Monday, August 6, 2012

From Kremlinology to Frankfurtology

 During the Cold War, lack of reliable information about the Soviet Union forced Western analysts to "read between the lines" and to use the tiniest tidbits, such as the removal of portraits, the rearranging of chairs, positions at the reviewing stand for parades in  Red Square, the choice of capital or small initial letters in phrases such as "First Secretary", the arrangement of articles on the pages of the party newspaper "Pravda" and other indirect signs, to try to understand what was happening in internal Soviet politics.

Kremlinology then was the name for the study and analysis of Soviet politics and policies, based on efforts to understand the inner workings of an opaque central government, while “Kremlinologist” referred to academic, media, and commentary experts who specialize in the study of Kremlinology (Wikipedia).
In the current “Cold War of the Euro” between southern and northern member states, and given the especially opaque decision-making in economic and monetary policy at the Union level, a new discipline of Frankfurtology is obviously a necessity.
Ambrose Evans-Pritchard is an outstanding practitioner of the approach and he provides an especially lucid analysis of Mr. Draghi’s skilled tactics (The Telegraph, August 6). According to him the ECB president has pulled off a master stroke. “He has secured a mandate for “unlimited open-market operations”, a far cry from the half-hearted and self-defeating bond purchases of the last two years”, he writes, and a licence to act like the US Federal Reserve does. He has done so with the help of Mario Monti in order to convince the conservative leaders in Nordic capitals to trigger an EFSF bail-out, with supplicant states (Spain and Italy) signing a "Memorandum" in which they  would pledge to enforce stricter austerity policies. Then, with the EFSF as the enforcer, the ECB would play the cash cow. According to the plan, Spain will go first, hat in hand, to request a bail-out that investors are already pricing in. Hence the 6% surge on Madrid’s bourse on Friday.

The key to this victory is the Italian (Draghi-Monti) mobilization of the Latins that realize they can inflict a deflationary shock and banking crisis on Germany at any time by walking out of EMU and imposing capital controls -- as a chorus of leading economists now advocate -- if provoked.

“But do they understand this in the Bundestag or the Tweede Kamer, or even want to understand? Or will they demand Carthaginian terms to placate their own electors before agreeing to any EFSF loan package? Will they push the great imperial capitals of Rome and Madrid one step too far?” asks Evans-Pritchard.

“The Draghi plan can still go badly wrong. Much of North Europe’s political class clings to a warped narrative of what has gone wrong in EMU, attributing the crisis to fiscal debauchery and Latin failings. They misdirect their wrath. The enemy is the currency itself. It is a structural crisis, a misalignment of cycles and real interest rates, a sorry saga of unbridled capital flows.

Without rehearsing the tedious details of this debate, let us remember that Spain ran a budget surplus of 2% of GDP during the Trichet bubble. Italy scores top of the IMF's fiscal sustainability index, far above Germany, France, Holland, Britain, the US, and Japan.

It is the euro that is suffocating Italy and Spain. They have the wrong intra-EMU exchange rate, and no sovereign control over anti-cyclical policy levers. The debt crisis -- a misnomer -- is a sympton. The sooner they break free, the better, for them.”

My comment:

Nevertheless, the prospect of an ECB flood of credit clearly implies a depreciation of the euro in foreign exchange markets and thus an improvement of the Eurozone economies competitive position relative to other countries of the world. It would also improve their short run growth perspectives as I explained in “Euro Exit”. That would make a survival of the euro more probable, on the one hand, but at the same time it would not solve the more serious problem of intra-EMU mispriced real exchange rates, while it would make it much easier for individual countries to get out of the euro (also explained in “Euro Exit”) on the cheap because the burden of their external debt in euros would have been reduced. 

Here lies the main virtue of Mr. Draghi strategy. By offering the best short term growth perspective for “saving the euro” in its present form, it also leads to the best opportunity for exiting the euro by reducing the burden of euro labeled debts without disrupting the international capital markets, and by minimizing the need for devaluation of the newly recreated national currencies.

If he succeeds, the sophisticated analyses of Frankfurtologists will loose much relevance just as those of Kremlinologists did when glasnost and perestroika disappeared overnight in their Soviet form as the Soviet Union imploded.

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