There’s no signed paper from Stockholm, London, Berlin, Bern, Paris, Athens, Rome or Madrid or any other incidental European capital, regarding how financial institutions can or cannot use the Euro.
EU economy started as a very young federation of countries, and the financial players immediately started speculating and gambling on the Euro’s value, too early before it could establish itself as a stable monetary currency.
They bowed down too easily to the demands of the capitalistic models, mainly from the US, that expected them to gamble as soon as possible.
First thanks Hellestal and the others too. This has helped me.
So if these are the choices, what would happen?
Correct me if I’m wrong. Defaulting seems the worst, but would it be like an individual contemplating individual bankruptcy, thinking, defaulting on personal debts ruins your credit for up to ten years, but it’s better than paying off longs for the next 25 years.
It seems like the news is saying those in charge of the Euro just don’t care. I find it hard to believe they are just sitting back and willing to let it collapse.
Can someone enlighten me what the powers behind the Euro are doing? And do you think it will help?
Again, I realize no one knows for sure if it will or will not work.
I think some of the unemployment figures, while high, are somewhat exagerated. When I lived in Spain in the 80s & 90s, the smug little senoritos had decided to count everyone leaving high school, even if they were going to university, as “unemployed”. This, in the build-up to joining the EU and the Euro. Which resulted in massive amounts of “assistance” from the EU.
Can’t imagine them changing a “good thing” llike that.
This is just plain old economics, not any sort of fanciful stuff.
Maybe I’m misreading you (and if so, apologies for the length of this mistargeted post), but you seem to be operating from some sort of Hawley-Smoot theory of depressions, as if international trade drives the whole process, but that’s a distraction from the real issue. If world trade hiccups, we lose a chunk of our exports – but we also import less. Those imports have to be replaced, which means internal production, with export capacity reassigned to satisfy domestic demand. The factories are still humming along, it’s just that their goods stay here instead of moving there. This is the same reason why new free trade agreements, while they are a good idea, are not going to pull us out of this malaise. We’ll sell more stuff overseas, sure, but we’ll also buy more stuff. It balances out. Trade is about efficiency, not demand.
With a big drop in trade, there’s supply-side friction, as factories retool to supply ourselves instead of other countries. It’s not a painless process, so it’s worth a point or two of unemployment (and long-term it’s inefficient for growth), but this process is not an extra 10% of unemployment. An extra 15% is out of the question. Think about the size of the market. The US exported 1.3 trillion last year – total, not just to the EU – which is about 8.5% of total production. Using “Okun’s Law” about as crudely as it possibly can be used, that corresponds to about 4 extra points of unemployment. And that’s using all exports as the baseline to give an upper limit. I’m obviously not trying to be precise here, I just want a ballpark figure.
Can unemployment go higher than that? Of course it can, much higher, with demand problems. So, will demand be taken care of?
Well, the Fed’s record the last three years is pretty horrific. Not ECB bad, but still pretty awful. The whole reason we’re at 9%+ unemployment instead of something reasonable like 6 or less is a failure of demand – which is pretty much equivalent to a failure of monetary policy. We’re still far off course from our previous NGDP trend line. They failed once and can possibly do it again. The question is, what is the current extent of their failure to sustain demand? Another 3 or 4% of real GDP, at most. Put them in a crisis situation a second time, and they’re not going to do worse than the first time after Lehman.
That’s an upper-bound of about an 8% increase in unemployment in the US, and that with mediocre money rules. With competent monetary policy, it would be less. Is that a jen-yoo-wine depression? Great Depression 2.0? Yes. Absolutely, especially in Europe. But it still doesn’t match version 1.0 in the United States. The only other possibility, if we’re on worst worst-case scenarios, is a complete and total breakdown of international trade, including oil and food. If letters of credit from major international banks are no longer accepted, then big containership trade stops entirely. And in that case, we’re not talking just 25% unemployment, but rather the end of the economy as we currently know it.
Neither the Bank of England, nor the Fed, nor the Nichigin, is going to allow the destruction of their most significant banks. We could lose a lot of Europe without losing liquidity in the international transport sector. They will all of them act as a proper lender of last resort – what the ECB is unwilling to do – because they have a much better idea of what’s at stake. This could be yet another moral hazard problem, but that’s a lesser problem compared to a complete seizure of money circulation.
Without the total apocalypse scenario, there is a limit to the misery. Even the Great Depression wasn’t great overnight. It took year after grinding year for everything to come apart. The financial crises were bad, but the most significant bank problems were also near the end of the downturn, at least in the US. That’s just not going to happen again, unless a goldbuggering moron winds up in charge of the Fed.
In that case, and that case only, I’d suggest stocking up on canned food, ammunition, and leather assless chaps. But that’s the actual fanciful scenario.
Having your own money to fight demand downturns is everything. If you want a historical analogue, you can look at China under the silver standard in the 1930s. China wasn’t tied to gold, which means China wasn’t tied to the rest of the world sinking into depression. Now obviously, that’s a highly imperfect comparison. The market integration wasn’t on nearly the same scale. But China was also not stuck in its own little world. They were connected to world markets. That was seen just a little bit later, when the US started buying up silver in 35, pushing up the price. This caused deflationary pressure, which forced them off the silver standard just as the major European countries had to abandon gold earlier.
China was stable, with its own different money, for a long time (until the US started messing with silver). Having your own currency is a significant buffer, and will mitigate the damage a smidge. We’re not tied to gold like we were in the 30s (like Spain is tied to the euro now), and we would not reach the same depressionary trough.
“Not volatile”?
Have you actually looked at the data?
Here are the prettycolors. The blue line subtracts out food and energy. The red line includes them. “Volatility” is defined by how much the line squiggles around. It is not some vast conspiracy to say, yes, the red line squiggles a helluva lot more. The inflation rate is the slope of those price index lines. Blue has a pretty constant slope: consistent small inflation. Red skips up and down: inflation/deflation.
That is what volatility is. The data is right there. It isn’t hidden from anyone.
I was thinking of this chart, favored by Brad DeLong and originally from Barry Eichengreen, listing major industrial powers of the time. But I double-checked the years on that. Germany’s dated incorrectly. They dumped gold earlier, although they did not ease money as much as they could have. So it is not, in fact, perfect. Good to know.
This can only work if you’re the only country doing it. The current problem is so bad that too many countries face devaluing their currencies, and the Euro itself complicates things enormously. It is far, far from a single fix situation.
Some comments. First the real unemployment rate is much higher than the official figure because the people who are so discouraged that they have stopped looking are not counted. Also people with part-time jobs who would like full-time employment. I have seen figures in 15-16% range for the real unemployment. Second, the reason for the moral hazard (which Krugman is as aware of as anyone) is that the banks were bailed out they paid no penalty, the shareholders lost nothing and the managers were rewarded with outsized bonuses. If a ship’s captain takes a chance and runs aground, he is virtually certain to be fired and certainly not rewarded with a bonus.
When Iceland defaulted on its external debt (which was to Iceland’s banks, not its government), people threw up their hands. But Iceland has largely recovered, or had before the current crisis. When countries default it is not like an individual bankruptcy. In fact, they become good credit risks (depending on their governance) because they don’t have that huge debt load weighing them down. Isn’t this what happened to Argentina in the 70s?
A good rule of thumb when thinking about macroeconomic issues like this, is don’t ever try to compare it to individuals, families or businesses. It’s usually misleading. If an individual goes into bankruptcy, that’s bad for his creditors and bad for his credit rating for a bit, but its effect on the wider economy is nothing. If Italy went into complete bankruptcy, you’d be talking about thousands of creditors losing trillions of dollars. The potential for wide-scale writedowns like that would cause runs on any bank thought to be holding a lot of Italian debt (including every Italian bank) and would probably freeze up global credit markets again, causing another, much more severe “credit crunch”. Greece will need to default anyway because it’s insolvent, and Iceland did default and came through it OK, but we’re not talking about individual bankruptcies here.
The problem is the way the Euro is set up. The steps required to prevent it collapsing basically involve the creditor countries of northern Europe, mainly Germany, ‘bailing out’ the weaker countries in some way. That could be by allowing the European Central Bank to announce it will act as lender of last resort to the weaker countries, or by pooling all of Europe’s debts somehow such as by creating “Eurobonds”, or even through directly transferring money to the weaker countries. But the catch is Germany has no control over the Greek or Italian budget. So they’re afraid that if they bail them out, those countries no longer have any incentive to institute painful reforms to their own economies to bring them back in line with Germany’s. Germany and the ECB are essentially playing a game of chicken with them: “you need to reform your economies now, because we’re not going to save you, no matter how bad this gets”. But Germany and the ECB have to save them at some point, otherwise the Eurozone will probably collapse. So it’s a question of who blinks first. The markets up until now have assumed that, when push comes to shove, Germany and the ECB will do what it takes to save the Eurozone. But we’re getting pretty damn close to “shove” already and they’re still adamantly refusing to step in, so who knows what’s going to happen.
Broadly speaking default could be compared to personal bankruptcy though there are some key differences. Also keep in mind defaulting and abandoning the euro are two different issues. If Greece were to default its debt goes away. Greek banks, which unsurprisingly hold a lot of Greek debt, would likely fail and be nationalized. A lot of other parties also hold Greek debt, including the central European bank (ECB) and institutions in other European countries. They would all take a pretty significant loss. They may have to recapitalize or they may fail. People aren’t big fans of bankers right now but if I bunch of banks fail and/or decrease their lending activity this is problem. Credit market’s seize up, confidence falls, and this in turn directly affects governments, businesses, and citizens.
Ireland and Portugal, who recently adopted some painful measures to deal with their own financial problems without defaulting might be tempted to say “Well if the Greeks defaulted, why don’t we?” and join the party, multiplying the problem. Either way the problem spreads across Europe and may accelerate a general economic collapse.
Greece could also leave the monetary union, adopt a new currency, and let it float that would deal with its debt and spur exports, but it also causes a host of new problems. The immediate turmoil could cause a contraction of the domestic economy of ~25%. There would probably be unrest. Greece has to import a lot of stuff that it doesn’t make domestically. It’s going to be hard to do that with its weak new currency. It also doesn’t export much, limiting its ability to benefit from its weak neo-drachma, though tourism could benefit somewhat.
Now, could Greece eventually improve its credit score so to speak? In a sense. For example Argentina defaulted relatively recently and has made about as good a recovery as can be expected, although they had much more robust exports than Greece does. There’s always someone willing to invest after a collapse. However, its debt is still rated as high risk and its real inflation is probably somewhere around 25-30% so I’m not sure the book is closed on Argentina quite yet.
If it were only Greece that might be tolerable but if multiple countries in southern Europe start defaulting the wheels are coming off the European, then global economy for a while. No one doubts that. So why are the people in charge of the Euro not doing something? I mean, they’re buying some bonds but they aren’t intervening aggressively.
Well, the people in charge of the Euro, when it comes right down to it, are German. They took big hits like everyone else in the crisis several years ago but their economy was strong enough they managed to make it through in pretty good shape. They are the dominant economy in the Eurozone right now. Up until now the euro has been beneficial to them. Just like the Greeks are stuck with a euro that’s too strong, in a sense the Germans have benefited from a euro that’s too weak, boosting their exports. If the European Central Bank cranks out the euros to monetize European debt, it hurts Germany. There’s also a proposal to issue a Eurozone bond, which would sort of be the equivalent of the US government issuing debt on behalf of the states states which could solve matters but Germans hate that too for the same reasons: ultimately they feel (not without merit) that they are propping up the crap economies of southern Europe and subsidizing their lousy decisions. Or to put it another way, why should they work well into their 60’s to pay the pension of a Greek hairdresser who retired at 55? Part of this is may be due to German history: The Weimar republic dealt with its debt by monetizing it, which lead to massive inflation.
What’s really interesting is you could make an argument that various parts of the US are somewhat analogous to Northern and Southern Europe. Some southern states might benefit from leaving the union, issuing their own currency and exporting their way to economic health. But no one really thinks like that and not too many people get upset that T-bills are backed by both residents of Manhattan and Baton Rogue. But Europeans don’t think that way and their central bank doesn’t have the powers ours does. But back to the topic at hand…
Now, people aren’t quite sure what to think. Some think the Germans are just playing chicken and are using this opportunity to wring some more reforms out of the weaker economies they will eventually bailout. Or they may stick to their guns and let it all burn for a bit. That seems crazy but remember TARP? Remember how it stuck in everyone’s craw to bailout the banks, even though it was in our own interest and they actually paid most of the money back with interest? It’s a tough pill to swallow and German voters will likely make it known in domestic elections if it comes to pass. And now what do you do with a country that’s too big to default and that now knows you’ll bail them out if they get into trouble? As hard as it was with the banks, it’s even harder with countries. There are no easy answers.
The problem is that it is not entirely clear that Germany can save the Euro. Italy needs a 600 billion dollar bailour and Spain needs a 500 billion dollar bailout. Just those two countries need bailouts that are 33% of German GDP. Germany just had a really bad bond auction, so there is a question about how much it can borrow. What the markets are looking for is a credible LOLR. However, it is possible that there is no one with enough money to be a credible LOLR. Inflation is needed and quick to help the economies but with inflation comes the need for higher interest rates on the bonds and thus more revenue. I hope inflation is the magic bullet for our economies but any thread on worst case scenarios needs to include the possibility that inflation might not work as well as intended and that defaults and an ensuing credit crunch are inevitable.
I’m curious as to what you mean by “supposedly stopped looking.” There’s no “supposedly” about it. The respondents are asked if they worked in the previous week. If no, they are asked if they actively looked for work (and what specifically they did) in the previouw 4 weeks. If yes, they are unemployed. If no, they’re not available labor because they are not trying to work…anymore than someone who doesn’t want or is unable to take a job. “Even though I’m not doing anything about it I really want a job and could take one if offered” is extremely subjective and therefore not useful for an objective measure of the labor force.
To further AUX302’s point. In this country we have had two rather large political protests, the TEA party, and occupy Wall Street, over the bailouts that mortgage holders and bankers had. Imagine what kind of protests would happen if the bailouts went to the bankers and government of Mexico and were twice as big. This is what the politicians in Germany face.
Tis is one big reason I massively disagree with Hellestal. Not about the potential consequences, which are bad, but about the means. The plain fact is that Europe cannot save the Euro. No, not even with massive inflation. Moderate inflation will not do; they need an influx of cheap money. But this will not solve the longer-term problems any more, and will in fact kneecap the Euro’s strongest members.
No, the ECB cannot do it either. They lack the means entirely. It’s not possible to do what you (or for that matter Krugman) wants. And where Hellestal thinks the ECB should sort out the “good from the bad”, I think that’s a silly diversion. There is no good and bad here - whole economies are crumbling. It hardly matters which banks you think are worthwhile, because the problem doesn’t start with the banks and the nations simply do not want to fix things the way they must be fixed - AND they don’t want to get rid fo the Euro. In that predicament, either they break or they drop the Euro.
Now, doing that would be tough. Going back from the Euro quickly would be a nasty shock on its own, not to mention the injury to the Euro-project. But it would permit the countries to function once again on their own terms. They would survive fiscally. We’d probably avoid a massive depression as people got used to things again, and maybe even see a boomlet.
Moverover, there’s really no good reason to expect the Germans to commit suicide to help anybody else, nor do I think they particularly have an obligation to do so. The Euro did not work and will not work for the foreseeable future. Maybe if you essentially turn the entire Euro Bloc into a dictatorship, which seems to be the method prefered by the technocrats who got everyone into the mess.
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A “worst case” thread would generally belong in IMHO, but I think this one is developing all of the hallmarks of a Great Debate, so I’ve moved it to GD.
[/moderating]
Why not? Preferably with cites. Krugman wants the ECB to pledge to act as lender of last resort, purchasing enough sovereign debt in the secondary markets as is necessary to prevent interest rates on Italian and Spanish bonds spiking to unsustainable levels. The pledge alone could stabilize interest rates without the ECB even having to buy many bonds at all, which is why for instance Finland’s interest rates are currently double Sweden’s despite both countries being fiscally and economically very similar; Sweden has a lender of last resort, Finland doesn’t. If interest rates were stabilized, fixing the Italian and Spanish economics wouldn’t be “impossible”: Italian already has a surplus in its primary budget and Spain is already implementing tough reforms. Granted more measures might be needed from then on, such as a slightly higher Eurozone inflation target, but that’s a more medium-term issue.
I think you have to explain why it would work at all beforehand. Already, German bonds are going nowhere flat - German bonds, which are as guaranteed as anything in Europe. Krugman appears to me to be making the mistake of believing that moving money around means there’s more of it - not surprising, given that he’s a trade theorist and not a macroeconomist of this stripe. In short, what the hell is the ECB going to use to keep interest rates down? Nobody has a fortune to spare and little hope of raising that much more.
Interest rates aren’t the problem. They’re the signal. You might be able to keep them down on average, but you’re not actually fixing things. Governments will simply be paying themselves money to pretend thigns are alright, while market sales will still be sky-high, with the real risk premium. This is not a situation which can be solved by confidence. The lack of confidence is following a real problem.
ECB can’t be believed as things stand currently, and I don’t see even its nest egg doing much, even leveraged as far as it will go. The plain fact is that most of Europe has too much debt. It can either find a way to deal with the debt or drop the Euro, but dealing with the debt has already been rejected, it seems.
Let me preface this by saying that I am no expert on economic matters, but can’t they do something closer to what Brazil did when they had economic problems. What if they introduce a sub-Euro currency that would be for the mismanaged countries. That way, they could convert the debt, ask the bankers to take a bit of a loss, and prevent the accompanying moral hazard that bailouts introduce? So account for all Greek debt, covert it to Geek Euros, then issues said currency in Greece itself. Tell the bankers to take the conversion rate, or risk losing their investment. Then allow that new currency to rise against the real Euro until the Greeks can correct the fundamentals of their government. Once, they can internally control the inflation of the Greek Euro, you can go back to the real one. Wouldn’t this week in theory?
Well, in theory. Lots of things work in theory. ANd it’s been bandied about by many. However, there are a few issues. First, if you want do this… why bother? You’ve effectively ended the Euro. The new currency will take up half the Euro-zone. At this point, why not just drop the Euro-currency altogether, since it wasn’t working? This isn’t going to be a temoprary situation. You won’t just “drop” the new currency once it saves the countries involved, because they’re not on a course which makes a currency union desirable.
Second, it doesn’t necessarily end the problem. Banks who hold investments in new “Latin Euros” (LO’s) would still owe money in Euros (or would they, and how do you decide which ones are paid out in what?) , so they’re still out a lot of cash. There is a question of whether it will end up causing hyperinflation, or something unpleasant, as governments inflate their debts and reduce the currency value by half at least. Then you have the question of who does the central banking for this, and how they shoudl do business, and how the EU will administer two entirely separate currencies, and whether the remaining old EU countries will even want to keep it afterward.
Now yes, all of these problems can be overcome with immense work. But only by collective action by a lot of people with dissimilar cutlure, who don’t really agree on anything, and who literally don’t speak the same language. Greeks don’t have any particular interest in Italy, and the Italians don’t give a damn about Spain. The French, who also probably would be involved, don’t care about anybody.
Given the trouble involved, I’m convinced they’re better off just pursuing their own currencies. That’s also hard, but it’s a damn sight easier. We’ve seen that separate currencies works, and each country still has a team who know fiscal matters and until last decade were doing that very work.
Oh OK, I was under the impression you understood some of these issues. Incidentally what the ECB would use to keep interest rates down is a pledge of unlimited bond purchases in the secondary market, and because the ECB can print as many Euros as it likes they do indeed have a “fortune to spare” in that sense. That’s what a lender of last resort is.
First off, can the 'tude, since you’re speaking highly theoretically. Second, the ECb does not have such a mandate. Third, nobody believes it will print potentially unlimited Euros. Fourth, if it did, it would be as I mentioned seriously harming the still-active economies while not necessarily fixing the basic problems of the weaker ones.
I always love how people tend to assume those who disagree with them on arcane technical (or financial) issues are either stupid or ignorant. And by love I mean, ‘despise’.
