Two days ago, Financial
Times columnist Martin Wolf made an attempt at Thinking through the
unthinkable. The "unthinkable" was the breakup of the
Reflections on the Easily Thinkable
For starters, a eurozone breakup is hardly
unthinkable given that no currency union in history has ever survived in the
absence of a fiscal union, and the Eurozone has no
such fiscal union.
I suppose one might not want to think about history while praying for a
miracle union, but the German Supreme court gratefully put a kibosh to the
bureaucratic nanny-zone of never-ending regulation with a definitive ruling
that no more German taxpayer funds can be out at risk without a common voter
Please see Germany's Top Judge Throws
Major Monkey Wrench Into Leveraged EFSF Machinery, Demands New Constitution
and Popular Referendum for Further Powers for details.
I do not want to dwell on the "easily-thinkable unthinkable",
I want to focus on poor economic theory within Wolf's post in regards to proposed
solutions to the crisis.
Four Proposed Solutions
Wolf quoted Nouriel Roubini's
proposed list of solution.
Restoration of growth and competitiveness through
aggressive monetary easing, a weaker euro and stimulatory policies in the
core, while the periphery undertakes austerity and reform.
A deflationary adjustment in the periphery alone,
together with structural reforms, to force down nominal wages
Permanent financing by the core of an uncompetitive
Widespread debt restructuring and partial break-up
of the eurozone
Wolf points out that option 2 will morph into option 4. I concur while
pointing out that is the path we are on, also in agreement with Wolf.
Wolf points out that German would veto option 3 but fails to point out the
absolute silliness of the idea in the first place, which I will get to in a
Option 4 is where we are headed, and the debate ought to be how to do that
correctly instead of how to achieve the impossible option 1 which Germany
would also veto.
I propose, as has Michael Pettis before me, that the best solution is to have
Germany exit the Eurozone rather than Greece, then,
Portugal, then Spain exit in succession.
Breakup Inevitable but How?
Here is a snip from France, Germany have
"Intense Consultations" on Smaller Eurozone;
Breakup Inevitable, but How?
the Eurozone is no longer tenable is at long last at
hand. In fact, "intense discussions" have been underway for months
but are just now admitted to by senior EU officials. ....
The Eurozone is a failed experiment. A breakup is
inevitable just as it has been from the beginning. Structural flaws were too great,
built up over the years. No currency union in history has ever survived
unless there was also a fiscal union.
The key question now is how?
It would be best for all involved if Germany left the Eurozone
and went back to the Deutschmark. Germany would have an immediately credible
currency. Should Greece or Spain leave first, those countries might
experience hyperinflation or massive inflation.
Breakup Scenarios and Logistics of Denial
It's important to remember that Germany suffers regardless. As long as the Eurozone stays intact (it can't and won't over the long
haul) German taxpayers have to keep acting bailing out foreign countries,
foreign banks, and their own banks.
On the other hand, were Germany to leave, the debts to German banks will not
be paid back in Deutschmarks but rather deflated Euros.
On the whole, Germany exiting the Eurozone would be
less disruptive, than massive inflation scenarios in Greece, Portugal, and
If France wants to stay in the Euro, let them. They can have the ECB as well.
Then the ECB will print money to bail out the French banks (just as French
president Sarkozy wants).
Logistics of Denial
Micahel Pettis presented a more detailed discussion
of various breakup scenarios as well as a discussion on the "Logistics
of Denial", in my September 16 article Eurozone Breakup Logistics (Never Believe Anything Until It's
In his opening gambit, to the lead question "Will the eurozone survive?" Wolf surmises "I suspect the
answer is, no."
Thus, it would be more helpful to debate the merits of "how" a
breakup should happen, which countries should leave, and details on how that
happens rather than hoping it won't.
Unfortunately, Wolf pines near his conclusion "[we] must go back to the
first on the menu of options laid out by Mr Roubini. Potentially solvent countries would be financed
and the eurozone would grow its way out of the
History and Common Sense
As noted earlier, unless there is a complete fiscal-nanny-zone with a one
size fits all policy, option 1 cannot possibly work.
Germany would veto option 1, for solid reasons. Moreover, and more
importantly, option 1 would not work anyway for the same reason option 3
cannot work: Printing money never solves anything.
How many times does this have to be proven before it sinks in?
Japan offered mammoth quantities of fiscal and monetary stimulus and all it
has to show for it is debt in excess of 200% of GDP. Economist Richard Koo
pines the lesson was Japan did not do enough stimulus. Sheeesh.
Cash-for-clunkers, multiple tax credits for housing, QE 1, QE 2, a trillion
in fiscal stimulus and a myriad of other fiscally insane programs did not
create jobs or a lasting recovery.
No amount of stimulus would work because the problem is debt. Yet, the Army
of Krugmanites propose we
need to do more.
Greenspan resorted to loose monetary policy and it created the biggest
housing bubble the world has ever seen.
Now Cristina Romer proposes GDP targets by the Fed
to which I responded in Dear Christina ... in light of
the facts I presented above in regards to the experiences of Japan, the
excess reserves at the Fed, the increase in inflation with no increase in
jobs, and the number of people on fixed income destroyed by the rise in price
level while getting 0% on their CDs, you have a hell of a lot more explaining
why "It's different this Time".
For starters the Fed does not control GDP so the suggestion in and of itself
is blatantly idiotic. The Fed can encourage spending but cannot force it. A
trillion dollar mountain of excess reserves of banks is proof enough, yet the
Monetarists want more.
No matter how much money one throws at a problem it is never enough. We had a
housing bubble followed by a crash. Throw enough money around and we will
have another bubble and a bigger crash, or simply a massive debt problem from
which there is no escape.
The average eighth-grader can easily understand this. The average economist
cannot because they are so tied up in monetary theory that has no real world
In September, Bernanke himself said he was puzzled by weak consumer
Bernanke is puzzled over something an eighth-grader can easily figure out.
Consumers have a mountain of debt and are underwater in their mortgages. Debt
is made worse by declining real wages, global wage arbitrage, and a dearth of
ZIRP did nothing to create jobs but it did affect food and gas prices and effectively
destroyed anyone on fixed income.
I would think that should be obvious, but obviously it's not because Bernanke
is puzzled over it. This is what happens when academics become addicted to
economic models that do not work in periods of debt deflation (assuming they
ever worked at all).
Krugman is a big believer in the idea "debt
does not matter". He made the mistake of using Italy as the prime
Guess what? Debt matters. Now Krugman is attempting
to pass off a foolish statement by blaming Original Sin for the Euro Crisis.
question that keeps coming up is, how can I reconcile my scorn for warnings
about bond vigilantes with what is happening to
Italy? This seems especially pointed because I have in the past used
Italy’s ability to carry debt exceeding its GDP as an illustration that
debt concerns were overblown.
The answer lies in the concept of original sin. Not the Pope’s kind,
but the economics kind — the long-standing notion that developing
countries were especially vulnerable to financial crises because they
borrowed in foreign currency.
The key point is that by joining the euro, Italy took a bite of the apple
— it converted its advanced-country status, as a nation issuing debt in
its own currency, into original sin, with debts in someone else’s
currency (Europe’s in principle, Germany’s in practice). That is
the root of its new vulnerability.
Krugman finishes with
"More on all this later, I hope."
I hope so too, starting with my questions
When did you realize Italy gave up the Lira?
Did you not understand Italy was on the Euro when
you used it as an example?
Are you looking for excuses after the fact?
Krugman Joins the Euro Cannot Work Parade
For all Krugman's pissing and moaning about imposed
austerity measures on Europe, he now has the gall to blame the mess in Italy
on "Original Sin" (which I might add also applies to Greece,
Portugal, and Spain).
Oh well, it's a start. Perhaps we can get Krugman
discussing the best way to break up the Eurozone
instead of everyone pretending Roubini Option 1 is
still in play.
As an aside, if Krugman turns to Japan for his
"debt does not matter" model, he will be wrong again.
Two Things We Can Say for Certain
Japan's Debt Does Not Matter Now
It Will, and in a Major Way (we just do not know
when, as with Italy)
All it takes to crush Japan is rising interest rates
or a collapse in its export model. Given the cyclical nature of a great many
things, one or the other or both will. And when it does, Japan will not be
able to get financing.
Debt matters when it matters, and it eventually will. Until it does, we have
to put up with foolish statements from major economists that it doesn't,
followed by excuses when they are proven wrong.
America and China must crush Germany into submission
Wolf's article was hard enough to take but it was followed by an even more
preposterous article by Ambrose Evans-Pritchard.
Please consider America and China must crush Germany into submission
we watch Italy's 10-year bond yields near 7.5pc and threaten to detonate the
explosive charge on €1.9 trillion of debt, it is time for the world to reimpose order.
Yes, this means mobilizing the full-firepower of the ECB – with a
pledge to change EU Treaty law and the bank's mandate – and perhaps
some form of quantum leap towards a fiscal and debt union.
The EU Project has become both dangerous and insane.
"Dangerous and Insane"
What's dangerous and insane is economists like
Prichard demanding treaties be tossed to the wind to test poorly thought out
What's dangerous and insane is economic theory that
says printing presses are the answer. It has never worked in history and will
not work now.
What's dangerous and insane is more leverage. Didn't
Lehman and LTCM prove that? How many more times do we have to prove that
before it sinks in?
What's dangerous and insane is the idea is that
central banks can impose their will on the world.
What's dangerous and insane is doing the same damn
thing over and over and over again hoping for a different result
What's dangerous and insane is the moral hazard
policy of time-and-time-again forcing the 99% to bail out the 1%.
The world will not end if banks fail. Forcing the 1% (banks and bank
bondholders) to take a hit will not cause the world to end either, nor will
it cause lending to cease.
Please, let's stop the blatant hyperbole that suggests otherwise.
The ECB could have and should have let Greece default. "We Say No To
Default" said a dangerously arrogant ECB president Jean-Claude Trichet.
Trichet loaded up the ECB balance sheet with Greek
debt against the advice of Axel Weber. Trichet's
move blew up in his face, and I for one am glad to see it. If only he would
have learned something from it.
The hubris of central bank wizards and economists is dangerous and insane.
Indeed it is central bank wizardry combined with fractional reserve lending
and insane levels of government bureaucracy that is at the root of the
Corruption, Bloated Bureaucracy, Poor Productivity
My advice for Pritchard would be to stop writing dangerously insane ideas and
start reading fellow columnist Nick Squires who has the common sense to write
Italy's debt crisis: doomed
by corruption, bloated bureaucracy and poor productivity
Insane Welfare System
I would also recommend Pritchard, Krugman, and Wolf
read Eight Reasons Why Italy Is
Such a Mess
The root of Italy's problems, the Wall Street Journal argues today, is
that the country "financed generous entitlements with high taxes and
towering piles of debt," and now finds the money running out as the
economy sputters. Indeed, Italy has more pensioners than workers and currently spends
about 14 percent of GDP on pensions -- more
than any other country in the Organization for Economic
Cooperation and Development (OECD).
Silvio Berlusconi pledged to raise the retirement age in Italy to 67 as part of his
raft of austerity measures, but it's a controversial move. In late October,
two Italian lawmakers exchanged blows in
parliament during a debate about whether to revamp the country's pension
system. House Speaker Gianfranco Fini had noted on
television that the wife of the Northern League's Umberto Bossi
had taken early retirement at 39 and cashed in on Italy's generous benefits.
Public Union Pension
Bear in mind that is just one of the eight reasons Foreign Policy Magazine
mentioned. The author called the pension system "wacky". I call
it fiscally insane.
Italy currently has more pensioners than workers. Is that insane or what?
In light of the above, can someone, anyone explain how Roubini's
option number 3 "Permanent financing by the core of an uncompetitive
periphery" can possibly work?
By the way, the same public union pension problem exists in the US and it is
the cause behind massive state and city deficits. Our system will blow up as
well, just give it time.
Instead of focusing on those problems (and for the US I propose scrapping
Davis Bacon, ending all prevailing wage laws, and ending collective bargaining
for public unions) Krugman wants more freaking
Quite frankly, it's insane. Want a compromise? Give me those three things and
I will even take higher taxes.
Exceptionally Sound Advice
My friend Pater Tenebrarum offers exceptionally sound
advice in The 'Technocrats' Are Coming
the EU All About?
“One keeps hearing demands for more centralization – tax
'harmonization', which is new-speak for 'let's impose the highest possible
taxes everywhere', more 'redistribution', and above all, 'more regulation',
especially of the evil financial markets where all sorts of bad things are
happening to sovereign bonds nowadays.
Naturally, fractional reserve banking and the inflationary boom-bust
sequences it has brought forth doesn't even rate a mention – since it
has also enabled the growth of this huge statist moloch
the EU and many of its member nations have become.
What is really needed is some introspection and
remembering what the EU was originally about. Its founders wanted to restore
19th century liberalism to Europe – free trade and freedom of movement
for people and capital within Europe.
They emphatically did not want to erect some sort of socialist super-state.
They wanted to bring back to Europe what the mad socialist and fascist
ideologues of the 20th century had destroyed.
Now we have a bureaucratic monster in Brussels that has produced nearly
300,000 new regulations over the past decade, in addition to the hundreds of
thousands of pages of 'administrative law' and other regulations the member
states themselves produce every year.
It is a miracle we still have a functioning civilization.
If we want the problems to be solved, the most important question should be:
what is needed to enable the production of new wealth? What kind of
environment will be most conducive to reviving the entrepreneurial spirit? It
should be simple enough, but it would of course threaten a great many vested
Crush Into Submission
You cannot fix a problem unless you understand it. Moreover, even if you do
understand the problem, you cannot fit it with unsound theory.
The discussion from Wolf, Pritchard, Roubini, Romer, the vast army of Krugmanites,
and the smaller army of equally misguided Monetarists suggests they do not
fully understand the problem, nor do they understand sound economic theory as
to what it takes to fix it.
To use Pritchard's catchy title, I respond "We Must Crush Ambrose
Evans-Pritchard, Nouriel Roubini,
Martin Wolf, the Army of Krugmanites into
That is the mission, and it is a desperately needed mission at that. To
accomplish the mission we must prove to the group, to their satisfaction,
their solutions are nonsensical.
Unfortunately, the only way I can think of doing that is to give the group
everything it wants, then watch it blow sky high.
That means turn on the global printing presses, bail out the public pension
plans, pour more money into Medicare and Medicaid, create a "living
wage" indexed to inflation, give Krugman his
tariffs, and declare China a currency manipulator. Not enough jobs? No
problem, the government can easily create them. That's what the vast army of Krugmanite Borgs thinks.
There is only one problem with the idea. When the plan blows sky high, Krugman would say "It wasn't enough".