” in the Telegraph, Sean O’Grady in The Independent, Ian Martin commenting on the speeding up of the euro-zone crisis in the Wall Street Journal.

And on the inconsistencies of the euro promoters see "The Eichengreen paradox" on Econospeak.

What’s next? No one can forecast the timing of extraordinary events and crises, but in a world of information abundance the moment you realize that something is going to change, that change has probably already happened. The day of reckoning may not be too far away.

Tuesday, November 23, 2010

Europe and Ireland: The Charge of the Tax Brigade

Here is Tyler Cowen (“Second Thoughts on Ireland”, Marginal Revolution, November 22):

“ 1.The Irish had some excellent economic policies, but they needed to regulate their banks more. They were simply too optimistic and too sloppy.
2. Irish troubles could have been contained, at some point over the last two years, had Ireland not been on the euro. They would have devalued, defaulted, and had a rapid bounce back up, within the next three years.”

And here is Randall Henning in a paper titled “European Pressure to Increase the Irish Coporate Tax Is Deeply Misguided”:

"The ironies and contradictions surrounding the demand by some European governments that Ireland raise the corporate tax rate as part of a program to address its present financial predicament are breathtaking. They threaten the political underpinnings of the euro area …

First, Ireland encountered the Financial crisis relatively early and came relatively clean. Rather than falsify its statistics and hide the problem, it acknowledged the magnitude of the crisis in its banking system and secured acknowledgement in return from the international community. …

Ireland is being asked to accept a program not because its government needs financing now but because other governments in Europe fear the contagion effects. … tax matters have not been devolved to the European Union; they fundamentally remain the province of member states. There are many governments in Europe that … hope to harmonize rates across the membership. But member states have not agreed to a common discipline on corporate taxes and Ireland ratified the Lisbon Treaty on the understanding that its relatively low rate … would not be constrained. To compound the irony, the OECD reports … that Ireland collects substantially more corporate tax revenue as a percentage of GDP (2.7 percent) than Germany (1.9 percent) and about the same as France (2.9). …

Raising Ireland’s corporate tax rate would not address the problems of the Itish banking system directly … (and) there are many sources of revenue beyond the corporate tax rate that can address this problem without the same damage to competitiveness. …

The French and German governments’ attempt to secure an increase in the Irish corporate tax rate as part of the financial package … appears opportunistic in the extreme.”

My comment.

To sum up: the Euro has been used as a permanent tariff protecting German industries from “southern” competition, due to a disequilibrium entry rate and ulterior real appreciation in the South. And now, its deep, fundamental crisis is used by France and Germany as an excuse and opportunity to eradicate tax competition from Ireland.

Who would dare say that the European monetary unification has been a “liberal” (pro market) policy when observing these deeply distorting, beggar-my-neighbor policies?

Monday, November 22, 2010

Policy Instrument Preferences of Pro- and Anti-Market Economists

Bryan Caplan is puzzled by the polarization of policy instrument preferences both of pro- and of anti-market economists. Excerpt:

“Austrians and hard-core libertarians usually jointly dismiss monetary and fiscal policy. But among more moderate economists, there's a long-standing tendency for pro-market views to correlate with a preference for monetary over fiscal policy. Friedman and Samuelson are the classic examples: Friedman combined highly pro-market views with a strong belief in the macroeconomic power of monetary policy and impotence of fiscal policy, while Samuelson combined rather anti-market views with a strong belief in the macroeconomic power of fiscal policy and far less confidence in the power of monetary policy. The generations of economists that Friedman and Samuelson taught usually bought the same intellectual bundles.

On reflection, these intellectual bundles are puzzling. Fiscal policy encompasses not just spending, but taxing as well. So when anti-market economists see a downturn and demand more government spending, pro-market economists could insist that tax cuts are just as good a solution, if not better. Indeed, in turns of libertarian purity, belief in the power of fiscal policy allows pro-market economists to claim that all government has to do in a downturn is "get out of the way." Belief in the power of monetary policy, in contrast, requires pro-market economists to advocate additional government action in the face of a downturn. Remember: Friedman's critique of the Great Depression is that the Fed didn't do enough.

Question: Is there any good explanation for the pro-market/monetarist and anti-market/fiscalist correlation? Or is the right story mere happenstance and path dependence?” (Econolog, November 21, 2010).

My comment.

First, a remark: the position of Milton Friedman towards the efficiency of monetary policy was rather ambiguous. Of course, he held the Federal Reserve responsible for the depth and intensity of the Great Depression, due to its excessively restrictive stance when confronted to banking failures. But otherwise he claimed that active monetary policy had mostly negative (inflationary) consequences, and anyway was much too imprecise, due to its lags in impact on real activity, to be useful for compensating shocks on the macroeconomy. He thus advocated an “automatic monetary growth” policy. Things got even more complicated with the later “rational expectations” school of monetarism that held monetary policy to be powerless. Hence the current criticism of the Fed’s quantitative easing.

Second, regarding the question raised by Caplan: Pro-market economists probably prefer monetary policy because its channels of influence are diffused through the banking system, and thus it is, as a first approximation, non discriminatory with respect to different sectors of the economy. Obviously monetary policy exerts some differential effects on small and big firms, individual and corporate borrowers, but these differences are relatively small.

On the contrary, fiscal policy is inevitably discriminatory and selective. An across-the-board spending policy his highly unlikely, and organized pressure groups are going to see that it is oriented towards their favorite beneficiaries.

In other terms a monetary policy is naturally more neutral than fiscal policy, and thus creates less distortions and welfare losses in the economy.

That being said, I completely agree that “when anti-market economists see a downturn and demand more government spending, pro-market economists could insist that tax cuts are just as good a solution, if not better”. That is indeed what I advocated earlier in this blog as the best policy in the current great recession: cut taxes and simultaneously cut some spending in order not to increase deficits too much, but do not give priority to cutting deficits (and especially not by increasing taxes in a recession). And at the same time adopt an expansive monetary policy in order to avoid over valuation of the currency and in order to stimulate exports in our typically quite open economies. It is a pro-market-neo-keynesian-old-monetarist policy.

The instrumental preferences of pro-market and anti-market economists are thus likely to be separated by more complex fault lines than that of the old monetarist/fiscal policy debate.

Thursday, November 18, 2010

Stein's Law, Lachman, and the Euro

Desmond Lachman apparently discovers, in The American that “Europe Confronts Stein’s Law”, meaning by that the aphorism of the late Herbert Stein: if something cannot go on forever, it will stop. And this appears particularly apt for the current eurozone, he concludes.

I agree of course since this is precisely the analysis and comparison that I presented at the “Convention Debout la République” at the French National Assembly, April 10, 2010.

My conclusion, in French, was:

“ Herbert Stein, ancien président du Council of Economic Advisers, avait formulé une « loi » qui s’énonçait : ‘lorsqu’une chose ne peut pas durer indéfiniment, elle cesse’. Cela me semble s’appliquer plutôt bien à ce que sera sans aucun doute le sort de l’Euro.”

Or, in English : Herbert Stein’s law seems to prefigure rather well what is going to happen, without any doubt, to the euro.

The whole paper was posted at the time on my homepage.

My comment: ideas do travel, but seven months to cross the Atlantic is much too long. Is the market for ideas that inefficient?

Wednesday, November 17, 2010

Greg Ip: The Little Book of Economics

I promised the readers of this blog (September 10, 2010) a comment on Greg Ip’s The Little Book of Economics, How the Economy Works in the Real World. Here it is.

Before reading the book (250 small pages) I was a bit put off by Ip’s quote, in the introduction, of Paul Krugman who declared that most macroeconomics – the study of the broad economy – of the last 30 years was “spectacularly useless at best, and positively harmful at worst.”

This was one of the hyperboles that went with the rather exceptional intensity of the 2008-2009 financial crisis, but now seems utterly wrong.

In a similar vein, the claim by the author that, as a young journalist, he “discovered a chasm between the economics taught in college and the real world” stroke me as excessive and largely misleading, intended perhaps to attract readers distrustful of “academic” thinking.

Fortunately, Ip proves exactly the contrary in his very clear and easy to understand little book. He uses extensively the best of macroeconomic theories to explain current and past events and policies, as well as the basic rules and mechanisms of growth and fluctuations. In the process he shows a real pedagogical talent for simplification and, more importantly, for judgment. In complicated matters he goes right to the crux of the problem and is able to select the relevant theory in the midst of the generally huge, complex, and mostly uninteresting macroeconomic literature. But he does that without burdening the lay reader with the usual lists of references and quotes that make the reading of textbooks often heavy going and boring.

Non economists interested by macroeconomic events and policies will find in the book a very readable introduction to the matter, without equivalent in other publications. This is moreover a useful introduction to macroeconomic and growth textbooks that develop these analyses in much more detail.

But professional economists too can find in Ip’s synthesis a useful bird’s eye view of that part of their theories that survived the “trial by fire” of the last few years.

Reading Ip helps one put everyday’s macroeconomic events and policies in an intelligible perspective. Not a small feat indeed.

Tuesday, November 16, 2010

The Euro Mess (continued)

“How a Financial collapse Starts” writes Tyler Cowen in his November 15 post in Marginal Revolution.


“The EU is pressuring Ireland to accept a bailout and Ireland does not (yet) want it; this should give pause to those who think that "no bailout" policies are time consistent. More generally, the simplest model is that the EU could take care of Ireland and Greece fairly easily, but the spectre of Spanish default lurks in the background. Spain is a much larger economy and the Germans cannot simply pay up to save it. All pronouncements and policies about Ireland (or for that matter Portugal) should be viewed in light of this larger "game." If Spain were fixed essentially the trouble could be paid off to go away, for now at least. But Spain is not fixed.”

As Irwin Stelzer notes in the Wall Street Journal:

“The shrinking of Greece's economy makes it likely that the inspectors now in Athens will report this week that Greece did not generate sufficient tax revenues to meet its deficit reduction targets. That will be grist for the mill of critics who are saying that the austerity program imposed on Greece by the IMF and the European Central Bank is the road to ruin, rather than to recovery.”

In the end:

“Greece will fail to meet its deficit-reduction targets, and lay plans for a default that will include some grief for the private investors that had a moment of relief when Ms. Merkel's eased her demands for a haircut. Portugal, still unwilling to adopt a strict austerity program, will follow suit, as will Ireland and, eventually, perhaps but not certainly Spain, which is less indebted than Greece. (…)

With a GDP approximately twice as large as the combined total of Greece, Portugal and Ireland, Spain matters. And the outlook is not good. The Spanish economy grew not at all in the third quarter. It's unemployment rate is now 20% and headed higher. Its banks have yet to recognize the losses incurred from property loans that have gone sour, or completed consolidation. Higher taxes and spending cuts will slow things even more next year.

The Royal Bank of Scotland estimates that banks outside the troubled countries hold over €2 trillion of those countries' debt, so their balance sheets will shrink, and with it their ability to lend in their home countries. Not a pleasant prospect in the run-up to Christmas.”

My comment: Remember the alleged virtue of the euro to shield member countries from the financial shocks that would ruin other non member ones? Remember a thing called "the stability pact" that Mr. Prodi famously but belatedly discovered to be a "stupidity"?And remember the so-called "no bailout condition" in the ECB charter? The conclusion: can you trust a monetary system that so consistently produced results completely contrary to its promises? Apparently the markets have some doubts.

Friday, November 12, 2010

An Excellent FT Lex Column about the G20 Circus and Real Problems


“Policymakers gathered in Seoul for this week’s G20 meeting may have been empathising with the circus entertainers who perform the delicate balancing act of simultaneously spinning many plates on top of long sticks. There is much that is up in the air: the next Eurozone crisis may be imminent as speculators increase their bets on a default by Ireland, the shockwaves of the US’ $600bn QE salvo in the ongoing currency war are reverberating around the world and the latest data from China has shown unequivocal evidence of vast and persistent imbalances. The president of the World Bank hinted that a return to the gold standard or a currency peg based on gold may be the answer, but besides being politically impossible, such a move would be viciously deflationary. Meanwhile investors are pouring the unnaturally cheap financing available in the US into emerging markets as the positive underlying rebalancing between rich and poor continues apace.”

I agree: China’s “Bretton Woods 2” type of exchange rate policy (a quasi fixed parity of the Yuan vis-à-vis the dollar) pushes the US Federal Reserve towards more monetary easing (i.e. money creation) in order to depreciate the dollar and stimulate the economy, also stimulating the carry trade (borrowing cheap liquidity in the US to invest in emerging economies. The US financial system earns fat profits recycling the Chinese savings towards other emerging markets. Meanwhile, the next step of the euro’s crisis could come from Ireland, even before the widely anticipated second act of the Grece’s crisis. And overall, European governments and ECB continue to advocate self-defeating deflationary austerity while preparing to borrow more in order to bail out Ireland.

That’s why so many investors currently see gold as the ultimate refuge, but an attempt to revive the defunct gold standard would bring about the ultimate disaster.

India’s Secret Weapon in its Economic Race with China

Demographics. I really like Ed Dolan’s recent post. Granted, there are many other factors of performance. But this one is a major one.

Friday, November 5, 2010

Are Newspapers Being Killed By Free Online Access?

... “the empirical evidence doesn’t support the thesis that print circulation is dropping because print subscribers are happily just reading the paper online” writes Felix Salmon , who quotes further analysis by The Guardian's Peter Preston:
« There is no clear correlation between a rise in internet traffic and a fall in newspaper circulation. Some papers are growing in both formats, others are succeeding in neither, according to new research ».

Tuesday, November 2, 2010

The Rise of Public Debt

Public debt levels keep rising throughout the world, but especially so in advanced economies: Brookings Institution’s Eswar Prasad and Mengjie Ding present the evidence and projections for 2015 in an article published today on the Brookings website.

They claim that “the public debt burden may ultimately fall on the working-age population rather than the entire population”, but that conclusion is much disputed on theoretical grounds. It depends in particular on future tax, debt, and inflation policies as well as on future growth. While the implied transfers across generations are uncertain, it is true that “rising debt levels pose risks to fiscal and macroeconomic stability” beyond some critical debt/GDP ratio, that, however, is not known with any degree of acuracy.

Monday, November 1, 2010

Bacterial History Vindicated: Plague Waves Originated in China

The three plague waves of history, the 6th century plague that reached Constantinople during the reign of Justinian and is thought to have killed perhaps half the population of Europe and to have eased the Arab takeover of Byzantine provinces in the Near East and Africa, the “Black Death” that began in Europe in 1347 and carried off an estimated 30 percent or more of the population, and the Manchurian Pneumonic Plague epidemic that reached Hong Kong in 1894, and from there San Francisco in March 1900, have been tied in a common family tree by a team of medical geneticists led by Mark Achtman of University College Cork in Ireland, as reported by the New York Times.

By looking at variations in living strains of “Yersinia pestis”, the bacterium first identified by the Swiss and French Pasteur bacteriologist Alexandre Yersin in Hong Kong in 1894 in his study of the bubonic plague epidemic there, the team has reconstructed a family tree of the bacterium and dated the branch points of the tree, correlating the major branches with historical events.

They conclude that all three of the great waves originated in China, where the root of their tree is situated. Plague would have reached Europe across the Silk Road. But then apparently it separated in two branches according to a team of biologists led by Barbara Bramanti of the Institut Pasteur in Paris and Stephanie Haensch of Johannes Gutenberg University in Germany. Analyzing ancient DNA and proteins from plague pits, the mass burial grounds across Europe were plague victims were interred, they have been able to distinguish two strains of the bacterium and they inferred that medieval Europe has been invaded by two different sources of Yersinia pestis, one reaching the port of Marseilles in 1347 and progressing rapidly north, and the other which arrived from Norway into Bergen op Zoom in the Netherlands.

These epidemic waves had momentous political and economic consequences: the Justinian plague arguably weakened in a decisive manner an already over-extended Byzantine empire, reducing its defense capacity by curtailing the number of soldiers it could mobilize against Eastern conquerors as well as its tax revenues, also opening the way to several major “barbarian invasions” of what was left of the Roman empire, while the Black Death radically changed the land/labor ratio in Western Europe, raising agricultural productivity and consequently wage rates, and stimulating the commercial revolution of the end of the Middle Ages, events beautifully analyzed by William McNeill in his pioneering and now classic book of 1976, Plagues and Peoples.

These new discoveries also provide and excellent example of the trend towards a “consilience” of various sciences (here biology, geography, economics and history) that McNeill first envisioned.

Saturday, October 30, 2010

Did France Cause the Great Depression?

In their Monetary History of the United States, Milton Friedman and Anna Schwartz held the Federal Reserve responsible for the transformation of the 1929 stock market crash into the worldwide great depression of the 1930s.

Now a new NBER working paper (29 october 2010) suggests that the French gold policy was also to blame. Here is a short presentation on the NBER website:

"France increased its share of world gold reserves from 7 percent to 27 percent between 1927 and 1932, creating an artificial shortage of reserves and putting other countries under enormous deflationary pressure. Douglas Irwin concludes that if the historical relationship between world gold reserves and world prices had not changed as it did, world prices would have increased only slightly between 1929 and 1933, instead of declining dramatically. Thus, it seems that France's shift in policy was an important contributor to the worldwide deflation of 1929-33."

Now beware of the enforcement of the "Deutsche Mark standard" by the European Central Bank that is managing the euro as a "strong" currency relative to the dollar (and thus to the yuan) and advocates strict austerity policies in Europe at a time when deflation appears to be the present and immediate danger. Have a look at a Mark Thoma's post (based on a San Francisco Fed analysis) showing that the US inflation rate path is following with a few years lag the Japanese one (see especialy the graph on the core inflation in Japan between 1989 and 2000, and in the US between 2001 and 2010).

A rerun of the 1930s has been avoided until now but the real bite of austerity programs in the eurozone is still to be felt in 2011 and 2012.

Monday, October 25, 2010

Big Banks Should Cut Dividends

The Italian ones show us the way here .

But cut the managers’ compensation and bonuses too.

Sunday, October 24, 2010

Christina Romer’s Advice

Now isn’t the time to cut the deficit, here.

My comment: Quite sensible indeed.

Crisis 2012

An interesting forecast from Greg Ip in the Washington Post.

Thursday, October 21, 2010

The First Industrial Revolution Ever and the Origin of Complex Life

« All animals, plants and fungi evolved from one ancestor, the first ever complex, or "eukaryotic", cell. This common ancestor had itself evolved from simple bacteria, but it has long been a mystery why this seems to have happened only once: bacteria, after all, have been around for billions of years.

Cells could not become complex until they could produce sufficient energy. This obstacle was overcome when a cell engulfed some bacteria and started using them as power generators – the first mitochondria.

Once freed from energy restraints, genomes could expand dramatically and cells capable of complex functions – such as communicating with each other and having specialised jobs – could evolve. Complex life was born. »

And, I would add, through specialization, exchange and production. Economics in a word.

A fascinating account of new research perspective by Nick Lane of University College London and Bill Martin of the University of Dusseldorf, in Newscientist.com.

Condoleeza Rice on German Reunification

« German Foreign Minister Hans-Dietrich Genscher, (…) seemed to think of the unification process as more of a merger. I preferred to see it as an acquisition. »

Read the complete interview in Spiegel Online.

Milton Friedman and the Interest-rate Fallacy

David Beckworth and William Ruger wonder what Friedman would say about Fed policy under Bernanke. Excerpt:

“First, low interest rates do not necessarily mean monetary policy is loose.

Friedman criticized the policies of the Fed in the 1930s and the Bank of Japan in the 1990s on this very point. Both central banks claimed to be highly accommodative at these times, pointing to low interest rates as evidence of easy monetary policy. Friedman countered, however, that low interest rates may reflect a weak economy rather than easy monetary policy.

Back in 1997, in fact, he called the idea of identifying low interest rates with easy monetary policy an interest-rate fallacy. The only time low interest rates do indicate loose monetary policy is when they are below the neutral interest-rate level, which is the interest-rate level where monetary policy is neither too simulative nor too contractionary and is pushing the economy toward its full potential.

The implication for today's Fed is that although its target federal funds rate is low, its stance still may not be very stimulative given that the neutral interest rate is also low. The Fed should not rely on the level of the federal funds rate to measure the stance of monetary policy to determine whether its actions are supporting or hindering the economy.”

Read their article in Investors.com.

Monday, October 18, 2010

ECB versus IMF

The Stelzer column in the Wall Street Journal .

A Few Reasons Why Economists Disagree (Mostly About Policies)

Solow's, Becker's and Mankiw's explanations: problems are especially complex, effects uncertain, and distributive outcomes contestable.

Read the New York Times column here .

Friday, October 15, 2010

Competitive Devaluations Could Be Good for Individual Countries and for the World Economy.

“Currency depreciation in the 1930s is almost universally dismissed or condemned. This paper advances a different interpretation of these policies. It documents first that depreciation benefited the initiating countries. It shows next that there can be no presumption that depreciation was beggar-thy-neighbor. While empirical analysis indicates that the foreign repercussions of individual devaluations were in fact negative, it does not imply that competitive devaluations taken by a group of countries were without mutual benefit. To the contrary, similar policies, had they been even more widely adopted and coordinated internationally, would have hastened recovery from the Great Depression.”

This quote is from Barry Eichengreen and Jeffrey Sachs, “Exchange Rates and Economic Recovery in the 1930s”, The Journal of Economic History, December 1985.

My comments: 1. The countries that exited the Gold Standard first got the strongest and most rapid economic recovery, while late floaters like France or Switzerland paid a heavy price in the form of a lengthier bout of depression and unemployment. Today the problem is to exit from the "Bretton Woods 2" regime of partly fixed exchange rates.

2. What we call “currency wars” or “chaos” can be seen as a simple “tâtonnement” of the governments towards and equilibrium vector of exchange rate prices. It is due to the fact that nobody knows exactly in advance the precise (and fluctuating) equilibrium price of the national currency, and especially not the other governments.

It follows that, while many economists claim that currency wars are a zero sum game (what one country gains another must loose) they nevertheless have a real utility: the production of new information about what the adequate equilibrium exchange rates should be. It is a positive sum game and a process of discovery, as useful as competition in other markets. Planners everywhere generally consider competition to be a pure waste. But they are wrong as the collapse of planned economies demonstrated.

Roubini on Currency War

"The first salvos in this war came in the form foreign-exchange intervention. To diversify away from US dollar assets while maintaining its effective dollar peg, China started to buy Japanese yen and South Korean won, hurting their competitiveness. So the Japanese started to intervene to weaken the yen.
This intervention upset the EU, as it has put upward pressure on the euro at a time when the European Central Bank has placed interest rates on hold while the Bank of Japan (BoJ) and the US Federal Reserve are easing monetary policy further. The euro’s rise will soon cause massive pain to the PIIGS, whose recessions will deepen, causing their sovereign risk to rise. The Europeans have thus already started verbal currency intervention and may soon be forced to make it formal."

Read the paper, here.

Tuesday, October 12, 2010

Job Search and Unemployment

Edward Glaeser explains the work of the new Nobel Laureates and its source in George Stigler’s economics of information here.

Monday, October 11, 2010

Factory Farming Is Extremely Inefficient

“It takes seven calories of food input into an animal to produce one calorie of food output.”

And the farm subsidy structure exacerbates the factory farm problem: it encourages farmers to feed corn to cows, a food that they’re not naturally able to digest.

Read the BigThink interview of Jonathan Safran Foer here .

More (Labor) Taxes, Less Work

Here is Greg Mankiw’s calculus.

Thursday, October 7, 2010

Immigrants Boost US Employment and Production

According to a new study by Giovanni Peri for the San Francisco Fed:

"The effects of immigration on the total output and income of the U.S. economy can be studied by comparing output per worker and employment in states that have had large immigrant inflows with data from states that have few new foreign-born workers. Statistical analysis of state-level data shows that immigrants expand the economy's productive capacity by stimulating investment and promoting specialization. This produces efficiency gains and boosts income per worker. At the same time, evidence is scant that immigrants diminish the employment opportunities of U.S.-born workers."

Here is the article in the FRBSF newsletter.

Monday, October 4, 2010

Stelzer, Euromess, and "Eurosud"

All over Europe officials are doing the same thing over and over again and expecting different results, writes Irwin Stelzer in the Wall Street Journal.

Greece led the peripheral countries in piling up debts that it had little hope of ever repaying. Non-peripheral countries, most notably Britain and France, joined in the fun. Then, given that national cupboards are bare, the Euroland authorities stepped in with a cunning plan to handle excessive debt: borrow more to repay the previous wild borrowing. The Irish government thus will drive its deficit to 32% of GDP to bail out banks hit by the inability of property developers to repay excessive borrowings.

The current chosen path combines austerity with borrowing by Euroland as a whole. The borrowing in effect transfers the debts of the broke countries to Germany’s balance sheet, while austerity concentrates the burden of repayment on the current recipients of government outlays – public-sector workers, benefit recipients, and private sector contractors for whom the government is a major customer. And it lets the creditors, who made the excessive loans in the first place, off the hook.

However, “history suggests that austerity without loose monetary policy can be self-defeating. Never mind: Eurocrats will pay any price to avoid the humiliation of restructuring and unleashing inflation worries in Germany. So a combination of austerity and tighter credit is in store …”

"Euroland politicians think they can (1) fight markets, (2) inflict infinite pain on voters in democratic countries, and (3) whip the profligate into line. They can do none of these" because markets set the borrowing rates and voters turn out politicians who push them too far.

Sensibly, Stelzer advocates a currency depreciation, large enough to restore competitiveness of the peripheral countries (and maybe of the others also I would argue) to avoid debt “restructuring” and a heavy dose of inflation. But the currency he has in mind would be a newly created “Eurosud”, the result of partitioning the eurozone into two smaller areas.

That would prove, in my opinion, doubly illusory. First a new currency limited to the countries of southern Europe would not constitute an optimal currency area any more than the current eurozone, and the Eurosud "one size fits all" monetary policy would thus not prove adequate for anyone of the member countries. And second, it would raise all the problems of creating a new currency in the middle of a confidence crisis, a daunting task, much harder than a simple return to national currencies (for which national monetary institutions and central bank are still in place) that would soon have to be repeated later, when each country would have to turn back to its own former national currency. It would be much better to proceed directly to that second stage now, especially because the euro is again gaining strength relative to the dollar, losing all the benefits of its beginning of the year depreciation to more reasonable levels.

And meanwhile, interest differential between peripheral countries and Germany keep growing, reflecting the increasing risk of their government bonds.

Saturday, October 2, 2010

Ptolemy Knew a Lot About Germany's Urban Economy

In 150 AD, the mathematician and astronomer Ptolemy drew 26 maps of the known world in colored ink on dried animal skins. One of these depicts “Germania Magna”, an area far remote from his residence in Alexandria. He nevertheless demonstrated extensive knowledge of the country even though the map has been until now difficult to interpret despite repeated efforts by linguists and historians.

But new work by a group of classical philologists, mathematical historians and surveying experts at Berlin Technical University’s Department for Geodesy and Geoinformation Science has produced, from the Ptolemy’s drawing, an astonishing map of central Europe as it was 2.000 years ago. The map shows that the North and Baltic Seas were known as the “Germanic Ocean” and the Franconian Forest in northern Bavaria was “Sudeti Montes”. It also shows a large number of cities such as Bicurgium (present day Jena) and Navalia (Essen). It turns out that half of the present day cities in Germany are 2.000 years old.

Researchers believe Ptolemy drew on Roman traders’ travel itineraries, analyzed seafarers’ notes and consulted maps used by Roman legions operating to the north. It was primarily surveyors with the Roman army, which appears to have advanced as far as the Vistula River, who collected information on the barbarians’ lands. The researchers had the great fortune to be able to refer to a parchment tracked down at Topkapi Palace in Instanbul, the document being the oldest edition of Ptolemy’s work ever discovered.

The complete article in the Spiegel Online is well worth reading and it includes two photos of the ancient medieval copy of Ptolemy’s map.

Friday, October 1, 2010

Why Monogamy is Prevalent in Rich Nations

A post by Marina Adshade, a professor of economics at Dalhousie University in Halifax, Nova Scotia, with a reference to the original work of three Israeli economists, Eric Gould, Omer Moav, and Avi Simhon, published in the American Economic Review, 2008: “The Mystery of Monogamy”.

Read the Adshade article here.

Thursday, September 30, 2010

The Meaning(s) of “Economic Reform”

Scott Sumner's analysis of the changing sense of the word:

“The term ‘economic reform’ meant more government between 1875 and 1975, and has implicitly meant less government since.”

Readers of my “Second Twentieth Century” know why.

He further notes that the recent financial crisis pushed the US towards statism, while the rest of the world seemed to be moving in the opposite direction.

Read the post here .

How Everyone Could Soon Accept Credit Card Payment

Simply with a cell phone: a small device that hooks up to an iPhone allows a person to scan and charge a credit card. Read the New York Times article.

A boon for individual entrepreneurs.

Immigration and the Economy: Food for Thought

Is everything that people usually believe about immigration and employment dead wrong? That’s what Rosemary Joyce, an anthropology professor at Berkeley, claims in a post on the Berkeley Blog.

A note for European readers: remember that the US labor market is characterized by much more flexibility of wages than European ones, making employment of low qualification immigrants much easier in the US than in Europe. Moreover the welfare protection is more extensive in Europe, attracting a larger pool of immigrants even though it weakens the effective labor supply and labor demand through higher cost of employment for firms and lower net wages for labor, due to a higher tax on labor.
Thus, the analysis of the immigration issue cannot be separated from an analysis of the unemployment effects of the regulation of labor markets and of the similarly negative effects of the payroll tax.