15 December 2011

The Hole-ly Trinity

Another 'historical' European summit fails. Haven't I posted this before?

Europe’s leaders cannot understand the Eurozone’s economic, banking, and sovereign-debt crises. They cannot resolve them as, in many ways, they are the crisis.
"At the root of the euro upheaval is a balance of payment crisis caused by the cumulative effects of a 13-year-old one-size-fits-all monetary policy and a fixed exchange rate for a collection of disparate countries in very different stages of economic and structural development." David Marsh, WSJ December, 2011,
There is a persistent belief that budget indiscipline is the main cause of the crisis (despite Spain and Ireland having budget surpluses in 2007). This makes it impossible for Europeans to accept a fiscal authority that treat all its subjects equally, financed by a simple euro bond with mutual debt sharing. Instead, there is now a Fiscal Compact that paradoxically insists on removing power from both Euro states and European citizens whilst imposing are even more responsibility and guilt for the results of having less power

The European Union system is dominated by one school of economic thought. It is determined to prevent other schools of thought ever being presented to the electorate. It outlaws them by asking for constitutional changes for balanced budgets and near-zero structural deficits with punishments and outside supervision for states that break, voluntary or involuntary, the agreement. Disagreeing economists will be silenced by the statement: "it's unconstitutional". No political party will be allowed to present an agenda that differs. Governments will be not longer accountable to their people but as law-breakers to an 'European court of Justice'. There is nothing just or democratic about it.

Europe's very own 'Impossibility Trinity'
The Eurozone had an illusion of convergence when it created trading imbalances financed under another illusion that the bonds of the trading deficit economies could be treated as close substitute for those trading surplus economies (Germany). When it became very apparent that individual members were solely responsible for their own sovereign debts, a debt crisis followed.

To solve this, the compact fiscal pact now tries the 'balanced-book convergence' illusion, in terms of agreed sovereign debt and government budget limits. Those hit harder by a recession will be forced to carry out pro-cyclical policies that deepen their own recession. Those that refuse will be sent to the European court of justice - a 'Death Star' ran by lawyers and bureaucrats zapping out troublesome economies. They will be forced to beg for mercy and understanding from the stronger economies of the euro-zone at a time when they are least able to provide it.

EU Death Star II
by @teacherdude
The new Compact Fiscal pact will deepen the original euro flaw. It sets one part the Euro Zone on a completely different development path to that of the other. The Eurozone, peacefully or not, will tear itself apart.

The plan is that reducing sovereign debt, shrinking an inefficient state, eliminating cartels and vested interests and lowering wage cost and benefits will all improve competitiveness. Reforms can help growth, but austerity and deficit reduction may not be the way to do it. With unequal power relations between creditors and debtors, the only thing that "Expansionary Austerity" expands is austerity.

The idea that Austerity might work is based on the view that government debt is the cause of everything - recessions, unemployment, inflation, higher interest rates, trade deficits. It is more or less a belief. The links are not that obvious. Early naive simplistic Keynesian models portrayed government budget deficit as a counter cyclical measure to provide a short-run stimulus to economies (neglecting stories on deficit financing). Later macroeconomic models viewed government debt in terms of a public and private sector competition for funds that crowded out private investment. This was then all pushed to one side by a theorem, first mentioned in the 19th Century by Ricardo, that ascribes no effects. If true, it makes fiscal policy redundant.

Ricardian equivalence
The reasoning is quite simple. An increase in government debts imply increases in future taxes. As everyone in the economy recognizes this, an increase in government debt is treated as the same as an increase in taxes. A stimulus to the economy (e.g. a lower of tax rate) increasing the government deficit will be recognized as a future tax increase and have no effect. Individuals do not run out and spend their extra cash as they will need it for the future tax increase. On the other hand. if the increase in debt is created by more government spending private investment is crowded out. As the government is always viewed as inefficient relative to the private sector, this will be seen as as having a negative impact on the economy. Thus reducing the government deficit, by increasing taxes will been seen as having no effect while doing it by reducing government spending will be seen as having a positive effect.

BUT, with increasing concentrations of wealth and power, access to capital markets becomes increasingly restrictive. The theorem, neoclassical economics and the economies that are ran by them are in deep trouble and fall apart. The ownership of debt and the distribution in wealth determines the relationship of creditors to debtors. The greater inequality, the more of the population that is hit by being unable to borrow or finance. Investment and consumer uncertainty rises. In a recession liquidity constraints run riot.

Massive inequality really counts:
"These models on why deleveraging matters are all about the net wealth distribution. We shouldn’t be surprised that this recession and the Great Depression were preceded by very large increases in wealth inequality. This is well documented during the 1920s and the 2000s. This is why I get a bit annoyed at the guys who are saying it’s just a pure wealth effect, because it’s something bigger than that" An Interview on Balance Sheet Recessions with Amir Sufi (via Business Insider)
And so, trying to reduce government deficits in a recession is met by liquidity constraints and investor and consumer uncertainty. It is not offset by an increased consumer spending or investment. The greater the inequality, the worse the recession becomes. Attempts to reduce government debts are frustrated by falling taxes revenues and increased spending on unemployment benefits. Targets are missed and the governments' ability to pay back existing debt is threaten.

In a sense a better and more direct policy than fiscal stimulus (and for those who hate the state) is debt forgiveness and writing off debts.

This crisis persists as too much power lies in the hands of creditors and most governments' policies are heavily influenced by them. Forced payments, and enshrined constitutional arrangements such as those proposed in the Euro-zone, generate liquidity constraints everywhere. This perpetuates and deepens the crisis.

In Greece clearly this isn't working.  An IMF report on 13th December showed the Greek economy even worse than predicted with growth forecast for 2011 wand 2012 as revised downwards yet again.  The 2011 deficit, predicted at 7.5% of GDP, has now been revised to 9%. Public debt was 130% of GDP in 2009 and now the it predicted to peak at 187% of GDP in 2013, It might fall to 152% by 2020.  It will take 10 years, the IMF reports, for Greece to close the competitiveness gap. It is taking a much shorter period to destroy the country we know.

Investment in a such an economy is not attractive and bond yields remain high without the backing of a central authority. Private investment does not necessarily make up for the reduction in government spending.  There are no investment and growth opportunities in the periphery and capital flies from them. Don't expect investors to return back.  The real economies of the euro-zone will not converge. The Wall Street Journal reports:
"We are seeing this deglobalization, a 'de-Euroization,' of the euro zone," said Andrew Balls of Pimco, head of the big bond shop's European portfolio management. "Investors are going back to their own markets. They may still hold bonds, but they won't have them spread across the euro zone as they had before."
"The scale of the shift suggests that the euro zone isn't merely suffering from a short-term confidence crisis but that the financial lifeline of some European states is ebbing away, perhaps not to return for years, leaving some countries exposed and in danger of financial breakdown....One result could be a departure by one or more countries from the monetary union, or even its breakup. WSJ December 16, 2011
The prospect of an exit from the Euro and dramatic currency depreciation would cause a massive flight of capital. It is more than ironic that it is happening anyway.

The European Court of Injustice:
You will not find forgiveness here. Merkel and Sarkozy are succeeding in binding the institutions of the EU to the so-called 'interests' of the eurozone via the courts and the commission, over the countries in debt.  It is very Orwellian to tie this to a European court of justice, as if populations are wholesale criminals with procedures undertaken to decide what penalties are deserved.

No-one should be force to agreed to a pan-European structure that they don't believed in for the sake of some misconstrued artificial notion of 'European-ness'.  The definition of 'European-ness' is not the exclusive property of Euro zone leaders. To divide those who agree and disagree with the fiscal compact as European and un-European is akin to McCarthyism.  Nevertheless, there is now one identity that many Europeans are beginning to share:

We're all Greeks now
Austerity succeeding in establishing a common European identity

Father Ted on the difference between inflation and hyperinflation

24 November 2011

A Very European Financial Coup d'état

The attempt to create a monetary union before a political and fiscal union placed the cart before the horse. Or was it... an attempt to steal the cart?

To achieve a fiscal union and political union would have required the democratic consent of the voters of each member state. Such an acceptance of this might then have implied an acceptance of a monetary union and its consequences. 'Acceptance' should not be underestimated.
Hyman Minsky: “Anyone can create money; the problem lies in getting it accepted
It was never likely that all Europeans would have accepted the idea of an United States of Europe. The  European Monetary Union was essentially an undemocratic method of press-ganging euro members into the Euro ship by financial force without their consent.

School kids are told that democracy is about listening to the people. When they grow up they are told it is about listening to the markets. Now we are all told to listen to un-elected bank clerks who (in Greece) are then forced to sign another piece of paper for approval by another set of banking clerks residing in the head office. The argument being of course one of 'trust'. Democracy, meanwhile, is forced to hide behind a tear gas mask.  In Greece there are now anit-semitic anti-islamic neo-nazies in the government.

via @Irategreek on twiiter

Why should anyone pay their taxes to pay the wages of such men? Indeed everyone has a duty not to pay for a regime that marches, increasing taxation in one step and decreasing representation in the other, towards a repressive dictatorship. It's like paying for your own firing squad.

Are economists to blame for this Euro disaster? Ancient economic papers (Monetarists, Keynesian, etc - choose your favourite school of economic thought) go back over 50 years giving detailed reasons why it would fail (see biography in this publication). Let me even apply a quote from F. A. Hayek to the Euro:
The curious task of economist is to demonstrate to men how little they really know about what they can imagine they can design F. A.Hayek The Fatal Conceit 1988)
To think of 'internal devaluation' and austerity as providing a way of adjusting to shocks that occur in the world beyond the EC borders is very naive. It is akin to a Napoleonic way of standardizing and metricizing economies into homogeneous diary products with fines on diary producers for failing to meeting these standards.  Milton Friedman, the monetarist,  made the following comment in 'The Times' (19/11/97) on the European project:
"...Europe exemplifies a situation unfavourable to a common currency. It is composed of separate nations, speaking different languages, with different customs, and having citizens feeling far greater loyalty and attachment to their own country than to a common market or to the idea of Europe". Milton Friedman
The Euro was a political exercise, but lets wipe the dust off more economic texts.

Brother Can you Spare A Euro.. "They used to tell me I was building a dream"
Or, how do we empty Greece to make the economy work?

M. Corden  (1972) warned that, if investment was sensitive to the business cycle, a monetary union would be heavily dependent on labour mobility and involve significant migration costs. United States, in the 1930's Great recession, produced "Hoovervilles"

In the 1960's, during the post-war American dream this was a more psychedelic experience, with some  'tripping' across states.

In Europe, neo-nazism rises, even becoming members of a government, Greeks emigrate to Australia and mobility tends to wear army boots 'making war 'not love'.
One of the things that makes the American common currency work across the country is we have a common fiscal authority and high migration - we're willing to allow North Dakota to become empty. In Europe, there's no fiscal authority, migration is more difficult and most of the countries are not willing to let themselves become empty.  Joseph Stiglitz: Austerity not the way to go for Europe
EuroVision and rigged voting

The European Commission's “One Market, One Money” Report (1990) concocted a modern version of Monetary Union theory. It did not deny that crises would occur but looked forward to them.
"I am sure the euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible to propose that now. But some day there will be a crisis and new instruments will be created." Romano Prodi, EU Commission President. Financial Times, 4 Dec 2001
"The future will belong to the Germans... when we build the House of Europe. In the next two years, we will make the process of European integration irreversible. This is a really big battle but it is worth the fight." Helmut Kohl, German Chancellor 1982-1988
And a strong dislike of referendums and elections
"A true European cannot not want a referendum [on the European Constitution]."
Jean-Pierre Raffarin, French Prime Minister from 2002. Quoted in 2003.
(The meaning of true?  Someone with direct lineage to 'Conon the Accountant' or, culturally, not those who disagree) 
"Europe's nations should be guided towards the super-state without their people understanding what is happening. This can be accomplished by successive steps each disguised as having an economic purpose, but which will eventually and irreversibly lead to federation." Jean Monnet, Founder of the European Movement. Former Cognac salesman and bureaucrat at the League of Nations. 30 April 1952. 
French and Dutch in 2005 voted against a European Constitution. When Ireland voted no, it was made to vote a second time to get it 'right'. This time changes to European Treaties are being force through by the argument of economic necessity in a crisis; one that is supposedly caused by a small troublesome nation in the periphery.

The Ring that binds - the sovereignty debt entrapment 

How did this Press Ganging of economies into the euro ship happen?

Any country that can issue its own currency (and is not pegged to any other currency or precious metal) does not risk default solvency risk. It cannot be forced into debt. It controls its own currency and can always spend, by crediting bank accounts to create money.

Hence flexible exchange rate economies like Japan can run far higher debt to GDP ratios than Euro-zone members while still having low interest rates on their sovereign debt. Thus there is no default risk premium.

The Euro maintained a stable currency that destabilized governments with uncontrollable default risk. It achieves this in three ways by: (1) generating trading account deficit with other euro-zone economies without any automatic means (exchange rates) to adjust competitiveness;  (2) restricting the controls to finance these deficits and (3) imposing external or self-imposed fiscal discipline that renders the economy helpless in times of crisis.  With one global storm economies begin to capsize and sink.

When an economy is hit by a recession from an unexpected shock in the global economy there are automatic increases in government expenditures (social security and unemployment payments) and reductions in government's tax revenues (as output falls).  This part of the government budget deficit is 'unplanned'.

If it tries to reduce expenditures and/or raise taxes it may exacerbate the impact, by reducing aggregate demand at exactly the wrong time to do so, and deepen the recession.  An Euro-zone economy running a budget deficit means that its central bank is using up reserves from its ECB account which it will need to replace.  Individual Euro-zone governments do not have the choice of monopoly issuer of currency to create money (by crediting bank accounts) to finance its budget deficit. The Euro-zone government will need to recover this by selling bonds, adding to its sovereign debt.

Just by maintaining existing government plans, an adverse impact on the economy increases the Euro-zone government's borrowings. Sovereign indebtedness for an Euro-zone country is not a simple choice; it is often beyond its control.

The Euro Bond-Age .. 

Recessions may be beyond the control of governments but a double-dip recession is generated by their collective stupidity and a denial collective responsibly. Ponzi financing (named after a fraudster “pyramid scheme" in the 1920s) occurs when a debtor must borrow just to pay interest, which means debt grows - typically in an unsustainable manner. A government that controls its own currency can never be in this Ponzi position. A euro-zone member can.

Euro-zone members, with trading deficit accounts, are therefore exposed to debt dynamics. The more they borrow, the more the markets demand higher interest rates to compensate for the increasing risk of insolvency.  The more the government attempts to solve its budget deficit, by cutting expenditure and raising its tax, the more it cuts it growth rate and its ability to repay its sovereign debt.  Moral hazard by the government comes into play here as the covering up off statistics will aid it to obtain lower interest rates its bond issues.

At some point it goes critical, as in Ireland and Greece at about bond rates of 7%, and the government spirals into a vicious circle of borrowing more and more to pay ever higher interest rates. The government finds itself locked out of the market.  This leads the Euro nation at the mercy of the intervention of the ECB and the Euro-zone credit nations for bail outs.
... the thought that monetary union may in time force the evolution of a deeper, more fundamentally political level of unification is probably not inconsistent with what the euro’s original architects had in mind. (Benjamin Friedman (1999))
 It is also an invitation for vultures (funds) to scour for opportunities.

The Blame Game

The blame is attached to insatiable, bureaucratic, corrupt governments. Greece is an easy target since it is  in fact corrupt and bureaucratic. (eg. How German Companies Bribed Their Way to Greek Deals - Der Spiegel).  Then it is attached to ethnics, morals and latitude. Germans blame Greeks, Greeks blame Germans and trust breaks down.

It is then argued that elected governments  should not be trusted as they may be guilty actually following the wishes of their electorate and break agreed (by who? nobody was allowed vote on) the fiscal rules. Their powers are therefore removed and administrated by un-elected super authority.

Elected officials its seems are corrupted by the voters. Unelected officials are not. European Commission President José Manuel Barroso spending a week on the yacht of the Greek shipping billionaire Spiro Latsis (a month before the approval of 10.3 million euro of Greek state aid for Latsis' shipping company). They just like swimming together.

The financial coup d'état is completed

with the creation of a euro-zone Ministry of Finance justifying its un-elected authority to oversee national budgets and other economic policies. Germany and France propose new intrusive powers over Eurozone budgets on the moral argument that gains should then to the virtuous and pain should to sinners.

The defunct electorate or sinners may tell them to go to hell.

......so there is just the small matter of pacifying the natives (when they stop blaming each other). Supply-side economics is then reduced to a form of crowd control encouraging the demand for new consumer products, such as this one from Taiwan

Mount Doom:

There is, however, one small problem. The ECB itself. To be effective, a central bank must act as a monopoly."It, just like Sauron, must control all." (FTalphavillebut...

The ECB not a real monopoly. It controls euro reserves but there are no common Euro bonds and individual Euro-zone central banks issue their own. Before the 2007-8 global crisis sovereign default risk did not seem to matter. Those with greater dependency on ECB liquidity, as in the case of Greece, found more of their bonds ending up at the ECB. The less bonds available for the market, the smaller the market and the more vulnerable it becomes. Holding a monopoly of them has little value, if no one wants your bonds.

The solution to this is a common euro bonds with collectively responsibility of sovereign debts. But, in order to be 'saved' by this, each member must not only surrender its sovereignty but also yield to a budgetary slavery that whips financial indiscipline.

There is a problem, the 'one ring of power' corrupts its owner. The present ring bearer (Germany) does not yet want to yield this power and agree to Eurobonds. The ECB, with the EFSF, is running out of time, and cannot forever support the bonds of Euro-zone states who are insolvent.

Austerity everywhere cannot last. Once one of the major Euro-zone economies, Spain or Italy, goes pass the point of no return (in its bond rates) everything falls. A bailout for one will trigger a chain reaction.
@Nouriel (Nouriel Roubini on twitter):  To rescue Italy, Spain & Belgium for 3 years you need at least a €2trillion rescue package. Hard to see how EZ & intl comm can mobilize that
@Nouriel It took 4 months to convince core EZ parliaments to approve modified 440bn EFSF. How long - 1year? - to have them vote a €1tr ESM, 2X original?

Pity the real world doesn't have a pause button.

18 November 2011

A Shot Gun Wedding

The Euro-zone is a tragedy. There is no automatic mechanism for adjusting the relative competitiveness of its members and no mechanism to compensate for this gap by recycling surpluses from one part of the Euro-zone to another.

And so the sovereign debt crisis refuses to go away. There is no more road to kick the can down. The Euro-zone will either quickly move to a political fiscal union backed by Eurobonds or disintegrate. Euro Leaders are loading their shot-guns.

There is no exchange rate to restore competitiveness and the absence of any sense of 'community' is resulting in the removal of democracy and the brutal repression of wages of citizens unfortunate enough to be living in the Euro-zone's periphery.  Uneven competitiveness produced trading account surpluses in the core economies and were matched by trading deficits in the periphery. It is this internal trading imbalance, or fault-line, that splits the Euro-zone and continues to shake its financial institutions to the ground. After a wasting two years in taxpayer financed 'theological' debate on sinning, the crisis will be resolved in a short period of time by separation or by the complete removal of sovereignty.

A Failed Romance.

This failure is a story of unresolved differences in the relative competitiveness of Euro-zone members, and one re-told by Breaking Up? A Route Out of The Eurozone Crisis (C. Lapavitsas et.al. RMF Occasional report 3 Nov 211). The three graphs below, taken from this report, capture the story.

Germany's competitive advantage in the Euro-zone did not result from gains in productivity but rather from applying severe wage restraint on German workers.

Wage restraint on German Workers gave Germany a competitive advantage over its Euro partners 

This graphs indicates a weakness in German productivity. Even Ireland and Greece performed better. 

German competitive advantage in the Euro-zone produced trading surpluses from across the Eurozone. Competitive disadvantage, particularly for Greece, appears in the periphery's trading deficits. Austerity has closed the gap in competitiveness by harshly reducing in wages in the periphery.
Trading account imbalance between members: how was this financed? 

The sovereign debt crisis emerges from how these trading imbalances were financed. While ECB kept interest rates low, Euro core banks, particularly French and German banks, maintained the financing. Lending jumped again after the 2008 Lehman collapse. The assumption that sovereigns would not be allowed to default (moral hazard) increased the over-exposure of these banks. 

Banks in the periphery also had access to cheap funds to expand their assets. Cheap credit fueled an illusion of high GDP growth rates in trading deficit countries (particularly Greece). The crisis of 2007 exposed the illusion, laying bare the divergence in competitiveness. Periphery countries found themselves heavily in debt and in Greece a large amount of this public debt was now owned by foreign lenders

The 2008 Lehman collapse was a shock to all parts of the Eurozone as exports and investment fell. The recession induced both automatic increases in government expenditure (e.g unemployment benefits) and falling tax revenues, which in turn increased Government deficits. Rescuing private sector banks from the impact of the Lehman's collapse, increased the deficit further. 

The financing of increasing budget deficits increased the growth sovereign debts in the periphery. When it became clear that the core economies, mainly Germany, would not take any responsible for theses debts, the sovereign debt crisis switched from a liquidity to a solvency crisis. Individual debtor economies no longer had the ability or growth to support such large debts.  Austerity measures reduced the ability to pay back debts even further.  The core economies instead focused on only the effects a default on an economy's sovereign debts would have on their own banks - the very banks that had become over exposed by taking advantage of the common currency. The welfare of the periphery economies was secondary to the goal of protecting the Euro and the banking system that sat on it. 

The euro project had failed to achieve any real convergence between its economies. But like a scandal, It is the cover-up that does a great deal of of the damage. Differences in the euro-zone economies, in terms of human, capital and physical resources, were left exposed without an counteracting mechanism to replace exchanges rates. Instead, the Euro-zone economies diverged whilst cheap credit and the Euro banking system financed the illusion.  In the case of an inefficient small economy like Greece, the lack of internal competition (localized monopolistic and cartels) translated into a higher rate of inflation than the core Euro-zone economies. The inflation rate hides another further distortion - relative price changes.  Since the introduction of the Euro, the costs of basics (food, fuel, rents, mortgage payments, etc) increased sharply while many "luxury" items (TVs, cars, electronics,etc) fell . There is no mechanism to fix this. It also means that the poverty wage line has increased. 

FISTal consolidation:  the beating of an economy into shape.  Any shape will do, but it must submit

Due to the changers in relative prices in basics to luxuries, forcing Greece go back to 2001 wage levels will create third world poverty conditions and political instability. By blaming sovereign debt on sovereign states, treating the symptom and ignoring the cause of the crisis, Euro leaders are playing a dangerous blame game encouraging nationalism and racism whilst exploiting the fear of financial instability to place the Euro-zone under an un-elected centralized authority. The secret hope is that European voters will welcome this as an alternative to austerity. National government will applied the stick and the fiscal authority may promise some goodies.

In the meantime, Euro Leaders are loading their shot-guns to forced member states to appear at a new 'Lisbon' marriage ceremony. Divorce is not in the statue book.


The Golden Wig Award

The Golden Wig award this year goes to Herman Van Rompey for his uncanny Woody Woodpecker impersonation in..

But who cuts the hair of the Barber of Seville?

And finally ...  how does one measure success?  

According to the new Technocrat Italian PM Monti  "What we're witnessing today is GREAT SUCCESS of Euro and the most concrete demonstration of that SUCCESS is Greece"

"I'm hungry" - The real face of Greece's bailout deal

Less hope for less success.

8 November 2011

Unfair for one, unfair for all

The world is in trouble. The Greek parliament is vacant; its members are vacant. Superhuman efforts do nothing. The crisis rolls on. It's out of balance, steering out of control. We need  ....

Pumping more air into the tyres isn't going to help get the tandem moving

The German flaw and why Germans should not be happy.

Just as the European Money Union' was being formulated, structural labour reforms were being agreed upon in Germany that would prevent real wages of workers from rising.  Increases in productivity were not rewarded by increases in wages.

This gave German firms a competitive edge over the Eurozone periphery.  German exports exceeded their imports from the Eurozone periphery producing an intra-trade surplus and corresponding trading deficits in the eurozone's periphery's. Trading surpluses from the north fed easy credit and bubbles in the south.
'Germany lost the advantage of low interest rates after the introduction and in part because of the euro. This led capital to pour into the countries of the periphery, while investment stagnated in Germany or even declined, leading to low growth, low inflation and persistently high unemployment. What Mr Pettis calls “excessively low interest rates” were actually too high for Germany in this monetary union' The Economist (Germany suffered from its surpluses):
But how was this 'capital' used in the periphery? Capital that poured into the periphery did not spur direct real investment. An increase in German wages could have restored the relative competitiveness of periphery and even encouraged more direct investment.  Instead, the surpluses that repressed German wages helped to create fed bubbles in Spain and Ireland and fiscal mismanagement. These bubbles and practices were popped and laid to wastes by the 2007-8 global financial crisis. (see also Minsky’s financial instability hypothesis)

The periphery was in desperate need for direct investment to improve competitiveness and catch up with the core.  Instead it got debt financing geared to consumption, providing credit facilities and the means to buy exports, corruption, suspicious deals and debt servicing.

The focus on debt refinancing, instead of direct productive investment in the periphery persists. Trading deficits that had accumulated, now increasingly replaced by debt servicing, continues to damage the periphery long term growth prospects.  Instead of allowing German wages to rise, internal devaluation and wage suppression is now being imposed on the periphery.  The cost of financing debts has increased, the ability to pay them back is shrinking, and the periphery economies move towards insolvency.

So the initial benefits to German economy may have had may well turn into long term losses. This is not just due falling eurozone demand for its products from the periphery, but mainly due the eventual bill that is left behind by insolvent countries.

Europe is actually a rich net capital exporter, and yet the peripheral Euro members cannot get finance due questions concerning solvency.

The unfairness to the German worker, in terms of being not rewarded their gains in productivity, translates as an unfairness to those in the periphery trying to compete against an unfair German export advantage.  Would German workers wouldn't mind having some extra money on a sinful holiday in Greece? Is an 'internal revaluation' any less crazier than internal devaluation?

The result of the first 10 years of the Euro, is an Eurozone split into two, moving in opposite directions covered by a veneer of financial arrangements. The 2007-8 global financial crisis (an asymmetric shock) exposed this and destabilized Europe. It has not recovered or found the means to re-balance. In the absence of a mechanism to maintain the relative competitiveness of euro economies, EC governments and institutions have stepped deeper and deeper into the murky world of weird toxic financing arrangements. One cannot fix or institutionalize macroeconomic disequilibria by pronouncing laws forbidding them to exist.

Two Greeks Phd. holders. One is has a job and the other doesn't have work.  They meet. The one without the job asks the one with the job: "Can I have a hamburger without ketchup. please


Incidentally, in case you are wondering where all that "Greek" Bailout money is going here is a diagram I 'lifted' from Zerohedge blog
"The bulk of the money that Greece is "getting" comes right back to the rest of the EU. Whatever posturing is going on, Greece will get away without meeting any of its stated goals, or at least it will until the EU decides it has written down enough principal and that the ECB can handle the shock."

There is still time to order the  new collectible edition of the Euro

Hurry as the offer in not indefinite

Further reading:

3 November 2011

2011 - Euro Odyssey

Live from the Euro Space Centre

 Koyaanisqatsi: Life Out of Balance, is a 1982 film directed by Godfrey Reggio with music composed by Philip Glass and cinematography by Ron Fricke).

The launch sequence is magnificent.
Then you slowly notice the rocket is leaning.
Something is wrong.
You realize it when you see it flying almost horizontally...
"If Merkel/Sarkozy dig precious things from Greek land, they will invite disaster".
- variation of the opening line of the Hopi prophecy

Credit to @stefanbjork

28 October 2011

The Laughter Curve

- the ability to laugh all the way to the Swiss Bank

The Laughter (Laffer) curve theoretically shows the relationship between government revenue raised by taxation and the taxation rate.

From the left, government tax revenues increase as the tax rate increases, but at a declining rate. It becomes more worthwhile hiring a accountant to avoid or evade paying tax. Beyond a certain point tax revenues fall as money pours into off-shore accounts. Capital flies out the country, reducing both investment and output, and inducing a further decline in tax revenues.  It falls to zero revenue at a 100% tax rate. There is some dispute over what this means. Has the individual moved to Switzerland, died, become street trader or is bartering?

One can reduce the number of tax cheats and fraudulent claims, by legalizing them.  It's not too difficult to imagine a country's tax system becoming unfairer (more regressive) and, at the same time, reducing the number of cheats (and vice versa).

The Curve was popular with Ronald Reagan who bent it to justify lower tax rates for high incomes in the US in the 1980s. From 1979 more than 40 countries cut their top rates of personal income tax.

This is what happened in the US:

and what motives the Wall Street protests. 


Now the problem with Greek austerity measures and structural reforms is all that money that has gone outside the country. Greek assets, including properties, will become even cheaper and capital will flow back in (hailed as a success) to buy them back up. Citizens, the poor, the ex-middle-classes, will be worse off (hailed a success. Well done Greece, more competitive, fly the flag, bright future etc). The result will be an increase in inequality and a re-vamped oligarchy energized by financial occupiers who would then slip away quietly. 

“To see what is in front of one’s nose needs a constant struggle.” (George Orwell). But injustice lingers with a rotting smell.

Back to the bunker

I forgot to mention the 27th October historic deal of day? Here why: ('of two minds': full post here via Zerohedge)

'EU Leaders Throw Europe a Plutonium Life Preserver
The euro system was doomed from inception for fundamental reasons; trying to conjure up "something for nothing" solutions will fail catastrophically, and soon.
As Europe flails helplessly in the waves of insolvency, its leadership has tossed it a life preserver. Too bad it's plutonium, and will take Europe straight to the bottom. Plutonium is of course one of the most toxic materials on the planet, and the "rescue" cooked up by the EU leadership is the financial equivalent of plutonium.
Stripped of propaganda .... "rescue" boils down to this: something for nothing .... in two ways:
1. The financial alchemist's favorite magic: leverage.....suddenly backstop 1 trillion euros of banking-sector losses, all with illusory money.
2. "Guarantees" to cover the first 20% of loan losses.... presented as the equivalent of 100% guarantees, because it is inconceivable that losses could exceed 20%. .... 80% of every bond is somehow "safer" because the first 20% will be paid by EU taxpayers.
..... "something for nothing" magic will turn lead into gold. Abracadabra....oh well, close; it's heavy, it's metallic--oops, it's plutonium.' (of two minds blog -Charles Hugh Smith)

Or a "haircut for the banks that will in reality just be a convoluted way to get citizens to pay get it without even realizing it" (Zerohedge). Compare the above deal with a 11-year-old boy's suggested solution to Greek debt crisis (here).

At least Archimedes knew what to do with leverages. He also invented another device for raising liquidity, but it seems the screw has a different meaning in Europe.

This is the point in the following video where G. Papandreou returns back from work.

'of two minds' goes on to describe the Euro model (add German taxpayers and workers don't win as well) as:

....... understanding the increasingly unstable dynamics of the EU is the post-colonial "plantation" model 

1. Low cost labor and low-value materials flow from the periphery (colonies) to the Empire (center), which then ships high-value, high-profit finished goods back to the colonies.
2. The colonies must buy the high-value finished goods on credit that is issued and controlled by the Imperial center.

....The euro cemented this co-dependency: ..... once the euro raised the cost of production in the periphery nations, then of course nobody could beat Germany's cost advantages. The euro actually lowered Germany's cost of production in terms of foreign exchange rates while raising the costs in periphery nations that were previously able to lower their cost of production via currency devaluations.

Having surrendered that mechanism to access the deep credit markets of the center, then they had no choice but to buy the high-margin finished goods from Germany, as nobody else could make the same goods for the low German price.

These booming high-profit German exports of finished goods to the European periphery generated vast surpluses of capital that were then loaned to the periphery to enable their further purchases of German goods

It's the classic mercantilist-consumer co-dependency on a gigantic scale, with low-cost credit fueling both increased consumption and production. ....... let's ask: how many German goods would have been imported by the EU periphery if those nations had been forced to pay cash for everything from the start? Precious little is the answer; the cash--in the form of actual surpluses available to spend on imports--would have run out immediately after the euro was launched.

In other words, the debt orgy enabled not just carefree consumption, it also enabled vast German exports to the Eurozone. Now we start seeing how the once-mutually beneficial co-dependency has become toxic: now that the periphery's debtors have become debt-serfs, German exports to the periphery are contracting.

When it all implodes, German exports to the periphery will be a shadow of their past glory, and the surpluses which enabled the leveraged orgy of credit will dwindle

Sovereign currencies are the only mechanism for discounting differences in credit worthiness and production costs. The euro was established as the currency equivalent of gold, holding the same value in every member country. But the mercantilist/quasi-colonial model requires credit to flow from the center to the periphery, and that is precisely what has happened in the EU.

In the colonial model, the colonists are indebted and poor. The net value of their labor flows to the Imperial center as interest payments, and the banks at the center set the cost of money and the terms--naturally.  (Full post at: of two minds blog -Charles Hugh Smith)

Germans are also ripped off, since their working poor will either produce trade surpluses or being made unemployed, and then there is eventual tax bill for the entire Euro mess.

"Prime Minister Papandreou said 'let's hope a new and better dawn emerges".  Dusk is more likely, as without economic growth, darkness descends on those unable to pay their lighting bills.  Greeks (for those who can find work) will be working for the good of WHAT country/institution/organisation at or near subsistence levels. It is hoped that the Greek sovereign debt will be reduce to 120% by the year 2020. The structural reforms is supposedly an ambitious plan, making the Greek economy more competitive and sending out the right signals.  So, students can relax. Don't rush your exams as you won't be needed until 2020.  An ambitious deal with the right incentives and signals, indeed.


Its now Oxi day. The day celebrates the Greek rejection of the ultimatum made by Mussolini on October 28, 1940 to be occupied or be invaded. The invasion led to a defeat of Mussolini's army. Swedish band Sabaton (excuse the metallic blood) shows the mythical status. Merkels' remarks, on the eve of this celebration, about refusing to accept the Euro deal would end the peace in Europe was unfortunate timing (Merkel wants 'permanent' supervision of Greece, warns of war).

18 October 2011

On the Brink

The previous post concerned economic agents and economic models  Lets zoom in a little closer.

Here is a blog-post (translated and appearing in the Greek left Review blog) that describes the life of a 37-year-old woman in Athens in these days of crisis. Many in Greece are trapped in similar circumstances. I am posting it, as it is also a story that is not so unfamiliar to other parts of the world.

“I have worked since I was 16 and I have lived in Athens since I was 24. I remember that many times I had to struggle in order to survive with two jobs, but never have I stayed unemployed for too long. During the past eight years there were times when things were tight and difficult and other times when things were more or less ok. But not even in the most difficult period of my life, as a University student, did I find myself in the position I am today. For thirteen years I struggled, I fought, I stood on my feet. But now I can’t take it anymore. I’m giving up."

"I’ve been unemployed for ten months. Knowing that I was going to lose my job, I started searching for a new one from as early as the Easter of 2010. By now I’ve send 155 CVs but I only got two replies back, both saying that they didn’t need employees. For the first time in my life I’m facing an eviction order by the end of this month. The landlord says that I have no dignity and that I live on her expense, forgetting the eight years that I have been meeting my obligations regularly or even the improvements I ‘ve made to her house on my own expenses. Still, she’s right. She’s no charity – she wants her money. The movers ask for 1200 euros to take my stuff back to my mother’s city or 150 per month in order to store them in a container. I cannot afford either of the twoscenarios. I will probably have to throw away my household of ten years. The tax service is demanding 300 euro as an emergency levy with a 3% interest for every month I don’t pay. Another emergency tax is expected with the next electricity bill and that’s going to be 420 €. I have to pay 640€ every two months for social security, although the company I worked for explicitly told me that they have no job to offer and that even if they did, they would pay a monthly salary of no more than 420 euro. In short: the city in which I have lived for the past 13 years is spitting me off to the margins like if I’m some kind of trash. For the first time in my life, I have no place to stay and no one to hold on to. Any stock of patience and courage I had has now vanished”.

(From the blog Typos Nykhterinos extract from Greece on the brink of social explosion)

The Inequality of Economic Theories Part 2

Where to next?  The Lost Map and the Territory

The model that has dominated macroeconomics, DSGE (dynamic stochastic general equilibrium model), has been suffering some heavy criticism. Economics has some very powerful tools. By all means, attack what they build and how they used it but don't throw away the tool box.

John Kay (The Map is Not the Territory: An Essay on the State of Economics) writes:

'Lucas has called structures like these ‘analogue economies’, because they are, in a sense, complete economic systems. They loosely resemble the world, but a world so pared down that everything about them is either known, or can be made up. Such models are akin to Tolkien’s Middle Earth, or a computer game like Grand Theft Auto'
I don't have a problem with this. I have a problem when the only game on the shelf for policy makers to play with is 'Grand Theft Auto'. Politics in Europe decides what can or cannot placed be on the shelf.

'Economists have tried to do something that even physicists have failed to do - unify the micro and macro cosmos' (Hitch Hiker's Guide to Macroeconomics). This is not as an argument to throw away science, Newtonian Physics or a Theory of Relativity. We retain our the models because of their usefulness, but in Economics we also have to ask useful for who and for what purpose?

Rational expectations was a powerful breakthrough. Its interesting to know both when and where they do or do not apply, and what happens in these situations. One may build a complex/algorithm or computer model that describes a baby's movements; it does not imply that a baby crawls around with a laptop in his hand. There might be reason to dismiss the model if it predicts that the baby should be bouncing with joy, when in fact it needs toilet training. On there other hand, such a model error might be flashing lights to tell you its time to change the baby.

So is the efficient market hypothesis a bad model because it not describing the financial markets, or is it good one as it can tell you there is something wrong with the markets (eg imperfect information, uncertainty or moral hazard) that need dealing with? The point being it is a tool not an ideology to believe in.

What people think they “know” and cannot know and how far they can see into the future is not constant. (also see Paul Davidson: The State of Economics).  The world of 2007 is different from that of 2011. Such variables should not be treated as constants. The various families of ARCH models in various ways recognise this.  It is neither 'animal spirits' or perfect information rationality, but something that varies between.

One problem, or decision to deal with, in macroeconomic modeling is the focus; the degree or over what we abstract. It determines the story that is to be told. This was one of the initial points of Macroeconomics.

For instance, the case against DSGE models blindly adopting the equivalence property could be made not because it is essentially wrong, but because it buries essential economic information.  Ricardian equivalence is often used in a particular way to tell one type of story: a government carrying out austerity measures to reduce government deficits will result in people recognising (rational expectations) the policy to mean lower taxes or higher spending in the future. They feel worse off today, but as they realise that they will be richer tomorrow, they will increase spending.

This has not happened and something is very wrong. (and even at this level as Krugman argues Ricardian Equivalence does not imply this outcome).  There might be a different story. Reducing deficits (and austerity measures) may be someones pain today and someone's else gain tomorrow.

In a similar way, I don't have a problem with real wages per se in models.  Given a shock that results in the price level and wages going up by 10% and 25%, we may well conclude that there is an increase living standards. This might miss an important story. To say that everyone is better off is to assume the effects on everyone are symmetrical, there are no redistribution effect and that there are no change in relative prices.  If the relative price of what the poor consume rises faster than that of the rich, and the numbers of poor have increased, then there is a completely different story to tell.  The problem of non-asymmetric shocks happens within an economy as well as the EuroZone - not just geographically but amongst agents themselves.

Politicians, however, can't seem to separate reality from fantasy, can't understand them and cut and paste them into their own versions of Middle Earth: the 'Euro's one ring to rule them all'.  The blindness, or deliberate refusal to turn away from such a world, leads them to select and finance only models that produce the desired answer. Politicians then use maps that have nothing to do with the territory they supposedly represent.  Or, as  the New York Times puts it, 'Austerity a political ideology masquerading as an economic policy' ('Britain’s Self-Inflicted Misery').  Europe is a particular tragedy, as a new road map is issued every two months.

Some random wonkish thoughts and a little cutting and pasting:

One neglected political business cycle theory, at the time of Keynes is from Michał Kalecki with a 1933 essay and important 1939 work "Essays in the Theory of Economic Fluctuations".  He put forward the argument that political decision processes of Oligarchic or Imperfectly Competitive system would not allow the persistence of full employment.

During the war he work with other Polish escapees for the British War time Government and eventually moved to the US in 1946. McCarthy's witch hunts of his close contacts and friends convinced him to move back to Poland and live behind the Iron curtain where his influence dwindle.

Kalecki towards the end of life 'made the sad but true observation that the story of his life could be compressed into a series of resignations in protest-against tyranny, prejudice, and oppression' (George Feiwel).

Whereas Keynes argued that governments could impose their plans on the economy to control the business cycle, Kalecki argued the reverse. The market structure would restrict any management of the economy and the business cycles would impose itself on governments.

It is of interest because it is built on the oligarchies, cartels and Monopolies and is about inequality.

Let me describe a story it can tell:

1) There are two groups in the global economy. Those who need to work earn wages and salaries and those who can just live off profits.
2) One group is defined as those working but cannot save significantly more than what they need to service debts. (eg Debt-Serfdom Is Now The New American Norm)
3) The other group can save and accumulate funds to invest or manage large portfolios that are highly mobile, moving with ease from one part of the world to another.

Now lets do a different type of Creative accounting.  To be provocative, I will use different labels than Kalecki:

Total Profits + (Total Wages - Debts) = Workers Consumption + (Corporate profits + Creditors)
                                                               Consumption + actual Investment
As most workers can't save or are enslaved to there debts we have:
(Total Wages - Debts) = Workers Consumption  
And canceling this from both this sides, gives:
 Total Profits = (Corporate profits + Creditors) Consumption + actual Investment

This is his famous profits equation, which simply says that profits are equal to the sum of investment and capitalist’s consumption.  Now ask a cause and effect question.

a) Does corporate owners’s consumption and investment determine profits or
b) Profits determine corporate owners’ consumption and investment?

Kalecki would argue the answer depends on who can decide. Corporate owners can choose to consume less now and invest for high expected returns in the future. Higher or lower than expected profits leads to an adjustment in their decisions. Here we could introduce all sorts of things (Kareken and Wallace model?). My second quote from Tom Sargent, rational expectations is "helpful in predicting the crisis, not the timing of the crisis because there are random variables, but in terms of predicting the measures that increase the probability of a crisis, and that’s the Kareken and Wallace model." So from above a) is the prime cause and b) the revision: profit rates leads to corrections

If corporate owners’s consume more, then one would image that they have less funds at the end of the period. This consumption, however, would also feeds backs in each other's profits. In a way,  Kalecki views them as masters of their fate. .... http://en.wikipedia.org/wiki/Micha%C5%82_Kalecki#Theoretical_contributions

It is interesting as it can leads use to model, income distribution, inequality and the economy being at inefficient allocations of wealth and income. We could of course look at other alternative models that might be better. Isn't that the point of Econometrics? Or is it just to make sure the data fits our favorite model? 

The Inequality of Economic Theories Part 1

Inequality and Inefficiency

The monetary base of economies has changed.  Global capital, which can refinance, is running circles around governments who cannot refinance themselves. (re: East India Company v's the 'absolute monarch', Louis XVI).

As the 2011 Nobel economics prize winner Tom Sargent comments, greedy bankers figure out odds, what’s their interests and increased the risks and probability of a crisis. That’s rational expectations.

Protesters are against greedy bankers, who they know can out figure the odds, their interests, run rings around the governments and increased the risks of the crisis.  Protesters' "we know what you are doing" is also rational expectations. The '1%, by the 1%, for the 1%' (Joseph E. Stiglitz in Vanity Fair) is the argument.  Global Protests are against a system that makes people study and work hard to produce low or zero returns. They protest against the inefficiency and a cycle, or downward spiral, of inequality.

Protesters have new social networking tools and technology that makes it both easier and more effective to organise change. (see 'Occupy' is a response to economic permafrost'). 'Horizontalism becomes endemic-techn makes it easy: it kills vertical hierarchies spontaneously'.

In the meantime governments are suffering coordination failure, or worse from illusions: RT@NickMalkoutzis 'thanks for the behind the scenes footage from the Eurogroup meeting'

Lets suppose a model where global capital has rational expectations, Governments suffer from coordination failure, political meltdown and protesters have rational expectations.  It makes an explosive model.

The current economic and political systems is tied by a Gordian Knot. In Greece both protesters and analysts agree that the system is inefficient, but who cuts the knot?

Inequality, and the squeeze on the middles classes, has struck hard at the 'advance' economics. Economic growth has moved eastwards. The room at the top has filled up, only few enter and leave it, and the door is firmly shut.  The inequality that it leaves outside kill opportunities, leaving an economy becomes increasingly inefficient (relative to its potential).

There are two double think theories on inequality that need to canceled themselves out:

1)   Lowering 'low' incomes increases productivity and competitiveness. Cheaper wages, leads to more exports (provided everyone doesn't do the same policy - who buys?), greater growth and the economy is prosperous (for your country, children, your children's children, religion or whatever). 'Be poor or we won't give a job' argument.  Great in a perfectly competitive model (homogeneous agents: everyone is equal, wealth does not restrict market entry, equal access, etc) but not in an oligarchic or monopolistic reality.

2)   The opposite argument if you are rich: increasing 'high' incomes increases productivity, as it rewards those for being the most productive in the economy. An 'I deserve to be rich; you deserve to be poor' argument from the 19th Century 'marginal-productivity economic theory. To make sure that the 'powerful' remain powerful, they then monopolise educational, resources and all pathways to power. Thus, financial managers of the crisis are rewarded for their contributions to society.  Austerity measures, falling output, poverty, destruction of human capital, whole sale destruction of communities are somehow necessary to keep up these wonderful contributions to society. Contrast this very few rewards received by 100,000s of contributions, ideas, pioneers, social enterprises and creative users on the internet.  Unsurprisingly cyber space wants also to also occupy physical space. To what extent was Microsoft's Encarta v's Wikipedia an uneven competition between private entrepreneur property and social entrepreneur property?

Inequality is inefficient:
1)  it restricts opportunity and deprives access to untapped resources. Practices result in dumping (human) resources to maintain or protect inequalities.
2) it reproduces itself, through monopoly power and preferential tax treatment for special interests and loop holes. Financial capital is highly mobile, but restricts the mobility of human capital via opportunities, uneven development, labeling, standardization, product discrimination into race, rationality, gender, age,fashion, etc.
3) it breaks up social and community action do deal with, for example, environment, health, education problems and to coordinate responses to financials crisis. It generates mistrust; a 'tragedy of the commons' 
4) misallocates resources, (buying power is uneven and supply is restricted), benefits are privatised and costs are socialise such as pollution or bank bailout. The most talented young people go into professions that are not actually productive - be it armies of lawyers, bureaucratic or finance - for the economy

As I write, a twitter: @INETeconomics "Market outcomes need to be modified to create a more even #distribution of incomes" Nobel laureate Michael Spence http://t.co/U2zUNdFK. Such is the speed of change.

10 October 2011

Zeno's Political Impossibility Paradox

...... and Reality

You might have noticed that the meetings, crisis, meetings, crisis .. are occurring at shorter intervals. There is a wise old Greek who might help us to understand this and why everyone is being pushed to and off their limits.

There is also the Box Bunny's carrot (less stick) version. The IMF  latest report recommends that countries should reverse their austerity measures. In very damning graphical detail, section 1.1 (Divergent Recoveries, but a Synchronized Slowdown?) shows the Euro as a very sub-optimal monetary union.

We could ask why Greece is not included in the recommendation to reverse austerity measures.  A Zeno swapping arrangement might have helped to explain -  but the following may serve better.

It's useful to remember above image when reading about "moral hazard" - it is after all about the control and exploitation of information.


A comment on a Nobel economics prize winner

Macroeconomics and Reality 2.0 – when will it be released?

Thomas Sargent and Christopher Sims won the Nobel economics prize on Monday. Many are speaking about their work on the impact of expectations on policy. I shall take a different line.

When Chistopher Sims published "Macroeconomics and reality" (Econometrica 1980) a revolution was instigated in macroeconometrics. C. Sims argued that existing macroeconomic models were strangled by "incredible overidentifying restrictions". Models were so prejudiced by the underlying assumptions and pet theories that were in vogue that hypothesis testing, policy analysis and forecasting were virtually rendered meaningless.  As Macroeconometric models failed to predict and handle the subsequent events of the 2008 global crisis, we might like to ask the same question today.

Learning, knowing or worrying about something affects the outcome (here enters Sargent and also the Alice-in-Wonderland Cheshire Cat) but, until Sargent's work on rational expectations, it was very difficult to build into macroeconometric models. Macroeconomics models were static representations of a complex dynamic reality. C. Sims provided a philosophy, co-developed a toolbox and opened the way to a new horizon of possibilities.

Back in 1980 C. Sims proposed freeing macroeconometric models from its cage by allow 'history' (past values of variables) to determined the shape of models and hopefully, if not visible, allow the causal nature and underlying structure of macroeconomic reality to feed into the models. The result was a revolution and an attempt to shift to move models away from classical statistical models.

He introduced a theoretical approach based on Vector AutoRegressions and Baynesian methods to allowing the data to speak to the structure of models (variables' past values could be switched on or off by he data) and/or the possibility of beliefs and theories to be imprinted on to the model without imprisoning it.  His subsequent contribution to the work on the econometrics package RATS (later CATS!) provided the tools for others join the revolution.

The possibilities seemed endless – that was also the problem.

Subsequent work by others, who were also to receive Nobel prizes, gave clues: Granger causality time series (testing if y is more related to x's past than x to y's past - or crudely - which comes first, the fire or fire engine?); Cointegration analysis (suppose a drunk is walking randomly around with his dog. Both are non-stationary. Both pull and tug with each other. Individual movements make no sense but there is a relationship), Error correction. Learning models, etc.  New tools seemed to be appearing all the time.

What went wrong?

Referring back to previous post: (How can blindness and Deafness be explained?), perhaps this gives an answer:
'I do not think that the currently popular DSGE models pass the smell test. They take it for granted that the whole economy can be thought about as if it were a single, consistent person or dynasty carrying out a rationally designed, long-term plan, occasionally disturbed by unexpected shocks, but adapting to them in a rational, consistent way... The advocates no doubt believe what they say, but they seem to have stopped sniffing or to have lost their sense of smell altogether.' 
Robert Solow, United States Congress hearings (July, 2010) investigating why macroeconomists failed to foresee the 2008 Financial crisis
The pioneering work of the 1980s opened up a new terrain. The same neoclassical building was built on it. Only a Walrasian auctioneer or single consistent rational super entity can occupy its premises.

The award to Christopher Sims comes at a good time.

28 September 2011

Euro Death Race

Euro Death Race 2011 is on release.  The Euro built by the world's finest surgeons. Now screening in Greece, coming to movie theaters in Italy and Spain.  Here is a trailer from the original 1975 version.

The new Greek Austerity measures are explained below:

The reaction in this?  Here's a speech from the Swiss Finance Minster (courtesy of Spiegel, and apologies for the poor translation)  

 More about the speechless shock here

24 September 2011

Time to get rid of the witch doctor

The reward for brutally enforcing a policy crippling the Greek economy is another €8-billion of emergency fund. It will go in through one door of the state and straight back out through another to the banks. It is Orwellian to call it a Greek rescue package. On each occasion the Government receives its 'bailout' money, the average Greek is left with less in his hands. Greeks are not dancing on the streets with overwhelming joy at being saved (see this Austria report). The relieved faces are elsewhere.

Greek default is inevitable and the longer it takes the more expensive it becomes for everyone. Talks focus on how to minimize the damage to the creditors. The Greek economy is secondary. Most of the Greek population do not believe it is working, is in their interests, or offers any hope. Austerity is so damaging that default comes as a relief. It has become a question of survival.

It is impossible for Greece to repay debts by measures that reduce its ability to pay. The economy will shrink 5.5 percent this year and another 2.5 percent next year (latest IMF report). Targets will be missed again. Greece's public debt was supposed to peak at 160% but now the IMF forecasts 189%.  Nearly a quarter of the working population will be out of work by December. The strains on Government revenues and ability to collect taxes are plain to see.

It simply will not work. Protesters on the streets in Greece have every right to say  'We won't pay!'.

Meanwhile urgent discussions and a complicated poker game is being played in Washington.  A G20 statement said the euro zone would take action to "maximize" the impact of the bailout fund by mid-October, recognizing that default and an substantial 'haircut' on Greek debt is essential.

Venizelos, the Greek Fin. Minister, spoke of “absolute fiscal derailment” and “we continue to generate deficits” True, but  austerity is derailing everything.  There will no engine let alone rails for the Greek economy to run. Austerity and the Third world experience, as World Bank's former Chief Economist testifies, does not work. Is there a such thing as  'growth-friendly fiscal consolidation'. The European Community (?) needed to undertake structural reforms not purely confined only to Greece but to the entire Eurozone structure. Balancing national fiscal consolidation without financing European-wide investment programs, reduces countries to colonies.  Why are such programs so politically unlikely? There was and is no Marshall plan.  Perhaps, the threat of a disorderly default will create the willingness for one.

Austerity is about making everyone miserable so that the accounts can look less miserable. In the end there is no paper left to print the account books on. It is a failure to recognise the causes of the Euro crises. This is an excellent read: http://streetlightblog.blogspot.com/2011/09/what-really-caused-eurozone-crisis-part.html 

Internal devaluation is a broken wand

When it comes to restoring trading balances, there is no substitute for actual devaluation. The inability to deal with cartels, local monopolies and market power makes internal devaluation impossible.  This applies not only to Greece but also to Europe.

Monstrosities, such as the Common Agricultural Policy and Investment projects (that require the borrower to match the same amount of money), favour the big against the small.  Food prices are artificially far too high and local cartels control the markets - here's an example of Greek food price fixing and supermarket cartels. One supermarket even imports Greek products back into the country and sells cheaper than French / German controlled supermarkets. In Northern Greece, those who can, go to the borders to get cheaper petrol, food and clothes. Not surprisingly many businesses are closing down.

Wages and incomes fall and many small private businesses close down. Some stay open by not paying their works for months.  Greece, once full small families businesses, is a country full of empty premises and closed shops. The poor have had enough and so have the middle classes - see 'Greece's Middle Class Revolt against Austerity' Austerity in the name of debt service has become a recipe for revolution.

Yesterday Venizelos said 'we would rather be the government who hit the lower and middle classes than be the government that failed to save the country"  So, one wonders, who is he referring when he says 'save the country'?

Greece will default, but it has to default on its terms not on the creditors. The sooner it defaults the quicker it will get out of its debt spiral.  But how do you get rid of the witch doctor?

There seems to be a democratic problem

More enlightening Venizelos quotes: “we are lucky to be under international control” and “when you depend on the markets, you have to accept the creditor’s point of view”

This may depend on how the Greek Parliament votes next week.  But, if we follow Venizelos' logic, what is the point of having a Greek parliament? Why not close it down, get rid of the pretence and save money? Besides, most European were not allowed to directly vote on the Euro. The European idea it seems is not to let Europeans directly vote on the Europe Idea - but they can vote every year on pop songs.

Yet, without a sense of community and mutual trust (and this must imply a better version of democracy) there can be no European common debt structure (ECB backed Euro bonds) or fiscal union.  Without this there is no hope for a common currency.  It becomes intolerable or unacceptable to one or more of its members and breaks down. A European tragedy of the commons.

Speaking of illusions and virtual reality, make what you think of the following:

Greek Default

Default, and the knock on effects on the other PIIGS economies, could mean that some members, such as Greece or even Germany, leaving the Eurozone.  The Greek government has to prepare for events that unfold.

Greece can restore competitiveness and rebuild its economy.  The problem is going from point A to point B and not forgetting that many legal, economics and democratic reforms are still needed.  

If Greece leaves, then the new drachma would fall and immediately restore competitiveness. It would boost the tourist industry and exporters would be able to sells goods and services aboard more cheaply. Imports would become more expensive and the country's trading deficit will shrink.  There are three difficulties with this story: the ability its citizens and businesses to survive the immediate financial crisis; what happens in Greece's export markets and/or the rest of the Euro zone; and access to capital and funds for investment, growth and economic recovery.  The answers are by no means clear ........

The depreciation (that some say could be as much as 50%) of the new drachma could turn any debts that remained in Euros into a crippling burden. It is this prospect that would create a massive run on the Greek Banking System and, is in one sense, the lock on the euro cell.   But to some extent, with the expectation of default, this has already been happening.

The Greek banking system is already in very bad shape. It is not only having to deal with the holdings of Greek debt but the flight of depositors. As the FT's alphaville scribbles on "a note to the troika – every time you say “lack of progress”, another depositor’s faith that a Greek bank is better than the storage space under a pillow dies."  Many deposits have left the country fearing a default and exit. Again from FT's alphaville 'The humble Greek (and Argentine) depositor'

Banks will have to be re-capitalised, provided with liquidity and socialised. If socialised, backed with public funds, the government will have the option to privatised (sell shares/stock of what it puts in later at a price that gives a profit) when the economy recovers. Businesses, those paying mortgages and Greek depositors will need protecting.  Debts will need to be re-negotiated and/or converted into local currency.  Some compensation scheme, for example a stake/shares in the re-capitalised banks, is needed to cover the loss in value of savings.

The Government will printing the new currency and, if there is no external assistance, pumping in liquidity into the banking system. The period is likely to be inflationary and at some point the brakes need to be put back on.  Here lies a difficult question. Would you trust the present Government to do this and not to use its printing presses postpone essential economic, democratic and legal reforms? I suspect a change to government and political system would be required.

The outcome would be chaotic, but planning is needed anyway to cover for the increasing possibility of a Euro-wide system breakdown. A great deal depends on the political struggle with creditors to force them to accept their losses.

It is in this struggle, that the Greek government still has an important weapon to limit the internal financial damage. Greeks governments bonds were issued and written under Greece law (and not yet roll-overed into English law) which gives the Government enormous power. It can call for much bigger losses on the part of creditor holders than what is currently being suggested. The tables can be reversed. Rather than debtor being coerced into doing whatever the creditor wishes, the ability to inflict large losses on the creditors ought to make them more receptive to the demand of the debtors. Hence individuals and companies usually have their assets seized, but countries don't.

The term 'selective default' ought to be re-defined to mean who the Greek electorate choose to 'selectively default'.  Good and bad creditors and debts should be separated and investigated. The international law on odious debts needs to be tested. Not all creditors (those supplying funds for real investment projects as oppose to bogus ones) ought bear the same costs. Here's the famous documentary (if you haven't seen it) explaining the idea:

Two are a couple of points that should be mentioned while speaking of Argentina.

Argentina suffered a debt crisis after fixing its currency to the US dollar in 1992. It lost its competitiveness, built up a large trading imbalance that could not be indefinitely financed  and a collapse in public finances.  It defaulted and eventually recovered. The crisis occurred when the global economy was in healthy circumstances.  Default in 2001/2002 forced bank to place limits on withdrawals. There were big losses for depositors and banks as their assets and liabilities were re-denominated, each at a different exchange rate. It survived. Look at the following graph (via Krugman – it is not up-side-down:

After a period of decline Argentina grew by 9% in 2003 and, with a surge in global demand for agricultural commodities carried on at around that rate until 2008. It survived the 2008 meltdown better. Economic growth occurred even though it did not have access to international capital markets. Perhaps a mixed blessing as the witch doctors will no longer in charge of its economy. Today it has growth rate near to 10% ( Yes it does have corruption and inflation).  Default, however, required an upheaval to the political system and a change in government.

The Greek situation is not quite the same as the Lehman Brothers collapse that triggered the 2007/8 global financial crisis. That was a shock.  A Greek default would not be a surprise and would not have the same effect on markets.  Financial markets have been trying to anticipate this event ever since the Greek crisis begin at the end of 2009. As everyone is expecting default, and those who can have ran for cover, the financial impact has been partly offset.  The crisis that never seems to end, is being perpetuated by throwing money at a lost cause.  At some point there will be none left to throw. 

Assuming the worst case scenario - default and exit leads to a lock out on all capital markets - there is a ray of hope in the following diagram. At the same, it explodes another myth about Greece (via Bloomberg).

This shows that Greek households (the red section), unlike the Greek state (white), haven't been 'spending above their means' to the extent that Germans have. The Greek State may have been partying but ordinary Greeks haven't.

If Greece defaults then it will lose its creditability and international ability to borrow. But hasn't it already lost it?  This would force Greece to live within its means, which is what the current austerity measures are suppose to be doing. But, possibly for only a few years. Greece still has resources and householders that are potential under-leveraged savers, which can provide a basis for future growth.   

As for the rest of the Euro Zone?

It might not be a bad idea to read 'Modest Proposal' after all. They might discover that it was also about saving the Euro. Remember that Marshall plan?