The Myth of Lazy Southern Europeans (Again)

German officials shouldn’t be so patronizing with the “PIGS”. Read the post by Kash Mansori (The Street Light) here .

Why Britain is in Better Shape than Italy

Here is Krugman on the advantages of having your own currency.

Meanwhile, the euro zone governments try to “save” the euro ...

Great Stagnation ... or Great Relocation?

An interesting post in Noahpinion on why the center of gravity of economic activity and growth is shifting from the rich West, and especially the US, to emerging Asia.

While Tyler Cowen (Marginal Revolution) explains in his book The Great Stagnation that slowing income growth in the US is due to a slowing down of innovation and scientific discovery, Noah’s hypothesis is that growing income per capita in the East, multiplied by a very large population, makes for larger markets there that exert an irresistible pull on firms and economic activity away from the West. This is the “Great Relocation” thesis, and I find it rather persuasive.

Among the measures he suggests to reverse the trend I would support the idea of increasing the population through immigration and that of concluding free trade deals with other rich countries.

My criticism however is that much of Asia’s growth is simply due to the catching up of US income level phenomenon, and as such is a transitory phase that does not necessarily implies a fall in the American income per capita. That was already the case of Western Europe after the war, and then of Japan. And in these latter cases the catching up didn’t affect the leading position and continued progress of the US economy. This is not a zero sum game but a transition towards a new, higher income level, equilibrium for all. It only means that the acceleration of delocalization of low wages industries and firms create a need for new, high technology industries, that requires a high-quality economic environment, in the West.

So that, I would call the present transformation one of Great Reallocation (or Great Restructuration) rather than a Great Stagnation or a Great Relocation one. And in that perspective, the US entrepreneurs will find new products and processes to replace departed activities, sooner or later, but as in previous economic revolutions it is impossible for us to imagine them in advance. This is precisely the painstaking day-to-day job of innovators and entrepreneurs. It has been done several times in the past and it will happen again in the future.

Feldstein on the Coming Greek Default …

… and France’s and Germany’s risky postponment gamble.

Excerpt:

“The markets are fully aware that Greece, being insolvent, will eventually default. That’s why the interest rate on Greek three-year government debt recently soared past 100% and the yield on ten-year bonds is 22%, implying that a € 100 principal payable in ten years is worth less than € 14 today.”

My comment: the best analysis of the current situation by the economist that clearly saw the future consequences of the euro as soon as projected, in 1992.

The complete post is well worth reading, here .

Greece on the Brink, Euro Should Fall Further

Twenty-four centuries after History’s first sovereign default, that of ten Greek municipalities in the 4^th century BC (the creditor was the temple of Delos), the country is at the edge of a major default, five times the size of Argentina’s default in 2001.

The expected “haircut”, could be as severe as 80% of the debts’ amount. But it would still be manageable, as far as French and German banks, as well as the ECB, are concerned, because they are said to be able to weather this magnitude of losses, given the small absolute size of the Greek economy and thus of its debt, compared to the size of the whole European economy and of the banks themselves. Their shares have been savaged nonetheless, for fear of something worse. The real danger would come from investors’ reaction to a Greek default: many would be selling Italian and Spanish government bonds to avoid a similar amputation on their much larger holdings of these countries’ debt, thus making for a fall of bonds’ market values and a rise of interest rates, and further aggravating the state of these governments’ finances. Italian and Spanish haircuts would also inflict much larger losses on the European banks and that would jeopardize the financial system in Europe, and maybe elsewhere too.

Fearing this, European governments, under pressure from the US, appear now ready to issue more bonds (possibly Eurobonds, even though it is not significantly different from pure German bonds) in order to avoid Greece a default. And the ECB is ready to lend more money to the governments (a monetization of their debts).

The question is: while all this would be good for the banks, would it be good too for economic growth? Incurring more debts is not going to help European economies to deleverage, nor reduce the burden of their over-indebted governments. It would increase in fact the debt/GDP ratio. But monetization would help:  is Mr. Trichet, finally, seeing the light and accepting a depreciation of the euro (which has already begun during the past week, the euro falling to less than 1,35 dollars)? There is still, however, a very long way to go to a value for the euro nearing equilibrium … (a one for one value to the dollar or even less in my opinion).

For Greece however, absent a very large depreciation of its currency, the drachma that is, after an exit from the euro zone, one cannot hope a return to positive growth even after default, but on the contrary a prolongation of the economic slump.

To conclude, remember that Japan tried the increased indebtedness policy strategy to get out of depression for a decade, thus avoiding the worse outcome, but accepted stagnation to this day. In a balance sheet recession, more debt is not the solution. A major realignment of exchange rates accompanied and caused by differential, and possibly massive, money creation is required. This is the common element between the 1930s required exit from the gold standard, and the present day required exit from the de facto Deutsche Mark standard. The later the exit, the later will be the return to growth.   

Read a very interesting Bloomberg post covering the very wide range of possibilities here .

The Most Dangerous Decade

A difficult transition awaits developed, corporatist capitalist economies: their problem is how to downsize both states and corporations to confront the competition of emerging economies in the new era of “small is efficient”.

Here is a lucid diagnosis posted in the CNBC’s blog:

“Robin Griffiths, technical strategist at Cazenove Capital, told CNBC that key markers, including the long-term low yields on U.S. Treasurys, indicate that the U.S. is in a depression not just a recession.

The bond market is clear and unequivocal in its message—this is a depression, not just a period of slower growth," he said, adding that a different approach was needed by developed economies to get out of the current mess.

History shows that what we need are small government, low taxes, and low regulation, but what we have is big government, big taxes, and big regulation, which is not going to work this time," Griffiths said.”

This is nothing less than a U-turn in economics conceptions and policies.

The European Debt Crisis

An excellent post by Jeffry Frieden, Professor of International Peace at Harvard University, in Econbrowser, yesterday: “Europe’s Lehman Moment”.

Frieden explains that “Europe is in the midst of its variant of the great debt crisis that hit the United States in 2008. Fears abound that if things go wrong, the continent will face its own “Lehman moment” – a recurrence of the sheer panic that hit American and world markets after the collapse of Lehman Brothers in October 2008.”

Excerpts:

“most of the public discussions have been highly misleading. In Northern Europe, and especially in Germany, the tone has been one of outraged indignation. The high moral tone is misplaced. Certainly many Southern European banks and households, and the Greek government, borrowed irresponsibly; but German and other Northern European banks and investors lent just as irresponsibly. It’s not clear that there’s any real ethical distance between irresponsible borrowers and irresponsible lenders.

And most Northern Europeans also seem to believe that the bailouts have gone to lazy Southern Europeans. In fact, their purpose has been to shore up the fragile Northern European financial systems. German banks are among the weakest in Europe; some of them (especially the state-owned landesbanks) are effectively bankrupt. If they were forced to mark down their Southern European debt, they might well collapse in a heap, and the European financial system could grind to a halt.”

“In Europe as in America (in 2008, JJR), the real question is how the costs of this devastating debt crisis will be distributed. Who will pay – creditors or debtors? Taxpayers or government employees? German or Greeks? More realistically, what combination of sacrifices will be politically tenable, both across countries and within countries. The aftermath of every debt crisis sinks into conflict over who will bear the burden of adjustment to the new reality.”

Europe’s experience, however, differs from that of America’s because of the existence of the euro. While the United States went on a consumption spree financed by borrowing trillions of dollars from abroad, much of it going to the housing’s market, in Europe the ECB’s interest rates at “Northern” relatively low levels have been made available – due to the euro – to rapidly growing countries in Southern Europe that had previously had high interest rates, reflecting both their higher inflation rates and their past exchange rate risks.

It followed that for a decade, a group of countries on the edge of the Euro zone borrowed massively from Northern European banks and investors. In Spain, Portugal, and Ireland, most of the borrowed money flooded into the overheated housing market, while in Greece, it helped finance a continual budget deficit and a consumption boom.

This, I would add, even though Frieden does not mention the point, is a classical case of an artificially distorted price (here the “Northern euro interest rates” offered, due to the euro and the single monetary policy, to the more inflationary and more risky Southern borrowers that should have paid inflation and risk premiums) generating a massive misallocation of resources, and specifically a boom in borrowing that reached unsustainable levels. As in the U.S. case, the responsibility of the lenders is a major one: they made huge profits in providing excess finance to the South, just as the mortgage lenders in the U.S. were offered an excess supply incentive by the governmental regulations subsidizing housing finance.

Frieden rightly concludes that the very solvency of major European financial systems is at stake and that “this – not some abstract desire to extend a hand to the Greek and Portuguese people, or to save the euro – has been the principal reason for Europe’s ongoing debt bailout.”

But until now, these bailouts have not been enough:

“It seems clear that the Greek and Portuguese austerity measures will not be sufficient to allow the countries to service their debts; Spain seems on the verge of a similar slide into default; and even Italy is now at risk of going the way of the other debtors. Some or all of these debts will have to be restructured, the interest rates reduced and maturities extended. If not, there will be a wave of defaults whose reverberations will rival those of Lehman failure.”

What Frieden does not contemplate, however, is that the situation is made much worse by the existence of the euro, and the absence of a central government in Europe. The euro has destroyed, over a decade of existence, the competitiveness of the Southern economies that benefited mostly to German exports. It follows that the austerity policies intended to reduce the indebtedness of the South are applied to enfeebled economies, thus pushing them further towards contraction and default. Today, the U.S. economy is still paying the price of the credit bubble’s burst. But in Europe the price will be much higher if the Southern economies are not allowed to regain competitiveness through an exchange rate depreciation that would purge it from the large costs differentials relative to the rest of the world in general (due to euro overvaluation) an to the Northern ones within the euro zone, accumulated over a decade of euro membership. And that means both a euro depreciation, and, on top of it, specific national currency depreciations that imply a return to national currencies.

The euro zone is thus facing a worse challenge than the one to which the U.S. were confronted in the 2008 debt crisis, because not only the sharing of losses is at stake, but simultaneously a radical reform of the monetary constitution is required. While the U.S. economy if following a slow, uncertain path back to recovery four years after the crisis, the recession could be much worse and extend for a longer period in Europe because of the difficulty involved in accepting to acknowledge the reality of the euro’s failure, and of the responsibility of the single currency in the current crisis. What is required is nothing less than a reversal of the monetary empire-building of the last few decades. And I understand that this is a rather hard truth to swallow for the euro zone elites.

The whole post is well worth reading here .