Euro Bedtime Stories

 Peter Boone and Simon Johnson just published a really important post, “The End of the Euro : A Survivor’s Guide” on their blog, The Baseline Scenario (May 28).

  

Excerpt :

“Some European politicians area now telling us that an orderly exit for Greece is feasible under current conditions, and Greece will be the only nation that leaves. They are wrong. Greece’s exit is simply another step in a chain of events that leads towards a chaotic dissolution of the euro zone.”

The punch line:

“Europe needs to salvage its great achievements, including free trade and labor mobility across the continent, while extricating itself from the colossal error of the single currency.

Unfortunately for all of us, our politicians refuse to go there – they hate to admit their mistakes and past incompetence, and in many case, the job of coordinating those seventeen discordant nations in the wind down of this currency regime is, perhaps, beyond reach.

Forget about a rescue in the form of the G20, the G8, the G7, a new European Union Treasury, the issue of Eurobonds, a large scale debt mutualisation scheme, or any other bedtime story. We are each on our own.”

My comment:

I wrote it back in 1998, in my book, L’erreur européenne (American edition, Euro Error, Algora 1999):

“The European mistake of the Nineties (the preparation for launching the euro) is the century’s most serious error of economic policy after that of the Thirties. The liabilities of governments are particularly heavy, their behavior inept and their responsibility immense.”(p.73).

“Prisoners of false conceptions and chimerical objectives, as in the Thirties, (our political leaders) will yield probably at the last moment, when faced with the ruin of the economy and the democratic revolt of the populace” (p.258).

The paper by Boone and Johnson, here, explains  in detail why a complete collapse of the euro is most likely, perhaps in months, or may take several more years, but anyhow is practically on the cards. It is a must read.


PS: I have been told that the link with The Baseline Scenario, Simon Johnson's blog, is out of order. It can be accessed through a Google search, however.

The Market and Political Power of Banks

An excellent article by Luigi Zingalez (University of Chicago Booth School of Business) for Bloomberg on the political power of US banks.

Excerpt:

“One beneficial side effect of the Glass-Steagall Act was to fragment the banking sector and reduce the financial industry’s political power. Another was to foster healthy competition between commercial banks and investment banks.

Starting in the 1970s, these limits were progressively removed. The deregulation unquestionably increased the efficiency of the banking sector and fostered economic growth. But with this growth came concentration. In 1980, there were 14,434 banks in the U.S., about the same number as in 1934. By 1990, this number had dropped to 12,347; and by 2000, to 8,315. In 2009, the number was less than 7,100.”

The article is well worth reading in full  here.

The Mysterious Japanese Economy

An interesting post by Scott Sumner (“The Money Illusion” blog) here. Is the Japanese standard of living declining or slightly increasing as Krugman claims? And is it an example for Western economies of how to manage the over-leverage crisis (the debt problem if you prefer)?

Read also the comments from readers pointing to the specific demographic condition of Japan.  

Becker and Posner on the Drachma

Not all economists have been wrong. Read a very clear analysis here.

No Solution Without Devaluation

Jeremy J. Siegel, a noted financial economist and a professor at Wharton, endorses a part of my policy prescription for the euro crisis: devaluation. He writes, in a tightly articulated article, here, that the “least disruptive route Europe can take is to sharply lower the value of the euro. This will help improve the trade deficit in the peripheral countries and bring some relief to their downward spiraling economies. Euro depreciation would push the German trade surplus even higher and cause some inflationary pressures in those few European countries that are still near full employment. Given the strong German labour market, a lower euro would be likely to raise German wages and help close the gap between German and other European labour costs.”

It is difficult indeed to understand why the German government and financial bureaucracy oppose such a solution. But even if they changed their mind a euro depreciation would, nevertheless, only constitute a partial solution to the European massive disequilibrium vector of exchange rates, frozen into the euro. Given the prices and costs divergences accumulated over the 1999-2012 period, no depreciation of the euro versus the dollar or the yuan could suffice to compensate the growing competitiveness handicap of southern Europe vis-à-vis Germany. A major realignment of nominal exchange rates has to take place within the eurozone, and that means a breakup of the euro.

The least disruptive way to do that would be, of course, for Germany to exit from the euro. The new DM would rise and the euro, now the currency of the rest, would fall markedly, thus solving in one stroke the two competitive handicaps, vis-à-vis the dollar and the yuan zone on the one hand, and vis-à-vis Germany on the other hand.

This would considerably improve economic activity in the southern countries, and also, by depreciating the external debts in euros, would make individual countries exits (in a second stage) much easier to do. Understandably, Germany will not retain such an option. But in that case a depreciation of the euro (as advocated in my recent book and also proposed by Siegel) would lead to a subsequent easier exit of individual members, the necessary condition for a return to growth.

For want of such a depreciation, “the current pressures by the German government to force austerity on the peripheral countries will accelerate the disintegration of the monetary union” concludes Siegel.

My analysis differs from his, however,  in that a disintegration of the monetary union seems to me absolutely necessary in any case, depreciation or not. But a lower euro would enormously reduce the cost of the exit.

I am now waiting with much interest the next article by Jeremy Siegel in which he should tackle the second part of the problem, the intra eurozone, euro distortion of competition and depressive influence that make exit highly recommended.

Jobs, Growth, and the Fiscal Union

At last, a bit of common sense on the destruction of the European economies by the euro. It comes, obviously, from outside the Eurozone. Read, by all means, the complete column by Boris Johnson in The Telegraph here.

J.P. Morgan on IMUs (Improbable Monetary Unions) and Why The Euro Was Doomed From The Start

Who defined economics as the dismal science? (Thomas Carlyle). Have a look at this clever chart showing the degree of dispersion of various nations, each one being characterized by more than 100 factors (from corruption to deficits),within “hypothetical monetary unions.”

The Eurozone major countries come out as more heterogeneous than even a grab bag of nations whose names are beginning with the letter “M”!

Read the article in The Atlantic here.

Roubini Is Right, As Usual …

“Greece must exit”, he writes for Project Syndicate (May 17). Of course it has to, for the welfare of the Greeks themselves. Politicians and commentators, meanwhile, keep obfuscating the issue and develop at length new denials of reality in the media, ad nauseam, even though everything that was labeled "impossible" yesterday becomes day after day the new topic of economic policy. Remember the time, a few months ago, when “more integrated European governance” was supposed to solve all the “PIIGS” problems? Remember the Eurobonds fantasy? Remember the Eichengreen fallacy that once a country entered the euro it was “forever”?

For someone who predicted long ago the present slow motion train wreck of the eurozone, further comments on the present evolution seems superfluous and indeed rather boring. Of course, Greece will default again and exit from the euro, and there will be no apocalypse, because on the one hand default diminish the burden of foreign debt, and on the other hand a massive depreciation of the new drachma in international currency markets will restore Greek competitiveness, especially in regard to the very important tourism industry (about 18 percent of Greek GDP), while discouraging imports that compete against local products and services.

Have a look at Roubini’s punch line:

“The experience of Iceland and many emerging markets over the past 20 years shows that nominal depreciation and orderly restructuring and reduction of foreign debts can restore debt sustainability, competitiveness, and growth. As in these cases, the collateral damage to Greece of a euro exit will be significant, but it can be contained.

Like a doomed marriage, it is better to have rules for the inevitable divorce that make separation less costly to both sides. Make no mistake: an orderly euro exit by Greece implies significant economic pain. But watching the slow, disorderly implosion of the Greek economy and society would be much worse.”

Quite right.

Is the ECB a "Bad Bank"?

Patrick Allen on excess leverage and risk in Frankfurt, here.

More Monetary Stimulus?

NDGP (nominal GDP) targeting is gaining ground. Now Chicago Federal Reserve president Charles Evans endorses it. Read the explanation in The Atlantic here.

Now if the US monetary policy turns more expansive what will the ECB do? Continue to look exclusively at the inflation target and limit its interventions to subsidizing ailing banks? What then will become of the dollar price of the European currency?