All posts in category The euro

The “China Bluff”

Nick Rowe has a short comment on the news that EU’s rescue fund the European Financial Stability Facility (EFSF) will try to tempt China to put money into the rescue fund by issuing bonds in Euros.

It is hard to disagree with Nicks’ comment: “The whole Eurozone problem is that each Eurozone country was issuing bonds in what was effectively a foreign currency, and so it lacked an effective lender of last resort. Now, if the Telegraph is correct, the Eurozone as a whole is planning to repeat the mistake, and become just like Greece.”

But that is not really what I want to comment on, but rather Nick’s comment reminded me about what we could call the “China bluff”. Since 2008 every time a bank or a country gets into serious trouble and is on the brink of collapse a CEO or Finance Minister or even a Prime Minister will say that some wealthy investor will soon throw money into the “project”. Most often these promises of “new money” coming in turn out to be far fetched fantasies.

The Icelandic collapse in 2008 maybe the most stunning example of the “China bluff”. At that time it was not China, but rather Russia that would come to the rescue of Iceland and the Icelandic banking sector. As the entire Icelandic financial system was collapsing suddenly Icelandic officials announced that Russia would step in with a loan to help Iceland and judging from the comments one was led to think that the Russian government already had agreed to a substantial loan to Iceland. However, the whole thing turned out to be a “China bluff” – an attempt by official to turn around market sentiment by promising that a wealthy investor would save the day. We all today know that Iceland had to call in the help of the Nordic countries and the IMF to avoid a default – Russian money was nowhere to be seen.

My recommendation to investors and the like is therefore that every time an embattled bank or nation “promises” money from China, Russia or the Middle East be skeptical…VERY SKEPTICAL. It might just be the China bluff.
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Update: Marcus Nunes also has a comment on the EFSF-China story.

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by Lars Christensen on October 29, 2011  •  Permalink
Posted in Banking crisis, China, euro crisis, MM Research agenda, The euro, The Great Recession
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Posted by Lars Christensen on October 29, 2011

https://marketmonetarist.com/2011/10/29/the-china-bluff/

The Hoover (Merkel/Sarkozy) Moratorium

The global stock markets are strongly up today on the latest news from the EU on the deal on Greek debt (and little bit less…). There is no reason to spend a lot of time describing the deal here, but I nonetheless feel it might be a good day to tell a bit about something else – the so-called Hoover Moratorium of 1931.

80 years ago it was not Greece, which was at the centre of attention, but rather Germany. Germany was struggling to pay back war debt and reparations for World War I and Germany was effectively on the brink of default and the Germany economy was in serious trouble – not much unlike today’s Greek situation.

On June 20 1931 US President Hoover issued a statement in which he suggested a moratorium on payments of World War I debts, postponing the initial payments, as well as interest. Hoover’s hope was the moratorium would ease the strains on especially the German economy and thereby in general help the global economy, which of course at that time was deep in depression.

Hoover’s idea was certainly not popular with many US citizens (like today’s German taxpayers who are not to happy to see their taxes being spending in “saving” Greece). However, the plan got most opposition from the French government, which insisted that the German government had to pay it’s debts on time as scheduled.

Despite the negative reception of Hoover’s proposal it went on to gain support from fifteen nations including France by July 6 1931.

An interesting side story on the Hoover Moratorium is why Hoover came up with the idea in the first place. Barry Eichengreen askes this question in his great book on the gold standard and the Great Depression, “Golden Fetters”: “It is unclear whether Hoover was motivated by the need for action to stabilize the international economy or by a desire to protect U.S. banks that had invested heavily in Germany”. Try replace “Hoover” with “Merkel/Sarkozy”, “U.S. banks” with “German/French banks” and “Germany” with “Greece”.

So how did the Hoover Moratorium play out? The initial market reaction July 1931 was very favourable. German stock jumped 25% on the Monday announce the initial announcement of the Hoover Moratorium. Here is how the New York Times described the global market reaction “the swiftest advance during any corresponding period in a generation” (quoted from Clark Johnson’s “Gold, France and the Great Depression”).

However, the party did not last and soon the international market turned down and the Depression continued. Many countries didn’t emerge from the Depression before the end of World War II. Lets hope we are more lucky this time around.

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by Lars Christensen on October 27, 2011  •  Permalink
Posted in Banking crisis, Economic and monetary history, euro crisis, The euro, The Great Depression, The Great Recession
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Posted by Lars Christensen on October 27, 2011

https://marketmonetarist.com/2011/10/27/the-hoover-merkelsarkozy-moratorium/

Google Trends: From Greek crisis to euro crisis

I have always found it fascinating how much information the internet is providing “real time” and  I believe that a lot of economic data can and should be “extracted” from data on internet activity. A good example is the development in google searches on the European debt crisis. Here Google Trends is an excellent tool.

We we input “Greek crisis” into Google Trends we get this timeline.

The graph is pretty clear – searches on the “Greek crisis” spikes in early 2010 and then start to ease off in May 2010. But then again from the early part of the Summer this year the “Greek crisis” start to take off again.

Then lets add one more search: “euro crisis”.

Here we compare the number of searches for “euro crisis” and “Greek crisis” respectively.

The picture is clear – there is a very high correlation between “Greek crisis” and “euro crisis”. However, there is more to tell. While “Greek crisis” searches is much higher the “euro crisis” searches in 2010 the picture has now changed.

Greek crisis becoming a euro crisis

Hence, since July the number of searches for “euro crisis” has outpaced the number of searches for “Greek crisis”. Zoom in on 2011 searches here.

Said in another way what Google Trends is telling us is that the Greek crisis has turned into a euro crisis. Is that a surprise? Maybe not, but it is an indication of the systemic risks involved in this terrible crisis.

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by Lars Christensen on October 26, 2011  •  Permalink
Posted in Banking crisis, euro crisis, The euro, The Great Recession
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Posted by Lars Christensen on October 26, 2011

https://marketmonetarist.com/2011/10/26/google-trends-from-greek-crisis-to-euro-crisis/

Calvinist economics – the sin of our times

A couple a days ago I had a discussion with a colleague of mine about the situation in Greece. My view is that it is pretty clear to everybody in the market that Greece is insolvent and therefore sooner or later we would have to see Greece default in some way or another and that it therefore is insane to continue to demand even more austerity measures from the Greek government, while at the same time asking the already insolvent Greek government to take on even more debt. My colleague on the other hand insisted that the Greeks “should pay back what they owe” and said “we can’t let countries default on their debt then everybody will do it”. It was a moral and not an economic argument he was making.

I am certainly not a Keynesian and I do not think that fiscal tightening necessarily is a bad thing for Greece, but I do, however, object strongly to what I would call Calvinist economic thinking, which increasingly is taking hold of our profession.

At the core of Calvinist economics is that Greece and other countries have committed a sin and therefore now have to repent and pay for these sins. It is obvious that the Greek government failed to tighten fiscal policy in time and even lied about the numbers, but its highly problematic that economic thinking should be based on some kind of quasi-religious morals. If a country is insolvent then that means that it will never be able to pay back its debt. It is therefore in the interest for both the country and its creditors that a deal on debt restructuring is reached. That’s textbook economics. There is no “right” or “wrong” about it – it is simple math. If you can’t be pay back your debts then you can’t pay. It’s pretty simple.

In another area very Calvinist economic thinking is widespread is in the conduct of monetary policy. Around the world central bankers resist easing monetary policy despite clear disinflationary or even deflationary tendencies and the main reason for this is not economic analysis of the economic situation, but rather the view that a loosening of monetary policy would be immoral. The Calvinists are screaming out “We will have another bubble if you ease monetary policy! Don’t let the speculators of the hook!”

The problem is that the Calvinists are confusing an easing of monetary policy or the default of insolvent nations with moral hazard.

If a central bank for example has a inflation target of 2% and inflation is running at below 1% and the central bank then decides to loosen monetary policy – then that might well be positive for “speculators” – such as property owners, banks or equity investors. The Calvinists see this as evil. As immoral, but the fact is that that is exactly what a central bank that is undershooting its inflation target should. Monetary policy is not about making judgements of what is “fair” or not, but rather about securing a nominal anchor in which investors, labour, companies and consumers can conduct there business in the market place.

The Calvinists are saying “It will be Japan”, “the global economy will not grow for a decade” and blah, blah…it nearly seems as if they want this to happen. We have sinned and now we need to repent. The interesting thing is that these Calvinists where not Calvinists back in 2005-6 and when some of us warned about excesses in the global economy they where all cheerleaders of the boom. They are like born-again Christian ex-alcoholics.

And finally just to get it completely clear. I am not in favour of bailing out anybody, or against fiscal austerity and I despise inflation. But my economics is back on economic reasoning and not on quasi-religious dogma.

PS anybody that studies history will note that Calvinist economics dominated economic thinking in countries which held on to the gold standard for too long. This is what Peter Temin has called the “Gold Standard mentality”. The in countries like France and Austria the gold standard mentality were widespread in the 1930s. We today know the consequences of that – Austria had major banking crisis in 1931, the country defaulted in 1938 and the same it ceased to existed as an independent nation. Good luck with your Calvinist economics. It spells ruins for nations around the world.

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UPDATE: Douglas Irwin has kindly reminded me that my post remind him of Gustav Cassel. Cassel used the term “puritans” about what I call Calvinist economics. Maybe Market Monetarists are New Casselians?

36 Comments
by Lars Christensen on October 20, 2011  •  Permalink
Posted in Economic and monetary history, General economic theory, MM Research agenda, Monetary policy, The euro, The Great Depression
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Posted by Lars Christensen on October 20, 2011

https://marketmonetarist.com/2011/10/20/calvinist-economics-the-sin-of-our-times/

Fear, hope, doubt and resignation

Sunday October 9:

Sarkozy: “By the end of the month, we will have responded to the crisis issue”

Merkel: “We are determined to do everything necessary to ensure the recapitalization of our banks”

Monday October 17:

German Finance Minister Schaeuble: “Upcoming EU Summit will not present final solution for euro zone debt crisis”

Seibert (Advisor to Merkel): “Dreams that everything will be solved on euro crisis next Monday can not be met”

 

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by Lars Christensen on October 18, 2011  •  Permalink
Posted in euro crisis, The euro

Posted by Lars Christensen on October 18, 2011

https://marketmonetarist.com/2011/10/18/fear-hope-doubt-and-resignation/

Monetary policy and banking crisis – lessons from the Great Depression

As the Euro zone crisis continues to escalate and European policy makers are trying to avoid that the Greek sovereign debt crisis develops into a European wide banking crisis it might be an idea to study history. The Great Depression gives us many insides to what to do and what not to do to avoid crisis.

Maybe European policy makers should start having a look at Richard Grossman’s excellent paper “The Shoe That Didn’t Drop: Explaining Banking Stability During the Great Depression“ published in Journal of Economic History in 1994.

The key hypothesis in Grossman’s paper is that there is strong connection between banking crisis and the monetary policy regime in a country.

Here is the abstract for the paper:

“This article attempts to account for the exceptional stability exhibited by the banking systems of Britain, Canada, and ten other countries during the Great Depression. It considers three possible explanations of stability–the structure of the commercial banking system, macroeconomic policy and performance, and lender of last resort behavior–employing data from 25 countries across Europe and North America. The results suggest that macroeconomic policy–especially exchange-rate policy–and banking structure, but not lenders of last resort, were systematically responsible for banking stability.”

Peter Termin in “The Great Recession in Historical Context” summaries Grossman’s results nicely and puts it into a greater perspective:

“Many countries continued to maintain deflationary policies in the early 1930s as they tried to hold on to the gold standard or, in the case of Germany, follow their prescriptions even after abandoning the gold standard. Some countries followed England off gold and created room for expansive policies, which were neither large nor expansive enough to stimulate recovery in countries that remained in thrall to gold. It has become common to attribute the continued economic decline to banking crises, but banks failed only in countries that adhered to the gold standard (Grossman, 1994). As long as countries set policies to maintain the value of their currency, their banks were at risk; bank failures were a damaging outcome of the depression, not its cause. Governments and central bankers–not commercial banks–led the way into depression in country after country.

Policies were perverse because they were formulated to preserve the gold standard, not to stabilize output and employment. Central bankers thought that maintenance of the gold standard would in time restore employment, while attempts to increase employment directly would fail. The collapse of output and prices and the loss of savings as banks closed in the early 1930s were precisely what the gold standard promised to prevent. Reconciling outcomes with expectations consequently required interpreting these exceptional events in unexceptional terms. Where the crisis was most severe, blame was laid on the authorities’ failure to embrace the gold-standard mentality.”

Hence, if monetary policy fails so do banks. Its very simple. Let that be a lesson for central bankers around the world.

Luckily at the top of the ECB management we have somebody with great inside into the history and causes of Banking crisis. That is Aurel Schubert who wrote the excellent book “The Credit-Anstalt Crisis of 1931“. Aurel Schubert today is Director General Statistics at the ECB. Hopefully somebody will ask Mr. Schubert about the lessons from 1931.

Peter Coy the Economics editor of Bloomberg Businessweek provides an excellent overview of the Creditanstalt crisis of 1931 and draws parallels to the situation to in this article.

5 Comments
by Lars Christensen on October 12, 2011  •  Permalink
Posted in Banking crisis, Economic and monetary history, Monetary policy, Reading recommendations, The euro

Posted by Lars Christensen on October 12, 2011

https://marketmonetarist.com/2011/10/12/monetary-policy-and-banking-crisis-lessons-from-the-great-depression/

Friedman vs Mundell revisited

The euro crisis continues, but the issues are not new. Already back in 2001 two of the most influential monetary economists ever debated the euro issue – and the question of fixed versus floating exchange rates. Milton Friedman represented the euro sceptic view, while Robert Mundell represented the pro euro view.

Both Milton Friedman and Robert Mundell have done fantastically insightful research on currency issues. Most notably Friedman already in 1950 presented “The Case for Flexible Exchange Rates”, while Mundell founded the theoretical foundation for the euro in “A theory of Optimum Currency Areas” in 1961.

The 2001 debate was originally printed in the Canadian magazine “OPTIONS POLITIQUES”. The article is available online. It is a real gem and I am still puzzled why the debate between these two giants of monetary theory has been so underreported.

I will not go through the entire debate, but let me just quote Milton Friedman:

“Will the euro contribute to political unity? Only, I believe, if it is economically successful; otherwise, it is more likely to engender political strife than political unity… Ireland requires at the moment a very different monetary policy than, say, Spain or Portugal. A flexible exchange rate would enable each of them to have the appropriate monetary policy. With a unified currency, they cannot. The alternative adjustment mechanisms are changes in internal prices and wages, movement of people and of capital. These are severely limited by differences in culture and by extensive government regulations, differing from country to country. If the residual flexibility is enough, or if the existence of the euro induces a major increase in flexibility, the euro will prosper. If not, as I fear is likely to be the case, over time, as the members of the euro experience a flow of asynchronous shocks, economic difficulties will emerge. Different governments will be subject to very different political pressures and these are bound to create political conflict, from which the European Central Bank cannot escape.”

Friedman died at an age of 94 in 2006. The euro outlived Friedman, but will it also outlive Robert Mundell?

3 Comments
by Lars Christensen on October 5, 2011  •  Permalink
Posted in Exchange rates, Reading recommendations, The euro

Posted by Lars Christensen on October 5, 2011

https://marketmonetarist.com/2011/10/05/friedman-vs-mundell-revisited/

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