Catastrophe or Liberation?

Kevin O’Rourke contributes an intriguing article on the shape of the new fiscal union emerging in Europe:

The most obvious point about the recent summit is that the “fiscal stability union” that it proposed is nothing of the sort. Rather than creating an inter-regional insurance mechanism involving counter-cyclical transfers, the version on offer would constitutionalize pro-cyclical adjustment in recession-hit countries, with no countervailing measures to boost demand elsewhere in the eurozone. Describing this as a “fiscal union,” as some have done, constitutes a near-Orwellian abuse of language.

Many will argue that such arrangements are needed to save the eurozone, but what is needed to save the eurozone in the immediate future is a European Central Bank that acts like a proper monetary authority. True, Germany is insisting on a “fiscal stability union” as a condition of allowing the ECB to do even the minimum needed to keep the euro afloat; but this is a political argument, not an economic one. Economically, the proposal would make an already terrible institutional design worse.

This is essentially a variation on the idea that while pro-cyclical measures might have solved the problems from being created (a la Keynes’ idea that austerity should be undertaken during booms, not busts), it won’t do anything to fix the problem now that the horse is out of the stable.

Of course, while I cannot see why anyone buys the pro-austerity view, the pro-printing view is merely a means of kicking the can down to the end of the pier. Boosting demand, creating inflation, and re-expanding bubbles does not really address any of the underlying structural problems, most significantly systemic fragility, and high residual debt. At very best O’Rourke’s “solution” buys more time to address those problems. As we have seen (and as I keep pointing out) policy makers and markets believe that bouncing back in a fluster of newly printed money is recovery, and then continue to ignore the problems, which means broken systems just continue to be broken, and old problems jump back out of the swamp to rear their ugly heads.

This brings me to the most intriguing aspect of O’Rourke’s view:

A eurozone collapse in the immediate future would be widely perceived as a catastrophe, which should at least serve as a source of hope for the future. But if it collapses after several years of perverse macroeconomic policies required by countries’ treaty obligations, the end, when it comes, will be regarded not as a calamity, but as a liberation.

When viewed from my perspective — that boosting demand is essentially just another perverse macro policy that will kick the can for a few more years — this really shines a light. The choice for European countries is a painful unwinding now, or years of crushing teutonic austerity (or Japanese-style zombification) unwinding in something far, far worse: riots, revolutions, international breakdown, perhaps even war.

10 thoughts on “Catastrophe or Liberation?

  1. It is amazing that the public discussion of the crisis [i.e. not just the eurozone but the entire post 2008 debt/insolvency situation] is presented as pseudo-keynesianism v austerity. Both these ‘solutions’ ignore the need for debt clearance. Both these solutions ignore that just about every bank in the world is insolvent.

    The scale of “ignoring the elephant in he room” makes me alternate between rage, despair and a kind of crazed giggling.

    There is a third option. That option is sanity. That option is acknowledging the insolvencies & fuckedness of the financial system, followed by a restructuring, a clean slate and a new birth.

    I wonder why this third option does not appear in mainstream media analysis, or from any(ish) politician?

    [disclosure: I know the answer to my question. Banks/status quo actors have bought/co-opted the media & the political system. Additionally the truth is too hard to accept and cognitive dissonance means most want to believe that the emperor is still wearing a beautiful set of clothes.Its fucked.]

    • My theory is that ultimately the creditors and rentiers are losing by not accepting haircuts. Of course, that is counter-intuitive, but really it’s obvious: a healthier, more productive and dynamic society will mean a real rise in the standard of living even for the institutional investor class.

      Ultimately, the creditors around the globe are shooting themselves in the foot by demanding full return of their capital. They’d do better to sell their low-yielding bonds and invest money in anyone with an idea, some hunger, and some chutzpah.

      • There are some Keynesians who do understand the reality that high residual debt is a problem — specifically Carmen Reinhart and Ken Rogoff. Unfortunately neither of these gets much camera time from the press, and neither of them has taken the step I have taken in identifying that creating inflation probably will not achieve anything at all in terms of deleveraging. All we get is Krugman cackling about fake alien invasions to boost demand. Is he even an economist or is he fundraising for DARPA?

      • That would be logical. However don’t forget the principal-agent effect here:

        Creditor as an institution (principal) would be best (maybe*) to take haircut and reinvest. However creditor is represented by employees who have very different agenda i,e, short term bonus & pay. The agent’s incentive is to keep the balls juggling and try to postpone losses (which would mean lower bonus etc). Agent is not interested in long-term well-being of creditor. Agent wants to maximise his personal income now before bank collapses/restructures/downsizes etc

        *FWIW: I think creditors are in a deeper hole than is implied in your analysis. I think they cannot afford to take haircuts as that would mean immediate bankruptcy. Most creditors are IMO (mark-to-market terms) insolvent . To book a loss via haircuts would mean collapse. I would think you can draw a direct line between e.g. SocGen being near collapse and Sarkozy pledging “no more haircuts/default ever”.

        Add to this that accepting haircut & booking loss would mean collateral crunch for lines of credit from ECB etc which still take PIIGS debt at mark-to-fantasy value for collatarel [I think].

        Banks cannot afford to mark-to-market.

        Speculating here: I think I see a much greater chance of widespread systemic bank collapse in the immediate future. I think any move we see now is desperation to try to avoid this. I tend to agree with the last couple of posts at the automaticearth [see the bit by ‘stoneleigh’. See also the more recent post.

        On the + side I think the zombification will therefore end. But it will be ugly.

        • I am talking about system-wide haircuts on all debt. In theory, rather than triggering a default cascade, this just shrinks the debt-to-GDP ratio without GDP having to increase. Of course, as we all know even mark-to-market (a topic I was thinking about much more widely last year) — let alone traditional haircuts — can trigger default cascades. But if the haircut is applied to everything as far as I can tell that risk disappears, because it all cancels out – everything is still in place (so it’s not defaulted on) it’s just smaller in size relative to M0, GDP etc. For this to work and not trigger a systemic collapse it has to be applied to everything, at the same time.

          Of course, this is really just me riffing, the way Krugman does about alien invasions. I know my idea is politically impossible; if creditors make it difficult to adopt inflationary policies, they would do anything to stop a ubiquitous debt haircut. So the issue of debt erasure will not be solved that way. That effectively leaves systemic collapse as the only way out. It’s just a matter of timing.

          I agree that there is a massive chance of systemic collapse in the immediate future. Motherfucking Global just went down 40:1. There are other balance sheet monsters out there (anything with Morgan in its name…) and significant new money printing (even nominal GDP targeting) may not be enough to keep them afloat, even in the immediate term.

          Thanks for Stoneleigh link. A very entertaining read. She always is, though I should note I think she goes overboard on the deflation. Never underestimate a central bank’s ability to print fuckloads of new benjamins.

  2. What is your view on the idea that Europe after world war 1 and 2 was ‘invaded’ by the American dollar economic system and colonized? The Euro is attempting to create a United States of Europe, where corporations and the economic model is the same as in the US.

    How does this information if true make us more knowledgeable?

    Well if see it like this, then we as individuals can begin to see just how bad the whole idea of the US of E is, how the whole American century is a disaster and how we need to get back to local small scale economies and currencies where corporations are tightly regulated and controlled.

    • Well, America was “invaded” by the European central banking model in 1913, when Congress adopted a Federal Reserve that ever since has distorted the business cycle, firstly through bubble-creation, and more recently through extend and pretend. The ECB ironically is probably less distortionary than the Fed because it has only price stability as its mandate. This means it will do little in the immediate term to conduct QE, so the extending and pretending is off the table. Given the size of the holes in European balance sheets (residual debt overhang) this means there will probably be considerable liquidation in Europe, and a default cascade that will engulf the world, and finally erase all or much of the residual debt.

      The O’Rourke article I linked to is quite informative about the similarities and differences between what Europe is trying to create, and the US: “Rather than creating an inter-regional insurance mechanism involving counter-cyclical transfers, the version on offer would constitutionalize pro-cyclical adjustment in recession-hit countries, with no countervailing measures to boost demand elsewhere in the eurozone”. That means no money printing to boost demand in the core, and deeper austerity in the periphery, which is the opposite of what happens in America.

      As for corporations, I am against corporate personhood altogether. In business, those who act must have skin in the game: this means no hiding from liability — actions must have consequences, and those consequences must be felt by those who invoke them, not by the taxpayer, or wider society. As far as I am concerned, revoking corporate personhood is probably the strongest regulator there could ever be.

      • A significant issue at the founding of the republic of the United States was how the country would fare as it grew and reached its potential as by far the largest democratic republic to ever exist. We now are there and the fears of those forward thinkers have been realized.

        I agree that corporate personhood is part of the problem. But I think U.S. abandonment of Federalism is an even bigger problem. The founders obviously envisioned that commerce would function, first and foremost, at the State level, hence the ‘commerce clause’ to smooth this process across and between the states. Additionally, the federal government would oversee the many states commercial dealings globally.

        Now we have arrived where the federal government is too big, many corporations are too big, (too big to fail), and citizens have little influence in most political and economic processes because of the conjunction between and among Washington, Wall Street, and the Corporations.

        I see Europe as somewhat better positioned to have an effective Federal system, but the individual countries must learn to constrain their economic behavior to retain their remaining sovereignty while enjoying the economic benefits derived from Federalism.

  3. Federalism works, when the States/Nations are sufficiently homogenous. This ensures cooperation and mutual respect.

    Fiscal control needs to be limited to a constitutionally mandated Taxation to GDP ratio which ensures Sovereign wealth funds harvest sufficient capital in “Good Times” and release the capital in the form of a direct payment into Taxpayer accounts when times are lean.

    That way Politicians cant “Fritter” away the wealth of the nation. A good example is Australia is now in Debt, even though we had a mining boom for 15 years. We are going into a recession without Fiscal “ammunition”

  4. Pingback: Euro Psychoanalysis « azizonomics

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