The Road to Serfdom

(With apologies to Friedrich Hayek)

“Having followed the German political scene closely for the last five months, it is clear to me that almost the entire German political establishment is out of its depth, ideological, sometimes smug, apt to view the EMU debt-crisis as a Calvinist morality tale, and lacking in deep understanding of what it has got itself into.

One can understand German worries about money printing – and especially the loss of fiscal sovereignty and democratic control – but matters have already moved on. It is too late for that.

As for the EU authorities with their mad contractionary fiscal and monetary policies in an accelerating slump, they seem to have achieved little by toppling two elected governments in one week.

In Italy they have already made matters worse. I doubt that much will change with “technocratic governments” in either Greece and Italy, yet immense damage has been done to democratic accountability.

The EU Project has become both dangerous and insane.  (link to article)

By Marshall Auerback

Forget about the S&P downgrade, which has had ZERO impact on the global equity markets. The downgrade was supposed to mean that it would be more likely that the US government would not be able to pay its debt than previously assumed. IF the markets took this warning seriously, then they would have attached a higher risk premium to US government bonds. Of course, the opposite occurred. US bonds soared in price. In other words, investors, both here and abroad, voted with money as loudly as possible that they view the US government debt as a very safe haven in a time of financial turmoil

So if it wasn’t the S&P downgrade which caused this downward cascade in the global equity markets, then what was it? By far, the most important factor currently driving the market’s bear trends is Europe or, more specifically, the future of the euro and the European Monetary Union. Systemic risk has migrated across the Atlantic to the euro zone.

And after yesterday’s joke of a summit between German Chancellor Merkel and French President Nicolas Sarkozy, it appears yet again that Europe’s policy makers have comprehensively blown it. Their persistent reluctance to get ahead of the looming systemic ticking bomb at the heart of the euro project has reached the point where it is likely to doom the euro’s existence. Their repeated “rescue plans” (and equally fatuous statements about new committees and “euro solidarity) can no longer mask the central problem, which is that countries with very different economies are yoked to the same currency in the absence of a fiscal transfer union which would otherwise facilitate growth, not ongoing economic depression and political turmoil.

Rather than attempting to stave off a double-dip recession by easing fiscal and monetary policy, the European Central Bank (ECB) has gone careening off in the opposite direction. The euro project is consequently being turned into a Hooverian instrument of economic torture from sado-monetarists, such as Jean-Claude Trichet, who see each bailout as a way for irresponsible nations to offload their liabilities onto their fitter neighbors, rather than considering the flawed institutional structures which created the need for these stop-gap measures in the first place. Interest rates have been raised, and member states have been forced into self-defeating austerity programmes which, by destroying growth, have made underlying debt dynamics even worse. It is hard to imagine a more tragic and self-defeating type of policy mix. It is 1937 writ large.

Monday, June 13, 2011

Should European Nations Repudiate the Debt?

By L. Randall Wray

It is becoming increasingly clear that the global economy (at least in the West) is heading for a steep downturn. Almost all the US data coming out in recent days have been bad. The UK and Japan are in austerity mode, with predictable results. Worst of all is Euroland. It has imposed severe austerity—the modern day equivalent of Medieval blood-letting—on its periphery nations. These nations are loaded with debt. In the case of Ireland, which had been a model of a Neoliberal utopia, the government got into debt by taking over its banks’ debts. In an unfathomable act of charity, this was done only to save French and German banks—which held the unserviceable and unguaranteed Irish bank debt. In gratitude for Ireland’s equanimity, the EU imposed the equivalent of IMF sanctions on Ireland. The government is supposed to downsize and squeeze blood out of its population in order to reduce its debt load—which has thrown it into recession and reduced tax revenues. The worst thing you can do to a debtor is to force her to reduce her income. But that is exactly the Medieval medicine the EU prescribed for Ireland. The story with the other highly indebted euro nations is similar—if not in the causes of their particular debt disease, at least in the remedy prescribed. …

Randall Wray concludes…

Defaulting whilst staying on the euro appears to me to include all the negative effects of leaving the euro but with none of the benefits. For example, Ireland and the other periphery nations would still be stuck with a vastly overvalued currency. At least if they abandoned the euro they could competitively devalue against German exporters. They will get sued in either case and rulings in EU courts will probably go against them. Perhaps it is best to leave the EMU and even the EU to protect their domestic economies if one is going to default.

The last option is to band together and to insist on EMU-wide reformation. Debts must be restructured and written-down. To be sure, default as well as leaving the EMU must be retained as a bargaining chip—but it should be “en mass”. And it should be made clear that the best option for both the indebted nations as well as the creditors is to come to mutually beneficial terms. European banks are, broadly, toast. Not only did they buy toxic US waste, but they also created plenty of their own. And they owe much of it to each other. Like the biggest US banks, they are “too big to fail”—which is to say that they are “systemically dangerous institutions” in Bill Black’s terminology. That means they must be “resolved”—downsized and closed, with assets and liabilities distributed to smaller institutions. Netting bad assets that banks owe to each other (within and across borders) would go a long way to downsizing exposures. (And banksters should be incarcerated. I suspect that the main reason that big banks are not closed is because governments know they will uncover massive go-to-jail fraud. It is not really that the banks are too big to fail but rather that they are too fraudulent to seize. If any honest examiner ever entered the doors of Goldman Sachs, for example, he could not leave with issuing thousands of subpoenas that would include the names of former, current and prospective future Treasury department officials.)

It is time to admit that the EMU was designed to fail. I have been arguing since the mid 1990s that the first serious financial crisis would bring it down. We are in that crisis. It is time to recognize that reality. The debts must be resolved and a new fiscal arrangement must be created. As I have argued many times, the EMU members are like US states, but without a Washington to help out in times of crisis. The chickens are here and they are roosting. We have come down to one viable choice—if the goal is to preserve European union. In addition to dealing with the debt, the EU must create a fiscal force similar in size to the US Treasury.

“An ominous pattern has emerged across much of the eurozone periphery: tax revenue keeps falling short of what was hoped. Austerity measures are eating deeper into the economy than expected, forcing further fiscal cuts. It goes too far to call this a self-feeding spiral, but such policies test political patience to snapping point.

There is little that these nations can in the short-run as EMU members. They cannot offset fiscal tightening with full monetary stimulus or a weaker exchange rate – as Britain can. All they do can is soldier on, sell family silver to the Chinese and Gulf Arabs, beg the ECB to join the currency war to bring down the euro, and pray that the fragile global recover does not sputter out.

Chancellor Merkel is ultimately correct. A mechanism for sovereign defaults is entirely healthy. Had it been in place long ago, EMU would have been stronger. The proper timing for this was at the Maastricht Treaty, or Amsterdam, or at the latest Nice, but in those days the EU elites were still arrogantly dismissive about the implications of a currency union. To wait until now borders on careless.”  (link to full article)

Mainstream Keynesian economics is facing its last hurrah. The global fiscal stimulus championed last year by the Obama administration is coming undone, repudiated by the same Group of 20 that endorsed it last year. Now, against a backdrop of a widening sovereign debt crisis, we need to abandon short-term thinking in favour of the long-term investments needed for sustained recovery.

Time to plan for post-Keynesian era

By Jeffrey Sachs

Published: June 7 2010 22:22 | Last updated: June 7 2010 22:22

“…

First, governments should work within a medium-term budget framework of five years, and within a decade-long strategy on economic transformation. Deficit cutting should start now, not later, to achieve manageable debt-to-GDP ratios before 2015.

Second, governments should explain, and the public should learn, that there is little that economic policy can do to create high-quality jobs in the short term. Good jobs result from good education, cutting-edge technology, reliable infrastructure and adequate outlays of private capital, and thus are the outcome of years of sustained public and private investments. Governments need actively to promote post-secondary education.

Third, governments must of course also ensure social safety nets: income support for the poor, universal access to basic healthcare and education, a scaling up of job training programmes and promotion of higher education.

Fourth, governments should steer their economies towards needed long-term structural transformation. External-deficit countries such as the US and UK will need to promote exports over the next few years, while all countries must promote clean energy and new transport infrastructure.

Fifth, governments and the public should insist that the rich pay more in income and wealth taxes – indeed, a lot more. The upward re-distribution of the past 25 years has made our economies into extravagant playgrounds for the super-wealthy. Politicians of both the mainstream left and right in the US and UK have fawned over those who pay their campaign bills in return for low taxation. Even playgrounds should collect tolls – when it is billionaires in the sandpit.

We need, in sum, to reset our macroeconomic timetables. There are no short-term miracles, only the threat of more bubbles if we pursue economic illusions. To rebuild our economies, the watchword must be investment rather than stimulus.

..The interesting feature of the Boone and Johnson article is that they focus on Ireland and explain why the fiscal austerity program will fail. They say:

Ireland was one of the first nations to introduce tough fiscal austerity in this cycle – in spring 2009 the government slashed public-sector spending and raised taxes. Despite the cuts, the European Commission forecasts that Ireland will have one of the highest budget deficits in the world at 11.7 percent of gross domestic product in 2010. The problem is clear: when you cut spending you also lose tax revenues from people who earned incomes from that money. Further, the newly unemployed seek benefits, so Ireland’s spending cuts in one category are partly offset by more spending in another. Without growth, the budget deficit still looms large.

So the point is – fiscal adjustment comes with growth. The raison d’etre of fiscal policy is to support growth when private spending is undermining it and to constrain growth when private spending is supporting it.

The mainstream economists’ case against the use of fiscal policy as a counter-stabilising tool of policy activism was based largely on their claim that it tended to be pro-cyclical due to implementation lags (the time taken to actually get projects rolling and the funds flowing). Now, the mainstream exemplar of fiscal prudence is to enforce pro-cyclical policy positions. Go figure that one out!

Boone and Johnson offer this interesting insight to further their contention. They show how the growth miracle that led to the “Celtic Tiger” reference was in large part a mirage and driven by major US corporations evading US tax liabilities by exploiting massive tax breaks supplied to them by the Irish government. They conclude that”

… 20 percent of Irish gross domestic product is actually “profit transfers” that raise little tax for Ireland and are owned by foreign companies … the Irish miracle was a mirage driven by clever use of tax-haven rules and a huge credit boom that permitted real estate prices and construction to grow quickly before declining ever more rapidly. The biggest banks grew to have assets twice the size of official G.D.P. when they essentially failed in 2008.

…The graph (from the latest Irish National Accounts ) shows the difference between Gross Domestic Product (which counts all output produced) and Gross National Product (which exclude the profits of foreign residents) for Ireland. Once you make that correction, then you can see how much worse the domestic contraction has been in the Irish economy.

So GDP was 7.1 per cent lower than in 2008 while GNP was 11.3 per cent lower than in 2008.

Once you adjust for this (ignore these transfers) by using Gross National Product (GNP) which “excludes the profits of foreign residents” then Boone and Johnson conclude that the “budget deficit was about 17.9 percent of G.N.P. in 2009, and … will be roughly 14.6 percent in 2010 and 15.1 percent in 2011″. They say that “(t)hese numbers make Ireland look similarly troubled to Greece, with a much higher budget deficit but lower levels of public debt”.

And they say:

Ireland’s politicians, rather than facing up to their problems, are making things ever worse.

However, I part company with them when they argue that the Irish government has to persist with the “tough fiscal steps” and take advantage of the IMF and EU bailout funding to “bridge the tough journey of fiscal cuts ahead”.

From an MMT perspective, all this is doing is insulating the government from being 100 per cent exposed to the private bond markets. It doesn’t stop the demand drain arising from the austerity and the already weak private spending.

It will also not allow the government to reduce its deficit very quickly at all – indeed as we have witnessed the budget deficit gets worse and places further strains on the government funding crisis. This vicious circle can only eventually collapse in default (a la Argentina). The same goes for Greece.

The problem is that the Irish government has no real options while they remain constrained by the Maastricht Treaty and their lack of sovereignty. As noted above, while the Prime Minister might define economic sovereignty as the avoidance of default in a fixed exchange rate world this is far removed from what true currency sovereignty constitutes.

Boone and Johnson understand that too. They say:

… the Irish need to consider seriously whether being in the euro zone is worth the cost. The adjustment to this awful situation would be far easier outside the euro zone – even though leaving the zone might have adverse repercussions for other nations.

This is one of my regular themes when discussing the Euro problems. The design of the monetary system is incapable of delivering sustained prosperity and is crisis-prone when there is a major asymmetric aggregate demand shock experienced across the member nations. All the bailout packages and other add-ons will not change that.  (link to full article)

Tuesday, May 11, 2010
Euro-Bankers to Greece: The Wealthy Won’t Pay their Taxes, So Labor Must Do So

By Michael Hudson

The “Greek bailout” should have been called what it is: a TARP for German and other European bankers and global currency speculators. The money is being provided by other governments (mainly the German Treasury, cutting back its domestic spending) into a kind of escrow account for the Greek government to pay foreign bondholders who bought up these securities at plunging prices over the past few weeks. They will make a killing, as will buyers of hundreds of billions of dollars of credit-default swaps on the Greek government bonds, speculators in euro-swaps and other casino-capitalist gamblers. (Parties on the losing side of these swaps now will need to be bailed out as well, and so on ad infinitum.)

This windfall is to be paid by taxpayers – ultimately those of Greece (in effect labor, because the wealthy have been untaxed) – to reimburse Euro-governments, the IMF and even the U.S. Treasury for its commitment to predatory finance. The payment to bondholders is to be used as an excuse to slash Greek public services, pensions and other government spending. It will be a model for other countries to impose similar economic austerity as governments run up budget deficits in the face of falling tax collections from the financial sector being enriched by the translation of junk economics into international policy. So the bankers for their part will have little trouble meeting their bonus forecasts this year. And by the time the whole system collapses, they will have spent the money on hard assets of their own.  (link to full article)

…Ireland is like a patient bleeding from two gunshot wounds. The Irish government has moved quickly to stanch the smaller, fiscal hole, while insisting that the litres of blood pouring unchecked through the banking hole are “manageable”. Capital markets may not continue to agree for long, triggering a borrowing crisis which will start, most probably, with a run on Irish banks in inter-bank markets.

Ireland may therefore present an early test of the EU bailout fund. However, in contrast to Greece, Ireland’s woes stem almost entirely from its banking system, and could be swiftly and permanently cured by a resolution which shares the losses of Irish banks with the holders of their €115 billion of bonds through a partial debt for equity swap. (link to article)

…Consider Ireland as Exhibit A in this regard. Ireland began cutting back deficit spending in 2008, when its banking crisis began to spread and its budget deficit as a percentage of GDP was 7.3%. The economy promptly contracted by 10% and, surprise, surprise, the deficit exploded to 14.3% of GDP. We would wager heavy odds that a similar fate lies in store for Greece, given the EU’s inability to understand or recognize basic financial balances and the interrelationships among the various sectors of the economy. Neither a government, nor the IMF, can predict with any certainty what the outcome will be–ultimately private saving desires will drive the outcome, as Bill Mitchell has noted repeatedly.

Why do we have huge budget deficits across the globe? It’s not because our officials have all suddenly become Soviet-style apparatchiks. It is largely because the slower global economy has led to lower revenues (less income=less taxes paid, since most tax revenue is based on income, and lower tax brackets) and higher spending on the social safety net. Gutting this social safety net because we extrapolate the wrong lessons from the euro zone’s particular (and self-imposed) predicament constitutes the height of economic ignorance. It also reflects a transparently political agenda, which the US would be ill advised to embrace. The rescue packages, the IMF intervention and all the talk about orderly defaults cannot overcome the EMU’s fundamental design flaw. Let neo-liberalism die with the euro.

*This post originally appeared on ND 2.0