Currency Union CAN work without Fiscal Union

Academics, assorted Analysts and Media Commentators regurgitate ad nauseam that Currency Union without Fiscal Union cannot work. Sorry but repeating this does not make it a truth. Admittedly a Fiscal Union would make things easier but the Euro-zone could function quite well without establishing a (technocratic) Super-Government far removed from any democratic control.
The Gold Standard - and the post-Bretton Wood system of fixed exchange rates - worked quite well without Fiscal Union. All it took was discipline on the part of the participating governments. This is what is missing - in most aspects of policy making - these days. The Currency Union is doomed if the member states do not adjust their internal economic and fiscal policies and disregard market signals.
Excessive speculation - magnified by leverage and uncontrolled capital flows - pose a risk as they turbo-charge price signals (falling sovereign bond prices in particular). This is akin to some panicky bodies in a small rowing boat. But decisive changes to policy measures should be able bring markets under control - fiscal adjustment, penal interest rates should quickly give the markets the right signal.
Do not blame lack of Fiscal Union for the problems of the Euro-zone. These have been left to accumulate in a reckless fashion over many years if not decades. Introducing Fiscal Union may douse the smoldering fire - for a while. But if there is no proper fundamental adjustment - remember the Mezzogiorno - patience in some member states that are paying high transfers will run out. In addition even bigger waves of speculation will set in when Fiscal Union looks frayed, funds will pour into the stronger member states until the pressure point is reached and the Currency Union can no longer be maintained. George Soros would relish this Mega-Tsunami if he would still be around at that time.

Bernanke & Co: Hero or Villain?

It is absurd that a professor of economics - who should know better - has no other solution to offer for the lack of growth in the world's major economy. Apart from the question whether or not eternal growth is really feasible - or desirable - he would only have to look a closer look at the relevant textbooks and he would find that pumping freshly printed dollar bills into the financial system is not the only (temporary and superficial) answer to what is in essence a question of fiscal indiscipline and wrong micro-economic measures.

More Micro and less Macro please!

Gavyn Davies provides another 'analysis' (Financial Times) that is based on observing just a few datapoints, not even close enough to the data one would need to have a reasonable basis to draw conclusions that should be the basis for policy decisions. The problem is that other factors are never equal. We all would love to have a multiplier larger than 1 on a sustained basis. Life would be easy, just let the government spend and spend. But in the case of the UK for example this simplistic view leaves out the fact that at some stage the policy would hit the buffers - when foreigners no longer support this policy. The Greeks can tell a story. A bit of deflation in the UK would be more than welcome, some factors of production would have to find better uses, people who are paid to sit at home or are surplus in certain sectors (some MP's?) would have to lower their wage demands, this would increase the buying power of the rest of the population and a virtuous circle of wealth creation would start. Less 'Macro' and more 'Micro' in policy making! Unfortunately the media, think tanks and the commentariat in the financial industry love the former and spend little or no time on the latter.

Establishment Economists helpless

By suggesting nothing else but another 'Support Package' for Greece the establishment economists admit that they are helpless when faced with a crisis such as the one Greece (and and.....) is facing. If there is no other solution in today's economic toolkit than to throw ever-increasing amounts of taxpayer's and helicopter money at a problem we might as well bin the insights of 300 years of economic thought.

Carried Interest Debate - Hairsplitting by Mankiw

Professor Mankiw admits that he is an adviser to Mitt Romney so one should not be surprised that he expends a considerable amount of energy confusing the straightforward case against a low tax on carried interest for private equity promoters with a variety of situations faced by hypothetical property investors. But the performance fee and basic management fee charged by private equity firms that predominately buy and sell existing assets can simply not be called a capital gain as there is no capital at risk. The exception is the portion of capital that has actually be invested by the managers of the pe firm. The rest simply is reward for putting in the effort to manage the fund. One problem we have to face is that the amount of this investment can easily be manipulated. Already, the insiders of the pe firms (promoters and senior management of the companies that the firms invest in) receive founder's shares (or options) at exceptionally favourable terms (something that would need closer attention by the 'limited partners', i.e. the investors who bear most if not all the costs and risks of the funds). Subsequently it can be claimed that the proceeds arising from the eventual sale of these shares (allocated at pennies) are a 'capital gain'. Maybe it would be a good idea for Professor Mankiw to let us know how he would prevent this abuse?

Saving by Spending more - not only in Britain

There is talk that the UK government may subsidise first-time home buyers. Apart from problems of policing the eligibility one has to ask how this proposal fits in with the urgent - not to say existential - need to bring public spending under control. Like Germany the UK benefits from the fact that the flight out of countries that are perceived as unstable makes it a 'safe haven' as capital has to be invested somewhere. This effect is similar to the one in the foreign exchange markets where the sale of one currency necessitates the purchase of another one - even if that one has blemishes as well. It is all a relative game, but the situation may one day change, perceptions or facts, and suddenly the UK will be exposed with all its weaknesses. Spending is still rising, despite all pronouncements to the contrary, and no one seems to have the will to impose fair, balanced and effective spending discipline. So all those putting their faith - and money - into the UK markets have been warned!

Poor Advice - we need to freshen up economist gene pool

When a former economic adviser to Ronald Reagan claims that the US debt amounts to $211 trillion one has to wonder who ever believes a word uttered by a representative of that 'science'. Adding up all future entitlements and other spending to arrive at this gargantuan number is the same as adding an individual's expected lifetime spending and declaring that he was 'in debt' by the resulting amount. The number would not be pretty - not for anyone past or present. This type of facile calculation forgets completely that the spending would (hopefully) be paid for by future earnings. To forget the income (or tax) side of the equation is a mistake that no serious economist should ever make. It produces good (and alarmist) headlines only.

Euro Drama - self-inflicted pain thanks to lack of democracy

The Euro has no democratic legitimacy, it is a construct created by (mostly unelected) bureaucrats, with unintended consequences (they are always the ones that count in the end).
Government spending in most countries is on an upward trajectory since early 1970s, no end in sight, in every election, in every country and from every party/politician you only hear about new 'projects', 'laws' etc that mean more spending.
But government can never spend 100% of the whole GDP, a limit will be reached and we are near it. Sooner or later those paying the bills will realise that more money does not buy more happiness in a finite life, why not make do and withdraw some of one's services.
That governments cannot cut 5 or 10 percent of GDP from their fiscal programs is an indicator for the lack of courage, best to cut all spending by an equal percentage, quick and avoids endless bickering.
Recommendation: avoid all banks in weak member states of the Eurozone, even check that any Euro Notes are not issued by central banks of these countries. Remember that 100 British Pounds in 1951 are worth only £ 4 in purchasing power today. It is a bit better in 'hard' currency countries but even worse in other countries. Germany's Mark (Euro) lost nearly 80 per cent of its purchasing power in the same period.

Italy: Desperate Fiscal Proposals

The proposed introduction of a 0.15 per cent tax on financial transactions and a 35 per cent tax on profits from proprietary trading by the banks (let's hope there are profits!) will do nothing but further strangle the financial marketplace. In an environment where the overall economy stagnates for the better part of the past ten years this can not be seen as an intelligent measure. In addition, the definitions required to make the fiscal net reasonably workable (which transactions? which institutions? - if only banks will that not give a tremendous boost for the 'shadow banking system'?) will not be worked out all that easily. As always, the political kleptocracy's instinct is to rely more on tax increases rather than conduct a root-and-branch reform of misdirected spending policies.

Greek Debt Crisis: Lunatics at the controls - sauve qui peut!

The headline that another Euro 100 billion (!!) might be spent by (mainly unaccountable) politicians and (international) bureaucrats on behalf of the citizen-slaves staggers the mind. In terms that can be understood by the man on the street that means that an average family of three Greek citizens indirectly benefits from a windfall of nearly 30,000 Euro. We have watched with alarm as the political class all over the 'Western Democracies' has allocated an ever-increasing amount of the national wealth creation towards the pursuit of the pet projects that benefit their client lobbies. The spending for the Greek bailout reaches new peaks of irresponsibility and is a blatant attack on all honest and parsimonious savers and investors. Those readers not only interested in protecting their wealth from predatory politicians but also looking for ways to stop misgovernment in its tracks should look at supporting Dirdem as more direct democratic control of decision making offers the only hope of turning things around.

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.

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.

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.

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.

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.

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.