Things have turned dire again in Europe. Hard on the heels of credit downgrades at France and Austria last week, S & P’s just downgraded the credit rating of the Eurozone bailout fund, a news item that carries a whiff of hilarity to it. Euro-TARP needs a bailout!
European financiers are hopeful the new bailout fund, established more recently and said to be more formidable, will surmount its predecessor’s feeblenesss. For that matter, European financiers are also still hopeful that the Germans will relent; that Frankfurt will open the ECB monetary spigots; failing that, they are hopeful that China might possibly be persuaded to swoop in to aid Europe; that the IMF will quietly assume central bank-like powers and make creditors whole; or that some other monetary authority (maybe the Federal Reserve!) will likewise mount its prized steed and ride to rescue of high finance.
These financiers are an excitable lot.
The press reflects the panic. Doomsayers abound. The poor Financial Times is reduced to a desperate prayer than the new Italian technocrat will prevail on German leaders to be less stingy; and the New Statesman to a suggesting that the UK’s government go ahead and “launder a euro bailout through the IMF.”
The Europeans, despite their panic or perhaps because of it, are forging ahead with austerity. Austerity means budget cuts on social spending and tax hikes. Its purpose is to ameliorate the enormous imbalances between output and liabilities that characterize so many Eurozone economies. (Also the US and Japan.) The problem is that austerity inclines to the contractionary: it lowers the denominator in those debt-to-GDP or deficit-to-GDP ratios, thereby weakening the effect of any budgetary reduction in the numerator. In some cases austerity’s consequence is even worse: markedly less revenue along with less output, that is to say, a larger numerator and smaller denominator.
Translating all this into an American context is not easy. Parts of these austerity programs appeal to the budget-cutting passion of Tea Party right-wingers; but tax increases alarm them. American liberals, meanwhile, agitate for the tax hikes with grand self-assurance; and recoil violently from any budget cuts. It is convenient for various factions, right and left, to elide the distinction between fiscal and monetary policy. Better for red-meat oratory to lump the Fed and the Treasury together in denunciation. I wonder how many rank and file Tea Partiers are aware that even so credentialed a capitalist as Milton Friedman would have favored monetary expansion while disdaining any fiscal expansion.
Of course, monetary expansion is not an option available to Eurozone nations. Therein lies a big problem. The Common Currency prevents indebted nations from having recourse to the one tried-and-true method of fighting a debt crisis: currency devaluation.
Germany, in exchange for preserving the capacity of periphery nations to borrow at German rates, in other words in exchange for German taxpayers financing periphery budgets, wants effectual power over periphery budgets. There’s a certain brute logic to it, but it’s serious business. Imagine being in Athens when a functionary from Frankfurt shows up to eliminate your job or trim your pension, in order to protect the investments of Teutonic or Arab or Chinese creditors. But that may well be the price for cheap debt issuance: sovereignty.
Forget the Cross of Gold: this is a Cross of Euros.
Here in America, self-confidence exceeds knowledge by an order or two of magnitude. Everyone thinks he knows better. What has happened in Europe could never happen here. This despite our country’s decision to imitate the European social-democratic model. Italians, too, thought 7% on sovereign bonds was an improbability too remote and awful to contemplate. To read certain Leftists, with their smug presumption that historically low borrowing rates will persist indefinitely, puts one in the mind of no one so much as the huckster banker who sold the Greeks on a big complicated, sight-unseen, currency swap device, back in the mid-2000s, all on the pristine assumption that bond issuance at German rates would endure, forever and amen: “Look, the thing to do is invest in useful capital when it’s cheap; and we’re just the guys to get that deal done for you.”
Meanwhile, to hear the way many critics of the Fed fulminate, one might be forgiven for supposing that all the facts were long been assembled, and all the research long concluded, concerning the crisis of 2007-09; when the toppling truth is that most of the key threads of factual causality will elude our feeble human faculties for decades or more. Economic science is not all that. We barely understand the Great Depression, and it ended 70 years ago. Devotees of a restoration of hard currency seem peculiarly susceptible to this aggressive self-confidence. The bare truth is that divining the consequences of an attempt to convert all dollar (along with euro and yen?) obligations into commodity obligations is beyond any art we here possess. Even the more modest project of re-introducing the old European national currencies would be an extraordinary adventure in international political economy. It’s one I trend to favor, but not without considerable trepidation.
Comments (16)
Why would a bailout fund have a credit rating in the first place?
Posted by jvangeld | January 17, 2012 3:27 PM
Paul,
I agree, bring back the drachma. The Eurocrats need to fine a way to assure that the Greeks would still pay back some of their debt as they inevitably inflate.
Any suggestion of German monetary and fiscal tyranny should be rejected emphatically.
Posted by Paul Sr | January 17, 2012 3:55 PM
jvangeld -- Because it was all set up to start issuing bonds.
Dad -- I agree that German fiscal control of all Europe is not an eventuality that we should desire.
Posted by Paul J Cella | January 17, 2012 4:20 PM
As always, Paul, we disagree on monetary policy and the advantages of spending cuts and balanced budges but agree on sovereignty. Returning to the individual currencies of the individual countries would allow the countries both to have their sovereignty and to experience the consequences of that sovereignty. If countries have different styles (and undoubtedly they do) this will affect their economies. Let them sink or swim individually. Germany should not have to bail out the less cautious Greeks. Greece should not have to be told what to do by Germany. These two truths should be joined at the hip.
Posted by Lydia | January 17, 2012 4:33 PM
Why would a bailout fund have a credit rating in the first place?
Perhaps the question was rhetorical, and if so quite well put. The reason, of course, is that the "bailout" is really just the expansion of debt with (it is hoped) higher quality cosigners to pay a debt whose payments are due. It is natural for people to think of "bailout" as some entity with the means to pay, i.e., someone with "money", helping out someone who lacks the means to pay, i.e., someone lacking in "money". But all "money" is, in today's reality, debt. In fact, the continued use of the term "money" may be one the things that is most Wrong With the World. In all financial discussions, the term "money" should henceforth be replaced by the term "debt". "How many IOUs for that chicken breast there?" More than any other asset, real property, which you are capable legally and/or physically defending, bears the closest resemblance today of what was historically understood to be money. But it is of course, very difficult to trade a tiny portion of your house for a loaf of bread. (And chances are, you don't really "own" your house anyway...)
Posted by anonymous | January 18, 2012 11:54 AM
Paul, you write,
"...when the toppling truth is that most of the key threads of factual causality will elude our feeble human faculties for decades or more. Economic science is not all that,"
which is one of your consistent themes, and yet you also write:
"The problem is that austerity inclines to the contractionary: it lowers the denominator in those debt-to-GDP or deficit-to-GDP ratios,"
http://www.project-syndicate.org/commentary/shiller81/English
"Of course, monetary expansion is not an option available to Eurozone nations. Therein lies a big problem. The Common Currency prevents indebted nations from having recourse to the one tried-and-true method of fighting a debt crisis: currency devaluation."
"The bare truth is that divining the consequences of an attempt to convert all dollar (along with euro and yen?) obligations into commodity obligations is beyond any art we here possess."
While we likely will never know everything, it seems, we do know some things. The trick is not to repeat past mistakes. We also need to note that unless Germany is willing to accept a higher inflation rate and deal with its current account balance things will likely not go well.
"To read certain Leftists, with their smug presumption that historically low borrowing rates will persist indefinitely..."
None of which I'm aware of. I know those who advocate pushing necessary spending forward while interest rates are low to non-existent but none who advocate policies that assume perpetually low borrowing costs. You really need to back up that assertion.
"American liberals, meanwhile, agitate for the tax hikes with grand self-assurance; and recoil violently from any budget cuts."
Which assertion you also need to back up as history is your enemy; you are decades behind. Our long term problem is health care - both public an private. Either we find a way to get our one big problem - health care costs - in check or it consumes us. Liberals are the only serious players (and too often, just barely), conservatives having rejected their own solutions and now advocating only cost shifting.
http://www.guardian.co.uk/commentisfree/cifamerica/2012/jan/10/economic-illiteracy-of-economists?CMP=twt_gu
"Everyone thinks he knows better. What has happened in Europe could never happen here."
Not as long as we have our own currency.
"This despite our country’s decision to imitate the European social-democratic model."
I wish. Anyway this is really a strange statement. Europe's current problems have nothing to do with their decades old welfare state. In fact, Ireland and southern Europe have weaker safety nets then their northern neighbors.
(Focusing on Greece is not useful. Greek governments were bad actors while Ireland and Spain were running surpluses and Italy was in sustainable and improving shape. Further absent Social Security, Medicare, Medicaid, and food stamps which are background or kick in automatically our situation would br far worse.)
Drawing conclusions requires comparing apples with apples. For example, Denmark and Finland are both in the EC and have welfare states yet Finland has seen its rates rise and Denmark hasn't. Denmark has its own currency while Finland uses the Euro.
The best direction is likely 180 degrees from your solution - greater fiscal unity and a real central bank.
Posted by al | January 18, 2012 6:11 PM
So you end up siding with Angela Merkel? Did not see that coming. (Or if not, then how do you get to fiscal unity and a real lender of last resort without risking a German or perhaps Franco-German empire?)
That the sovereign debt crisis spread so rapidly to the sustainable and improving Italy (I agree with that assessment, by the way, with regard to deficits; but Italy's accumulated debt is sizable) is perhaps the first piece of evidence I would submit in counseling caution about our predictive capacity.
Are you really saying that I need to back up the assertion that American liberals favor tax increases and oppose budget cuts? Really?
I know those who advocate pushing necessary spending forward while interest rates are low to non-existent but none who advocate policies that assume perpetually low borrowing costs.
Just rolling over the debt on our current spending essentially presumes upon long-term low rates, since a decisive and sustained spike in rates would likely do to us what it did to Italy: make debt service the driving force in politics.
Posted by Paul J Cella | January 18, 2012 8:34 PM
I will admit to ignorance about monetary policy. All I know for certain is that intentional inflationary methods tend to reduce the value of debt obligations. This is good for those who owe (if the inflation wasn't planned for), not so good for those who are owed (if the inflation wasn't planned for), and bad for the principles of private property, lending, and for defense of contracts, though not indefensibly bad for them. One way to defend against it is simply to write all debt instruments to accommodate inflation as a variable, and tack on "interest" on top as a separate premium.
I can see how debt-to-GDP ratios are important, as descriptors of your condition - actually, as signs and symbols of the condition. High ratios indicate precarious, unwholesome positions, all other things being equal. I cannot see how these ratios should actually DRIVE policy in this crisis, especially when the anticipated change in the ratio will come from a change in underlying reality that is toward a good long range result, even if it the short term result is unpleasant: the change in ratio is merely no longer a good measure of the value of the policy. If austerity is absolutely essential to recovering sound balance, then the contraction in the GDP is something regrettable but bearable, and the consequent rise in the ratio is merely telling you something that you already know: that temporarily things will feel worse on their way to soundness. It doesn't mean austerity is the wrong policy, it means austerity will feel unpleasant because it is unpleasant. OTOH, if austerity isn't going to help get you toward healthy balance, then it fails for underlying reasons of which the increase in ratio can only be a signal for, not the actual cause.
I don't think that I have seen an adequate DESCRIPTION of the crisis we are living in, much less an adequate analysis of the causes of it, far from good proposals for it solution.
Posted by Tony | January 19, 2012 6:30 PM
I tend to agree, Tony, that it is unfortunate that the sterile numbers and ratio come to drive policy, but it certainly happens. Eurozone nations have been fudging their numbers, of course, but in theory the various treaties are supposed to obligate deficits of no higher than X% of GDP for X numbers of years: so deficits as a ratio of national output.
Anyway, the best description I can come up with is that most of the Eurozone nations, in return for being able to issue debt at very low rates, agreed to adopt a dearer currency, the euro. From one angle what they did was sign on with Germanic norms of tight money and low inflation in return for the cheap rates of capital available to Germany.
What did Germany get for its troubles? Why, it got to import Eurozone demand, and grow steadily by mercantile principles, especially through its high-end manufacturing.
Posted by Paul J Cella | January 20, 2012 11:42 AM
Austerity was suicidal in the 1930s; it still is unless one has control over ones currency, is able to increase exports, and it doesn't kick in until recovery is established. Europe is run, for the most part, by center-right governments who dance to Germany's tune and Germany has forgotten, it seems, that it was deflation, not inflation that immediately preceded Hitler.
This may be of interest,
http://delong.typepad.com/sdj/2012/01/the-british-economy-is-now-doing-worse-than-it-did-in-the-great-depression.html
"especially when the anticipated change in the ratio will come from a change in underlying reality that is toward a good long range result, even if it the short term result is unpleasant:"
In 2000 we had surpluses to infinity. All it took was a coup by the Supremes to blow that up. Start to finish, life is a tap dance. There is no "long range" static condition possible on this veil of tears except that we all die.
"I tend to agree, Tony, that it is unfortunate that the sterile numbers and ratio come to drive policy..."
Except they don't which is why the Fed doesn't raise the inflation target and why we don't have a sane fiscal policy. Economic policy is driven by a micro morality play view of things which is why the "serious" types focus on deficits and inflation.
Posted by al | January 27, 2012 2:14 PM
You mean the deflation that was the natural and inevitable consequence of the even more disastrous hyperinflation of 1923? THAT deflation?
Posted by Tony | January 28, 2012 5:15 PM
"You mean the deflation that was the natural and inevitable consequence of the even more disastrous hyperinflation of 1923? THAT deflation?"
?????????? "natural and inevitable"? Based on what? Given what followed the Bruning deflation in the early 1930s, your assertion that the hyperinflation of 1923 was "more disastrous" is hard to justify.
The 30s deflation was the result of political decisions that tilted mightily towards austerity in an attempt to correct Germany's current account deficit and the credit problems arising from the 1929 Minsky moment.
This isn't to say that there weren't long term problems stemming from the early 20s hyperinflation; it just didn't inevitably lead to crippling deflation several years later.
There are many reasons to avoid Austerity,
http://rortybomb.wordpress.com/2012/01/27/household-formation-divorces-births-correlated-with-unemployment-across-states/
As always the best information will be found on the left - this is useful,
http://www.social-europe.eu/2011/11/european-austerity-is-this-1931-all-over-again/
Posted by al | January 29, 2012 3:55 PM
There are indeed reasons to avoid austerity. But there are also reasons to pursue it. Among the decisive ones is a sudden inability to sell sovereign debt except at crippling rates. (Note: I am not recommending austerity, much as it is convenient for Al to pretend I am. I am only suggesting that European governments are adopting austerity for reasons other than that they are big mean plutocrats.)
Also, this term austerity could use some unpacking. It can and does mean: cuts in public services, reductions in public payrolls and benefits, and tax increases. That's a considerable mix of policy. One might fairly say that both Warren Buffet and Scott Walker are proponents of austerity.
The specifics of the policy mix matters. Big time. Both Wisconsin and Illinois have pushed through austerity measures in the past year, the former heavy on public sector reductions and the latter heavy on taxes. One state is doing a lot better than the other. (Hint: it ain't the state recently downgraded to the lowest credit rating of all 50.)
Posted by Paul J Cella | January 29, 2012 7:05 PM
"Among the decisive ones is a sudden inability to sell sovereign debt except at crippling rates."
Ah! uncertainty - the last refuge of the serious people. Paul, we have a real TIPS 10-year rate of -0.29%/year. Where does the demand for safe assets go if U.S. rates spike? What short of the Yellowstone super-volcano going off could cause this?
"One might fairly say that both Warren Buffet and Scott Walker are proponents of austerity."
I guess bargaining is also part of the process when ones ideology is dying. I doubt the situation boils down to tax hikes vs. union busting and budget cuts in this cycle. Anyway, back to the nation; think of counter-cyclical policy as a bridge loan. Of course, that requires the will to raise taxes and run surpluses in times of plenty (which means one doesn't elect folks who believe that deficits don't matter and that tax cuts are ones due as well as running wars off budget and passing unfunded benefits, but I digress).
You should also keep in mind that what counts besides timing is the aggregate and we are deleveraging in terms of private debt.
(All this gives us some good filters - e.g. someone comparing the U.S. situation to that of Greece is, to be kind, either lying or ignorant.)
“The recognition is coming that austerity won’t work,”’ said Mr. Fritz-Vannahme, “but how to get beyond austerity politics is completely unclear. There is no master plan under discussion in this country.”
http://www.nytimes.com/2012/01/30/world/europe/30iht-union30.html?_r=1&pagewanted=all
PK also has an interesting column in today's NYT.
This article by Zandi may be of interest.
http://www.washingtonpost.com/realestate/fannie-and-freddie-dont-deserve-blame-for-bubble/2012/01/23/gIQAn3LZMQ_story.html
Posted by al | January 30, 2012 6:31 PM
Al, I'm not going to follow all your links and entangle myself in sorting out what you really believe when you won't give me the same respect. There aint enough hours in the day, man.
Obviously my remark about crippling rates referred to Europe. Italy in particular but with broader application of the same principle. For you to elide this distinction suggests a basic unseriousness as a commenter.
We've been through this before: I am not unalterably opposed to government spending, for precisely the reason you give: we can borrow money for so cheap and inflation is almost nonexistent (for now). I am emphatically not a tight money guy in this environment; you recall that my fellow contributors, even, regularly castigate me for this view, no? What I'm opposed to is useless spending to, say, prop up unsound public sector union pensions; or to dismantle welfare reform; or to subsidize pie-in-the-sky green energy boondoggles. That sort of thing.
Where does the demand for safe assets go if U.S. rates spike?
Well that there is the big question, isn't it? Do you think it will go unanswered forever? Your horizon may well be the day you cease to draw breath; for me and most of us here there are considerations in the out-years.
But to repeat another point we've been over before: If you're working on the assumption that the dollar reserve is the eternal ground of economical analysis; that the safe asset will always been US Treasury securities; that we'll always and forever be able to sell debt at near-zero interest rates -- why, you're operating in a world I can't recognize. Blind faith as compared to empiricism.
How about this, Al: if Apple Computer were to issue 30-bonds (they carry ZERO long-term debt), it would instantly become a safer asset than US Treasurys. Apple's revenue stream is not, in fact, wholly dependent on the dollar reserve. Indeed, I suspect high-grade global corporate debt could probably be reworked to provide the "risk-free" baseline in fixed income markets. (This process, I'm told, was actually underway back in the late 1990s when the US approached budgetary surplus.)
someone comparing the U.S. situation to that of Greece is, to be kind, either lying or ignorant
The utility of the comparison is limited, but it is not nonexistent. Unquestionably the US financial position is better than Greece, by an enormous margin. However, as we've seen, you don't have to reach a Greek-level disorder in private sector prosperity vis-a-vis public obligations to get burnt. See, e.g., Italy.
But my main point, Al, is that it'd be nice if you were actually committed to a civic discussion. I happen to think it would be fruitful. Alas, that requires a reciprocity you can't or won't give.
Posted by Paul J Cella | January 31, 2012 12:47 PM
Its really good to know that it does help with fighting a debt crisis.
I am hoping that every nation will able to do the same strategies all through out.
Carla from parasol de plage
Posted by Carla | July 7, 2012 4:19 AM