Cross posted with Naked Capitalism

By Warren Mosler, an investment manager and creator of the mortgage swap and the current Eurofutures swap contract and Philip Pilkington, a journalist and writer based in Dublin, Ireland

Recently the Greek economist Yanis Varoufakis responded to the euro exit plan that we published on Naked Capitalism a few days ago. While Varoufakis was broadly supportive of the plan if an exit was absolutely necessary, he criticised some of the details therein.

Before we deal with some of the issues he raised – some of which are very important – we should first note as clearly as possible that neither one of us is advocating exit from the Eurozone for any countries therein. We both agree with Varoufakis that this would probably be a more painful option than simply staying in the currency union even with the current austerity programs in place.

In addition to this, both of us have published pieces arguing that the Eurozone will likely weather this crisis and the ECB, in some shape or form, will probably step in to backstop the debt of the peripheral governments in the coming months.

We merely published our sketch of an exit plan because both of us believe that it is always good to have a Plan B at the ready should any contingencies arise. We also think that having a viable plan in hand strengthens peripheral governments bargaining power vis-à-vis their neighbours.

But more on this in a moment. First, let us deal with some of the issues that Varoufakis raised. (All numbered points in italics are Varoufakis’, below is our response):

1. All contracts by the government to the private sector (abroad and domestically) will be renegotiated in the new currency after the initial depreciation of the latter. In other words, domestic suppliers will face a large haircut instantly. Many of them will declare bankruptcy, with another large lump sum loss of jobs.

First of all, there may not be any initial depreciation of the new currency if the government initiating the exit gets the exchange rate right. Since the new currency is required to pay taxes we anticipate that there should be a fairly consistent demand for it especially when it is first introduced.

Take the example of a domestic industry – say, a cement manufacturer that sells its goods to the government. It would be paid in the new currency and provided that the currency’s value remains somewhat constant the new currency can then be used to pay workers. In addition to this they will, as they do now, price their output relative to their costs so there would be no threat of bankruptcy.

Perhaps the key point here is that we do not anticipate a severe shortfall of demand for the new currency. Since it is released into the system slowly, and since it is required to extinguish tax liabilities, and finally since there will be an immediate need for cash in circulation, it should be widely sought after by economic actors.

If, on the other hand, a company has loans outstanding in euros they may need to convert some of their profits from the new currency into euros to service these obligations. Again, this has as much to do with how large the profits they accumulate are, as it does with the exchange rate between the two currencies. If their real income falls they might take a hit. But such is business.

Then there is the question of where these businesses get their inputs. If these inputs come from the domestic economy they will be able to pay for these in the new currency. If they come from abroad they will cost more money, if indeed the new currency does depreciate when introduced and even then the costs would be passed on to the consumer.

2. The banks will run dry and will not be kept open by the ECB. Which means that the only way Ireland or Greece or whoever adopts this plan can keep its banks open is if they are recapitalised in the new domestic currency by the Central Bank. But this means that bank account deposits will, de facto, be converted from euros to the new currency; thus annulling the beneficial measure of no compulsory conversions of bank holdings into the new currency.

This seems to us the most important point that Varoufakis raises. European banks do indeed have problems with both euro and dollar denominated liquidity and these problems will only worsen should there be a default and exit. Hence, we are back to the prospect of bank runs and other financial nasties.

In this case the government in question would, of course, only be able to provide liquidity in the new currency. The problems caused by this will only be as substantial as the amount by which the exchange rate between the new currency and the euro diverges. In the meantime, depositors will be exchanging euros for the new currency in order to meet ongoing payments (payrolls, taxes etc.). Once again, we underline the fact that we believe that the demand for the new currency would be quite strong and devaluation limited.

However, if a bank’s net worth (equity capital) falls below required minimums for any reason, the government will have to take it over and reorganise it. Options will then include: selling the bank as an ongoing business or selling the assets to other institutions. Both of these could lead to large losses for equity holders and, if the losses are severe enough, losses for depositors. It is not unheard of for depositors to suffer losses of the order of 25% during liquidation. We do advocate full deposit insurance be put in place to protect deposits denominated in the new currency, but deposits in euros will still be at risk and in this sense Varoufakis’ concerns have merit.

3. The authors claim that the above ill effects will be lessened by the government’s new found monetary independence which will enable it to discontinue austerity programs immediately and adopt counter-cyclical fiscal policy, as Argentina did after its default and discontinuation of the pesos-dollar peg. This may be so but all comparisons with Argentina must be taken with a large pinch of salt. For Argentina’s recovery, and associated fiscal policies, was far less due to its renewed independence and much more related to a serendipitous rise in demand for soya beans by China.

The extent to which soya bean price rises led to the Argentine recovery is subject to much debate. Certainly, it allowed Argentineans access to foreign reserves which they could use to extinguish foreign loans, but to what extent it was the cause of the recovery is a definite grey area. We hold that the fiscal policies initiated by the Kirchner government that removed substantial fiscal drag played a significant role in the recovery.

Varoufakis, by saying: “Argentina’s recovery, and associated fiscal policies, was far less due to its renewed independence and much more related to a serendipitous rise in demand for soya beans by China”, seems to imply that the fiscal policy expansion was somehow ‘allowed’ by the rising soya bean demand and the influx of foreign currency reserves. This is not the case. When Argentina ended the dollar peg they became able to extend government spending in as large quantities as they saw fit – that is, practically speaking: reducing fiscal drag by as much as the inflationary pressures created thereby were tolerated.

After depegging, Argentina’s fiscal position could be run into deficit without risking insolvency or causing interest rates to skyrocket, both of which were the key constraints on government spending throughout the dollar peg era. In this way, the Argentinean example is perfectly viable as a comparison to a Eurozone country undertaking an exit. If the exit is undertaken and a floating exchange rate adopted, fiscal policy can be run into deficit until political limits, devaluation or inflation allows it to run into deficit no more.

4. While it is true that the weaker currency will boost exports, it will also have a devastating effect: The creation of a two tier nation. One nation that has access to hoarded euros and another that does not. The former will acquire immense socio-economic power over the latter, thus forging a new form of inequality that is bound to operate as a break on development for a long while – just like the inequality that sprang up in the post 1970s period did enormous damage to our countries’ real development (as opposed to GDP growth numbers) in the second post-war phase.

Once again, the currency may not depreciate very significantly but even if it does, as the economy is brought back to full employment and output through reduced fiscal drag and increased exports, the government is then free to address distributional issues as it sees fit. The key point here would be to highlight these issues clearly prior to the exit taking place.

5. Last, but certainly not least, even if one country exits the eurozone in this manner, the eurozone will unwind within 24 hours. The European System of Central Banks will break instantly down, Italian spreads will hit Greek levels, France will turn instantly into a AA or AB rated country and, before we can whistle the 9th Symphony, Germany will have declared the re-constitution of the DM. A massive recession will then hit the countries that will make up the new DM zone (Austria, the Netherlands. possibly Finland, Poland and Slovakia) while the rest of the former eurozone will labour under significant stagflation. The new intra-European currency wars will suppress, in unison with the ongoing recession/stagflation, international and European trade and, therefore, the US will dive into a new Great Recession. The postmodern 1930s that I keep speaking of will be a tragic reality.

We should again reiterate that we are not actually calling for an exit. We simply believe that the governments should have a contingency plan and, most importantly, that this contingency plan would steer them away from the very real desire to peg their new currency to either the euro or to some other foreign currency in the case of default. As we wrote in the original plan, should this happen we expect another Argentinean/Russian style financial collapse within a few years of the new currency peg being adopted.

We should also point out that having a viable exit plan and having this exit plan and its possible results openly talked about gives the peripheral countries more bargaining power vis-à-vis their austerity loving neighbours. At the moment we should be focused on drafting any sort of national strategy that can give power back to sovereigns vis-à-vis the Eurozone. (In this, we know that Varoufakis sympathises as he has recently shown interest in our jobs program funded by tax-backed bonds which one of the authors [Pilkington] is currently trying to flog in Ireland).

We also think that it is unlikely that an exit will actually occur. We both think that the ECB will almost undoubtedly step in to backstop the unruly debt burdens of the periphery. However, this will probably mean that the periphery will be kept on ‘life support’ while austerity continues to be imposed upon it. Once again, it is imperative that countries within the periphery have as many bargaining chips as possible in their negotiations with their fellow Europeans.

Lastly, we should note that, should a nation exit the Eurozone in the manner we have outlined, a worldwide deflationary collapse might actually work to their advantage. Why? Because with their new currency they could undertake an Argentinean-style jobs guarantee program which would maintain full employment domestically while real terms of trade shifted dramatically in their favour as worldwide prices fell. Or, to put it another way: peripheral countries like Ireland would no longer have to rely on export-oriented growth in a world plagued by massive deflationary contraction. Instead they could run fiscal deficits to maintain full employment and high living standards while having little concern for the potential devaluation of the new currency caused thereby because worldwide prices would be falling at the same time.

A critique of the European Commission’s Green Paper on ‘Stability’ Bonds, by Stuart Holland published by Yanis Varoufakis,

…This (Stuart Holland’s) paper both critiques the Green Paper and proposes Twin Track approaches for Union Bonds to stabilise the crisis and Eurobonds to finance growth. It claims that this should be acceptable to Germany and other surplus Member States on the grounds that neither such proposal needs Joint Guarantees, Fiscal Transfers or Debt Buyouts, that a conversion of a share of national debt to the Union could be on an enhanced cooperation basis, and that Eurobonds for the recovery of growth would be funded not by German or other taxpayers but by inflows to the Union through their purchase by the central banks of emerging economies and sovereign wealth funds…..

Stuart concludes his critique thus..

..The Green Paper not only displaces the vital importance of growth, and fails to refer to the Delors White Paper whose aims resonated for more than a decade at the highest political level.

It also is recommending proposals which imply not only mutual guarantees and therefore potential fiscal transfers, but also Treaty revisions and new institutions.

In so doing it neglects to cite other proposals for bonds both to stabilise the crisis and to fund growth which could be effected without the need for Treaty revisions. These include “Twin Track” alternatives with Union Bonds for Stability and Eurobonds for growth.[7] This approach:

► does not imply joint guarantees, fiscal transfers – or a general buying out of national debt – to which Germany and other key Member States are opposed;

► recognises that this could be by an enhanced cooperation procedure which would not bind all member states and with the key political advantage that Germany and other member states could keep their own bonds;

► distinguishes Union Bonds for stability which would not be traded from Eurobonds for growth which would be traded and attract inflows from the central banks of emerging economies and sovereign wealth funds.

- Without Joint Guarantees, Fiscal Transfers or Debt Buyouts  

The precedent that neither transfer of a share of national debt to the Union nor net issues of bonds need joint guarantees, fiscal transfers of debt buyouts is that of the European Investment Bank which has issued bonds without them for more than 50 years and has been so successful that it now is more than twice the size of the World Bank and the world’s largest multilateral development bank.

- By Enhanced Cooperation

The case for introducing Union Bonds for stability by enhanced cooperation by whichGermanyand other surplus member states could keep their own bonds has not been considered by the Commission Green Paper. But the precedent is strong in the introduction of the Euro itself which was a de facto case of enhanced cooperation.

The procedure for enhanced cooperation within the institutional framework of the EU requires nine member states. The voting procedure for enhanced cooperation depends only on the consent of the member states instigating it, not a qualified majority decision. ^[8]

- Union Bonds

On lines similar to the Bruegel proposal (Commission Green Paper Proposal 2) a conversion of national debt of up to 60% of GDP could be converted to Union Bonds for debt stabilisation by those member states consenting to them.

Unlike the Bruegel proposal, these need not be traded but could be held in a consolidated EU debit account. Such a debit account could not be used for credit creation any more than a credit can be drawn on a personal debit card.

Since the converted bonds would not be traded they would be protected against speculation by rating agencies. But they would not need fiscal transfers between member states. Member States whose debt is converted into Union Bonds would service their share of them.

The Bruegel Institute has proposed a new institution to hold the conversion of such a share of national debt to theUnion. But a new institution is not needed. The converted Union Bonds could be held by the European Financial Stability Faculty and, after it, by the ESM.

- Eurobonds

Eurobonds to finance recovery and growth would be traded and attract inflows to theUnionfrom the central banks of emerging economies and sovereign wealth funds. Brazil, Russia, India, China and South Africahave re-stated in September 2011 that they are interested in holding reserves in Euros in order to help stabilise the euro area.

Doing so by investing in Eurobonds rather than by national bonds both could strengthen the Eurozone and enable the BRICS to achieve their ambition of a more plural global reserve currency system.

- Not Counting on National Debt

Eurobonds would not count on national debt since they would be the bonds of theUnionrather than member states. An analogy is US Treasury Bonds which do not count on the debt of member states of the American Union such asCaliforniaorDelaware. They would not need member state guarantees anymore than do European Investment Bank bonds, while EIB bonds also do not cunt onMemberStatenational debt (see below).

- Union Bonds and the ECB or the EIF

Parallel proposals have suggested that the converted national debt should be held by the European Central Bank and net bond issues also managed by it.[9]

Alternatively eurobonds could be issued by the European Investment Fund which was set up by Delors to issue Union Bonds and now is part of the European Investment Bank Group. The EIF would gain from the EIB’s vast experience and expertise in bond issues while the ECB could back them withut any further backing from the member-states or anyone else. The case that net issues of Eurobonds (for financing growth rather than existing debt-conversion) should be by the EIF as part of the EIB Group also makes operational sense in that the EIB has decades of experience of net bond issues whereas the ECB has none.

- Growth

Growth would be enhanced since Eurobonds would co-finance EIB investment projects which are serviced by the revenues of the Member States benefiting from them, rather than fiscal transfers between Member States.

None of the major Eurozone Member States, nor Ireland, Portugal or Greece, count EIB project funding against their national debt, nor need any member state do so. The decision whether or not to do so is governmental and does not depend on a Treaty revision.

- Cohesion

Cohesion would be enhanced in that, since the Amsterdam Special Action Programme, the EIB already has a cohesion and convergence remit for investment projects in health, education, urban renewal, the environment and green technology, as well as financial support for small and medium firms and new high tech start-ups.

- Competitiveness

Competitiveness would be enhanced by a share of the net inflows into Eurobonds financing a European Venture Capital Fund for small and medium firms, or a European Mittelstandspolitik, which was one of the original aims of the European Investment Fund.^[10]

- Maastricht Compliance

With a conversion of debt of up to 60% of GDP to Union Bonds all Member States other thanGreecewould beMaastrichtcompliant on their remaining national debt.Greecewould remain a special problem, since still well in excess of the 60%Maastrichtlimit but, as such, an exceptional case meriting continued debt buy outs.

- Stability and Growth Pact

The “Twin Track” strategy of Union Bonds for debt stabilisation and Eurobonds to finance growth also would give political and public credibility to the SGP where growth has been sacrificed to stability and would further be so by the proposals in the Commission Green Paper.

- Debt Restructuring and Reducing National Debt

None of the above is to the exclusion of debt restructuring in the sense of debt write downs. Nor does it deny the case for reducing national debt. But this could be phased over the medium to longer term in line with the “Twin Track” Strategy for combining stability through Union Bonds with growth through Eurobonds.

The case for reducing national debt through for growth has been demonstrated in the US case by the adoption of such a strategy by the Clintonadministration and that in each of the four years of its second term the federal budget was in surplus.[11]

sholland@fe.uc.pt

Interesting.  Stuart Holland is an insider with long experience.  He worked with the original visionaries of the European Project as a very young economist.  It does seem extraordinary that the current mandarins do not pay more attention to his prescriptions.  

Saturday, August 13, 2011

William K. Black interviewed by Ian Masters on KPFK FM-90.7 – Los Angeles

William K. Black was interviewed by Ian Masters on KPFK FM-90.7 – Los Angeles. Click here to listen to the full interview. You can also listen to the full program .

….Europe’s whole financial system was out of control, and still is. The North has not yet forced banks to rebuild their capital buffers or nationalize those that cannot do so, understandably in one sense since it might risk a credit crunch. Germany’s policy towards the Landesbanken is a study in paralysis.

That is why Europe dares not lance the boil with “haircuts” and debt restructuring. It dares not risk a repeat of Europe’s Lehman moment in May 2010. It is why the EU has scotched any quick move by Ireland to deflect the shards of pain from taxpayers to senior bank creditors.

How long will democracies accept being made the scapegoat for what is in part a Franco-German-Benelux banking debacle?

Not for ever, judging by comments this week by Avriani, a paper with ties to Greece’s ruling PASOK party. “We should default and return to the Drachma to punish foreign loan sharks who have bled us dry,” it said.

Ireland’s Enda Kenny may ultimately have to choose between his EU club loyalties and his duties to the sovereign nation that elected him. Some within his coalition ranks already seem tempted to retaliate by pulling the plug on EU banks. That would certainly remind Chancellor Merkel and President Sarkozy what this crisis is really about.

Popular revolt is the dog that has not barked since the long slump began. This may just be a question of time. The pattern of the 1930s is that deep alienation starts in year three as austerity grinds on, and in this case tensions on the eurozone peripery can only turn nastier as the ECB tightens monetary policy.

What is clear is that sovereign states are being forced to cut wages and dismantle parts of their welfare state under foreign diktat, with a gun held to their heads. This will not be forgotten lightly. The character of the European Project has changed utterly. (link to full article)

Ireland’s bond yields leap on default fears, By David Oakley, Published: March 23 2011

Ireland saw a leap in its cost of borrowing on Wednesday as peripheral eurozone economies came under pressure because of worries over the risk of sovereign bond defaults.Dublin has come under pressure because of fears Germany will refuse to back down over its demands that Ireland must increase corporation tax rates in return for lower interest rate costs for bail-out loans.  Irish two-year bond yields, which have an inverse relationship with prices, leapt nearly 1 percentage point to 10.7 per cent at one stage as European Union heads of state gather in Brussels for a summit on Thursday and Friday.  (link to full article)

Wednesday, July 7, 2010
Latvia’s Third Option: Neither Devaluation nor Austerity, but Tax Restructuring
By Michael Hudson

As Europe’s banking crisis deepens, Greece’s and Spain’s fiscal crisis spreads throughout Europe and the US economy stalls, most discussions of how to stabilize national finances assume that only two options are available: “internal devaluation” – shrinking the economy by cutting public spending; or outright devaluation of the currency (for countries that have not yet joined the euro, such as Eastern Europe).

The Baltics and other countries have rejected currency depreciation on the ground that it would delay EU membership. But as most debts are denominated in euros – and owed mainly to foreign banks or their local branches – devaluation would cause a sharp jump in debt service, causing even more defaults and negative equity in real estate. Devaluation also would raise the price of energy and other essential imports, aggravating the economic squeeze.

Sovereign governments of course can re-denominate all debts in domestic currency by abolishing the “foreign currency” clause, much as President Roosevelt abolished the “gold clause” in U.S. bank contracts in 1933. This would pass the bad-loan problem on to the Swedish, Austrian and other foreign banks that have made the loans now going bad. But most government leaders find currency devaluation so unthinkable that, at first glance, there seems to be only one alternative: an austerity program of fiscal cutbacks.

The EU, IMF and major banks are telling governments to run budget surpluses by cutting back pension and social security programs, health care, education and other social spending. Central banks are to reinforce austerity by reducing credit. Wages and prices are assumed to fall proportionally, enabling shrinking economies to “earn their way out of debt” by squeezing out a trade surplus to earn the euros to carry the enormous mortgage debts that fueled the post-2002 property bubble, and the new central bank debt taken on to support the exchange rate.

The Baltic States have adopted the most extreme monetary and fiscal austerity program. Government spending cutbacks and deflationary monetary policies have shrunk the GDP by more than 20% over the past two years in Lithuania and Latvia. Wage levels in Latvia’s public sector have fallen by 30%, and the central bank has expressed hope that the wage squeeze will continue and lower private-sector wages as well.
The problem is that austerity prompts strikes and slowdowns, which shrinks the domestic market and investment. Unemployment spreads and wages fall. This leads tax receipts to plunge, because Latvia’s tax system falls almost entirely on employment. Half of the employers’ wage bill goes to pay the exorbitant set of flat taxes amounting to over 51%, while a VAT tax absorbs another 7% of disposable personal income. Yet the central bank trumpets the wage decline as a success – and would like even further shrinkage!

Property prices have plunged too, by as much as 70%. Mortgage arrears have soared to over 25 percent, and defaults are rising. Downtown Riga and the Baltic beach suburb of Jurmala are filled with vacancies and “for sale” signs. Falling prices lock mortgage-burdened owners into their properties. Meanwhile, the virtual absence of a property tax (a merely nominal rate in practice of about 0.1%) has enabled speculators to leave prime properties unrented.

About 90% of Latvian mortgage debts are in euros, and most are owed to Swedish banks or their local branches. A few years ago, bank regulators urged banks to shift away from collateral-based lending (where the property backed the loan) to “income-based” lending. Banks were encouraged to insist that as many family members as possible co-sign the loans – children and parents, even uncles and aunts. This enables banks to attach the salaries of all co-signing parties.

The next step is to foreclose on the property. Bank regulators are concerned only with maintaining bank solvency (mainly for a foreign-owned banking system) not with the overall economy. Their model is Estonia which combined stable finances with 15% economic shrinkage in 2009, and was rewarded by last month’s promise of entry into Euroland.

The result is that instead of running the banking system for the economy, Latvia and other post-Soviet economies are managing their economies to maintain bank solvency – as if the indebted population is really expected to spend the rest of their lives paying off the deep negative equity left in the wake of bad loans.

This is causing such havoc that some business owners are emigrating to escape their debts. The newspaper Diena recently published an article about a woman of modest means in the mid-sized Latvian town of Jelgava. After taking out a 40,000 lat ($65,000) mortgage she lost her job. The bank refused to renegotiate and auctioned off her property for just 7,500 lats, leaving her still owing 30,000 for the shortfall, to be paid out of future income.

Mortgage lending to fuel the property bubble has been financing the trade deficit – but now has stopped
Until the property bubble burst two years ago, euro-mortgage lending provided the foreign exchange to cover Latvia’s trade deficit. The central bank is now borrowing from the EU an IMF, on the condition that the loan will be used only to back the currency as a cushion. This seems self-defeating, because monetary deflation will cause financial distress, aggravating the bad-debt crisis and spurring financial outflows.

Can governments that promote such policies be re-elected to office? In Latvia and other East European economies, political parties are developing a Third Option as an alternative to devaluation, economic shrinkage and declining living standards.

This Third Option is to reform the tax system. It starts with the fact that Latvia’s bloated 50%+ tax package on employment means that take-home wages are less than half of what employers pay. Latvia has the worst remunerated northern European labor, yet it is proportionally the highest-cost to employers. And to make matters worse, real estate taxes are only a fraction of 1%. This has been a major factor fueling the real estate bubble. Untaxed land value is paid to banks, which in turn lend their mortgage receipts out to bid up property prices all the more – while obliging the government to tax labor and sales, raising the cost of labor and the price of goods and services. A similar high flat tax on labor and little property tax has plagued the entire post-Soviet block ever since 1991.

The good news is that this malformed tax system leaves substantial room to shift employment taxes onto the “free lunch” revenue comprised of the land’s rental value, monopoly rents and financial wealth. At present, this revenue is left “free” of taxation – only to be pledged to banks.

Latvia’s economy can be made more competitive simply by freeing it from the twin burden of heavily taxed wages and housing prices inflated by easy euro-credit. It has a wide margin to reduce the cost of labor to employers by 50 percent, without reducing take-home wages. A tax shift off labor onto the land’s rental value would lower the cost of employment without squeezing living standards – and without endangering government finances.

Lowering taxes on wages would reduce the cost of employment without squeezing take-home pay and living standards. Raising taxes on property, meanwhile, would leave less value to be capitalized into bank loans, thus guarding against future indebtedness.

This was the policy that underlay Hong Kong’s economic rise – the example that Latvian leaders hope to emulate as a banking service entrepot and international technology center (as Latvia was in pre-1991 Soviet times). Hong Kong promoted its economic takeoff by relying mainly on collecting the land’s rental value, enabling it to minimize employment taxes (presently only 15%).

Shifting the burden of tax from labour onto land would therefore hold down the price of housing and commercial space, because rental value that is taxed will no longer will be recycled into new mortgages.
The tax shift also can bring down property prices, because rental value that is taxed no longer will be available for banks to capitalize into mortgage loans. Housing in debt-leveraged economies such as the United States and Britain typically absorbs 40 percent of family budgets. Reducing this proportion to 20 percent – the typical rate in Germany’s much less indebted economy, where lending has been more responsible – could enable wage receipts to be spent on goods and services rather than as mortgage debt service. It thus would provide further scope for wage moderation without lowering living standards. This means that Latvians and other Eastern European countries do not need to sacrifice the economy on a cross of euro-debts and suffer from currency devaluation or austerity programs.

Shifting the tax off employees onto the land would cut the cost of living for Latvians, by holding down the price of housing and commercial space. The economic rent – income without any corresponding cost of production – would be paid to the government as the tax base rather than being “free” to be pledged to banks to be capitalized into mortgage loans. Property prices are determined by how much banks will lend, so taxing the land’s rental value (but not legitimate returns on building and capital improvements) would reduce the capitalization rate, holding down property prices.

In sum, the problem with monetary deflation (“internal devaluation”) is that it leaves the existing dysfunctional tax structures in place. The main issue in Eastern Europe and beyond over the coming years will be whether economies can free themselves from the twin burden of heavily taxed wages and inflated housing prices, while avoiding an overdose of needless austerity. The tax structure needs to be changed – along the lines that most countries in the West expected to see a century ago.

The aim should be to make the economy more competitive by minimizing the cost of living and doing business. The Third Option serves to bring property and monopoly prices in line with necessary costs of production. Taxing away “empty” pricing in excess of cost-value – economic rent – was part of the “original” liberalism of Adam Smith and John Stuart Mill, and indeed of classical economists from the French Physiocrats down through Progressive Era reformers.

The national parliamentary elections scheduled for this October will be fought largely over the Latvia Renewed economic development program, sponsored by Harmony Center the coalition of left-wing parties. At the latter’s annual meeting on May 29-30, party leaders moved to start preparations to translate the above alternative into law and drawing up a land-value map of Latvia.

*Michael Hudson is Chief Economist of the Reform Task Force Latvia, http://www.rtfl.lv, commissioned by the Harmony Center coalition.

……Why the wrong turn in policy? The hard-liners often invoke the troubles facing Greece and other nations around the edges of Europe to justify their actions. And it’s true that bond investors have turned on governments with intractable deficits. But there is no evidence that short-run fiscal austerity in the face of a depressed economy reassures investors. On the contrary: Greece has agreed to harsh austerity, only to find its risk spreads growing ever wider; Ireland has imposed savage cuts in public spending, only to be treated by the markets as a worse risk than Spain, which has been far more reluctant to take the hard-liners’ medicine.

It’s almost as if the financial markets understand what policy makers seemingly don’t: that while long-term fiscal responsibility is important, slashing spending in the midst of a depression, which deepens that depression and paves the way for deflation, is actually self-defeating.

So I don’t think this is really about Greece, or indeed about any realistic appreciation of the tradeoffs between deficits and jobs. It is, instead, the victory of an orthodoxy that has little to do with rational analysis, whose main tenet is that imposing suffering on other people is how you show leadership in tough times. (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.

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)

What is undeniable is that Club Med and Ireland are being told to implement the same policies that crippled Europe in the early 1930s, that led to Laval’s “deflation decrees” in France, and led in different ways to Hitler, Franco, Antonescu, and Metaxas in Greece. Is that a good idea? (Link to article)