11 September 2011

Euro Bits and Pieces

Insanity is doing the same thing over and over again and expecting different results. (Albert Einstein). 

Megan Greene's Aug 3rd post  said September will be a perfect storm. September was also the month when UK went off the gold standard in 1931 and the month that the UK was booted out of the European Exchange Rate Mechanism in 1992. (The Economist). Time for Roosevelt's 1932 inaugural address:  'The only thing we have to fear is fear itself'.

Greeks have been given an ultimatum.

"Ladies and gentlemen, the situation is serious in Greece," Schaeuble said in a speech in the Bundestag lower house of parliament. "At the moment the troika mission is suspended. There can be no illusions (?) here. As long as this mission cannot confirm that Greece has fulfilled the conditions, then the next aid tranche cannot be paid. There is no wiggle room here." 

The Dutch prime minister, Mark Rutte, has also warned that fiscal violators who refused to give up sovereignty over their budgets to a new European "discipline" czar should leave the bloc (Reuters). No doubt, at some point, a change to the constitution will be demanded (to enforce balance budgets on all future governments) to ensure voters don't vote for anything different to what is being prescribed.  I don't agree that budgetary indiscipline is the cause of the crisis. I also don't believe in austerity.  Suspending the rights of those who disagree is an act of a dictator.  The terms of surrender are foreign administration, selling off assets, unemployment, falling GDP, rising poverty, more debt and bond servitude.

The damage to today's youth will be felt for decades by everyone. Those who cannot vote now will nevertheless pay the price for a disastrously designed monetary system.  Yet, the Greek government has been trying (a difficult word for them) to put up some resistance.  PASOK, the ruling party, faces extinction by attacking and shrinking the middle class and public sector workers that vote for it.  According to one survey, some 75% of people aged between 18 and 24 said they wanted to leave the country.  "Citizens will judge us in 2013," Papandreou told a party conference.

According to the Kathmerini, without the sixth tranche, the government will be 1.5 bn euros short on October 17th (interesting date in Greece) and won't be able to pay wages and salaries. The government has decided to freeze all disbursements apart from salaries and pensions.  Cleary Gottlieb (Lee Buchheit, the partner represented Iceland and  Argentina) law firm hire was hired by Greece over a month ago.

Greece cannot meet its targets, are at odds with the EU/IMF and talks are on pause.  Next week there is another emergency meeting with the Greek Government. This strategy came to mind:

Key policy makers are still failing to recognise the causes of the crisis. Wolfgang Schauble, the German finance minister, wrote in the Financial Times:
“It is an indisputable fact that excessive state spending has led to unsustainable levels of debt and deficits that now threaten our economic welfare.”
This is a very disputable factSpain and Ireland were running a budget surplus, unlike Germany, before the market meltdown in 2008. They also had lower debt % to GDP than Germany.  In Ireland and Spain it isn't excessive state spending; Ireland ruined it finances by deciding to bail its banking sector; and in Spain a massive property bubble burst.  This was brought about by a global crisis and a faulty Euro. 
I could argue that austerity measures leads to unsustainable levels of debt and deficits, reducing GDP, savaging the tax base, destroying small businesses and reducing tax receipts. Even at the micro level there are difficulties:

(VAT on eating out has been increased in Greece. If demand for eating out falls (%) more than the increase (%) in tax, then tax revenues will fall. Add to this the number of restaurants that will close down or refuse to pay to stay in business, then it is easy to see how this particular tax target will be missed.)

The maths will not work out, like Alice in Wonderland: Let me see: four times five is twelve, and four times six is thirteen, and four times seven is -- oh dear! I shall never get to twenty at that rate!

What the various PIIGS economies do have in common are unsustainable trading deficits with their Euro partners and no tools (exchange rates, monetary policy) to restore competitiveness and correct the imbalance.

The crisis began with banks and the private sector risk markets over-extending themselves. They were bailed out directly by supports or indirectly through austerity measures. Risk was transferred from private to the public sectors and  private toxic assets became public toxic assets.  Countries bail out banks but banks won't bail out countries. The EuroZone was particularly vulnerable with internal trading imbalances.  It has no flexible no mechanism to restore members' competitiveness.  Boot it up and it will fail again.  Europe’s diverging economies is now a fact.

If deficits are sinful, then so are surpluses:  ὁδὸς ἄνω κάτω - the road up and down is one and the same, Heraclitus (c.500 BCE).  Some surplus euro countries have become dependent on its partners for export markets. This graph (from Reuters EcoWin / Fathom) shows Germany exports more to the EuroZone than it does to the rest of the world.  
Germans have a right to ask what happen to these surpluses.  Their real wages were kept low (perhaps if they had more to spend on Greek holidays, things wouldn't be so bad). German wage inflation could be a good thing for Greeks - reducing both the German surplus and the Greek deficit (instead, we have the opposite: austerity)

A chronic trade surplus provided funds for a financial system lacking discipline in the euro periphery.  German exporters and banks also ate at the Greek/Spanish/Irish table.  Those left, pay the bill - the German tax payers, bankrupt Greek/Spanish businesses and the unemployed.  But its worse. The money used for the bill could have been used to make investments that unemployed young of Europe so desperately need.  The price of gold is soaring and the Swiss Franc has appreciated sharply. Look for the missing surpluses in gold and Swiss bank accounts.

As the wealthy rush to Gold and Swiss Bank accounts, others are finding some other interesting exit solutions. How about Flioritos issued by a small town outside Rome or the Exarchia-Lira in Athens?  

A Re-Cap on Economics Principles:
As most of the world is intent on beating itself up with austerity measures,  it  might be a good idea to beat yourself up with basic principles of economics.  I found this (YouTube, - the textbook mentioned here costs a Greek weekly wage) profitable.

The principles of Bah Bah Bah
Paul Krugman asks, since we are in a crisis 'what are marcoeconomists for?' Unfortunately, the profession has become dominated by a narrow range of neoclassical economists; that is, homogeneous versions of Voltaire’s Dr. Pangloss, who always insisted that we live in the best of all possible worlds. Let the markets be.

The chief economist at the IMF said in 2008 "Like all revolutions, this one has come with the destruction of some knowledge, and suffers from extremism and herding. None of this deadly however. The state of macro is good." (Olivier Blanchard 2008)

Yet only Dr. Pangloss is allowed to prescribe. Austerity measures, no matter how bad, is always better than what would otherwise be. Ironically, the secret to Belgium's 0.7% growth while the rest of the world lags is that it has no real government to apply austerity packages. The paradox is that Dr. Pangloss should not be prescribing.

Hitch Hiker's Guide to Macroeconomics
In the dominant DSGE macroeconomic models (see a previous post) markets are always stable and everything is always priced just right. Say 42. Models proclaimed stability (it's the only thing they can ever predict).  Anything that falls outside the economic theory of 'life, the universe, and everything" is a 'fairy tale'. 

Economists tried to do something that even physicists have failed to do - unify the micro and macro cosmos.  The unified theory of everything is constructed around individuals being rational and markets being efficient. Pan-dimensional creators assuming the form of mice guarantee that financial markets always get asset prices right given the available information.  The model maintains its consistency, producing the answer 42 every time. When bubbles burst in their faces, modellers refuse to accept that markets go wrong - the message 'trust the markets' evolves into a religious, un-falsifiable act of faith.

Market failures, “externalities” — costs that some (in my view the banking system) impose on others without paying the price - are ignored as they don't generate the prescribed right answer.  Rationality is conveniently defined as those who agree with view of the world; whilst those who don't are irrational (as it won't be in the agents budget constraint). Lets reverse the situation: monopolies exist, capital markets are imperfect and accept that most individuals are rational - they realise that markets are inefficient. Policy-makers/ economists who cannot perceive this state of the world, persisting believing in efficient markets, are irrational. The result? Political instability.

As as Voltaire puts it: “it is dangerous to be right when the government is wrong”

Another feature buried in macroeconomic models and the debate on austerity versus fiscal expansion is something called Ricardian equivalence. If a government carries out austerity measures to reduce government deficits (by reducing spending or increasing taxes) people will recognise that such a policy means lower taxes or higher spending in the future. They seem to be worse off today, but as they will be richer later, they will increase spending.  Not quite. The problem is the pronoun. Many are poorer today, but a few will be richer tomorrow (and if you are nice they might even employ you).

Back to the Hitch Hiker's Guide, Arthur pulls random letters from a bag, but only gets the sentence "What do you get if you multiply six by nine"?
     "Six by nine. Forty two."
     "That's it. That's all there is."
     "I always thought something was fundamentally wrong with the universe"
Six times nine is, of course, fifty-four. The Euro program should have run correctly, but the unexpected arrival of the Anglo Saxon speculators has caused input errors into the system. This has meant the European electorate subconsciously asks the wrong question. It shouldn't ask about democracy.

Some one else who based some of his stuff on Ricardo is back in vogue on Wall Street. 'Marx is hot' headlines Businessinsider.com and Forbes has "The U.K. Riots And The Coming Global Class War".

The London correspondent of the New York Tribune (in 1850s)
A senior UBS economic adviser at Swiss UBS, urges policy makers to 'Give Karl Marx a Chance to Save the World Economy'. Things are serious. 

Money... its a gas

Minsky: "Anything can be money, the difficulty is in getting others to accept it."

One of the biggest problems was that crucial developments in financial markets, the risks of an unregulated shadow banking industry, were ignored. The technologies behind payments, stores of value and the creation of new financial assets have dramatically changed the macroeconomic landscape.

Many economists were fed the classic quantity theory of money: MV = PY.

If I have a 10 euro note (M) and I buy something, then that person buys something else with the same note, and so on and so forth, it speeds around  (V for velocity) the economy.  What this note buys at the end of a period are things brought times their price (PY).  (Simplistic, but now add banks deposits and the money multiplier)

The view that governments control M (printing notes and bank regulations on banks deposit creation) and V is fixed by culture and technology is now wrong.

Banking and financial technologies have changed all this. Today's wide variety of payment options are nowhere to be found in traditional monetary aggregates. The volatility of velocity (V) and the shifting definitions of what is accepted as means of payment (particularly for corporations and governments) has led most Central banks to give up on monetary aggregates. They have loss control of the link between money and the economy and instead targeted short-term interest rates.
During a period of prosperity "... velocity-increasing and liquidity-decreasing money-market innovations will take place.....In time... a slight reversal in prosperity can tigger a financial crisis" (Minksy (1982) "It can happen again)
National Government have loss control, if they ever had any, of the link or transmission mechanism between money and the economy.

Within this space operates the shadow bank industry  -   an industry involved in money, securitized mortgages/bonds and debt creation with large corporations and institutions use commercial paper to finance their short-term needs for cash. A system of  special purposes vehicles and securitizations that jump off balance sheets, behave as banks deposits but can bypass safeguards, increase leverage and profits in boom but increases losses in the crisis. This made the recreation of the 1929-31 banking crisis possible.

Look again at MV = PY

(Update: According to a Nov 18 2012 report (PDF) by an international body of regulators (Financial Stability Board) worldwide assets in shadow banking, ranging from money-market mutual funds to banks’ off-balance-sheet vehicles to credit derivatives, totaled $67 trillion last year.)

The explosive growth of the shadow banking system calls for a re-think of MV=PT.  The speed of money is not a constant, but a variable that can manipulated profitably in a global environment.  The move to the Euro involves a loss of sovereignty to member states, but there is also another loss of sovereignty occurring in the background. We are in a world where governments can default, but banks are saved don't, and the assets of countries are claimed. Where are the global lenders of last retort?

Nassim Taleb and Mark Spitznagel on the US economy: "The elephant in the room is the amount of money paid to bankers over the last five years. In the United States, the sum stands at an astounding $2.2 trillion".

Minsky moment:
The amount of money pumped into 'saving' the banking industry does not go to investments such as hospital, schools or industrial project.  Excessive leverage is the basis for profits and, when the bubble bursts, massive losses are left to the public (who will then argue with each other).  The banks take risks, get paid when things work out, and when they don't pass it on.  The more this risk can be passed on, the more they buy. Risky assets get over-valued and bubbles burst.  Government bonds can be leveraged, creating more financial products, debts and even more returns.  When massive losses occur, there is a merry-go-round of passing the debt.  Taxpayers pay, debtors countries can be forced to undergo austerity measures .  In the end taxpayers are expected to pay for the failure'.

As I said before  .. 'preventing defaults at all cost is in many ways perverse.  It is perverse as one would usually expect the buyers of risk, not the sellers of risk, to suffer the losses. It rewards poor investment decisions. In such perverse conditions, the market collapses into a frenzy of speculative feeding. It is perverse, by Casino rules. The Casino is saying come and play here. If you lose, don't worry our staff will pay. This is not sustainable.'

The Euro is badly built road on an impossible terrain. Flattening everything may succeed in forcing euro economies converge towards a desolate landscape of abandoned businesses.  The strength of Europe has been its rich diversity; its weakness its inability to accept diversity.

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