Ferguson on the Coming European Defaults

Niall Ferguson has many interesting things to say about Europe, and particularly this :

« You cannot base fiscal federalism exclusively on a pact – a kind of pact of death that nobody ever runs a budget deficit. »

And this:

“There are, in fact, three ways out of an excessively large public debt. One is that you default … the second is that you inflate it away … a third way … is that you grow your way out of it. That’s rare. … the default scenario is the most likely of the three, simply because to inflate the debt away is something that the ECB is prohibited from doing. And as for growth, well, if austerity is the only solution in German minds, you can forget that.”

Read the interview in Business Insider.

Euro-Crisis, Bargaining, and Unpredictability

A good post in The Monkey Cage by political scientist Henry Farrel who compares the  Cuban crisis competition in risk taking and the current euro crisis with the help of Nobel Prize winner Thomas Schelling’s analysis.

The risk of one actor going too far in the current game of chicken and thus precipitating breakdown by accident “is all the higher given the importance of market reactions in determining success or failure, and the inability to predict with even the faintest degree of confidence how markets might react to this or that move (it is clear from previous iterations of this game that the key political actors’ ability to model market reactions to their proposals is … limited).”

I came to a similar conclusion by a different reasoning in my book on the topic: there are so many different combinations of national strategies, and conflicting interests, in this oligopolistic game that predictability of the issue is nil. The only conclusion that seems to me reasonably likely is that the outcome will not be consensual. It will be arrived at by acute confrontation and partial or total breakdown, not by a new unanimous agreement.

Read the whole post here.

Eurozone About to Unravel

"Is Europe About to Unravel?" asks Tim Duy here.
Excerpt:
“Even the illusion of political unity in Europe appears to be dissolving before our eyes.  This, of course, should come as no surprise to anyone watching the European crisis unfold.  The key problem always was the internal imbalances, a problem for which European policymakers have never offered a credible solution.  They simply don't have such a solution in the context of a system of fixed exchange rates.  I believe that currency devaluation is the only option that will change relative competitiveness in any reasonable timeframe and restore internal balance. But that option is unavailable for Euro members. 

Lacking currency devaluation as a tool to resolve imbalances, European policymakers turned to fiscal austerity.  That plan has failed, pushing nation after nation into ever deepening recession.  With Greece going on its fifth year of recession, I imagine by now that Portugal, Spain, and even Italy now see the writing on the wall for themselves.  Sadly, however, the alternative is exiting the Euro, which almost certainly means financial chaos for the Continent as a whole.  

The Eurozone is like a roach motel.  You can get in, but you can't get out.

Still, peripheral nations can only accept so much pain before the costs of being in the Euro outweigh the costs of leaving.  And Italy is now sending Berlin a clear warning that such an endgame is approaching.” 


My comment:

Except for the “you can’t get out” false assertion, Duy’s is an accurate description of the “euro error”. I disagree also on the idea that devaluation is unavailable for Euro members. Depreciation of the euro would be a good first step, even though it does not solve the problem of cross national prices divergence within the zone. But the latter difficulty could indeed be solved more easily by exits from the zone once the value of the euro  vis-à-vis the dollar and other currencies has been seriously curtailed, and only a marginal correction of intra european exchange rates remains to be done.

Hierarchical, or Managerial, Capitalism

John Kay endorses in a Financial Times column ("Business leaders of today are not capitalists") an analysis of contemporary “capitalism” that I developed in “The Second Twentieth Century: Decline of Hierarchies and the Future of Nations” (Hoover Press, 2006) and extended in an article in the French review “Commentaire” (“La crise des capitalismes hiérarchiques”, Hiver 2006-2007).

While in XIXth century capitalism “the economic and political power of business leaders derived from their ownership of capital and the control that ownership gave them over the means of prouction and exchange”, “the business leaders of today are not capitalists in the sense in which Arkwright and Rockefeller were capitalists. Modern titans derive their authority and influence from their position in a hierarchy, not their ownership of capital. They have obtained these positions through their skills in organizational politics, in the traditional ways bishops and generals acquired positions in an ecclesiastical or military hierarchy”.

What Kay does not mention however is that they often got their position through progress in the political system, and thanks to the support of the state hierarchy.

This system is still capitalist in the sense that managers need the consent of shareholders, even if it is only formal. But it is more accurately described as “managerial” (the power is detained by salaried managers), hierarchical, and corporatist (there is a deep collusion between political managers and business managers).

What Kay does not mention either is that, as I explain in my analysis, the extent of hierarchies in society is governed by the abundance or scarcity of information. As explained by Ronald Coase a long time ago, productive hierarchies (business firms) exist in order to economize on information, relative to a decentralized mode of production operating through individual craftsmen intensively using market exchanges (in the polar case).

And market exchanges are much more intensive in information than hierarchies, thus an increase in available information (a decrease of its cost) leads to a shrinkage of hierarchies and a development of markets.

The result is that in a period like ours, at a time when there is an extraordinary abundance of cheap information (the IT revolution), hierarchies tend to shrink while markets expand.

And this is the source of the present crisis of hierarchical, or managerial, or corporatist capitalism, a regime inherited from the previous period of high production and scarce information, extending from the last quarter of the XIXth century (the second industrial revolution) to the last quarter of the XXth century. This was the apex of the hierarchical capitalism, an organizational regime that produced the Rockefellers but also the Lenins and other totalitarian dictators, while empires expanded as never before.

The current trend is one of complete reversal of these organizational structures. And the problem for managerial capitalisms (and their managers) is how to get out of the previous system, and reorganize production, both public and private, along more markedly markets lines. How to break up big structures to bolster productivity again.

To conclude, there is one last thing that Kay does not mention: it is my book, even though it has been translated into English! Come on John, be a little more generous next time …

S&P’s Diagnosis

Here it is, in a nutshell, as summarized by  The Economist:

“According to S&P, EU leaders have misdiagnosed the euro-zone crisis. They have focused too much on tackling the increase in governments’ budget deficits, which is only part of the problem. As a result, they did not pay enough attention to the deeper causes of the crisis: the divergence in competitiveness between the euro-zone’s core of strong economies and its struggling “periphery” as well as the huge cross-border debts that stem from this gap. Reforms based solely on fiscal austerity could easily become self-defeating, notes S&P.”

They are perfectly right of course, and of course also fiscal austerity has already proved to be self-defeating (in Greece for instance). But the reason for this misdiagnosis of European leaders is that the fundamental problems of the euro-zone so well described by the rating agency are inherent to the very existence of a single currency, forced upon very dissimilar economies. 

The financial mechanism resulting from the euro is by nature destabilizing: a single interest rate boosts activity and bubbles in countries that have an above average inflation rate, while it further depresses activity in those that have an under average inflation rate (probably resulting from under average activity level). The divergence is built in and cumulative.

Moreover, a single interest rate and structurally fixed (or suppressed) exchange rates boost capital flows from higher income countries towards lower income economies, the “huge cross-border debts” problem signaled above.

Realizing that leads inevitably to a disturbing diagnosis: the source of the problem is the euro itself, and thus what is required is a policy of euro exit. The governments concerned are not ready yet, politically, to face such a reality. A deeper crisis is needed before they do. 

Big Mac and Currencies

The Economist’s “Big Mac Index” of currencies’ over or under valuations is back in this week’s “Daily chart” here. 

The Swiss Franc is the most overvalued currency relative to the US dollar (by more than 60 %), beating Norway, Sweden and Brazil. The most undervalued national currencies are those of India (by 60 %), Ukraine, and of Hong Kong. China comes fifth.

But why, oh why, are the intra eurozone real exchange rates over or under valuations not published? Given the current debate on potential euro exits it would provide a measure of relative competitiveness that could be compared to the conventional user cost of labor data.  

Fukuyama on European Identities

An interesting analysis of diverse European experiences in The American Interest.

France is best and Britain worst … for once …

Read it here.