Evans-Pritchard Is Right: Eurozone Monetary Expansion Is Required

The eurozone badly needs monetary expansion and some inflation, that is, a depreciation of the euro as I advocated in my recent book. It is the first step to get out of the crisis.

Evans-Pritchard writes in The Telegraph:

“A near universal view has emerged that Europe’s crisis can only be solved by governments and fiscal policy, with varying views over the proper dosage of pain.

I beg to differ. This is a monetary crisis, caused by a jejune central bank that aborted a fragile recovery by raising rates earlier this year, allowed the money supply to collapse at vertiginous rates in southern Europe, and caused a completely unnecessary recession – and a deep one judging by the collapse in the PMI new manufacturing orders in November.

Needless to say, drastic fiscal austerity is making matters a lot worse. You cannot push two-thirds of the eurozone into synchronized fiscal and monetary contraction without consequences.

Note that five-years break-even spreads have dropped below zero for Italy, meaning that markets are now pricing in outright deflation. For a country with public debt stock of 120pc of GDP, that is a death sentence.

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The eurozone economy is in imminent danger of crashing into deflation, bringing down the whole interlocking edifice of sovereign debt and distressed lenders.

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This crisis can be stopped very easily by monetary policy, working through the old-fashion Fisher-Hawtrey-Friedman method of open-market operations to expand the quantity of money, ideally to keep nominal GDP growth on an even keel.

This does not solve the 30pc intra-EMU currency misalignment between North and South, of course, but it  quite literally “solves” the solvency crisis for Italy and Spain. They would not be insolvent if the ECB had not driven them into depression by letting their money supply implode.

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The bank can reflate Club Med off the reefs. It chooses not to act for political reasons because this means higher inflation for Germany. That is the dirty secret. Everybody must be crucified to keep German internal inflation under 2pc.”

The whole article here is a must read.

My comment: the lack of decision of the governments in the eurozone is not happenstance: it reflects this basic conflict of national objectives and requirements. It shows very clearly that one size fits none, and that the continental centralization of macroeconomic policy is terribly dangerous.  That is, unworkable.

Crazy Ideas and Vested Interests

Simon Johnson criticizes the notion that the European Central Bank could make a massive loan to the International Monetary Fund, which would then turn around and lend to countries like Italy. “This is a bizarre notion” he writes.

Instead, “the ECB should provide financial support directly to Italy, if that is the goal.

But that goal increasingly seems both to be the only idea of officials and the last failed notion of a fading era. More bailouts and the reinforcement of moral hazard – protecting bankers and other creditors against the downside of their mistakes – is the last thing that the world’s financial system needs.”

The whole post (about Too Big to Fail banks ad how to cope with them) is well worth reading, here.

Euro and the Confidence Fairy

By Paul Krugman. 

Excerpt:

“The idea that austerity measures could trigger stagnation is incorrect,” declared Jean-Claude Trichet, then the president of the European Central Bank. Why? Because “confidence-inspiring policies will foster ad not hamper economic recovery.”

 But the confidence fairy was a no-show …

 Read the post  here.

Various Opinions About the Euro’s Future

"A Freakonomics Quorum",  here.

A mixed bag, of course.

More Plans to Save the Euro

Is the “Great Dither” over? Can political centralization really proceed? here is Edward Harrison’s analysis for Credit Writedowns.

I am still skeptical. It seems more likely that some more time will be bought, and temporary hopes stimulated, until the next “last chance to save the euro”. The reason for being so wary of official discourse? It has been consistently false, and often deliberately so, over the past twenty years ... Remember the claims according to which the strong euro was good for growth and employment, that it would compel national inflation rates to converge, that it would protect national economies from economic and financial crises?

The Religion of an Increasingly Godless America

An interesting post by Amanda Marcotte for Reuters.

Excerpts:

“Listening to the national discourse, one could be forgiven to imagining that America is becoming an ever more religious place. The amount of God talk in the public square has dramatically increased in a generation. Prior to the 70s, the concept of “the religious right” had barely existed, but now it’s a powerful lobbying force with multiple groups from Focus on the Family to Concerned Women for America, all sitting on more money than most liberal special interest groups could ever hope to accumulate.”

But:

“If you poll actual Americans, you’ll find that the trend is not towards more religiosity, but towards less. Much less, in fact.”

How come?

“The heightened emphasis on religion in politics is the death throes of the old order.  … It’s only when (Christian) started to feel their power threatened (that) they become defensive, and in doing so, became much louder.” And the Americans are becoming more fond of the separation of church and state.

Read more here.

The Coming Euro Depreciation

Simon Johnson agrees with the first step towards a solution of the euro problem that I suggested in my book, “L’euro: comment s’en débarrasser”. Namely, a substantial euro depreciation that would stimulate growth in the eurozone.

In his post for Project Syndicate on November 23, “Does Europe Have a Korean Option?” he writes:

“The obvious escape route leads through economic growth, which would reduce the debt-to-GDP ratio that make interest payments look reasonable. But the standard ways to stimulate the European economy are not available: fiscal policy is constrained by already-high debt levels; and the European Central Bank, fearing inflation, has kept a tight rein on monetary policy.

None of the other ideas on the European table, including various kinds of “structural reform,” will provide fast growth in the short term.

…  A genuine devaluation, on the other hand, would work wonders for the real economy. The moribund Italian economy would spring to life if the euro fell by 30%, adjusted for inflation.”

Some observers wonder how the euro could be depreciated, given that it is a floating currency, the price of which is market determined. But Johnson explains the obvious:

“If the ECB agreed to loosen monetary policy or provide enough “liquidity” to support various bailouts, investors would fear inflation, weakening the euro. On the other hand, if the ECB preferred to let major countries, such as Italy, default on their debts, this would likely weaken the euro even further, as investors feared a contagion of defaults.

While depreciation would never be eurozone officials’ stated policy, it currently looks like all roads lead in that direction.”

There are major obstacles in the way of a conversion of the ECB to a loosening of its monetary policy: first the statutes of the institution that assign it only one aim, price stability. But also the German aversion to inflation, due not so much to a memory of the 1923 hyperinflation, but more to the re-export model of the German economy that rely on a strong currency and non increasing wages.

An increase of inflation would fuel wage increases in Germany and a depreciating euro would inflate the cost of buying intermediate industrial components from Central Europe and elsewhere, thus jeopardizing the competitiveness of German exports. 

As a result it seems to me much more likely that the German government will stick with its “brinkmanship” policy leading to Greek and probably Italian governments defaults. Indeed, austerity programs (the shrinking of government spending), while necessary in the medium term, bring the southern economies closer to default.

As explained in The Economist article “Is this really the end?” (November 26), here:

“Add the ever greater fiscal austerity being imposed across Europe and a collapse in business and consumer confidence, and there is little doubt that the euro zone will see a deep recession in 2012 – with a fall in output of perhaps as much as 2%. That will lead to a vicious feedback loop in which recession widens budget deficits, swells government debts and feeds popular opposition to austerity and reform. Fear of the consequences will then drive investors even faster towards the exits.”

And it will lead to a major depreciation of the euro. It has started already with today’s temporary low point of 1,33 to the dollar, and one can only hope that it continues all the way to something like a 1 to 1 parity or even less.

This would alleviate the current pressure leading to a break up of the euro. But it is the only way out of the crisis and it would make the exit of individual countries from the eurozone much easier, avoiding the high cost of total collapse.