The Key to Eurozone Stability Isn’t Monetary

The Eurozone debt crisis has raised important issues in the profession of economics. With regards to monetary integration much knowledge has been developed thanks to the crisis. Economist have virtually all rallied to the idea that  monetary unions exacerbate competitive imbalances. The Proof is in the widening gap of current accounts between the germanic like economies and the profligate periphery economies. Germany has never exported so much while the PIIGS have not suffered so much in a while. While the causes of the crisis are apparent to almost everyone (except maybe the Greeks) policy prescription differences abound. The prevailing view is to infuse massive amounts of liquidity into sovereign debt markets to stop the liquidity haemorrhage. The theory that the Eurozone is in a temporary liquidity crisis has strong proponents such as Paul Krugman or Roger Bootle. While Ireland has a strong growth profile and Italy does have a primary surplus that could justify monetary stopgap policies the problems of the other Euro profligates cannot be tidied over by temporary monetary measures because their issues are of a structural competitive order.

Once monetary policy impotence is accepted two policies approaches remain. The first is fiscal integration. A lot of economist advocate Euro bonds to alleviate market pressures on individual member finances. The obvious problems pertain to moral hazards. One of the causes of the crisis was that the reduction in sovereign interest rates because of decreased currency risk would induce profligacy. Such a phenomenon would be continued and compounded by Eurobonds. A fairness issue would also arise as lower debt countries would pay for the debt spending of others and AAA rated countries would actually pay heftier interest than they deserve. A problem in construction is also obvious. Eurobonds would be a substitute investment for sovereigns, unless Eurobonds replaced sovereigns entirely they would cannibalize demand for sovereigns and might actually help increase sovereign yields as German bunds have done to French Bonds today.

Instead of pooling liabilities to decrease individual sovereign risk, why not pool assets? This might be somewhat more palatable to German hawks. One way of pooling assets would be to federalize Unemployment Insurance. All members could pay into a fund that would back payments of insurance payouts. This would further effectively create an internal counter cyclical government spending stabilisation. As some states power ahead the transfers would automatically alleviate budgets in ailing economies. This already exists in Canada to great inter-provincial budgetary stability, the proof being that Quebec’s yields are at historical lows although the province has comparable debt levels to many PIIGS. Unfortunately as with all insurance schemes moral hazards subsiste, but the idea remains a good way to alleviate massive intra monetary union budgetary differences.

Fiscal integration however will not in the long term eradicate structural problems. The crux of the Eurozone problem is quite simply competitive differences. For a monetary union to survive in the long run productivity must balance out across its membership. Standardizing macro-prudential or regulatory frameworks across the zone is a good idea, but only when the policies standardized across the monetary union are good. Mis-regulation at a central level is worst than at the individual problem, imagine what the Eurozone sovereign debt crisis if everyone had emulated Greece or Spain’s policies. Diversity and regulatory competition is good so long as it leads to emulating of best practices. That countries aren’t emulating Germany is testament to political and not economic issues.

The only issue remaining is that of markets prevented from punishing political cultures conducive to bad policy. Greece has a political culture conducive to demagogy and fiscal populism. Markets are sending Greeks a message, “change your ways or suffer” that the European Union prevents this pedagogical process from unfolding is the real long term risk to Eurozone stability.

“Francois Hollande” or “Homo Economicus Has Left the Room”

Many people may be forgiven for forgetting that France is one of the Worlds great nations. Let’s gloss over some of France’s economic credentials. Fifth largest nominal GDP, ninth largest in PPP adjusted terms and second largest economy in the European Union. Fifth largest exporter in the World, with over half a trillion of exports annually. Member of the G8 countries, G20 group, OECD, third highest military spending in the World and second largest gross foreign aid provider. Needless to say this stature and success has arisen because of the hard work, industriousness, and entrepreneurial spirit of the French people. The French people while reveling in their stature externally are much more cynical about their successes at home. Most Frenchmen speak of the “Glorious Thirty” and the “Pitiful Thirty” years, eras of post-war economic boom and subsequent economic stagnant malaise. Much attention and commentary is dedicated in political and intellectual circles to restoring the lost equilibrium of previous times of plenty. Much media analysis revolves around the stagnant fortunes of the French way of life and the middle class’ dwindling standard of living.

The French are also quite the political people. A country were successive constitutions have put the onus of wealth creation on governments and on individuals but only through their political choices. France thus, has seen successive ideologies and political currents wrestle with the central question of balancing collective wealth and well being with that of the individual. One might assume that through its rich political and governmental experiences certain lessons of history might have been learned. Moreover, the French being great internationalists and multilateralists, one might further assume that the country strives to benefit from the experience of its fellow nations with regard to its great equity dilemma. One would, seemingly, be wrong to assume these things. The popularity of France’s current presidential candidate front-runner would leave any Homo economicus perplexed.

The first big splash by the ‘Parti Socialiste’ presidential candidate came when he announced on live television that he wanted to impose a 75% top marginal income tax rate for revenues over a million euros. Other policies announced supposed to reduce ‘inequality’ were; a maximum lowest paid worker to CEO salary ratio of 1 to 20 and a new tax bracket from 150 000 euros to 1 000 000 at a higher 45% marginal rate (currently standing at ~41%). In Hollande’s campaign platform other musings are added to the effect of reducing income tax deductibles for the wealthy. Now, what might be the effect of such policies? (aside from giving Swiss bankers a collective orgasm). One effect would be to vilify the wealthy, to the point where many might leave, if not most. Since most wealthy people (first generation at least) are entrepreneurial and industrious business builders, maybe the intention is to reduce wealth and job creation? One French daily has aptly called the phenomenon of geographical tax jurisdiction arbitrage “Fiscal Exodus”. If the Laffer curve central thesis remains correct, all other things equal, the number of wealthy Frenchmen in Brussels, Geneva and London may well continue to swell.

Ultimately these measures are only for show. They only serve the populist and demagogic purpose of insuring the poor and disenfranchised vote with the socialist. A Hollande aide confessed that the measure might only bring in 250 million extra euros to the treasury, a paltry sum compared to the economic damages the policies will wrought. A policy that is sure to impact the treasury much more severely will be the promise to return the minimum legally insured retirement age back to 60 years of age. The present right of center French administration pushed through an increase in the minimum legally guaranteed retirement age to 62 from sixty back in 2010. The measure was put into place to more or less avoid a Greek fiscal fiasco when baby boomers begin to retire ‘en masse’. Francois Hollande plans to jettison that law, because he believes, apparently, that for every 2 years worked in one’s life, one deserves a year of retirement on average. Add on to that policy his intention to re-tinker the corporate tax rate (35% for large co.’s and as low as 15% for very small enterprises) this would cement France’s third place in the highest corporate tax rates for industrialized nations category. Combine the fact that progressiveness in corporate tax rates is just an incentive for small corporations to generate a maximum of dividend by not reinvesting profits into growth and the fact those marginal rates are going up and it would seem the French Socialist Party is on a war against international competitiveness!

While the above policies don’t really hold up to current economic thought standards, they can be forgiven as staples of the Left’s campaigning and showmanship. The policies that really drive me up the wall are Hollande’s policies towards the Euro. The first policy is one of negotiating a new fiscal treaty where Euro bonds would be issued. With benchmark French 10 year bonds yielding over 90 basis points over similar maturity German Bunds, the trans-Rhine cash grab is barely veiled. No wonder Angela Merkel does not want to meet her greedy potential counterpart. The second Euro Zone focused policy is even more morally hazardous than the first. The socialist candidate wants the ECB to adopt a dual mandate of inflation targeting and growth promotion. Never mind the moral hazard of bailing out broke Euro members, has nobody in the socialist party opened a Monetary Policy introductory book in the last 20 years? Since the early 1990’s central bank after central bank have shifted their monetary policy objectives from currency targeting and growth maximization to inflation targeting with invariably positive results. For a leading candidate to the highest public office of one the greatest nations of the World, to have such a crass and laymen understanding of fundamental economics is astounding to say the least.

So, while arguably the most archaic central bank of them all (the Fed) moves towards greater transparency and is subtly shifting its policy onus from a balance between inflation and growth towards inflation targeting, the French socialists want the ECB to move 20 years backward and forsake its stellar inflation record. Hollande could just as well shout out “To hell with responsibility and orthodoxy”. So let us recap. While the American Left embodied by the democrats and President Obama talk of lowering corporate taxes (to 28% at last check) and encourage the Fed to be more contemporary, the French Left embodied by Hollande wants to turn back the clock of time to a time were symbolism and intentions matter more than results, where its central bank would be ‘nicer’ to poor countries and its corporate tax rate would be higher. Let’s hope that sober economic thought prevails at the end of this campaign, because so far it’s only been mired in intellectual mediocrity. France has always wanted to go against the grain of conformity, who would have know that being conform even in success was so distasteful.

Shout out to our Ghanaian readers!

Cius

End of a Monopsony, Beginning of a New Era?

Canada is getting rid of one of its oldest market distorting institutions, the Canadian Wheat Board’s monopsony. Since its inception in 1935 the Canadian Wheat Board has been the only buyer of albertan, saskatchewan and manitoban barley and wheat. True to its electoral promise the conservative government is voting away the CWB’s market exclusivity. Western Canadian grain growers will now be free to market and sell their own products or choose their own intermediaries. While the move is not universally approved not least of which by a majority of the affected agricultures, it remains well worth celebrating.

Before moving to unilaterally de-monopolize the CWB the conservatives had organized a plebiscite of the farmers to seek political cover. The plebiscite was marginally defeated by wheat farmers and soundly defeated by barley farmers. Hence the wait for a majority government to move forward with the plan. Armed with a majority government the Conservatives have moved legislation to de-monopolize the Wheat Board by August 1st, 2012. Farmers will effectively be able to sell their produce on the open market or contract the grain marketer of their choice.

With the Conservatives 2010 move to block the hostile takeover of Potash Corp of Saskatchewan using the Investment Canada Act and the Conservatives public endorsements of Canada supply management schemes for poultry and dairy products, faith in Canada’ openness to foreign investment was on the skids. However, recent musings by ministers have been more encouraging. The governments bid to join the Trans Pacific Partnership is a case in point. Canada has seen its bid to enter the multilateral agreement  blocked based on its intransigence with regard to its agricultural policies. Prime Minister Stephen Harper has however indicated a willingness to put “everything on the table” in order to join negotiations. The file of Canadian-European free trade seems to be moving briskly as well with negotiations on the Comprehensive Economic and Trade Agreement. CETA is speculated to open up Canadian municipal procurement. While a few unions and entrenched interest will cry foul as they always do, it remains obvious to most that more trade only means more wealth on average.

The move to open up western Canadian agriculture to more competition was an easy move politically, as the conservative vote remains quite entrenched in the prairie provinces. Opening up poultry and dairy industries to more competition however is a much harder sell. Most of the poultry and dairy industries are concentrated in Ontario and Quebec, provinces containing ~60% of the Canadian population and vote. Political backlash from well organised farming syndicates from these provinces has turned discussion of liberalizing agriculture into a taboo. While Canada has traditionally been a positive element and proactive participant in international multilateralism, its stance on agricultural trade has prohibited it from helping the Doha round of trade talks escape collapse. On top of giving Canada a bad rap internationally, these two industries who’s members don’t even represent a single percent of the Canadian workforce, have been gouging consumers for decades without pity.

So it is time that the federal government brought down the gavel of justice on the heads of these special interest. It is time for Canada to liberalize its trade relationships. It’s time for Canadian entrepreneurs to start exporting increasingly competitive products to the rest of the World. It’s time Canadians began enjoying the fruits of trade which are higher quality products from home and abroad at cheaper prices. It’s time Canadian municipalities began running budget surpluses thanks to better priced procurement products and contracts. It’s time Canada did its part in alleviating World poverty not by splurging more resources on fruitless foreign aid development campaigns but rather by opening up its borders to the labour, services and goods of all nations and peoples of the World. It’s time for Conservatives to live up to the esteem that Canadians have bestowed upon them based on a fleeting impression that the CPC represent good economic stewardship! Riding Canada of an inefficient monopsony was a first step towards greater competitiveness and wealth, let CETA be the second but not the last.

Cius,

Many thanks to the readers of this blog from Vietnam!

In praise of all that is German

Germany hasn’t been getting a lot of slack of late. Between accusations of trying to succeed where they’ve failed in two previous World Wars – dominating Europe – or accusations scuttling the European Project out of selfishness, and again with cries that Germany is abandoning the Euro, the nation of sauerkraut and beer is in the throws of a full blown Greek tragedy (lol pun intended). Asides from the on camera superficial Merkozy marriage, no french love seems to be crossing the Rhin. Further compounding the courteous hate fest, Italian flirting has gone from invitations to the bunga bunga parties (most often refused anyways) to the sober and stale Monti ear whispering for more cash. Somehow, I don’t think encouragements from the euro-sceptic nationalisty Finns was the recognition Berlin technocrats were looking for. The Euro area is eerily looking like an Animal Farm in the throes of its Orwellian infancy. Need I really specify which Euro countries are acting like over-eager egalitarian PIIGS, hrum I mean pigs, seeking the overthrow of opulent and oppressive markets, hrum… I meant masters. All punning aside, I believe there may be a little lack of balance in the debate over fiscal and monetary policy proposals to the Euro area mess.

Let’s start by awarding praise where it is due and sing the virtues of the German machine, hrum… economy sorry forgot about the inter-temporal analogy bank. To my knowledge German policymakers are the only ones of any major economy who seem to have learned the lessons of history. This is no coincidence as not-repeating the errors of history has become part of German culture. Little children are taught at school about the immeasurable harm generations of their ancestors have wrought upon the world (maybe even too zealously). A cursory look at the lessons young children learn from Dortmund to Munich, leaves the history amateur with a few residual lessons in economic virtue, that we shall survey here:

1) Inflation = bad. How so? Well inflation leads to economic inefficiencies most notable of which is the rise of unemployment, which then leads to socio-political problems we need not raise here. To see just how hawkish they are monetarily, read anything on the Bundesbank or even the ECB.

2) Trade competition = good (especially when your winning). How so? The best buffer when in hard times is to have a trade surplus and savings. Germany has been at the forefront of multilateral trade talks, especially in Europe (see European Union history) but also internationally. I guess Germans remember how bad Smoot-Hawley was for everyone and how good the life has been since… well… 1946 I guess.

3) Hard work = prerequisite to 2). Now I know this might sound sacrilegious to all of us westerners getting used to resting on the laurels of previous generations hard work but bear with me. Our current level of wealth is tied if anything to previous generations working hard, earning dough, not spending but saving dough in the bank account, that dough being magically transformed by the financial industry into fixed capital formation, a.k.a. every single piece of equipment, factory infrastructure that buttresses our current economies. If you didn’t follow the flow working harder than your living standard would entail serves as the anvil of tomorrows wealth. Germans get that, they preach it, than they actually do it. This saving/underspending/fixed capital forming needs to happen at the household level, the firm’s level and the governmental one.

4) Mash up all of the above = hawkishness in every sphere of public policy (and private actually) = kicking the worlds butt economically.

So what has been going on exactly in Europe? following the above stated framework for success lets see where things went wrong. Europe was a place of high savings (or at least American savings though the Marshall Plan)a, hard working and rebuilding for while following WWII. No problems so far. Italy, Britain and France had thriving industries, peripheral Europe slowly started democratizing itself. Than they started moving towards the European Union. Savings and investment flows started getting a little complex at this point. Big Euro countries started saving for peripheral ones, sending money so that those countries could invest in infrastructure modern

isation and other stuff of the like. Eventually thy took a bunch of countries with a myriad of fiscal and monetary systems and patched them together into a big currency block. Germany kinda knew where this was going so they tried the  true and tested policies. They retrenched further into fiscal and macro-prudential austerity. So yes this national savings craze as measured by a current account surplus peaking at 7.4% of GDP just before the crisis hit in 08, did lead to some imbalances within the Euro block by depressing Euro wide inflation numbers and interest rates. The real trouble however wasn’t German economic virtue it was the rest of Euro countries, more particularly the PIIGS, reaction to these circumstances. How did they react, like all good socialisty, humanisty, mushy hearted westerners, they indulged in profligate entitlement spending. Riding on the coattails of previous generations of hard work and contemporary German virtue (i know redundant), they offered their people an easy life at low borrowing costs.

Then one day the masters hrum… markets, sorry, woke up and said “the break is over back to work”. The current crisis boils down to looking to the Germans and saying no we don’t want to work as hard as you! keep paying. Unfortunately markets tend to act like the tough love parents that they are and Germany seems content to not act like the over-indulgent parent its savings temporarily were. Now some might quibble that the crisis is one of solvency or simply liquidity needing some temporary patching to be corrected. What needs correcting is peripheral Europeans expectation of living standards they must go down! if they are one day to go up to Germany’s level. Increasing the ESM or EFSF or introducing eurobonds does not solve the problem. Even Angela Merkel’s suggestion of limiting federal governments deficits to 0.5% of GDP remains to timide a goal. Mario Monti is somewhat on the right track in Italy. Although his reforms are limited in scale they are in the right direction. A combination of fiscal austerity coupled with market liberalization is the equivalent of putting italians back to work. Less play more labour! is the key to making labour unions howl and incidentally generating long-term wealth. Let’s hope more european nations decide to go the german path to prosperity before the s*** really hits the fan.

Cius