Last Days Of Pompeii?

This week we got what seemed to be some good news in the ongoing Euro debt crisis. Bond spreads in many of the countries on Europe’s periphery tightened vis-their German equivalents. Unfortunately we also got some bad news to go with it (no silver lining these days without the accompanying black cloud it seems): the tighter spreads were the result of a weakening of German bunds (or a rise in their yields) following what many considered to be a failed bond auction.
Continue reading

It’s not dead, it’s resting

Financial Times 22 November 2011:
In the longer term lending markets, Europe’s banks have largely been unable to raise new senior unsecured debt, the bread and butter of their funding, in recent months as investors fret over the effects of the eurozone crisis.
Since the beginning of July, the region’s banks have sold a collective €11bn of senior unsecured debt according to Société Générale data. That compares to €121bn raised year to date, and about €150bn raised annually in 2009 and 2010. In the longer term lending markets, Europe’s banks have largely been unable to raise new senior unsecured debt, the bread and butter of their funding, in recent months as investors fret over the effects of the eurozone crisis.Since the beginning of July, the region’s banks have sold a collective €11bn of senior unsecured debt according to Société Générale data. That compares to €121bn raised year to date, and about €150bn raised annually in 2009 and 2010.

Irish Times 19 November 2011 processology on the 2010 Irish IMF/EU program  —
Tension surfaced as [Brian] Lenihan [Finance Minister] sought to raise the possibility of imposing losses on senior bank bondholders, to ease the burden on the State, which the ECB opposed but the IMF believed would be feasible. Fearing an outburst of contagion in wider bank markets, the ECB insisted that a “relatively small amount of money” was at stake against the risk of destabilising the total stock of European banking debt. But the IMF refused to yield, saying the question should not be ruled out. “The idea smouldered in the background,” says a source. The ECB kept seeking to have the notion taken off the table entirely while the IMF and the government sought the opposite. Legal advice was taken, yet there was no end to the stalemate.

So the ECB is requiring Ireland to make payment in full to legacy bondholders in Irish banks with the rationale of not scaring the market for senior unsecured bank debt … a market that is now, of its own accord, dead.

How Would You React To The News Your Local Central Bank Just Went Bust?

Well, it’s been more time than I care to remember since I posted anything on this site. In the interim many things have happened, especially on the European sovereign debt front. I think I now have plenty of stuff lined up to waffle about, but maybe one simple way to ease myself back in to the world of blogging would be to republish the lengthy interview I just gave to the website Barcelona International Network. The topics covered range from the debt crisis itself, to prospects for Spain under the new Partido Popular government of Mariano Rajoy, and to the kinds of tensions with might arise in the months and years to come between Catalonia and the rest of Spain, and, of course, how this relationship might itself in turn have an impact on the debt crisis itself. Continue reading

Don’t make decisions about money when you are poor

Ah, behavioural economics. Remember when we imported evolutionary biology into psychology and how suddenly neither field had any stupid ideas in it? It looks like we’ve done it again. Astonishingly, hungry people value filling, energy-dense food a lot. Well, yes. That’s what the word “hungry” means.

You should never make decisions about food when you are starving. When you go to the supermarket hungry, the food you are drawn to is high-calorie junk food,” said Dr Alain Dagher, a neurologist at the Montreal Neurological Institute. “You assign way too much value to calories and so way too little to health and other things.”

No, you should never make decisions about food when you are starving. By the same logic, I suppose, you should never make decisions about money when you are poor, or about charity when you are rich. Of course, if you’re hungry it is rational to want calories. You do, in fact, want calories in the old sense of the word “want” – you need more of them. Presumably, you should wait until you aren’t as hungry before deciding what to eat?

Before we descend into cheap snark, there’s an important point here. Dagher is quoted down at the bottom of the article as saying that this may explain why people who miss meals and eat at irregular hours tend to get fat. Fair enough, and good advice. But the problem is that by the time you get off the third bus and stand in front of the aerosol-cheese aisle, you’re hungry. You’re not somehow faking it, and signs lecturing you about healthy eating aren’t going to stop you eating. The point is to avoid getting into this position in the first place, which might involve things like changing jobs or moving that are difficult and require resources.

Similarly, fans of “nudge” tend to complain that poor people make bad decisions about money, typically by prizing cash up front above everything. To put it in econospeak, irrational discounting leads them to have extremely high liquidity preference. But liquidity is useful, and people tend to want it if they are facing a dangerously uncertain future. And typical reasons to need cash fast include things like “topping up the electricity meter”, “the kids are hungry”, “collection goons are threatening physical violence”. It’s not as if they don’t need cash on hand for very good reasons.

Where is the line between responses that are merely insufficient, and ones that actually tip over into mockery?

Is the best NGDP targeter a union?

So, a good row in comments at Nick Rowe’s blog, about nominal GDP targeting. I think I should probably develop the argument a little more. This particular “leftie” has doubts about NGDP targeting because, basically, I think it relies on assumptions about political economy that don’t hold.

Chris Dillow argues that the Bank of England is currently operating something very much like an NGDP target, in that it seems to have decided that inflation being over target isn’t a problem as GDP is in the toilet. I would add that the UK Treasury has a declared policy of austerity plus “monetary activism” – i.e. a ZIRP, quantitative easing, and at least benign neglect of the sterling exchange rate. (Although it devalued sharply early in the recession, it’s now picked up somewhat, so you can’t really say that they have a policy of competitive devaluation. But they certainly aren’t trying to push it up, and I suspect they’d welcome it if the rate went lower still.)

Now, this policy is certainly managing to add quite a bit of inflation to the flat or falling real GDP. Even the relatively low-reading CPI is over 5%. This is probably helping with the debts from the Great Bubble, but is it working for the real economy? The problem here is that prices are rising at an impressive clip but wages aren’t. The simple truths of household budgeting can only mean that consumption, the biggest chunk of aggregate demand, will be declining and that’s precisely what the statistics show. On the following chart, the red line shows the change in private consumption, the green line shows the change in wages, and the blue line shows the change in the consumer price index. Consumption obviously tracks wages, but it seems to be strongly influenced by the spread between wage and price inflation.

UK households get squeezed by shadow-NGDP targeting

As a result, absent a massive export (what, with depression in the EU?) or investment boom (and a pony), the economy is going nowhere fast. If this situation persists, whatever is gained by inflating off the debts will be lost on GDP growth. The exact reckoning depends on how much the impact on wealth-effect of reduced debt helps demand vs. how much the squeeze on household budgets hurts it. But the key point is that the effects of the policy are working against each other, reducing its effectiveness

At this point, Nick Rowe accused me of being fallacious, being like Ron Paul (the guy whose newsletter advised readers to arm themselves in order to shoot at their black neighbours because “the animals are coming”, and worse, a big fan of let’em starve gold standard macroeconomics – stay classy, Nick), and being like Michal Kalecki. I guess that last one is an improvement.

His point is that, in theory, changes in the unit of account (like inflation) shouldn’t change anything in the real economy. Knock a zero off the currency, or tack one on, and relative prices – like pints of beer per hour of labour – should remain the same.

Well, that’s sensible enough in as far as it goes. However, it may not go very far. It’s trivially obvious that inflation (or deflation) does have different effects on different actors in the economy. People with lots of liquid savings lose out, people with debts benefit. People whose money is invested in bonds (if they aren’t indexlinked) lose out; people whose money is invested in shares tend to benefit. Entrepreneurs do well, rentiers don’t. In general, inflation (or deflation) changes the terms-of-trade between the present and the future. Inflation causes people to bring forward purchases, deflation to put them off.

To understand this, let’s work through the process. So there is inflation, and both prices and wages rise. But for some reason, prices inflate more than wages. Aggregate demand will, all other things being equal, be reduced. What happens if prices keep going up faster than wages? Eventually, they will price themselves out of the market and there will be a recession, which will eventually drag prices back in line. Mr. Keynes, however, will remind us that the long run can be very long indeed. If nominal prices were frictionless, of course, this wouldn’t be a problem, and I wouldn’t write this and you wouldn’t read this, and Nick Rowe would be out of a job as a macro-economist. We have to deal with the empirical realities.

Of course, I’ve left out an important actor here. What about workers? Sticking with the standard economic apparatus, you’d probably say that if prices inflate faster than wages, “wage bargainers” will integrate higher inflation expectations into their negotiating position and bid wages up. This is all very well if they can negotiate a raise. But we’re starting off in a recession, in the zero lower bound environment, with millions unemployed! Worse, we’re coming off 30 years of macro-economic policy designed to defeat the wage-price spiral – i.e. to damn well stop them bargaining wages upwards and to set expectations of wage inflation as low as possible.

This is where the political economy comes in. The idea of getting out of depression via NGDP targeting requires robust wage bargaining. In the absence of it, in a political context that has invested huge efforts in the destruction of expectations of wage growth, it is useless if not actively harmful.

There’s also another trap here. If prices have to overshoot and fall back in order for monetary neutrality to work, this requires deflation. Deflation is not generally considered – even by the most ferocious monetarist – to be a great recovery plan. And it is the exact opposite of an inflationary exit from a balance sheet recession.


Here’s a helpful chart of consumer price inflation and wage inflation in Canada from 1970 to the present day! As you can see, there is absolutely no spread between them. Or…is there?

Prices can rise faster than wages

More energetic remedies

“We [Eurozone] all have to become more competitive” — Jens Weidmann, Bundesbank President, in a FT interview.

Alice in Wonderland, Chapter III:

‘But she must have a prize herself, you know,’ said the Mouse.
‘Of course,’ the Dodo replied very gravely. ‘What else have you got in your pocket?’ he went on, turning to Alice.
‘Only a thimble,’ said Alice sadly.
‘Hand it over here,’ said the Dodo.
Then they all crowded round her once more, while the Dodo solemnly presented the thimble, saying ‘We beg your acceptance of this elegant thimble’; and, when it had finished this short speech, they all cheered.

Sympathy for the devil. Well, at least he’s not Berlusconi

Well, what a week that was. 7% was the new 6%, the cows broke through the ECB’s electric fence, the Greeks took a week to decide who ought to be prime minister after, to be honest, the G20 decided George Papandreou shouldn’t be, and Silvio Berlusconi went the same way.

It’s hard to feel much for bunga boy, but this post from James Hamilton at Econbrowser explains why I feel some sympathy for the old devil. Basically, as everyone sort of knows, the long term constraint on a government budget is that nominal GDP growth is ahead of the nominal interest rate on the debt it needs to raise (or roll-over) every year. As Italy is close to primary-balance, the roll-overs are the interesting bit.

How you think about this is important – quite a few people are arguing over whether Italy is “illiquid or insolvent”. But this is a distinction without a difference, as it’s quite possible to get from solvency to insolvency (or the other way around) just through changes in the nominal interest rate. The rate is both cause and effect at once. On the other hand, you could say the same about GDP and indeed Hamilton and our own Ed Hugh do.

But once you accept this, there are some important policy implications. For a start, it creates the possibility of self-defeating austerity.

If you decide to increase taxes and/or reduce government spending in order to increase the primary surplus and pay down the debt faster, you are basically going to reduce nominal GDP. Public-sector saving is a withdrawal from national income. You may argue that this represents supply-side reform that will have good consequences down the line, but does anyone imagine that the long run was uppermost in anyone’s mind last week? And if it was, how come Italy can sell one-year treasury bills at better rates than it can 10-year bonds? Clearly, the markets actually expect that the worst is still to come.

Similarly, you might argue that it is internal devaluation, but then, the constraint is nominal GDP growth higher than nominal interest rates. And you’d have to make some brave assumptions about the price-elasticity of your exports, the percentage of their price accounted for by labour, and the impact on the consumer sector of the internal devaluation. The condition of non-exploding debts says nothing about whether growth is internal or export-led.

Another problem is that the market can stay irrational longer than you can stay president. Imagine a scenario in which there really is some package of reforms that need a dramatic cuts plan right now, but certainly will pay off in higher GDP growth in the future. I mean, I can’t, but perhaps others can, as so many politicians seem to manage it. Does anyone doubt that, if it depressed GDP in the first year enough to get significantly under the constraint, that the interest rate wouldn’t spike high enough to bring about a massive budget crisis in short order?

So yes, Berlusconi was dancing around the very real possibility of a completely pointless and indeed self-defeating purgebinge. Wouldn’t you?

There is a wider point here. Kantoos is very keen on the point that Italy lost a sizable margin of competitiveness during the 2000s. (And who’s responsible for that? we all cry – would it be the dynamic businessman from Milan with the permanently refilled Viagra prescription by any chance?) But this Street Light post makes an excellent point. Southern Europeans put in more hours per worker, and in some countries more of them work, than Germans. The fact that all this effort is going to waste should embarrass everybody, and especially Silvio Berlusconi. But it is more embarrassing that the proposed solution is to put a lot of them out of work!

That reminded me of this post of Peter Dorman’s at Econospeak on another frequent AFOE concern, demography. He makes the excellent point that it is a problem in so far as productivity growth per worker doesn’t keep up with the dependency ratio, and only in so far as it doesn’t. If you want me to take you seriously about why Italian or Greek wages should fall, kindly set out your proposals for what Italian and Greek management can do to close the productivity gap.

There’s an argument that the best thing managers could do would be to resign and leave the workers to self-manage, but it’s somehow unlikely that this will be on offer. It’s true, however, that getting rid of employment protections has no measurable benefit in terms of GDP growth.

All that said, Dani Rodrik has a fascinating paper out on manufacturing and productivity. Specifically, it’s the only sector that shows a clear global trend in which less productive economies catch up with the best in class. Worryingly, this is most pronounced in exactly the subsectors that the German economy is strongest in. That certainly puts this Blodget Insider post in an interesting light. On the other hand, even in China, we’re seeing the end of cheap labour.

Sewing? No. Reaping.

The deflationary settlement of intra-eurozone imbalances has not necessarily developed to Germany’s advantage. German industrial order books shrank by 12.1% for exports to the eurozone, while orders from the home market fell 3% and from the rest of the world by 0.3%. Interestingly, the worst sub-sector was semi-manufactured goods and chemicals, i.e. inputs into industrial supply chains. This, to me, suggests that the crisis is affecting places like northern Italy – not just selling fewer BMWs to the periphery, but also selling fewer fancy chemicals to go into the plant in La Spezia that made the propellers for the Queen Elizabeth class aircraft carriers.

Meanwhile, does it worry anyone else that no media outlet has managed to report Angela Merkel’s actual words leaving the G20? Reuters started it, but didn’t provide an actual quote, and anyway it’s usually good practice to distrust any English-speaking journalist’s German. At the same time, the Guardian‘s live blog gave up and started reporting what people were posting on Twitter. Not just that – I’ve also seen journalists referring to “Berlusconi’s economic stimulus plan”. If only!

It’s been a bizarre week, but if the papers can’t do mindless stenography of the words of the powerful, what are they for?

Occupy the space to the left of the European Council. There’s a lot of it

This morning’s Irish Times reports that German opposition leader, former environment minister, and Social Democrat Sigmar Gabriel was in town. And what did he say? Every damn thing.

THE AUSTERITY measures being imposed on Greece are “mad”, and indicate that Europe learned no lesson from the rise of the Nazi Party, Germany’s main opposition leader said yesterday. Sigmar Gabriel, the chairman of the Social Democratic Party and potential future chancellor, said the measures were “mad” and amounted to an “evil circle”….At a seminar organised by the Institute of International and European Affairs in Dublin yesterday, Mr Gabriel cited the example of Weimar Republic chancellor Heinrich Brüning, who cut successive budgets during the Great Depression. Germany ended up with six million people unemployed. Brüning’s cutbacks contributed to a rise in support for the Nazi Party, which grabbed power in 1933.

He went there. Wham.

Mr Gabriel said it would be “impossible” for Greece to solve its problems without a policy for growth and unemployment. He accused the European Council of leading the country into a “dead-end street”.

Mr Gabriel said countries such as Greece and Italy should have taken advantage of lower interest rates when they joined the euro zone to develop their economies and infrastructure and become more competitive. Instead, they used it for current spending.

That, at least, isn’t controversial. But this is:

He also criticised his own country, which had accumulated about €1 trillion in savings that could have been invested in the real economy, but instead went into high-risk investments and real estate.

Well, yes. As I said back in May, 2010:

Every Sparbuch is the flipside of a tax break for a mobbed-up developer setting fire to a Greek hillside. Obviously, it would be silly to hold individual German savers responsible – but the Great Banks of Frankfurt, the institutions through which the German trade surplus is recycled?

However virtuous all those savers in Exportland were (if you go with Angela Merkel) or however successful German internal devaluation was (if you go with Kantoos) or however ruthless German politicians and executives were in demanding wage cuts in Germany and a massive trade surplus with the rest of Europe (if you go with me), it seems pretty clear that the European financial sector failed to allocate the capital it collected up north into productive uses. Instead, well, we got golf courses in the semi-desert of Andalusia and ships flagged-out to Liberia.

You might not be surprised to find that Gabriel’s remarks were part of a coordinated push. Here’s the piece the German, Swedish, and UK opposition leaders pushed out later in the day. The key points are that austerity everywhere isn’t helping, that something needs to be done about banks, that the politicians have lost legitimacy and authority, and that we need the surplus states to reflate and enjoy some sunshine, already.

It’s high time there’s an opposition program in Europe. This could be better, but it’s a start.

Meanwhile, of all people, Marine Le Pen is going to Occupy Wall Street. That’s what narrative power sounds like.