Two days ago, Financial Times columnist Martin Wolf made an attempt at Thinking through the unthinkable. The "unthinkable" was the breakup of the Eurozone.
Reflections on the Easily Thinkable
For starters, a eurozone breakup is hardly unthinkable given that no currency union in history has ever survived in the absence of a fiscal union, and the Eurozone has no such fiscal union.
I suppose one might not want to think about history while praying for a miracle union, but the German Supreme court gratefully put a kibosh to the bureaucratic nanny-zone of never-ending regulation with a definitive ruling that no more German taxpayer funds can be out at risk without a common voter referendum.
Please see Germany's Top Judge Throws Major Monkey Wrench Into Leveraged EFSF Machinery, Demands New Constitution and Popular Referendum for Further Powers for details.
I do not want to dwell on the "easily-thinkable unthinkable", I want to focus on poor economic theory within Wolf's post in regards to proposed solutions to the crisis.
Four Proposed Solutions
Wolf quoted Nouriel Roubini's proposed list of solution.
Wolf points out that option 2 will morph into option 4. I concur while pointing out that is the path we are on, also in agreement with Wolf.
Wolf points out that German would veto option 3 but fails to point out the absolute silliness of the idea in the first place, which I will get to in a moment.
Option 4 is where we are headed, and the debate ought to be how to do that correctly instead of how to achieve the impossible option 1 which Germany would also veto.
I propose, as has Michael Pettis before me, that the best solution is to have Germany exit the Eurozone rather than Greece, then, Portugal, then Spain exit in succession.
Breakup Inevitable but How?
Here is a snip from France, Germany have "Intense Consultations" on Smaller Eurozone; Breakup Inevitable, but How?
Realization the Eurozone is no longer tenable is at long last at hand. In fact, "intense discussions" have been underway for months but are just now admitted to by senior EU officials. ....
The Eurozone is a failed experiment. A breakup is inevitable just as it has been from the beginning. Structural flaws were too great, built up over the years. No currency union in history has ever survived unless there was also a fiscal union.
The key question now is how?
It would be best for all involved if Germany left the Eurozone and went back to the Deutschmark. Germany would have an immediately credible currency. Should Greece or Spain leave first, those countries might experience hyperinflation or massive inflation.
Breakup Scenarios and Logistics of Denial
It's important to remember that Germany suffers regardless. As long as the Eurozone stays intact (it can't and won't over the long haul) German taxpayers have to keep acting bailing out foreign countries, foreign banks, and their own banks.
On the other hand, were Germany to leave, the debts to German banks will not be paid back in Deutschmarks but rather deflated Euros.
On the whole, Germany exiting the Eurozone would be less disruptive, than massive inflation scenarios in Greece, Portugal, and Spain.
If France wants to stay in the Euro, let them. They can have the ECB as well. Then the ECB will print money to bail out the French banks (just as French president Sarkozy wants).
Logistics of Denial
Micahel Pettis presented a more detailed discussion of various breakup scenarios as well as a discussion on the "Logistics of Denial", in my September 16 article Eurozone Breakup Logistics (Never Believe Anything Until It's Officially Denied)
In his opening gambit, to the lead question "Will the eurozone survive?" Wolf surmises "I suspect the answer is, no."
Thus, it would be more helpful to debate the merits of "how" a breakup should happen, which countries should leave, and details on how that happens rather than hoping it won't.
Unfortunately, Wolf pines near his conclusion "[we] must go back to the first on the menu of options laid out by Mr Roubini. Potentially solvent countries would be financed and the eurozone would grow its way out of the crisis."
History and Common Sense
As noted earlier, unless there is a complete fiscal-nanny-zone with a one size fits all policy, option 1 cannot possibly work.
Germany would veto option 1, for solid reasons. Moreover, and more importantly, option 1 would not work anyway for the same reason option 3 cannot work: Printing money never solves anything.
How many times does this have to be proven before it sinks in?
Japan offered mammoth quantities of fiscal and monetary stimulus and all it has to show for it is debt in excess of 200% of GDP. Economist Richard Koo pines the lesson was Japan did not do enough stimulus. Sheeesh.
Cash-for-clunkers, multiple tax credits for housing, QE 1, QE 2, a trillion in fiscal stimulus and a myriad of other fiscally insane programs did not create jobs or a lasting recovery.
No amount of stimulus would work because the problem is debt. Yet, the Army of Krugmanites propose we need to do more.
Greenspan resorted to loose monetary policy and it created the biggest housing bubble the world has ever seen.
Now Cristina Romer proposes GDP targets by the Fed to which I responded in Dear Christina ... in light of the facts I presented above in regards to the experiences of Japan, the excess reserves at the Fed, the increase in inflation with no increase in jobs, and the number of people on fixed income destroyed by the rise in price level while getting 0% on their CDs, you have a hell of a lot more explaining why "It's different this Time".
For starters the Fed does not control GDP so the suggestion in and of itself is blatantly idiotic. The Fed can encourage spending but cannot force it. A trillion dollar mountain of excess reserves of banks is proof enough, yet the Monetarists want more.
No matter how much money one throws at a problem it is never enough. We had a housing bubble followed by a crash. Throw enough money around and we will have another bubble and a bigger crash, or simply a massive debt problem from which there is no escape.
The average eighth-grader can easily understand this. The average economist cannot because they are so tied up in monetary theory that has no real world application.
In September, Bernanke himself said he was puzzled by weak consumer spending.
Bernanke is puzzled over something an eighth-grader can easily figure out. Consumers have a mountain of debt and are underwater in their mortgages. Debt is made worse by declining real wages, global wage arbitrage, and a dearth of jobs.
ZIRP did nothing to create jobs but it did affect food and gas prices and effectively destroyed anyone on fixed income.
I would think that should be obvious, but obviously it's not because Bernanke is puzzled over it. This is what happens when academics become addicted to economic models that do not work in periods of debt deflation (assuming they ever worked at all).
Krugman is a big believer in the idea "debt does not matter". He made the mistake of using Italy as the prime example. Oops!
Guess what? Debt matters. Now Krugman is attempting to pass off a foolish statement by blaming Original Sin for the Euro Crisis.
Krugman finishes with "More on all this later, I hope."One question that keeps coming up is, how can I reconcile my scorn for warnings about bond vigilantes with what is happening to Italy? This seems especially pointed because I have in the past used Italy’s ability to carry debt exceeding its GDP as an illustration that debt concerns were overblown.
The answer lies in the concept of original sin. Not the Pope’s kind, but the economics kind — the long-standing notion that developing countries were especially vulnerable to financial crises because they borrowed in foreign currency.
The key point is that by joining the euro, Italy took a bite of the apple — it converted its advanced-country status, as a nation issuing debt in its own currency, into original sin, with debts in someone else’s currency (Europe’s in principle, Germany’s in practice). That is the root of its new vulnerability.
Reflections on "Dangerous and Insane"As we watch Italy's 10-year bond yields near 7.5pc and threaten to detonate the explosive charge on €1.9 trillion of debt, it is time for the world to reimpose order.
Yes, this means mobilizing the full-firepower of the ECB – with a pledge to change EU Treaty law and the bank's mandate – and perhaps some form of quantum leap towards a fiscal and debt union.
The EU Project has become both dangerous and insane.
Public Union Pension Woes
Wacky Welfare System
The root of Italy's problems, the Wall Street Journal argues today, is that the country "financed generous entitlements with high taxes and towering piles of debt," and now finds the money running out as the economy sputters. Indeed, Italy has more pensioners than workers and currently spends about 14 percent of GDP on pensions -- more than any other country in the Organization for Economic Cooperation and Development (OECD).
Silvio Berlusconi pledged to raise the retirement age in Italy to 67 as part of his raft of austerity measures, but it's a controversial move. In late October, two Italian lawmakers exchanged blows in parliament during a debate about whether to revamp the country's pension system. House Speaker Gianfranco Fini had noted on television that the wife of the Northern League's Umberto Bossi had taken early retirement at 39 and cashed in on Italy's generous benefits.
Crush Into SubmissionWhat's the EU All About?
“One keeps hearing demands for more centralization – tax 'harmonization', which is new-speak for 'let's impose the highest possible taxes everywhere', more 'redistribution', and above all, 'more regulation', especially of the evil financial markets where all sorts of bad things are happening to sovereign bonds nowadays.
Naturally, fractional reserve banking and the inflationary boom-bust sequences it has brought forth doesn't even rate a mention – since it has also enabled the growth of this huge statist moloch the EU and many of its member nations have become.
What is really needed is some introspection and remembering what the EU was originally about. Its founders wanted to restore 19th century liberalism to Europe – free trade and freedom of movement for people and capital within Europe.
They emphatically did not want to erect some sort of socialist super-state. They wanted to bring back to Europe what the mad socialist and fascist ideologues of the 20th century had destroyed.
Now we have a bureaucratic monster in Brussels that has produced nearly 300,000 new regulations over the past decade, in addition to the hundreds of thousands of pages of 'administrative law' and other regulations the member states themselves produce every year.
It is a miracle we still have a functioning civilization.
If we want the problems to be solved, the most important question should be: what is needed to enable the production of new wealth? What kind of environment will be most conducive to reviving the entrepreneurial spirit? It should be simple enough, but it would of course threaten a great many vested interests.”
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