The A-b-e Of Economics

And the world said “Let Shinzo Abe be”, and all was light.

A new craze is sweeping the planet. Known by the title “Abenomics” over the last couple of years it has been steadily gathering adepts in financial markets across the globe. Despite the fact Abe’s move fits comfortably within the austerity vs growth policy axis, at the heart of the new approach lies not a strategy to directly create growth per se, but rather one to try to induce inflation. For those who have not been following the Japan saga as it has developed over the last twenty odd years this whole debate may seem like a strange way of thinking about things. After all isn’t inflation supposed to be a bad thing, one central banks are supposed to combat? And how can a country possibly become more ever more competitive by force-feeding itself inflation?

Of course, falling prices are not necessarily in-and-of themselves a bad thing – as any old consumer will tell you – since products get cheaper and cheaper with each passing day. So the run of the mill consumer might find life in Japan quite a pleasing and desirable thing, especially if that particular consumer happens to be retired and living on a fixed income derived from savings as indeed many contemporary Japanese actually are. Falling prices only really become a problem in a more general macroeconomic sense if they lead people to postpone consumption, and if this postponement becomes self-perpetuating in a way which leads prices to continually fall, as the combination of constant productivity increases and stagnant demand serve to produce perpetual oversupply. Falling prices also represent a nasty headache for policymakers since while prices go down the value of accumulated debt doesn’t, and herein lies the rub. So additional “stimulus” which doesn’t lead to increasing nominal GDP simply pushes the sovereign debt even farther along an unsustainable trajectory.

As everyone now recognizes and accepts Japan has a rapidly ageing population and an ageing and contracting workforce. This is the end result of several decades of very low fertility. The number of children in Japan fell to a new low in 2013, while the amount of people over 65 has reached a record high as the population ages and shrinks. This demographic background, which has really been obvious to demographers for years, has only lately come to be regarded as a significant factor in the “Japan problem” by economists. This neglect has most probably been due to the influence of a deep seated predisposition among adherents of neoclassical growth theory to think that population dynamics don’t fundamentally influence economic performance in the long run. For many years the Japan phenomenon was simply seen as a classic example of what Richard Koo terms a “balance sheet recession” wherein the need for the private sector to deleverage from excessive indebtedness leads to a form of structural under-consumption.

Perhaps the most important thing which the whole Abenomics episode has brought to light is the urgent need to bring the existing corpus of economic theory somehow up to date with our modern realities. Despite all the talk of policies for “growth, growth, growth” a simple look at the population outlook in OECD countries and especially the potential work force numbers suggests that, at some point or another, economic growth will turn broadly negative. So the real point is there is an experiment being conducted in Japan, but the experiment isn’t Abenomics (which I suspect won’t work, and could end badly). No, the experiment is about learning to grow old with dignity, not as individuals, but as societies. It is about managing debt in a time of deflation, about giving opportunities to the young, even while the force of the ballot box rides with the old, and about finding ways to ease that rate of work force decline to give some additional room to allow productivity to help, which means both immigration and helping the young – at they are the ones who start families.

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Hungary’s Matolcsy Joins Japan’s Abe In Practicing The Ancient Art Of Verbal Intervention

It’s amazing what you can achieve these days just by promising to do something. It’s also fascinating to watch just what a storm you can stir up.

Last July Mario Draghi surprised markets when he  vowed to do anything – whatever it would take – to save the Euro. He didn’t go into details, he didn’t really need to. He simply informed his audience that whatever he did it would be enough. What I suppose no one – not even Mr Draghi himself -  imagined at the time was that doing precisely nothing would turn out to be sufficient. Yet since that time that is just what has happened, he has done nothing, nothing whatsoever – no bonds have been purchased and no country has even asked for aid. So to date this verbal style intervention has been exactly what he said it would be, enough. Continue reading

When opposites agree

A surprising moment of consensus: Der Spiegel and the Taz both rip into Peer Steinbruck, former German finance minister and leading the race for the SPD’s candidacy as chancellor. Not only that, they do so for substantially the same reasons.

First, they agree that Steinbruck denied in the autumn of 2008 that the financial crisis was a problem, claiming that it was the Americans’ fault and nothing to do with Germany, and even said that there was no need to bail out the banks. Secondly, they agree that he argued vehemently that a response to the crisis would be national-but-coordinated, rather than European, thus leaving Ireland and Spain to cope on their own, and he refused to lead an IMF working group on the issue. These days, he supports euro-bonds. Thirdly, despite all his bluster, he then reversed course and bailed out the banks, setting a precedent.

It’s fascinating that the green-left Taz and Der Spiegel, which might as well be the Bundesbank’s house journal, manage to agree on so much. Taz is predictably more radical, pointing out that WestLB swelled up with dodgy asset-backed securities and eventually burst while Steinbruck was its regulator and that he even got a light-touch regulatory policy for derivatives written into the 2005 coalition agreement, and that he also denied that there was any need for stimulus in the autumn of 2008 before changing his mind. (Who now remembers crass Keynesianism?)

Meanwhile, Guy Verhofstadt and Danny Cohn-Bendit have a manifesto. What can those two possibly agree on? Inevitably, it’s more federalism. As with everyone who uses the phrase “more Europe”, what they want to do with it isn’t clear.

Making the eurozone fit for the challenges of the 1990s

British economist Jonathan Portes remembers the UK’s exit from the Exchange Rate Mechanism:

We argued that the fundamental problem was that we’d joined the ERM at the wrong rate; sterling was overvalued, meaning that we were stuck with a structural current account deficit. The only way to maintain the peg would be through what is now, in the eurozone context, referred to as “internal devaluation”; that is, real interest rates at a higher rate than dictated by internal conditions, and a long and grinding squeeze on wages and prices.

Our solution? We didn’t dare suggest complete abandonment of the ERM. One possibility was for sterling to “realign”, that is devalue, to a considerably lower rate, boosting exports and allowing interest rates to fall. Even better, politically and perhaps economically, would have been if the Germans could have been persuaded to realign upwards, so avoiding the perception that sterling was being singled out; but the French were resolutely opposed to any devaluation of the franc.

The fascinating thing here is, of course, that nothing has changed. In many ways, this is because the issues haven’t changed. Keynes said that the whole complex problem of European currencies and trade in the 1920s could be reduced to one question: how much of France’s war debts would be paid by workers and how much by savers, whether through taxation or through inflation. The answer would set the price level and hence the exchange rate, and how much of a trade surplus Germany could run, and therefore how much of Germany’s war debts could possibly be paid.

Similarly, in 1992 the questions was how the costs of German reunification would be split. Taxation was chosen over inflation, capital was privileged over income. Now, arguably, the question is how the cost of the Great Bubble will be split, and you guessed it. Portes is damning on the reasoning behind this:


The UK had long suffered from periodic cycles of boom and bust, most recently exemplified by the deep recession of the early 1980s and the unsustainable boom of the late 1980s. Monetarism – targeting various measures of the money supply – had failed miserably. The alternative was to “import” credibility from a country with a demonstrated record of maintaining low inflation while avoiding boom and bust – Germany, and we could do exactly that by tying our exchange rate and monetary policy to theirs…

But for me, the most important lesson was a more general one about “credibility”- a concept often used and abused by both politicians and economists. As with the ERM, the argument made by the current government and its supporters for sticking to its fiscal consolidation plan, despite its evident failure, is that the strategy has established “credibility”, especially with financial markets, which can only be preserved by sticking with it.

But of course this is not a justification, economic or otherwise, for the policy. Instead it is an argument for never changing policy at all…

The real hit to credibility comes from sticking to unsustainable policies; and economic success comes from abandoning them and doing something sensible instead. That is one lesson from Black Wednesday we could usefully remember.

Meanwhile, Migeru from the collectif antilibérale has an excellent column taking a sector-balance approach.

Taking A Man At His Word

Legendary hedge fund supremo Ray Dalio is in ebullient mood. Following a series of moves by Mario Draghi to underpin European government financing Dalio told Bloomberg that, in his opinion, the euro will now “likely” stay together because existing growth-constraining austerity measures will henceforth be balanced by money printing over at the European Central Bank. His statement was, of course, a response to ECB President Draghi’s save the Euro pledge. Continue reading

What’s Up Doc?

According to Wikipedia, Kabuki is a classical Japanese dance-drama known for the stylization of its plot and for the elaborate make-up worn by the key performers. This definition also seems to fit the drama in an unknown number of acts currently being acted out on the European stage by some of the continent’s leading central bank players perfectly.

It all started last Thursday when, as surely everyone but my blind and deaf uncle must now know, Mario Draghi made what is widely though to have been an important speech. We will do whatever it takes, as long as it is in the mandate, he is reported as saying. And since stopping anything which could be life-threatening to the Euro dead in its tracks forms part of the bank’s mandate under any conceivable interpretation, the ECB now have the widest possible brief within which to circumscribe their actions. The only limitation is that it should be enough, just enough, and no more. As Mario Draghi said, “believe me, it will be enough”.
Continue reading

Whom The Gods Would Destroy

The Times They Are A Changin, as the old song goes. Neither in jest nor in total earnest was a truer word ever said in terms of the 2 year old Euro Debt Crisis. The to-ing and frow-ing we have seen over the last few days as commitment to decisions taken at the recent summit started to wobble only serve to underline how hard it is at times to change. These days I have no central “Euro” scenario. Only tail scenarios exist, under which the debt crisis veers in either one direction or the other according to the decisions taken or the absence of them. Naturally this makes the eventual outcome very hard to foresee, which is why the financial markets are having such a hard time of it, and why we see so much volatility.

In the case of the full banking, political and fiscal union scenario the efficient causes which could make it happen are obvious: just keep the various participants looking down into the abyss often enough and long enough. In the case of complete breakup things are rather different, since it is hard to concretise what would actually bring it about, although the risk is evident, and indeed in many ways it seem a more probable end point than the other one.

After thinking about this for some time, the conclusion I have reached is that it is towards political risk, and the progressive destabilizing of Europe’s democratic systems, that we need to look, which is what makes recent events in Romania look like something rather more than a mere historical footnote. Continue reading

Political union is transfer union

It is very often suggested that there is no point looking at solutions to the European crisis that don’t involve more “political union”, an EU institutional term meaning a move towards a more centralised and “federal” (in the special EU sense) union. This argument is curious.

For a start, what is it about political union that is meant to solve the problem? Some people will probably say that it would be “a message” or “a signal” or something, a demonstration of commitment to the European Union that would in itself create confidence. But this sounds a lot like hand-waving to me, or the kind of genius that suggested introducing a pan-European tax as a way of making the Union more popular (yes, Mr. Verhofstadt, it is not entirely forgotten).

More seriously, political unions tend to have a substantial budget and the capacity to use it in a discretionary sense. In the political union between the provinces of Germany, there is a systematic redistribution of money between richer and poorer parts of the union. In the political union between the states of America, there is less overt redistribution, but there are very large federal agencies that in practice tend to redistribute money around the union. NASA, for example, had a secondary and very important role subsidising the industrial development of the South-Eastern US, and this goal influenced important design decisions in the Apollo and Shuttle programs.

It is also true that some degree of redistribution is inseparable from anything that could be described as a political union. Try to imagine the opposite. The political union would have to be designed so as to make absolutely no change to the a priori distribution of income, an exercise that boggles the mind in its complexity and futility.

The simplest model would probably be a libertarian utopia/dystopia with a minimal state devoted solely to defence, funded by a flat tax on the citizens. But now imagine what would happen when its army deployed for annual exercises. A large quantity of income collected all over the union would suddenly be spent in the exercise area. If, as is likely, there were a limited number of convenient training areas, or the army tended to train where it expected to fight strategically, we would expect to see a military-industrial complex emerge in those areas.

Just because your biggest customer is the army doesn’t make you useless, of course, it may make you indispensable. And in that case, our political union that is not a transfer union would have to think about how to keep you going between deployments, in which case it would be undertaking both industrial and regional policy. A state (or political union) that has no budget, or a budget that is economically indistinguishable from the absence of one, is no state (or political union). Marx thought that the state would wither away in true communism; you can argue about what he meant, but I think he imagined a society in which the functions of the state were either unnecessary, or else carried out by the citizen as a matter of course, not even perceived as a duty. A state whose budget changed the structure of the economy so little as to be totally non-redistributive would, I think, have a fair claim to have withered away.

I can’t see how an entity that made no transfers of wealth or income can be considered to have the functions of a political union. Further, even if a political union was created that was not also a transfer union, it wouldn’t solve the problem. Various parts of Germany need transfers from others; the same goes for all political unions. Declaring “political union” doesn’t solve the problem in itself. It might be taken to mean “direct ECB management of Greek public finances”, but then this is just hoping that the Greeks can find some more money with more will, and perhaps a pony as long as the pony is Karlsruhe-compliant.

Here is the problem: political union is transfer union, or it is not political union, and anyway, if it is not transfer union it is no solution. Transfer union is unacceptable. Therefore, political union is unacceptable, and anyone who talks political union is saying “Let the file mature while we do what the EU does best, holding an Inter-Governmental Conference”.

On The Brink Of What?

This weekend I have been thinking quite a lot about what the world is gonna look like on Monday, and have come to the conclusion that it won’t be that different from the way it was last Friday. The big news surprise of the weekend was in fact Greece related  - since the national football team qualified for the quarter finals of the Eurocopa, beating the Russia by a resounding 1-0.

Oh yes, they also had elections in Greece, didn’t they? Continue reading

ECB decides now is not the time for complexity

Strangely timed ECB announcement

The Governing Council of the European Central Bank (ECB) has decided to discontinue the preparations for the Collateral Central Bank Management (CCBM2) project in its current form. In the project detailing phase, a number of challenges in the field of harmonisation were identified and the Eurosystem has decided to address these issues first before proceeding further with a common technical platform. The existing Correspondent Central Banking Model (CCBM) for cross-border collateral management remains in place.

Tracking back through the link trail, it seems that CCBM2 is a project that has existed since 2007, and was being jointly led by the Central Banks of Belgium and the Netherlands. It was focused on unifying the platforms for handling of cross-border collateral posted with the national central banks. Now while the functions of CCBM2 embraces some hot-button issues such as collateral and Target2 balances, this all appears to be a sensible decision that an IT-heavy project was dragging on, getting more complicated than first envisaged, and probably diverting time from other more important tasks. But with the fevered speculation out there about this weekend, did this seem like a good day to bury bad news that could instead be the wrong day to be telling people that the Eurosystem collateral management system has a few holes in it that won’t be fixed for a while?