I appreciate your frustration, and I read you suggestion with interest. Can I own up to something here, I haven’t a clue what will work, and worse, I haven’t the time to go into all the arguments – since they truly are myriad.

I am not saying that this is all not very important, just that it is beyond my expertise, and at the end of the day I think we all need to recognise our limitations.

I am focused on some of the macro economic implications of the financial crisis (like deflation) and what we can do about them, hence this post. What to do about the banks? I wish I knew. I just hope that amid all the arguing that is currently going on someone will come up with something that will work, and they can finally restore some sort of order to the whole system, since we badly need it.

Meantime, people are being sent home one (or ten) at a time, and asked to wait and twiddle their thumbs.

Well extraordinary measures must be taken indeed, not only by the ECB, but also by governments. In this perspective I support the idea proposed by Kees de Kort, to force bondholders from banks that are in deep trouble, to exchange their bonds for shares. And only if there is no other way, to support those banks with tax money.
I shall explain. Lets look at the current situation with relation to the positions of the bank’s shareholders and bondholders, and the taxpayers. When there is a threat that a bank goes bankrupt, the owners of this bank (the shareholders) are taking a great loss because their shares will lose a lot of their value. The one’s who were taking the risk of lending money to this bank (the bondholders) are nowadays fully protected by the money of the taxpayers. The taxpayers who have no responsibility for this bank’s bad financial position, have to pay for the bailout. There is something amoral about this situation. Why should people who have wilfully decided to loan this bank money (the bondholders) be fully protected for the risk the have taken, with the taxpayer money? The taxpayers have not taken this risk, but nevertheless the are forced to pay for it.
Now lets look to the situation when under a threat of bankruptcy, the government forces the bondholders to exchange their bonds for shares. In this situation, the Bank will get rid of a lot of debts (the bond loans), and those debts will be replaced with a increase of property (the shares). With this new much better balance account, this bank probably will be financial healthy enough to survive without much tax money. Due to this much better financial position the financial-market will have more trust in this banks future, and the value of the shares will increase. This will be of course good news for the shareholders and the former bondholders. Also, everybody happy.
Ron.

“If I understand him right (and I´m not sure here) he seems to be saying that at close to zero interest rates quantitative easing doesn´t work?”

Well this is a very complex problem. I think familybusiness brings out some of the question. Basically, the evidence from Japan is that quantitative didn’t have a very substantial effect on the price level, although it did stabilise the situation. But this was in part because they focused on maintaining the quantity of liquidity in the bank balances with the BoJ. In fact the ECB has been practicing this kind of operation, especially after last September.

We need to think it terms of two stages here – bashing the credit crunch and changing price expectations. Expanding the balance sheet can do quite a lot in the mid term to ease a credit crunch, but it can’t change patterns of consumer behaviour once negative price expectations set in. To do that you need to convince people that you are really serious about fuelling up inflation.

Then you need to print money and buy government bonds to finance fiscal spending in sufficient quantity that everyone starts to worry that inflation is coming. This is known as “committing to being irresponsible” This is what Kugman seems to think isn’t practical at the moment. I would be interested in why he thinks it isn’t practical. I had an exchange of opinion with him last time round, since I was taking the somewhat obtuse view that GWB might have been a more effective person at convincing people that he was going to be irresponsible that (say) Obama would be now. Unsurprisingly K didn’t seem to see the funny side of that at the time.

Krugman clears this up in his quick response to Scott Sumner.

“My view, which I thought was pretty clear, is that the liquidity trap is real: no matter how much the Fed increases the monetary base, it has no effect, because it just substitutes one zero-interest asset for another. If the Fed could credibly commit to inflation at rates higher than the 2-ish percent target it’s already believed to have, that would be effective. But right now I don’t see that as a realistic option, hence the emphasis on fiscal policy and bank recapitalization.”

Er, no. Germany is the world’s biggest exporter; your argument is the classic The Economist one of wearing a Swiss watch and a (German) Hugo Boss suit, driving a BMW to the airport to catch an Airbus with one eye on your Nokia mobile phone (with its Infineon RF chip and Balda AG touchscreen, talking to a Nokia-Siemens Networks base station), using electricity generated by a Siemens turbine to bother the Germans about their supposed inefficiency.

Further, Germany spent the 2000s having a fairly tough wage squeeze in order to boost export competitiveness. It had both a trade and a budget surplus as recently as 2007. Germany’s problems now are driven by the fact that world trade is in the crapper, and if your economy is specialised in global industrial exports, you’re operationally geared to world trade.

> People here in Germany know (in their brain) that the economic outlook is bad and that the
> situation will get a lot worse.

> On the other hand their personal situation (on average) right now probably “feels” better
> than in years.

Question : how did Germany end up in the state in the first place? rigid labour market, etc, no? too much Government regulation? basically, unethical and uneconomic behaviour. Which to some extent has been addressed, but now we have more on the way with this stimulus bill.

> Wages finally increased significantly in 2008.

> After stagnating since around 2000/2001. Coupled with lower gas prices that means people
> have more available income for the first time in several years. Some gets saved and some
> gets spent. Which might explain why retail sales stayed stagnant rather than fall. And it
> might explain why Germans actually used that car bonus to buy new cars. The money is
> there and that “gift” bonus finally was irresistible.

My view in this is that trying to scrute the inscrutible is the profoundly unwise and doomed to failure.

The economy, in its detail, is beyond human comprehension. It is orders of magnitude too complex even in its original form and then made massively, unpredictably, bizzarely perverse by the pervasive cancer of State regulation.

Because of this whenever you try to manipulate the economy, it always fails. Even if you manage to have some effect in your intended direction – which is frankly improbable – you will certainly have unintended consequences of a far greater magnitude.

Where I wear my Adam Smith tie and see the world in that way, the only game in town for me is to abide by sound macro-economic principles (which inherently implies ethically, where all contracts are voluntary and well-informed), because I *know* they work, and let the rest take care of itself – because it is impossible for humans to care of it.

I believe in individual freedom as an economic policy.

Current Governments do not.

> Also, unemployment year over year in February 2009 was still lower than in February 2008.
> Helped by the government “short-time worker assistance”. If you have to work short-time
> you´ll get a government compensation to partly close the financial gap.

Was it helped? Maybe companies were doing that anyway. Employement depends on the amount of capital in the economy and companies use that money in the best way they can to generate more capital. The Government has taken that capital from these companies, who earned it and to whom it properly belongs and who could have done with it as they please, and as such has reduced employment. The Government then spends it, giving it to people who are now working part-time.

Great. What about those people who don’t *have* a job any more, because of this tax?

What about the fact this money *belonged to someone else?*

> That helps a bit to avoid job cuts now and helps a bit with domestic spending.

No. It increased job cuts, but gave more money to those who are working short-time.

Also, I’ll just go shoot a few people and share out their organs.

> Extending this program, by the way, is also part of the stimulus package.

As you can imagine, for me, this is bad news. More job losses.

Edward, I think the crux of the matter in your proposal is “the produce of the same of those bonds were to be deployed by the commission across the Union to fulfill pre-agreed objectives.”

Which is actually my first concern with your proposal. As in, the “newly-printed” money from the EU bonds might be used for some bail-out, banks or countries. And will subsequently vanish into bank vaults. Never to be seen again because banks are now hoarding money.

Say, we help Eastern Europe with that “extra” money. Don´t you think that some / a lot of that money will or must be used to repay maturing loans? And I don´t think the Austrian, Italian or whatsoever banks will loan that money out again? And if that money doesn´t stay in circulation…

And my second concern.
If that money is used for some stimulus package, doesn´t that allow member states to borrow less money? As in, they use EU money where before they would have used national money for a stimulus package?

I guess my question is how easy or hard is it to actually enlarge the money supply if the banks aren´t functioning?

As an aside here is a Krugman post.
(Assuming HTML code works.)

Quote:
“You still see people saying, in effect, “never mind the zero interest rate, why not just print more money?” Actually, the Bank of Japan tried that, under the name “quantitative easing;” basically, the money just piled up in bank vaults. To see why, think of it this way: once T-bills have a near-zero interest rate, cash becomes a competitive store of value, even if it doesn’t have any other advantages. As a result, monetary base and T-bills — the two sides of the Fed’s balance sheet — become perfect substitutes. In that case, if the Fed expands its balance sheet, it’s basically taking away with one hand what it’s giving with the other: more monetary base is out there, but less short-term debt, and since these things are perfect substitutes, there’s no market impact. That’s why the liquidity trap makes conventional monetary policy impotent.”

If I understand him right (and I´m not sure here) he seems to be saying that at close to zero interest rates quantitative easing doesn´t work?

People here in Germany know (in their brain) that the economic outlook is bad and that the situation will get a lot worse.
On the other hand their personal situation (on average) right now probably “feels” better than in years.

Wages finally increased significantly in 2008.
After stagnating since around 2000/2001. Coupled with lower gas prices that means people have more available income for the first time in several years. Some gets saved and some gets spent. Which might explain why retail sales stayed stagnant rather than fall. And it might explain why Germans actually used that car bonus to buy new cars. The money is there and that “gift” bonus finally was irresistible.

Also, unemployment year over year in February 2009 was still lower than in February 2008. Helped by the government “short-time worker assistance”. If you have to work short-time you´ll get a government compensation to partly close the financial gap.
That helps a bit to avoid job cuts now and helps a bit with domestic spending.
Extending this program, by the way, is also part of the stimulus package.

But I also agree with Edward that the situation will get a lot worse. And that it will last longer than the German government is currently officially expecting.

http://sports.espn.go.com/nfl/preview07/news/story?id=2973338

The reason is quite simple. The German labour market only “turned” in November, so the package was timely, and kept people in work and confidence up so people were still prepared to take the risk of buying cars. In Spain the labour market turned in July 2007, and has been headed downhill ever since. If a good intervention had been practised in Spain in, say, October 2007 (I was already pointing out the magnitude of the problem in Spain well before this, so personally I am on safe ground) then the situation might have been bad, but might not have become so rotten ripe as it is now. But Zapatero and company were busy saying there was no real problem at this point.

Now it is impossible to get that many people to make large purchases, whatever the subsidy, since everyone is afraid for their jobs.

The thing is, I think the situation in Germany is going to get worse, a lot worse, before it gets better, since I don’t think the economy is going to recover over the time horizon the German leaders are currently anticipating, which is basically what this post is about.

“*and* it presumes we know best.”

Here we go with another philosophical argument xavi

Satre already got to the point than an omnipotent and omniscient deity was a contradiction in terms. The entity could be one thing or the other, but not both at one and the same time.

But then, going from saying that we don’t know everything to saying we know nothing, and from saying we are not all powerful to saying we can do nothing is not legitimate. We are, as Nietzsche put it “humam all too human”, but we are human (still, and at the moment, anyway).

“This assumes the analysis of events is correct.”

You bet. Economics is an empirical science, even if I have to use a tautological argument – that only those who don’t understand it claim the contrary – to justify my suggestion. When you go to the dealer and by one of those subsidised cars and turn the key you do expect the engine to work don’t you, you aren’t worried that it won’t. So why the lack of confidence in the technicians here?

I know, don’t answer that .