Meltdown

[Coopmv]

The death of the EU?  I don't blame the Germans that they are opposed to bailing out Greece.  I would be equally outraged if the US has to bail out Mexico.  Admission of Mexico into NAFTA was a mistake but admission of Greece into the EU was an even bigger mistake ...   

U.S. Investors woke to heavy selling led by European markets as questions surrounding the very existence of the European Union rose yet again. The fate of the noble EU experiment could effectively be decided as soon as this week when the German Constitutional Court votes to determine if it's constitutional for the ECB to buy the debt of foreign nations. If Germany refuses to participate in an expansion of the ECB's balance sheet, none of the other nations have the wherewithal to chip into the kitty, if you will. Given that the German economy is even closer to an official recession than the U.S., it seems a long-shot that German citizens will opt to send more money abroad.

I asked Rod Smyth, Chief Investment Strategist at Riverfront Investment Group to help piece together exactly what's going on in Europe. Suffice it say, it's not great. The German Constitutional Court's "vote could not be coming at a worse time," noted Smyth. "What you need in Europe is exactly what the Federal Reserve did in 2008; you need a lot of money to secure a lot of bonds."

Whatever you think of the Fed's TARP program, it wasn't much of a problem getting it enacted. There's one US central bank - the Federal Reserve- whose power is recognized by 50 states. The ECB represents 17 different countries bound only by a series of treaties. Seceding from the European Union is a decision Germany can and will make, should their citizenry balk at picking up even more of the ECB's tab.


"It's a very tenuous situation," said Smyth, one he is loathe to handicap (at least verbally). In terms of voting with his investment feet, Smyth said he's "as underweight in Europe as we've ever been." He thinks a European recession is in the cards regardless of Germany's and France's actions; it's just a matter of the depth and whether or not European nations go into the downturn together or individually.

I've said it before and will no doubt say it again: The EU's death is fast upon us and will seem obvious in retrospect. What that means for European, global economies, and stocks is just about anyone's guess.

[Todd]

The death of the EU?  I don't blame the Germans that they are opposed to bailing out Greece.  I would be equally outraged if the US has to bail out Mexico.  Admission of Mexico into NAFTA was a mistake but admission of Greece into the EU was an even bigger mistake ...   

Huh?  This makes no sense.  First of all, NAFTA is a trade agreement only, with each nation retaining its own currency and issuing sovereign debt in said currency.  The type of problem that exists in Europe cannot occur under NAFTA.  That written, the US did help bail out Mexico in the 90s.  Note that the world did not end as a result of that bailout.

Second, the EU is distinct from the Euro and the related crises in some countries.  It would be possible for the EU to remain in place while either eliminating the Euro or kicking some countries out.  There is too much at stake to let the EU die, though the currency may be scaled back.  I'm far more inclined to think that the long-term outcome of this will be to further centralize power in the EU so that it may deal with economic crises more effectively.

[Coopmv]

Huh?  This makes no sense.  First of all, NAFTA is a trade agreement only, with each nation retaining its own currency and issuing sovereign debt in said currency.  The type of problem that exists in Europe cannot occur under NAFTA.  That written, the US did help bail out Mexico in the 90s.  Note that the world did not end as a result of that bailout.

Second, the EU is distinct from the Euro and the related crises in some countries.  It would be possible for the EU to remain in place while either eliminating the Euro or kicking some countries out.  There is too much at stake to let the EU die, though the currency may be scaled back.  I'm far more inclined to think that the long-term outcome of this will be to further centralize power in the EU so that it may deal with economic crises more effectively.

Ever heard of Brady Bond?  There is no free lunch in this world! 

[Todd]

Ever heard of Brady Bond?  There is no free lunch in this world! 

Yes, I know what Brady bonds are.  What does your use of the 'no free lunch' have to do with this, or anything as it pertains to financial crises, for that matter?

[Coopmv]

Yes, I know what Brady bonds are.  What does your use of the 'no free lunch' have to do with this, or anything as it pertains to financial crises, for that matter?

But do you know if all the Brady Bonds have been fully repaid by the LatAM countries?  If not, who ended up paying for them?  Remember, government does not generate revenues ...

[snyprrr]

But do you know if all the Brady Bonds have been fully repaid by the LatAM countries?  If not, who ended up paying for them?  Remember, government does not generate revenues ...

Ooo... Ooo... I know this one. Pick me! Pick me!!

[Todd]

But do you know if all the Brady Bonds have been fully repaid by the LatAM countries?  If not, who ended up paying for them?  Remember, government does not generate revenues ...

There have been some defaults, which of course means that taxpayers pay for them.  What has this to do with the 'no free lunch' concept?  And one must weigh the cost of the bonds in this case to various scenarios of directly bailing out banks in a more overt fashion. 

Also, though the government doesn't generate revenues in the traditional sense, but it is worth noting that the Fed is one of the most "profitable" entities in the world over the past few decades, and TARP may still end up yielding a postive return for taxpayers.  Some specific parts already have.  (One might almost expect that given that several Goldman guys helped construct it.)

[Coopmv]

There have been some defaults, which of course means that taxpayers pay for them.  What has this to do with the 'no free lunch' concept?

If someone ended up having to pay for those defaulted Brady Bonds, then it was no free lunch, plain and simple.  What is your definition of free lunch?

And one must weigh the cost of the bonds in this case to various scenarios of directly bailing out banks in a more overt fashion. 

Wasn't this done to bail out our financial institutions in 08 and 09? 

Also, though the government doesn't generate revenues in the traditional sense, but it is worth noting that the Fed is one of the most "profitable" entities in the world over the past few decades, and TARP may still end up yielding a postive return for taxpayers.  Some specific parts already have.  (One might almost expect that given that several Goldman guys helped construct it.)

I am not so convinced if the US government is profitable from the TARP OVERALL.  If you want to pick your individual case, sure.  There will be some isolated cases of profits.  How much did the government pump into AIG?  I thought it was $180B.  What is current federal debt to GDP ratio?

[Bulldog]

I've said it before and will no doubt say it again: The EU's death is fast upon us and will seem obvious in retrospect.

I doubt there will a death of the EU.  For better or worse, we are slowly heading toward a global economy/government.  The EU is part of that trend.  What's "fast" and "obvious" to you just doesn't track with reality.

[Todd]

What is your definition of free lunch?

I am not so convinced if the US government is profitable from the TARP OVERALL.  If you want to pick your individual case, sure.  There will be some isolated cases of profits.  How much did the government pump into AIG?  I thought it was $180B.  What is current federal debt to GDP ratio?

Free lunch is an opportunity cost concept in economics.  The standard "definition" is that if someone pays for your lunch, it is not free because you are giving up other opportunities to eat that lunch.  In more basic parlance, it means you don't get something for nothing.  I'm not sure how either definition fits the scenario you describe, especially when alternatives to Brady Bonds were discussed and tried in prior crises.  No one I am aware of stated that bailing out any institution has no financial or opportunity cost.  Can you point out cases where that happened?

As to TARP, if you read what I wrote a bit more carefully, you will notice that I wrote it "may still end up yielding a postive return for taxpayers."  That is decidedly different from stating it has, though in specific cases it has.  Not all of the expenditures are finally resolved yet, including AIG, and taxpayers may very well lose a lot of money on that specific part of the bailout. 

[snyprrr]

I doubt there will a death of the EU.  For better or worse, we are slowly heading toward a global economy/government.  The EU is part of that trend.  What's "fast" and "obvious" to you just doesn't track with reality.

...mmm...

[eyeresist]

...mmm...

I remember reading the Protocols of Zion years ago, and thinking, "Actually, this all sounds pretty good to me."

[snyprrr]

I remember reading the Protocols of Zion years ago, and thinking, "Actually, this all sounds pretty good to me."

Interestingly, hoax or not, the things outlined in there are happening in the world today. Gosh! Soooomeone's taking it seriously.


Yes, we are all benevolent dictators, haha!

[drogulus]

      From the Krugman blog at the NYTimes:

September 30, 2011, 9:33 am

Defeatism

Martin Wolf is getting frantic, as well he should. The austerians have brought us to the brink of a vast disaster. A recession in Europe looks more likely than not; and the question for the United States is not whether a lost decade is possible, but whether there is any plausible way to avoid one.

Wolf directs us to a recent speech by Adam Posen (pdf), which opens with a passage that very much mirrors my own thoughts:

    Both the UK and the global economy are facing a familiar foe at present: policy defeatism. Throughout modern economic history, whether in Western Europe in the 1920s, in the US and elsewhere in the 1930s, or in Japan in the 1990s, every major financial crisis-driven downturn has been followed by premature abandonment—if not reversal—of the macroeconomic stimulus policies that are necessary to sustained recovery. Every time, this was due to unduly influential voices claiming some combination of the destructiveness of further policy stimulus, the ineffectiveness of further policy stimulus, or the political corruption from further policy stimulus. Every time those voices were wrong on each and every count. Those voices are being heard again today, much too loudly. It is the duty of economic policymakers including central bankers to rebut these false claims head on. It is even more important that we do the right thing for the economy rather than be slowed, confused, or intimidated by such false claims.

Indeed. Posen's "unduly influential voices" are my Very Serious People. And it has been an awesome spectacle watching the VSPs search, obsessively, for reasons not to fight mass unemployment. Fiscal policy must tighten to appease the invisible bond vigilantes and please the confidence fairy. Interest rates must rise because, well, um, inflation, well, no, low rates cause moral hazard — yes, that must be it.

And we're not (just) talking about ignorant politicians. This stuff has been coming from the European Central Bank, the Organization for Economic Cooperation and Development, the Bank for International Settlements.

I don't fully understand it. But a large part of it, it seems obvious, is the intense desire to see economics as a morality play of sin and punishment, where the sinners are, of course, workers and governments, not the bankers. Pain is not an unfortunate consequence of policies, it's what is supposed to happen.

How obsessive are these people? So obsessive that when the financial doom they predict fails to materialize, they consider this a bad thing: punishment must be administered, so what are the markets waiting for? Here's Alan Greenspan a while back:

    Despite the surge in federal debt to the public during the past 18 months—to $8.6 trillion from $5.5 trillion—inflation and long-term interest rates, the typical symptoms of fiscal excess, have remained remarkably subdued. This is regrettable, because it is fostering a sense of complacency that can have dire consequences.

Gosh, it's regrettable that the markets aren't confirming my warnings! And today Ronald McKinnon laments, yes, laments the failure of the invisible bond vigilantes to show themselves — they're supposed to be "disciplining the government", so why aren't they here?

Just to reiterate a point I've made before, none of this reflects actual economic theory. Throughout this crisis, people like Adam Posen and yours truly have been basing our arguments on standard textbook macroeconomics, whereas the Very Serious People have been making up stories on the fly to justify their calls for pain. As Wolf, who really seems to have eaten his Wheetabix, puts it,

    The waste is more than unnecessary; it is cruel. Sadists seem to revel in that cruelty. Sane people should reject it. It is wrong, intellectually and morally.

And this cruelty rules our world.

     

[bwv 1080]

Free lunch is an opportunity cost concept in economics.  The standard "definition" is that if someone pays for your lunch, it is not free because you are giving up other opportunities to eat that lunch.

the saying has nothing to do with opportunity cost - it refers to the 19th century practice of saloons offering free lunches with a drink purchase - the cost of the lunch was reflected in the hidden in the price of the drink, hence it really was not free.

[bwv 1080]

      From the Krugman blog at the NYTimes:

September 30, 2011, 9:33 am

Defeatism

Martin Wolf is getting frantic, as well he should. The austerians have brought us to the brink of a vast disaster. A recession in Europe looks more likely than not; and the question for the United States is not whether a lost decade is possible, but whether there is any plausible way to avoid one.

Wolf directs us to a recent speech by Adam Posen (pdf), which opens with a passage that very much mirrors my own thoughts:

    Both the UK and the global economy are facing a familiar foe at present: policy defeatism. Throughout modern economic history, whether in Western Europe in the 1920s, in the US and elsewhere in the 1930s, or in Japan in the 1990s, every major financial crisis-driven downturn has been followed by premature abandonment—if not reversal—of the macroeconomic stimulus policies that are necessary to sustained recovery. Every time, this was due to unduly influential voices claiming some combination of the destructiveness of further policy stimulus, the ineffectiveness of further policy stimulus, or the political corruption from further policy stimulus. Every time those voices were wrong on each and every count. Those voices are being heard again today, much too loudly. It is the duty of economic policymakers including central bankers to rebut these false claims head on. It is even more important that we do the right thing for the economy rather than be slowed, confused, or intimidated by such false claims.

Indeed. Posen's "unduly influential voices" are my Very Serious People. And it has been an awesome spectacle watching the VSPs search, obsessively, for reasons not to fight mass unemployment. Fiscal policy must tighten to appease the invisible bond vigilantes and please the confidence fairy. Interest rates must rise because, well, um, inflation, well, no, low rates cause moral hazard — yes, that must be it.

And we're not (just) talking about ignorant politicians. This stuff has been coming from the European Central Bank, the Organization for Economic Cooperation and Development, the Bank for International Settlements.

I don't fully understand it. But a large part of it, it seems obvious, is the intense desire to see economics as a morality play of sin and punishment, where the sinners are, of course, workers and governments, not the bankers. Pain is not an unfortunate consequence of policies, it's what is supposed to happen.

How obsessive are these people? So obsessive that when the financial doom they predict fails to materialize, they consider this a bad thing: punishment must be administered, so what are the markets waiting for? Here's Alan Greenspan a while back:

    Despite the surge in federal debt to the public during the past 18 months—to $8.6 trillion from $5.5 trillion—inflation and long-term interest rates, the typical symptoms of fiscal excess, have remained remarkably subdued. This is regrettable, because it is fostering a sense of complacency that can have dire consequences.

Gosh, it's regrettable that the markets aren't confirming my warnings! And today Ronald McKinnon laments, yes, laments the failure of the invisible bond vigilantes to show themselves — they're supposed to be "disciplining the government", so why aren't they here?

Just to reiterate a point I've made before, none of this reflects actual economic theory. Throughout this crisis, people like Adam Posen and yours truly have been basing our arguments on standard textbook macroeconomics, whereas the Very Serious People have been making up stories on the fly to justify their calls for pain. As Wolf, who really seems to have eaten his Wheetabix, puts it,

    The waste is more than unnecessary; it is cruel. Sadists seem to revel in that cruelty. Sane people should reject it. It is wrong, intellectually and morally.

And this cruelty rules our world.

   

i.e. 1937

When the dollar was re-pegged to gold at $35 per oz. in January 1934, the US essentially went back on a gold standard. Gold reserves constituted 85% of the monetary base and changes in those reserves accounted for most of the changes in the monetary base. Because the US received large gold inflows in the mid-1930s, monetary policy was expansionary. This was the primary reason for the economic recovery (Romer 1992).
But when the Roosevelt administration began to worry about the potential for higher inflation, the Treasury Department decided to sterilise all gold inflows starting in December 1936. In essence, its new gold holdings were held in an inactive account rather than with the Federal Reserve, where it would have become part of the monetary base and money supply. Thus, instead of allowing the monetary base to grow with the inflow of gold, the monetary base was essentially frozen at its existing level.

http://www.voxeu.org/index.php?q=node/6965

[Todd]

the saying has nothing to do with opportunity cost

Well, then, you and I learned economics at different times and with different texts because that's how it was covered in micro courses.

Gosh, it's regrettable that the markets aren't confirming my warnings!

Krugman is being disingenuous, but then he is on occasion.  While there are certainly those who foolishly want austerity now, the (or at least a) long term concern is that continuing fiscal profligacy will lead to unpleasant outcomes, namely high inflation, and that while in theory it's possible – hell, it's easy – to boost spending for a while and then curb it when things are better, it's a whole lot harder to do in the real world.  Spending programs foster groups dependent on the programs, thus possibly turning short-term expansionary spending into structural spending.  While I think Krugman and other Keynesians are essentially correct that additional spending is needed now and for the short-term (12-18 months, maybe 24 months) followed by long-term, structural fiscal changes, it's more complex than that, and Krugman knows it. 

His comment about "standard textbook macroeconomics" is a wee bit flippant, too, methinks.  Policy-makers of the 60s and 70s often followed then textbook macroeconomics, and we ended up with stagflation. 

[drogulus]

      Here's one explanation for why this lunacy continues: The failure to implement expansionist policies, or the failure to continue them even when the signs appear they are having the predicted effect, is seen as the failure of the policies themselves. So, when the stimulus applied in 2009-2010 produced 3 million jobs, roughly what was expected, and the 3 million turned out to be much less than enough to reverse a worldwide downturn, the contractionists blamed the expansionist measures, not our feckless underutilization of them. You see, they said, it doesn't work. Of course the evidence is that they did work as expected and if all we needed to fill the hole was half a hole's worth of dirt, then we accomplished the mission.

     Maybe the example of Europe makes it easier to understand. While we cautiously expanded, they contracted, because they were more worried about debt than economic collapse. That made our job harder as we fought through the headwinds of budget cutting and balancing abroad as well as at home at the level of state and local governments, which cut employment because the aid from the federal government to keep people employed was inadequate. Nothing about our predicament is hard to understand, and the solutions are obvious and known to work (not applying them is not, contra the conservatives, an instance of them not working).

Krugman is being disingenuous, but then he is on occasion.  While there are certainly those who foolishly want austerity now, the (or at least a) long term concern is that continuing fiscal profligacy will lead to unpleasant outcomes, namely high inflation, and that while in theory it's possible – hell, it's easy – to boost spending for a while and then curb it when things are better, it's a whole lot harder to do in the real world.  Spending programs foster groups dependent on the programs, thus possibly turning short-term expansionary spending into structural spending.  While I think Krugman and other Keynesians are essentially correct that an additional spending is needed now and for the short-term (12-18 months, maybe 24 months) followed by long-term, structural fiscal changes, it's more complex than that, and Krugman knows it. 

His comment about "standard textbook macroeconomics" is a wee bit flippant, too, methinks.  Policy-makers of the 60s and 70s often followed then textbook macroeconomics, and we ended up with stagflation. 

     Krugman has on occasion talked about deficits as though they were a primary rather than a secondary concern. This is wrong IMO. Only ability to pay matters in my book. All other questions about deficits are answered by examining what the deficits are used for, and the use is the question, not the deficits.

     Expanding into an overheated economy isn't a good thing, nor is it going to produce the same results when exogenous shocks like oil embargoes bring about inflation. I don't see this as relevent in a period of contraction like we are in now. Nor do I think inflation is an absolute evil in current circumstances. We could add a couple of percent to inflation as a price of expansion with positive results overall. But we can't convince the Germans to go along.

[Todd]

Only ability to pay matters in my book.

I would hesitate to make such a categorical claim.  Large, sustained fiscal deficits can and usually do lead to higher rates as well as crowding out of private investment.  These are not big concerns today, of course, but over time they are. 

[drogulus]

     When the economy is booming you can cut back and raise taxes. See Bush I and Clinton. Of course the practical problem is made difficult by boom-and-bust psychology which tends to magnify underlying economic trends. That's why we contract in a recession and accelerate booms when we should pull back. But though I understand how bubbles and busts are amplified by human predilections I don't think we should just throw up our hands and give up.

I would hesitate to make such a categorical claim.  Large, sustained fiscal deficits can and usually do lead to higher rates as well as crowding out of private investment.  These are not big concerns today, of course, but over time they are. 

     I think Krugman said something like that. In the long run deficits matter is how it goes. I don't believe it.