The Christensen Media Blitz on the euro, ‘Open Borders’, China and ‘currency war’

I have been in a bit of media blitz recently. Here is some of it:

I have been on Russia Today’s Boom-Bust show to talk to Ameera David about the euro and why I think the euro is a Monetary Strangulation Mechanism. Watch here (after 3:35).

And while we are talking about the euro here is an op-ed of mine from the Danish newspaper Jyllandsposten on the same topic (in Danish).

Then something completely different – here I am telling Berlingske Business the story of my Great-great grandfather Sven Persson who emigrated to Denmark from Sweden in 1880 and hence contributed to the economic development in both countries. I make the case for completely Open Borders and argues that that we could double global GDP if we removed all anti-immigration regulation globally. See my ‘video blog’ here (also in Danish).

Here is an op-ed from the Danish Business Daily Børsen on the Chinese on the Chinese devaluations and why the talk of ‘currency war’ mostly is nonsense.

Finally here is an interview (in French) with Atlantico.fr about the risk of a repeat of the 1997 Asian crisis, My answer is yes, the Chinese situation is worrying, but the good news is that we have floating exchange rates across Asia rather than fixed exchange rates.

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

Horror graph of the week – Greek PMI collapses

If you ever read Friedman and Schwartz’s “A Monetary History of the United States” you know what happens when a central bank fails to act as a lender-of-last resort in the event of a bank run and/or at the same time fails to offset the impact on broad money growth of such bank run.

It of course happened in the US in 1930-31 and again in Europe after the collapse of Credit-Anstalt in Austria also in 1931. In both cases the result was a deep depression. Now it has happened again in Greece, but Greece is already in a deep economic depression.

Just have a look at this shocking graph from Macropolis.gr.

Greek PMI

There is no great reason to trust eyeball-econometrics, but judging from the sharp drop in Greek July PMI (released today) then we should expect another 10-15% drop in Greek real GDP in the next couple of quarters. That would mean that we soon will have seen Greek real GDP being halved since the start of this crisis.

I think it will be very hard to find any other example of a (peacetime) collapse of real GDP of this magnitude in any other country in the world in the past 200 years and there is nothing positive to say about this. It is the terrible consequence of massive policy failures in Brussels, Frankfurt, Berlin and Athens.

A truly Greek tragedy.

HT Joe Wiesenthal.

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: roz@specialistspeakers.com.

Also note that I am on a Speaking Tour in the US in October. See more here.

The Euro – A Fiscal Strangulation Mechanism (but mostly for monetary reasons)

In my earlier post The Euro – A Fatal Conceit I argued that had the euro not be introduced and had we instead had freely floating exchange rates then “European taxpayers would (not) have had to pour billions of euros into bailing out Southern European and Eastern European government”. Said in another way had we not had the euro then there would not have been a European “debt crisis” or at least it would have been significantly smaller.

A simple way of illustrating this is to have a look at the debt development in the euro countries (and the countries pegged to the euro) and comparing that with the debt development in the European countries with floating exchange rates.

I use the same countries as in my previous post – The Euro – A Monetary Strangulation Mechanism. 21 euro countries (and countries pegged to the euro) and 10 countries with more or less floating exchange rates.

The graph below shows the development in (median) gross public debt (% of GDP) in the two groups of countries. (All countries are hence equally weighted).

debt change 2007 20014 floaters peggers

The picture is very clear – while both the floaters and the euro countries saw their public debt ratios increase sharply on the back of the 2008 shock (albeit less extremely for the floaters than for the euro countries) – from 2011 there is a very clear difference in the debt development.

Hence, from 2011 the floaters have seen as seen a gradual decline in gross public debt (as share of GDP), while the euro countries (and the peggers) have seen a steep increase in public indebtedness.

So while the floaters have seen their public debt increase by just above 10% of GDP from 2007 to 2014 the euro countries have seen a rise in public debt of more than 25% of GDP!

The graph below shows the individual breakdown of the data.

Publ debt green red

Again the picture is very clear – the euro countries (and the euro peggers) have had significantly more negative debt dynamics than the European floaters. Even if we disregard the PIIGS countries then the euro countries are on average doing a lot worse than the floaters in terms of public debt dynamics .

The euro countries are trying harder, but are succeeding less

One could of course argue that the difference in debt development simply reflects that some countries are just less prudent than other. However, the graph below shows that this is not a very good explanation.

Fiscal tightening

The graph shows the annual change in the fiscal stance (measured as the annual change in IMF’s estimate for the structural public balance as share of GDP). Positive (negative) values are a fiscal easing (tightening).

A few interesting conclusions emerge. First of all overall both euro countries and floaters seem to have had rather pro-cyclical fiscal policies – hence, both groups of countries eased fiscal policy in the ‘good years’ (2005-2009), but tightened the fiscal stance in the ‘bad years’ (2010-14.)

Second, it is notable that the fiscal stance of the euro countries and the floaters is highly correlated and is of a similar magnitude.

So even if the fiscal stance has an impact on growth in both groups of countries it seems a bit far-fetched to in general attribute the difference in real GDP growth between the two groups of countries to difference in the fiscal stance. That said, it seems like overall the euro countries and peggers have had a slightly more austere fiscal stance than the floaters after 2010. (Some – like Greece of course have seen a massive tightening of fiscal policy.)

This of course makes it even more paradoxical that the euro countries have had a significantly more negative debt dynamics than the floaters.

It is not a debt crisis – it is an NGDP crisis  

So we can conclude that the reason that the euro countries’ debt dynamics are a lot worse than the floaters is not because of less fiscal austerity, but rather the problem seems to be one of lacking growth in the euro countries. The graph below illustrates that.

NGDP debt

The graph plots the debt dynamics against the growth of nominal GDP from 2007 to 2014 for all 31 countries (both euro countries and the floaters).

The graph clearly shows that the countries, which have seen a sharp drop in nominal GDP such as Ireland and Greece have also seen the steepest increasing the public debt ratios. In fact Greece is nearly exactly on the estimated regression line, which implies that Greece has done exactly as good or bad as would be expected given the steep drop in Greek NGDP. This leaves basically no room for a ‘fiscal irresponsibility’ explanation for the rise in Greek public debt after 2007.

This of course nearly follows by definition – as we define the debt ratio as nominal public debt divided by nominal GDP. So when the denominator (nominal GDP) drops it follows by definition that the (debt) ratio increases. Furthermore, we also know that public sector expenditure (such as unemployment benefits) and tax revenues tend to be rather sensitive to changes in nominal GDP growth.

As a consequence we can conclude that the so-called ‘Europe debt crisis’ really is not about lack of fiscal austerity, but rather a result of too little nominal GDP growth.

And who controls NGDP growth? Well, overall NGDP growth in the euro zone is essentially under the full control of the ECB (remember MV=PY). This means that too tight monetary policy will lead to too weak NGDP growth, which in turn will cause an increase in public debt ratios.

In that regard it is worth noticing that it is hardly a coincidence that the ECB’s two unfortunate rate hikes in 2011 also caused a sharp slowdown in NGDP growth in certain euro zone countries, which in turn caused a sharp rise in public debt ratios as the first graph of this post clearly shows.

Consequently it would not be totally incorrect to claim that Jean-Claude Trichet as ECB-chief in 2011 played a major role in dramatically escalating the European debt crisis.

Had he not hiked interest rates in 2011 and instead pursued a policy of quantitative easing to get NGDP growth back on track then it seems a lot less likely that we would have seen the sharp increase in public debt ratios we have seen since 2011.

Of course that is not the whole story as the ECB does only control overall euro zone NGDP growth, but not the NGDP growth of individual euro zone countries. Rather the relative NGDP growth performance within the euro is determined by other factors such as particularly the initial external imbalances (the current account situation) when the shocks hit in 2008 (Lehman Brothers’ collapse) and 2011 (Trichet’s hikes.)

Hence, if a country like Greece with a large current account deficit is hit by a “funding shock” as in 2008 and 2011 then the country will have to have an internal devaluation (lower prices and lower wage growth) and the only way to achieve that is essentially through a deep recession.

However, that is not the case for countries with a floating exchange rate as a floating exchange country with a large current account deficit does not have to go through a recession to restore competitiveness – it just has to see a depreciation of its currency as Turkey as seen since 2008-9.

Concluding, the negative debt dynamics in the euro zone since 2008 are essentially the result of two things. 1) The misguided rate hikes in 2011 and 2) the lack of ability for countries with large current account deficits to see a nominal exchange rate depreciation.

The Euro is Fiscal Strangulation Mechanism, but for monetary reasons 

We can therefore conclude that the euro indeed has been a Fiscal Strangulation Mechanism as fiscal austerity has not been enough to stabilize the overall debt dynamics in a numbers of euro zone countries.

However, this is only the case because the ECB has first of all failed to offset the fiscal austerity by maintaining nominal stability (hitting its own inflation target) and second because countries, which initially had large current account deficits like Greece and Spain have not – contrary to the floaters – been able to restore competitiveness (and domestic demand) through a depreciation of their currencies as they essentially are “pegged” within the euro zone.

PS I have excluded Croatia from the data set as it is unclear whether to describe the Croatian kuna as a dirty float or a dirty peg. Whether or not Croatia is included in the sample does not change the conclusions.

Update: My friend Nicolas Goetzmann pointed out the Trichet ECB also hiked interest rates in 2008 and hence dramatically misjudged the situation. I fully agree with that, but my point in this post is not necessarily to discuss that episode, but rather to discuss the fiscal implications of the ECB’s failures and the problem of the euro itself.

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

The Euro – A Monetary Strangulation Mechanism

In my previous post I claimed that the ‘Greek crisis’ essentially is not about Greece, but rather that the crisis is a symptom of a bigger problem namely the euro itself.

Furthermore, I claimed that had it not been for the euro we would not have had to have massive bailouts of countries and we would not have been in a seven years of recession in the euro zone and unemployment would have been (much) lower if we had had floating exchange rates in across Europe instead of what we could call the Monetary Strangulation Mechanism (MSM).

It is of course impossible to say how the world would have looked had we had floating exchange rates instead of the MSM. However, luckily not all countries in Europe have joined the euro and the economic performance of these countries might give us a hint about how things could have been if we had never introduced the euro.

So I have looked at the growth performance of the euro countries as well as on the European countries, which have had floating (or quasi-floating) exchange rates to compare ‘peggers’ with ‘floaters’.

My sample is the euro countries and the countries with fixed exchange rates against the euro (Bulgaria and Denmark) and countries with floating exchange rates in the EU – the UK, Sweden, Poland, Hungary, the Czech Republic and Romania. Furthermore, I have included Switzerland as well as the EEA countriesNorway and Iceland (all with floating exchange rates). Finally I have included Greece’s neighbour Turkey, which also has a floating exchange rate.

In all 31 European countries – all very different. Some countries are political dysfunctional and struggling with corruption (for example Romania or Turkey), while others are normally seen as relatively efficient economies with well-functioning labour and product markets and strong external balance and sound public finances like Denmark, Finland and the Netherland.

Overall we can differentiate between two groups of countries – euro countries and euro peggers (the ‘red countries’) and the countries with more or less floating exchange rates (the ‘green countries’).

The graph below shows the growth performance for these two groups of European countries in the period from 2007 (the year prior to the crisis hit) to 2015.

floaters peggers RGDP20072015 A

The difference is striking – among the 21 euro countries (including the two euro peggers) nearly half (10) of the countries today have lower real GDP levels than in 2007, while all of the floaters today have higher real GDP levels than in 2007.

Even Iceland, which had a major banking collapse in 2008 and the always politically dysfunctionally and highly indebted Hungary (both with floating exchange rates) have outgrown the majority of euro countries (and euro peggers).

In fact these two countries – the two slowest growing floaters – have outgrown the Netherlands, Denmark and Finland – countries which are always seen as examples of reform-oriented countries with über prudent policies and strong external balances and healthy public finances.

If we look at a simple median of the growth rates of real GDP from 2007 until 2015 the floaters have significantly outgrown the euro countries by a factor of five (7.9% versus 1.5%). Even if we disregard the three fastest floaters (Turkey, Romania and Poland) the floaters still massively outperform the euro countries (6.5% versus 1.5%).

The crisis would have long been over had the euro not been introduced  

To me there can be no doubt – the massive growth outperformance for floaters relative to the euro countries is no coincidence. The euro has been a Monetary Strangulation Mechanism and had we not had the euro the crisis in Europe would likely long ago have been over. In fact the crisis is essentially over for most of the ‘floaters’.

We can debate why the euro has been such a growth killing machine – and I will look closer into that in coming posts – but there is no doubt that the crisis in Europe today has been caused by the euro itself rather than the mismanagement of individual economies.

PS I am not claiming the structural factors are not important and I do not claim that all of the floaters have had great monetary policies. The only thing I claim is the the main factor for the underperformance of the euro countries is the euro itself.

PPS one could argue that the German ‘D-mark’ is freely floating and all other euro countries essentially are pegged to the ‘D-mark’ and that this is the reason for Germany’s significant growth outperformance relative to most of the other euro countries.

Update: With this post I have tried to demonstrate that the euro does not allow nominal adjustments for individual euro countries and asymmetrical shocks therefore will have negative effects. I am not making an argument about the long-term growth outlook for individual euro countries and I am not arguing that the euro zone forever will be doomed to low growth. The focus is on how the euro area has coped with the 2008 shock and the the aftermath. However, some have asked how my graph would look if you go back to 2000. Tim Lee has done the work for me – and you will see it doesn’t make much of a difference to the overall results. See here.

Update II: The euro is not only a Monetary Strangulation Mechanism, but also a Fiscal Strangulation Mechanism.

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

The Euro – A Fatal Conceit

Imagine that the euro had never been introduced and we instead had had freely floating European currencies and each country would have been free to choose their own monetary policy and fiscal policy.

Some countries would have been doing well; others would have been doing bad, but do you seriously think that we would had a crisis as deep as what we have seen over the past seven years in Europe?

Do you think Greek GDP would have dropped 30%?

Do you think Finland would have seen a bigger accumulated drop in GDP than during the Great Depression and during the banking crisis of 1990s?

Do you think that European taxpayers would have had to pour billions of euros into bailing out Southern European and Eastern European governments? And German and French banks! (I elaborate on this here.)

Do you think that Europe would have been as disunited as we are seeing it now?

Do you think we would have seen the kind of hostilities among European nations as we are seeing now?

Do you think we would have seen the rise of political parties like Golden Dawn and Syriza in Greece or Podemos in Spain?

Do you think anti-immigrant sentiment and protectionist ideas would have been rising across Europe to the extent it has?

Do you think that the European banking sector would have been quasi paralyzed for seven years?

And most importantly do you think we would have had 23 million unemployed Europeans?

The answer to all of these questions is NO!

We would have been much better off without the euro. The euro is a major economic, financial, political and social fiasco.

It is disgusting and I blame the politicians of Europe and the Eurocrats for this and I blame the economists who failed to speak out against the dangers of introducing the euro and instead gave their support to a project so economically insane that it only could have been envisioned by the type of people the British historian Paul Johnson called “Intellectuals”.

And don’t say you where not warned. Milton Friedman had warned you that forced monetary integration would cause political disunity and would be an economic disaster. He was of course right.

Bernard Connolly who wrote the book “The Rotten Heart of Europe” warned against exactly what is going on right now. Nobody wanted to listen. In fact Bernard Connolly was sacked from the European Commission in 1995 for speaking his mind.

The sacking of Bernard Connolly unfortunate is telling of lack of debate about monetary policy matters in Europe. Any opposition to the “project” is silenced. The greater “good” always comes first.

There have only been referendums about euro adoption in a few countries. In Denmark and Sweden the electorate have been wise enough to go against the “orders” of the euro establishment. As a consequence both countries today are better off than if the electorate had followed the orders of the elite and voted ‘yes’ to euro adoption.

It is easy to understand the frustration of the European voters. They have been lied to. Unfortunately the outcome is that voters across Europe now are happy to vote for parties like Front Nation, UKIP, Podemos and Syriza. I ask you the cheerleaders of the euro project – is this what you wanted?

I can only say that I can understand the Greek population’s anger over seven years of economic and social hardship and I likewise can understand that the taxpayers of Finland don’t want to pay for yet another meaningless bailout of Greece. But you should not blame each other. You should blame the European politicians who brought you into the euro.

Blame the eurocrats who never understood Hayek’s dictum from his great book “The Fatal Conceit”:

“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

The euro is a fatal conceit.

UPDATE: I now have some empirical evidence that the euro is indeed a Monetary Strangulation Mechanism.

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

Remember the “Corralito”? Lessons on Greece and Argentina from the New York Times

This is from the New York Times today:

Greece will keep its banks closed on Monday and place restrictions on the withdrawal and transfer of money, Prime Minister Alexis Tsipras said in a televised address on Sunday night, as Athens tries to avert a financial collapse.

The government’s decision to close banks temporarily and impose other so-called capital controls — and to keep the stock market closed on Monday — came hours after the European Central Bank said it would not expand an emergency loan program that has been propping up Greek banks in recent weeks while the government was trying to reach a new debt deal with international creditors.

The debt negotiations broke down over the weekend after Mr. Tsipras said he would let the Greek people decide whether to accept the creditors’ latest offer. That referendum vote is to be held next Sunday, after the current bailout program will have expired.

And this is from the New York Times on December 2 2001:

The government (of Argentina) has limited cash withdrawals from banks and taken a step toward adopting the dollar as Argentina’s currency, as part of a desperate effort to avert a run on banks and a chaotic devaluation.

The measures, announced late Saturday, were another sign that Argentina is on the brink of a default on its $132 billion in public sector debt. It has already cut the interest payments it makes on $45 billion in bonds in recent days.

A month later we had street rioting, banking sector collapse, a sovereign default and a major devaluation – not to mention the collapse of government and a very busy rotating door at the presidential palace!

Will Greece be luckier in the coming month? Let’s hope so.

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

How the RECOVERY will look like when Greece leaves the euro

Most indications are that Greece this weekend effectively has been pushed over edge by the collective failures of Greek and European policy makers. The combined forces of an European monetary straitjacket, the lack of a coherent European sovereign debt crisis resolution mechanism and weak Greek institutional structures and a lot of badwill on both sides of the issue in the end did it.

And we are now facing bank run, possible banking sector collapse, the likely introduction of capital controls, a Greek sovereign default and potentially also a Greek exit from the euro area.

So there is no doubt that the future looks very bleak for the Greek economy, but there are also good arguments that all this actually might mark the beginning of a Greek economic recovery in the same way the Argentine default and devaluation in January 2002 was the beginning of a sharp recovery in Argentine growth in from 2002 to 2007.

Argentina in 2001-2, Greece today 

it is no coincidence that I mention the example of Argentine. Hence, I have long argued that the present Greek crisis is very similar to the Argentine crisis of the late 1990s and early 2000s. Both countries have been suffering under the combined pressures of a monetary regime that creates strong deflationary pressures and a weak domestic political system.

We can essentially think of this as both a demand and a supply problem. With the monetary system causing a collapse in aggregate demand and weak institutional structures at the same time causing a negative supply shock as well as creating downward rigidities to wages and prices.

In the late 1990s the Argentine’s currency board set-up created serious deflationary pressures and a drop in nominal GDP, which caused a rise in Argentine debt ratios. There was a simple “solution” to this problem – Argentina should give up the currency board and devalue. That happened in early 2002.

Even though the contraction in the Argentine economy continued in the first couple of quarters after the devaluation growth soon picked up and in fact Argentine real GDP growth in the period 2003-2007 averaging nearly 8.5% per year. Obviously we should not forget that GDP dropped 10% in 2002, but that was essentially the impact of the banking crisis that played out ahead of the devaluation rather than a result of the devaluation.

I think that we very well could be in for a very similar development in Greece if the country indeed leaves the euro area. Obviously we are now in the midst of an extremely chaotic political and economic situation and what could become a full scale banking crisis and a disorderly sovereign default. The bank run we effective already have seen on its own constitutes a massive monetary tightening – due to the drop in the money-multiplier – and that on its own is going to have a strongly negative impact on the Greek economy in the coming quarters.

However, Grexit will also remove the monetary straitjacket, which has had caused an enormous amount of economic hardship in Greece since 2008. The removal of this straitjacket will cause a significant easing of Greek monetary conditions, which in my view very likely will cause a sharp rise in nominal GDP in Greece in the coming years. The graph below shows the development in Argentine M2 and nominal GDP on the back of the Argentine devaluation in 2002.

I think we might very well see a similar development in Greece on the back of Grexit and given the price and wage rigidities in the Greek economy we are likely to see a sharp recovery in Greek real GDP growth – after the initial deep recession, but my guess is that Grexit will be the beginning of the end of this recession.

The graph below shows the development in real GDP in Argentina eight years ahead of the default and the devaluation in 2002 and in eight years following the initial collapse. The graph also includes Greek real GDP. “Year zero” is 2001 for Argentina and 2014 for Greece.

Argentina Greece RGDP

The recovery will not primarily be about exports

Hence, I believe there is good reason to think that a potential Grexit will be the beginning of a sharp recovery in Greek growth – following the initial sharp contraction. However, I would like to stress that contrary to the common-held view such recovery will not be about Greece becoming more “competitive” due to the drop in value of the “New Drachma” (I easily see a 70-80% devaluation following Grexit).

Rather we are likely to see a sharp recovery in domestic demand as a likely sharp rise in inflation expectations will cause a sharp increase in money velocity. This combined with the expected increase in the money supply will cause a significant easing of Greek monetary conditions, which likely will spur a strong recovery in Greek growth.

This is exactly what happened in Argentina. This is from Mark Weisbrot and Luis Sandoval’s 2007-paper on “Argentina’s economic recovery”:

“However, relatively little of Argentina’s growth over the last five years (2002-2007) is a result of exports or of the favorable prices of Argentina’s exports on world markets. This must be emphasized because the contrary is widely believed, and this mistaken assumption has often been used to dismiss the success or importance of the recovery, or to cast it as an unsustainable “commodity export boom…

During this period (The first six months following the devaluation in 2002) exports grew at a 6.7 percent annual rate and accounted for 71.3 percent of GDP growth. Imports dropped by more than 28 percent and therefore accounted for 167.8 percent of GDP growth during this period. Thus net exports (exports minus imports) accounted for 239.1 percent of GDP growth during the first six months of the recovery. This was countered mainly by declining consumption, with private consumption falling at a 5.0 percent annual rate.

But exports did not play a major role in the rest of the recovery after the first six months. The next phase of the recovery, from the third quarter of 2002 to the second quarter of 2004, was driven by private consumption and investment, with investment growing at a 41.1 percent annual rate during this period. Growth during the third phase of the recovery – the three years ending with the second half of this year – was also driven mainly by private consumption and investment… However, in this phase exports did contribute more than in the previous period, accounting for about 16.2 percent of growth; although imports grew faster, resulting in a negative contribution for net exports. Over the entire recovery through the first half of this year, exports accounted for about 13.6 percent of economic growth, and net exports (exports minus imports) contributed a negative 10.9 percent.

The economy reached its pre-recession level of real GDP in the first quarter of 2005. As of the second quarter this year, GDP was 20.8 percent higher than this previous peak. Since the beginning of the recovery, real (inflation-adjusted) GDP has grown by 50.9 percent, averaging 8.2 percent annually. All this is worth noting partly because Argentina’s rapid expansion is still sometimes dismissed as little more than a rebound from a deep recession.

So you better get ready for the stories in the media following a potential Grexit that this will be “good for Greek tourism” and “feta exports”, but if you study monetary history you will know that this will only be part of a the story and looking ahead over the coming five years it is much more likely that the story will be a sharp recovery in Greek domestic demand.

But don’t forget Greece’s quasi-Constitutional problems

Concluding, I am probably more optimistic that a potential Grexit will cause a recovery (after the initial contraction) in the Greek economy than most economists who tend to stress Greece’s structural problems. That, however, does not mean that I don’t think Greece has structural problems. In fact I believe the Greece has very serious structural problems and I will even go so far as to say that Greece’s deep structural problems are a result of fundamental constitutional problems.

Hence, at the core of the problems that have dominated the Greek economic development for decades (if not centuries!) is a flawed political system. Therefore, if Greece wants to avoid ending up as present-day Argentina – where the initial positive effects of monetary easing has been “replaced” by overly easy monetary policy and large political uncertainties – then there is a need for fundamental constitutional reform to reduce the role of government in the Greek economy and constrain the unhealthy relationship between economic and political interests.

So yes, monetary easing can solve the demand problems in the Greek economy (I think that actually was under way prior to Syriza winning the parliament elections), but monetary easing will not do anything about Greece’s structural and constitutional problems.

Finally, on a personal note I must say I have a very deep sympathy for the economic and social suffering of the Greek population and I full well understand their justified frustration they have with European and Greek policy makers who so utterly have failed in the past seven years. I equally understand the frustration of German, Danish and Slovak tax payers who directly or indirectly over the past seven years have been asked to pick up the bill for numerous badly designed bailout packages. They have done very little good to Europe or Greece.

But I mostly hope that we would give up the national stereotyping and instead study the fundamental economic and monetary issues. The Greek crisis is not about the Greeks being “lazy” (in fact Greeks work a lot more than the Germans…) or corrupt, but it is about the serious monetary policy failures of the ECB and a generally badly designed monetary policy framework in Europe combined with the failures of the Greek political establishment.

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

Yanis Varoufakis has a point – the Greek debt crisis is mostly about the collapse of NGDP

The Greek Finance Minister Yanis Varoufakis has a new article for Project Syndicate. He is making a point that Market Monetarists have been making since the outbreak of the euro crisis – it is not really a ‘debt crisis’, but rather a monetary crisis.

This is Varoufakis:

The view that Greece has not achieved sufficient fiscal consolidation is not just false; it is patently absurd. The accompanying figure not only illustrates this; it also succinctly addresses the question of why Greece has not done as well as, say, Spain, Portugal, Ireland, or Cyprus in the years since the 2008 financial crisis. Relative to the rest of the countries on the eurozone periphery, Greece was subjected to at least twice the austerity. There is nothing more to it than that.

Here is his graph:

Now compare that with a graph I had in one of my blog posts back in 2012:

And this is what I wrote then:

The conclusion is very clear. The change in public debt ratios across the euro zone is nearly entirely a result of the development in nominal GDP.

The “bad boys” the so-called PIIGS – Portugal, Ireland, Italy, Greece and Spain (and Slovenia) are those five (six) countries that have seen the most lackluster growth (in fact decline) in NGDP in the euro zone. These countries are obviously also the countries where debt has increased the most and government bond yields have skyrocketed.

This should really not be a surprise to anybody who have taken Macro 101 – public expenditures tend to increase and tax revenues drop in cyclical downturns. So higher budget deficits normally go hand in hand with weaker growth.

The graph interestingly enough also shows that the debt development in Greece really is no different from the debt development in Germany if we take the difference in NGDP growth into account. Greek nominal GDP has dropped by around 10% since 2007 and that pretty much explains the 50%-point increase in public debt since 2007. Greece is smack on the regression line in the graph – and so is Germany. The better debt performance in Germany does not reflect that the German government is more fiscally conservative than the Greek government. Rather it reflects a much better NGDP growth performance. So maybe we should ask the Bundesbank what would have happened to German public debt had NGDP dropped by 10% as in Greece. My guess is that the markets would not be too impressed with German fiscal policy in that scenario. It should of course also be noted that you can argue that the Greek government really has not anything to reduce the level of public debt – if it had than the Greece would be below to the regression line in the graph and it is not.

So yes I agree with Varoufakis that a lot of Greece’s fiscal troubles are a direct consequence of the collapse of Greek GDP. That, however, does not change the fact that Greece needs serious structural reforms – including pension reform, tax reform and privatisation – preferably also in my view serious constitutional reforms and I am not sure that the hard-leftist Syriza government is able or willing to deliver such reforms.

And I am not arguing that the EU and the IMF should let Greece off the hook, but on the other hand I do think that there are ways forward.

In my view the best solution – and there are no easy solutions at this point – is deep structural reforms in Greece combined with a refinancing of Greek government debt so the present debt to the European Stability Mechanism is replaced by newly issued bonds linked to Greek NGDP.

Interestingly enough Varoufakis has also suggested that Greek public debt should be linked to NGDP. This is how I explained the idea recently:

The general idea with NGDP linked bonds is that the servicing of the public debt is linked to the performance of Greek NGDP. This would mean that if growth picked up in Greece then the Greek government would pay of more debt, while is NGDP growth slows then Greece will pay of less debt.

This of course would make Greek public finances much less sensitive to shocks to NGDP and therefore reduce the likelihood that the Greek government would be forced to defaults if growth fails to pick-up. On the other hand German taxpayers should welcome that if there I a pick-up in NGDP growth in Greece then the Greek government would actually pay back its debt faster than under the present debt agreement.

Furthermore, more if public debt servicing is linked to the development in NGDP growth then Greek public finances would become significantly more counter-cyclical rather than pro-cyclical.

NGDP linked bonds is not a solution for all of Greece’s problems – far from it –  but it could help reduce the pain of necessary structural reforms.

So once again I have to say that I to a large extent agree with Varoufakis analysis and some of his policy proposals. That, however, does not mean that I think he has the backing in the Syriza government to implement the serious structural reforms in the Greece that I also think is badly needed.

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

“Now the enriched country merely declares it is insolvent and spits on Its victims.”

I can’t help of thinking of events in the 1930s when I see the headlines in the financial media these days. One thing is the geopolitical situation – another thing is the new Greek government’s attempt to negotiate a new debt deal with the EU.

To me it is striking to what extent the economic and political situation in Greece resembles that of Germany in the early 1930s. And similar the position of Germany today – both that of the German media and of the German government is very similar to the French position in the early 1930s.

In 1931 the German economy was in a deep crisis with deflation and ever mounting debt – both public and private. A rigid monetary regime – the gold standard – was strangulating the German economy – while extremist parties on the left and right became increasingly popular among voters. At the same time the position of French government was uncompromising – Germany’s problems is of her own making. The answer was more austerity and there could be no talk of a new debt deal for Germany. Nobody seemed to think there was a monetary solution.

I therefore think we can learn a lot from studying events in the early 1930s if we want to find solutions for the euro zone crisis and it might be particularly suiting for the German newspapers to take a look at what they themselves were writing in early 1930s about the French position and then compare that with what today is written in Greek newspapers about the German position today.

Or compare what the French media was saying about Germany in 1931. Just take a look at this quote:

(The French newspaper) L’Intransigeant describes Germany‘s financial methods as frankly dishonest bankruptcy. “In 1923,” it states, “Germany reduced the national debt to nothing, then borrowed abroad on short terms credit which was invested on long terms, and is thus unable to repay her creditors. Now the enriched country merely declares it is insolvent and spits on Its victims.”

I am pretty sure I could find a similar quote in the Bild Zeitung today about Greece.

I encourage my readers to have a look at the newspaper achieves from 1931 to find similarities with the situation today in regard to the relationship between France and German in 1931 and Germany and Greece today. I will be happy to publish your findings (drop me a mail at lacsen@gmail.com).

Jens Weidmann should be promoting (some of) Varoufakis’ ideas

The new Greek Finance Minister Yanis Varoufakis is all over the international media these day and surprise, surprise he is making a lot more sense than a lot of people (including myself) had feared.

I have certainly not been optimistic about what the new hardcore leftist Greek government would come up with. However, I most admit that I have some (considerable) sympathy for the fact that Greek public finance problems are not entirely a result of Greek economic-political mismanagement (even though there has been a lot of that).

Hence, the sharp rise in Greek public debt to GDP since 2008 to large extent is a result of the collapse of Greek nominal GDP and I have often been arguing that we do not (primarily) have a debt crisis in the euro zone. We have a nominal GDP crisis and the euro crisis is primarily a result of overly tight monetary policy.

While Varoufakis certainly is not a monetarist he fully well understands that at the core of the Greek crisis is the collapse in NGDP and I was very pleasantly surprised to see his proposal for a new Greek debt deal with the EU.

This is what Financial Times writes about Varoufakis’ new proposals:

Attempting to sound an emollient note, Mr Varoufakis told the Financial Times the government would no longer call for a headline write-off of Greece’s €315bn foreign debt. Rather it would request a “menu of debt swaps” to ease the burden, including two types of new bonds.

The first type, indexed to nominal economic growth, would replace European rescue loans, and the second, which he termed “perpetual bonds”, would replace European Central Bank-owned Greek bonds.

He said his proposal for a debt swap would be a form of “smart debt engineering” that would avoid the need to use a term such as a debt “haircut”, politically unacceptable in Germany and other creditor countries because it sounds to taxpayers like an outright loss.

So Varoufakis is suggesting is to swap the Greek debt to the EU (and ECB) with nominal GDP linked bonds. What can I say? Great idea Yanis!

I have of course for years be arguing that governments should issue debt linked to nominal GDP – not only because NGDP linked bonds would provide a very good measure of the monetary policy stance, but also because it would be good from a public finance perspective (and from a general macroeconomic stability perspective).

I therefore wholeheartedly support Varoufakis’ proposal – as a general principle to debt restructuring. Obviously to make a deal it should be in the common interest of both the EU and Greece and there are certainly very good arguments against just sending another big cheque to Athens. But this is exactly the point – this would (in general) be in the interest of both Greek and German taxpayers.

What we want to see is a situation where Greek government continues to service its debt. But we also want a situation where this doesn’t push Greece to a disorderly default and a disorderly exit, which would jeopardize economic and financial stability in Europe. I believe that a new debt deal that to a larger extent links Greek public debt to the future developments in nominal GDP would make it easier for Greece to service the debt, but also make it less likely that we get a disorderly collapse.

How would it work?

The general idea with NGDP linked bonds is that the servicing of the public debt is linked to the performance of Greek NGDP. This would mean that if growth picked up in Greece then the Greek government would pay of more debt, while is NGDP growth slows then Greece will pay of less debt.

This of course would make Greek public finances much less sensitive to shocks to NGDP and therefore reduce the likelihood that the Greek government would be forced to defaults if growth fails to pick-up. On the other hand German taxpayers should welcome that if there I a pick-up in NGDP growth in Greece then the Greek government would actually pay back its debt faster than under the present debt agreement.

Furthermore, more if public debt servicing is linked to the development in NGDP growth then Greek public finances would become significantly more counter-cyclical rather than pro-cyclical.

Jens Weidmann should be Varoufakis’ best friend

Hence, there are some very clear advantages with NGDP linked bonds. The most important, however, might be that if Greek public debt is linked to NGDP then it would significantly ease the pressure on the ECB to do things that fundamentally has nothing to do with monetary policy.

The ECB’s job odd to be to ensure nominal stability in the euro zone economy. It is not and should not be the job of ECB to bail out governments and banks. Unfortunately again and again over the past six years the ECB has been forced to bailout euro zone countries for example through the so-called OMT programme. Hence, ECB has again and again conducted credit policy (rather than monetary policy) to avoid euro zone countries defaulting.

The ECB is largely to blame for this itself because it has kept monetary conditions far too tight. However, it does not change the fact that the ECB has been under tremendous pressure to bailout nations and banks rather than conduct sound monetary policies.

By linking Greek public debt to NGDP (in Greece) Greek public finances would be more immune to monetary policy failure in the euro zone.

And this is why the hawkish Bundesbank chief Jens Weidmann should be an enthusiastical support for Varoufakis’ debt plan as the “cost” of tight monetary policies in the euro zone would be smaller.

Just imagine that all public debt in the euro zone had been linked one-to-one to euro zone NGDP. The ECB might have failed in 2008 to keep NGDP “on track”, but there would not have been any public finances crisis in the euro zone as public debt to (N)GDP ratios would have remained fairly stable and it would have been very unlikely that Greece would have needed an bailout. In such a situation the pressure to the ECB to support government lending would have been much smaller.

The graph below illustrates the very close correlation between NGDP growth and public debt developments in the euro zone. Greek debt ratio spiked primarily because Greek NGDP growth collapsed.

I have a lot of sympathy for the “German view” that the ECB should not bailout banks and countries, but if the ECB fails to deliver nominal stability it is unavoidable that there will be pressure on the ECB to do things it shouldn’t be doing.

Therefore, Jens Weidmann should not only endorse the general principle that Greek public debt to a larger extent should be linked to NGDP growth, but he should also advocate that public debt across the euro zone should be NGDP linked as it would significantly reduce the pressures the ECB to conduct problematic credit policies, which increases moral hazard problems.

Varoufakis should pay tribute to David Eagle

Yanis Varoufakis probably never heard of David Eagle. In fact most economists never heard of David Eagle. However, I believe that David is the economist in the world who has done the most interesting academic work on what he has termed quasi-real indexing. David’s work centres on both the principle of making debt linked to the development in nominal GDP and on the advantages of NGDP targeting.

David back in 2012 wrote a numbers of very insightful guess posts on this blog about these topics. Everybody interested in the theoretically foundation for Varoufakis’ ideas should read this guest post. Here is an overview:

Guest post: GDP-Linked Bonds (by David Eagle)

Guest blog: NGDP Targeting is NOT just for Central Banks! (David Eagle)

Guest Blog: The Two Fundamental Welfare Principles of Monetary Economics (By David Eagle)

Guest post: Why I Support NGDP Targeting (by David Eagle)

Guest post: Central Banks Should Quit “Kicking Them While They Are Down!” (by David Eagle)

Quasi-Real indexing – indexing for Market Monetarists

David Eagle’s framework and the micro-foundation of Market Monetarism

Dubai, Iceland, Baltics – can David Eagle explain the bubbles?

A simple housing rescue package – QRI Mortgages and NGDP targeting

Supporting NGDP-linked bonds, but not the entire “Syriza package”

I have in this blog post voiced my support for the Greek Finance Minister’s suggests for a debt swap based on NGDP bonds. I should stress that that does certainly not mean that I in any other way supports the Greek government’s economic proposals. In fact I am deeply concerned about some of the ideas, which has been floated by the Greek government. The governing Syriza party is an extreme leftist party, which is strongly opposed to the free markets ideals I hold dearly, but on the issue of the desirability of NGDP linked bonds the Greek government has my full support.

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