Two days ago, Financial Times columnist Martin Wolf made an attempt at Thinking through the unthinkable. The “unthinkable” was the breakup of the Eurozone.
Reflections on the Easily Thinkable
For starters, a eurozone breakup is hardly unthinkable given that no currency union in history has ever survived in the absence of a fiscal union, and the Eurozone has no such fiscal union.
I suppose one might not want to think about history while praying for a miracle union, but the German Supreme court gratefully put a kibosh to the bureaucratic nanny-zone of never-ending regulation with a definitive ruling that no more German taxpayer funds can be out at risk without a common voter referendum.
I do not want to dwell on the “easily-thinkable unthinkable“, I want to focus on poor economic theory within Wolf’s post in regards to proposed solutions to the crisis.
Four Proposed Solutions
Wolf quoted Nouriel Roubini’s proposed list of solution.
- Restoration of growth and competitiveness through aggressive monetary easing, a weaker euro and stimulatory policies in the core, while the periphery undertakes austerity and reform.
- A deflationary adjustment in the periphery alone, together with structural reforms, to force down nominal wages
- Permanent financing by the core of an uncompetitive periphery
- Widespread debt restructuring and partial break-up of the eurozone
Wolf points out that option 2 will morph into option 4. I concur while pointing out that is the path we are on, also in agreement with Wolf.
Wolf points out that German would veto option 3 but fails to point out the absolute silliness of the idea in the first place, which I will get to in a moment.
Option 4 is where we are headed, and the debate ought to be how to do that correctly instead of how to achieve the impossible option 1 which Germany would also veto.
I propose, as has Michael Pettis before me, that the best solution is to have Germany exit the Eurozone rather than Greece, then, Portugal, then Spain exit in succession.
Breakup Inevitable but How?
Realization the Eurozone is no longer tenable is at long last at hand. In fact, “intense discussions” have been underway for months but are just now admitted to by senior EU officials. ….
The Eurozone is a failed experiment. A breakup is inevitable just as it has been from the beginning. Structural flaws were too great, built up over the years. No currency union in history has ever survived unless there was also a fiscal union.
The key question now is how?
It would be best for all involved if Germany left the Eurozone and went back to the Deutschmark. Germany would have an immediately credible currency. Should Greece or Spain leave first, those countries might experience hyperinflation or massive inflation.
Breakup Scenarios and Logistics of Denial
It’s important to remember that Germany suffers regardless. As long as the Eurozone stays intact (it can’t and won’t over the long haul) German taxpayers have to keep acting bailing out foreign countries, foreign banks, and their own banks.
On the other hand, were Germany to leave, the debts to German banks will not be paid back in Deutschmarks but rather deflated Euros.
On the whole, Germany exiting the Eurozone would be less disruptive, than massive inflation scenarios in Greece, Portugal, and Spain.
If France wants to stay in the Euro, let them. They can have the ECB as well. Then the ECB will print money to bail out the French banks (just as French president Sarkozy wants).
Logistics of Denial
Micahel Pettis presented a more detailed discussion of various breakup scenarios as well as a discussion on the “Logistics of Denial“, in my September 16 article Eurozone Breakup Logistics (Never Believe Anything Until It’s Officially Denied)
In his opening gambit, to the lead question “Will the eurozone survive?” Wolf surmises “I suspect the answer is, no.”
Thus, it would be more helpful to debate the merits of “how” a breakup should happen, which countries should leave, and details on how that happens rather than hoping it won’t.
Unfortunately, Wolf pines near his conclusion “[we] must go back to the first on the menu of options laid out by Mr Roubini. Potentially solvent countries would be financed and the eurozone would grow its way out of the crisis.”
History and Common Sense
As noted earlier, unless there is a complete fiscal-nanny-zone with a one size fits all policy, option 1 cannot possibly work.
Germany would veto option 1, for solid reasons. Moreover, and more importantly, option 1 would not work anyway for the same reason option 3 cannot work: Printing money never solves anything.
How many times does this have to be proven before it sinks in?
Japan offered mammoth quantities of fiscal and monetary stimulus and all it has to show for it is debt in excess of 200% of GDP. Economist Richard Koo pines the lesson was Japan did not do enough stimulus. Sheeesh.
Cash-for-clunkers, multiple tax credits for housing, QE 1, QE 2, a trillion in fiscal stimulus and a myriad of other fiscally insane programs did not create jobs or a lasting recovery.
No amount of stimulus would work because the problem is debt. Yet, the Army of Krugmanites propose we need to do more.
Greenspan resorted to loose monetary policy and it created the biggest housing bubble the world has ever seen.
Now Cristina Romer proposes GDP targets by the Fed to which I responded in Dear Christina … in light of the facts I presented above in regards to the experiences of Japan, the excess reserves at the Fed, the increase in inflation with no increase in jobs, and the number of people on fixed income destroyed by the rise in price level while getting 0% on their CDs, you have a hell of a lot more explaining why “It’s different this Time”.
For starters the Fed does not control GDP so the suggestion in and of itself is blatantly idiotic. The Fed can encourage spending but cannot force it. A trillion dollar mountain of excess reserves of banks is proof enough, yet the Monetarists want more.
No matter how much money one throws at a problem it is never enough. We had a housing bubble followed by a crash. Throw enough money around and we will have another bubble and a bigger crash, or simply a massive debt problem from which there is no escape.
The average eighth-grader can easily understand this. The average economist cannot because they are so tied up in monetary theory that has no real world application.
In September, Bernanke himself said he was puzzled by weak consumer spending.
Bernanke is puzzled over something an eighth-grader can easily figure out. Consumers have a mountain of debt and are underwater in their mortgages. Debt is made worse by declining real wages, global wage arbitrage, and a dearth of jobs.
ZIRP did nothing to create jobs but it did affect food and gas prices and effectively destroyed anyone on fixed income.
I would think that should be obvious, but obviously it’s not because Bernanke is puzzled over it. This is what happens when academics become addicted to economic models that do not work in periods of debt deflation (assuming they ever worked at all).
Krugman is a big believer in the idea “debt does not matter”. He made the mistake of using Italy as the prime example. Oops!
Guess what? Debt matters. Now Krugman is attempting to pass off a foolish statement by blaming Original Sin for the Euro Crisis.
One question that keeps coming up is, how can I reconcile my scorn for warnings about bond vigilantes with what is happening to Italy? This seems especially pointed because I have in the past used Italy’s ability to carry debt exceeding its GDP as an illustration that debt concerns were overblown.
The answer lies in the concept of original sin. Not the Pope’s kind, but the economics kind — the long-standing notion that developing countries were especially vulnerable to financial crises because they borrowed in foreign currency.
The key point is that by joining the euro, Italy took a bite of the apple — it converted its advanced-country status, as a nation issuing debt in its own currency, into original sin, with debts in someone else’s currency (Europe’s in principle, Germany’s in practice). That is the root of its new vulnerability.
Krugman finishes with “More on all this later, I hope.”
I hope so too, starting with my questions
- When did you realize Italy gave up the Lira?
- Did you not understand Italy was on the Euro when you used it as an example?
- Are you looking for excuses after the fact?
Krugman Joins the Euro Cannot Work Parade
For all Krugman’s pissing and moaning about imposed austerity measures on Europe, he now has the gall to blame the mess in Italy on “Original Sin” (which I might add also applies to Greece, Portugal, and Spain).
Oh well, it’s a start. Perhaps we can get Krugman discussing the best way to break up the Eurozone instead of everyone pretending Roubini Option 1 is still in play.
As an aside, if Krugman turns to Japan for his “debt does not matter” model, he will be wrong again.
Two Things We Can Say for Certain
- Japan’s Debt Does Not Matter Now
- It Will, and in a Major Way (we just do not know when, as with Italy)
All it takes to crush Japan is rising interest rates or a collapse in its export model. Given the cyclical nature of a great many things, one or the other or both will. And when it does, Japan will not be able to get financing.
Debt matters when it matters, and it eventually will. Until it does, we have to put up with foolish statements from major economists that it doesn’t, followed by excuses when they are proven wrong.
America and China must crush Germany into submission
Wolf’s article was hard enough to take but it was followed by an even more preposterous article by Ambrose Evans-Pritchard.
Please consider America and China must crush Germany into submission
As we watch Italy’s 10-year bond yields near 7.5pc and threaten to detonate the explosive charge on €1.9 trillion of debt, it is time for the world to reimpose order.
Yes, this means mobilizing the full-firepower of the ECB – with a pledge to change EU Treaty law and the bank’s mandate – and perhaps some form of quantum leap towards a fiscal and debt union.
The EU Project has become both dangerous and insane.
Reflections on “Dangerous and Insane”
- What’s dangerous and insane is economists like Prichard demanding treaties be tossed to the wind to test poorly thought out economic ideas.
- What’s dangerous and insane is economic theory that says printing presses are the answer. It has never worked in history and will not work now.
- What’s dangerous and insane is more leverage. Didn’t Lehman and LTCM prove that? How many more times do we have to prove that before it sinks in?
- What’s dangerous and insane is the idea is that central banks can impose their will on the world.
- What’s dangerous and insane is doing the same damn thing over and over and over again hoping for a different result
- What’s dangerous and insane is the moral hazard policy of time-and-time-again forcing the 99% to bail out the 1%.
The world will not end if banks fail. Forcing the 1% (banks and bank bondholders) to take a hit will not cause the world to end either, nor will it cause lending to cease.
Please, let’s stop the blatant hyperbole that suggests otherwise.
The ECB could have and should have let Greece default. “We Say No To Default” said a dangerously arrogant ECB president Jean-Claude Trichet.
Trichet loaded up the ECB balance sheet with Greek debt against the advice of Axel Weber. Trichet’s move blew up in his face, and I for one am glad to see it. If only he would have learned something from it.
The hubris of central bank wizards and economists is dangerous and insane. Indeed it is central bank wizardry combined with fractional reserve lending and insane levels of government bureaucracy that is at the root of the problem.
Corruption, Bloated Bureaucracy, Poor Productivity
My advice for Pritchard would be to stop writing dangerously insane ideas and start reading fellow columnist Nick Squires who has the common sense to write Italy’s debt crisis: doomed by corruption, bloated bureaucracy and poor productivity
Insane Welfare System
I would also recommend Pritchard, Krugman, and Wolf read Eight Reasons Why Italy Is Such a Mess
Wacky Welfare System
The root of Italy’s problems, the Wall Street Journal argues today, is that the country “financed generous entitlements with high taxes and towering piles of debt,” and now finds the money running out as the economy sputters. Indeed, Italy has more pensioners than workers and currently spends about 14 percent of GDP on pensions — more than any other country in the Organization for Economic Cooperation and Development (OECD).
Silvio Berlusconi pledged to raise the retirement age in Italy to 67 as part of his raft of austerity measures, but it’s a controversial move. In late October, two Italian lawmakers exchanged blows in parliament during a debate about whether to revamp the country’s pension system. House Speaker Gianfranco Fini had noted on television that the wife of the Northern League’s Umberto Bossi had taken early retirement at 39 and cashed in on Italy’s generous benefits.
Public Union Pension Woes
Bear in mind that is just one of the eight reasons Foreign Policy Magazine mentioned. The author called the pension system “wacky”. I call it fiscally insane.
Italy currently has more pensioners than workers. Is that insane or what?
In light of the above, can someone, anyone explain how Roubini’s option number 3 “Permanent financing by the core of an uncompetitive periphery” can possibly work?
By the way, the same public union pension problem exists in the US and it is the cause behind massive state and city deficits. Our system will blow up as well, just give it time.
Instead of focusing on those problems (and for the US I propose scrapping Davis Bacon, ending all prevailing wage laws, and ending collective bargaining for public unions) Krugman wants more freaking fiscal stimulus.
Quite frankly, it’s insane. Want a compromise? Give me those three things and I will even take higher taxes.
Exceptionally Sound Advice
My friend Pater Tenebrarum offers exceptionally sound advice in The ‘Technocrats’ Are Coming
What’s the EU All About?
“One keeps hearing demands for more centralization – tax ‘harmonization’, which is new-speak for ‘let’s impose the highest possible taxes everywhere’, more ‘redistribution’, and above all, ‘more regulation’, especially of the evil financial markets where all sorts of bad things are happening to sovereign bonds nowadays.
Naturally, fractional reserve banking and the inflationary boom-bust sequences it has brought forth doesn’t even rate a mention – since it has also enabled the growth of this huge statist moloch the EU and many of its member nations have become.
What is really needed is some introspection and remembering what the EU was originally about. Its founders wanted to restore 19th century liberalism to Europe – free trade and freedom of movement for people and capital within Europe.
They emphatically did not want to erect some sort of socialist super-state. They wanted to bring back to Europe what the mad socialist and fascist ideologues of the 20th century had destroyed.
Now we have a bureaucratic monster in Brussels that has produced nearly 300,000 new regulations over the past decade, in addition to the hundreds of thousands of pages of ‘administrative law’ and other regulations the member states themselves produce every year.
It is a miracle we still have a functioning civilization.
If we want the problems to be solved, the most important question should be: what is needed to enable the production of new wealth? What kind of environment will be most conducive to reviving the entrepreneurial spirit? It should be simple enough, but it would of course threaten a great many vested interests.”
Crush Into Submission
You cannot fix a problem unless you understand it. Moreover, even if you do understand the problem, you cannot fit it with unsound theory.
The discussion from Wolf, Pritchard, Roubini, Romer, the vast army of Krugmanites, and the smaller army of equally misguided Monetarists suggests they do not fully understand the problem, nor do they understand sound economic theory as to what it takes to fix it.
To use Pritchard’s catchy title, I respond “We Must Crush Ambrose Evans-Pritchard, Nouriel Roubini, Martin Wolf, the Army of Krugmanites into Submission.“
That is the mission, and it is a desperately needed mission at that. To accomplish the mission we must prove to the group, to their satisfaction, their solutions are nonsensical.
Unfortunately, the only way I can think of doing that is to give the group everything it wants, then watch it blow sky high. That means turn on the global printing presses, bail out the public pension plans, pour more money into Medicare and Medicaid, create a “living wage” indexed to inflation, give Krugman his tariffs, and declare China a currency manipulator. Not enough jobs? No problem, the government can easily create them. That’s what the vast army of Krugmanite Borgs thinks.
There is only one problem with the idea. When the plan blows sky high, Krugman would say “It wasn’t enough”.
Mike “Mish” Shedlock
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