Tuesday, December 20, 2011

Feldstein Now Endorses My Euro Policy Prescription

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.



Sunday, December 18, 2011

How Debt Is Impacting the Current Slow Recovery

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.

Saturday, December 10, 2011

A Japanese Style Europe

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.

Friday, December 9, 2011

Euro Crisis: From Bad To Worse

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 …

Monday, December 5, 2011

Austerität vs. Souverainisme

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


“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. 

Saturday, December 3, 2011

Germany as a Geo-economic Power

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.

Friday, December 2, 2011

Evans-Pritchard Is Right: Eurozone Monetary Expansion Is Required

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

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

By Paul Krugman. 
“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

"A Freakonomics Quorum",  here.

A mixed bag, of course.

More Plans to Save the Euro

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?

Friday, November 25, 2011

The Religion of an Increasingly Godless America

An interesting post by Amanda Marcotte for Reuters.

“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.”

“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.

Read more here.

The Coming Euro Depreciation

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.     

Wednesday, November 23, 2011

Germany’s Only Concern Is …

... 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 ….

Sunday, November 20, 2011

Centralized and Undemocratic Europe

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.

Thursday, November 10, 2011

Euro: When Money Stops Flowing

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.

Sunday, November 6, 2011

American and Chinese Realistic Views of Europe

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.

Friday, November 4, 2011

Calomiris: Greece Should Leave the Euro

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

“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. 

Wednesday, November 2, 2011

Greek Democracy

 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.


… “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.