Draghi the Euro Breaker?
Update (9/30): Eurostat just released the September figures for inflation: Headline: 0.3%, Core, 0.7%
Hans Werner Sinn did it again. In the Financial Times he violently attacks Mario Draghi and the ECB. To summarize his argument (but read it, it is beyond imagination):
- The ECB gave too much liquidity to banks in peripheral EMU countries since 2008, thus fueling a spending boom.
- Then, with the SMP and the OMT programs it “lowered the interest rates at which overstretched eurozone members could obtain credit and reversed the losses of their foreign creditors, triggering another borrowing binge”
- Finally, “The ECB’s plan to purchase [private borrower’s] debt could end up transferring dozens if not hundreds of billions of euros from eurozone taxpayers to the creditors of these hapless individuals and companies.”
- Last (but not least!!) he claims that deflation is necessary in EMU peripheral countries to restore competitiveness
I am shocked. Let me start from the last point. Even assuming that competitiveness only had a cost dimension, what would be required is that the differential with Germany and core countries were negative. Deflation in the periphery is therefore only necessary because Germany stubbornly refuses to accept higher inflation at home. And no, the two things are not equivalent, because deflation in a highly leveraged economy increases the burden of debt, and triggers a vicious circle deflation-high debt burden-consumption drop-deflation. I refuse to believe that a respected economist like Hans Werner Sinn does not see such a trivial point…
As for the rest, the spending binge in peripheral countries began much earlier than in 2008, and it is safe to assume that it was fueled by excess savings in the core much more than by expansionary monetary policies.
Further, does Sinn know what a lender of last resort is? Does he know what is “too big to fail”? Where was he when European authorities were designing institutions incapable of managing the business cycle, while forgetting to put in place a decent regulatory framework for banks and financial institutions?
And finally, does Mr Sinn remember what was the situation in the summer of 2012? Does he remember the complete paralysis of European governments that were paralyzed in front of speculative attacks to two large Eurozone economies? Does he realize that were it not for the OMT and the “whatever it takes”, today Spain and Italy would not be in the Euro anymore? Which means that probably the single currency today would not exist? Maybe he does, and he decided to join the AfD…
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Sparse Thoughts of a Gloomy European Economist 
If Sinn does see the trivial point, which he obviously must, that leaves one conclusion. Sinn intends to destroy the periphery so it can be bought by the core, and the long-standing goal of takeover of the European periphery by the core will be accomplished. If you can offer another interpretation, I am all ears.
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I think this is a version of an area of banking economic analysis that is generally missing, as if all of banking and economics was apolitical, divorced from human competition. Here’s notes from the same viewpoint about how it was that Lehman didn’t get bailed out when everyone else did.
Since Rubin, every Treasury Secretary has been from Goldman Sachs. The NY Fed was run then by a Goldman Sachs man. Lehman was Goldman Sachs biggest competitor. When the opportunity to kill Lehman presented itself, Goldman Sachs took it. That left $600 billion more pie for Goldman Sachs to go after. More room to grow. More room for big bonuses. It was what you call a no-brainer.
But the collapse of AIG, and what that meant? That was definitely not a no-brainer. That was a big, big surprise. The Fed had no idea what was going on, because the Fed believed (and mostly still believes) that it can tell by activity at the discount window how much money creation is happening. But this was no longer true. There was something new under the sun. There was a new banking money multiplier at work that AIG enabled, and very few understood.
That banking money multiplier had no realistic limit. See: Release of the Kraken: A Novel Money Multiplier Equation’s Debut in 21st Century Banking. Hanley 2012, Economics eJournal. http://www.economics-ejournal.org/economics/journalarticles/2012-3/view
The collapse of AIG was a threat to all of US banking because of the new money multiplier that AIG enabled. When the rug was pulled out from under that new money multiplier, the reserves left were on the order of 1:1000 or less.
Treasury couldn’t allow all those other US banks to fail. It would have ended US hegemony over global finance and the dominance of the dollar. That picture became clear very fast, despite still being quite muddy. So all those banks had to get bailed out, with AIG as the keystone. But AIG has mostly been ignored by the media.
The power of nations has long been tied to the strength of their banks and confidence in their currency. Since the end of WWII, banking and finance has been the primary theater.
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An alternative interpretation is that for Sinn – as well as for several members of the German establishment – there is no way out of the conundrum but Southern Europe deflating. Not necessarily because of malignity. Just because high inflation just is absolute evil to Germans.
Is there any way out of this nightmare ? technically yes: helicopter money in Southern Europe to reflate demand and reduce taxes on labor
– either via the introduction of parallel currencies – http://bastaconleurocrisi.blogspot.it/2013/09/tax-credit-certificates-certificati-di.html
– or engineered by the ECB (and to avoid being unfair, Germany should receive it too and use eg to buy back government debt).
What if a political consensus will not develop to do any of this ? A euro breakup could be the only way-out, then. I agree it’s not the most efficient solution. But damages created by austerity in Europe over the last two years makes me believe that Draghi “whatever it takes” did, alas, more harm than good.
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“and triggers a vicious circle deflation-high debt burden-consumption drop-deflation”
The scare mongering of short sighted artists of manipulation. It is exactly the inflationary monetary policies and abuse of currencies for short term economic growth benefits that led to the build-up of all these imbalances and massive credit volumes that burden the economy the world over. The direct and indirect subsidies to the financial industry, and yes, also in the form of the lender of last resort, has corrupted the basic principles of capitalism and turned it into crony capitalism. We do not have to continue transferring the costs of risk away from the creditors to the general population but rather start to write off all those debts that will never be repaid. Rather then facing the consequences of past errors, some economists just seem unable to learn anything and stick to their indoctrinated policy advice even if it leads to the evaporation of all democratic values and simply increasing the concentration of power further in all those bureaucrats who created the mess in the first place.
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The ECB even more than the Fed failed in its responsibility to maintain a steady growth in NGDP. They did not even maintain their minimum inflation targets.
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Incorrect analysis… For the euro area, the problem was a common currency, free capital flows, and a one-size fits none monetary policy that made monetary policy inefficient, while some euro area countries used beggar-thy-neighbor wage moderation policies while others were attempting to growth their economies and achieve EU objectives of “real convergence”.
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Sorry Thaomas, my above comment is meant as a reply to Linus Huber (10:56).
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“One size fits all” monetary policy is a problem in any currency union, including the US. The issue is what is the size. ECB has chosen a size that did not and is not maintaining steady growth in NGDP or even that meets its minimum inflation target for the area as a whole.
Going back farther private sector investors made the mistake of confusing the disappearance of currency risk following the introduction of the Euro with the disappearance of country risk. If anything, lenders should have seen that the lack of an exchange rate instrument for adjusting to shocks made cross border lending more risky as events have shown.
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@ Patrick
You seem to misunderstand my comment in that you think it is directed toward one specific currency area. No, it is meant to address the common doctrine of the past 50 and more years in that currencies are used to achieve temporary economic growth benefits by devaluing it and the inability to recognize the unseen longterm consequences thereof. You seem to represent the perfect example of that creed of econometric number crunchers who are able to see simply the direct results of an action.
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@ Linus Huber (6:01pm) : “You seem to represent the perfect example of that creed of econometric number crunchers who are able to see simply the direct results of an action” … Thank you, I’ll take that as a complement 🙂 ; at least I can see that much, it’s more than can be said for some!
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I have doubts that “helicopter money” or the ECB buying any significant amounts of public bonds is in the pipeline; as for outright purchases of public debt, it is ruled out by the ECB’s statutes. Low inflation and deflation will be the only way forward, with euro area (EU) governments striving to comply with the SGP (“Fiscal Compact”) rules but unable to achieve the required objectives for many years to come. This will inevitably lead to a weakening of the status and credibility of the SGP and fragilise the EU institutions.Will EU institutions have the guts to actually go ahead and fine France now (and other Member states later) for excessive deficits, will the EcoFin Council follow the Commission? Future EU Council meetings could become heated, polarised and finally gridlocked.
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Dear Mr. Saraceno:
I think it is problematic to entirely neglect the guarantees that the core states have explicitly or implicitly made to the periphery countries. Germany alone has already guaranteed for over 300bn EUR (and that’s even without OMT and the banking union).
The Southern states have accepted these prospective credits under certain conditions. But now they’re demanding high relative deflation in the core countries, which is equivalent to paying back much less and thus effectively annihilating wealth in these countries.
This was not part of the deal; the South should have left the eurozone already four or five years ago.
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Sinn colonial economics adds nothing to the debate, and makes gross errors (2008 spending boom is offensive, to say the least, for us Portuguese, Greeks and Irish)
Some questions must be addressed in this debate, namely first where does the ECB consolidate and who profits from the ECB. The thing is that ECB isn’t a regular central bank, but it’s holding large amounts of sovereign European debt. In a normal country, there would be the possibility of consolidation between treasury and the central Bank, making the debt burden much lower. This consolidation also makes more transparent the product of the intervention of the Central Banks in the debt market, since the sovereign debt it buys at discount are then profits for the treasury of the country.
To put it in a simple the question is who’s going to profit from the huge discounted debt the ECB bought during the sovereign debt crisis? If the issuer country isn’t the one benefited, then it resembles like “agiotage” from the ECB.
The second question, is why are we forcing deflation has the only way to regain competitive equilibrium within Europe. Why are we forcing the impoverishment of countries to control internal demand and curve imports? There is a much easier, historic mechanism to do it….import Taxes, or in the case of Europe, allowing the intervened countries to have differential VAT taxes on imported products.
Fixed exchange rates and free trade policies are probably one of the most destructive ideas mankind has ever created.
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Assuming that “Deflation in the periphery is therefore only necessary because Germany stubbornly refuses to accept higher inflation at home” this is a description of reality: what could ‘Germany’ actually do to ‘accept’ higher inflation (which is somewhere at 0.8%, I think)? And I am talking about feasible things, respecting the Geman and international laws. No wishful academic thinking, please. BTW, maybe I just missed it, but what are your rebuttals to your line items 2) and 3)?
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The German government could, for example, encourage growth in real wage rates, private consumption growth and higher investment (such as in infrastructure) through fiscal incentives or outright policy decisions.
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Germany could support ECB adopting a monetary policy appropriate for the entire Euro area, maintaining a steady growth in NGDP and, now that it failed to do so since 2007, to catch up to trend growth rate in NGDP. It needs to repair a lot of damage that is has done by its inaction.
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I met Sinn about one year ago. He approached me during an economic meeting after hearing me speaking. He suggested that Italy should really, really ‘do something’ about its competitiveness gap, since “we are not going to close it” (meaning we are not going to create inflation in Germany). He tought competitiveness gaps were at the root of the EZ mess. So much for the facts.
At the time my interpretation was that he was despising the weak. He felt that someone (or a country) challenged by an external power or problem, unable to react in a tough way, is not ‘a real man’, he is like a child, and thus unfortunately he deserves to suffer: he is the cause of his problems. Maybe when he has suffered enough he will learn the lesson, he will react in an appropriate way. Expecting someone else to save him is pitiful and shameful… Something like that.
As for Germany, he felt that (1) that Germany is not going to move is a FACT, so – whatever you think about it – you should take this into account, endogenize it in your reaction function, and react ‘rationally’ in a consistent way (deflate). (2) it is obvious that Germany is not going to do something against its own interests – hey!, that’s life, didn’t you know it? – He sees the world (and the EZ) as a competition arena, other countries as competitors. Beware the weak!
Finally, he stressed that he was telling me these things in the interest of my country, Italy; he worried that otherwise things would go from bad to worse in Italy. But I also perceived a slightly euphoric sentiment of triumph and pride (Germany over Italy: ‘we won’, ‘we are the better ones’, you are shameful). And at the same time the desire not to ‘win too much’, not to humiliate his opponents, to respect his competitors when they are defeated. And I also perceived a vague fear that there might be negative feedbacks for Germany if things went really bad in Italy.
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No way out of this awful mess but Southern European countries taking unilateral actions.
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@Marco:
Possibly, but the ECB ought to try getting NDGP back up to the pre-2007 trend before one concludes that.
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I think at the core of the awfull german thought is the concept of “Standortkonkurrenz” (ie: international competition to attract economic resources to a location). Capital is free moving arround the world and the local policy has to do everything to attrac it. It is something like a metaphysik of free trade of everything, but the people. So the people have to cut wages to attrac capital … This metaphysik is burned into the german brains.
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http://juanramonrallo.com/2014/10/la-sistematica-tergiversacion-de-say/
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Last link is an article refusing one thing you said.
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