Been a pleasure, Europe

[Surlethe]

I have to say this thread reminds me of the "bread queues before the year's out" one that appeared when the banking crisis first hit the US.

Yes, the shit has hit the fan and it isn't pretty, but this type of over-reaction is very premature.

We're not talking about "bread queues before the year's out", we're not talking about the collapse of civilization, we're not talking about Peak OilTM. We're just talking about a painful second recession and the breakup of the largest currency union and free trade zone in the world. I don't think anybody's predicting bread lines or another world war (at least I'm not, although a German takeover of the European periphery is a tried-and-true method of dealing with depression ... I don't know why I like that joke, but I keep using it). So I'm not seeing how this is hyperventilation or overreaction.

[Starglider]

Those circumstances: full employment, no sovereign debt problems, financial system not about to implode.

While I agree with your basic sentiment your reasoning is bogus. You are trying to reason based on conventional contemporary economic wisdom, which developed over the last fifty years in bull markets, credit expansion and a relative abundence of resources and shortage of labor (in the first world). You are parroting the prevailing Keynesian model of inflation, which is focused on wage pull and demand surplus. This is an extremely limited view of economics at best, a dangerous delusion in practice.

What we are seeing now is cost push biflation, as developed world currencies devalue at the same time that developing countries are ramping up their demand for every kind of commodity (oil, food, minerals and precious metals). Lagging wages temporarily constrain price growth, but ultimately margin compression destroys profits, capital is pulled, companies shut down, people are laid off and demand is destroyed (a vicious circle of course). This is nothing like the kind of inflation economists are conventionally worried about. Did you think Zimbabwe had the 'full employment, no sovereign debt problems and a solid financial system' Keynesian wisdom claims is necessary for money printing to cause inflation?

Any fears about hyperinflation are so completely unfounded, it's not even worth thinking about. The ECB is not flirting with printing too much money.

Hyperinflation and inflation are different things. Hyperinflation is not just 'more inflation', it's structurally different. When inflation is high everyone gets into the expectation that both costs and wages keep rising, and tries to plan for that, but still price everything in terms of their native currency and don't question its fundamental utility. Hyperinflation occurs when people no longer value the currency, and proceed to dump it and move to other assets and means of exchange. A strong government would just switch to dealing in alternate currencies, but usually this happens when the government is totally dependent on monetisation to fund deficits, and hence they try to stave off the end and squeeze the last drops out of value out of their fiat monoply (by printing the currency into oblivion).

For the euro hyperinflation is unlikely in general and very unlikely in the short term, as there is no bannanna republic dictator able to order that much printing (or benefit from it). Rather we should be concerned about double digit annual price inflation, with wage growth lagging several percentage points. This is quite enough to cause mass poverty and unrest. In fact we are already seeing exactly this in energy prices, but these are conventiently excluded from government figures due to 'volatility'.

[Surlethe]

Those circumstances: full employment, no sovereign debt problems, financial system not about to implode.

While I agree with your basic sentiment your reasoning is bogus. You are trying to reason based on conventional contemporary economic wisdom, which developed over the last fifty years in bull markets, credit expansion and a relative abundence of resources and shortage of labor (in the first world). You are parroting the prevailing Keynesian model of inflation, which is focused on wage pull and demand surplus. This is an extremely limited view of economics at best, a dangerous delusion in practice.

What we are seeing now is cost push biflation, as developed world currencies devalue at the same time that developing countries are ramping up their demand for every kind of commodity (oil, food, minerals and precious metals). Lagging wages temporarily constrain price growth, but ultimately margin compression destroys profits, capital is pulled, companies shut down, people are laid off and demand is destroyed (a vicious circle of course). This is nothing like the kind of inflation economists are conventionally worried about. Did you think Zimbabwe had the 'full employment, no sovereign debt problems and a solid financial system' Keynesian wisdom claims is necessary for money printing to cause inflation?

Um, you're reading too much into what I said. I'm reasoning from MV = PQ (which, BTW, is not Keynesian). The point is that right now printing money, in the quantities that the Fed or ECB would be likely to produce, is not going to cause high inflation or hyperinflation. Although I do think that high inflation right now is what the economy needs.

Any fears about hyperinflation are so completely unfounded, it's not even worth thinking about. The ECB is not flirting with printing too much money.

Hyperinflation and inflation are different things. Hyperinflation is not just 'more inflation', it's structurally different. When inflation is high everyone gets into the expectation that both costs and wages keep rising, and tries to plan for that, but still price everything in terms of their native currency and don't question its fundamental utility. Hyperinflation occurs when people no longer value the currency, and proceed to dump it and move to other assets and means of exchange. A strong government would just switch to dealing in alternate currencies, but usually this happens when the government is totally dependent on monetisation to fund deficits, and hence they try to stave off the end and squeeze the last drops out of value out of their fiat monoply (by printing the currency into oblivion).

Yes, yes, I'm being imprecise. When I say "hyperinflation" you may take it that I mean "double-digit inflation," similar to the US in the '70s.

For the euro hyperinflation is unlikely in general and very unlikely in the short term, as there is no bannanna republic dictator able to order that much printing (or benefit from it). Rather we should be concerned about double digit annual inflation, with wage growth lagging several percentage points. This is quite enough to cause mass poverty and unrest.

And when the economy is moving into a deflationary recession, high inflation is not a likely outcome of money-printing. And when high inflation causes recessions to pass faster --- as when nominal wages need to fall in order to return the economy to full employment --- it is better to embrace high inflation than keep inflation low and prolong the suffering.

[Surlethe]

Let me be more precise: When the economy is moving into a deflationary recession, in quantities of money the central bank is likely to produce, high and persistent inflation is not a likely outcome.

[J]

Although I do think that high inflation right now is what the economy needs.

Why? I'd be quite interested in hearing the reasoning behind this.

[D.Turtle]

Isn't the problem in most of the "periphery" of the Euro-zone a lack of competitiveness? Wouldn't in such a case high inflation - without a corresponding increase in wages - dramatically increase competitiveness on an international stage, by essentially lowering manpower costs?

At least thats pretty much what I understand Krugman, for example, to be arguing.

[Starglider]

The point is that right now printing money, in the quantities that the Fed or ECB would be likely to produce, is not going to cause high inflation or hyperinflation. Although I do think that high inflation right now is what the economy needs.

You can't just say 'high inflation', because the prices of various goods and assets, and the average and top-bracket wages do not increase by the same amount. We can't just say 'we will get the same kind of inflation we had in the late 70s' because the global economy is quite different now. We certainly have too much debt and inflation is the traditional fix for that, but criticially it is wage inflation that makes debts easier to pay down. In the 1970s union politics would and did ensure that printing lots of money would have gone into public sector and state owned / subsidised company wage increases. If we print lots of money and use it to buy bonds, equities and mortgage backed securities, the inflation is focused first on financial asset prices and secondly on commodity prices (via FX impact). Pushing up input costs and compressing margins will do much more economic damage than the eventual benefit of devaluation of loan service costs relative to income. Sure you might get a 5% pay rise instead of a 2% one in two years time, which will make paying off the credit card slightly easier, if your employer hasn't had a wage freeze or laid you off completely by then. This is assuming governments keep a lid on real interest rates as well; having a low LIBOR is fine for banks but is no good for households if their mortgages, credit cards and bank loans at at all time wide spreads to LIBOR.

And when high inflation causes recessions to pass faster --- as when nominal wages need to fall in order to return the economy to full employment --- it is better to embrace high inflation than keep inflation low and prolong the suffering.

Ah, that is an interesting statement, 'nominal wages need to fall'. Interesting as in 'political dynamite'. I don't think Broomstick et al or the OWS protestors or anyone who cares about record income inequality would agree that 'nominal wages need to fall'. Most of the time what actually needs to happen is 'productivity must rise to be globally competitive', reducing wages is one option, working harder or more efficiently are others.

[Dominus Atheos]

Although I do think that high inflation right now is what the economy needs.

Why? I'd be quite interested in hearing the reasoning behind this.

From what I understand, a large part of the problem that is causing low employment (and thus low tax returns, high social safety-net spending, and high deficits) is that people are sitting on what money they have and not spending it. This is because they are worried about the future and want a nest egg to fall back on, and because there isn't anything to spend money on (the so-called "Liquidity Crisis"). Even if companies wanted to use their cash reserves to hire people, there isn't anything for them to do since nearly all companies are producing the most they can that will still get purchased (the so called "Output Gap"). People are also supposedly worried about "high" deficits and debt (the so-called "Deficit Crisis") and our trade gap ("Trade Deficit").

Relatively high inflation would go along way toward combating those crisis', by making holding onto money a less attractive option, reducing the value of our debt, and decreasing the prices of our goods in foreign markets.

[Simon_Jester]

If something goes wrong and suddenly there are twice as many euros

Ridiculous. Stop being hysterical.

...Wait, what the hell?

Starglider, I understand that you're parodying your own version of how you think Thanas thinks, an act I've seen you take a lot of glee in these past few months. Even so, I'm honestly very surprised at the reaction I got out of you. My point was addressed to Ryan- that as a practical matter, scrapping the entire financial structure, telling everyone to ignore the numbers in their bank accounts and just keep swapping around the physical goods as if nothing were wrong is not going to work.

Not unless you go right over to the edge of outright command economy. I attempted to illustrate this with hypothetical points, as a 'toy model' of how inflation screws up economies and how ignoring all the financial paperwork creates problems of its own. Yes, it is a simplistic answer that ignores a thousand thousand nuances you take great pride in knowing everything about.

It is a simplistic answer- one that is still, in practice, correct in that the state cannot print huge amounts of money and arbitrarily give it away to people without impact on prices in the newly inflated currency. And that the state cannot repudiate all its debt without creating second-order impacts that become crises in their own right. And that, no, you can't just say "Okay, let's put the economy in debug mode, tweak it, and start over."

Ryan asked a simplistic question. I gave him a simplistic answer. I fail to see the problem.

What you want to do is, essentially, burn all the paperwork and start over. This would work if we didn't have so many institutions that run on paper.

Netting things out would help significantly, but it would kill profits for a lot of market participants (mostly banks) who take a commission both ways when country A buys country B's debt just so that B can turn around and buy A's debt. This would be a good thing of course, but those entities own a lot of politicians.

Heh.

Well, I suppose the short term chaos might be justifiable- what I wanted to get across to Ryan was that it is not a simple, easy, or cure-all solution. At best, it's more like using a branding iron to cauterize a wound to stop tetanus from spreading, a crude treatment that can backfire but may beat dying of lockjaw. You can do it, but approaching the problem as one of those adolescent "just do X and it'll get better somehow" ideas isn't going to cut the mustard.

[Stark]

What would people speculate would have resulted from taking a different course with the PIIGS? Would kicking them out early have lowered confidence anyway? Or did they just waste a bunch of money? :v

[Zed]

For the record, there's no reason to resort to slurs like "PIIGS". The term is intentionally derogatory and the financial press has ceased or significantly reduced its use for precisely that reason.

As to your questions about kicking those countries out of the Eurozone: it is unclear how that could have been done, certainly in a short timeframe. Firstly, it's really difficult to argue that there was a need to do this for Italy, Spain, Ireland and Portugal. Those countries have been relatively responsible about their budgets. Italy and Spain, for example, have problems in their economies, but those problems have been present for decades without causing their interest rates to spike (see e.g. http://blogs.reuters.com/great-debate/2 ... han-usual/).

The only member state that might have warranted removal from the Eurozone was Greece, the impact of which remains peripheral when compared to the third largest sovereign bond market in the world that is Italy. One might argue that Greece should have been removed - but there are no provisions in the Treaties for forcing a member state out of the Eurozone; even the provisions for a voluntary departure are very vague.

[Stark]

Oh poor corrupt countries feeling bad? My heart bleeds for their kickbacks.

In what sense is the Greek situation 'peripheral' to a loss of confidence in the EU?

[Zed]

It's not peripheral to the loss of confidence, it's peripheral to the actual EU economies. The fact that the E.U. hasn't been decisive on anything has been a rather influential factor. There's too many different factions pulling strings. Merkel trying to impose austerity regimes as compensation for bail-outs (so as to reduce moral hazard in the future), Sarkozy trying to maintain his own country's AAA status), Cameron trying to drive a further wedge between Eurozone and non-Eurozone in order to repatriate powers from the EU in full-on crisis mode, etc. There is no coherent plan on the level of EU fiscal policy, and that's what's worrying the markets. That idea is what started the vicious circles that are driving Spanish and Italian bond yields up.

[Stark]

I can agree with that, which is why I'm curious if this would have happened if (by magic) the EU hadn't included those countries. Would the lack of direction have killed confidence anyway?

[Zed]

It's rather difficult to consider such a counterfactual, because the Euro would have been in a very different position in the first place if those countries hadn't been part of it. The Greek mess wouldn't have put the lack of a unified fiscal policy in the spotlight in that case, but that doesn't mean that it would never become apparent.

[Lord Zentei]

Although I do think that high inflation right now is what the economy needs.

Why? I'd be quite interested in hearing the reasoning behind this.

Krugman commented on the situation here:

Repost: European Inflation Targets

One problem with blogging is that at any given time many of your readers don’t know about ground you’ve already covered. I’ve tried to remedy that in part with my list of macroeconomics posts over to the right — before commenting on my macro analysis, you might want to read them. Still, it sometimes helps to repost an earlier argument.

So, about why the euro needs inflation to work, here’s what I wrote some time ago:

Jean-Claude Trichet is sounding hawkish about inflation again — and this is very bad news for the European periphery. Let me offer a stylized example to explain why.

So, imagine a eurozone that contains only two countries, Germany and Spain. And let’s make two assumptions: first, Germany’s economy is three times the size of Spain’s, so that German inflation is 3/4 of the overall index, Spain’s inflation 1/4; second, past events have left Spanish wages and prices 20 percent logarithmic too high relative to Germany. (Why logarithmic? So I can just add percentage changes, without having to worry about compounding.)

Now suppose that you want to get relative prices and wages back in line over the course of 5 years. How can this happen? Well, one way or another we need to have German inflation 4 points higher than Spanish inflation over that period.

So consider two scenarios: in scenario A, we have 2 percent German inflation and 2 percent Spanish deflation. This implies an overall eurozone inflation rate of 1 percent. In scenario B, we have 4 percent German inflation and zero Spanish inflation, implying eurozone inflation of 3 percent.

In a frictionless world, it wouldn’t matter which scenario gets chosen. But in reality, scenario A, the low-inflation scenario, is vastly worse for Spain — for two reasons. First, it’s much, much harder to get actual deflation than simply to have stable prices, so scenario A means much higher unemployment. Second, because Spanish debt is in euros, scenario A implies a significantly worse debt burden.

So what we’re seeing is an ECB catering to German desires for low inflation, very much at the expense of making the problems of peripheral economies much less tractable.

This is going to be ugly.

I’d add that the ECB and European leaders have been in complete denial on this point, willing neither to acknowledge the deflation their policies require nor to accept the need for higher overall inflation if deflation is to be avoided.

[Colonel Olrik]

Oh poor corrupt countries feeling bad? My heart bleeds for their kickbacks.

Piss off.

1  Denmark 9.3
1  New Zealand 9.3
1  Singapore 9.3
4  Finland 9.2
4  Sweden 9.2
6  Canada 8.9
7  Netherlands 8.8
8  Switzerland 8.7
8  Australia 8.7
10  Norway 8.6
11  Iceland 8.5
11  Luxembourg 8.5
13  Hong Kong 8.4
14  Ireland 8
15  Austria 7.9
15  Germany 7.9
17  Barbados 7.8
17  Japan 7.8
19  Qatar 7.7
20  United Kingdom 7.6
21  Chile 7.2
22  Belgium 7.1
22  United States 7.1
24  Uruguay 6.9
25  France 6.8
26  Estonia 6.5
27  Slovenia 6.4
28  Cyprus 6.3
28  United Arab Emirates 6.3
30  Israel 6.1
30  Spain 6.1
32  Portugal 6
33  Puerto Rico 5.8
33  Botswana 5.8
33  Republic of China 5.8
36  Bhutan 5.7
37  Malta 5.6
38  Brunei 5.5
39  South Korea 5.4
39  Mauritius 5.4
41  Oman 5.3
41  Costa Rica 5.3
41  Poland 5.3
44  Dominica 5.2
45  Cape Verde 5.1
46  Macau 5
46  Lithuania 5
48  Bahrain 4.9
49  Seychelles 4.8
50  Hungary 4.7
50  Jordan 4.7
50  Saudi Arabia 4.7
53  Czech Republic 4.6
54  Kuwait 4.5
54  South Africa 4.5
56  Malaysia 4.4
56  Namibia 4.4
56  Turkey 4.4
59  Latvia 4.3
59  Slovakia 4.3
59  Tunisia 4.3
62  Croatia 4.1
62  Ghana 4.1
62  Macedonia 4.1
62  Samoa 4.1
66  Rwanda 4
67  Italy 3.9
68  Georgia 3.8
69  Cuba 3.7
69  Montenegro 3.7
69  Romania 3.7
69  Brazil 3.7
73  Bulgaria 3.6
73  El Salvador 3.6
73  Panama 3.6
73  Trinidad and Tobago 3.6
73  Vanuatu 3.6
78  Greece 3.5

The corruption levels of Ireland, Spain and Portugal have nothing to do with those of Italy and Greece. The fucking culture between those three groups (Ireland is a group apart) is significantly different. This explains, among other things, why cars and street shops aren't and won't be burning in Lisbon, and why nobody in the EU is complaining/laughing about the high degree of tax evasion in Ireland or Spain.

[Starglider]

The corruption levels of Ireland, Spain and Portugal have nothing to do with those of Italy and Greece. The fucking culture between those three groups (Ireland is a group apart) is significantly different.

Agree. The first three countries essentially had a massive foreign direct investment bubble, which unfortunately went largely into real estate of dubious productive value. That increased both house prices and property taxes to unrealistic levels, and supported an unsutainable construction boom (with corresponding income taxes), which allowed the government to get used to spending money they didn't have. The governments are still to blame for letting the boom get completely out of control, but frankly that's almost all governments; politicians almost never seriously try to put a brake on the 'good times'. They're in serious trouble and probably have to exit the euro just to get a competitiveness boost for their economies, but it's still fundamentally bubble hangover rather than systemic failure.

Greece and Italy on the other hand are hopelessly dysfunctional, kleptocratic sinkholes for bailout funding; Greece is just a few years further down the road to bankrupcy. I would say five years further, but with the pace of events continuing to accelerate Italy won't have the long easy slide Greece did.

...Wait, what the hell? Starglider, I understand that you're parodying your own version of how you think Thanas thinks,

There's no 'thinks', he posted the first respone and it was a content-free snarky one-liner that would have been split to the HoS if it came from me, Stark or anyone else. Don't take my parody personally

[Surlethe]

Why? I'd be quite interested in hearing the reasoning behind this.

Well, here's one reason. When there's a real shock to the economy, production falls, demand for labor falls, but nominal wages are sticky, so unemployment rises. Unexpectedly higher inflation during a recession means nominal wage stickiness falls away, which means that the labor market reaches equilibrium faster, which means the recession ends faster. (The key is expectations, of course, so you get a short-run Philips curve with slope.)

Asking for low inflation during a recession is like supporting unions or trade barriers: you're basically telling the people without jobs, "I got mine, fuck you."

You can't just say 'high inflation', because the prices of various goods and assets, and the average and top-bracket wages do not increase by the same amount. We can't just say 'we will get the same kind of inflation we had in the late 70s' because the global economy is quite different now. We certainly have too much debt and inflation is the traditional fix for that, but criticially it is wage inflation that makes debts easier to pay down. In the 1970s union politics would and did ensure that printing lots of money would have gone into public sector and state owned / subsidised company wage increases. If we print lots of money and use it to buy bonds, equities and mortgage backed securities, the inflation is focused first on financial asset prices and secondly on commodity prices (via FX impact).

Sure I can say 'high inflation.' We'd not get the same kind of inflation as in the '70s, but the broad pattern will be the same. Perhaps more importantly, it doesn't matter how the rising prices percolate through the economy; the whole system is still going to be better off than if it were to undergo deflation.

Ah, that is an interesting statement, 'nominal wages need to fall'. Interesting as in 'political dynamite'. I don't think Broomstick et al or the OWS protestors or anyone who cares about record income inequality would agree that 'nominal wages need to fall'. Most of the time what actually needs to happen is 'productivity must rise to be globally competitive', reducing wages is one option, working harder or more efficiently are others.

[Sorry about the typo -- REAL wages need to fall.] But yep to "productivity has to rise;" part of that process is discarding the less efficient workers. They have to accept lower wages to re-enter the labor market. Anything that speeds up that readjustment process means that fewer people get fucked with long-term unemployment. I don't particularly care if the OWS or Broomstick et al disagrees; when demand for a good falls, you can't magically keep its price AND the quantity demanded above equilibrium, not even if that good is man-hours worked. The best you can do is either trick the price into falling or vacuum out the excess supply with government purchasing a la WPA and hope your government don't push itself into an unsustainable spiral.

[Skgoa]

Stark: how is prooving that we are going to kick out every country that overburdens itself with debt going to increase confidence in those country's ability to pay their debt?

[Hillary]

I have to say this thread reminds me of the "bread queues before the year's out" one that appeared when the banking crisis first hit the US.

Yes, the shit has hit the fan and it isn't pretty, but this type of over-reaction is very premature.

We're not talking about "bread queues before the year's out", we're not talking about the collapse of civilization, we're not talking about Peak OilTM. We're just talking about a painful second recession and the breakup of the largest currency union and free trade zone in the world. I don't think anybody's predicting bread lines or another world war (at least I'm not, although a German takeover of the European periphery is a tried-and-true method of dealing with depression ... I don't know why I like that joke, but I keep using it). So I'm not seeing how this is hyperventilation or overreaction.

The point I was making is that the predictions of how the world was coming to an end 3 years ago (Duchess, J and AV, I'm particularly looking at you here) were not even close to being right. We were, at that time, given all sorts of graphs and tables showing why a 1920's style depression was not only likely, but unavoidable. It didn't happen. Now we are being given tables and graphs showing that the collapse of the Euro and EU are not only likely, but pretty much unavoidable. Can you understand why I am not exactly running for the hills?

[K. A. Pital]

Isn't this a 1920s-style depression? I mean, the economy is different, etc., but unemployment is at 9%, and by alternate measures far greater. Bread queues during the Great Depression weren't universal either - they were for the unemployed and they were for free food (which is today compensated by food stamps, wherein lots of people participate).

[Starglider]

We were, at that time, given all sorts of graphs and tables showing why a 1920's style depression was not only likely, but unavoidable. It didn't happen.

As Stas said, it did happen. Numerous economic indicators including most tellingly average length of unemployment are at multi-decade negative extremes. Drop by the venting threads for assorted people saying how awful things are. The only reason things aren't worse is that there was massive, early government intervention; printing money, bailing out banks, subsidising manufacturing (e.g. General Motors, Chrysler, Solyndra) and delivering record transfer payments (SNAP). What you mean it 'it hasn't happened to me personally, yet'. It most likely will once the sovereign defaults start and the developed world goes back into recession (i.e. next year).

[Surlethe]

Another way to put it: the economy hasn't recovered from the recession. It's been plodding along at 10-15% under trend since 2008. Eyeball this:

US GDP should be somewhere between $14 trillion and $14.5 trillion. It's hovering a little above $13 trillion. That means the economy is producing somewhere between 7 and 13% under capacity. Now look at how fast the economy has been growing since 2009. It's growing just as fast --- in fact, somewhat more slowly --- than it was before the recession. So the economy is 10% under capacity and not growing to catch up. That looks like a depression to me. The only reason it's not as bad as 1930s is the Fed didn't screw up quite as bad this time.

(Edit: the y-axis is a log scale, so to see trend, draw a straight line in your head.)

[J]

When there's a real shock to the economy, production falls, demand for labor falls, but nominal wages are sticky, so unemployment rises. Unexpectedly higher inflation during a recession means nominal wage stickiness falls away, which means that the labor market reaches equilibrium faster, which means the recession ends faster. (The key is expectations, of course, so you get a short-run Philips curve with slope.)

Which leads to the next question: when and where has this worked without destroying living standards?

Another way to put it: the economy hasn't recovered from the recession. It's been plodding along at 10-15% under trend since 2008. Eyeball this:

Recall that GDP is consumption + investment + government spending + net exports. If the government borrows $2 trillion and sets it on fire, that amount counts towards GDP. If the government borrows $13 trillion and flushes it down the White House toilets it doubles the GDP of the nation.

Thus to obtain the actual GDP, the component of government spending which was borrowed must be subtracted out. At all levels of government. Since ledgers must balance we know how much was borrowed if we know what the budget deficit was in a given year. And we do.



Which gives us this.