If Europe is going to “resolve” the current crisis in an orderly way, it is going to have to move very quickly – not just for the obvious financial reasons, but for much narrower political reasons. I am pretty sure that the evolution of European politics over the next few years will make an orderly solution progressively more difficult.
For ten years I have used mainly an economic argument to explain why I believed the euro would have great difficulty surviving more than a decade or two. It seemed to me that the lack or fiscal centrality and full labor mobility (and even some frictional limits on capital mobility) would create distortions among countries that could not be resolved except by unacceptably high levels of debt and unemployment or by abandoning the euro. My skepticism was strengthened by the historical argument – no fiscally fragmented currency union had ever survived a real global liquidity contraction.
I am now going to veer off into a very different realm, that of politics. I don’t in any sense pretend to be an expert on the subject, but one of the things that surprises me is that as far as I know (perhaps because I am looking in the wrong places) and in spite of very clear historical precedent, very few analysts, even the greatest euro-skeptics, are wondering about the changes in electoral politics that are likely to take place in Europe over the next few years as a consequence of the euro adjustment. For example Wolfgang Munchau has an excellent article in the Financial Times in which he concludes, like I did in my post last week, that:
The eurozone is manoeuvring itself into a position where it confronts the choice between two alternatives considered “unimaginable”: fiscal union or break-up.
Obviously I think he is right, but I would add that the window for that choice is a small one. If Europe doesn’t move quickly, within two or three years it will probably be very difficult, if not impossible, to engineer fiscal union. By then domestic politics are likely to be too unstable for the European political elite simply to arrange union over the heads of the citizenry.
I have addressed the issue briefly before. After my piece last week on financial prospects in Europe I received a lot of comments and questions from clients, especially about this part:
Political radicalism in these countries will rise inexorably as a consequence of rising class conflict. As Keynes pointed out as far back as 1922, the process of adjusting the currency and debt will primarily be one of assigning the costs to different economic groups, and this is never an easy or conflict-free exercise. Of course the less stable a government becomes as a consequence of this adjustment, the more likely it is to prefer very short-term solutions.
This week then I will ignore China (although as China’s largest export market, what happens in Europe clearly matters to China) and focus on explaining what I meant.
The point I was trying to make in the passage is an obvious historical one – that the resolution of Europe’s crisis will inevitably involve a difficult political debate over apportioning the cost of the resolution. In one of my favorite history books (The Financial History of Western Europe), Charles Kindleberger argued that the political structure of Europe after the First World War guaranteed that different economic interests would necessarily struggle over income distribution.
When it came to deciding how countries would adjust to currency and debt misalignments of the 1920s and 1930s, the main issue, according to Kindleberger, was “whether deflation and unemployment would saddle a major share of the load on the working class, as contrasted with the rentier.” He goes on: “Keynes observed in 1922 that the choice between inflation and deflation comes down to the agonizing outcome of a struggle among interest groups.”
We need to remember what Kindleberger and Keynes meant by this. As everyone knows, markets are very, very nervous about currency and sovereign debt crises in Europe.
How to adjust
But this nervousness will soon pass. I have no doubt that enormous amounts of scotch tape, paper clips, and chewing gum are going to be deployed quickly to hold the whole thing together, and that perhaps in a week or two we will be all throwing sighs of relief as policymakers firmly announce that Europe was put to the ultimate test and proved itself manfully.
But does that mean we can stop worrying – was this really the ultimate test? No, of course not. If previous history is any guide, this crisis will re-emerge in different places every few months until it is truly resolved, and increasingly the crisis will manifest itself in the political realm.
Unfortunately it is going to require a lot more than emergency liquidity loans, no matter how plentiful, to arrive at a final resolution. These loans simply paper over the financing gap until the next big refinancing exercise, and each new loan effectively shortens the duration of the debt or claims a higher level of seniority, so that the capital structure becomes increasingly risky. As the capital structure becomes riskier, it takes a smaller and smaller event to set off the next crisis.
We’ve seen this kind of problem before so many times that I think it is fairly easy to draw the map of outcomes: growth will slow sharply and there will be several short-term liquidity panics, during which time the political consensus will be become increasingly fractured, and increasingly fractious. In some countries the political system might radicalize, and anger will increase. This will go on until finally we have the grand resolutions of the crises.
I don’t think there is a whole lot of disagreement among economists over what are the possible resolutions. Any country whose domestic cost structure is too high to allow it to compete in a globalized world – whose “currency” is in effect overvalued – must eventually adjust its cost base. There are broadly three ways for a euro-zone country to adjust it cost base to foreign competition:
- The afflicted country can redenominate its debt (and all domestic financial transactions) into a new currency unit, abandon the euro, and devalue the new currency.
- It can regain international competitiveness by forcing down the cost of labor (and deflating other inputs). The most efficient way to do this, of course, and perhaps the only way, is to run very high levels of unemployment for many years.
- It can impose trade barriers so as to protect domestic manufacturers and raise domestic employment while it adjusts.
Similarly any country whose debt levels are too high, so that it faces financial distress costs that will force a slowdown in growth and an unsustainable rise in debt, will have to improve it’s relative ability to repay. In that case there are also roughly three ways it can do so:
- It can regain control of monetary policy by abandoning the euro in favor of a local currency, and then inflate the debt away.
- It can default or threaten to default on the debt, and receive significant debt forgiveness.
- It can regain fiscal credibility by raising consumption or value-added taxes, by raising income taxes, probably on businesses since it will be hard to raise income taxes on households, or by cutting expenditures sharply, probably social welfare expenses.
There is I guess a fourth way – the country can “grow out” of its debt burden – but although we will hear this fourth way invoked a lot, I think we can safely ignore it. High debt levels themselves prevent growth by encouraging disinvestment and altering the incentives for investors and creditors in ways that punish growth (although here reviving Argentina’s GDP warrants can provide a very interesting partial solution).
Who pays?
Most of the afflicted European countries suffer from both of the above problems – an uncompetitive economy and excess debt (in some cases after we include contingent banking liabilities) – and in the aggregate all of the above resolutions accomplish more or less the same thing. They allow the country to bring costs of production, including most importantly the cost of repaying the debt, back to some sort of manageable level, and to reduce financial distress costs.
The means by which each economy adjusts however involves very different distributions of the pain of adjustment. And make no mistake, there is absolutely no way for Europe to adjust without significant pain. Often enough whenever a euro-skeptic says that Country X should abandon the euro, aghast euro-philes insist that country X should never abandon the euro because it would involve heavy costs, which they identify mainly as a rise in debt to GDP and vague – and historically suspect – warnings of hyperinflation. Of course abandoning the euro would involve costs, but under the circumstances so would not abandoning the euro. Abandoning the euro, in other words, is not about taking on costs. It is about distributing existing adjustment costs.
What Keynes and Kindleberger (and the other K: Krugman) remind us is that the distribution of these costs is not determined by economic theory but rather by political interests. That is why I said last week that political radicalism in Europe will almost certainly rise and the process of governing will become increasingly unstable. It is through the political process that the costs of adjustment will be assigned to the different groups, and when the costs are likely to be so high, the squabbling over the assignment of those costs is likely to be quite brutal.
In order to see how, let’s go through the distribution of costs:
- Abandoning the euro and devaluing imposes much of the burden on creditors whose assets are redenominated, especially those with newly mismatched books (i.e. their redenominated assets were funded with non-redenominated euro liabilities). These may include the wealthy, but because they know this, we will probably see significant flight capital as they liquidate assets and take them out of the country. Foreign banks who have lent to the redenominating country will also take big losses. This may sound invidious, but although an approach in which foreigners bear a disproportionate share of the pain may not be fair, it certainly is convenient.
- Forcing down labor costs through unemployment puts the bulk of the burden on workers and the lower middle classes, especially non-unionized workers. Other forms of deflation hurt borrowers, including small businesses and mortgage borrowers.
- Trade barriers may be impractical within Europe (at least before abandoning the euro), but to the extent that they are imposed they force domestic consumers and foreign producers to bear the cost of the adjustment. Remember however that local households comprise both domestic consumers and domestic workers, so the real impact on household income may be positive if trade barriers are expansionary for employment (which they usually are in diversified deficit economies). The question is which households. The unemployed working class may benefit while the struggling middle class may get hurt.
- Inflation hurts everyone on a fixed income. Middle class people with savings, pensioners, and non-unionized workers are usually the ones hurt the most.
- Default and debt forgiveness places the adjustment cost on lenders, in this context especially on lenders to the sovereign borrower. Again, it is worth remembering that if a disproportionate share of lending comes from foreigners, they absorb a disproportionate share of the cost.
- Raising consumption and value-added taxes hurts consumers, mainly the middle and working classes since the poorer you are the higher consumption is as a share of your income, while raising income taxes on businesses puts the pain of adjustment on businesses, especially small businesses who often aren’t able to protect themselves. Finally cutting fiscal expenditures mainly affects the middle classes (medical and education) and the working classes and poor.
Its politics, not economics
There may be other types of resolution and other distribution of costs. For example former Argentine Economy Minister Domingo Cavallo in April advised Greece to raise VAT taxes and reduce payroll taxes. This works broadly in the same way import tariffs would work, with a similar distribution of costs. Sellers of consumers goods, many of whom are foreign, effectively end up subsidizing domestic producers.
But whatever the proposed solution, my main point remains. We cannot escape the fact that these costs have somehow to be assigned to different economic groups, and the process of assignation is wholly a political one. And with such high stakes, it is likely to be angry.
In Latin America in the early and mid-1980s, unemployment pushed most of the burden onto the working classes. By the end of the decade inflation and hyperinflation hit the Latin American middle classes hard. Once US banks had sufficiently rebuilt their capital bases, by the very late 1980s, debt forgiveness passed on a small part of the adjustment onto foreign banks.
This formally began in 1990 with the Mexican Brady Plan. But formal or secret discounted debt buybacks throughout the decade ensured that part of the cost was passed on to foreign lenders earlier – mainly US regional banks and European banks whose exposure was small enough to allow them to absorb the losses.
In retrospect (and even for some of us back then) I think it is pretty clear Latin Americans should have demanded debt forgiveness much earlier. This would have been terrible news for the large American and European banks, but failure to receive debt forgiveness may have condemned these countries to slower or negative growth for much longer than they otherwise would have experienced. (As an aside, check out this fairly common-sense primer on how to default.)
Throughout the decade, and largely because of the debt crisis, Latin American politics were unstable and difficult, with a variety of responses throughout the region, ranging from conservative free-market adjustments to radical and populist adjustment. In her very interesting book, Who Adjusts?, Beth A Simmons focuses on the similar processes experienced by European countries in the 1920s and 1930s. We saw there the same range of outcomes, and Simmons tries to explain why different countries chose different outcomes.
She makes the following point about how different types off governments attempted to resolve the crisis in a cooperative or combative fashion:
Stable governments and quiescent labor movements contributed to international economic cooperation, while domestic political and social instability undermined it.
I interpret this to mean that over the next few years, in countries in which there is significant labor unrest, we are probably far more likely to see sovereign debt defaults and the abandoning of the euro. If this is true, this argument also gives us a sort of conceptual timetable – any solution aimed at preserving the euro or at an orderly debt restructuring that protects the European banking system must take place while the current political elite, left or right, is still in control. The longer we wait the less likely a coordinated solution.
In fact Simmons’ book, for those who are interested, is an interesting study of how different European countries evolved different approaches to adjustment depending on political and social conditions. I suspect that the basic problems and approaches she identifies are pretty much the same ones we will be watching over the next few years.
I am not suggesting that politics will get nearly as crazy or as radicalized as they did in the 1930s. There are much more robust mechanisms today for transferring and sharing adjustment costs, and I assume (hope) we learned enough from the 1930s to recognize that asking one side or the other to pay the full cost is not likely to be good for anyone. But it is hard to imagine that the kinds of disruptive political sectarianism that we saw in some European countries as recently as 20 or 30 years ago cannot revive.
P.S. Yves Smith, over at one of my favorite blogs, Naked Capitalism, comments on this post and argues that I am being overly optimistic in my timing. Yves doubts we have two years to get this right — more like two months. Maybe. One of the commenters on that blog discusses irish politics in a way that suggests that my prediction of a radicalization of European politics may already be stale. Another commenter notes a furious piece by the always-lucid Barry Eichengreen in Wednesday’s Handelsblatt. You can find a translation in the Irish Economy blog — a definite must-read.,
Thank you for this great post. It is highly paradoxical in the sense that, though it focuses on politics, there is very little to disagree about. I especially appreciate your non-biased views about “the distribution of costs”.
However, I’d challenge the conclusion. It is hard to imagine that the kinds of disruptive political sectarianism that we saw in some European countries as recently as 20 or 30 years ago cannot revive.
Of course, Europe is a demographically weakened continent. Of course it has lost a war, on economic ground, to Asia. But this economic war, how tough it may have been, is certainly not to be compared to “la grande guerre”, in moral and political terms. The social fabric of our societies is not to be compared to their counterparts in the 20s. This has some advantages in terms of politics.
I was re-reading the 1932, Garet Garett “A bubble that broke the world”. Sure the situation is rough to-day in Europe. But you should not discount the political implications of the welfare policy run here. They certainly have nasty financial implications. But on the other hand, I do not believe that the political situation here will evolve the way, some outside Europe, would believe. At least now. Even in case of a partial break-up of the Euro system (my current uneducated guess).
dont you think then that creditor nations who have “run up” such massive FE reserves would be trying to creatively “invest” in debtor nations, particularly, in Europe’s case, where the potential for social unrest is quite high between central/eastern euro countries and western nations?
It would seem to me, for example, that food security might be a great and useful aim of such investment where Hungary and other central european countries have excellent food productive capabilities for supplying rising chinese food demands, especially the basic staples of grains and oilseeeds. seems like a rather useful project for some key government leaders in china and europe to get together on it and bring in private industry to nail down the nuts and bolts of it…
Daniel, of course I agree with you, and I tried briefly to suggest that in my last paragraph. There are big differences between today and earlier periods, and one of those differences is a more robust mechanism for the distribution of costs across social groups, including the welfare system. On the other hand I worry that rising ant–immigration feelings might add fuel to an already-combustible mix of events. The main point is that until we figure out how the costs are going to be distributed, we haven’t really resolved anything, and that this resolution is necessarily a political process.
Keith, Keynes (and many others) would argue that transfers from surplus to deficit countries, including especially transfers of demand, are precisely what is needed, but history suggests that surplus countries will strongly resist the transfers, to their and everyone else’s detriment. Let’s hope this time really is different.
They may resist, Michael, but in some cases, they transfers could be a “win-win” for BOTH countries because each gets precisely what the other needs: cash for investment and commodities for consumption. I know that Chinese govt’s have been in Africa and other nations doing just this sort of investment, but I think it should be speeded up exponentially to mitigate the kind of situation you describe in your article above.
Michael, great post. So I am beyond a typical observant of the euro crisis. I’m sure I’ve made my conclusion on this mess but based on your opinion, What has ECB done correctly? I’m keeping tallies and like what munchau said ” the ECB has been complacent ” and their response has been lukewarm , inappropriate and suicidal. Allowing this crisis to spread quickly to Spain, a big economy, and eventually take out Italy is stupid. I agreed on your earlier post that Germany should be consuming more if the austerity are going to be implemented at the peripherals. Comments from ECB and from Germany are antagonistic and do not give markets confidence. Perhaps diluting German influence on ECB by self restraint or anymeans would give the euro extra years of survival. That is the ultimate and maybe the most effective political adjustment.
I am not going to make any comment about what you have written apart from to say how much I appreciate your blog. Thankyou.
Hell – I can’t stop myself. One of my sayings to my friends and family is that ‘policy is not designed to provide solutions but to decide who pays’. Nice to see you affirm my opinion. For instance for a ‘miser hoarding his savings’ he sees the ‘feckless’ being saved by the printing machine. However, I think all of us would love to see bank employees (esp. directors and traders), regulators and politicians take on more of the costs through lower wages to reflect their part in the crisis (I’m speaking entirely emotionally here of course which is not always a ‘bad thing’).
For Europe I would like to see how they resolve trade imbalances which to some extent are cultural by nature. How can you trade in balance with a country that has the same word for ‘debt’ and ‘guilt’ (schuld).
Thanks again for your insigths Dr. Petty. I Think this kind of analyses are what we really need. You know, these days I have been paying attention to media outlets just to see what are the opinions issued to the public on this matter. The vast majority of economical comentators, not necessarily expertes, argue that it should be the households who bear the cost of adjustment through high unemployment and high salaries. Debt restructuring appears not to be an option in most media, as well as abandoning the euro which is limited to radicalized euroskeptic libertarian outlets.
This emphasis in only one of the ways to distribute costs is alarming, at least for me, and you know what, that idea of frugality, austerity and so is gaining ground in public opinion according to my limited perception. That may give politics some room for what otherwise should be very impopular measures. A good example of that, I believe, is the United Kingdom. If these feelings are maintained for a long time, seems to me that a deflationary path is on our future.
In the particular case of Spain, I believe that a very reasonable way to muddle through this crisis should be to impose certain commertial barriers given our high current account deficit. And I believe that imposing consumer taxes that effect specifically goods which are mainly imported is a good option (a good example is petroleum), but luxury cars and other luxury items are good targets.
Interestin post, Michael, but I wish we would return to Cina. Neither you nor most of the regular commenters seem to have the right (I mean German) approach, which makes the post irrelevant. Maybe I will send my men to take care of you. One reason to prefer China to Europe is that for a European it is a lot easier to stay detached about China than about Europe, and despite the fact that I am a firm believer in the capacity of politicians to manipulate constituencies (and someone who respects Marx, be it from the other side of the class divide), I believe that it is simply not possible to imagine the structure and shape of changes in the Euro with any degree of plausibility. One reason is that this was a political construct with economics favoring the core, the other is that I cannot see anything but misery for the periphery, either in or out, devaluing or not, rescheduling or not. It is just too unpredictable. And absent a clear way out, the bias will be to stay in and tinker with the structure. Todays comments from the ECB are also designed to raise the cost of leaving and easing temporarily staying in.
The EU pipeline of financial reforms also includes one to make the bond markets more transparent (not popular in the UK) and that should make it a little easier to see who sells what and to whom etc. Also, a European rating agency replacing non-Europeans and looking at the problem from a European perspective, not the the perspective subsidiary of a US media concern that also includes Fox News, would help the very unhappy sellers from the core, who would prefer to hold or even buy.
I also happen to believe that policies aiming at fostering FDI from the core into the EUR periphery (rather than in China or former CMEA) replacing unproductive investment in residential real estate may actually be the achievable. The very large policy error is that Spain etc let residential construction soak up the unemployed (plus at least a million of cheap illegals) by not creating selective budget constraints through the banking system. The “market” has overcorrected that, but there are plenty of unemployed in the South that could, given the right incentives for workers and employers, compete with production in other locations. There was once a textile industry in Portugal that was transplanted from Holland and Germany. Now the equipment resides in China. Building cars 20 KM from the Austrian border in an EU member that has digested a few lessons is much cheaper than in Zaragoza, it should not be and Spain should be glad that VW still supports its SEAT business with fresh technology and development despite the lack of short term economics . So my solution for Europe would be that the EUR core supports a mild form of import substitution (and hence import controls from outside the area (preferably, but politically not easy to also affect the non EUR EU members, unless they commit to shadow as much as they can and coordinate their fiscal policies (maybe without being too explicit about that) with what the core needs to survive in a zero sum trading world. I am pretty sure that would be very unpopular with the elites and very presentable to the non-elites..
(not to be published) In the previous message I sent, where I wrote “high salaries” I wanted to write “lower salaries”.
Best regards
it is interesting to note that the eurozone as a whole has been roughly in balance, suggesting that there is a balance among members between surplus and deficit countries. perhaps france could provide a crucial mediating role if it comes to the crunch, falling between both camps as it does?
one thing the eurozone should be able to agree on is to shift maximum losses / adjustment pain to the rest of the world, which will mean (i) euro devaluation and (disguised) trade protectionism, and (ii) losses to creditors (particularly lenders to banks) combined with rescues of domestic lenders struck by these losses where appropriate – i.e.banco espirito santo defaults on its loans from soc gen, then france rescues soc gen.
Your analysis that it is a political choice is evident. May I add that most of the “builders” of the Euro are still around, forget for one minute the “pure political” aspect of this currency union. Those in charge of Europe in France and Germany have a personal stake in the fight, as it is their reputation which is on the line.
Yes there will be a fight between capital and labor (Man, Marx would love this fight!), but there is also an entire political engine that holds a stake in the game; some will want to preserve the Euro for sake of preserving their political heritage, and not driven by economic considerations.
This week then I will ignore China (although as China’s largest export market, what happens in Europe clearly matters to China) and focus on explaining what I meant.
Will China be scared into shoring up their own currency against shocks? Will this discourage further stimulus and a increase in gold reserves by china?
Sorry I wasn’t clear above
My question was for fear of their own currency crisis in the future will China be discouraged to Spend down their surpluses?
A quick PS. Yves Smith, over at one of my favorite blogs, Calculated Risk, comments on this post and argues that I am being overly optimistic in my timing. Yves doubts we have two years to get this right — more like two months. Maybe. One of the commenters on that blog discusses irish politics in a way that suggests that my prediction of a radicalization of European politics may already be stale. Another commenter notes a furious piece by the always-lucid Barry Eichengreen in Wednesday’s Handelsblatt. You can find a translation in the Irish Economy blog — a definite must-read. If you want to read Calculated Risk and the Irish Economy, go back to the bottom of my post and find the PS. They are linked there.
How the English speaking world craves a break-up of the Eurozone!
Whether its because they would like to see a major economic rival sink or whether they just love to see their preconceived ‘objections’ to the currency union vindicated, what unites all these eurobashing voices – and there is a very worrying absent of dissent in the anglosphere – is their utter ignorance of European affairs, as well as their blindness to facts that contradict their self-serving alarmism.
The euro will survive intact. Indebted countries will receive lifelines through EFSF and ECB monetization. Political conditions on the Continent are much more favourable than those in the social wastelands of post-Thatcherite/Reaganite UK and US. Which is also why austerity will likely have a positive effect on productivity in the medium term.
The anglosaxon media and public are not our friends. They’re our rivals and, considering some of the hateful drivel they produce about the euro, our enemies. Time to treat them as such.
Great post. So far most analysis has been focused on the horizontal inter-European conflicts in adjustment, so your addition of the vertical class conflicts is well apreciated. It seems, to me, that Ireland is the most likely breaking point. Not because they have the most active strike culture, but because both class conflicts and foreign creditor fault line is so readily apparent via the contingent bank liabilities.
Check out this op-ed from Barry Eichengreen written originally for a German audience that compares the Irish ‘bail-out’ to reparations…
http://www.irisheconomy.ie/index.php/2010/12/01/barry-eichengreen-on-the-irish-bailout/#more-8831
Rien:
Isn’t what you suggest the very opposite of what you said couldn’t happen before. When speaking to the US China case, and the EU Core Periphery, FDI case. Why?
Ya know, it is hard to reconcile these things, sometimes its even harder to understand.
CS
“What Keynes and Kindleberger (and the other K: Krugman) remind us is that the distribution of these costs is not determined by economic theory but rather by political interests. ”
I would add that the policies that led to this were also not based on sound economic theory. Why should we be surprised that any solutions would therefore be?
Also is this really any different than the usual topic here? Mercantilism has very different long and short term costs. It is ‘politics’, not economics, that extend such practices beyond the point of usefulness into detriment (party-cocaine-heart attack-reaction). As such and much like the situation in Europe, politics, not economic theory, will dictate who pays the price.
As it stands we should be putting down the Keynes, Kindleberger and Krugman and picking up the works of Gordon Tullock (The Calculus of Consent), Duncan Black and James M. Buchanan if we want to figure where things are heading.
M Pettis
The Blog you are referring to is Yves Smiths “Naked Capitalism”
http://www.nakedcapitalism.com/
Michael,
How significant is the use of naked CDSs in aggravating the crisis? Can the writing of naked CDSs actually force the bond yields up? Soros explained a while ago why he thought they should be banned. I guess they weren’t really around for Latin America in the 1980s, or Asia/Russia in 1997-8.
Naked Capitalism?
Calculated Risk is also good.
Yves Smith is at Naked Capitalism blog. Your link is correct, the name is incorrect.
Michael,
Thanks for an excellent post. As I mentioned previously, I have been reading your book and have been very impressed with it. In the current context, I find the chapter on debt restructuring particularly germane. I think it would be very helpful for commentators and policymakers to get a refresher on those ideas, particularly the Laffer curve esque idea that there are times when the value of debt outstanding would rise, even with a restructuring.
Is there any chance you could post this chapter or write a post or article on this topic? The time is now for that thinking to be used. The quality of life of many people in Europe for many years ahead depend on their politicians realizing very, very soon that they can say no to senior bond holders and restructure their banks’ debt. Thank you
Correction: Yves Smith’s blog is Naked Capitalism, not Calculated Risk (which is also an excellent blog, just not hers).
Terrific posts, as usual.
Brilliant. Whether your predictions work out or not is almost not the point, it is the clarity you can provide by your clear demarcations by shifting to considering the poilitical analysis that is invaluable.
In fact, looking at this as an econometric problem or issues of ratios in national accounts can only lead to complete bafflement as crisis that are thought solved keep reappearing and become crises.
The only way to gain prescience, or at least an appropriate appreciation of risk, is to see this through the political lense.
But I offer that you need to take it one more step which also gives more credence, I think, to your worries on strife and tensions. Not only is this a political crisis but the politics come from this being a constitutional crisis of the first order – the type that usually only appear once a century (unless you are France). And not only is it a constitutional crisis but it is a constitutional writing brand new – not working off of previous versions like France’s serial republics. And it is a constitution so as to change from a non-representational plutocracy to a messy and emotional representational government. At least it has to be representational or there will be “blood in the streets”.
It makes me wonder that folks are convinced that a political entity – Europe – that was formed so as to stop the most significant bloodshed in world history – would not offer new risk of bloodshed during the transistion from the cold calculations and calmness of a plutocracy to the emotional drive of a democracy.
The other problem is I see no leadership coming from anyone in the current leadership pool for the simple fact that such a constitutional event likely means the end of their careers. The spawn of the technocrat/plutocrat Monet are not electable. So, if leaders do not take on the required drafting, the constitution writing might be done from the streets and be written by radicals and in blood. Or it could also means to forestall the constitutional writing, the current leadership of plutocrats will move to de facto disctatorship so as to maintain power and privelege. Perhaps some Irish faction gains control of the country, opts out, and with the massive US based corporate base recently built sues the US to join NAFTA as remedy – that would be too repulsive for any dialogue so a Ireland is placed into receivorship under the EC…and so on and so forth, just to paint some scenarios. All fantastic thoughts of course but are now well into the third decade of an entrenched priviliged crowd of bureacrats who are not only not accountable to an electorate but are elitist and instinctively disdainful of them.
All the above sounds ridiculous of course but it is very very eerie how the book “The Vertigo Years: Europe 1900 to 1914″ depicts a very similar era when war was an absurdity, only whacko terrorists disturbed the peace, and the government organizations were built on a granite bedrock of temperance, good will, advanced politcal science and the nobility of reasonable man. Plutocrats ran the show as royalty stamped around showing the flag. It was risible then the opinion that any possible commotion or disruption would ever rock this pinnacle of throughful advanced civilization.
This “thing” that is going down in Europe, the transformation of China, these things are what wars are made of as outcomes become strings of massive unintended consequences.
On a less dramatic note, I find it very very hard to answer the question; “Outside of the intitial pain or reorganization in the leaving – what good does ‘Europe” do for the average Spaniard, Greek, Portugese, Irish, or even Italian?” In five years, whatever is cobbled together has to answer the question populists will be asking these folks – “Are you better off now than you were five years ago?”.
Rien Huizer and Michael Pettis,
“Building cars 20 KM from the Austrian border in an EU member that has digested a few lessons is much cheaper than in Zaragoza, it should not be and Spain should be glad that VW still supports its SEAT business with fresh technology and development despite the lack of short term economics.”
Apart from the funny idea that a foreign private company is making us a favour by investing in Spain (no favours there, just the market working: Spain produces as many cars per capita as Germany does), you have chosen a very good example to explain all this mess: car production.
Spanish car production is export-oriented. Around 80% of the 2-3m trucks and cars made in Spain are exported. You say we shouldn’t have let all money inflows create a real-estate bubble; you are probably right. Unfortunately, we didn’t have the benefit of hindsight then. Moreover, I’m not sure we could have directed private loans toward specific sectors without breaking EU rules.
Anyway, let’s suppose Spain had put an upper limit on mortgages, so that banks couldn’t channel more than 40% of its loans into housing, construction, real-estate, etc. What would have happened? Money would have been poured into unproductive investment, anyway, be it irrational mergers, an internet bubble, or whatever. The point is: persistent real negative interest rates produce overinvestment, be it in housing, manufacturing or whatever. We wouldn’t be in a better situation today if there had been even more overinvestment in some Spanish manufacturing sectors, e.g. green-energy equipment.
No matter where those huge money inflows would have gone into, Spanish inflation would have soared anyway, reducing growth opportunities and competitiveness for the really productive, non-oversized, industries, including car production.
So there wasn’t much Spain could have done to stop money inflows and overheating, barring a 10% fiscal superavit no one ever recommended us. I’d be glad to read Pettis’ take on this matter.
But again, it’s easier to make policy with the benefit of hindsight.
I meant a 10% fiscal surplus… superavit is a Spanish word, sorry.
have you seen this piece from euro-thinktank bruegel?
http://www.bruegel.org/publications/show/publication/the-blue-bond-proposal.html
btw, they pinched the idea from me (scroll down to comments section):
http://blogs.ft.com/maverecon/2009/01/sovereign-default-in-the-eurozone-and-the-breakup-of-the-eurozone-sloppy-thinking-101/#more-416
Oops, guess I just missed your update comment on Eichengreen
As an additional aside, the addition of the welfare state has slightly muddied the vertical conflict. But it has added an element of longitudinal conflict, via age. Most famously pensions, of course, but also child benefits and education in Ireland and the UK.
Michael, thank you for the thoughtful post. Needless to say, I agree whole heartedly with the thought that burden sharing is ultimately being fought within the realm of international politics, which makes the matter even more complicated when you apply this thought process to the US / Japan / China dynamics. It is indeed ironic that when the Fed prints money, inflation shows up in China, and does little in the US. While China appears defenseless in this dynamics, yet at the same time, with the amount of foreign exchange reserve that it has, it is actually capable of unilaterally set exchange rates among USD, EUR and JPY within the current world economic / political architecture. In your opinion, what, if any investment implication can one derive from this analysis?
Yves is of course at Naked Capitalism. The Calculated Risk Blog focuses more on Housing and the US economy. Yves often refers readers to this Blog. I think that was how I came to read here as well. I guess this Blog is another of the brilliant sources of information that are allowing the Common Man to see trough the “respectable veils” that cover the “basic elements” of capitalism.
Just a quick note regarding the above comment “How can you trade in balance with a country that has the same word for ‘debt’ and ‘guilt’ (schuld).”
The same is true for Scandinavian countries (at least Sweden), but in my mind these are very different concepts and it has never affected my behaviour to avoid debt, as my student loans is a very good proof of.
Michael,
Small technical point: One can appreciate both Calculated Risk and NakedCapitalism, but Bill and Yves are two VERY different people who provide two VERY different blogs.
If one progresses from macroeconomic NIA to politics, it would seem reasonable to then progress to the microeconomic policies that might result or at least the differential impact of various political paths on economic outcomes. Can we hope you will post on this?
Yves’s blog is Naked Capitalism, not Calculated Risk, though both are excellent.
Excellent post.
I wonder about the interplay of economics and policy, though. People will be trying to guess the likely outcomes when making their investments, so, for example, a policy to force unacceptable debt onto Irish taxpayers may result in disbelief on the part of investors and interest spreads that will negate the policy, forcing creditors to accept a bigger portion of the losses. In other words, by anticipating reasonable outcomes, the market may bring them about more or less automatically, though some signals of displeasure on the part of distressed parties may be needed (street riots over cuts in social spending, for example) more as a vehicle for transmitting information than as an actual political force.
In this regard, deliberate misinformation may play a bigger role in preventing the automatic market adjustments than is desirable – for example, polciies of hiding or denying the extent of the problems may be counterproductive. Something like wikkileaks could perform valuable services in this area, IMO.
I just finished “Only Yesterday” by Frederic Louis Allen – a contemporary history of the 20s written in 1931. What struck me in his “summing up” of the poiltical mood as of summer 1931 was his remarking how surprising it was that none of the radicalism of the early post-WWI years had made a comeback. He looked around and saw people mostly just trying to take care of themselves – mass politics seemed to be the last thing on their mind.
It seems to me that when you have a major economic disruption like 1929 or 2008, it takes awhile for the new reality to sink in. People first blame themsleves for their situation, but when it goes on they start looking for answers, and the radicals, whether left or right, start getting listened to. If the timing today is anything like the 30s, we might start to see a real revival of obth fascism and communism (probably under different names) in many places, starting in 2011.
Michael,
A little more from Handelsblatt the following day (sorry, no time to translate the German but I assume you read German yourself and let’s face it sometimes people use even Chinese..):
“Donnerstag, 02.12.2010ZeitungAbo-/Leser-ServicesBusiness-ContentE-PaperShopReisenVeranstaltungenNewsletterJobs
RegistrierenPremiumLogin Depot/Services
28.11.2010
WÄHRUNGSUNION
Der Preis der Stabilität
Die Führungsriege der Währungsunion hat noch immer kein überzeugendes Konzept zur Lösung der schweren Schuldenkrise gefunden. EU-Wirtschaftskommissar Olli Rehn hat daher sehr recht, wenn er eine “systemische Antwort” auf die Krise einfordert.
ARTIKEL
von Ruth Berschens
Ruth Berschens ist Korrespondentin in Brüssel Quelle: Pablo Castagnola
Irland ist nur vorläufig gerettet, und die Zukunft des Euros bleibt ungewiss. Dieser bitteren Wahrheit kann sich niemand entziehen – auch die EU-Finanzminister nicht. In Brüssel ging es gestern um viel mehr als nur um eine kleine grüne Insel im Norden Europas.
Die Führungsriege der Währungsunion musste sich selbst eingestehen, dass sie noch immer kein überzeugendes Konzept zur Lösung der schweren Schuldenkrise gefunden hat. Bisher hetzten die Politiker bloß von einem Brandherd zum nächsten, und sobald ein Feuer gelöscht ist, bricht anderswo ein neues aus: Portugal, Spanien, Italien, Frankreich? Man mag sich gar nicht ausmalen, wo die Finanzmärkte künftig noch zündeln.
EU-Wirtschaftskommissar Olli Rehn hat daher sehr recht, wenn er eine “systemische Antwort” auf die Krise einfordert. Denn nun wankt die Einheitswährung wirklich. Das bisher Undenkbare könnte tatsächlich eintreten: Der Euro könnte untergehen – mit unabsehbaren Folgen für die deutsche Wirtschaft und für den politischen Zusammenhalt der Europäischen Union.
Dass es mit dem Euro so weit kam, hat auch mit einem teilweise dilettantischen Krisenmanagement zu tun. Die EU verschreckte fahrlässig private Investoren. Wer Anleger an den Kosten von Staatsinsolvenzen beteiligen will, der muss auch sagen wie. Die EU-Regierungschefs aber kündigten beim letzten Gipfel Ende Oktober nur vage an, dass der private Sektor bei der Entschuldung von Euro-Staaten eine “Rolle” spielen soll. Damit öffneten sie Horrorvisionen an den Märkten Tür und Tor, und die Angst vor Enteignung griff um sich. Die Anleger wissen nicht mehr, welche Risiken sie beim Kauf europäischer Staatsanleihen eingehen. Es wird höchste Zeit, dass die EU hier für Klarheit sorgt.
Außerdem müssen alle Beteiligten bisher unverrückbare politische Positionen noch einmal neu überdenken. Das gilt vor allem für Deutschland. Bisher setzte die Bundesregierung auf Kreditpakete und Spardiktate. Doch das reicht offensichtlich nicht, um strauchelnde Länder wieder auf die Beine zu bringen. Sparprogramme dämpfen das Wirtschaftswachstum und die Steuereinnahmen. Trotzdem sollen die Milliardenkredite von EU und IWF auf Euro und Cent zurückgezahlt werden. Staaten wie Griechenland können das gar nicht schaffen – ihre Schuldenlast ist einfach zu schwer. Die Politiker wollten sich das bislang nicht eingestehen, doch die Märkte wissen es längst.
Die starken Euro-Staaten werden daher nicht umhinkommen, den schwachen einen Teil ihrer Schulden- oder zumindest Zinslast abzunehmen. Die Kanzlerin verlangt völlig zu Recht eine solide Haushalts- und Wirtschaftspolitik überall in der Euro-Zone. Doch sie hat auch die Pflicht, den hochverschuldeten Staaten die Chance für einen Neustart einzuräumen. Deutschland wird für die Stabilität des Euros einen Preis zahlen müssen. Denn sein Untergang käme ungleich teurer.
As you see, this more internally oriented piece is quite useful.
Regarding Eichengreen’s piece again (and thanks, it is provocative, flawed (probably for good reasons) and the many comments on the Irish blog are at least as interesting).
But we should see correct figures some day. Lots of people are throwing all kinds of numbers around, without any reference to assets. But, take for instance the much vaunted exposure of banks outside Ireland to the Irish banking sector: according to the interim reports of BoI and AIB, all of their interbank funding was secured (and the figure corresonds roughly to the ECB exposure. There were no conventional interbank deposits. These two had about EUR 50 bn bonds outstanding. Under Basle II, it is unlikely that those bonds are/were largely held by banks for their own account. They (looking also at the currency distribution with lots of SFr, GBP etc) may well have been placed in private banking portfolios and a little in domestic institutional ones. But it appears (if the rest of the Irish banking system (ex Anglo Irish) follows the same pattern and branches and subs of banks with HQs outside Ireland are excluded) that the bulk of Irish bank debt is not worthless (all of the ECB funding is secured), only say 50 bn in senior notes is of an as yet unknown quality, apart from the Irish gvt guarantee. So it cannot represent a systematic risk factor for the European banking system, that produces net revenue far in excess of EUR 50 bn. Of course there might be very complicated derivatives positions but one assumes that these would all be collateralized by now.
Likewise, it is as yet unresolved how one should look at the overall Irish debt picture after this operation. Although I agree that those bank bonds should never have been guaranteed (and I am still not sure that they represent an identical risk as gvt debt) and be among the first to be written down (at least the shareholders have been wiped out or virtually so), there is in my view plenty of scope for the banking system to yield a couple of banks with an interesting franchise that could appeal to healthier groups from outside Ireland (which is probably what the Irish “ruling class” has been trying to avoid at all costs). I reckon that the franchise value would be at least 10 bn EUR and that a buyer would relieve the gvt of its guarantees for bank debt or at least a portion.
So first, I do not believe that a large austerity package in a very open, flexible and young economy like Ireland will not work (it will require a lot of political will) . The country has a structural external surplus and remains an attractice location for investment, since the corporate tax regime has been protected. Second, I suspect that the package is somewhat oversized, in order to leave room for the opposition, once in power, to show some minor successes. Finally, as can be seen from the German piece above, the debate in Germany is becoming a bit less unidimensional and who knows, maybe the people who took on the DDR will show some generosity to the Irish.
At any rate, Eichengreen, comments (unless he has had access to as yet confidential IMF information) seem to be speculative, but maybe useful.
It would be interesting to see a pro forma on the Spanish banks (probably mainly the regional banks with their mythically bad portfolios) I doubt that a targeted rescue effort would be unaffordable.My off the cuff calculation of liquidity support for distressed banks in the PIGS (to be provided by the ECB, and maybe against collateral injected by their respective governments as recapitalisation (in a similar way to Indonesia in 1997) would be roughly 1 trillion. That is not as much as it sounds and suitable for managing the problem until the US recovers. Meanwhile the EUR would continue to be under pressure. And maybe it could provide a pretext for some otherwise protectionist programs that would facilitate proper crossborder investment in those countries. There will be plenty of labor.. But it would not be cheap. And that would make people prudent for years to come…
And of course your fears that EU austerity will hurt the global recovery are now getting some fresh support. But in a zero sum world, who cares? would some politicians say.
I’m sorry but I come at these issues more from the political end, rather than as an economist, so I am not very clear what you mean by “political radicalism”. Of course there will be many political differences over how the costs are distributed , once it is more accepted there will be costs, and there will be differences over what those costs should be. I know it is very frustrating for economists that politicians seem to be so far behind the curve in delivering solutions. But politics, especially complex and difficult politics, can be a hideously slow process and allow serious problems to fester for extended periods without solution. Some capable politicians even deliberately and skillfully follow that path, as timing can be everything.
You are correct it is unlikely this will be a replay of the fascists versus the communists of the first half of the twentieth century. Not only are political groups less likely to turn to such ideologies, they are less likely to use the same methods. Unions are no longer large groups of unskilled labourers a generation off the land, they are skilled long-term employees who have an interest in preserving the existing system. They may be willing to compromise to a surprising degree before their politics takes a “radical” turn. No doubt nationalism and ethnic scapegoating will increase, but there are few signs it will be a major political force. And undoubtedly there will be anarchist-types smashing windows and tossing a few bombs, but the media attention they receive will far outweigh their political impact.
It will definitely be a difficult time to govern as the realization that the future will not be as prosperous as hoped sinks in. There will be intense and emotional debate over who pays and how. And these debates will occur internally within countries as well as between countries. But there will also be intense pressure to find workable solutions as those who have an interest in finding workable solutions far outweigh those who will seek to bring down the system. Whatever solutions come forward will probably not be ideal in the eyes of economists and may serve no purpose other than to buy more time, but maybe time is what will be needed.
I have no clue whether the Eurozone will survive. If it does it will be a struggle and it may take a lot longer than you expect to find out that answer. Sometimes in politics all that really matters is survival.
Another brilliant post. But while its a close call, if I had to bet,it would be on a slightly different outcome. Which is, when push comes to shove, and regardless of what they are saying now,the French and the Germans will print the money – and rescue the banks through the back door, as it were. Note that this does not result in a radically different future of political disruption than the one you predict – just one that has more of the muddle through. It also eases the pensioner problem – as in, a back door cut in benefits. We will know who is right in about a year or so – when we see how many bonds the ECB buys; and when we see the changes in bank assets.
Another quick PS: As many people noted, I confused two excellent blogs. When I said Calculated Risk of course I meant Naked Capitalism. Friends don’t let friends blog after drinking.
Ben we have already had this silly discussion before. I am Spanish and I believe Michael is too, or at least half. There are many other Europeans, some on this blog, who believe the euro structured as it is has serious problems and if they are not addressed things will get worse for us, not better. It is the mark of a fool to think that the euro crisis is merely a consequence of anglo-saxon evil intentions, and you, I am afraid, are a complete fool. May the good god protect Europe form your brand of euro-nationalism. And may thoughtful analysis of the problems continuing coming from Europeans and, yes, anglo-saxons.
I concur with Patricia. I am Italian and I think professor Pettis has done a very valuable service in analysis, and I am even afraid he is right in a way that can never be true for the blind people who say the euro will survive and give no reasons other than faith. The survival of the idea of Europe depends not on stupid fantasies but on truth and hard thinking, but I see people like Ben prefer the current path of fantasy from our leaders. I truly hope Europe will be united and the euro will be our currency, but I believe the general stupidity of our leaders, and who ever elected this fool Rompuy?, will force us into collapse.
Calculated Risk is probably one of her favorite blogs, too, but Yves blogs at Naked Capitalism.
Also Eichengreen seems to be dipping into blogging (hooray!) at the site for his latest book. I think you should encourage him by linking there.
http://www.exorbitantprivilege.net/?s=the-euro-as-an-international-currency
I always appreciate the depth of perspective you bring to discussing China; very nice that you share with us your thoughts on the wider picture.
There is a less painful way to reduce this crisis and provide some hope of avoiding a train wreck. That is for Germany and other surplus countries to start spending their excess export earnings. It is pretty obvious that the deficit countries cannot pay their debts, or even stop accumulating more while the surplus countries continue to run large surpluses. The first and possibly most difficult step is for the leaders of those countries to openly accept this as both a moral imperative and as necessary for the long term health of their own economies. If they could get past this step, they could begin the political process of making adjustments within their countries to make it happen. Spending the money internally would boost their economies while at the same time helping the deficit countries through this transition. Obama has asked nicely and has been rebuffed. Geithner asked for a modest target of limiting surpluses to 4% of GDP and was summarily dismissed. (4% is far too high as a long term average value). It seems that the window for asking nicely is passing or has already passed. It looks like the deficit countries will need to start playing hardball or the surplus countries will never get it.
Ben,
You hit the nail on the head. There is no reason why US’ers and UK’ers should be gloating!
Why does no one come up with a realistic scenario for EUR dissolution, or exit of individual members? Maybe some here think that I would not welcome a few exits. I do, but I cannot see how this can be done without causing a lot more damage. Because it requires a bit of technical thinking and as it turns out, it is very hard to devise a mechanism, while liquidity support and monetization of debt (in moderation, would not like to see Spain treated in the same way as Ireland, but Spain will probably look better after itself) are relatively easy. And maybe, we will have a little bit of inflation here and there, despite all this “austerity” in marginal economies. And possibly the populists in the “strong” countries will see reason and accept that despite the fact that the Greek and Irish cases can mainly be blamed on the locals’ own politicians (stupid or bad or both), it would do no harm to lend a helping hand.
The main problem of this approach (muddling through) is that it will make the world wide trade situation a little more problematic, because Europe will again become a mainly parasytic player again. But Europe in the aggregate does not need a lot of growth, just the distribution over geographies and sectors must change. And voters only care about their own back yard.
Given that and the unpleasant economics of the thing right now while it is very hard to change the structure, it is likely that there will be a lot more short term measures to cure the symptoms, while leaving the real problems intact.
That is no reason for gloating for anyone, on the other hand, even the welfare state still exists despite all the efforts to kill it. Things that are hard to change tend to stay the same, getting just a little less appetizing as time goes by.
Rien Huizer,
I am afraid you haven’t understood anything. What Europe needs is for Germans to lend a hand to *themselves*, i.e. taking measures to secure debt collection out of the euro’s periphery and secure their own sphere of influence, namely the eurozone.
It is so very easy to imagine a euro break-up scenario… man, you could be in October 1917 in Moscow and be unable to imagine a Communist revolution. What is more difficult to imagine is a *partial* euro break-up. Truth is, after some euro members start exiting and defaulting on their debts, I can’t see why anyone would want to stay on an even more unbalanced, German-centric eurozone. E.g. would France want to stay on a euro without the softening presence of the Southern European countries? France would see their bond yields skyrocket in anticipation of a possible French exit, which would make that exit even more probable.
Anyway, we’ve read lots of times the cheap slogan that a crisis is an opportunity. Breaking up from the euro may be more of an opportunity than a risk for many countries.
Keith, what the surplus countries really need to do is not channel investment so much as expand domestic demand so that their trade surpluses could shrink rapidly, thereby boosting demand for the deficit countries. Of course that isn’t easy, even if the surplus countries wanted to do it.
Ignacio, I suspect you are right in saying that most commentators agree that households should pay for the adjustment in the form of higher unemployment. This is almost always the default solution in the beginning of a crisis. The problem is that after a while unemployed workers begin disputing the solution. I will be in Spain for the Christmas holidays and am very curious to get a frontline view of what people think.
Ha ha you’re right, Rene, it is easier for a European to read my China skepticism with detachment, but here in China I notice that my skeptical European posts generate more enthusiastic discussions in my class. Needless to say it is always easier to discuss problems that other countries might be having.
I think I am less optimistic than you that the problem is one of bond market transparency or of a more sympathetic rating agency. Financial crises are remarkably similar over history, and so I am always very doubtful when people point to specific factors in the current crisis has having an important role in the crisis. As for your and Bena’s proposal for a little more mercantilism on the part of Europe, I have no doubt that this will be part of the proposed solution, but unfortunately this is likely to be part of everyone’s proposed solution, and the only countries that can enforce this are the deficit countries. Europe is in surplus and this surplus is likely to explode in the next year or two. That will make it harder to use the external sector to generate domestic demand.
Frozeninthenorth, yes, most of the architects of the euro are still around and in power. Like you, I am pretty convinced that they will fight ferociously to maintain their legacy, but perhaps unlike you I am not very sure that they will be around much longer. In that context it is interesting to see how English leaders in the late 1920s and early 1930s were very reluctant to dismantle the free-trade structure they had done so much to implement, but when first Mosley and then Churchill signaled their turn against free trade the writing, was on the wall. Either the leadership reversed their views or they would be voted out of office.
RS, I am not sure what you mean by “shoring up.” They already intervene massively.
Ben, I don’t see anything practical in the recitation of your faith. If you had any knowledge of previous debt and currency crises you would have probably been a little more reluctant to say almost exactly the same kinds of nonsense that were said in every previous case. Screaming for the heads of the doubters may be emotionally satisfying but it has never yet prevented a crisis from happening. In the end it is not evil Anglo-Saxons who will determine the fate of the euro. It is just whether or not the numbers add up.
Bob in MA, as I mentioned in my response to Rene, I am not a big believer in specific instruments as having caused a crisis. The culprit is usually monetary, and although the form in which the crisis depends on the institutional structure, the institutional structure doesn’t prevent it from happening. After all Mexico managed to have a ferocious and similar crisis in 1994 without the help of CDS.
Mick Costigan, thanks for the suggestion. I was thinking about rewriting some of that for inclusion in my next book. Maybe I can try it out on my blog.
Ignacio, I agree with the point in your second comment. Placing restrictions on one kind of excessive risk-taking does not solve the problem when liquidity conditions are too loose. They simply move risk-taking elsewhere. Two days ago I had dinner with the chairman of a large French bank and he argued that if bank capital requirements had been higher this wouldn’t have happened. In that case, I suggested, risk-taking activity would simply have moved outside the banking system and would have happened anyway, and pointed to the Lehman Brothers example. He agreed. As a hard-core Minskyite, I would argue that you simply cannot eliminate risky behavior by creating safeguards. Stabilizing legislation is itself destabilizing. The key is in managing crises, not trying to eliminate them, but that is a whole other topic.
HJ, I am not sure I agree that Chinese inflation is caused by excessive US money creation. That is a popular claim in the press here, but few academics I know believe it. Inflation started up long before QE2, for example, and is really a consequence of domestic monetary policy and food shortages. I am also not sure the PBoC can really do much about exchange rates without embroiling itself in further controversy and recrimination. Remember how the Japanese reacted when it was perceived to have been buying yen.
Jim Baird, I’ve wanted to read that book for a while now.
Thanks Rene, but no, I cannot read German. By the way the FT has some interesting interactive graphics on debt numbers within Europe.
Jkbi, you may be right that the French and Germans will rescue the banks, but this leaves open the question of whether the problem is a liquidity problem or a solvency problem. If the latter, bank rescues are only part of the distributive process. They still don’t say who will ultimately pay.
G. Stegen, yes, as martin Wolf has been screaming, Germany must expand domestic demand, perhaps by eliminating VAT taxes and otherwise boosting disposable household income. That will quickly end the myth that Germans love to save and will create the equivalent of a large fiscal boost for the rest of Europe, without of course the concomitant debt. But Germany doesn’t seem to want to do that. It continues to hoard for a rainy day, and in a world of weak demand, hoarding is little more than an attempt to force an even greater adjustment onto the rest of the region. I am not trying German bash, but really, this is the same stupidity that Keynes accused the US of doing in the 1930s.
Rene and Ben, skepticism is not gloating. Your assumption that all Europeans agree with you and all non-Europeans gleefully disagree is not terribly convincing. At any rate from the point of view of predicting the outcome it is pretty irrelevant.
@Michael Pettis
Given the eerie unanimity in MSM and self-proclaimed independent blogs in the anglosphere, assuming some kind of irrational drive does not have to amount to a conspiracy theory or any such debate-killing suggestion.
I guess there’s group-think at play, sensationalism of course, definitely europhobia, as well a a dose of perceived self-interest (speculation, distraction, directing safe-haven flows, whatever).
The irrationality of these debates about Eurozone breakup (which are, as any polylinguistic European can see, largely limited to the english-speaking world) is marked by endless expositions on the most unlikely scenarios, i.e. euro exits and devaluations, Eurozone breakup etc.
The scenario with the highest probability both in financial and political terms is usually not even discussed. This is the scenario that Trichet and others have repeatedly hinted at, of the EFSF evolving into a permanent arrangement backed by a form of common European bond. As I’ve said before, such a scenario does not require Treaty change, only political will – which is consistently underestimated, as Trichet noted – and amounts largely to a formalization of current measures.
Given the asymmetry in probabilities, the prevalence of one unlikely scenario in discussions on the subject does suggest a preference based on sentiment rather than reason and facts.
Wouldn’t the effect of expanding Germany’s domestic demand be quite disappointing in terms of a fiscal boost for the PIIGS? I would guess the incremental demand is more likely to flow to Germany’s other major import partners, since the PIIGS only make up about 12% of Germany’s imports even though they’re 27% of EU GDP.
I think Wolfgang Munchau is right. I also believe the at this stage, a fiscal union would be a better choice, though unthinkable. But to sort out the politics would be a painful process, so Europe can only choose what is less bad. Does the bond issuance by the European Financial Stability Fund serve as a step forward to fiscal union in your view?
Also sprach Analyst
“Two days ago I had dinner with the chairman of a large French bank and he argued that if bank capital requirements had been higher this wouldn’t have happened. In that case, I suggested, risk-taking activity would simply have moved outside the banking system and would have happened anyway, and pointed to the Lehman Brothers example.”
You are going to have to expand on this, especially because you do a serious disservice to bank depositors and stakeholders by dismissing capital requirements with this argument.
Quoting Michael Pettis, Mark wrote:
>>”In that case, I suggested, risk-taking activity would simply have moved outside the banking system and would have happened anyway, and pointed to the Lehman Brothers example.”
You are going to have to expand on this, especially because you do a serious disservice to bank depositors and stakeholders by dismissing capital requirements with this argument.<<
Michael can defend his position himself, but I don't see where he dismisses capital requirements. He clearly acknowledges that they have the effect of reducing risk-taking within the banking system, which clearly affects bank depositors and stakeholders, even though they do not eliminate risk-taking outside (which also affects bank depositors and stakeholders but in a more indirect way).
Ben,
may I ask you why no high-ranking politician, both from the core and the periphery of Europe, has taken that euro-bond solution for granted? Just announcing it would relieve pressure on Europe’s periphery. But you can’t hint at it if you know for sure that’s not an option.
It’s obvious that euro-bonds, coupled with a European-wide deficit-spending strategy, would solve the current problem. However, we’ve been suffering the pain for most of a whole year and Germany has rejected euro-bonds once and again. Nor would there be a solution withouth deficit spending at a European-wide scale, which Germans are rejecting, too.
Now, unless you can tell me why Germany (and some other silent countries) would suddenly accept what they have been rejecting for a full year of successive panics and financial implosions, and especifically why the German public would accept it after being mis-informed and brainwashed about PIIGS’ lazyness and lack of discipline for a whole year, I’ll hold my conclusion that Germany won’t change heart overnight and political disagreements are structural in the euro.
With no euro-bonds and no deficit spending, the eurozone is on the path of disintegration.
can regain international competitiveness by forcing down the cost of labor (and deflating other inputs). The most efficient way to do this, of course, and perhaps the only way, is to run very high levels of unemployment for many years.
Wouldn’t a more efficient way to force down labour costs be to liberalise the labour market, and shift more legal powers to employers, encouraging them to take on more staff? Unemployment has a high hysteresis effect, whereby the longer people are unemployed, the longer they tend to stay unemployed. Also, the distributional effect of keeping x people employed on high salaries and y people living only on unemployment is not good. And of course these unemployed people aren’t producing anything valuable. So I think your proposal is inefficient from both an economic and a social perspective.
It can impose trade barriers so as to protect domestic manufacturers and raise domestic employment while it adjusts.
Um, how does this work? You raise costs for your own customer base, becuase they’re now obliged to buy from domestic manufacturers rather than from whomever is cheapest (if your domestic manufacturers are cheapest then you don’t need to protect them). Consequently, your exports will get more expensive, relative to world prices, so you’ll be less competitive, not more, and as you’re earning less money from your exports, you’ll have more problems paying back your debts, not less.
This seems to be like trying to reduce your risk of cancer by taking up smoking.
raising income taxes on businesses puts the pain of adjustment on businesses,
Actually businesses don’t pay taxes. Income taxes on businesses are paid by some combination of the following groups:
1. By the shareholders
2. By the workers, in the form of lower wages.
3. By the consumers, in the form of higher prices.
And when I say they’re paid by shareholders, I mean that they’re paid by domestic shareholders, ones who can’t take their capital elsewhere. Foreign shareholders can easily not invest in your country and thus will only continue to invest in your country if they get at least the same rate of return, taking into account risk, as they would get elsewhere. If you raise taxes on foreign shareholders, they’ll withdraw from the marginal investments.
“As for your and Bena’s proposal for a little more mercantilism on the part of Europe, I have no doubt that this will be part of the proposed solution, but unfortunately this is likely to be part of everyone’s proposed solution, and the only countries that can enforce this are the deficit countries. Europe is in surplus and this surplus is likely to explode in the next year or two. That will make it harder to use the external sector to generate domestic demand.”
this is of course true. my observation was predictive, not prescriptive.
Tracy,
Excellent comments. As it happens, Irelands labor market is already quite (for European standards) liberralized and it’s labor is (due to age, education and language) probably the most mobile in all of europe, be it that most of that mobility would be in the Anglo-saxon/non EUR world. The Irish Bricklayer is long gone and cannot compete with the Polish Plumber. So that would not help. What austerity will do to Ireland is turn it into some kind of East Germany after reunification: the young and mobile move away, the old and benefit-dependent stay. And Irish fertility is no longer what it used to be so, gloom.
Trade barriers would not really work, although maximizing VAT (where would the correct level be) is an excellent way to do so, while helping the gvt deficit without hurting producers. A special tax on cars and a few other items would also be very good (given also the fact that Ireland has few safe roads)
Corporate tax increases in Ireland would hurt the economy in a macro sense, since if you look at Ireland’s national acoounts you will notice the impact of foreign-controlled output. What happens (like in Singapore, Ireland’s model and competitor) it that some industries (farma, high end electronics, media) chooose Ireland as tax domicile for high margin sales, and then add the minimum of substance to escape their home fiscal authorities’ scrutiny. So, Ireland’s GDP would drop disproportionally to employment if they chased the tax jurisdiction shoppers away, but that would also mean that the former Docklands in Dublin would be wasteland (with cridiot losses for the banks) again. Furthermore, a lot of the corporate arrangements may well be semi-private so that the Irish tax office would face legal hurdles in implementing this. No I think that Ireland will be able (with a bit here and there) recobver much easier that Greece, provided Sterling stays close to the EUR from here on. Which would also be in the interest of the UK treasury, given rather large UK bank exposures to the Irish economy and the fact that the Ireland imports over EUR 10 bn from the UK, much from Northern Ireland.
Seit zwei Jahrhunderte hat Deutschland die beste..
Talking about all the crises with economic theory and political terms gets a bit confusing. I prefer thinking on a mundane basis, and so what I see is a world enmeshed in “liar loans,” wherein the proper amount of collateral, trust and documentation has been mostly and sometimes wholly absent. The Greek budget numbers were a fine case in point, but on a small level the American Fannie Mae making liar loans to individuals can be extrapolated to whole governments now. With so much debt requiring short term rollover, I wager inflation must come one way or another, because it is capital which will be in short supply. And those seeking “new money” will be liars, just as Bolivia’s recent nationalization of private pension capital comes only 13 years after the last privatization-as-answer-to and earlier nationalization. Liar loans strike me as a fine way to describe all the high finance by governments in massive debt, the US being the largest liar, followed by some European neighbors. The currency which needs no debt restructure will become the world’s safe haven. At the moment, that means hard assets, difficult to nationalize and convert to cash by cash-starved, nationalizing mentalities. It comes back to basics, and this show Bastiat’s observation so clearly: Government is in fact people finding ways to live off of other people, far beyond the scope of simple charity. I expect martial law in places, as the working-class figures out the political classes are intent on shifting costs on to them, massively.
We often talk of the financial crisis as a solvency problem and not a liquidity problem.
In the same way the political crisis is not a policy problem, but a sovereignty problem.
Central bank “capital” is fundamentally based on the public accepting the legitimacy of the state. But the Eurozone has an abstract and amorphous state – what is there to legitimize? And who exactly is the Euro public? Either this Euro state/public must come into being and reveal its nature, or the symptoms of an incomplete transition will continue to worsen.
It IS pragmatically possible for a country to exit the Euro. The member states still have national banks, still have governments, the mechanisms are in place, the historical knowledge is there, more or less. They are bound by treaty, and there is no realistic expectation of military force to be used to maintain Euro membership.
The fact that academics and commentators (and I believe even German central bankers, occasionally) openly discuss the possibility of a country leaving the Euro shows that the political crisis has already arrived, and that technocratic policy changes cannot work.
But is there any serious discussion on what a centralized government/fiscal agency would look like in Europe? And is there any realistic expectation that the public would see this as a solution instead of a another centralized power grab? And again, how would the public legitimize such a state?
The Euro architects have painted Europe into a corner. Who will jump out first?
Diego, I’m no economist, but I think euro-bonds are not far to come. I perceive it more prudent to restructure the obligations of the out-of-control spenders via the leverage of borrowing costs, prior to accepting any joint sale of euro-bonds to 1) minimize the increase in borrowing costs that responsible spenders will have to realize. 2) maximize euro dollar stability. I would suspect the debt restructuring must happen rapidly following the issue of joint euro-bonds, or failure will ensue.
Michael, What do you think the chances are that Germany will accept joint euro-bonds if the biggest spenders concede to the lenders? The combination of monetizing US and European debt certainly adds more fuel to the trade surplus in China anyway.
Michael:
Did you see this one:
http://www.dnaindia.com/money/interview_china-can-t-win-a-trade-war-it-will-be-massacred_1473640-all
CS
I always enjoy reading your posts, professor Pettis; in this case however I think you fall to the economist’s mistake of failing to consider the secondary effects of policy.
It is true that the immediate costs of devaluation are, in a debtor nation, born by foreign lenders. However as things rebalance, the process of devaluation amounts to a destruction of the capital that was gained from the foreign lenders in the first place. Consequently, the nation returns to whence it began… capital deficiency. Only the problem is now compounded by the precedent of the sovereign government dishonoring contracts, a situation that inevitably scares lenders both foreign AND domestic. There is a very real, if unquantifiable, long-term economic cost associated with this — one which will most definitely not spare the working class. The nation in question buys current jobs at the cost of future ones.
To put this another way, by borrowing directly from foreign entities and failing to achieve anything but bureaucratic self-propagation with the funds borrowed, and then devaluing, the governments of these countries will prevent capital from going in the future to where it should have gone in the first place: the productive economy.
I would argue that without a proper diagnosis, your assessment of costs will always be incorrect. Perennial unemployment, even in exceptional cases like austerity, is a result of immobility, which in turn is a result of the legal system and the extent to which it codifies an impractical economy. Western regulations and labor laws naturally result in western unemployment. The expanding bureaucracy has always been government’s answer to the joblessness created by its policies; but this is only possible by deferring the costs to future generations through the use of debt or the cannibalization of the nation’s wealth. What has happened in Latin America, and continues to happen, is the result of a colonial culture which (like its European progenitors) has never known real liberalization.
Keynes was wrong, and you’re wrong to agree with him. You cannot control who will bear the costs of readjustment, only WHEN they will bear it. Any advantage bought by labor will be paid for in the future, by labor. Nevertheless I believe you’re right about the political situation in Europe. More’s the pity.
Michael,
I think your writing is excellent but in the end waltzed around several core issues.
Can devaluation solve the problems of debtor countries? Between 1956 – 58 Harry Johnson laid out the principles of the transfer and adjustment process from which one may infer that to reduce its external debt a country must engage in a mix of expenditure reduction and expenditure shifting policies. Devaluation of the real exchange rate (uncompensated by subsequent inflation) is a part of the expenditure switching policy (that shifts spending from imports to exports) but will never be enough because of the empirical failure of the Marshall Lerner condition. So, expenditure reduction is also required. The freedom to devalue does NOT necessarily make it politically easier to avoid default on external debt. Some of your commentators seem to be aware of this.
You conclude, correctly in my view, that the EMU must either break up or
become also a fiscal union. This should be the start not the end of your political analysis. You should recognize that Germany is the country that has the most to gain from the former and lose from the latter. After two world wars in the first half of the 20th century, the EMU was designed by Europe’s Lilliputs, that had “won” the wars, to tie down its Gulliver – Germany. The loser, Germany, had no alternative at the time but to acquiesce. The politics of the EMU breakup scenario therefore involve a return of Germany to dominance in Europe. I believe that top Germans realize this and desire it and, therefore, that they will resist the fiscal union scenario which is anyway otherwise unlikely given the desire of other European governments to retain some independence.
Prof Pettis
No doubt the attractiveness of the euro abandonment option will increase as the sovereign debt crisis becomes full blown over the coming months, thing is what implication will it have for rescue packages that are already financed by some members of the EU, the capital flight will also necessarily exact punishment for any government that resorts to that option. Not that traditional havens will be complaining.
As for debt forgiveness, it takes both hands to clap and considering the state of some international/foreign banks, that is a huge question mark behind “when” and “how (much)”.
Sad but ironically fitting that the song playing on the list is “the end of the innocence”. Politics is going to get that much more sclerotic and vicious pretty soon. Not something to look forward to.
Prof Pettis
Vastly amused by the default primer piece. Some things have fleshed out, some haven’t. Including some very obscene profits by some market makers when “restructuring” their sovereign clients’ debts. In fact, weren’t some strategies adapted for use by corporations in recent times? Interesting how some things played out. Care to do a reflective piece on the primer and how it’s played out?
Sorry about posting consecutive comments, here’s a piece by Alistair Darling i the NYT on pretty much the same topic that this post was based on.
http://www.nytimes.com/2010/12/06/opinion/06darling.html?pagewanted=2&ref=opinion
A moderate view?
This is about China, and maybe no suprise but still…
From FT Alphaville:
Something else made in China – Chinese GDP
Posted by Tracy Alloway on Dec 06 13:57. 2 comments | Share
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Uh oh.
Wikileaks, fresh from angering US authorities, might be about to incur the wrath of China’s economic establishment. The controversial site has published a US embassy cable containing comments made in 2007 by Li Keqiang — then head of the Communist Party in Liaoning and now the man some tip to become the PRC’s next head of government. More…
Uh oh.
Wikileaks, fresh from angering US authorities, might be about to incur the wrath of China’s economic establishment. The controversial site has published a US embassy cable containing comments made in 2007 by Li Keqiang — then head of the Communist Party in Liaoning and now the man some tip to become the PRC’s next head of government.
The cable was published as part of last week’s massive release of American diplomatic transcripts — and was just spotted by Malcolm Moore at the Telegraph.
The relevant bit of the cable, below:
Describing some of the challenges he faces as Party Secretary, Li related that despite brisk economic growth of SIPDIS 12.8 percent in 2006, Liaoning’s income gaps remain severe. Liaoning ranks among the top 10 Chinese provinces in terms of per capita GDP, yet the number of its urban residents on welfare is among the highest in the country and average urban disposable income is below the national average. By contrast, rural disposable incomes are above the national average. Even so, incomes for Liaoning farmers are only half that of urban residents.
¶4. (C) GDP figures are “man-made” and therefore unreliable, Li said. When evaluating Liaoning’s economy, he focuses on three figures: 1) electricity consumption, which was up 10 percent in Liaoning last year; 2) volume of rail cargo, which is fairly accurate because fees are charged for each unit of weight; and 3) amount of loans disbursed, which also tends to be accurate given the interest fees charged. By looking at these three figures, Li said he can measure with relative accuracy the speed of economic growth. All other figures, especially GDP statistics, are “for reference only,” he said smiling.
Michael,
I have yet to see a good argument for countries to leave the Eurozone, even if they have to default (likely).
Arbitrarily re-denominating contracts and obligations into a new currency is really no different that just downsizing those same contracts and keeping them in the same currency. You don’t trick anybody by the currency change… Why not impose the same adjustment through defaults and large wage adjustments, and stay in the currency club?
Can’t a government cut public sector wages as easily as it can re-denominate them into a new currency?
For anyone looking for a comprehensive survey of the economics literature regarding monetary unions in general and the EMU in particular (Greece is in there, Ireland obviously not) in a top class peer reviewed academic journal:
R Beetsma and M Guiliodori: The Macroeconomic Costs and Benefits of the EMU and Other Monetary Unions: and Overview of Recent Research. Journal of Economic Literature 48 (September 2010): 603-641
http:www.aeaweb.org/articles.php?doi=10.1257/jel.48.3.603
Maybe this will help understand how narrow and political the media debates about the EUR are, and that the comments about the possibility of sovereign defaults (and ways to structure the subsequent procedures) have a context, in the sense that the previously very low spreads to the German benchmark paper, could have indicated a lack of credibility of the ECB’s no-bailout clause (p 620).
Ironically one could argue that one of the positive factors of the current events is that the spreads at least (and of course the noises from Germany) indicate that maybe credibility is less in doubt now.
Michael,
A little off topic but the recent Wikileaks leak showing that Li Kequiang stated that GDP figures are “man made” got me thinking. Could the Chinese economy be less imbalanced than the official GDP numbers make it out to be? In know a lot of the “fudging” gets done at the provincial level and it seems to me that investment may be easier to embellish than consumption figures.
Interested to hear your comments.
Michael,
Some pleasant news on Ireland:
http://imf.org/external/pubs/ft/survey/so/2010/car071410a.htm
Except this was dated 14 July, 2010. What happened in the meantime?
Rien, I believe the excessive capital in speculation and the appetite for returns is following perception rather than fundamentals, otherwise these massive debt to GDP levels and trade deficits would not exist. Of course there is huge money to be made in pumping and dumping a nations debt. Hedge funds will argue that they are the messengers of fiscal responsibility, I say this is bullshit………they can’t wait to short a bubble that is stressed and I don’t think they give a rats ass about employment. These type of shorting opportunities should not exist at this scale in the first place. I would like to think that the messenger of fiscal responsibility prevents bubbles in the first place.
Marcus,
What an interesting thought. Excessive capital must be one of the most important ingredients in speculative waves, but, what is capital, what is it that makes it excessive? The hedge fund that lives around the corner from my house will say that it has too little capital and that the bubble in 2005 Lady Dianne Cullen is there to be shorted. But I rather drink the stuff. As to employment, maybe that is not the primary problem. There appear to be enough people to do the available jobs, which is better than the opposite, right? Michael, what about returning to China, I think it/she is really trying to draw our attention again. The Irish are safe, the Germans respectably gloomy and far from satisfied and the French have not gotten their statist protectionism, while the Spanish seem to be off the hook. This blog is devoted to China isn’t it?
China is on a path towards a brick wall. The political elite are trying to manage a soft landing, but with so much overcapacity and mal-investment (partly due to crony capitalism) China could crash.
Some interesting views by Jim Chanos:
http://www.planbeconomics.com/2010/12/10/will-china-hit-a-brick-wall-jim-chanos-answers/
Hitler parody video – Hitler as a CEO
Michael
Hope you write some more on Europe soon – could use the input.
Whatever the outcome, what seems to be a major problem for almost all market participants is they keep hammering on the European crisis with economic and financial forms of analysis.
But Europe is an absolutely standard issue constitutional crisis, it is 100% political in nature. Only by considering it as a constitutional crisis can any useful conclusions or prescience formed.
My own conclusion is that a Confuscious type of rule by a plutocratic meritocracy will never work. And since the plutocracy now will fight to the end to keep representational and constitutional based government from being formed (whats more a constitution would never be accepted now in Europe), and ony if a written or unwritten constitution appears on the scene…. well this all means that unless a Marshal Plan like subsidy appears form the USA and /or China – Europe is doomed but to be a pragmatic free trade zone.
Europe will prove me wrong if three things appear on the scene, which all require a centralized European sovereign governmet: 1) a European “full faith and credit” debt issuance and a market for that debt; 2) European taxation where all areas pay the same rate and all proceeds go to a European balance sheet; 3) equalization payments wihin Europe that go to poor regions equal to at at least 10% of GDP – or at least $1 trillion per annum.
If any of the three do not come into being in short order – the Euro ceases to exist. All three are essential for the Euro to survive. That is a certainty. And there is no doubt the Euro plutocracy, heirs to Monet, cannot implement those three required and only a constitutional forming event will allow for a government that can implement those three conditions. Market bets in Europe should be based upon the liklihood of a constitution shortly being published in Europe. ….when pigs fly.
George Robertson,
Maybe you should look at the things that are being discussed and agreed between the EU/EUR member states. There was never the intention that countries wirth poor budgetary policies could not default. However, a variety of circumstances has created a situation where it would be costly to let -by themselves justified- defaults happen. Once the two facilities designed to support the market in EUR sovereign loans are fully implemented, bonds offending states should be risky, as was intended (the “no bail out clause” of the SGP), but until recently not believed by most market participants. The recent “bail outs” (I doubt they really are bailouts, because significants costs are imposed on the countries in question) should lead to short term market stabilization, while the fiscal measures taken by many of the UER gvts should created confidence that these gvts mean to impose economic discipline. Of course that is exactly what non -EU gvts fear, because it means, if successful, that as Michael has warned on these pages many times, this will contribute to the global imbalances.
Will these global imbalances be aggravated in such a way that the European gvts mainly involved in financing the bail outs and promoting (limited to the region) stabilizing policies would prefer to accept much looser discipline or even a breakdown of the EUR mechanism (not the same as losing one or two minor participants)? I doubt it. A prolonged recession in the US will be a big problem for the world, but mostly for the US. And they have had a few good years..
Good post, though I don’t agree with all the premises. I think a haircut is mandatory and I’m not sure one can inflate away foreign debt that easily. I was hoping to find Yves post in this thread, but I must have missed it. In short, I think Michael Hudson’s theory that debt that can’t be paid wont be.
This goes beyond politics and economics into debt dynamics itself. We are talking about a world that is totally saturated in debt, based on the dollar standard. The experience of prior years can be centered on the idea that a country can be placed in a microcosm by itself, but this is no longer true. We have reached a point where the accumulating class, as Dr. Batra called it, has accumulated a pile so large that the game is up. They can only lend more to those that cannot pay and pretend they are going to get their money. Debt and debt money has its own redistributive property that goes outside of politics and economics. These principals are known as default, peonage and feudalism, depending on the solution provided.
In this case, we do have only a short time. If the debt is enforced, the compound nature of debt and the reverse effect of shrinking economics with shrinking credit, means it makes its way up the social class to the point that only violence and force can enforce any symbolence of repayment. IF we have default, it also makes its way through the economy. I will expand more on my blog, as this is a complex idea to develop.
In short, I do believe Michael has it somewhat right in that we are going to see band-aids put on this until something forces the hands of those involved. One is going to have to look toward not only what is possible on a mathematical basis, but for a path back to sustainable prosperity. The status quo or anything close to it won’t work. Printing money will merely destroy the economies of all involved.