The Army of Krugmanites into Submission: Dangerous and Insane

Extrait de: We Must Crush Ambrose Evans-Pritchard, Nouriel Roubini, Martin Wolf, the Army of Krugmanites into Submission; Reflections on "Dangerous and Insane", Mish Global Economic, 11-11-2011

Two days ago, Financial Times columnist Martin Wolf made an attempt at Thinking through the unthinkable. The "unthinkable" was the breakup of the Eurozone.

Reflections on the Easily Thinkable

For starters, a eurozone breakup is hardly unthinkable given that no currency union in history has ever survived in the absence of a fiscal union, and the Eurozone has no such fiscal union.

I suppose one might not want to think about history while praying for a miracle union, but the German Supreme court gratefully put a kibosh to the bureaucratic nanny-zone of never-ending regulation with a definitive ruling that no more German taxpayer funds can be out at risk without a common voter referendum.

Please see Germany's Top Judge Throws Major Monkey Wrench Into Leveraged EFSF Machinery, Demands New Constitution and Popular Referendum for Further Powers for details.

I do not want to dwell on the "easily-thinkable unthinkable", I want to focus on poor economic theory within Wolf's post in regards to proposed solutions to the crisis.

Four Proposed Solutions

Wolf quoted Nouriel Roubini's proposed list of solution.

1.      Restoration of growth and competitiveness through aggressive monetary easing, a weaker euro and stimulatory policies in the core, while the periphery undertakes austerity and reform.

2.      A deflationary adjustment in the periphery alone, together with structural reforms, to force down nominal wages

3.      Permanent financing by the core of an uncompetitive periphery

4.      Widespread debt restructuring and partial break-up of the Eurozone

Wolf points out that option 2 will morph into option 4. I concur while pointing out that is the path we are on, also in agreement with Wolf.

Wolf points out that German would veto option 3 but fails to point out the absolute silliness of the idea in the first place, which I will get to in a moment.

Option 4 is where we are headed, and the debate ought to be how to do that correctly instead of how to achieve the impossible option 1 which Germany would also veto.

I propose, as has Michael Pettis before me, that the best solution is to have Germany exit the Eurozone rather than Greece, then, Portugal, then Spain exit in succession.

Breakup Inevitable but How?

Here is a snip from France, Germany have "Intense Consultations" on Smaller Eurozone; Breakup Inevitable, but How?

Realization the Eurozone is no longer tenable is at long last at hand. In fact, "intense discussions" have been underway for months but are just now admitted to by senior EU officials. ....

The Eurozone is a failed experiment. A breakup is inevitable just as it has been from the beginning.

Structural flaws were too great, built up over the years.

No currency union in history has ever survived unless
there was also a fiscal union

The key question now is how?

It would be best for all involved if Germany left the Eurozone and went back to the Deutschmark. Germany would have an immediately credible currency. Should Greece or Spain leave first, those countries might experience hyperinflation or massive inflation.

Breakup Scenarios and Logistics of Denial

It's important to remember that Germany suffers regardless. As long as the Eurozone stays intact (it can't and won't over the long haul) German taxpayers have to keep acting bailing out foreign countries, foreign banks, and their own banks.

On the other hand, were Germany to leave, the debts to German banks will not be paid back in Deutschmarks but rather deflated Euros.

On the whole, Germany exiting the Eurozone would be less disruptive, than massive inflation scenarios in Greece, Portugal, and Spain.

If France wants to stay in the Euro, let them. They can have the ECB as well. Then the ECB will print money to bail out the French banks (just as French president Sarkozy wants).

Logistics of Denial

Micahel Pettis presented a more detailed discussion of various breakup scenarios as well as a discussion on the "Logistics of Denial", in my September 16 article Eurozone Breakup Logistics (Never Believe Anything Until It's Officially Denied)

In his opening gambit, to the lead question "Will the eurozone survive?" Wolf surmises "I suspect the answer is, no."

Thus, it would be more helpful to debate the merits of "how" a breakup should happen, which countries should leave, and details on how that happens rather than hoping it won't.

Unfortunately, Wolf pines near his conclusion "[we] must go back to the first on the menu of options laid out by Mr Roubini. Potentially solvent countries would be financed and the eurozone would grow its way out of the crisis."

History and Common Sense

As noted earlier, unless there is a complete fiscal-nanny-zone with a one size fits all policy, option 1 cannot possibly work.

Germany would veto option 1, for solid reasons. Moreover, and more importantly, option 1 would not work anyway for the same reason option 3 cannot work: Printing money never solves anything.

How many times does this have to be proven before it sinks in?

Japan offered mammoth quantities of fiscal and monetary stimulus and all it has to show for it is debt in excess of 200% of GDP. Economist Richard Koo pines the lesson was Japan did not do enough stimulus. Sheeesh.

Cash-for-clunkers, multiple tax credits for housing, QE 1, QE 2, a trillion in fiscal stimulus and a myriad of other fiscally insane programs did not create jobs or a lasting recovery.

No amount of stimulus would work because the problem is debt. Yet, the Army of Krugmanites propose we need to do more.

Greenspan resorted to loose monetary policy and it created the biggest housing bubble the world has ever seen.

Now Cristina Romer proposes GDP targets by the Fed to which I responded in Dear Christina ... in light of the facts I presented above in regards to the experiences of Japan, the excess reserves at the Fed, the increase in inflation with no increase in jobs, and the number of people on fixed income destroyed by the rise in price level while getting 0% on their CDs, you have a hell of a lot more explaining why "It's different this Time".

For starters the Fed does not control GDP so the suggestion in and of itself is blatantly idiotic. The Fed can encourage spending but cannot force it. A trillion dollar mountain of excess reserves of banks is proof enough, yet the Monetarists want more.

No matter how much money one throws at a problem it is never enough. We had a housing bubble followed by a crash. Throw enough money around and we will have another bubble and a bigger crash, or simply a massive debt problem from which there is no escape.

The average eighth-grader can easily understand this. The average economist cannot because they are so tied up in monetary theory that has no real world application.

In September, Bernanke himself said he was puzzled by weak consumer spending.

Bernanke is puzzled over something an eighth-grader can easily figure out. Consumers have a mountain of debt and are underwater in their mortgages. Debt is made worse by declining real wages, global wage arbitrage, and a dearth of jobs.

ZIRP did nothing to create jobs but it did affect food and gas prices and effectively destroyed anyone on fixed income.

I would think that should be obvious, but obviously it's not because Bernanke is puzzled over it. This is what happens when academics become addicted to economic models that do not work in periods of debt deflation (assuming they ever worked at all).

Original Sin

Krugman is a big believer in the idea "debt does not matter". He made the mistake of using Italy as the prime example. Oops!

Guess what? Debt matters. Now Krugman is attempting to pass off a foolish statement by blaming
Original Sin
for the Euro Crisis.

One question that keeps coming up is, how can I reconcile my scorn for warnings about bond vigilantes with what is happening to Italy? This seems especially pointed because I have in the past used Italy’s ability to carry debt exceeding its GDP as an illustration that debt concerns were overblown.

The answer lies in the concept of original sin. Not the Pope’s kind, but the economics kind — the long-standing notion that developing countries were especially vulnerable to financial crises because they borrowed in foreign currency.

The key point is that by joining the euro, Italy took a bite of the appleit converted its advanced-country status, as a nation issuing debt in its own currency, into original sin, with debts in someone else’s currency (Europe’s in principle, Germany’s in practice). That is the root of its new vulnerability.

Krugman finishes with "More on all this later, I hope."

I hope so too, starting with my questions

·         When did you realize Italy gave up the Lira?

·         Did you not understand Italy was on the Euro when you used it as an example?

·         Are you looking for excuses after the fact?

Krugman Joins the Euro Cannot Work Parade

For all Krugman's pissing and moaning about imposed austerity measures on Europe, he now has the gall to blame the mess in Italy on "Original Sin" (which I might add also applies to Greece, Portugal, and Spain).

Oh well, it's a start. Perhaps we can get Krugman discussing the best way to break up the Eurozone instead of everyone pretending Roubini Option 1 is still in play.

As an aside, if Krugman turns to Japan for his "debt does not matter" model, he will be wrong again.

Two Things We Can Say for Certain

Japan's Debt Does Not Matter Now

It Will, and in a Major Way (we just do not know when, as with Italy)

All it takes to crush Japan is rising interest rates or a collapse in its export model. Given the cyclical nature of a great many things, one or the other or both will. And when it does, Japan will not be able to get financing.

Debt matters when it matters, and it eventually will. Until it does, we have to put up with foolish statements from major economists that it doesn't, followed by excuses when they are proven wrong.

America and China must crush Germany into submission

Wolf's article was hard enough to take but it was followed by an even more preposterous article by Ambrose Evans-Pritchard.

Please consider America and China must crush Germany into submission

As we watch Italy's 10-year bond yields near 7.5pc and threaten to detonate the explosive charge on €1.9 trillion of debt, it is time for the world to reimpose order.

Yes, this means mobilizing the full-firepower of the ECB – with a pledge to change EU Treaty law and the bank's mandate – and perhaps some form of quantum leap towards a fiscal and debt union.

The EU Project has become both dangerous and insane.

Reflections on "Dangerous and Insane"

·         What's dangerous and insane is economists like Prichard demanding treaties be tossed to the wind to test poorly thought out economic ideas.

·         What's dangerous and insane is economic theory that says printing presses are the answer. It has never worked in history and will not work now.

·         What's dangerous and insane is more leverage. Didn't Lehman and LTCM prove that? How many more times do we have to prove that before it sinks in?

·         What's dangerous and insane is the idea is that central banks can impose their will on the world.

·         What's dangerous and insane is doing the same damn thing over and over and over again hoping for a different result

·         What's dangerous and insane is the moral hazard policy of time-and-time-again forcing the 99% to bail out the 1%.

The world will not end if banks fail. Forcing the 1% (banks and bank bondholders) to take a hit will not cause the world to end either, nor will it cause lending to cease.

Please, let's stop the blatant hyperbole that suggests otherwise.

The ECB could have and should have let Greece default. "We Say No To Default" said a dangerously arrogant ECB president Jean-Claude Trichet.

Trichet loaded up the ECB balance sheet with Greek debt against the advice of Axel Weber. Trichet's move blew up in his face, and I for one am glad to see it. If only he would have learned something from it.

The hubris of central bank wizards and economists is dangerous and insane. Indeed it is central bank wizardry combined with fractional reserve lending and insane levels of government bureaucracy that is at the root of the problem.

Crush Into Submission

You cannot fix a problem unless you understand it. Moreover, even if you do understand the problem, you cannot fit it with unsound theory.

The discussion from Wolf, Pritchard, Roubini, Romer, the vast army of Krugmanites, and the smaller army of equally misguided Monetarists suggests they do not fully understand the problem, nor do they understand sound economic theory as to what it takes to fix it.

To use Pritchard's catchy title, I respond "We Must Crush Ambrose Evans-Pritchard, Nouriel Roubini, Martin Wolf, the Army of Krugmanites into Submission."

That is the mission, and it is a desperately needed mission at that. To accomplish the mission we must prove to the group, to their satisfaction, their solutions are nonsensical.

Unfortunately, the only way I can think of doing that is to give the group everything it wants, then watch it blow sky high. That means turn on the global printing presses, bail out the public pension plans, pour more money into Medicare and Medicaid, create a "living wage" indexed to inflation, give Krugman his tariffs, and declare China a currency manipulator. Not enough jobs? No problem, the government can easily create them. That's what the vast army of Krugmanite Borgs thinks.

There is only one problem with the idea. When the plan blows sky high, Krugman would say "It wasn't enough".