9 June 2011

The Blindness and Deafness to Modest Proposals

The Blindness
The Euro was suppose to provide a stable currency and remove currency risk.  Martin Wolf in the 'Financial Times' asks where would you prefer to keeping your savings: in a bank in Germany or one in Greece?  The Euro was suppose help economies converge to each other. To argue that Euro economies can stop diverging from each other by using austerity measures that push indebted economies so far back that it will take years to recover is simply madness.

Why are Euro-technocrats so insistent? Here's one explanation. The world is flat. Here's another. When their policies are walked through, or rather when their policies take them for a walk, something non-linear happens … 

How can this blindness be explained? The European Central Bank uses a BVAR forecasting model, based on something called a Dynamic Stochastic General Equilibrium (DSGE) model, to see (!) what is happening in the Eurozone. It does not analyze individual European countries separately – well, are they separate? 

In July, 2010 Robert Solow attacked DSGE models at the United States Congress hearings investigating why macroeconomists failed to foresee the 2008 Financial crisis
'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, July, 2010.
(Personally, I used such models over 20 years ago to examine the rubbish bins of famous (forecasting) models to try and find out more about their love lives than they were willing to admit.  I was surprised to find them so fashionable.  Rubbish bins are useless without some misbehaving model to throw rubbish into them, but it seems that's what we have got. Its a pity their advocates have lost their sense of smell)
The model assume efficient financial markets, and when things go wrong, blames both the labour market and the state.

There is some truth in this. According to the OECD, the Greek worker in 2008 on average worked 2120 hours per year – second only to Korea in the OECD countries - and 690 hours more than a German worker. Many of these hours are wasted, supporting armies of bureaucrats, lawyers, accountants and, if the constant processing makes you sick, doctors. Foreign tourists don't see this, as stereotypes are used to sell the tourist industry. Tourists pay to see the 'Zorba the Greek' smashing plates, and dancing on a tavern table. They don't pay to see exhausted Greeks frantically scrambling around the concrete jungles to get to work. 
The crisis is more than just about work ethnics. The Euro model is generating a fatal system error; this point is reached when a country is reduced to choosing between living on Junk Bonds or living on Junk Food for the next 10 years.
“Why is everyone clapping”, asked Alice, “all the arrows missed the target!' “Yes, but its a fine distribution of misses” replied the Queen
“Yes, but shouldn't the arrows being getting closer?”
“Off with their heads!” roared the Queen “.. see... '
There are many things wrong with the Greek economy. It won't meet its targets. Its ugly and bureaucratic, but don't kill it.

The Deafness:

The Euro has created an imbalance with some countries producing persistent surpluses and others incurring deficits. This is at the heart of the European Debt problem and it ties down any attempts to make the Greek economy competitive. 'A Modest Proposal' by Yanis Varoufakis and Stuart Holland provides a way of solving this, without substantially amending existing treaties, by converting debts into Euro-bonds and re-cycling trading surpluses into investment programs to help correct trade imbalances. The plan rightly addresses the twin aspects of the indebtedness, government bond crisis and consumer indebtedness, that the Euro is creating and is threatening to both country and consumer sovereignty. The crucial part is a Marshall Plan for Europe, the re-cycling of trading surpluses to create a massive investments program through an active European Investment Bank.

If not this, then something like 'A Modest Proposal' version 2.0 or 3.0 could work. However, the disturbing feature to such plans is the deafness of ECB/IMF officials. According to the New York Times the proposal was 'seriously' considered by Georgios Papandreou and turned down because Germany and the ECB would never accept it. The leader of small but heavily indebted eurozone country appears helpless. 

School kids are told that democracy is about listening to the people and when they grow up are told it is about listening to the markets. It is interesting when stock market analysts agree with Facebook protests in Greece. 
“Greece can't pay? No problem, let's give them another loan that they can't afford. To me, this is very similar to the MCI Worldcom scandal. What the global monetary powers that be simply do not appear to understand is that you can't hold people accountable that clearly aren't accountable.” Glen Bradford, Seeking Alpha
At the moment, Nobody is better than Georgios Papandreou. In the polls of the last 6 months, to the question “Who is the best Prime Minister?” 47% of the Greeks had answered 'Nobody'. Perhaps Nobody is more threatening. If an economy that represents 2% of the overall Eurozone Economy can bring about an European-wide crisis, then why is it incapable of representing its own interests? If it can't then Nobody will and Facebook demonstrations will grow. 

A Modest Proposal is also the title of Jonathan Swift's satirical essay in 1729 suggesting that impoverished Irish might ease their economic troubles by selling their children as food for rich gentlemen and ladies. We are not going down that road, are we?

Jean-Claude Trichet, President of European Central a couple days ago made an speech that was picked up by the BBC.
A vein running through this speech is the belief that governments can't be trusted with spending while officials can. In this vision citizens and voters don't appear to have a seat at the table.
"Would it go too far if we envisaged," he said, "...giving euro area authorities a much deeper and authoritative say in the formation of the country's economic policies if these go harmfully astray?" http://www.bbc.co.uk/news/business-13641063
which means, with a permanent trade imbalance, that some countries are always likely to go 'harmfully astray' Was there any democratic consent to this? 

There was also deafness when the 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'. Every time a crisis occurs, officials appear acting as doctors trying to save a sick patient. The patient comes back for more and more treatment until it is eventually institutionalized. Greece is institutionalized and social policies become secondary to an economic policy directed unelected officials. Americans frequently complain about the tyranny of Washington, but they can take comfort in the fact that there was a George Washington.





  1. Informative & compulsive reading... I will revisit this post often.

  2. Jonathan Smith25 June 2011 at 02:14

    The euro bond option featured in the Economist some time ago but does not seem to have achieved traction, probably because of Trichet at the ECB, presumably they would have to back them. They are already exposed to the Greek National Bank, and thus to the backing the bank gives to the individual Greek banks in terms of liquidity. The crunch, or the next stage of it, is coming. If there is a ‘haircut’ then the capital of the Greek banks would be drastically reduced, or in the case of Pireus Bank, eliminated. Eurobonds would also reflect the soundness of the aggregate issuers, so the interest rate would still be higher than, say, German bonds.

    The major problem seems to be the lack of any sufficiently coherent central authority to knock heads together and come up with a realistic plan that would actually be adequate to deal with the magnitude of the problem. It reminds me of the ‘Kursk’; the Russians and the US argued about who and how to rescue the crew while the poor buggers slowly drowned in icy Arctic water. Unlike the Kursk, it’s not just the hapless crew of one submarine that is involved, but the future of the whole Euro zone. Every day that passes exacerbates the problem itself and undermines the credibility of any solution they may arrive at, and of the whole institution itself.

    In concrete terms the problem is not that big; Greece has a population of about 10m, let us say 3% of the eurozone, give or take a percent. Undoubtedly, Greece, or rather its pocket lining politicians, has been egregiously delinquent, but the instinct to punish the Greeks and see them suffer has to be balanced against the likely outcome. Any solution has to take into account the possibility that it may also have to be applied to the other PIGS, and, more frighteningly, to Italy, which is skating on ever thinner ice as the financial climate warms up. It is a scary prospect, but this should be the spur to decisive action of some sort; squabbling like children or running around like headless chickens is a certain recipe for catastrophe. The situation is hardly helped by Giorgaike’s repeated protestations that Greece will not default and will pay its way out of debt. Could this be a possibility? I suppose nothing is impossible, but I give it about the same chance as a celluloid duck in hell. We shall see what difference Venizelos makes. I am not optimistic, but he might just have the forcefulness to ram home the reality of the Greek domestic situation to the nabobs of Brussels, if he chooses.

    Two hundred years ago in England, if a doctor arrived to find a patient in a semi-comatose condition, the first thing they did was to bleed the patient copiously in the mistaken belief that removing a sizeable proportion of the patient’s life blood was the fastest and surest route back to rude health. It seems that this is still a fashionable solution in economic circles. There is no doubt in my mind about the need for a radical restructuring of parts of the Greek economic system, the public sector in particular where clientelism and nepotism have produced a situation where a fair proportion of the population sit around drinking coffee and smoking cigarettes all day and what little work they do is in the direction of tying the rest of the working population up in tangles of red tape that effectively waste much of the effort they put into genuinely earning a living.