Greece Will Default : Feldstein

I agree. Read the paper here .

The Folly of Currency Pegs

John H. Makin has an excellent post with that title in the May issue of the American Entreprise Institute Outlook Series. He draws an apt parallel between the current crisis of the Euro, and the demise of the Bretton Woods system, and finds that it gives the European economies good reason for hope, if only their governments accept to recognize the facts.

Excerpt:

“The current flap over the sustainability of Greece's membership in the European Economic and Monetary Union (EMU) is reminiscent, in many ways, of the events leading up to the collapse of the Bretton Woods system--another ultimately untenable currency regime--which was put into place after World War II and terminated by the break of the dollar's link to gold after August 1971. The period of increased exchange-rate flexibility that followed the demise of the Bretton Woods system turned out to be beneficial. The same possibility exists with respect to the aftermath of the current currency crisis in Europe.”

Makin further notes:

“The abandonment of fixed exchange rates--although it was not realized at the time--was fortunate. The oil-price shocks of 1973-74 would have blown apart any system of fixed exchange rates in the midst of a highly disruptive crisis environment that required substantial exchange-rate adjustments. Today, substantial exchange-rate adjustments are required in the EMU in the aftermath of the 2008 financial and economic turbulence caused by the bursting of the housing bubble.
Since the 1970s, among the most ill-founded currency pegs are those involving Argentina, Greece, and China. Argentina's peg to the U.S. dollar lasted from 1991 through 2001 and ended with a debt default by Argentina and, of course, a break in the exchange-rate peg of the Argentine peso to the dollar.”

His conclusion:

“The obvious fact is that the eurozone, with its single central bank and sixteen separate national treasuries, will not survive the aftermath of the 2008 bursting of the financial bubble. The corollary to this is that, given the persistent recurrence of such bubbles, currency pegs are inadvisable ex ante and even more damaging ex post while governments are wasting resources and delaying necessary adjustments by lending to accommodate fixed exchange-rate regimes that will ultimately break own.
… Let us hope that the Europeans see the light before even heavier costs and distortions are visited on Europe to support the fantasy that it constitutes an optimum currency area. As Greece, Ireland, Spain, and Portugal are discovering the hard way, it does not.”

The complete paper is first rate and well worth reading. It is the best one I have seen recently.

Paul Krugman also reaffirms in the New York Times his former euro-skeptical analysis – he writes that it is vindicated, and I agree -, and honestly recognizes that he was wrong to follow Barry Eichengreen’s assertion that exit was impossible.

My comment: I really can’t understand this kind of ultra conservative argument that since some (international) arrangement has been created, it can’t be changed afterwards. Don’t these people read history, including ancient and contemporary monetary history?

How Reversible is Krugman on the Euro?

The Euro crisis is currently deepening, with concern about Spain seriously mounting, as we forecast (with my co-author Philippe Villin) would be the case, in a paper published in the French daily Le Figaro in February (downloadable on my homepage here).

Analysts are now busy constructing exit scenarios as does for instance the staunch pro-euro Wolfgang Munchau, in a briefing note Eurozone meltdown on his website, Eurointelligence. Even Paul Krugman, who, from the start, was quite critical of the euro but lately deemed exit impossible, following Barry Eichengreen , is now reconsidering his position.

Excerpt:

“… as Eichengreen argued, any move to leave the euro would require time and preparation, and during the transition period there would be devastating bank runs. So the idea of a euro breakup was a non-starter.

But now I’m reconsidering, for a simple reason: the Eichengreen argument is a reason not to plan on leaving the euro — but what if the bank runs and financial crisis happen anyway? In that case the marginal cost of leaving falls dramatically, and in fact the decision may effectively be taken out of policymakers’ hands.

Actually, Argentina’s departure from the convertibility law had some of that aspect. A deliberate decision to change the law would have triggered a banking crisis; but by 2001 a banking crisis was already in full swing, as were emergency restrictions on bank withdrawals. So the infeasible became feasible.”

My comment: I never believed that exit was impossible. First because many countries did exit from monetary unions over the years (see the paper by Andrew Rose who counted that in the postwar period seventy countries exited from currency areas while only sixty remained continuously within unions), and second because, following Herbert Stein’s Law “when something can’t continue indefinitely, it will stop”. As the saying goes, nothing human is irreversible, except death and taxes.

More seriously, as Krugman argues, there is a point where the economic damage from maintaining a far from equilibrium exchange rate exceeds the possible damage incurred by exiting from a non-optimal currency area. And the damage to European economies could grow considerably in the near future if vulnerable European banks are hit by government defaults.

Europe Lackluster Perspective: It is the Tax Cost of Labor and the Bureaucracy, Stupid!

For a very good analysis of the prospect for Europe after the partial Greek default that is to come, read Irwin Stelzer’s article in today’s Wall Street Journal Europe.

Excerpt:

“It is now fashionable to say that the southern euro zone consists of profligate, laggard economies such as Greece, Spain and Italy, while the northern euro zone is home to sound, efficient economies.

There is some truth to that, but only some. The northern tier is indeed efficient by comparison with the southern tier. But, the current recovery in France and Germany notwithstanding, no one expects euroland as a whole to grow at a long-term annual rate close to that of the U.S. and China. Europe’s failure to reform its labor markets and welfare states will inevitably become an irresistible drag on growth.

Doubt that and consider a new study by James Heckman and Bas Jacobs, professor of economics at the University of Chicago and professor at the Erasmus School of Economics in the Netherlands, respectively. In their careful and equation-laden study (“Policies To Create And Destroy Human Capital In Europe”), prepared for the nonpartisan National Bureau of Economic Research, they find, “High marginal tax rates and generous benefit systems reduce labor force participation rates and hours worked and thereby lower the utilization rate of human capital.”

A better description of conditions in most European countries would be difficult to find. So it seems likely Europe will be an economic laggard long after the Greek problem is solved, if the injection of new layers of bureaucracy and the imposition of deflationary policies can be classified as a solution.”

Note that the Heckman-Jacobs study vindicates the diagnosis of Edward Prescott on the effect of labor tax on European labor supply and demand that I used in my paper (in French) “Comment gagner plus” (downloadable on my homepage here .

There are two, and only two, decisive policies for stimulating durably European growth: get rid of the euro, or at least depreciate it relative to the US dollar by some 30 or 35% , and second, reduce the tax on labor by limiting it to the amount necessary for maintaining the current vertical transfers between high wages and low wages, but in the form of a health insurance voucher scheme instead of imbedding it in a compulsory monopoly, and tax financed, state insurance. This would preserve the generosity of the present social policy while reducing the current tax on labor for health care by 2/3.

See also my post of June 19, 2009, “U.S. Beware: Don’t Go European on Health Care Costs”.

The US Trade Deficit and the Financial Sector Expansion

Mike Mandel has an interesting post on the topic, and offers a rather convincing explanation. Now the trade deficit has to be explained too, and the Bretton Woods II system of quasi-fixed (and disequilibrium) exchange rates, coupled with the extraordinary expansion of emerging economies, could be a main part of the story.

2012, the Next Greek Crisis

According to The Economist, the bail-out for Greece has merely bought time, for about about three years. An eventual restructuring of Greek debt remains highly likely.

Excerpt:

“The bail-out, which was certainly bigger than the markets had expected, has all but eliminated the risk of default this year. But Greece still faces a deep medium-term solvency crisis. …

The rescue package has merely bought time—three years, in effect, to contain the adverse consequences of a possible Greek default. …

Even on optimistic assumptions, we reckon Greece will need €67 billion or more of long-term official loans in the next few years. Its debt burden will peak at 150% of GDP in 2014, a level exceeded now only by Japan. …

… the history of emerging-market debt crises, especially Argentina’s in 2001, suggests that, if default is overwhelmingly likely, it is better to get it over with rather than put it off with quixotic rescue packages. But this is not true in the Greek case, for two reasons that have less to do with Greece than with the rest of the euro area.

First, a Greek default now would carry a serious risk of triggering debt crises in Portugal, Spain and even Italy, the other euro-area countries suffering from some combination of big budget deficits, poor growth prospects and high debt burdens. The EU does not have the firepower to cope with these.

Second, a default now could also have calamitous effects on the fragile European banking system. Euro-area banks hold €120 billion of exposure to Greece, of which we reckon perhaps €70 billion is Greek sovereign debt. French and German banks account for 40% of the total. Many European banks might well require more government help if they lost a lot on Greek debt. Indeed, the sums involved might easily be greater than the German and French contributions to the Greek rescue loans. And if contagion then pushed Spain and Portugal to a crisis, the entire European banking system could implode."

Read the article here .

“I, not Alfred P. Sloan, invented the M-form organization” - Napoléon –

In his celebrated work on the era of the large-scale firm – The Visible Hand (1977) - that I call the “first twentieth century”, the late Alfred D. Chandler attributes a central role to the long time manager of General Motors, Alfred P. Sloan, in the invention of that type of business organization.

But read the following historical description:

“Having taken over from Carnot as the “organizer of victory,” Napoleon used the full power of the police to break such opposition to conscription as still existed. Not only was the imbalance between men and arms soon corrected, but the result was to provide the French state with forces larger than any since Herodotus had Xerxes lead a million and a half men into Greece in 480 BC; however, there was nothing mythical about the Grande armée. Instead of marching in a single block, as had been standard practice from the day of the Greek phalanx to that of Frederick the Great, willy-nilly the French troops had to be spread out over a much wider front in order to live and move. The construction of such fronts both demanded and was made possible by the organization of the forces into corps d’armée. First proposed by the National Convention in 1796, each corps or “body” possessed a permanent commander in the person of a maréchal de France, a title which Napoleon did not invent but to which he gave a new, more precise significance. Each had its own staff and its own proper combination of the three arms (infantry, cavalry, and artillery), as well as its own intelligence, engineering, and logistic services. Each one constituted a miniature army in its own right, one which, as common wisdom went, was capable of performing its mission independently of the rest and of holding out for two or three days even in the face of a superior force attacking it.” (Martin Van Creveld, The Rise and Decline of the State, Cambridge University Press, 1999, p. 246).

This structure is precisely that of the multidivisional firm, the M-form, that has characterized, as Chandler claimed, the rise of the modern giant business, and for the same reasons: the growing number of employees and volume of production of giant firms that accompanied the second industrial revolution.

If, arguably, the East India Company was the forerunner of modern firms, the Grande armée then was the first example of the M-form company.