Tuesday, 28 December 2010

Euro Crisis: German Experts miss the point

Leading German economic 'experts' urge Chancellor Merkel to take the lead in rescuing the Euro. But while their suggestions may all have some merit they miss the key aspect: All the mentioned remedies are at best a sticking plaster. The critical aspect has been overlooked: the banking system must be isolated from the impact that a bankruptcy in any member state - or a leaving of the Eurozone - can have. Only that would guarantee that no fiscal transfers or bailouts are necessary.

Sunday, 19 December 2010

QE: Miracle Cure or Con Job?

Just finished re-reading Mackay's classic on the Madness of Crowds. So this topic is of timely interest to me. The academic - and to a lesser extent political and media - debate for and against quantitative easing rages: but while I am not able to devote as much time and intellectual firepower (?) to this subject as the deep thinkers who offer their wisdom on the subject as I have to pursue a day-job as well , I would just like to observe that until this recent attack of collective madness anyone suggesting the use of helicopter money as a means to combat economic problems would have been considered to be NUTS! If this social experiment is successful it surely opens the door to end the 'economic problem' for good. Alternatively it will go into the history books as the greatest Ponzi scheme and con trick ever, on a par with the South Sea Bubble, with Ben Shalom Bernanke in the role of John Law.

Monday, 13 December 2010

German Banks fear for Euro 400 Billion

Update: the more representatives of financial firms argue that a 'fiscal union' in the EU is unavoidable in order to 'save the Euro', the more we are convinced that faulty (or wishful) thinking is behind their arguments. See recent interviews from Pimco and Commerzbank.
Horror headlines such as these do nothing to further a rational discussion about debt problems in Europe. There really are three simultaneous crises happening in Europe at the moment: Most national states have run up their debts to a level that has become unsustainable. This would have also been the case if the Euro would never have been introduced. Buying votes by inventing more and more handouts can not go on forever as the state can not increase its share of GNP beyond a certain level - and definitely not beyond 100 per cent! The crisis of the Euro is the next crisis - and this one is aggravated by the banking crisis. No one has made any provision in banking practices or regulations for the possibility that a member state may wish - or be forced - to leave the Eurozone. If any of the zillions of 'experts' in the EU and its member states would have been farsighted enough, the banking system would not have been allowed to build an enormous web of assets and liabilities throughout the EU while pretending that the Eurozone would exist forever. A German bank for example should have been obligated to make ample risk provisions for the eventuality of a break-up. Maybe funding for international exposure should have been on a matched-funding basis so that all assets in, say, Spain are funded by a separated Spanish subsidiary that gets its funding in Spain. In that case the problem faced by 'peripheral' EU member states would have been reduced to a pure problem of economic and fiscal policy in the respective country and would not have endangered the Eurozone as a whole. When 'experts' now say that the only solution to the problems of the Eurozone is the introduction of a fiscal union one can explain this wrong prescription in two ways: either these experts are just plain wrong or they are motivated - as were the fathers of the Euro - by the hidden agenda that was intended to create a European (Socialist) Superstate all along, where money gets freely directed to the pet projects of unaccountable lobbies or the politically well-connected. To return to the problem mentioned in the headline above: one should never confuse overall exposure with the level of the final loss that has to be expected. As the Latin American debt crisis of the 1980's demonstrated, recovery levels may be well below 100 per cent but they will be substantial if an intelligent debt workout plan is adhered to.

Saturday, 16 October 2010

Quantitative Easing misses the point

Compared to the drivel that the Keynesian party among the economics tribe perpetrates, the doctrines of the mercantilists must sound like the epitome of logic and rationalism. Who really thinks that helicopter money is the solution to the economic woes the commentators diagnose for the United States? During the quite intense recession of the mid-1970s there was no question of QE, the politicians (and the media) did not panic. Today anything less than growth a l'outrance seems to be simply unacceptable. But is a decline of 5 per cent in someone's annual income (from a level higher than ever seen in human existence) really a disaster calling for extreme (and ultimately futile) measures? What magnifies the real or perceived economic problem faced by the US is rampant militarism and extreme inequality exacerbated by a dysfunctional political system that is hopelessly dominated by special interests and checkbook politics. As more and more parts of the population slide towards the fate of becoming an underclass the urgency of trying anything (apart from sensible economic and political reform) to stem this tide is at least understandable - even if it will ultimately fail.

Wednesday, 6 October 2010

Are Governments more risky than some banks?

Until the full force of the credit crunch hit the investment landscape during 2007-2009 this question would have been brushed aside with a quick No! At least this was the situation in the 'developed world'. But during the past year the cost of insuring against the default by the state in many a 'developed' country has regularly surpassed the cost of insuring against the default by a large commercial bank.
After the mini-panic of May 2010 when a default by an EU member state suddenly looked more than likely the markets have calmed down. The pricing of government debt allows investors to make a rational analysis of the likelihood of future default and this has calmed the markets - for the time being.
We think that the burden of excessive and unproductive debt carried by many governments will eventually be whittled down by inflation. The resulting loss in purchasing power will be the involuntary contribution made by savers and investors to finance the politician's pet spending projects.

Wednesday, 29 September 2010

Quantitative Easing - Economics of the Stone Age

There is no way one can say something nice about the growing consensus among the 'experts' that QE (Quantitative Easing) is the only solution to the lacklustre growth experienced in many 'Western' economies. The momentum behind this consensus originated in the Anglo-Saxon economies, the US and the UK, and these two countries are so far the leading practitioners of this dubious strategy to solve their real or perceived economic problems. (see Fed mulls new bond approach) The curious aspect is that growth is not even negative in the United States and Britain. But it seems that it is just not large 'enough' to satisfy the never-ending aspirations of the politicians for more growth. For decades now governments tried to satisfy more and more real or perceived needs among their electorate. Spending and Taxation was on a relentless upward trajectory since the mid-1970s and I have always predicted that this trend line at some stage would hit a wall. Well, the wall has been well and truly hit and the community of economists does not have the guts to tell the populace and the politicians the truth: employment growth will not resume unless structural problems (distorted markets) are tackled. To promote the use of 'Helicopter Money' is utterly devoid of imagination and while it is not easy to predict the ultimate consequences of this policy I have the uneasy feeling that an act of this crudeness will not lead to a happy ending.

Friday, 27 August 2010

Deadly Debt Spiral - Phoney War before the Storm?

The only people concerned about the economy seem to be analysts and commentators - and the unfortunate minority of those who have lost their jobs. The working majority seems to be oblivious of the fact that the ship of state is continuously getting closer to the rocky cliffs of insolvency. A recent report in the UK warned that total public debt may actually be as high a £4.84 trillion! How many ordinary people can deal with that type of number? It took even me longer than expected to figure out that this is around £80,000 per man, woman and child in the realm. Or put another way: total debt may be as high as £4,840, 000, 000, 000!! Shopkeepers in the UK and elsewhere report that customers have returned....we wonder how long this phoney economic war can continue

Tuesday, 6 July 2010

US Debt Service and Defense Budget out of control

When Niall Ferguson warns about the level of US debt service surpassing the defense budget in 6 years time he fails to account for the fact that the US defense budget is out of proportion with what any reasonable government would spend on defense. Not only is it grotesquely over-sized but the spending is also woefully misdirected and a gift to the military-industrial complex that produces ever-more sophisticated (and expensive) toys for the generals. In any case, it does not need the 'hottest deficit hawk' to make us aware that the US budget spending needs a severe pruning and that gloating about real or perceived problems in the Eurozone is no substitute for proper housekeeping in the USA.

Wednesday, 16 June 2010

Simple solution for deficits

A heated debate rages in most countries: where should governments cut spending? where and how shall taxes be increased or introduced? Most commentators reject the lawnmower method as too crude. This would mean that all spending and/or taxes are adjusted by the same amount, without any exception. As everybody benefits from certain spending measures every expenditure has a natural constituency that fights tooth and nail to preserve that spending. People in favor of the lawnmower are therefore thin on the ground. In addition, no one wants to be branded 'cruel or inconsiderate' or (in academia) a simpleton. Much better to dream up elaborate - and complicated - schemes that hurt no one but miraculously slay the deficit dragon.

But is the lawnmower method really so crude? Cutting spending by 5 per cent and increasing taxes by 5 per cent cannot really be called brutal. After all, a few years ago everyone got perfectly by on an income that was, on average, about 10 per cent lower than it is today.

Introducing new taxes such as VAT or carbon taxes create just more red tape and are a dead weight on enterprise and future employment. They do nothing to reduce spending - and that is what got most countries into the deficit mess in the first place.

Thursday, 27 May 2010

Tax Burden: the limit may be close

The steady rise in the share of government spending since the early 1970s was a trend that was inexorably moving towards a level that was bound to create tremendous tensions. No longer would it be possible to bribe and pay off various segments of the voters and thus paper over conflicting aspirations in the various parts of the population. It is mathematically impossible for the state to command more than 100% of GDP and breaking point is reached at a much lower level. High tax levels will ultimately sap the willingness to work in those individuals milked by the state for the benefit of the lazy. They may then throw in the towel and happily consume what they have already earned. Why should a well-off professionals or entrepreneurs who have done well and are in mid-life continue to work hard just for the privilege of having half of their income confiscated? In reality his tax burden is much higher as the remaining half is also subjected to additional taxes and fees – above all VAT levied by the government. Once a large part of the producers of wealth starts to live a rentier’s life the whole edifice of the welfare state – and even government – would stand on exceedingly shaky ground.

Wednesday, 26 May 2010

Orderly reduction of debt levels is feasible

Irwin Stelzer should gloat a bit less (Wall Street Journal), there is no reason why the debt mountain cannot be reduced in an orderly fashion. Of course, what has been built over several decades can only be reduced in a slow and systematic way. This means that the 'freebies' distributed by the politicians will have to be withdrawn. But people survived without them in the past and with leadership and good will they will survive perfectly well. The army of 'invalids' living on state benefits in Britain for example has swollen dramatically since the early 1980s (yes, it started under the 'Iron' Lady!).

Unfortunately the economic debate is dominated by those seeking to profit from the implosion of the economies in (Southern) Europe and those trying to make their living by serving them. This unhealthy symbiotic relationship between Investors (especially Hedge Funds) and their 'advisors' in sell-side investment banks means that they are only happy if there is 'volatility' in the markets, the more the better for their business (and out-sized profits at the expense of the wider investment public and the taxpayers in general).

A few numbers to illustrate the feasibility of an orderly return to stable fiscal regimes: Greece with about Euro 300 billion in debt has to pay around 15 billion in interest with an interest rate around 5 per cent. To bring debt down to a more reasonable 150 billion over a period of 30 years would mean a net repayment of 5 billion. This total of 20 billion Euros distributed over a population of 11 million may appear to be a heavy burden but it is only 6 per cent of GDP. Now we all know that spending is more fun than saving but to say that this is not possible is not a statement of fact.

The will may be lacking but like in personal life, is it really too much to cut spending by 6 per cent? At least some part of this money goes to internal creditors who will spend the money and thus stimulate the economy. Money does not disappear in a black hole! Repayment will also mean that interest rates will be on a downward trajectory or remain low. And repayment of foreign creditors will allow them to spend more and stimulate the whole European Economy.

Tuesday, 27 April 2010

Controlled inflation - solution to debt overhang?

We try to keep economics out of our blog but sometimes we just cannot resist the temptation. The reason why there is a slowly-rising tide of calls for allowing a 'controlled' rise in inflation seems to be that politicians and technocrats seem to see no chance in reversing - or even stopping - the tendency for public (and private) debt to grow. Naturally, reversing a trend that has been going on for the better part of nearly four decades is not achievable in a year or two. So the only way to reduce total indebtedness would be a painful adjustment process lasting many years - much longer than the election cycle in any western democracy. But this is not to say that it would be impossible and it is doubtful whether relying on inflation would mean that the adjustment burden is shared more equally between all groups of the population. One should also not forget that in a closed economy the citizens owe the debt to themselves in aggregate. The problem is that the debtors and the creditors are different people and therefore repayment of the debt means that the debtors carry the adjustment burden.