Guido Mantega be careful what you hope for

A friend wrote this on Facebook (I paraphrased it slightly):

It’s a bit ironic that the large emerging markets countries, which complained about monetary easing in the US (Brazilian Finance Minister Guido Mantega called it ‘currency war’) now these countries are the hardest hit when talks about tapering are now hitting the headlines… Be careful what you hope for… Brazil just had a massive weakening of its currency and the central bank had to hike rates to defend the currency. Not good for growth. Talk about bad policies….

My friend is of course is completely right. Monetary easing in the US and Japan was never a problem for Emerging Markets and in the case of Brazil it is clear that the country has much bigger problems than monetary easing in the US and Japan to worry about.

HT Transmussen

The moral hazard of 3-year old boys

My three year old son Mathias had an accident in his kindergarden the other day. He fell from a tall chair and as a result hurt is lip so his mom had to take him to the emergency room.

Luckily he did not have to any stitches in his lip and he took the whole thing very well (much better than his parents). After having been to the emergency room my wife took Mathias to a toyshop to buy him a small present because he had taken the whole thing so well. He got himself a laser gun.

When I put him to bed at night we had a talk about the events of the day and as always we talked about what he was going to do the next day:

Me: “It has been a rather special day today, but what will you be doing tomorrow?”

Mathias: “I will go to the hospital!”

Me (in shock): “You are not going to the hospital – you are going to kindergarden”

Mathias: “No, I am going to hospital and then mom will buy Spiderman for me in the toyshop!”

See that is moral hazard for you!

HT Vlad

If there is a ‘bond bubble’ – it is a result of excessive monetary TIGHTENING

Among ‘internet Austrians’ there is an idea that there is gigantic bubble in the global bond markets and when this bubble bursts then the world will come to an end (again…).

The people who have these ideas are mostly people who never really studied any economics and who get most of their views on economics from reading more or less conspiratorial “Austrian” school websites. Just try to ask them and they will tell you they never have read any economic textbooks and most of them did not even read Austrian classics as “Human Action”. So in that sense why should we worry about these views?

And why blog about it? Well, because it is not only internet Austrians who have these ideas. Unfortunately many central bankers seem to have the same kind of views.

Just have a look at this from the the Guardian:

A key Bank of England policymaker has warned of the risks to global financial stability when “the biggest bond bubble in history” bursts.

In a wide-ranging testimony to MPs, Andy Haldane, Bank of England director of financial stability, admitted the central bank’s new financial policy committee is taking too long to force banks to hold more capital and appeared to criticise the bank’s culture under outgoing governor Sir Mervyn King.Haldane told the Treasury select committee that the bursting of the bond bubble – created by central banks forcing down bond yields by pumping electronic money into the economy – was a risk “I feel acutely right now”.

He also said banks have now put the threat of cyber attacks on the top of their the worry-list, replacing the long-running eurozone crisis.

“You can see why the financial sector would be a particularly good target for someone wanting to wreak havoc through the cyber route,” Haldane said.

But he described bond markets as the main risk to financial stability. “If I were to single out what for me would be biggest risk to global financial stability right now it would be a disorderly reversion in the yields of government bonds globally.” he said. There had been “shades of that” in recent weeks as government bond yields have edged higher amid talk that central banks, particularly the US Federal Reserve, will start to reduce its stimulus.

“Let’s be clear. We’ve intentionally blown the biggest government bond bubble in history,” Haldane said. “We need to be vigilant to the consequences of that bubble deflating more quickly than [we] might otherwise have wanted.”

I must admit that I am somewhat shocked by Haldane’s comments as it seems like Haldane actually thinks that monetary easing is the cause that global bond yields are low. The Bank of England later said it was not the view of the BoE, but Haldane’s “personal” views.

If Haldane ever studied Milton Friedman it did not have an lasting impact on his thinking. Milton Friedman of course told us that low bond yields is not an result of easy monetary policy, but rather a result of excessively TIGHT monetary policy. Hence, if monetary conditions are tight then inflation and growth expectations are low and as a consequence bond yields will also be low.

Hence, Milton Friedman would not be surprised that Japanese and US bond yields have risen recently on the back of monetary easing being implemented in the US and Japan.

In fact the development in global fixed income markets over the past five years is a very strong illustration that Friedman was right – and why Haldane’s fears are misguided. Just take a look at the graph below – it is 10-year US Treasury bond yields.

10y UST

(If you think you saw this graph before then you are right – you saw it here).

If Haldane is right then we should have seen bond yields decrease following the announcement of monetary easing. However, the graph shows that the opposite have happened.

Hence, the announcement of TAP and the dollar swaps lines in early 2009 was followed by an significant INCREASE in US (and global) bond yields. Similarly the pre-announcement of ‘QE2’ in August 2010 also led to an increase in bond yields.

And finally the latest sell-off in the global fixed income markets have coincided with monetary easing from the fed (the Evans rule) and the Bank of Japan (‘Abenomics’)

If you think there is a bond bubble

then blame the ECB’s rate hikes in 2011

Looking at US 10-year yields over the past five years we have had three major “down-legs”. The first down-leg followed the collapse of Lehman Brothers in October 2008. The second down-leg played out in the first half of 2010 following the hike in Federal Reserve’s discount rate in February 2010 and the People Bank of China’s increase in the reserve requirement in January 2010.

However, the biggest down-leg in US 10-year bond  yields followed the ECB’s two rate hikes of 2011 (April and July). Believe it or not, but the ECB was “able” to reduce US 10-bond yields more than the collapse of Lehman Brothers did.

Hence, if there is a ‘bubble’ in the global fixed income markets it has not been caused by monetary easing. No if anything it is a result of excessively tight monetary conditions.

In fact it is completely absurd to think that global bond yields are low as a result of central bank ‘manipulation’. Global bond yields are low because investors and households fear for the future – fears of low growth and deflationary tendencies. Global bond yields are low because monetary policy have been excessive tight.

Rejoice! Yields are rising

Unlike Andy Haldane I do not fear that day the bond ‘bubble’ (it is not a bubble!) will burst. In fact I look forward to the day US bond yields (and UK bond yields for that matter) once again are back to 5%. Because that would mean that investors and households again would believe that we are not heading for deflation and would once again believe that we could have ‘normal’ GDP growth.

And unlike Haldane I don’t believe that higher bond yields would lead to financial armageddon and I don’t believe that Japan will default if Japanese bond yield where to rise to 3 or 4%. Banks and countries do not go belly up when growth takes off. In fact the day US bond yields once again is back around 5% we can safely conclude that the Great Recession has come to an end.

Concluding, there is no ‘bond bubble’ and Andy Haldane should not have sleepless nights over it. The Bank of England did not cause UK yields to drop – or rather maybe it did, but only because monetary policy has been too tight rather than too easy.

PS I never heard any of these ‘bubble mongers’ explain why Japanese property prices and equity prices have been trending downward for nearly two decades despite interest rates being basically at zero in Japan.

PPS the graph above also shows that “Operation Twist” in 2011 failed to increase growth and inflation expectations. Any Market Monetarists would of course have told you that “Operation Twist” would fail as it did nothing to increase the money base or increase the expectation for future money base expansion.

—–

Related posts:

When US 30-year yields hit 5% the Great Recession will be over
Confused central banks and the need for an autopilot
Two cheers for higher Japanese bond yields (in the spirit of Milton Friedman)
Tight money = low yields – also during the Great Recession

‘Bullish Mikio’ makes me optimistic on BoJ (and the world)

As my loyal readers would know I have been somewhat critical about the Bank of Japan’s handling of the recent rise in bond yields in Japan. See for example here and here.

However, there is no reason to give up on the Bank of Japan. At least that is what the always clever Mikio Kumada is telling us. This Mikio’s excellent comment on my latest comment on the BoJ.

“Just wanted to say that in substance, I share your concerns. And I think it’s important that you raise these questions/criticisms.

I am, however, perhaps, less ideological, and try to look at things in the context of the real world.
Policy makers act in a political/institutional framework, with constraints. And in that context, the BoJ under Kuroda is dong a good job – as good as it gets, so to speak, from a market monetarist perspective.

By the way, yesterday, Kuroda met Abe and both made statements afterwards. Neither of them mentioned the need to keep interest rates low. They said all the other things – Kuroda reaffirmed he will beat deflation and Abe said he will do his part via reforms, but they didn’t make statements about interest rates.

That is another indication that Kuroda believes that higher nominal rates are desirable, and logical. And he may have convinced Abe not to talk about “lowering interest rates” (if Abe needed any convincing). But at the same time, Kuroda can’t yet openly that say he wants rising nominal rates.

My sense is that Kuroda, and also Prof. Koichi Hamada, a trusted advisor to Abe, are open to market monetarist ideas. But they would probably face a hailstorm if they openly say things that are too “revolutionary”. They first have to convince enough people that rising nominal yields are good, as long as real yields (and real wages) remain low, or keep falling during the “reflation” phase. But I would not recommend Abe to talk too much about “falling real wages” publicly ahead of an election, of course. He should just stick to demanding rising (nominal) wages.

I also sense that yesterday’s decline in stocks may have been due to (an erroneous) “disappointment” of investors that Abe/Kuroda didn’t say they want low/lower long term rates.

So, overall, I remain quite optimistic that, over time, the market will come around to accept the view that higher nominal rates are a good thing.”

I find it hard to disagree with Mikio’s comments. So I am starting the weekend being quite optimistic that the BoJ eventually will get it right and if Mikio indeed is right then the market turmoil we have seen over the last couple of weeks will soon come to an end. Fingers crossed.

PS Joseph Gagnon has an excellent comment on the BoJ and the need for not stepping back on monetary easing.

Join the Global Monetary Policy Network on Linkedin here (Mikio is a member).

“Bitcoin is Memory”

Bitcoin has been one of the most talked about talked topics over the past year. Despite of this there is relatively little economic research that has been done on the topic so far. However, a new working paper by William Luther and Josiah Olson add important insight to the economics of bitcoin.

This is the abstract for Luther and Olson’s paper “Bitcoin is Memory”:

“We maintain that the crypto-currency bitcoin is a practical application of what is termed “memory” in the monetary economics literature. After reviewing the theoretical literature on money and memory, we offer a brief overview of the bitcoin protocol and argue that, like memory, bitcoin functions as a public record-keeping device. Finally, we provide evidence that — in line with the standard theoretical account of memory — bitcoin use has soared as the expected cost of storing traditional monies increased.”

Have a look and let me hear what you think of Will and Josiah’s paper.

Will is telling me that he and Josiah have more in the pipeline. I will look forward to that – Will never disappoints writing interesting stuff.

Is Bernanke pulling Greece out of the crisis?

For the first time in a couple of weeks I have felt kind of optimistic today. It might actually be that the Federal Reserve and the Bank of Japan will not repeat the mistakes of 1937 – at least I am hopefully we have learned something from 1937.

So I think we need an optimistic graph for the weekend. Take a look atthe  European Commission’s Sentiment Indicator for the Greek economy. The rebound since September – when the Federal Reserve effectively announced the Evans rule – has truly been remarkable.

 Bernanke Greece

Of course this might also be the impact of Draghi’s comment that he would do “whatever it takes” to save the euro (in July) or the combinded efforts of Prime Minister Abe and BoJ chief Kuroda to get Japan out of the deflationary trap.

It could of course also be that years of austerity are finally paying off, but I find that to be extremely unlikely. Not matter what this is probably the most positive graph we have seen on the Greek economy in years. Lets hope for the sake of the Greek people and the European economy that there will be a lot more graphs like that in the future.

Mr. Kuroda’s credibility breakdown

This morning the Nikkei index has dropped has much as 6%. By any measure this is an extreme drop in stock prices in one day. Furthermore, we are now officially in bear market territory as the Nikkei is down more than 20% in just three weeks. I can only see one reason for this and one reason only and that is the breakdown of the credibility of Bank of Japan governor Kuroda and his commitment to fulfill his official 2% inflation target.

I would particularly highlight three events for this breakdown of credibility.

First of all I would stress that it seems like the Japanese government has been taken by surprise by the natural increase in bond yields and that is causing officials to question the course of monetary policy. This is Economy Minister Akira Amari commenting on the increase in bond yields on May 19:

“We need to enhance the credibility of government bonds to prevent a rise in long-term yields.”

This at least indirectly indicates that some Japanese government officials are questioning what the BoJ has been doing and given the highly political nature of the Japanese monetary policy setting these comments effectively could make investors question the direction of monetary policy in Japan.

Second the Minutes from Bank of Japan’s Policy board meeting on April 27 released On May 26 and comments following this week’s monetary policy meeting.

This is from the May 26 Minutes (quoted from MarketWatch):

“Regarding the effects of JGB purchases on liquidity in the JGB and repo market, a few members … expressed the opinion that it should continue to deliberate on measures to prevent a decline in liquidity”

Said in another way some BoJ board members would like the BoJ to try to keep bond yields from rising – hence responding to Mr. Amari’s fears. There is fundamentally only one way of doing this – abandoning the commitment to hit 2% inflation in two years. You can simply not have both – higher inflation and at the same time no increase in bond yields. Bond yields in Japan have been rising exactly because Mr. Kuroda has been successful in initially pushing up inflation expectations. It is that simple.

And third, at the BoJ’s monetary policy announcement this week Bank of Japan governor Kuroda failed to clarify the position of the BoJ and that undoubtedly has unnerved investors further.

5-year-inflation-expectations-japan

Hence, it is important that market turmoil does not reflect a fear of higher nominal bond yields on its own, but rather whether higher bond yields will cause the BoJ to abandon the commitment to increase inflation to 2%.

Therefore what is happening is a completely rational reaction from investors that rightly or wrongly fear that the BoJ is changing course.

As I again and again has stressed Mr. Kuroda can end the market turmoil by first of all stating that the increase nominal bond yields is no worry at all (particularly as real bond yields actually have dropped sharply) and furthermore he should clearly state that the BoJ’s focus is on inflation expectations. Hence, he should state that the BoJ effectively is ‘pegging’ market (breakeven) inflation expectations to 2%. If he did that he would effectively have hindered inflation expectations dropping over the past three weeks. The drop in Japanese inflation expectations in my view is the main cause of the turmoil in global financial markets over the past three weeks.

Should we give Mr. Kuroda a break?

I might be too harsh to Mr. Kuroda here. After all should we really expect everything to be ‘perfect’ at this early stage in the change to the monetary policy regime Japan after 15 years of failure?

This is the alway insightful Mikio Kumada commenting on Linkedin on one of my earlier posts on Japan:

“Lars, give it some time. The regime change at the BOJ is still very new and the ideological shifts in old conservative institutions, with long traditions, such as the BOJ take some time. I think Kuroda made it implicitly clear enough that higher nominal rates are ok as long as real interest rates slump/stay low.”

I think Mikio (who like a lot of market participants, central bankers and monetary policy nerds have join the Global Monetary Policy Network on Linkedin) is on to something here.

We are seeing a revolution at the BoJ so one should not really be surprised that it is not all smoothing sailing. However, on the other hand I am personally very doubtful where we are going next. Will Kuroda effectively be forced by events to abondon his commitment to 2% inflation or will he reaffirm that by becoming much more clear in his communication (don’t worry about higher nominal bond yields and communicate clearly in terms of inflation expectations).

I have my hopes, but I don’t know the answer to this question, but one thing seems clear and that is that nearly everything in the global financial markets – from the value of the South Africa rand, commodity prices and the sentiment in the US stock markets – these days dependent on what Mr. Kuroda does next. Don’t tell me that monetary policy is not important…

PS David Glasner is puzzled by what is going on the US financial markets. I think I just gave the answer above. It is not really Bernanke, but rather Mr. Kuroda David should focus on. At least this time around.

Confused central banks and the need for an autopilot

For somewhat more than a decade I have regularly been watching monetary policy decisions from different central banks around the world. Most ‘modern’ central banks in the world announce changes to monetary policy once every month. Mostly these events are pretty much none-events – the central banks do not surprise markets much. However, over the last fives years it has certainly been harder to predict the outcome of these meetings compared to how relatively easy it was in the decade before the crisis.

The reason it has become harder to predict central banks is that we are no longer on ‘autopilot’ in monetary policy. One we are unsure about ‘where we are going’ – the central banks’ monetary targets have become less clear – and in some case the target has even changed. Second, especially central banks where interest rates have dropped to close to zero are unsure about what instruments to use in the conduct of monetary policy.

This uncertainty has created more volatility in financial markets as the markets have a very hard time “reading” the central banks. The monetary policy decision from the Bank of Japan this morning is instructive.

Yesterday the Nikkei was up around 5%, but this morning the market has been slightly nervous ahead of the monetary policy announcement. However, after the announcement Nikkei initially dropped 1.5% on ‘disappointment’ (as it is said in the financial media) that the Bank of Japan did not introduce new measure to curb ‘bond market volatility’.

This is really rather bizarre. Central banks really shouldn’t run around and announce new initiatives and new monetary policy instruments every other month. Unfortunately we look at the major central banks such as the Federal Reserve, the ECB and Bank of England these banks over the past five years again and again have introduced new policy instruments. A lot of these instruments have not even been aimed at changing monetary conditions (changing the money base and/or expectations of future changes to the money base), but have been credit policies.

Ideally central banks should not even need to hold these monthly monetary policy meetings. If the central bank clearly defines its monetary policy target and define what primary instrument it is using to change monetary conditions then monetary policy to a large extent would be on autopilot. 

Try to target one target and no more than that

First of all the central banks of the world should make it complete clear what they are trying to achieve. What is the central bank targeting?

Second, the central banks should make it clear that it is targeting future value rather than present value of these variables – be it inflation, the price level or nominal GDP. Therefore, central banks should communicate about the expectation for these targets.

For inflation targeting central banks like the Bank of Japan the central bank is lucky has it actually have market expectations for future inflation. Hence, there is no reason for the Bank of Japan to even comment on present inflation. The only thing, which is important, is market expectations. If market expectations for future Japanese inflation is below the BoJ’s 2% inflation target then the BoJ will have to conclude that monetary conditions still are too tight. It can of course easily do something about that – it can just announce that it will continue to escalate the growth of the money base until the market is pricing in 2% future inflation. Remember there are no limits to the central bank’s ability to print money. The term that the central bank should keep the powder dry therefore is also idiotic. The central bank will never run out of gun powder.

Third, central banks should stop confusing themselves and the markets by pursuing more than one target. Essentially the central bank only has one monetary policy instrument – and that is the money base. Hence, the central bank can only hit one nominal target. One would think that this should be obvious, but unfortunately it is not.

Lets take the example of the Polish central bank (NBP). Last week the NBP cut its key policy interest rates by 25bp – effectively trying to boost the growth of the money base. Within days after that decision the same Polish central bank intervened in the currency market to strengthen the zloty. Hence, the NBP was selling foreign currency and buying zloty. Said, in another way the NBP tried to reduce the money base. Are you confused? It seems like the NBP is.

Unfortunately the NBP is not the only central bank in the world, which is confused about its own policies. The recent increased volatility in the Japanese markets is exactly a result of a similar kind of policy maker confusion.  In April the BoJ moved decisively to ease monetary policy. This was seen as a credible and permanent expansion of the money base. Not surprisingly this sparked a rally in the Japanese stock market, weakened the yen and have push up nominal bond yields. Market Monetarists were not surprised. Higher bond yields reflect higher growth and inflation expectations.

However, the BoJ seems to have been surprised by the impact of its own actions – particularly the increase in bond yields have made policy makers nervous. This led both BoJ and government officials to make unclear statements about the connection between bond yields and monetary policy. However, it is clear that if the BoJ in somewhat tries to target the level of bond yields it cannot also target inflation.

A similar problematic tendency of central bankers these days is an aversion against using certain policy instruments. Hence, central bankers have a preference to conduct monetary policy through interest rate changes. However, if the interest rate is close to zero then other instruments have to be used – for example directly expanding the money base.

However, it is very clear that for example a lot of Federal Reserve officials can’t wait to reduce the US money base. Logically that obviously makes no sense as it basically mean that the policy instrument enters on both the left-hand and the right-hand side of the central bank’s reaction function. The fed should obviously not reduce the money base before it is clear that it will hit its – not too well-defined – target.

The textbook advice to central banks therefore must be to target one nominal variable and target the market expectation of the future value of this variable.

Let the markets be the autopilot for monetary policy  

If the central bank formulates its target in the form of expectations then it is really very simple to introduce an autopilot monetary policy.

Again lets take the example of the Bank of Japan. The BoJ is now officially targeting inflation at 2%. It wants to achieve that target in two-years.

The market obviously provides a measure of how likely the BoJ is to meet this target in the form of breakeven inflation expectations from inflation-linked Japanese government bonds. The verdict from the market is clear – while inflation expectations have risen significantly the market is still far from pricing in 2% inflation.

In fact 2-year/2-year inflation expectations – that is the market expectations for inflation two years from now and two years ahead – is closer to 1% than to 2%.

So while the BoJ has credibly eased monetary policy its inflation target is still far from credible.

The easiest way to make that target credible is simply to announce that market expectations for Japanese inflation should be 2%. Or as I have suggested before the BoJ should simply ‘peg’ the inflation expectation to 2%. It should announce that if inflation expectations are below 2% when the BoJ will simply buy inflation linked bonds until inflation expectations hit 2% and similarly of course sell inflation-linked bonds if inflation expectations move above 2%.

In that scenario Japanese monetary policy would be completely on autopilot. The BoJ would not have to confuse itself and markets by introducing instruments every months or by giving cryptic statements about the state of the Japanese economy.

The BoJ could simply monthly report on the markets’ inflation expectations. If that BoJ did that then this months’ monetary policy statement would look something like this:

“The Bank of Japan is targeting 2% inflation. Market expectations for inflation on all relevant time horizons shows that inflation expectations have increased over the past year. Unfortunately inflation expectations are still significantly below 2% and as such the 2% inflation target is no yet fully credible.

However, the Bank of Japan has the full control of the Japanese monetary base and is ready to expand the money base as much as needed to bring inflation expectations fully in line with the inflation target. Hence, the Bank of Japan will continue to step up the buying of inflation-linked government bonds until there is full correspondence between the inflation target and market expectations.”

If I were a market participant that read that statement I would start buying inflation-linked bond immediately – and I would sell the yen and buy some more Japanese equities. And I am sure we very fast would see the market price in 2% inflation. Mission accomplished.

And once inflation expectations have been ‘pegged’ to 2% the BoJ could simply put the following text on it website: “Bank of Japan targets 2% inflation. Inflation expectations are at 2%. Monetary policy is 100% credible. We have gone golfing”.

I am writing this on a flight to Brussels (so I am not on the internet) while BoJ governor Kuroda is having a press conference. I very much hope he will be saying something similar to what I have suggested, but I am not overly optimistic.  

 —

Update: A quick glance through Kuroda’s comments indicates that he doesn’t really get it. He talks about controlling bond market volatility and makes some but not too impressive comments on breakeven inflation rates. It is sending stock markets down around the world. (By the way if Japanese monetary easing is part of an evil ‘currency war’ why are global stock markets falling when the BoJ fails to deliver?) 

Denmark and Utah – Miles Kimball and me

Scott Sumner has an interesting new post in which he argues that Utah is “America’s Denmark”. I like Scott’s theory a lot. Mostly because I think of Utah is how Denmark used to be. I really don’t like to write about Denmark, but this topic is too interesting to miss.

I left a long answer to Scott on his blog. This post is based on that answer.

Lets start out with Scott’s PS:

“I knew Miles and Lars had something in common”

Scott obvious thinks of Miles Kimball and yours truly. If I am not wrong Miles grew up in Utah as a Mormon (Miles in no longer a Mormon).

Miles and I indeed have a lot in common. So Scott is on to something – Utah in fact is “Danish” in the sense that a large share of the early Mormon pioneers in Utah in fact came from Denmark. In fact Miles is 1/4 Danish. Miles’ grandfather was named Elmer (Madsen). Elmer happens to be my son’s middle name (a very rare name in today’s Denmark).

Last year I spoke at Brigham Young University in Utah. At my presentation I was asked how the Danish welfare model could work. My answer was “because we are like you”. Ever since I visited Utah last year I have been thinking about the early Mormon society as an anarchic form of a welfare society. A society where collective goods problems are solved through common norms (religion). Denmark of the 1950s and Utah of the 1860s probably have that in common. That is not a surprise – a lot of the people in both places of course were/are Danes. As Miles’ grandfather and my grandfather. In fact I have for some time had the crazy idea that I want to try to write a book in the topic of how collective goods problems were solved in early Mormon society in Utah. As a Dane I might have a comparative advantage in that endeavor (The other thing is that I don’t have time to undertake this task… )

My argument was that the “original” Danish welfare state really just is a form of the Mormon style welfare system. Everybody in society are very similar and as a consequence there is little difference between a “one-size-fits-all” tax funded system and a private based system like the Mormon private based welfare system.

The interesting thing here is that the Mormon pioneers in Utah established a basically anarchic welfare system that basically covered everybody. That worked fine and I believe that is not really that different in the foundation form the Danish Welfare system. What is different is how the two systems developed over time. In fact I believe that had Utah not become part of the United States Utah might very well have developed into Danish style welfare state. This of course is somewhat os a paradox – anarchic welfare society that develops into a society with a very large public sector. Maybe some of the Bleeding Heart Libertarians have a view on this topic.

However, I am too optimistic on the future of the Danish welfare model. First of all I think it is extremely important to notice that the Danish model really was largely private sector based until the late 1960s. In fact until the mid-1960s the size of the public sector in Denmark (and all the other Nordic countries) was smaller than in public sector in the US (as share of GDP). Hence, when Milton Friedman wrote Capitalism and Freedom (in 1962) Denmark really was closer to his ideal than the US was.

In the end of the 1960s the public sector in Denmark started growing very dramatically until the early 1980s. In that period Denmark also started its relative income decline.

Finally I would note that in a society where everybody “normally” works and where most people are very similar people would tend to be “honest” and not misuse public benefit systems and because your neighbours come knocking on your door and tell you to get your act together if you want to be invited over for BBQ etc. That undoubtedly was the case in Denmark until the early 1970s. However, that changed in the 1970s.

Two things happened. First of all, unemployment rose dramatically in Denmark in the early 1970s as a result of the first oil crisis AND a sharp increase in benefits levels. That made it “socially acceptable” to be unemployment and live of taxpayer money. Second, Denmark saw a sharp increase in immigration from the late 1960s and until the early 1980s. That changed Denmark from an extremely homogeneous society to a more multicultural society. These two factors in my view removed the implicit ‘social threat’ that your neighbors would think of you as an idiot if you remained on the dole for years. That effectively sharply reduced the cost of misusing the public welfare system.

As consequence while Dane used to the work ethics as Utah Mormons Denmark today is a “leisure society” with low work ethics. This in my view probably is the biggest threat to the “Danish model”. A new working paper by Casper Hunnerup Dahl has an interesting discussion of this topic.

Finally, the strength of the “flexicurity system” in my view is mostly a myth. Yes, we have a very flexible labour market in Denmark with low levels of labour market regulation. There is for example no official state sponsored minimum wage and firing and hiring rules are liberal. However, high benefit levels is a massive burden to public finances and in the long-term the model will not survive in its present form.

Denmark, however, still benefits from have a fairly homogenous society in the sense that it probably has positive impact on the political system. Hence, while the welfare state is overblown Danish policy makers over the last three decades in general have agreed on the overall need for scaling back the public sector and continue economic reforms. Hence, since the early 1980s different (left and right) governments have tried to reform the welfare state. Hence, had it not been for the policy mistakes of the late 1960s and early 1970s Denmark would probably have had a public sector of a similar size to Switzerland. Incredibly enough the present centre-left government has – much against its voters wishes – pushed from reforms of welfare benefits, educational reform and pension reforms.

Concluding, I believe Scott in general is right. Utah might be America’s Denmark, but it is probably the Denmark of 1960 rather than of today.

PS I hope Scott will soon visit Denmark to take a look for himself. I know Miles will soon be here.

“Political Extremism in the 1920s and 1930s: Do German Lessons Generalize?”

While surfing a bit on Brad DeLong’s blog I came across a reference to what looks like a very interesting paper by one of my favourite economic historians – Barry Eichengreen. He has co-authored the paper “Political Extremism in the 1920s and 1930s: Do German Lessons Generalize?” with Kevin H. O’Rourke.

Here is the abstract:

“We examine the impact of the Great Depression on the share of votes for rightwing anti-system parties in elections in the 1920s and 1930s. We confirm the existence of a link between political extremism and economic hard times as captured by growth or contraction of the economy. What mattered was not simply growth at the time of the election but cumulative growth performance. But the effect of the Depression on support for right-wing anti-system parties was not equally powerful under all economic, political and social circumstances. It was greatest in countries with relatively short histories of democracy, with existing extremist parties, and with electoral systems that created low hurdles to parliamentary representation. Above all, it was greatest where depressed economic conditions were allowed to persist.”

As usual when I see an interesting paper I want to share the reference with my readers before even reading the paper – this is also the case this time around.

So just two observations.

First, why only rightwing extremist parties? Why not also communists and other left-extremist parties? After all it was not only the nazis and other rightwing extremist parties that did well in the German elections in 1932, but also the Communist party.

Second, even though I think there is reason to fear that the present economic crisis can lead to extremism I must say that one of the positive surprises about this crisis has been that we have not seen a general rise in political extremism and even better we have not seen the kind of political violence that we saw in many countries in the 1930s. The Baltic States which truly have gone through a very deep recession since 2008 have so far come through the crisis without seeing any significant rise in extremism. There are of course horrible examples in Hungary, Bulgaria and Greece, but even in these countries the extremists parties are not in power.

Luckily these guys (“Golden Dawn” parliament members in Greece) are ‘outliers” today.

Golden Dawn MPs

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