Blame the ECB

Opening paras of my latest at The National Interest

As the euro zone stumbles towards a seemingly inevitable collapse, it is easy to blame the politicians involved or the whole idea of a common currency. The outcomes of the latest top-level meeting, including a pledge to create a single euro-zone banking supervisor and a relaxation in conditions for lending to Spain, are welcome enough but seem, yet again, to be too little, too late to save the common currency.

In reality, the real problem is not with the euro but with the institution set up to manage it, the European Central Bank. The idea behind its creation—a central bank completely independent from government control—is detached from economic reality.

The ECB’s disconnectedness was evident in the decisions by President Jean-Claude Trichet to raise interest rates twice during the course of 2011, at a time when the danger of complete collapse was already evident. Although these decisions were subsequently reversed, they killed any chance that Europe would grow its way out of the debt crisis.

46 thoughts on “Blame the ECB

  1. @BilB

    What you are saying are proposed solutions not problems, the thread was initially about the problems of Europe not proposed solutions.

    “Another mechanism is to apply a time limited global (national) levy (3 or 4 %) to all non European and non primary resource imports of goods and services. This would apply a small bias towards local manufacture and fund industry restart programmes.”

    This will only have very small effect for some of the EU nation’s recovery. EU nations trades mainly within the EU area itself, e.g. the country in the biggest trouble, Greece, major import partners (2009) consist of the following:

    •Germany 12.1%

    •Italy 11.7%

    •Russia 7.4%

    •China 5.6%

    •France 5.1%

    •Netherlands 4.7%

    In which only China and Russia are not EU nations with combined import only 1% higher than from Germany. Not only so, Euro to RUB (although higher than prior 2009 exchange rate) has been on a declined since 2009 after the initial spike in 2009. Euro to CNY has fallen very significantly from around 11:1 in 2008 to recently about 8:1.

    A proper Europe stabilising program will be great if it can actually be proposed and agreed to, as well as getting the ECB to supply the money supply. IF the ECB is and was willing to do so, so many Keynesians won’t be crying everywhere about the ECB. If the Euro was so co-operative to each other to agree to a stabilising program that requires hundreds of billions, some countries won’t be crying for stimulus measures instead of EU wide austerity in the first place.

    Don’t you get it? A lot of the things your saying are all already proposed and said by a lot of Keynesian economists all over the world in the past few years. It’s problem is not there is no solution but they won’t co-operate. Like I already said, this thread wasn’t about proposing solutions, it’s about the problems EU face.

  2. “Europe’s situation is unique and they will get through it, and…be much stronger for the so doing.”

    My sentiments exactly.

    And, considering Greece has the most polluting coal power plant in the Euro zone and a lot of sunshine and a huge coastal line, there are obvious projects for EU funds and employment. But this will not happen over night.

    In contrast to the FED, the ECB was created by elected governments. The ECB can only ‘dictate’ to governments as long as the rules, created by elected governments, allow. The rules of the ECB can be changed by the Euro member governments, subject to their respective constitutions.

    President Holland of France announced taxation changes (including 75% income tax on incomes > 1.0Euro). Clearly, being a Euro-zone member is not a constraining factor.

    Germany’s once famously generous welfare system is but a shadow of its former past (since unification, brought about by the CDU-CSU Kohl government and paid for by West German taxpayers under the SPD Schroeder government). There are proverbial millions of ‘working families’ in Germany who would like to spend a holiday in Greece but for their tight budget constraint they fly to Turkey (approximately equal air pollution). There are proverbial millions of retired Germans who won’t be able to go to Greece or Spain on holiday because their savings and pension funds have shrunk (nevermind the export sector of ‘the country’) as a consequence of the GFC.

    ‘Inflating the debt problem away’ is a nice solution in a one period macro-model (with one individual!) but it doesn’t necessarily solve the so-called ‘European debt problem’ (= a bad debt problem in a few countries, related to a US style housing boom and bust (CDOs, rating agencies, proverbial Wall Street banks) and to a creative accounting problem in another) because, unless the rules of the financial market game is changed, new debt problems will grow (and more inflation).

    As pointed out by Freelander, recommending ‘inflating the debt problem away’ isn’t the same thing as achieving inflation (see UK).

    Writting off debt is an alternative. As long as new debt problems grow, the same logic applies as for the inflating debt away. The common currency is not the constraining factor but the international financial system is.

    Writing off debt has different consequences for real life people in the USA and in the EU. While in both regions banks write off debt (if they have enough equity), only in the USA is housing debt recourse. In most if not all EU countries, people who can’t pay their housing loans lose their house but the debt remains. The USA system appears more humane but is it? Is it humane to create a new financial security (CDO) to confuse debt with equity? It was and still is profitable for some, that’s for sure.

    How would fiscal and monetary policy union, in the image of the USA, preserve any notion of cultural sovereignty (surely an important element of ‘national sovereignty’) in the EU?

    Europe’s situation is unique but, despite their common currency, the Euro-member countries are not independent of the USA and the rest of the world. Europe will muddle through, I believe, and in the meantime we blame the ECB.

  3. A good response, Tom. Yes, a personal failing of mine is that I only think in terms of solutions, not problems.

    Greece imports twice as much as it exports (I wonder how long they can keep that up). The 4% levy on 13 % of imports would yield 224 million euro. not a huge amount but not an insignificant stimulous if applied intelligently to promote import substitution. And that is an annual collection meaning a billion euros over 4 years.

    More importantly Europe has signed up to a 600 billion dollar commitment for the Desertec renewable energy system. Accelerating that programme with a healthy share of the contracts exercised in the GIPSI countries could very well improve Europe’s Climate Change Action position while providing a significant profit in the course solving a vexing economic problem.

    Furthermore, in Greece’s case, defaulting taxpayer accruals can be converted to assets if there is the political will to do so.

    Guilty. I see more solutions than problems. I’m watching the Tour de France. What a beautiful country Europe is, even with all of this economic drama.

  4. Here we go again, “Three Central Banks Move to Stimulate More Borrowing” :

    … so that banks can make profit to repay their loans from the central banks.

    But who among the many retirees in ‘the North’ would be stimulated to borrow money to finance a holiday on the Costa del Sol in Spain, parts of Italy and larger parts of Greece that rely on tourism?

    Who among the net savers in ‘the North’ would be stimulated to borrow money to finance a holiday in the above mentioned locations?

    Who within the building industry in the Costa del Sol region would be stimulated to brorrow money to build houses and generate ‘jobs’ (hire unemployed bricklayers, carpenters, ..)) given an enormous excess supply of various types of real estate?

  5. @Ernestine Gross

    I agree with the sentiment that Europe should get through it. The euro has been talked down since its inception by both the Americans and the British. If their arguments against the claimed unworkability were taken seriously then the US itself would have several rather than one currency. The benefits from the greater market with one currency massively outweigh the hypothesised benefits of breaking the zone up. Clearly a massive strain has been placed on economies as a result of the American’s flicking a lot of bad paper around the world certified as AAA+ when it was junk, and the mess made to the financial system when counter parties could no longer assess each others credit worthiness has increased risk premia and restricted willingness to lend. Since reality dawned there have been plenty of policy missteps. Things are grim but a decision to break up the zone would simply be the worst decision. The weaker countries are being protected from even more extreme capital flight simply because they are in the euro. Remember not so long ago the libertarian paradise, Iceland, turned to the euro and Europe because their own currency was not worth having. The nirvana of leaving the euro and all would be right with a floating currency is the sort of nirvana nonsense like the suggestion that all would be right if the gold standard or ‘free banking’ were introduced into banking. Like the South Sea opportunities the South Sea bubble was based on, and any myriad of imagined counterfactuals, it is easy to make claims about what is not. On that basis I make the claim that if only the world turned to a decimal time system all would be well. 24 hours, 60 minutes, seconds, the months, days of the year and so on they are the source of all our problems and if time was simply decimalised all would be right in the world.

    Anyway, given all the problems the western world is facing, it would take great wisdom to identify the problem most pressing. That the western world could create such headaches in the space of less than a couple of decades is truly remarkable. Although we do have form. The mess made during the couple of decades after the war to end all wars was surely evidence that collective madness did not end with the so called enlightenment.

  6. What policy makers in Europe need to remember is that however bad things may seem at the moment, it is well within their power to make them considerably worse. Lets hope they don’t, however inadvertently, exercise that power.

  7. It is worth reading this article titled “Robert Mundell, evil genius of the Euro”.

    http://www.guardian.co.uk/commentisfree/2012/jun/26/robert-mundell-evil-genius-euro

    I am astonished that so few people realise that loss of currency sovereignty is the key financial economic problem for countries in the Euro zone. I put the basic arguments at comment one so I won’t repeat them here. There are also real economic problems like the increasing scarcity and cost of energy and other resources. This latter problem is beginning to affect the whole globe.

    There are ways that a single currency could be implemented effectively and equitably IF (and it’s a big “IF”) the zone in question was indeed an “optimum currency area” OCA. Incidentally, Robert Mundell is credited with the OCA concept but he used the concept disingenuously for the advantage of financial capitalist.

    It is clear Europe is not an OCA while it has different national governments. The first test for an OCA would be an effective democratic Federal government (like Australia) encompassing the entire area. In that way Federal (and democratic) transfers like Australia’s transfers to small and/or decentralised states and territories can be effected. Attempting to make an OCA out of a set of independent nations is flawed from the start. Placing the currency issuer (the ECB in the case under argument) effectively in the hands of financial capital is a recipe for exploitation and impoverishment of the bulk of the people.

    I also suspect that on OCA (optimal currency area) has upper limits, upper area extents. The more economically, politically and demographically homogenous an area is the larger the OCA could be. The less economically etc. homogenous, the smaller the OCA could be. From some of the problems that the USA and Australia face we can see (IMO again) that they must be near the upper limit of an OCA.

    As a side-light, it is interesting that of the anciently civilized (meaning “city-ised”), settled areas only India and China have managed to create unified states over a large area and population. The partition of India/Pakistan/Bangladesh even calls into question India’s qualification for this achievement.

  8. People don’t recognize it because it isn’t true. When currencies were linked to gold countries didn’t have currency sovereignty anyway. And even then the absence of currency soveriegnty wasn’t the problem.

    I think the real problem is that is that people in Europe don’t have three arms. If they had three arms productivity would be at least fifty percent higher and everything would be fine. I am surprised that no one had identified that as the euro’s real design flaw!

  9. Let’s face it. There are no barriers to entry in the let’s talk nonsense about the euro game!

  10. Freelander,

    Which currency do you think that NSW state should adopt in order to cope with the conflicting influences between massive minerals exploitation and employment generating manufacturing?

  11. They could adopt the Wran. Canberra needs their own currency too because their economy is quite different again, based as it is on electoral cycles. Their currency could be called the Waffle.

  12. The optimal currency stuff is just the type of bunk that gives economics a bad name. Model building and theorising without a shred of empirical support,acknowledgement of the importance and magnitude of the impacts of what has been left out,and totally devoid of common sense. If the OCA stuff were to be taken seriously,why stop at countries? Why not different currencies for households or for individuals based on their differing economies. The benefits of a shared currency are great. Of course, the policies within any currency zone, can be bad or awful, regardless of the zones size, but that is a problem totally separate to the question of the advantages or disadvantages of the shared currency. The most important skill one learns from studying economics is the ability to talk BS. A much underrated ability considering its place in the world and the huge rewards to those who display fluency.

  13. When religion ruled the world that was largely as a result of their facility to spout BS. However, that power waned as their BS became cliched. Economics has now cornered and monopolizingd that market with a new infinitely flexible form useable for any occasion. Hence the dominance of economics in policy and elsewhere despite overwhelming evidence of its failures. Nothing beats a good story. Certainly not facts or other forms of evidence.

  14. I don’t think that I agree with you primary notion, Freelander. The common currency is not the core problem. A common currency can be inconvenient at times, but it simply represents an operating level or standard. Having ones own currency does not necessarily represent having control over that currency, and it can have its own peculiar inconveniences.

    Greece, apart from its many internal problems, probably suffered for an insufficient level of European integration. For instance if Europe had a common defence force then Greece would not have felt the need to over invest in military equipment or personel to counter an imaginary threat from Turkey. They would still have had to contribute to the common fund but that would have been a small percentage of what they did spend.

    All of those issues are now spilt milk. Greece and the other at risk countries now have to work their way out of their difficulties.

  15. Greece has problems of its own creation. Sure, they made their problems worse by the fraudulent way they entered the euro. Also,the euro as one of its benefits provided Greece and others with access to cheap finance on which they pigged out.

    None of those problems were due to the currency. They were due to the incompetent governments involved. Putting the blame elsewhere has an illustrious history. But there is no need to buy into it.

  16. Like a person who douses himself with petrol and sets fire to himself. Silly to blame the match because it worked as designed.

  17. I find this an interesting statement in the original article by John.

    “Such measures are always unpopular, at least with borrowers, who are almost invariably more vocal and politically potent than savers.”

    Do you have any data on that? Any theories as to why that might be?

  18. I might also add my insider views from Berlin on the German psyche.

    With interest rates at an all time low and fears of inflation racing through the country like an Aussie wildfire, the Germans have embarked on one mother of a spending spree. A building boom is well underway. Excess of 10% annual growth in property values in the major cities over the last year or two. Even Frau Merkel is perplexed at how the consumer sentiment can remain so high in the face of falling exports and business sentiments. It appears to me that the Germans are keen to extract the most out of their position in Europe at the moment, before their savings and loan portfolios are inflated away. They do not seem to mind that other parts of the world economy are suffering because of Europe’s problems because if they can take a big part of the European pie, then they will be doing pretty well. The only problem will be if the other countries hate them so much that they have nowhere to go for their holidays.

  19. Well, the fate of Greece has been decided. Recently elected world’s greatest economist (or at least some in Britain think so) Mr Roger Bootle has announced that Greece will exit the euro “in a matter of months”. Reasons why or evidence why, not available.
    http://www.bbc.co.uk/news/business-18727928

  20. I can’t seem to find posts about the current economic excitement in Queensland, despite 2000-3000 contract jobs having just been slashed, with apparently more to come in September.

    I guess I have to look harder…

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