Wednesday, November 30, 2011

Feldstein on Italy

Martin Feldstein weighs in on the Euro crisis (Italy can save itself and the euro), and makes some interesting points.

First, as Feldstein notes, Italy has a huge stock of debt, but it's flow situation is not that bad - it has been running a large primary surplus for years, unlike Greece. It could reduce its deficit and enhance market confidence with realistic adjustments to taxation and spending. This is an important point, since the measures asked of Greece are truly impossible to successfully implement.

Feldstein also makes another good point - that with public spending running at half of GDP, there must be savings that Italy can make somewhere. This is clearly true: Italy has a public sector that wastes resources on a truly awesome scale. However, it is also true that any major cuts will be contractionary in the current climate, and could reduce what little growth Italy has in store.

And that brings us to another point. As Feldstein shows, that required fiscal adjustment, with measures taken to increase growth, could quickly rebalance the situation. But if the reforms needed were so easy to achieve, maybe they would have been implemented already, given Italy's poor economic performance over the past two decades. Clearly, the time for such reforms was in the more buoyant climate of the late 1990s and early 2000s - now they will probably have contractionary effects.

That all said, there is a lot of low-hanging fruit when it comes to possible reforms. More women could be encouraged in the labour force very easily (see the weird but interesting proposal by Alesina and Inchino to reduce employment taxes for women), competition could be usefully introduced into some closed markets (the 'professions', local transport, retail). A bonfire of pointless regulations could save a lot of time and energy for businesses and citizens and allow resources to be deployed more productively.

The trouble is, there is at present no political constituency for these measures. The majority position in Italy is economic and cultural conservatism, with occasional bursts of intolerance towards groups such as immigrants that are key to the country's future. Berlusconismo has to be defeated before anything good can happen.

Monday, November 28, 2011

The Euro elite

Reuters reports that Germany is planning 'elite' bonds with 5 nations. So this is still all about saving Germany's skin? The only reason to be hopeful about a development like this would be if it was a preliminary step to a bailout of the periphery. But that bailout needs ECB intervention, and I can't see how a 'hard' Eurobond makes any difference to that.

Saturday, November 26, 2011

The German burden

Paul Krugman once again puts the boot in (Mysterious Europe). What occurs to me reading this post is that ultimately all that the Germans would be required to do to resolve the problem is allow the ECB to backstop Southern European debt, and in the meantime spend some (preferably all) of their surplus on Southern European products.

So, we are inviting the Germans to spend some nice holidays in Greece and Spain, preferably eating lots of good local food, and buy a bunch of Gucci handbags and the odd Ferrari.

Is that really so much of a sacrifice?

'via Blog this'

Thursday, November 24, 2011

Understanding the Euromess

Great lecture from Barry Eichengreen - Europe's Never Ending Crisis (link courtesy of Mark Thoma). All you need to understand the basics of what is going on in Europe.

Wednesday, November 23, 2011

Chart of the week

Here's great chart courtesy of Nick Andrews. It shows the bond yields for Eurozone countries from the early 1990s to the present:



Yet further proof of the efficient markets hypothesis, if you ask me.

Reform, reform, reform!

The technocratic turn in the Euro crisis has brought us yet more talk of 'reform'. German central bankers grimly warn that there can be no quick fixes and that debtor countries must 'reform' in order to save the euro. But what do they mean by reform?

There is a deep irony in all of this. Germany spent close to two decades being lectured by the Anglo-Saxons about 'reform' - the German social market economy, based on social partnership, long-term investment, strong social protection and a heavily regulated service sector, were singled out by neoliberals as the reason for Germany's weak economic performance after reunification. And Germany did reform - the Hartz measures moved the German social model in a more liberal direction, permitting the creation of more low skilled and low paid jobs and reducing welfare entitlements, at least for some workers. And lo and behold, Germany quickly shed its reputation as the sick man of Europe and is once again calling the shots in Europe.

How much of this is down to 'reform', rather than Germany's rather conservative consumer culture, is a difficult question to answer. However, one simple point that can be made is that Germany is not the only country in Europe that has 'reformed'. Italy and Spain have both had waves of labour market reform and important institutional changes in financial markets. The obvious implication is that reform is not necessarily a solution to anything, and that we need to be a bit more specific about what reform means.

One good example of this is that the dominant orthodoxy of the last couple of decades has been the deregulated capital markets were good for both stability and growth. Ahem. Germany actually resisted reform in this area (the famous Mannesman takeover by Vodafone led to a more restrictive law), much to the disgust of Anglo-Saxon observers. Meanwhile Spain embraced contemporary financial practice much more enthusiastically, resulting in an unsustainable housing boom which has left the country deeply exposed in the current crisis.

The Euro crisis is bad for everyone, but the pain does not seem to correspond in any consistent way with the extent of reform in the various European countries. It is not easy to see how more of this ill-defined reform is going to solve the problem.

Tuesday, November 22, 2011

The myth of technocracy

Paul Krugman has written a great Op-ed (Cruel Euro Romantics) which, as usual, nails it.

The arrival of technocrats at the helm of two of Europe's most stressed governments has been largely welcomed by people who should know better. And indeed, no genuine democrat can really regret the demise of Silvio Berlusconi. But what exactly can technocracy offer us in the middle of this terrible crisis?

Well, they don't have a magic wand, for sure. Times remain tough, and Italy's bond spreads have merely stabilized at the unsustainable levels they reached under Berlusconi. But, as Krugman argues, the problem with technocracy goes further - that in fact, these technocrats are the ones who got us in this mess in the first place, with their fantasy world of a diverse Eurozone gliding seamlessly towards convergence under monetary union. Why on earth should anyone have expected this to happen?

So these technocrats are really 'romantics' - rather than robotically applying the findings of the best economists, they chose instead to invent for themselves an imaginary world in which the Euro would succeed where other monetary experiments had failed. Krugman, of course, argues that the failure of technocracy is their choice to use the wrong kind of economics, and that the right kind - his kind - would allow us to solve the problem, or least avoid catastrophe. I'm inclined to agree. But there is something else here that Krugman misses.

The other problem with technocracy, is that it does not engage the people. In fact, this is the very point of it. Technocrats have the theories and facts to make the right decisions, so they should be left to do it, free of the daily noise and fury of politics. But even if they had the right policies, they still have to convince the people that their policies will deliver some approximation of the collective good, otherwise the compliance with rules and norms any society rests on will break down.

This is the colossal failure of the European Union. It is bad enough that they designed institutions that have left us on the brink of disaster. But worse, they did so without ever bothering to explain what the benefits, costs, and likely risks of the project were. Now, again, the European policy elite wants us to write another blank cheque to the same people who have already let us down. It can't work.

Published thoughts on Italy

Piece for Foreign Affairs: How Italy's Democracy Leads to Financial Crisis.

Blurb: Monti’s appointment fits an established Italian pattern: fiscal laxity under populist center-right governments followed by brief emergency periods of technocratic austerity under the center-left and EU. To make fiscal responsibility stick this time, Brussels should back Monti as he builds up a popular mandate for gradual reform.

Friday, November 18, 2011

Time for Germany to show leadership

Great piece by (interest declared) my friends Matthias Matthijs and Mark Blyth in Foreign Affairs: Why Only Germany Can Fix the Euro. They argue that Germany is copping out of its responsibilities: 'As the eurozone's biggest economy, it was Germany's job to stabilize the system when the first signs of financial trouble appeared. Instead, it did precisely the opposite. Whether the euro survives depends on Frankfurt finally assuming its role as leader.'

The argument is similar to Wolf's but punchier. And there are some valuable home truths thrown in. That Germany's virtue is the mirror image of Southern Europe's supposed vices, that Germany can only be like Germany if others are like Greece, that deflation can only end in disaster, and that the answer lies with the ECB acting as a lender of last resort. Some great data snippets in there too: the Euro engineered the colossal current account imbalances within Europe that have created the problem. So

Between 2000 and 2007, Greece's annual trade deficit with Germany grew from 3 billion euro to 5.5 billion, Italy's doubled, from 9.6 billion to 19.6 billion, Spain's almost tripled, from 11 billion to 27.2 billion, and Portugal's quadrupled, from 1 billion to 4.2 billion.

Basically, the Euro locked Southern Europe into acting as the borrower of first resort for German savers. Then when the music stopped, they asked for it back, all at once. Too late.

Martin Wolf on Italy

A characteristically clear and articulate analysis from the FT's Martin Wolf: Europe must not allow Rome to burn. Wolf argues that Italy can survive the crisis, but only with strong support from outside, and that means Germany authorizing the ECB to backstop Italian debt.

Given Guido Westerwelle's obtuse offerings in the same newspaper yesterday, the chances of this happening don't look good.

Thursday, November 17, 2011

Important news just in

You turn if you want to

Like the markets, I'm oscillating between fear and terror on the future of the euro. On a good day, I'm simply deeply worried. On a bad day, I stick my head under a blanket. This article by Guido Westerwelle (Germany is not for turning on how to save the euro) is actually the kind of thing that keeps me under the duvet.

As well as the ritual commitment to standing firm and avoiding easy get-outs (we prefer to do things the difficult way), Westerwelle shows a touching faith in 'reforms'. So, he states, the way to tackle the immediate crisis is for 'Greece’s government (to) without further delay adopt and implement the necessary reforms'.

Right. Presumably in a minute he'll tell us what the reforms are. Yes, here goes: 'Only when states regain trust by immediate and thorough reforms, can the crisis be overcome.'

Yes, couldn't agree more. So, these reforms are....? Well, he doesn't say, but he does mention that 'Putting the European Central Bank’s printing presses to work... would have dire consequences, both raising inflation and dissipating vitally important incentives for reform'.

So reform is the key. The thing is, there are reforms and reforms. Germany spent most of the last two decades resisting reforms that Brits and Americans insisted were necessary to drag it out of the post-unification torpor. It did make major changes to labour markets and the welfare state, but avoided reforms in a host of other areas. So not all reforms are good reforms, at least for Germany.

Southern European countries have also adopted reforms. Labour markets have been liberalized, financial markets opened, public spending cut, pension ages increased. Not just now, but well before the crisis. Some of these reforms were beneficial, maybe some didn't go far enough. But the notion that reform will solve everything assumes that we know what reforms will restore growth, competitiveness and fiscal stability. And we don't.

Hanging the fate of the Euro on a vague and untested programme of 'reform' is wishful thinking at its most dangerous. It won't work politically, and it probably won't work economically. And it certainly won't deal with Germany's €182 billion trade surplus, which it lent out to the rest of the Eurozone thus creating the debts that we're all worrying about.

Wednesday, November 16, 2011

Monday, November 14, 2011

Bunga bunga economics

Only just noticed this great op-ed by Paul Krugman.

Apart from the great opening line 'this is the way the euro ends — not with a bang but with bunga bunga', the really interesting point is this:

"Spain and Italy in effect reduced themselves to the status of third-world countries that have to borrow in someone else’s currency, with all the loss of flexibility that implies. "

I've long believed that Europe was the main reason Italy had not ended up like Argentina. Maybe I was over-optimistic.

Economists at work

Research by Mark Hallerberg and my LSE colleague Joachim Wehner finds that Economically-troubled countries are more likely to be led by those with economics training.

Although my colleagues suggest the causal chain runs the other way, it doesn't look good for Papademos and Monti... More seriously, placing faith in technocrats might make more sense if they hadn't been such enthusiastic promoters of the particular model of monetary union that has created this mess.

The Monti effect

Sunday, November 13, 2011

Depression or Inflation?

Nice post by Simon Johnson at The Baseline Scenario: Johnson lays out neatly and concisely the choice facing Europe, and the world, at this juncture: monetization or depression.

The logic is that, as many others have been pointing out for a good while now, there is no feasible readjustment or recovery under the existing regime. Sovereigns will default unless bailed out, and Italy is too big to bail out unless this is achieved through the ECB printing money to buy up Italian bonds. And sovereign default would drag Germany down with the rest of us.

Johnson argues that there is a huge moral hazard problem here, but at this point we're just going to have to deal with that later. After all, what's the point of averting moral hazard by destroying the world economy?

'via Blog this'

Saturday, November 12, 2011

The worst politician in democratic history?

Well, he's actually gone and resigned (Silvio Berlusconi si รจ dimesso la piazza in festa grida: "Buffone").

He leaves behind a country on its knees, and still in denial for the most part about what is happening. Maybe Monti can start by telling people the truth - will Italy be able to face it?

Friday, November 11, 2011

Nouriel Roubini's prophetic words on Tremonti, Italy and EMU

Paul Krugman reminds us of an incident in 2006 where Nouriel Roubini told Giulio Tremonti a few home truths, much to the Italian Finance Minister's disgust:
Italy’s Tremonti’s Temper Tantrums on EMU in Davos…a Sad Embarrassing Episode for Italy…

Pity Italians didn't pay more attention - it could have spared them a lot of trouble.

Tuesday, November 8, 2011

The Berlusconi effect



(spread with German bonds, Bloomberg)
Today is a big day. Berlusconi could survive today's vote, in part because the opposition may well abstain to avoid the technical difficulties resulting from the failure to approve last year's government accounts. But even the Northern League is now calling for him to resign. It may take a few days yet, but I'll be putting some champagne in the fridge (or maybe Prosecco).

Monday, November 7, 2011

Gavyn Davies on the Euromess

Seeing Berlusconi finally on the verge of political oblivion produces mixed feelings, because in fact he has not been defeated by his own mistakes or political weaknesses. Instead, like the fall of Papandreou and Zapatero, it is a result of the fundamentally unsustainable nature of monetary union.

As Gavyn Davies points out in the FT, the German current account surplus more or less exactly corresponds to the current account deficit of Spain, Greece, Italy and Portugal. The stark implication of this is that

Viewed in this light, it is clear that there needs to be a capital account transfer each year amounting to about 5 per cent of German GDP from the core to the periphery. Without that, the euro will break up.

I wonder how many Germans have understood this. In any case, as Davies points out, there is not way this can happen under current arrangements (austerity, deflation and limited ECB intervention). And so the end game continues until the Southerners have had enough and opt for the Argentine route.

Berlusconi, Papandreou and the various corrupt networks they represented should not be exonerated, but ultimately the collapse of this phase of monetary union is not actually their fault. Ireland, with a very difficult social structure, economic regulation and political system (although corrupt enough in its own way) is in a similar mess. More enlightened politicians would probably not have averted disaster. The proof of this is that Spain, the star pupil of economic reform in Southern Europe, is barely better placed than Italy and Greece.

The sad thing is that Northern Europeans may happily blame corruption for the South's plight, but Southern citizens are not in the mood to listen to the sermon. Ironically, the humiliation of the bailout arrangements could end up stirring national pride and generating an alternative (and equally implausible) narrative: blame the Germans.

Berlusconi finally meets his match


Yes, Berlusconi has dealt with pretty much anything that Italian politics has been able to throw at him over the years, but in the end the power of the bond markets is going to get him ("Va via": borsa su. "Resta": crollo I mercati e il destino del premier).

Brings to mind the famous phrase of James Carville, about the bond markets being far more powerful than a president, a pope, or a .400 baseball hitter.

Anyway, I think Silvio may well go tomorrow, if the vote in parliament on the government accounts doesn't produce a majority. If not, with bond yields hitting their Euro-era record today, it can't be much longer.



Sunday, November 6, 2011

Happy birthday, my blog

Yes, Unpublishable Thoughts has reached its third birthday. Despite the difficulties in posting regularly (I often don't) and coming up with insightful posts that add something to the crowded blogosphere (ahem, as I was saying...), it's still here.

Unfortunately, the main reason I started blogging - the financial crisis and the resulting recession/depression - is also still here. Three years on, things look increasingly desperate, and we're still a long way from the kind of political transformation that I fondly imagined would take place once the failures of free market idolatry were revealed to all.

By the way, my first post was a celebration of Obama's election victory, and shortly after I mused on the consequences of Britain's decision to stay out of the euro.

Roubini and Depression

Krugman cites Roubini On Internal Devaluation characteristically predicting gloom and doom in Europe. I was optimistic about European leaders responding to the obvious disfunctions in the Eurozone institutions by enhancing the EU's capacity to do the kind of things states do when faced with asymmetric shocks. Now I'm not so sure. The failures of the past two weeks make it more and more likely another Lehman-style collapse will force their hand. By that stage, the distrust between member states and the increasing costs of resolving the problem will make it harder to cut the kind of deal that is needed.

In short, I'm depressed. Thanks, Nouriel.


Friday, November 4, 2011

Rogoff and Eurojunk

Kenneth Rogoff weighs in to the debate surrounding the G20 (The eurozone does not need IMF help) in the FT today.

As well as rehearsing a few well known arguments about the inadequacy of the Eurozone's governance arrangements, he tellingly suggests that

it is hard to see much benefit in (the IMF's) involvement, aside from providing a fig leaf for large-scale European Central Bank purchases of euro sovereign junk bonds

And this gets to the nub of the matter. The only plausible way of keeping the Eurozone together is for the ECB to do what any national central bank would do when faced with a sovereign debt crisis - print money to buy the debt. This is off the table, for political reasons. But it is the only way out, and we will have to get there at some point. So how?

One way is the IMF route suggested by Rogoff, another messier, but more likely, route is that the money will be printed to bail out European banks when the default actually happens. Strangely, in the weltanschauung of the current global leadership, it makes more sense to bail out banks than states. The logic is the same, but of course the damage (political as well as economic) is greater.

There is a pattern in this whole saga. The policies that might work economically don't work politically, and viceversa (the now famous Eurovenn). But when the politically palatable policies fail, we edge towards the economically viable ones, albeit having raised their costs and created a lot of damage along the way.

A set of arrangements designed to have as little democratic legitimacy and executive efficacy as possible is proving catastrophic when faced with a serious crisis. The EU has to become something radically different, or jump back to the 1970s.