Monday, November 11, 2013

“Strong” Euro, Deflationary Risk, and Globalization Bashing

 Euro's excess strength implies an increased risk of deflation in the eurozone and a continued "globalization bashing" in public opinion.

Indeed the ECB surprise rate cut reflects (at long last) a growing concern over the inflated price of the Euro and the risk of deflation in the Eurozone that it creates.

Deflation is a problem because lower prices mean lower incomes and ultimately profits, so businesses cut spending on everything from new capital investment to wages and jobs, while consumers cut on their spending too and try to deleverage. Everyone is poorer and the cuts in corporate and household spending can bring further price cuts and usher the EU economy in a deflationary spiral whereas growth is already paltry and falling. The EU inflation rate is currently at 0.7% a year, well below the official 2.0% target and the EU official growth rate forecast for the year has recently been revised downwards from 1.2% to 1.1%.

With lower incomes debtors have a harder time repaying fixed debt payments (interests). The ratio of interest payments to current national income increases, increasing also the risks of default of debtors while EU banks hold hundreds of billions of southern governments bonds. And in theses countries too the debt/Gdp ratio keeps rising despite optimistic official declarations to the contrary.

In itself, the recent strength of the Euro price versus the Dollar (and thus the Yuan) determines a weakening blow to the Eurozone economy because it hampers exports to the rest of the world and boosts imports from the rest of the world, depressing the production of the Eurozone firms exporting to the rest of the world and of the Eurozone firms that compete with the imports from the rest of the world.

This explains why a growing and vocal share of the opinion in the Eurozone condemns “globalization”. Open markets (free trade) mixed with a massively overvalued currency can destroy an economy. Confronted with rigid wages, decreased incomes, and rising taxes rates (in recession governments need to increase transfers and social spending to stay in power while their tax receipts contract) exporters file for bankruptcy as well as firms faced with an increased competition from imports.

 There is no way out of such a dangerous situation without a major return of the Euro price to an equilibrium level with the Dollar and the Yuan, meaning approximately a 1 to 1 parity with the Dollar. The smallish adjustment that followed Mr. Draghi’s mini-cut of interest rates (from 0.5 to 0.25%) is dramatically inadequate to the task. A major correction is, however, “what it takes to save the Euro”, or, more to the point, to ”save the Eurozone economies”, even though even a major external adjustment of the Euro price would not in itself be enough to correct the competitive unbalances between individual countries within the Eurozone. Further corrections of exchanges rates between Italy, Spain, France and Germany would be necessary, on top of a major depreciation of the Euro relative to the dollar (and the Yuan), for these countries to return to sustained growth. Hence the necessary return to national currencies. The price of the currency is not the only determinant of growth of course, but with external prices of national products and services overvalued by 25% or 30% and imports undervalued by the same proportion, no return to growth is possible.

Unfortunately there is a wide and growing divergence about monetary policy within the ECB between representatives of the “north” and of the “south”. It follows that it is likely that ECB’s policy will not be radically changed towards expansion at a time when the US Federal Reserve has delayed the ending of quantitative easing.  These divergences of monetary policies on both sides of the Atlantic prevent any major correction of the Euro’s excessive pricing in the short run while making the euro quite popular with international investors. But the risk is growing that such an unbalance is unsustainable. That’s why the risk ratings of euro debtors are downgraded and it is a sign of further weakness in the Eurozone economies, until a new crisis of the euro, echoing that of last year, returns and compels the eurocrats to adopt some radical new stance.

Tuesday, October 15, 2013

An Economic Interpretation of Nazism

I’ll deliver a lecture on « Totalitarianism and Democracy in the Twentieth Century: The Case of Nazism » at the Institut d’Histoire Sociale (Library La Souvarine in Nanterre, near Paris) next Wednesday, October 23 at 6.00 p.m.

For more information go to: 

Everything You May Want To Know About the New Nobel Laureates

Several interesting comments by Tyler Cowen, Alex Tabarrok and others in Marginal Revolution here.

Wednesday, September 18, 2013

Mr. Schäuble and the Euro Doomsday Machine

Ambrose Evans-Pritchard apologizes – tongue in cheek -- in The Telegraph for having “been wrong about everything” concerning the Euro crisis and German policies, in an article titled “My groveling apology to Herr Schäuble”, a response to Mr. Schäuble’s own article “Ignore the doomsayers: Europe is being fixed”, published in the Financial Times (September 16).

According to the German finance minister “the eurozone is clearly on the mend both structurally and cyclically” under the guidance of courageous German policies and following the example of their own earlier old-fashioned root-and-branch reform (which was social democrat (SPD) Gehrard Schroeder’s accomplishment, by the way).

Some excerpts from Evans-Pritchard stinging rebuttal:

“I apologise for mentioning that the debt trajectories of Spain, Greece, Italy, and Ireland have accelerated upwards under the austerity plans, and therefore that the policy has been self-defeating.

I apologise for suggesting that German reforms under Schröder have been vastly overblown, and that German competitiveness gains have been chiefly the result of a beggar-thy-neighbour wage squeeze at the cost of EMU trade partners.

It was unconscionable of me to say that Germany has locked in a semi-permanent trade advantage over Club Med, or for saying that the trying to close this gap by imposing deflation on the South is impossible because this will play havoc with debt dynamics.

How could any of in the eurosceptic camp have stooped to the historical pornography of the 1930s, suggesting for one moment that EMU replicates the worst errors of the interwar Gold Standard, or that the German-led creditor bloc is doing to Spain exactly what the US-led creditor bloc did to Germany from 1928-1933? Just sheer smut.

I should not have questioned his wisdom in thinking it is possible to harmlessly enforce contractionary policies on the South of a single currency zone without offsetting expansion in the North.

It was carping for me to suggest that recent charts showing a dramatic narrowing of unit labour costs in Spain et al are largely bogus, the mirror of mass unemployment that causes an automatic rise in apparent productivity; and nor should I have quibbled about the low trade gearing of Spain, Italy, Portugal, and Greece, or suggested that exports are too small a share of GDP to lift these countries out of the morass quickly. This is just pointy-headed, clever-clever, anorak stuff, and frankly laughable.

The eurozone is recovering. It is immune to the sharp rise in the exchange rate of the euro over the last six months. It is immune to a 70 basis point rise in borrowing costs imported from Fed tapering. It is immune to the emerging market crisis. It doesn’t matter that the M3 money supply has rolled over again, slowing to stagnation levels, or that EMU credit contracted at an accelerating rate of 1.6pc in July. None of this matters.”

And to conclude:

“I apologise personally to Mr Schäuble for calling him a dangerous mediocrity: arrogant, shallow, narrow-minded, provincial, and unscientific in equal degree. This was shockingly rude. It brings shame to Fleet Street.”

At last the euro war lets some British fresh air (and some fun) enter in a non-debate enforced by officials from all member countries (“politicians of all countries, unite!” (with apologies to Karl Marx) ) who cannot convincingly answer the mounting euroscepticism in public opinion, both North and South, while the election deadline approaches in Germany.

Read more.

Monday, September 2, 2013

How Much Europe?

An interesting post on Reuters (Sunday September 1) by Luke Baker. Excerpt:

“In the dark days of Europe's debt crisis in 2012, when it seemed Greece might be forced out of the euro and the single currency could implode, leaders believed "more Europe" was the only answer.
Only deeper integration can bolster the region to withstand future crises, they said. A more united Europe will punch its weight in the world, not collapse on the ropes.
Among the more fervent voices in support was German Chancellor Angela Merkel, whose declaration that "we need more Europe; we need more cooperation" prompted policymakers to draft plans for a banking union, closer fiscal ties and, in time, a more complete political integration of the union's 28 countries.

How times have changed.
A year on, banking union - the idea of providing a single backstop for all the region's banks - stumbles ahead but only as a shadow of its original self. Fiscal union is barely mentioned, while the steps that would have come after are long forgotten.
Instead of "more Europe", the more common phrase in Brussels these days might be "EU-lite". Rather than the relentless logic of "ever closer union" - the guiding principle of Europe's federalists for 60 years - the attitude among some member states is better described as "only as much Europe as we really need".”

Read  more.