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.