Italy Needs EU Bonds And It Needs Them Now!

You see, this isn’t a brainstorming session — it’s a collision of fundamentally incompatible world views.
Paul Krugman

As a wise man recently said, failure to act effectively risks turning this slump into a catastrophe. Yet there’s a sense, watching the process so far, of low energy. What’s going on?
Paul Krugman

First, focus all attention on reversing the collapse in demand now, rather than on the global architecture. Second, employ overwhelming force. The time for “shock and awe” in economic policymaking is now.
Martin Wolf

OK, I think no regular reader of this blog could seriously suggest I have much sympathy for the sort of views you normally find being propagated by Italy’s Finance Minister Guilio Tremonti, but when he starts to send out the kind of red warning light danger signals that he has been doing over recent days, then I think we should all be taking note, and when the republic is in danger, then its all hands to the pumps, regardless of who is sounding the alert. This is not a brainstorming session, it is a real flesh and blood crisis.

Perhaps few of you will have noticed it, but our erstwhile logician has been getting extremely nervous in recent days, and most notably chose his visit to Davos to indicate that he personally would look extraordinarily favourably on any move to inititiate the creation of EU bonds (for a brief explanation of why these are important, see Wolfgang Munchau’s argument in favour of such bonds here. (Or the longer version here)

Italy’s Finance Minister Giulio Tremonti has said he favoured the issuance of government debt by the European Union. “Now my feeling — I am speaking of a political issue not an economic issue — is … now we need a union bond,” Tremonti said at the World Economic Forum in Davos. Countries in the euro zone currently issue sovereign debt in their own name, rather than regionally. Bond traders concerned about the mounting public debt of Italy, Greece and Ireland have pushed down the value of their government bonds, sparking speculation they might be driven out of the euro zone.

Now why would he be arguing this? Well the state of Italy’s own banking sector would be one part of the explanation, and the fact that the Italian government is in no position to mount a rescue operation on its own given the size of its existing debt to GDP commitment, would be another. In particular, and as I have been arguing, Unicredit – and its Eastern Europe exposure – is a huge worry.

Indeed the situation is now so delicate, that according to this Reuters report last week, Unicredit really doesn’t know which government to turn to. The Italian one perhaps, or the Polish one, or “it could consider doing it in Austria”.

Italian bank UniCredit is considering requesting state support in Italy and Poland, a source close to the bank told Reuters on Thursday. “The bank does not exclude possible state support in Italy and Poland,” the source said on condition of anonymity. In an extract of an interview to be published in Germany’s Handelsblatt newspaper on Friday, UniCredit Chief Executive Alessandro Profumo said the bank could consider “state support as insurance against unpredictable events.” If the bank does seek state aid, it could consider doing it in Austria, for example, he added.

UniCredit SpA is considering asking for government capital amid the credit crunch, Chief Executive Officer Alessandro Profumo said. “State support as insurance for unforeseeable events” is conceivable, Profumo told Handelsblatt newspaper in an interview at the World Economic Forum in Davos, Switzerland. A UniCredit official confirmed the comments to Bloomberg. Italy’s top bankers met with central bank Governor Mario Draghi last week to discuss the financial crisis, which has caused bankruptcies and government bailouts across the world, while stocks have plunged and credit markets have seized up. UniCredit and some of its rivals have tumbled in Milan since the start of 2008 amid concern about the strength of their finances.
Bloomberg 29 January 2009

The announcement that Unicredit was seeking state aid came on the same day that the bank admitted that investors had placed orders for only 0.5 percent of the shares they were offering in a rights issue. The bank received orders for a mere 14.3 million euros of stock out of a total of 3 billion euros, and the plan was to sell leftover stock in the form of convertible bonds, but even this hit a snag, as

The shares were offered at 3.083 euros apiece, or over twice what they were trading for in Milan at the time (around 1.408 euros). Shareholders, including Allianz SE and the Central Bank of Libya, are among those who agreed to buy the convertible bonds, according to the bank offer document. Shares of UniCredit have dropped 54 percent since October, when the rights offering was announced, amid concern the capital raising won’t be sufficient. But even the bonds issue is running into trouble, since Il Sole 24 Ore reported that Unicredit may raise only 2.5 billion euros rather than the full 3 billion euros because because investor Fondazione CariVerona, which holds a 5 percent stake in the bank, reportedly hasn’t received approval from the government to buy the securities, however, the reason they have not received approval may well be that they have not yet applied since the Italian Treasury, in what is a rather unusual step, said on Thursday announced that they had yet to receive a request from CariVerona to sign up for the bond issue. All this suggests, of course, that Tremonti’s warning about an imminent bailout could be a piece of brinksmanship, designed to presssure CariVerona to stop playing “positioning” games and come up with the money, but irrespective of whether or not this is the case, some sort of rescue operation for Unicredit surely cannot be far away at this point.

And the fact that Bulgaria’s Finance Minister Plamen Oresharski was running around last week assuring everyone that Bulgaria’s banks have not asked for state rescue aid so far, and that the government is not worried about the banking system’s health for now, is hardly helping to calm already troubled nerves. About 80 percent of the 29 commercial banks operating in Bulgaria are foreign-owned, with the biggest lenders being run by Italy’s UniCredit, Hungary’s OTP Bank, Greece’s National Bank of Greece and Austria’s Raiffeisen.

And only today Tremonti has warned that the announcement of more EU bank bailouts is imminent, and maybe as early as this weekend.

European governments may have to bail out more banks as soon as “this weekend,” Italian Finance Minister Giulio Tremonti said today. “So far in Europe there have been more than 30 bank bailouts and I can’t rule out that there will be more this week- end,” Tremonti said, speaking at a press conference after today’s Cabinet meeting in Rome.

So how should we address this danger, imminent or otherwise? At this point in time I have four proposals:

a) The creation of EU bonds
b) The introduction of quantitative easing by the ECB (quantitative easing is the monetary policy which is currently being applied in both the US and Japan, and probably soon in the UK too).
c) Letting those members of the East who want to join the eurozone immediately do so.
d) A new “pact” – one which would be much, much stronger than the old Stability and Growth Pact – to be signed by all countries who enter the EU bond system, a pact which gives direct fiscal remedies to Brussels in the event of non-compliance together with a substantial dose of effective control over the economies of individual countries – since nothing, Mr Sr. Tremonti, ever comes completely for free.

Obviously all of this is quite radical, and indeed fraught with danger, but these are hardly normal times. In all of this (d) is obviously the most important part, as any protection given to EU member economies by the Union must be credible and serious. So no country could or should be forced in, but it should also be pointed out to those who chose sovereignty and remaining on the fringes to participation that they would run an enormous risk. Since almost all EU economies seem vulnerable at this point, anyone staying outside could rapidly see themselves exposed to the risk of forced default, since lack of protection is simply an invitation to attack. Letting ourselves get picked off one by one is not an appetising prospect (Latvia, Hungary, Greece, Austria, Italy, Spain, Ireland, the UK, Romania, Bulgaria………).

Clearly those who wish to remain “dissenters” should have the liberty to do so, but they should bear well in mind that should they do so they could very easily end up in a group – possibly lead by Diego Armando Maradona – together with Yulia Timoshenko (Ukraine), Cristina Fernadez (Argentina), Rafael Correa (Ecuador) and (possibly) whoever is the new prime minister in Iceland, bankrupt, and without the aid of international financial support to help deal with their mess.

Perhaps readers may think I am being rather shrill here, and perhaps at this point Tremonti (for whom I have no afinity, elective or otherwise, see linked post above) is only playing brinksmanship, but if he isn’t, and Unicredit is about to need bailing out, then push does quickly come to shove, since the EU leaders agreed on October 12 in Paris to bail out systemic banks, and Unicredit is a systemic bank. So will will need to know how they plan to stand by their commitment, and if they don’t, well then everyone of us stands exposed, since credibility rapidly falls towards zero.

Maybe this is a false alarm situation, and Unicredit will not need bailing out this weekend, or the next one, but one day it will, and one day Spain’s huge non performing loan and household debt default problem is going to need sorting out. So I think this is a line in the sand situation, and we are much nearer to having to make up our minds which side of the line we are on than many seem think.

To paraphrase Paul Krugman again, in flirting with the idea of whether the first to default should be Greece, or Hungary, we truly are flirting with disaster.

This entry was posted in A Fistful Of Euros, Economics and demography by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

26 thoughts on “Italy Needs EU Bonds And It Needs Them Now!

  1. Please tell me if I understand EU bonds correctly; it means that the rate on the bond is that for the EU as a whole, rather than for a single country?

    And so this would mean Italy, which currently has a very high rate, due to chronic gross fiscal incompetence, will be able to borrow even more money, where it currently cannot, because the market charges too much for lending?

    Frankly, I’m in favour of economic catastrophe. You should experience the consequences of your actions. How else can things improve in the long term? if Italy is permitted to escape, this time, from its own financial madness, without the reforms necessary to ensure that madness stops, then it will still sooner or later fail – for its behaviour will not have changed – but it will be that much further in debt that the eventual failure will be that much harder.

  2. Comments regarding the prescription offered:
    a) The creation of EU bonds
    I said so in comments here several years ago. The concept will now have to be accepted by the German government and then implemented in practice. That is not going to happen overnight.

    b) The introduction of quantitative easing by the ECB
    Just plain no. QE is nothing but window-dressing. To the extent that “more needs to be done”, it can and should always be done via fiscal policy. Just size the EU fiscal deficit in accordance with the desired stimulus. There is utterly no point in having the ECB intervene in the Italian, Greek or any other markets.
    The QE issue is has been muddied to an incredible degree. It is, e.g., not a good idea at all that the British government intends to implement it as a clandestine operation. There needs to be accountability. If the British want to do it the Zimbabwean way, they should be mindful of the outcome in Zimbabwe – the elimination of currency sovereignty. (Then again, maybe this is what Lord Mandelson expects to happen.)
    Furthermore, it should be noted that, although the ECB keeps its interest rate higher than the Fed does, lending in the European banking system has clearly been reduced to a lesser degree than in the US.
    To sum it up, there are three reasons why QE does not make sense in the European context: it is not a good idea anyway; the ECB has not yet reached what Krugman terms the zero bound; an EU bond market for the ECB to intervene in does not even exist yet (and it should not intervene in national markets). Basically introducing EU bonds and having the ECB engage in QE are two proposals that are at odds with each other. There is no benefit to be had by building a new European institution – an EU bond market – with the intent of improving economic management in the EU while at the same time compromising an existing institution – the ECB – which has so far been significantly more successful than Euro-sceptics would have thought possible at the time of its inception.

    c) Eurozone membership acceleration
    This is an option. It´s not, however, a case of TINA (There is no alternative). While the IMF would be overburdened if it it had to bail out the whole world, it is a eurocentric institution and can deal with the Euro periphery. It does not suffer from a lack of instruments to apply in times of crisis. In fact, if the Asians could be compelled to speed up their attempts at building an intervention mechanism analogous to the IMF but centered around the ADB, then the IMF could officially be relieved of a large part of its former tasks. It would then be free to solve problems in those areas of the world that dominate its decision-making process anyway.
    In short: hastening the accession process is not likely to pay a dividend. One could imagine that German reunification might offer some lessons that could be applied here, but, in fact, it does not: it was mismanaged. Even with hindsight, no easy alternative solutions to the actual policies implemented at the time have been offered.
    d) A revamped Maastricht
    Firstly, it would have to be more than that: a revamped Lisbon treaty. Centralizing the power of macro-economic intervention in Brussels should not be allowed to happen without empowering the European parliament to exercise control over spending, taxation and borrowing.
    Secondly, the process of installing fiscal constraints is already under way. Germany is currently on the path to implementing a debt ceiling via introducing a change to the constitution that is scheduled to be ratified in parliament in summer. While some of the details are still being worked out, the debt limits have already been defined: 0,85% for the federal government and 0% for the states. If I recall the facts correctly, this is more restrictive than the U.S. arrangements. It would make no sense whatsoever without an accompanying massive push for higher spending in Brussels. Similar rules can easily be adopted by all the other EU countries. Tremonti´s language clearly indicates that he is aware of this and will probably go along with it.

    Let´s be perfectly clear about this: There is rising opposition against the “bailout mentality” everywhere. U.S. polls show this, German polls do so, too. If the EU does not opt for popular representation in fiscal decision-making and instead chooses to go down the path of elitist self-dealing, endless bank subsidization and counterproductive policy manoeuvres á la QE, if the EU does not commit to a clear strategy of establishing an EU treasury that is characterized by both significant fiscal authority and political accountability, then it is going to implode at some point.
    Germans would chase away their current power elites with as much determination as was recently displayed by the protesters in Greece – for very much the same, perfectly understandable reasons.

  3. Hi Blank Xavier,

    “Please tell me if I understand EU bonds correctly; it means that the rate on the bond is that for the EU as a whole, rather than for a single country?”

    Yep, that’s exactly what it means. And not just eurozone members, all EU states collectively would guarantee these bonds. Effectively we would become another USA overnight. Shotgun wedding, or something like that.You shouldn’t have gotten the poor girl pregnant in the first plece. If Italy is now hopelessly in debt this is something to do with the cheap interest rates which have been funding the debt, and of course the Spanish and Irish cases are much more obvious and scandalous.

    “And so this would mean Italy, which currently has a very high rate, due to chronic gross fiscal incompetence, will be able to borrow even more money,”

    Definitely. But do remember this is also due to the implicit guarantees that the zone have been offering. I have been screaming high heaven on this blog for years about the dangers inherent in all of this, and the day when the issue can no longer be avoided, has finally arrived, a line must be drawn in the sand, we are democratic societies, and you are fully entitled to your view.

    “Frankly, I’m in favour of economic catastrophe.”

    OK, well I am not, but this is your right. That is why I put the Krugman quote at the top of this post:

    “You see, this isn’t a brainstorming session — it’s a collision of fundamentally incompatible world views.”

    Those countries who wish to stay outside and join Iceland, Julia Tymoshenko and Cristina Fernandez are quite free to do so. But remember, once the defaults start the back draft will reach all the way to Tokyo and Washington – just look what happened to the banks when Lehman Brothers went. Financial catastrophes are never pleasant affairs, and I think it is very dangerous to play with matches in the vicinity of boxes of dynamite. We cannot sit back and watch the eurozone gradually meltdown, and we cannot sit back and watch our East European co-citizens simply reduced to penury.

  4. If you make the club of EU bond issuers voluntary, the weak will join it and the strong will not. Secondly don’t you make defaulting more attractive this way?

    Thirdly, a state is hard to make go broke because it has tax revenues. The EU can’t raise tax revenues that much. And if you want to give tax authority to the EU, see my first point.

    On the fourth hand if you want quantitative easing, whose bonds is the ECB to buy? How do you decide?

  5. “Frankly, I’m in favour of economic catastrophe”

    I agree with this sentiment, yet on the other hand I don’t want to be chained to a dead body.

  6. “If you make the club of EU bond issuers voluntary, the weak will join it and the strong will not. Secondly don’t you make defaulting more attractive this way?”

    Well, first off Oliver, you could hardly make it compulsory. But, secondly, and this is where it gets really interesting, virtually no one knows who is safe and who isn’t at this point. Virtually no one is sure in Eastern Europe, Poland have just announced they are in talks with the IMF (post coming) and among the big 5 in the old EU 15, really only France could say she is not under some sort of threat. Germany certainly cannot be considered “safe” with the size of the bank debt at risk and the force of the slump which just hit. Germany is vitally dependent on Eastern Europe. It looks quite likely that both Russia and Ukraine will default within the next 12 to 18 months and we need to protect those who are under our wings as it were.

    The UK is in a now you see me now you don’t situation. Maybe Italy will have to help bailout the UK. Now that would be a turnup for the books, wouldn’t it?

    And even France doesn’t know what would happen to her finances if the south of Europe started to melt down. So this is why I feel now is the time to do this. No one is clear at this point who is safe and who isn’t, a perfect “prisoners dilema” situation.

    On all the details, see separate posts which are to come.

  7. Hi Jörg,

    Nice to see you back. You make a lot of detailed points, and I will try and handle some of them as we go with the future posts.

    “The concept will now have to be accepted by the German government and then implemented in practice. That is not going to happen overnight.”

    Well, I agree. But the time bomb is ticking away even as we excahnge views. Of course, the pain factor and the danger is now going to rise by the month, so maybe with the passage of time more people will become more receptive. Going back to my point with Blaat, it is important to do this before it is totally clear who the walking corpses are, and who they aren’t, since if we wait to long all that famous “solidarity” will simply melt.

    “The introduction of quantitative easing by the ECB. Just plain no.”

    I’ll deal with all this in a separate post.

    “if the EU does not commit to a clear strategy of establishing an EU treasury that is characterized by both significant fiscal authority and political accountability, then it is going to implode at some point.”

    Agreed.

  8. [EU bonds]
    > Yep, that’s exactly what it means. And not just eurozone members, all EU states
    > collectively would guarantee these bonds. Effectively we would become another USA
    > overnight.

    Dear God, yes – it is so. The politicial implications of EU backed borrowing are enourmous.

    > Shotgun wedding, or something like that.You shouldn’t have gotten the poor girl pregnant
    > in the first plece.

    Emotive, but I’m not sure if it’s correct. Who was the irresponsible suitor in this case?

    > If Italy is now hopelessly in debt this is something to do with the cheap interest rates which
    > have been funding the debt, and of course the Spanish and Irish cases are much more
    > obvious and scandalous.

    I’m not inclined to concur; Italy understood the terms and voluntarily accepted them. There was no coercion. Italy is responsible for its own situation.

    > Those countries who wish to stay outside and join Iceland, Julia Tymoshenko and Cristina
    > Fernandez are quite free to do so.

    Yes. But those who are already inside, they are not free to leave – not in practical terms. They are on a rollarcoaster now.

    > But remember, once the defaults start the back draft will reach all the way to Tokyo and
    > Washington – just look what happened to the banks when Lehman Brothers went.

    Yes. But this is properly tantamount to economic blackmail and I think if the defaults are avoided by succumbing to that blackmail (“we know we’re chronically grossly incompetent, but if you don’t give us money so we can spend our way out of it, we’ll take you down with us”), the badly managed countries will not change their ways and that means sooner or later, the same problem will reoccur.

    Although TBH, you know Italy, all they’re going to do with that money is a pork-barrel, pet-Government-projects spending plan. It won’t do the economy any good now, it will make things worse when the recovery occurs because it will only be by then that the spending will occur; and what’s more, it’s about the worst way to spend that money in terms of creating economic activity. I think tax cuts are the right answer, but is any Government going for that? Government instinct is to tax and spend. In a crisis, to borrow and spend.

    It seems to me Italy is better off not being given this money *anyway*.

    > We cannot sit back and watch the eurozone gradually meltdown, and we cannot sit back
    > and watch our East European co-citizens simply reduced to penury.

    It will be easier now than it will be in the future. You are I suspect attempting to avoid a bad fate now for them, for a worse one in the future.

  9. Hi again,

    “Emotive, but I’m not sure if it’s correct. Who was the irresponsible suitor in this case?”

    The EU Commission, the ECB, and the eurozone member governments, for going ahead with the euro without the necessary political architecture to support it. See eg Paul Krugman – the pain in Spain – on his NYT blog. It is simply outrageous to blame the citizens of Spain (or Greece, or Ireland) for the economic by product of a “one size fits all” monetary policy. As it happens there are ways of handling this – like very tight lending and earnings documentation rules from the central banks (which in this case would need to be cordinated at ECB level) and strong fiscal SURPLUSES in the countries where “overheating” was so obviously occuring. I say obviously, since it was to me. Try googling “afoe hot labour anyone” for example amongst the myriad of posts I made about all this over the last five years. But since virtually no one in any responsible position was arguing this case, it is very cruel simply to ask Spain’s citizens to accept long term unemployment and lose their homes simply because of someone else’s incompetence.

    “It will be easier now than it will be in the future. You are I suspect attempting to avoid a bad fate now for them, for a worse one in the future.”

    Well I think this is the point at the end of the day. These are simply two different views, and people will have to decide, at the ballot box if necessary. I mean, we are talking about the UK and Germany just as much as we are talking about Italy here it seems to me, since Germany is completely dependent on all the rest for its exports, while its was Germany’s banks who funded all the irresponsible lending, so it will be German pension funds which go down the tubes behind the defaults. And the UK, well who knows at this point, but the UK could very easily turn out to be Iceland on a slightly smaller scale – ie banks with only 400% of GDP in liabilities, and not, as in Iceland 700%.

  10. Incidentally Xavier,

    Sine you seem to be focusing on Italy, which countries in the EU 27 do you think would be safe from contagion if both Greece and Hungary default (in my view Greece would go before Italy if we simply sit back and let it happen)?

    I can only see France as comparatively safe. Perhaps you think I am being shrill, and perhaps at this point Tremonti (for whom I have no afinity, elective or otherwise, see linked post) is only playing brinksmanship, but if he isn’t, and Unicredit is about to need bailing out, then push does quickly come to shove, since the EU leaders agreed on October 12 in Paris to bail out systemic banks, and Unicredit is a systemic bank.

  11. I do not get it.

    If virtually all European countries are up to the ears in debt, who are the creditors? Russia (for NG, on the brink of default), ME (for oil; currently reported that ME is loosing 2.5 trillion in investments), US (also in debt), China (in the brink of economical collapse), Japan (same) ?

    Which currency is in downward spiral, considering that all currencies are in downward spiral?

    Isn’t it imaginary cross-bounded paper losses and debts you are worrying dead about?

  12. > Sine you seem to be focusing on Italy, which countries in the EU 27 do you think would be
    > safe from contagion if both Greece and Hungary default (in my view Greece would go
    > before Italy if we simply sit back and let it happen)?

    I do not hold an opinion due to lack of knowledge.

    > I can only see France as comparatively safe. Perhaps you think I am being shrill,

    No.

    > and perhaps at this point Tremonti (for whom I have no afinity, elective or otherwise, see
    > linked post) is only playing brinksmanship, but if he isn’t, and Unicredit is about to need
    > bailing out, then push does quickly come to shove, since the EU leaders agreed on October
    > 12 in Paris to bail out systemic banks, and Unicredit is a systemic bank.

    Indeed. The fact is, we can think what we think, and we may be right (for the right reasons or for the wrong reasons) or we may be wrong, and it makes no difference at all.

  13. >> “Emotive, but I’m not sure if it’s correct. Who was the irresponsible suitor in this case?”

    > The EU Commission, the ECB, and the eurozone member governments, for going ahead
    > with the euro without the necessary political architecture to support it.

    And now in the heat of crisis, that architecture is created, since it can be used to support borrowing. It’s not too surprising. I concur with the view that the euro was created without the pan-European institutions to support it; a sort of half-way house of unified moneterization, where a group of countries agree to share a currency without agreeing to give up the necessary degree of fiscal independence. Now push comes to shove and the lack of pan-European institutional support grows apparent – the immediate cost of not having it is high, which acts to minimize the long term consequences, e.g. federalisation.

    > It is simply outrageous to blame the citizens of Spain (or Greece, or Ireland) for the
    > economic by product of a “one size fits all” monetary policy.

    Yes. It is unethical. But that’s how it is. Life isn’t fair. Life doesn’t know about fairness or justice or right or wrong. It just *is*. What you get is what you get, given everything that happened and exists. And the citizens of these countries are getting shafted. If you want it to be different, you need a better political system. I know of one (the free market) but the market as a form of Government is understood by a few economists and that’s it, so it cannot yet exist. So you’ve got what you’ve got – centralised democracies – and that means you’ve got what you’ve got – these people getting the short end of the stick.

    > As it happens there are ways of handling this – like very tight lending and earnings
    > documentation rules from the central banks (which in this case would need to be cordinated
    > at ECB level) and strong fiscal SURPLUSES in the countries where “overheating” was so
    > obviously occuring. I say obviously, since it was to me. Try googling “afoe hot labour
    > anyone” for example amongst the myriad of posts I made about all this over the last five
    > years. But since virtually no one in any responsible position was arguing this case, it is very
    > cruel simply to ask Spain’s citizens to accept long term unemployment and lose their homes > simply because of someone else’s incompetence.

    I could be wrong, but from my point of view, you are confounding “didn’t happen” with “couldn’t happen”. It is not a case of the correct actions having not been taken when they should have been; it is actually the case that those correct decisions *could not have been taken*.

    It seems to me that the arrangement of incentives upon people in significant political positions is such that they *cannot* make correct, timely economic decisions. No one will ever be able to convince them to act, consistently and in the long term, against their own best interests, which is exactly what is required for sound economic management.

  14. Hi Xavier,

    “It seems to me that the arrangement of incentives upon people in significant political positions is such that they *cannot* make correct, timely economic decisions. No one will ever be able to convince them to act, consistently and in the long term, against their own best interests, which is exactly what is required for sound economic management.”

    Well, it is very hard for me to disagree with this, which is why, generally speaking, economists tend to think it a good idea to have independent central banks, but then, since the case of the ECB they were trying to implement a politically driven project without the necessary tools to make it work, well, perhaps the result is hardly surprising.

    On the other hand something inside me resists sitting back and watch the car race straight into the brick wall. Basically, there is another part of my agenda which perhaps I should make explicit, the question of population ageing. Basically, as you rpesumeably our aware, our populations are ageing rapidly, and in some countries elderly dependency ratios are set to rise to historically unprecedented levels (Italy unfortunately is one such country).

    My opinion is that the impact of all of this will really start to lock in around 2020 (at the latest) and in the meantime we have a window of opportunity to get so many things straight. If we spend the first half of this window messing around with what to do about semi bankrupt countries then we really will sink in to an even deeper mess as 2020 approaches. Which is why despite being able to see the force of your argument I still want to hope that we can convince enough people in positions of responsibility to act. Otherwise….

  15. > On the other hand something inside me resists sitting back and watch the car race straight
    > into the brick wall.

    Ah, the optimism of youth ;-)

    > Basically, there is another part of my agenda which perhaps I should make explicit, the
    > question of population ageing. Basically, as you rpesumeably our aware, our populations
    > are ageing rapidly, and in some countries elderly dependency ratios are set to rise to
    > historically unprecedented levels (Italy unfortunately is one such country).

    Which, if I do understand correctly, is a problem because we have State run pension plans, whereby current workers pay for the pensions of the retired. If we had free market plans, where people build up their own pension during their working life, it wouldn’t be an issue.

    > My opinion is that the impact of all of this will really start to lock in around 2020 (at the
    > latest) and in the meantime we have a window of opportunity to get so many things straight.

    No. We do not have a window of opportunity. It would only be so if there existed political instutitions capable of consistently acting in the best interests of their countries economies.

    > If we spend the first half of this window messing around with what to do about semi
    > bankrupt countries then we really will sink in to an even deeper mess as 2020 approaches.

    Correct. Governments will fiddle, time will roll on, and then we will *really* be in trouble. It would have been possible in principle to have done something about it, but it was not done, because it could not be done. You get what you get, when all things are taken into account. We do not have institutions capable of acting in a timely and appropriate manner to stave off disaster, so we get disaster.

    I suspect we have, historically speaking, come too quickly to industrialisation and too slowly to more advanced forms of Government. There is an capability imbalance between our economic state and our politicial state.

  16. “Which, if I do understand correctly, is a problem because we have State run pension plans, whereby current workers pay for the pensions of the retired. If we had free market plans, where people build up their own pension during their working life, it wouldn’t be an issue.”

    Well on my view the problem is much bigger than this. This is what my research is about. I am actively working the hypothesis that the uneven pace with which the demographic transition is being rolled out is largely behind the global economic imbalances we currently have. The transition regulates saving, borrowing and consumption patterns via shifting median population ages. This is why,on my view and for example, the German and Japanese economies go crash every time the rest of the world slows down (and each time the crash is louder) since they simply become more and more export dependent as their population ages as they don’t have enough people in the critical “borrowing” age groups. No easy fix here, either.

    The pensions problem is a related, but entirely secondary one from a macro economic prerpsective. Indeed I would see the politicians obsession simply with pension funds as yet another example of their limited time horizons.

    “I suspect we have, historically speaking, come too quickly to industrialisation and too slowly to more advanced forms of Government. There is an capability imbalance between our economic state and our politicial state.”

    Well, what can I say to this, except that I suspect you may be right, but wow, this is a one-off species-relative thing, we will never be here again, which means, basically, we’ve fluffed it. At the same time this debate is as old as the hills. You can go all the way back to Pelagian and Augustine, and find the same sort of conversation going on.

    So, taking one last “trago” from that now near empty bottle of cheap cognac, I think I will still head off into the storm, since I fully intend to go down with the ship, fighting, I just wouldn’t feel right with myself otherwise.

  17. Xavier,

    In a way this conversation reminds me of one which reputedly took place a century or so ago between Antonio Gaudi and Santiago Rosinyol. Gaudi, as most people are aware, was a Barcelona based architect who had plans to build a cathedral, while his close friend Rosinyol was a painter, playwright, and general Bohemian.

    So Rosinyol asked Gaudi “when you gonna finish that cathedral of yours then, Antonio”, to which Guadi replied “not for a long time, maybe not for a century or two”.”Gee, that is a long time” Rosinyol replied to which Gaudi earnestly retorted “well back in the middle ages nobody blinked an eye at taking two or three hundred years to build a cathedral”.

    Then Rosinyol wearily lifted his eyes and said “yes, Antonio, but will Christianity still exist in two or three hundred years?”

    This is the point I think, as Keynes said “in the long run we are all dead”, but there are shorter runs we could think about. Maybe we are all headed for catastophe as a species, but do we really have to go careering off the cliff tomorrow. I was kinda having a nice Sunday, as it happens.

  18. > I suspect we have, historically speaking, come too quickly to industrialisation and too
    > slowly to more advanced forms of Government. There is an capability imbalance between
    > our economic state and our politicial state.

    I’m not sure this actually makes any sense.

    Economic systems depend on political systems.

    Historically, you had political systems which placed strong constraints on the economic system in use. Feudalism for example, where the peasent was tied to a given landlord and wasn’t even allowed to physically leave the location, let alone change job. Moving forward to today, we can have political systems (such as democracy) where economic behaviour is in principle entirely free (although in practise still painfully constrained via the State), or we can have systems where although the economic system is not in principle free (such as China), the current body politic deliberately permit a certain degree of economic freedom (in the Chinese case, out of enlightened self-interest, to avoid political unrest).

    So, our economic state *derives from* our political state. You can’t have a capability imbalance in the original way I wrote, where I implied the two states (economic and political) are independent. Your current economic situation is what it is depending on how far you’ve managed to get with your political system, and I think the more free your economy is, the more wealth there is.

    So we’ve got what we’ve got – quite a lot of wealth, it’s all very nice – given what we’ve got politically (democracy, with plenty of State interference in the market) because of the degree of economic freedom it provides.

    And that’s just where we’re at.

    It’s *not* like we’ve managed to make this whizzy economy but fucked up on our Government organisation. It’s actually that we’ve got what we’ve got for an economy *given* what we’ve managed to achieve for a Government organisation.

    I hope we will in time adopt a free market as a mechanism through which to organise the State, which will result in a better economic state – greater production of wealth, much more individual liberty and freedom, hopefully the elimination of these boom-bust cycles.

    Of course, it may not work out that way. We may find State regulation increasingly strangling the economy (which of course has concomitant reductions in individual liberty and freedom), to the point that the State is economically dictatorial – in other words, although we have a democracy, where in principle economic behaviour is free, in practise, freedom becomes so constrained that we all become much, much poorer and of course, unfree; the State needing to know a great deal about what we all do, to control the economy in the way it wants to (which means controlling *us*).

    I am concerned this outcome may occur, because the broad mass of people do not understand what a free market is and what it means and cleave instinctively to a sort of mushy Keynesim, which the centralised democratic State instinctively uses to expand its budget and power. We see in the UK now the State spends 49% of our GDP. In the USA, the Federal Government owns now 30% of all land.

  19. Hi again,

    “I suspect we have, historically speaking, come too quickly to industrialisation and too slowly to more advanced forms of Government. There is an capability imbalance between our economic state and our politicial state.”

    Well, funnily enough I like it the way you put it the first time, and a lot less the way you qualify it above. Not that I am not concerned about “freedom”, but I suspect I am a lot less worried about big government than you are. Indeed I am neither intrinsically in favour of it or against it – I leave that up to my fellow citizens who doubtless understand all that stuff rather better than I do. Basically, as an economist I am rather neutral on this topic (political systems rarely enter my analysis as such – possibly as a dummy variable for institutional quality). Empirically I can’t find the connection you are looking for.

    On the other hand the state is the referee, and when the system is about to fall in – for whatever reason – under its own weight, I am rather inclined to try to find ways to stop it doing so.

    “where I implied the two states (economic and political) are independent.”

    Yeah, well this was the part I intuitively liked. Which all brings us back to where we started, and Paul Krugman’s point:

    “You see, this isn’t a brainstorming session — it’s a collision of fundamentally incompatible world views.”

    I mean, I don’t agree with many of your assumptions, although I completely defend your right to hold them. But at this point in time I am not especially disposed to participating in lengthy debates and seminars about the benefits of big goverment vs more private sector activity (curiously it is the French economy which is the most centralised in the G7 which is proving to be the most stable at the moment) and I am interested in everything not going careering off the cliff tomorrow, which is why I want them to issue EU bonds now to bail out the Italians (and you don’t), and I don’t think all this very friendly discussion has moved either of us one iota on that.

    Still, it was nice talking. It has helped me pass the time as I move on with writing something on the onerous topic of why the causal arrow seems to go something like credit money – output – fiat money, and not the opposite way round (which is what Bernanke seems to believe).

    Edward

  20. Hi Edward,

    Did you consider the implications of your point d) being implemented successfully? Think of the EU imposing austerity measures on some spendthrift government. This could put the EU close to the IMF in the institutional (dis)popularity leagues, which in turn might then tarnish the popular perception of other EU projects even if they have nothing to do with those measures (say turkish membership which isn’t all too popular to begin with).

    Regards

    CurlyWurly

  21. Hi,

    “Did you consider the implications of your point d) being implemented successfully? Think of the EU imposing austerity measures on some spendthrift government.”

    Actually it is precisely because I feel ashamed when I think so many of our member states will have to go one by one to the IMF for rescues becuase we haven’t the will to do the necessary ourselves. This makes us look more like naughty schoolchildren than anything else.

    Many of the countries who are worst affected by this crisis are very, very poor, and I think the IMFs limited resources would best be used going to help the really needy.

    If we aren’t able to take difficult decisions ourselves then we have no future, and maybe it would be better to recognise that now.

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