"When the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals.
We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues"

( JM Keynes, "Economic Possibilities for our Granchildren" 1930 )

Wednesday, May 26, 2010

Will 2011 turn into 1938?

" History Does Not Repeat Itself, But. It Sure Does Rhyme"(Mark Twain)

This is not an exercise in mathematics, it´s about Economics and History. Western governments have lately adopted serious measures aimed to reduce the growing deficit of their public accounts. The list is impressing: The governments of Greece, UK, Spain Italy, Portugal Germany and other countries decided to reduce costs and impose austerity measures expected to inflict a serious ( and additional ) economic stress on their ( more modest ) citizens. Just for the record, alternative or complementary measures as increasing the tax burden (which affects the more affluent classes) or improving the tax collection system are inexistent or of secondary nature.

Such measures can be justified only if that their expected benefits exceed the negative impacts of such measures on the economy. Put it in other words the hidden assumption is that economy is already on “the right track” so the demand of public sector is less crucial than before. However, the propagandist effort pointing on the imminent “recovery” (Green Shots, “We saved the world “ and so on) relies upon a not very solid ground : GDP growth figures are still fragile, interest rates extremely low and unemployment rates high. My claim is that such policies the wrong cure for the wrong disease and they could easily exacerbate the economic recession we are still suffering.

That debate resembles the situation along the mid 30 when the Great Depression was still around but growing pressures for “balanced budget” forced the US administration to cut expenses. True, history does not repeat itself, but it definitively “rhymes”, so the lesson in that case could be interesting.

From the Wikipedia
"The Recession of 1937–1938, sometimes called the Roosevelt Recession, was a temporary reversal of the pre-war 1933 to 1941 economic recovery from the Great Depression in the United States. Economists disagree about the causes of this downturn. Keynesian economists tend to assign blame to cuts in Federal spending and increases in taxes at the insistence of the US Treasury while monetarists, most notably Milton Friedman tended to assign blame to the Federal Reserve's tightening of the money supply in 1936 and 1937".
“…….. In June 1937, some of Roosevelt's advisors urged spending cuts to balance the budget. WPA rolls were drastically cut and PWA projects were slowed to a standstill.
The Results ….
"...The American economy took a sharp downturn in mid-1937, lasting for 13 months through most of 1938. Industrial production declined almost 30 per cent and production of durable goods fell even faster”. Unemployment jumped from 14.3% in 1937 to 19.0% in 1938, rising from 5 million to more than 12 million in early 1938.Manufacturing output fell by 37% from the 1937 peak and was back to 1934 levels. Producers reduced their expenditures on durable goods, and inventories declined, but personal income was only 15% lower than it had been at the peak in 1937. In most sectors, hourly earnings continued to rise throughout the recession, which partly compensated for the reduction in the number of hours worked. As unemployment rose, consumers' expenditures declined, leading to further cutbacks in production".

A few Graphs for illustration

2011 = 1938¿

As can be noticed, the 1937 brilliant cut ( it was a cut, not an increase of taxes) wiped out 2 years of unemployment reduction bringing back the figure to the 20% area. The figures beyond 1939 are irrelevant as the mobilization following the outbreak of WWII changed the rules of the game.

The risks of repeating 1937 1938 experiences are high which means social, economic and political devastating consequences. If history can teach us something, how can we explain the risk approach of policy makers? Given the timing and the nature of these measures, I cannot escape the thought that political decision makers are disproportionally prone to respond to any short term oscillations of financial markets. Personal interest? Class interest? Lack of intellectual skills? Opportunism? Just name it. An honest leadership with a longer run and civic perspective, and even with some “historic” touch would probably adopt a more human and economic measures.

Let us hope that 2011 does not turn into 1938, as the real risk is that 2012 would turn into1939.

Wednesday, May 19, 2010

60.2 Millions Silent Votes in favor of the Euro

During the last weeks we have been witnessing the spectacular collapse of the common currency: Just a month ago the Euro value was ap. 1.35 USD while today ( 19.5.2010) we are at 1.22, a devaluation of app. 10% within a very short period. Such violent movements between currencies are very unusual across the majors ( i.e. the most liquids currencies of the big economic superpowers) and have the potential to trigger financial and economic turbulences.

One of the typical outcome from huge financial movements is the sudden proliferation of real, imaginary and /or self proclaimed "experts". These people do not limit themselves to a post mortum analysis of known facts, but tend to extrapolate the current state of affairs into future doomsday scenarios. In the case of the recent Euro collapse the perceived ZeitGeist can be described as the expectation of experiencing in the near future more volatile markets and a possible collapse of the Euro as a single currency of the EU. The story does not end heresd : such developments could carry the potential to drag the whole project named “European Union” into the abyss. WOW !

These experts claim (correctly) that the EU lacks the economic and political mechanisms needed to maintain the cohesion of the Union sufering from severe economic disruptions. According to that logic, the ACTUAL self interests of the EU countries are against the EU and tge Euro , so the common currency is deemed to demise , sooner or later. The last violent shifts of the currency valuations reflect the markets´ perceptions of these difficulties , a mere reflection of the real weakness. In economic jargon, at present the cost of the Euro exceed its benefits so its future is more than questionable. Clear Cut.

As a matter of fact that line of thinking is not new at all, it´s just a modern adaptation of a 50 years old theory (“Optimal Currency Area” OCA) developed by the Noble Laureate R. Mundell. So, if both theory and common sense advocates against the formation of a common currency in European style circumstances, the natural question should be as follows : Why Europeans countries engaged in such “impossible mission?. Were European leaders so fool (or G-D forbid, corrupt), to lead their people into an economic inferno?

That question as it´s presented describes the line between abstract theories and an historical perspective of the economy. THe common economic analysis tends to be based upon abstract models which are supposed to resemble the real life. However, from a "pure" theoretic perspective, economists tend to forget that even the most accurate theoretic models respond to a specified set of assumptions. That principle applies to the OCA theory as well.

Now, it is permitted even under the most abstract models to change the assumptions as long as they are relevant and reasonable. Now, if we will modify the analysis but only incorporate a slight and sensible modification: Lets assume that an OCA tends to reduce the number and magnitude of armed conflicts ( since a common economic policy generates common interests ,,, etc.) . Wouldn´t the sensible change of the assumptions have some impact on the outcome of our respected OCA model?

Going back to the 50 , this is probably the question European leaders asked themselves when they established the first foundations for an economic (and political) union. However, this is where the historical perspective of the analysis enters and practically changes the outcome.

Let us not forget that by mid 50 the silence of more than 50 million people killed a decade ago was louder than the cries from “frenzy markets”. Although economic models were as abstract as ever, the huge economic cost of two world wars was still fresh in minds and was determinant at the moment to decide whether to maintain the old and risky European model or advance toward an economic and political mechanism that would be able to prevent a future WWIII. I guess European leaders were very conscious about the hardships of such an entrepreneurship, but they understood that the alternative for Europe and the world are much worst. One of the consequence of their decisions is the Common currency and one of the longest peace periods in Europe (more than 60 years w/o serious wars!!).

My last point is that I hope that the proper historical perspective is present in front of the European leaders when they are asked to evaluate the pros and cons of maintaining the cohesion of the Union. There is only one thing that they can count on it for sure: 60.2 millions of silent votes would probably vote in favor of the EU and the Euro despite the conjectural difficulties.

Tuesday, May 11, 2010

Wanted : Astrophysicist for Central Banks

Lets see an interesting new which could have some economic implications:( from Timesonline , April 25th 2010)

“Don´t talk to aliens warns Stephen Hawking”

The aliens are out there and Earth had better watch out, at least according to Stephen Hawking. He has suggested that extraterrestrials are almost certain to exist — but that instead of seeking them out, humanity should be doing all it that can to avoid any contact.

The suggestions come in a new documentary series in which Hawking, one of the world’s leading scientists, will set out his latest thinking on some of the universe’s greatest mysteries.”

If you ever met any alien I would suggest to ignore Hawking´s advice to do “all it can to avoid any contact” and stick to the principle to “look for an opportunity in any threat”.

It´s not just for fun or curiosity. My advice applies especially nowadays, as the troubled economy combined with wild turbulences in capital markets should force us to adopt more innovative approach to deal wit the economy. Therefore, if I take seriously Stephen Hawking´s warnings, I hereby propose the European Council, US government or the IMF the idea to nominate an astrophysicist for an executive role in their organizations. The main task of that new member will be to look for aliens and introduce them into our economic sphere. Although the idea might sound a bit weird, I am confident that the next paragraphs will clarify the arguments.

First of all I would like to state that there is no intention to underestimate the role of my colleagues, the economists. On the contrary, the call for a contribution from such a distant discipline as astrophysics derives from a perspective that any mainstream economist would adopt without any hesitation.

Generally speaking, policy makers shared a common vision about economic issues which brought them to adopt ap. 30 years ago a set of policy tools which can be described according to the following scheme :

First step: Facing a deficient aggregate demand, banks are allowed, even encouraged to lend to anyone, interest rates are lowered, asset bubbles are ignored. From a external perspective foreign countries are asked to finance excessive consumption, mercantilist countries build their way to welfare through artificial manipulation of its currency, etc.

Second Step: Since debt cannot be piled forever the first step turns to be unsustainable in the mid run. As cracks appear, national governments and central banks are asked to step inside and to bailout privileged industries (“too big to fail”) industries, and especially the financial sector with public money and boost demand through spending. Since tax increase is the big taboo, the only way to generate demand is through deficit spending .The result is that previous private debt becomes public obligations. Needless to say, that system is also unsustainable since no government can run deficits forever unless the economy recovers (Anyhow, why should the economy recover?? )

Third Step: International Organizations are enlisted to support national policies and mitigate the consequences of the galloping deficits and probable rising inflation. National problem becomes an international issue. However, International Organizations lack any independent income resource, so in many cases they are just an extended arm of sovereign governments and their limited extra contribution is the economy of scale. Nevertheless, these institutions have a limited scope as they can be relevant for the weaker part of the chain. They cannot rescue the big guys.

Here astrophysics enters into the picture. The private debt system of step turned into a national debt partially turned into an international problem must be rolled over ,and if possible to outer space. This is not a peculiar whim , it is a vital need for an economic (and political) belief that inherent contradictions in the economic system can be “solved” by injecting debt that “someday” and “somehow” will be paid back.

If our benevolent scientist could dedicate his efforts and find a real "Superman" lender from the outer space able to finance the accumulated debt burden, the current system would be able to roll over and over, without having to face the crude consequences of a distorted economic system. This could be a great task for that special kind of “central banker”. If that eventually happens shouldnt we rename Ben Bernanke “Helicopter Ben[1]” as “UFO Ben”…..??? :-)

[1] In 2002, Bernanke gave a speech about deflation "The U.S. government has a technology, called a printing press (or today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at no cost." (He referred to a statement made by Milton Friedman about using a Helicpoter drop of money into the economy to fight deflation. Bernanke's critics have since referred to him as "Helicopter Ben" or to his "helicopter printing press."

Thursday, May 6, 2010

European Ants and Grasshoppers

The narrative of the Greek (and probably Spanish, Portuguese… ) bailout is accompanied by the reaffirmation of a border line within the EU, a line between relatively stable, prosperous countries and their weak and “spendthrift” partners. Now, as “the party” (i.e. irresponsible spending) is over, the former are being asked to rescue the former and so on. In many respects, the narrative resembles the tale about the hard working Aunt and the Grasshopper*....

The apparent soundness of the narrative overlooks basic economic principles. First of all, there is nothing special in existence of debtors and creditors, that is a normal characteristic of a modern credit economy: For each Grasshopper “spender” there MUST be an "Aunt" lender, for each “irresponsible” country there must be a “responsible” one that is willing to pay the bill.

Second, it is not that bad to have a spender country besides you:Since economic prosperity of nations is measured in terms of production, the very existence of foreign “spenders” ( or even credits ) contribute to the prosperity a country as an outlet for the rich country production. The debt is considered as an asset, so the rich country becomes richer.

Now, lets check out some graphs to analyze who really benefits from the debts. Since Germany is the quintessential “responsible” country, the analysis focuses on German figures

Definition : External balance of goods and services/ Gross domestic product (output approach)

As can be easily noticed from the above graph, since the beginning of the century, the external trade has contributed up to 6% to the German GDP, in other words, German jobs and their relative prosperity relies on external consumers ( otherwise they would be forced to reduce prices or not to produce). It should be noted that such situation cannot last forever, or at least for a huge country like Germany.

And who are these clients?

Source: Bundesbank

The main clients for the German surplus are the partners in Europe 15, a phenomenon that became crucial after the introduction of the Euro (and its predecessor, the ECU). Needless to say, the excessive European excessive consumption was financed by Capital transfers or debts accumulated along the whole decade and the Euro was a main catalyst for that process

How the Euro is linked to the unbalanced trade and debts between European countries? The Euros , the monetary union involved not only the adoption of a common currency but the adoption of similar interest rate. These rates are always a compromise , they are adequate for some countries and might become inadequate for others (too high or too low)

Lets see the evolution of interest rates at the EU compared to the inflation rates:

Source: OECD

As can be seen, since the introduction of the Euro, the short term interest rate set by the BCE was very low, and practically with only two years of real positive ( interest – inflation) in Spain due to its higher inflation. That low and negative interest rates were the drive for a consumption and real estate “Fiesta” which brought about a huge indebtedness of the Spanish economy. Needless to say, the spending frenzy was funneled to purchase foreign products, including Germany´s.

Summarizing: The actual debt problem owes its existence not only to the spending habits but also to the structural weakness of the “prospereous” economies which managed to evade recessions by injecting liquidity and debt to their partners. The conclusion is that the responsibility for the debt crisis is common and therefore the cost of the bailout should be shared by all the Union and not only by the citizens of the countries which are sinking in debts. In other words, in the end we are all A bit of aunts and a bit of grasshoppers ....

* The Ant and the Grasshopper, is a fable attributed to Aesop, providing a moral lesson about hard work and preparation.

Monday, May 3, 2010

Greek Myths and European Facts

Mainstream press and politicians claim that the lamentable situation of the Greek pubic finance is the result of an irresponsible, let alone criminal behavior, or put it in other way a tragic story about a country which tried to bridge the gap between a (too) generous welfare state and the requirements of belonging to the exclusive EU club.

As the current economic crisis turned the Greek system unsustainable, EU countries (especially Germany) are now being asked to support the country contributing huge amounts of money. However, despite the magnitude of the problem and possible consequences, tough questions are not being asked (yet), and the debate is being deviated into an obscure and weird blend of Economy and Culture, Finance and Race. The main message is that Europe suddenly realized that the Greeks are a nation of opportunists, hedonistic and lazy people. Europe had ten years to be aware of that "detail"... but lets leave that for now.

The counterparty of Greek (and if you push hard you would find all the “PIGS group, Portugal, Italy, Spain,,,,) lifestyle is the hard working, ever prudent Europeans, and above all the efficient Germans . Quasi racist generalizations cannot be dealt in the realm of the images, since there cannot be a real dialogue about a subjective term as "perceptions", so the best way ( and ironically, a very "German" method ) is to analyze real facts. To answer the question whether the perceptions about the Greeks are basedupon hard date I´ve checked a few statistical databases. I found some interesting data that are presented in the following graphs:

1. Weekly average hours (Source OECD)

As can be noticed, Greeks work more than 20% than Germans, not exactly the lazy partners….

2. Total Annual Hours ( in case someone suspected that Greeks work only half year ….) (Source OECD)

As can be noticed, the Greek workforce dedicates ap. 50% more hours per year to labor than the German average worker. Once again, the myth remains a myth…

3. Participation in working force ie. The number fo adults which wirk or look for work among the adult population ( source EU Stat)

As can be seen from the above graphs, more Germans are involved in the working market than the Greeks (more than 10% gap!), so the claim that the Germans are more hard working sounds sensible. However, the above German advantage has a peculiar explanation if we discompose the labor participation into sexes

As can be seen, there is a gap among males, but it is much less severe than the overall gap , less than 3%. (2009). A gap, but still not an alarming figure.

In the case of females the picture is different:

So , the explanation for the overall participation rates between the countries is the female participation rates, which is much lower in Greece than Germany. That gap is due to cultural differences and other motives and under any case the women that work as housekeepers are not eligible to social rights as workers despite their work at home.

Summarizing, stereotypes are not always related to facts, thus any debate concerniig current (and probable) future bailout should be confined to the economic sphere and based on solid facts. Presumed images or perceptions, useful for immediate political purposes could be detrimental for the future of Europe.