Guest post: Europe’s problem is not a Greek drama but a medieval Calvinist morality play (by Mikio Kumada)

I have asked my friend Mikio Kumada to write a guest post on blog on a topic he knows very well – the Greek crisis. While I do not agree with everything Mikio writes (I do agree with most of it) I think it is extremely important to get a broader and more insightful perspective on the Greek crisis (and the euro crisis) than the standard “Calvinist” version.

Good luck.

Lars Christensen

Guest post: Europe’s problem is not a Greek drama but a medieval Calvinist morality play

by Mikio Kumada

The crisis that Greece has found itself in over the past five years has been invariably labelled as a “Greek tragedy” by the media around the world – which is both wrong and misleading. More importantly, it is very unhelpful when it comes to finding a way out for Greece and for Europe as a whole.

The reality is that, if one wishes to use catchy cultural labels, it would be more appropriate to call it a medieval European morality play of the Calvinist sort – and a rather bad one at that, too. Bad, because it harks back to notions of good and evil that perpetuate mistakes and delay a solution to the actual problem.

In this “Calvinist” play, the Europeans are telling Greece:

“We understand that your house is on fire, but you cannot use our stand-by fire extinguishers and fire engines, because you’ve been a bad boy/bad girl, and you have to repent for your sins first. You can use the extinguishers in the rooms in which our property is stored, but for the rest, use this bucket of water instead, which we so generously provide to you.”

What you say if your house was on fire, and your “friends” gave the above “advice” and “help”?

Do not get me wrong: Greece was predominantly responsible for the fact that its house was so easily inflammable, and that that it was ill-prepared to cope with the disaster. But it is only to a smaller part responsible that the fire is still raging.

Furthermore, over the past five years, Greece has done its best to put out the fire with the water bucket, and to “repent”, as recommended – i.e. it has implemented a wide range of difficult reforms and cuts (Prof. Karl Whelan of University College Dublin provides a good account here). Even Greece’s new government is willing to compromise to a considerable degree.

That said, let me move straight on to what I believe is the most likely scenario of how things will play out in the coming days or weeks – depending on the level of European intransigence ability to admit mistakes and lose a little bit of face, for the sake of avoiding an even greater calamity.

In spite of what I may have appeared to suggest above, I believe Europeans in general and Northern Europeans in particular are emotionally capable of soul-searching and intellectually perfectly endowed for reflection and pragmatism, to use a very Greek term. Thus, realistic, practical solutions will ultimately prevail in this whole affair.

Consequently, I still think there will not be a “Grexit” – not this week, not this quarter, not next year, or in any other year. What is most likely (though of course not certain) to happen, is the following:

  • There will be an extension of the current (revised and softened) program for something like 3 to 6 months.
  • In order to achieve this, the Europe will find a way to move Greece’s current liabilities versus the IMF and the ECB to the ESM, without actually having to spend a single “new” penny. The funds required for this purpose are available – in the form of the unused 10 billion euros from the Greek bank recapitalization fund, the roughly 2 billion euros in ECB profits from its older purchases of the Greek bonds, and by allowing Athens to borrow a couple of billion more from its own banks (the issuance limit of T-bills is subject to approval by the ECB). This will also allow the Europeans to get the IMF off their backs for now.
  • This, in turn, should eventually allow Greece to participate in what is the most important determinant factor for Europe’s economic recovery in the near future – the ECB’s first proper quantitative easing program that began in March – before it’s too late.
  • There will be a third financing program for Greece sometime early next year, which will be much smaller in size and more realistic by design than the previous ones. It will probably include a specific European commitment to provide debt relief – in order to get the IMF back on board. Or it will completely “Europeanize” the problem.
  • Under these conditions, it will be possible for Greece to produce nominal GDP growth – which is the mother of all debt sustainability miracles, as it is the basis of all household income, corporate profit, and tax revenue.

I should add that international political considerations regarding the IMF form an important part and driver of the above scenario. Point 2) would calm the US-led IMF, for now, as it would avoid a global loss of face for Europe, if an EU member is allowed to default vs. the fund.

Needless to say, such an event would weaken Europe’s global standing in the organization, and beyond. No matter how much Northern Europe would like to detach itself from it, Greece is a European affair.

Here, it is useful to remember that we live in an era in which the Bretton Woods organizations will soon be competing, to say the least, with similar international institutions-in-the-making, led by China and the BRICs. This is no small matter.

Europe’s huge combined share aside, the IMF’s two largest shareholders are the US and Japan, which, by the way, stands behind the Eurozone bailout loans with some 90 billion US dollars.

And while Germany, and others, could try to squarely place the blame on Athens, but hardly anyone would really buy that. The rest of the world would see this as a European failure, especially since the IMF was (reportedly) pressured by the Europeans to bend its rules to lend to Greece. Allies and friends such as the US/UK and Japan will have a harder time siding with Europe, and the emerging economies will see as proof that Europe’s role in the IMF is not just oversized, but also very costly, to say the least.

The problem of the “Calvinist” approach to the Greek crisis also plays a role on this level.

After all, practically all major countries outside Northern Europe are less moralistic and more pragmatic when it comes to debt problems. One example can be found in the fact that the US, UK and Japan were quicker in intellectually accepting QE, without concerning themselves too much about whether this represented inappropriate / immoral “stealth government financing” (I believe QE is simply a perfectly legitimate, useful and important tool of monetary policy). Another example can be found in a side-quip by a Chinese economist I overheard in Hong Kong, who described Beijing’s ongoing (vaguely veiled) bailout of its highly indebted provinces as being akin to Europe’s bailout of Greece – “just without the austerity”.

To make a long story short, I do believe that Europe will overcome the limitations imposed by the simplistic application of culture-specific morality in internationally relevant policy affairs – especially when the tools and means to overcome its problem are clearly available.

And if there is any “Greek drama” involved in this, it could very well prove useful for Europe as a whole, by confronting it with important policy questions – and thus ultimately help it move on to a more workable, and pragmatic, solutions to its problems.

© Copyright (2015) Mikio Kumada

Maybe Jens Weidmann and Francios Hollande should switch jobs

There seem to be two main positions on how to solve the European crisis. One represented by Bundesbank chief Jens Weidmann and that is that monetary policy should not be eased anymore and fiscal policy needs to be tightened (this is the Calvinist position). The other position is held by the new French president Francios Hollande who wants to spur European growth by easing fiscal policy (this is the keynesian position)

I would claim that both positions are wrong. At the core of the European crisis is rising public debt ratios in Europe. The public debt ration (d) is defined in the following way:

(1) d=D/NGDP

Where D is public debt in euros and NGDP is nominal GDP.

Anybody with rudimentary monetarist insights would inform you that D is determined by the fiscal authorities, while NGDP is determined by monetary policy (remember MV=PY).

If you want to stabilize or reduce d then you have to either decrease D and/or increase NGDP. So what you basically need is fiscal tightening and monetary easing.

Unfortunately Weidmann is basically arguing for reducing NGDP and Hollande is arguing in favour of increasing D. Both positons will lead to an increase in d and hence worsen the crisis. Hence, it would be better if the two gentleman switched jobs  – at least mentally. It would be a lot more productivity if Weidmann argued for monetary easing and Hollande argued for fiscal consolidation. That would do the job and the crisis would come to an end fairly fast.

Between the need for fiscal tightening and the need for increasing NGDP I have no doubt that it is much more important to increase NGDP. The public debt ratios in Europe has not primarily increased because fiscal policy has been eased, but because NGDP has collapsed. In that sense the crisis is not a debt crisis, but a monetary crisis.

….

Note to the two gentlemen:

To President Hollande (The keynesian): Fiscal policy cannot increase NGDP. Recommend reading: There is no such thing as fiscal policy

To Bundesbank chief Weidmann (The Calvinist): Monetary policy is a panache and it can increase NGDP as much as you like it to be increased. Recommend reading: “Ben Volcker” and the monetary transmission mechanism

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