tag:blogger.com,1999:blog-51428108750392730292024-03-29T04:02:52.779-07:00Ivory Towerescoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.comBlogger27125tag:blogger.com,1999:blog-5142810875039273029.post-57786210846406044952022-02-28T06:05:00.001-08:002022-02-28T08:10:37.643-08:00Russia will lose the war<p> <span face="Calibri, sans-serif" style="text-align: justify;">Russia is a small country.</span><span face="Calibri, sans-serif" style="text-align: justify;"> </span><span face="Calibri, sans-serif" lang="EN-US" style="text-align: justify;">From an economic perspective,</span><span face="Calibri, sans-serif" lang="EN-US" style="text-align: justify;"> </span><span face="Calibri, sans-serif" lang="EN-US" style="text-align: justify;">that is</span><span face="Calibri, sans-serif" style="text-align: justify;">. The gross domestic product (GDP) of Russia is about the same size as the combined GDP of Belgium and the Netherlands. Even if you add those two countries together, you still have a small country. Russia's GDP represents barely 10% of the EU's GDP. Russia is an economic dwarf in Europe.</span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;"><o:p></o:p></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;">Can such a small country win an intense war against a country that is resisting tooth and nail and <span lang="EN-US">that</span> will have to be occupied for a long time? My answer is no. Russia does not have the resources to do so.<o:p></o:p></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;">To win such a war, Russia will have to drastically increase its military spending. Russia today spends about $62 billion (nearly 5% of its GDP) on <span lang="EN-US">the </span>military. That's 8% of US military spending. Such a military budget will not be sufficient to continue waging an intense and protracted war. <span lang="NL">M</span>ore military spending will have to be made. But military spending is economically wasted. The tanks and combat aircraft that must be produced to wage the war are investments that are economically useless. This contrasts with investments in machines (and other production factors) that make it possible to produce more in the future. Tanks and fighters will not allow one extra ruble of production in the future. They will, however, put further pressure on productive investment. The economically small country that Russia is today will therefore become even smaller in the future.<o:p></o:p></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;">Instead of cutting back on productive investment, the Russian dictator could cut consumption in Russia to make way for more military spending. The fact that Russia has such a small GDP while the country has 146 million inhabitants (more than 5 times the population of Belgium plus the Netherlands) hides the fact that most Russians live in relative poverty. Putin will have to push them even further into poverty to realize his megalomaniac ambitions. It is doubtful whether this policy will strengthen his dictatorship.<o:p></o:p></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;">There are other effects to be expected from a policy that pushes a country into a war economy. The incomes earned in the war industry will not be able to be spent on consumer goods because the<span lang="EN-US">se</span> are <span lang="EN-US">in short supply</span>. As a result, inflation will rise sharply. The temptation will be great to introduce price controls. The result is known: rationing and scarcity. Paradoxically, this will fulfill Putin's ambition: a return to the Soviet Union with its long waiting lines <span lang="EN-US">in front of </span> the shops.<o:p></o:p></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;">Russia is economically a small country; it is also an underdeveloped country. It has a production structure of a typical African country. The country mainly exports raw materials and energy (gas and crude oil). They make up 80% of Russian exports. Imports are concentrated in <span lang="EN-US">manufacturing</span> products (machinery, transport equipment, electronics, chemicals, pharmaceuticals). Those products represent more than three quarters of total Russian imports.<o:p></o:p></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;">The problem with such an underdeveloped country is that export earnings are subject to large fluctuations. Today, energy and commodity prices are very high. That has allowed Russia to pile up more than $600 billion in international reserves (dollars, euros, pounds, gold). It has also boosted the budgetary revenues of the Russian government. But those are temporary effects. They have created the illusion that Russia has the resources to wage a protracted war.<o:p></o:p></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;">It is already clear that this is an illusion. About half of th<span lang="EN-US">e</span>se international reserves are now <span lang="EN-US">being </span>frozen by the punitive measures imposed by Western countries. <span lang="EN-US">This</span> also makes clear how dependent an underdeveloped country is on the Western powers that control the international financial system. The vast stock of international reserves now available to Russia is not a source of power, but its Achilles heel.<o:p></o:p></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;">Moreover, these high commodity prices are a temporary phenomenon. “What goes up must come down”. Gas prices, oil prices and commodity prices will fall again and will reduce the resources available to the Russian government today and make a protracted war impossible.<o:p></o:p></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;">Russia may cut off deliveries of gas to Europe in response to Western sanctions. This would certainly be painful in the short run in those countries that foolishly have made themselves dependent on Russian gas. If Russia cuts its gas deliveries today this would, in the longer run, destroy one of the pillars of Russian foreign revenues as European countries would look for alternatives. It would reduce even further Russia's resources to wage war. </p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;">Russia is economically a small and fragile country. It is of course a large and powerful country thanks to its nuclear arsenal. Nuclear bombs do not win a conventional war <span lang="EN-US">but</span><span lang="EN-US"> </span><span lang="EN-US">one</span> can destroy a country with it, in the blink of an eye. And here lies a great risk for the rest of the world. What will a dictator do when he realizes that he cannot win the war by conventional means but by other means? That remains the most terrifying question today.<o:p></o:p></p>escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com4tag:blogger.com,1999:blog-5142810875039273029.post-39083571733612325162021-02-12T08:53:00.000-08:002021-02-12T08:53:11.400-08:00Debt cancellation by the ECB. Does it make a difference?<p> <span style="font-family: Calibri, sans-serif; text-align: justify;">The recent newspaper publications of a proposal made by more than 100 economists to cancel the government debt held by the European Central Bank has</span><span style="font-family: Calibri, sans-serif; text-align: justify;"> </span><span style="font-family: Calibri, sans-serif; text-align: justify;"> </span><span style="font-family: Calibri, sans-serif; text-align: justify;">reignited the discussion about the role of the central bank in supporting the government. The question that many ask themselves is whether this proposal is to be taken seriously. In order to answer this question it is good to go to the basics of fiat money creation.</span><span style="font-family: Calibri, sans-serif; text-align: justify;"> </span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><span lang="EN-US">When the central bank buys government bonds, say in the context of QE, it substitutes interest bearing government bonds for monetary liabilities, (money base typically taking the form of bank reserves). In the old days these liabilities of the central bank were not remunerated. Since about 10 years, however, central banks have fallen victim to the lobbying by the banks and have started to remunerate these banks reserves. Nothing in the statutes of the central banks forces them to do so, and they could quickly reverse this policy. In fact, since a couple of years major central banks apply negative interest rates on these bank reserves, indicating how easy it is to reverse the remuneration policies.<o:p></o:p></span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><span lang="EN-US"> </span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><span lang="EN-US">At the moment when the central bank buys government bonds, it creates “seigniorage”. This is the monopoly profit arising from the creation of money. This “seigniorage” is transferred to the national government budget in the following way: the government pays interest to the central bank which now holds the bonds, but the central bank returns this interest revenue to the government. Thus, when the central bank buys the government bonds, de facto, the government does not have to pay interest any longer on its outstanding bonds held by the central bank. The central bank’s purchase of government bonds is therefore equivalent to debt relief granted to the government.<o:p></o:p></span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><span lang="EN-US"> </span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><span lang="EN-US">What happens when the government debt held by the central banks is explicitly cancelled? I will argue that economically nothing of substance happens.</span><o:p></o:p></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><o:p> </o:p></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;">As long as the government bonds are on the balance sheet of the ECB bonds do not exist anymore <span lang="EN-US">from an economic point of view</span>. <span lang="EN-US">This is so because, as I argued earlier,</span><span lang="EN-US"> </span>when a government bond is on the central bank's balance sheet, <span lang="EN-US">a circular flow of interest payments is organized from the national treasury to the central bank and back to the treasury. </span>So, the burden of the debt <span lang="EN-US">for the national government has become</span> zero. The central bank can cancel that debt (i.e. set the value equal to zero) <span lang="EN-US">thereby stopping the circular flow of interest payment. T</span>his would not make a difference for the burden of the debt. <span lang="EN-US">Put differently, the profit of the money creation has been transferred to the government at the moment of the purchase of the bonds by the central banks. <o:p></o:p></span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><o:p> </o:p></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;">What happens when the bonds that are kept on the balance sheet <span lang="EN-US">of the central bank </span>come to maturity? The ECB has promised that it would buy new bonds to replace those that come to maturity. Again, no difference with outright cancellation.<span lang="EN-US"> Thus, as long as the government bonds remain on the balance sheet of the central bank it does not make a difference from an economic point of view at what value these bonds are recorded on the balance sheet of the central bank. These can be recorded at their face value, their market value ,or they can be given a value of zero (debt cancellation): from an economic view this does not matter because the government bonds on the balance sheet of the central bank cease to exist. <o:p></o:p></span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><span lang="EN-US"> </span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><span lang="EN-US">What matters is the size of liabilities of the central bank. This is the money base that has been created when the bonds were purchased. As long as the money base is kept unchanged, the value given to the government bonds on the balance sheet of the central bank has no economic consequence. If these bonds were to be set equal to zero (so-called debt cancellation) the counterpart on the liabilities side of the central bank would be a decline in equity (possibly becoming negative). But again, this is of no economic consequence. A central bank issuing fiat money does not need equity. The value of equity on the books of a central bank only has an accounting existence. <o:p></o:p></span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><o:p> </o:p></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><span lang="EN-US">Thus, debt cancellation is fine, but it is equivalent to no-debt cancellation as long as the bonds are held on the balance sheet of the central bank. </span>The problem <span lang="EN-US">may arise</span> in the future <span lang="EN-US">if inflation surges and </span>if the ECB wants to prevent the inflation rate from exceeding 2%. In that case it will have to sell the bonds, so as to reduce the money <span lang="EN-US">base (and ultimately the money stock)</span>. If the bonds are still on the balance sheet <span lang="EN-US">(</span>because they have not been cancelled<span lang="EN-US">) the central bank will sell these. As a result, they will be held by the private sector and </span> the burden of the debt of the governments will increase because the interest paid on the bonds will go to private holders who do not return it to the treasuries. <o:p></o:p></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><o:p> </o:p></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;">If the bonds have been cancelled <span lang="EN-US">they cannot be sold anymore and the central bank </span>will have to reduce the money <span lang="EN-US">base</span>in another way. It could issue its own interest-bearing bonds in exchange for the outstanding money <span lang="EN-US">base</span>. But this means that the central bank <span lang="EN-US">will have to pay interest in the future. As a result, it </span>would transfer less profit to the treasuries. Again, no (or little) difference with outright cancellation.<o:p></o:p></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><o:p> </o:p></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;">The conclusion here is that if the ECB wants to keep inflation at 2% it does not make a difference whether it cancels the debt or not today. <span lang="EN-US">In that case if the inflation surges beyond 2%, it will have to reduce the amount of outstanding money base by either selling government bonds or issuing its own interest bearing bonds, thereby taking back the seigniorage it granted to the government when it bought the bonds. <o:p></o:p></span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><span lang="EN-US"> </span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><span lang="EN-US" style="border: 1pt none windowtext; padding: 0cm;">Things would be different</span><span style="border: 1pt none windowtext; padding: 0cm;"> if the ECB were to allow more inflation in the future</span><span lang="EN-US" style="border: 1pt none windowtext; padding: 0cm;">; in other words if it decided that it will do nothing when the inflation exceeds 2%. </span><span style="border: 1pt none windowtext; padding: 0cm;">Then it would not have to sell the bonds (or issue its own bonds). </span><span lang="EN-US" style="border: 1pt none windowtext; padding: 0cm;">In that case, the</span><span style="border: 1pt none windowtext; padding: 0cm;"> higher inflation would reduce the real value of the </span><span lang="EN-US" style="border: 1pt none windowtext; padding: 0cm;">government </span><span style="border: 1pt none windowtext; padding: 0cm;">debt that </span><span lang="EN-US" style="border: 1pt none windowtext; padding: 0cm;">is not on the balance sheet of the central bank, and that was issued </span><span style="border: 1pt none windowtext; padding: 0cm;">during the last few years at very low interest rates.</span><span style="border: 1pt none windowtext; padding: 0cm;"> <span lang="EN-US">The government would gain. But note again that this gain would accrue to the government whether or not the debt was cancelled. <o:p></o:p></span></span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><span style="border: 1pt none windowtext; padding: 0cm;"> </span><o:p></o:p></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;">Who would pay for this <span lang="EN-US">inflationary policy</span>? The investors<span lang="EN-US">. Nominal interest rates would increase, thereby reducing the price of the long-term bonds that these investors</span><span lang="EN-US"> </span>were f<span lang="EN-US">o</span>olish enough to buy at negative or zero interest rates<span lang="EN-US">. <o:p></o:p></span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><span lang="EN-US"> </span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><span lang="EN-US">Two last comments. First, the 100 plus economists proposing debt cancellation have created the illusion that debt cancellation reduces the debt and therefore allows governments, unburdened by old debt, to issue new debt to finance great projects. </span> <span lang="EN-US">I have argued that the debt relief occurs at the moment of the bond purchases by the central bank and not when the central bank puts the value of these bonds equal to zero on its balance sheet. The illusion is to think that you can have debt relief of the same debt twice.<o:p></o:p></span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><span lang="EN-US"> </span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 0cm; text-align: justify; vertical-align: baseline;"><span lang="EN-US">Second, except if at the moment of the debt cancellation governments force the ECB to cancel its commitment to an inflation target of 2%, the future increases of inflation will necessarily force the ECB to reduce the amount of money base thereby undoing the debt relief it organized when it bought the debt. Thus, as long as the ECB remains committed to its inflation target, explicit debt cancellation is likely to only reduce the debt burden temporarily. Only if the ECB reneges on its inflation commitment will debt cancellation permanently lower the government debt burden. But somebody will then pay for the inflation tax. One may still argue, however, that some more inflation is worth the price for permanently reducing the government’s debt burden. Maybe this is what the 100-plus economists had in mind.<o:p></o:p></span></p>escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com19tag:blogger.com,1999:blog-5142810875039273029.post-58501310342732315132020-12-17T02:56:00.004-08:002020-12-17T08:21:32.753-08:00How to trade when countries insist on sovereignty<p> <span face="Calibri, sans-serif" style="background-color: whitesmoke; text-align: justify;">The UK government has become entrenched in its demand for full sovereignty. Rules about safety, the environment</span><span face="Calibri, sans-serif" lang="EN-US" style="background-color: whitesmoke; text-align: justify;">, </span><span face="Calibri, sans-serif" style="background-color: whitesmoke; text-align: justify;">health, </span><span face="Calibri, sans-serif" lang="EN-US" style="background-color: whitesmoke; text-align: justify;">workers’ rights, </span><span face="Calibri, sans-serif" style="background-color: whitesmoke; text-align: justify;">and state subsidies shall be made in Westminster without any interference from Brussels. </span><span face="Calibri, sans-serif" lang="EN-US" style="background-color: whitesmoke; text-align: justify;">The UK government</span><span face="Calibri, sans-serif" lang="EN-US" style="background-color: whitesmoke; text-align: justify;"> </span><span face="Calibri, sans-serif" lang="EN-US" style="background-color: whitesmoke; text-align: justify;">insists on</span><span face="Calibri, sans-serif" style="background-color: whitesmoke; text-align: justify;"> the right to diverge from the rules that exist in the internal market. </span><span face="Calibri, sans-serif" lang="EN-US" style="background-color: whitesmoke; text-align: justify;">No doubt, that is what sovereignty means. </span><span face="Calibri, sans-serif" style="background-color: whitesmoke; text-align: justify;">At the same time, </span><span face="Calibri, sans-serif" lang="EN-US" style="background-color: whitesmoke; text-align: justify;">however, the UK government</span><span face="Calibri, sans-serif" style="background-color: whitesmoke; text-align: justify;"> also wants to maintain access to the </span><span face="Calibri, sans-serif" lang="EN-US" style="background-color: whitesmoke; text-align: justify;">EU </span><span face="Calibri, sans-serif" style="background-color: whitesmoke; text-align: justify;">internal market </span><span face="Calibri, sans-serif" lang="EN-US" style="background-color: whitesmoke; text-align: justify;">under these UK made rules. To use the chicken example: </span><span face="Calibri, sans-serif" style="background-color: whitesmoke; text-align: justify;">The UK </span><span face="Calibri, sans-serif" lang="EN-US" style="background-color: whitesmoke; text-align: justify;">government wants to have</span><span face="Calibri, sans-serif" style="background-color: whitesmoke; text-align: justify;"> the right to decide what the sanitary rules will be for their chickens (for example, they can be washed in chlorine) and at the same time the right to sell those chickens </span><span face="Calibri, sans-serif" lang="EN-US" style="background-color: whitesmoke; text-align: justify;">in the EU</span><span face="Calibri, sans-serif" style="background-color: whitesmoke; text-align: justify;">. </span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;"><span lang="EN-US" style="background-color: whitesmoke;">The problem with this view is that the EU also is sovereign and therefore has the right to impose tariffs on the import of unwelcome chicken. How can trade be made to work when two partners in a trade deal claim full sovereignty? <o:p></o:p></span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;"><span lang="EN-US" style="background-color: whitesmoke;">Here is how a full sovereignty model could work. Full sovereignty has two implications. First, it means that each of the two countries decide independently about the laws that will apply in their lands. Thus, all firms (including EU firms) selling in the UK comply to UK laws. Similarly, all firms (including UK firms) selling in the EU comply to EU law.<o:p></o:p></span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;"><span lang="EN-US" style="background-color: whitesmoke;">A second implication of full sovereignty is that each of these two countries decide independently how they will control compliance within their own borders. Firms that do not comply are sanctioned and each country is free to decide about the nature of these sanctions (barring sales, tariffs, etc.). Thus, UK firms selling goods in the EU that do not comply to EU law face these sanctions decided by the EU. The same holds for EU firms selling in the UK. <o:p></o:p></span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;"><span lang="EN-US" style="background-color: whitesmoke;">Such a trade deal based on full sovereignty would actually be easy to reach quickly. In a full sovereignty model there is no need for complicated joint committees that after long negotiations will have to identify the degree to which rules and regulations in both countries diverge. No need for setting up complicated procedures for settling disputes when divergence is observed. Such committees take a long time to come to decisions. They are time bombs leading to permanent conflicts between the trading partners. Thus, a trade deal based on full sovereignty would be easy to arrive at; it would also be relatively easy to govern in the future, as each country keeps its sovereign power to identify rule divergence and to sanction it. <o:p></o:p></span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;"><span lang="EN-US" style="background-color: whitesmoke;">Once such a deal is agreed upon, it would be difficult if not impossible, to avoid an asymmetric future development. This asymmetry follows from the fact that the EU internal market is the biggest in the world and much bigger than the UK market. This will lead to what is known as the “Brussels effect”. UK firms will eagerly comply to the EU rules so as to be able to sell in the largest single market in the world. Not doing so, would be punished by the EU and would lead to large losses for many UK firms. For EU-firms the UK market is small and, therefore, being excluded from that market would not be a loss comparable to what UK firms loose when excluded from the EU internal market. <o:p></o:p></span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;"><span lang="EN-US" style="background-color: whitesmoke;">This asymmetry will put great pressure on future UK governments to align their laws on EU laws. Of course, the UK government could initially resist this. This, however, would put UK firms at a competitive disadvantage. They would have to produce for the UK market under UK rules and for the EU market under EU rules. This would raise their production costs. Over time pressure from the UK business sector on the UK government would very likely lead the latter to align its legislation to the EU one. </span><span style="background-color: whitesmoke;">There is no need to try to impose this today. It will come about automatically. </span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;"><span lang="EN-US" style="background-color: whitesmoke;"></span></p><p class="MsoNormal" style="font-family: Calibri, sans-serif; margin: 6pt 0cm 0cm; text-align: justify;"><span lang="EN-US" style="background-color: whitesmoke;">The previous discussion makes clear that the trade model based on full sovereignty is an evolutionary one. It may ultimately lead to free trade. This will happen when one of the two trading partners, in this case the UK, will recognize that it is futile to continue to pursue full sovereignty. It also shows that free trade can only be achieved if one of the two partners recognizes this. Note that the other partner, in this case the EU, can continue to enjoy full sovereignty and free trade. This “exorbitant privilege” comes from the fact that the EU is by far the larger partner, and thus becomes the rule-maker. This happens as a result of system competition. Firms realize that it is in their interest to take over the rules prevailing in the EU, and then pressure their governments to do likewise. At the end of that tunnel free trade emerges. </span><span lang="EN-US"><o:p></o:p></span></p>escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com1tag:blogger.com,1999:blog-5142810875039273029.post-16861366924166355782019-02-26T13:03:00.001-08:002019-03-11T07:26:23.567-07:00Green money without inflation<div class="MsoNormal" style="font-family: Cambria; margin: 6pt 0cm 0.0001pt; text-align: justify;">
To what extent can the money created by the central bank be used to finance investments in the environment? This is a question that is often asked today. The green activists respond with enthusiasm that the central bank, and in particular the European Central Bank (ECB), should act and stimulate the financing of environmental investments through the printing of money. The ECB has created 2,600 billion euros of new money since 2015 in the context of its quantitative easing (QE) program. All that money has gone to financial institutions that have done very little with it. Why can’t the ECB inject the money into environmental investments instead of pouring it into the financial sector?<o:p></o:p></div>
<div class="MsoNormal" style="font-family: Cambria; margin: 6pt 0cm 0.0001pt; text-align: justify;">
Most traditional economists react with horror. The ECB should not interfere with the environment, they say. The government should do that. If the ECB jumps on the environmental bandwagon, it will be obliged to print too much money. This will fuel inflation in the long run, with terrible consequences. Ultimately, the environment will not be served.<o:p></o:p></div>
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Who is right in this debate? To answer that question, it is good to recall the basics of money creation by the ECB (or any modern central bank). Money is created by the ECB when that institution buys financial assets in the market. The suppliers of these assets are financial institutions. These then obtain a deposit in euros at the ECB in exchange for relinquishing these financial assets. That is the moment when money is created. This money (deposits) can then be used as their reserve base by the financial institutions to extend loans to companies and households.<o:p></o:p></div>
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There is no limit to the amount of financial assets that the ECB can buy. In principle, the ECB could purchase all existing financial assets (all bonds and shares, for example), but that would increase the money supply in such a way that inflation would increase dramatically. In other words, the value of the money issued by the ECB would fall sharply. To avoid this, the ECB has set a limit: it promises not to let inflation rise above 2%. That imposes a constraint on the amount of money that the ECB can create. So far, the ECB has been successful in maintaining the 2% inflation target. <o:p></o:p></div>
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There is also no restriction on what types of assets the ECB can buy. Since 2015 when it started its QE-program, the ECB has mainly bought government bonds, but also corporate bonds from financial institutions. The ECB could, however, also purchase bonds issued to finance environmental investments. The only restriction on these purchases (again) is that they do not endanger the 2% inflation target.<o:p></o:p></div>
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What are the options for the ECB? The ECB has bought 2,600 billion of government and corporate bonds since 2015. These purchases have not fueled inflation, which has remained below 2% in the Eurozone. The ECB has now stopped making new purchases. It has announced though that when these government and corporate bonds come to maturity, new bonds will be bought in the market so as to keep the money stock (money base) unchanged. This creates a "window of opportunities" for the ECB. It could replace the old bonds with new "environmental bonds", i.e. bonds that have been issued to finance environmental projects. In doing so, the ECB would not create new money. It would only reorient money flows towards environmental projects. As the total amount of money would remain the same there would be no risk of additional inflation..<o:p></o:p></div>
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A possible objection is the following. If the ECB buys these "environmental bonds", it will be involved in the decision-making process about which environmental investments should have a priority. For example it would have to answer questions such as: How much public and private investments must be made? Should it be renewable energy or nuclear energy? Should the priority be given to public transport? These are all questions that have to be settled by political authorities, and not by the central bank.<o:p></o:p></div>
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One possible way out: The European authorities give a mandate to the European Investment Bank (EIB) to finance, for example, 1000 billion of environmental investments. These political authorities add guidelines for the EIB about environmental priorities. The EIB issues bonds to obtain the resources necessary to fund these investments. This is the moment the ECB can step in by buying the EIB-bonds at a pace dictated by the expiration of the old bonds on its balance sheet. This way the ECB creates “green money” without fueling inflation. At the same time, as the ECB buys EIB bonds, it creates the possibility for the EIB to increase its borrowing in the capital markets without endangering its AAA-status.<o:p></o:p></div>
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The bottom line is that it is perfectly possible for the ECB to use the instrument of money creation to favour environmental investments without endangering price stability. Of course, one could also argue that the ECB could use its monetary instrument to favour other worthwhile projects, e.g. poverty reduction. This is certainly true, and if a majority of the population were to desire this, it should be done. Nevertheless, I am rather reluctant to go in this direction, as it would create the risk that the ECB is loaded with too many social responsibilities that it cannot handle properly. <o:p></o:p></div>
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That’s why I conclude that given the existential nature of the degradation of the environment, including climate change, the priority should be to use the ECB’s money creation capacity towards the support of environmental projects. This can be done without creating inflation. <o:p></o:p></div>
escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com410tag:blogger.com,1999:blog-5142810875039273029.post-86739775805196378242018-12-08T02:12:00.000-08:002018-12-08T02:12:00.274-08:00Who should pay for the cost of climate policies?<div class="MsoNormal" style="font-family: Cambria; margin: 6pt 0cm 0.0001pt; text-align: justify;">
There should be little doubt that drastic measures are required to protect the planet from environmental catastrophes. But who should pay the bill for these urgent environmental policies? This is the question that is central today and that was placed on the political agenda recently by the “yellow vests” protestations. Many want to save the environment but few want to bear the cost. Yet without resolving this question of who will foot the bill no progress can be made in developing effective climate policies. <o:p></o:p></div>
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The problem exists at two levels. There is the question on which shoulders of the <i>current </i>generation the greatest burden will be placed. There is also the question of how the costs will be spread between current and future generations. <o:p></o:p></div>
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The first question is receiving most of the attention today. It is indeed important to design redistributive policies that will ensure that those with the “strongest shoulders” bear a proportionally larger part of the cost of climate policies. This could be achieved by transferring the whole (or part) of the proceeds from the taxes on fossil fuels to those in the lower income brackets. It appears that although this simple principle is easy to formulate, the political conflicts that arise when one wants to apply it are intense.<o:p></o:p></div>
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The second distributional question, the one between the present and future generations is of equal importance. This is the one I want to address here. When we impose extra taxes on households and businesses today to finance environmental policies, we actually ask them to pay the full cost of a policy that will benefit the future generations. Many people resist this today, and then rationalize this resistance by denying the urgency of climate change. It is therefore important to set out a policy that ensures that the costs are spread between current and future generations in such a way that the distribution of these costs also reflects the distribution of the benefits over time.<o:p></o:p></div>
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There is one policy domain where we can actually apply this distributional rule, and that is public investment. The latter, together with private investments, are essential to transform the economy from the use of fossil fuels to renewable energy sources. Public investments must be made in new energy infrastructure, in public transport, in research and development, and in many other areas. <o:p></o:p></div>
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The formula that achieves the objective of spreading the costs over time is to finance public investment through the issuance of government bonds. The issue of bonds today provides the financing for the investment project while the payment of interest costs is spread over time. Thus, such a financing distributes the costs of the investment between present and future generations. The latter will enjoy most of the benefits of those investments and will also contribute to their costs. Such a financing also makes it possible for the current generation to be partially relieved of the costs of these investments. This reduces the resistance to costly environmental policies.<o:p></o:p></div>
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Unfortunately the European authorities have put sticks in the wheels. The budgetary rules imposed today by the European Commission prevent the costs of public investment from being spread over time. The rule that the government budget must be (structurally) in balance makes it impossible for public investment to be financed through the issuance of bonds. The reason is that the latter creates a structural deficit in the budget and that is forbidden by the fiscal rule. <o:p></o:p></div>
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The consequence is that when Eurozone governments want to make environmental investments, they are obliged to increase taxes and/or to reduce other government expenditures (e.g. social security). In other words, they are obliged to force 100% of the costs of these investments to be paid by today’s households and firms. And quite naturally, these resist and rightly so.<o:p></o:p></div>
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The solution to this problem is actually very simple and is sometimes called the “golden rule”. The European authorities should allow public investments to be put into a "capital budget". These may be financed through the issuance of bonds. The European rule of structural balance would then only apply to the ordinary budget consisting of current spending and taxes. Since current spending represents more than 95% of the total budget in most European countries, this would ensure that more than 95% of the budget would be subject to the balanced budget rule. <o:p></o:p></div>
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The only thing that stands in the way of this solution is the dogma that government debt is <u>always </u>bad. Public debt is indeed bad when it serves to finance consumption. Public debt is good when it serves to make productive investments that help keeping the planet safe from future environmental catastrophes. <o:p></o:p></div>
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The problem with the dogma that government debt is always bad is that it originates from an obsession that only looks at the liabilities side of the balance sheets of governments. We would never do this when we want to evaluate the financial health of private companies. We would always look at both the asset and liabilities sides to make a judgment about the solvency of these companies. Yet when we make such a judgment about a government we close our eyes for the asset side of its balance sheet; a wholly irrational procedure. When the counterpart of the higher government debt consists of productive assets whose returns exceed the cost of the debt, there is no problem of raising this debt. The debt can then permanently exceed 60%, or 100% for that matter. It then makes no sense for the European Commission to desperately trying to force public debts into unconditional surrender. <o:p></o:p></div>
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<span style="font-size: 12pt;">It is time we shed the dogma that government debt is always bad. We have to shed this dogma to make it possible to massively invest in projects that will prevent climate change from destroying the planet. Such investments can only be made if the costs are shared by current and future generations.</span><span style="font-size: 12pt;"> </span></div>
escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com23tag:blogger.com,1999:blog-5142810875039273029.post-46719697973021694012018-10-23T07:33:00.000-07:002018-10-23T07:33:12.822-07:00The European Commission should accept democratic change in Italy<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The Italian budgetary and financial crisis is getting worse.
The conflict between the Italian government and the European Commission on the proposed
budget is intensifying. It does not seem likely that the Italian government
will yield to the demands of the Commission to adjust the budget. This conflict
leads investors to continuing to sell Italian government bonds leading to a
surge of the yields on these bonds. It has become the major source of upheaval
in the Italian government bond market and risks escalating into a full-fledged crisis of the Eurozone.<o:p></o:p></div>
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Time to think again about the budgetary rules that are being
applied by the European Commission.<o:p></o:p></div>
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Since the Eurozone’s debt crisis in 2010, the European Commission
has seen a dramatic increase in its power to supervise and control national
budgets. This development was motivated by the will of the creditor countries
to impose budgetary discipline on the debtor countries, such as Greece,
Ireland, Spain and Portugal. As a result, the Stability and Growth Pact was
strengthened and the power of the European Commission over the budgetary
process of the euro zone member states was tightened.<o:p></o:p></div>
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The new responsibilities of the European Commission create a
problem of democratic legitimacy. Not in the sense that the Commission's
tighter role in the budgetary procedures of the Member States have been
achieved in an undemocratic manner. This increased power of the Commission is
the result of decisions in the Council of Ministers and in the European
Parliament. These are bodies that have been established in a democratic manner
and that have decided to give the European Commission more power over national
budgetary procedures after applying the majority rule. Formally there is
nothing wrong with the legitimacy of the European Commission.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
However, I am talking here about political legitimacy. The
European Commission can now force countries to increase taxes and reduce
expenditures without, however, having to bear the political costs of these
decisions. These costs are borne by national governments. This is a model that
does not work.<o:p></o:p></div>
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National governments bear the political costs of expenditures
and taxes. The risk therefore arises that they will contest the decisions of non-elected
officials who do not bear these costs. This has happened a few times in the
past. In 2003-04, when their economies were not doing well, the German and
French governments collided with the European Commission about their budgets.
The European Commission wanted to force these governments to reduce their
budget deficits. Both governments refused to do this and the rules were changed
"à la tête du client".<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Today the Italian government is doing the same. It is a
government that has made a number of election promises and wants to implement
them now. That has budgetary implications. The European Commission is now
trying to force the Italian government to abandon these election promises
without having to bear the political cost of doing so. The new Italian
government would pay the political price for shredding its election promises. It
will not do so, as the French and German governments did not do in 2003-04. <o:p></o:p></div>
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The model of top-down budgetary control does not work in
Europe. It does not work because the whole process of decisions on taxes and
expenditures still exists at the national level. It is also at the national
level that the democratic principle of "no taxation without
representation" is implemented. The European Commission's attempts to
bring Italy into line today are therefore also attempts to impose exceptions to
this democratic principle. It does not work, and fortunately so.<o:p></o:p></div>
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The only way out of this institutional crisis is to go further
into political unification. This implies that large parts of the national
budget processes would be transferred to the European Parliament. The principle
of no taxation without representation would then be applied at the European
level. This would raise the democratic legitimacy of the budgetary process to a
higher European level.<o:p></o:p></div>
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We are very far from such a political unification today. This
means that, at regular intervals, democratically elected national governments
will reject the European Commission's attempts to go counter the will of the
electorate. <o:p></o:p></div>
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<span style="font-family: Cambria; font-size: 12.0pt; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: "MS 明朝"; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-fareast; mso-hansi-theme-font: minor-latin;">One would hope that the European Commission
understands this quandary and that it takes a flexible position, allowing the
Italian government to have its budget deficit of 2.6%. It would be a bow of the
Commission to the outcome of a democratic change in Italy. It would also take
away a major source of upheaval in the Italian government bond market, and the
risk that this entails for the Eurozone as a whole. </span><!--EndFragment-->escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com20tag:blogger.com,1999:blog-5142810875039273029.post-41459937477341338672018-04-11T09:22:00.000-07:002018-04-11T09:43:19.664-07:00Why Russia is politically and militarily strong while being an economic dwarf<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Last week I saw a surprising statistic: the GDP of Russia is
of the same order of magnitude as the combined GDP of Belgium and the
Netherlands. In 2017 Russian GDP was 1,469 billion dollars (according to the
International Monetary Fund). Belgium had a GDP of 491 billion dollars and the
Netherlands 824 billion dollars; together $ 1,315 billion. In GDP terms, Russia
is only 12% larger than Belgium plus the Netherlands.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
This perplexing statistic prompted me to ask why politically Russia
weighs so much more in the world than Belgium and the Netherlands, while economically
that country is hardly stronger than these two countries bordering the North Sea.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Before answering that question, first some other figures that
illustrate how an economic lightweight Russia is. US GDP reached USD 19,362
billion in 2017. With GDP as a yardstick, the US is 13 times bigger than
Russia. In the same way, other countries can be compared with Russia. China is
economically 8 times larger than Russia; Germany 2.5 times more, France 1.8
more, and the European Union as a whole is 12 times bigger than Russia.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The economic size of a country is one of the most important
factors that determines its military and political importance in the world. A large
economy is needed to provide the means that gives the country military and
political weight in the world. So it is clear: Russia is boxing above its
economic weight on the international scene.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The fact that Russia means so little economically implies that
the country must exert extraordinary efforts to create a strong military
potential. In 2017, Russian military spending<span style="mso-spacerun: yes;">
</span>amounted to 61 billion dollars (according to the International Institute
of Strategic Studies). The US spent nearly 10 times more, namely $ 603 billion.
China spent $ 151 billion on defense. France and Germany together spent 90
billion dollars on defense, 50% more than Russia. And yet all these countries
spent a much smaller proportion of their GDP on the military than Russia. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Russia is not a major player in the field of military
spending. To have a certain military weight, that country must reserve a much
larger share of its GDP for defense than the other countries. To mean something
militarily, Russia has to put a heavy burden on its own economy.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
I come back to my question: why is it that Russia, which
economically is a lightweight, has such an importance politically and
militarily? Here is an attempt to answer that question.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
First there is the fact that, at the time of the Soviet
empire, Russia built up a nuclear arsenal that, together with the USA, gives
this country a unique position in the world. This is the position of
"Mutually Assured Destruction" (MAD). This means that the country has
the capacity to completely destroy the opponent in the event of a nuclear
attack on its own territory. No other nuclear power (outside the US) has that
capacity today. As long as Russia has such a terrible MAD capacity, it will be
politically heavier than its GDP suggests.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Russia is also an important supplier of raw materials,
including oil and gas. This gives the country a political lever with regard to
Western Europe. It is possible by turning the tap (or threatening to do so) to
exert pressure on a number of European countries. However, that effect should
not be overestimated. Russia also knows that the use of this weapon will in
time encourage European countries to find other sources of supply. The power of
Russia is limited in this domain because the country does not have a monopoly
in oil and gas.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Finally, and that is my most important point, Russia is
powerful because Europe grants that power to Russia. Europe has built up an
economic union but not a defense union. The European Union is economically 12
times larger than Russia; A huge potential power. However, this economic power
is not converted into military and political power because defense has remained
a national matter. By merging their military capabilities, it would be possible
for France and Germany to build a credible defense against Russian threats, without
having to spend more. The combined military spending of such a Franco-German
defense union would be 50% higher than Russian military spending. Enough to
offer a counterweight to a Russian dictator whose political and military ambitions
in Europe remain unknown. <o:p></o:p></div>
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<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
"Si vis pacem, para bellum" said the Romans. If you
want peace, you should prepare the war. Translated to the European situation of
today this means that Europe should build a credible defense union. This by
itself would reduce the military and political power of Russia. <o:p></o:p></div>
escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com81tag:blogger.com,1999:blog-5142810875039273029.post-30407811791154833932017-12-18T15:04:00.002-08:002017-12-18T15:05:56.162-08:00The bitcoin is not the currency of the future<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
There seems to be no end in sight for the bitcoin bubble. This
comes close to the great bubble developments that we have known in history,
including the tulip bulb bubble in sixteenth century Holland, the South Sea
bubble in the eighteenth century, and many others. These bubbles and today’s
bitcoin bubble are always driven by an excessive optimism about the value of some
asset and an expectation that the price of that asset will continue to rise in
the distant future. But each time these bubbles came to an end and the prices
collapsed. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The expectation that the price of bitcoins will continue to
rise in the distant future has a lot to do with the belief of many people that
the bitcoin, and other "cryptocurrencies", are the money of the
future. Nothing could be farther from the truth. In fact, the bitcoin is an
archaic currency like gold used to be. Archaic currencies are created by using
scarce production factors. Gold had to be digged deep in the ground by using a
lot of labor and machinery. Keynes called gold an "barbaric relic".<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The same can be said of the bitcoin. Bitcoins are made
("mined" as it is called in the bitcoin terminology by analogy with
gold) by using large amounts of computing power. The computers needed to mine
bitcoins use a lot of electricity and thus large amounts of scarce energy
sources (crude oil, coal nuclear energy, renewable energy sources). According
to some estimates, the energy needed to produce bitcoins for one year is
equivalent to the energy consumption of a country like Denmark. A phenomenal
cost, if we also take into account the external costs, such as the CO2
emissions, associated with the production of electricity.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Although the bitcoin is perceived as the currency of the
future, it is in fact, like gold, a currency of the past. The contrast with
modern money is striking. Modern money is also called "fiat money"
because it is made from nothing. Of course, the production of paper money costs
a lot, but we use less and less of it. Instead we use more and more electronic
money by making payments with debit and credit cards. Electronic money is
produced with minimal use of scarce resources. As the cost of communication continues
to decrease, the use of electronic money will become even cheaper in terms of
resources needed to produce it. In this sense electronic money, not bitcoin, is
the money of the future. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
It is possible that technological innovations lead to a
further decline in the resource cost of mining bitcoins. But surely, today the
handicap of bitcoins in providing a resource-cheap-form of money compares very
badly with the existing forms of electronic money that can be produced with
small fractions of the cost of bitcoins. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
There are, however, other and possibly more serious reasons
why bitcoins and other cryptocurrencies have no future as means of payments and
units of account, the two essential functions of money. First, as the supply of
bitcoins is fixed asymptotically, its generalized use as a means of payment
would lead to permanent deflation (negative inflation). The reason is that the
world economy is growing and in need of an increasing supply of money to make
growing transactions possible. The only way this can be dealt with in a bitcoin
economy is by declining bitcoin prices of goods and services, i.e. negative
inflation. The quantity theory of money tells us that it could also be dealt
with by increasing the velocity with which bitcoins are used, but there is a
limit to that possibility. Thus a bitcoin economy would face permanent
deflation, not a very attractive situation.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Capitalism is based on entrepreneurs taking risky initiatives.
These entrepreneurs are usually of the optimistic type. They expect increasing
sales in the future. It is the optimism that drives the dynamics of capitalism.
In a bitcoin economy where prices are declining every year this optimism is
negatively affected. Price declines lead consumers to postpone their purchases
and investors to postpone their projects. It is a world with less optimism and
probably less growth. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
In order to avoid this problem, cryptocurrencies should
provide for a protocol that allows the supply of these currencies to increase
in the steady state. A rule à la Friedman where the supply of the currency is
subject to a constant yearly growth rate would do the trick. This is not the
case of the bitcoin, making this cryptocurrency particularly unfit to function
as the money of the future.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
There is a second and even more serious reason why the bitcoin
is not suitable as a currency. In fact it would be a dangerous currency. If the
world turns to bitcoins, banks will start lending bitcoins to households and
firms in need of credit. But banking is a risky business. The problem is that
as the supply of bitcoins will be fixed, there will be no lender of last (LoLR)
support in times of banking crises. And these are certain to occur. Even if the
supply of bitcoins or of other cryptocurrencies could be subjected to a
constant Friedman growth rule it would not solve this problem. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The LoLR support presupposes that the central banks can create
money out of nothing. In a monetary system where the stock of money is fixed
(or growing at a constant rate), there is no such LoLR possible. This leads to
the prospect of regular banking crises that will lead to failing banks and
further negative domino effects on the economy. This is exactly what we
observed during the heydays of the gold standard, which was characterized by
frequent banking crises leading to deep recessions and much misery. Again, the
bitcoin standard, like the gold standard, is something of the past, not of the
future. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
More generally, the problem of a bitcoin economy is that in
times of financial crisis, which one can be sure will arise again, there is a
generalized flight into liquidity. That’s when a central bank is needed to
provide all the liquidity needed. In its absence, individuals scrambling for
liquidity sell assets, leading to asset deflation and insolvency of many. A bitcoin
economy does not have this flexibility and therefore will not withstand
financial crises. A bitcoin economy will not last in a capitalistic system,
which regularly generates financial crises.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Today the bitcoin bubble is sustained by the belief that this
cryptocurrency has intrinsic value; a value that derives from the belief that
it is the money of the future which in addition will be available in<span style="mso-spacerun: yes;"> </span>limited quantities.<span style="mso-spacerun: yes;"> </span>When enough people come to the realization
that bitcoins and other cryptocurrencies have no future as means of payments, it
will be clear that the bitcoin has no intrinsic value, that the “emperor has no
clothes”. Then the bitcoin bubble will burst and there will be a lot of
handwringing of the speculators who have stepped into the bubble too late.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
All this does not mean that the blockchain technology used in
cryptocurrencies may not have other important applications. For example, the
storage of large data using blockchain technology will make it possible to do
so in a decentralized way, opening up a vast array of new applications. The
current design of the bitcoin, however, makes it unsuitable as a currency for
the future.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The idea that the bitcoin is the currency of the future is
very popular with market fundamentalists. These are wildly enthusiastic about
the bitcoin because it is created entirely outside the control of central
banks. The latter are seen as the source of much evil. The fiat money they
create will, according to those fundamentalists, lead to hyperinflation and
other disasters.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
There is indeed a potential problem with fiat money. Because
its production is so cheap, there is the danger that too much of it is produced.
That then leads to inflation. However, since the 1990s, many central banks have
followed a policy of strict inflation targeting. And that has proved very
successful. It has ensured that annual inflation has remained close to 2
percent in the last 30 years in most industrialized countries. In the US, for
example, average yearly inflation was 2.35% from 1990 to 2017.<br />
<span style="font-family: cambria;">That will not convince the market fundamentalists.
They continue to believe that the moment of hyperinflation has yet to come. In
addition, for many of them bitcoin has become the symbol of a free market world.
A world in which markets unhampered by government controls create great wealth
for many. It is also a world in which markets have self-regulating features
that prevent financial crises from occurring. Indeed in such a fictional world
the bitcoin would provide the anchor of stability. Not in the real world.</span></div>
escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com26tag:blogger.com,1999:blog-5142810875039273029.post-25800094077617441202017-10-19T08:46:00.002-07:002017-10-19T13:11:16.816-07:00Why Facebook should be taxed and how to do it<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The new information technologies have created a whole range of
companies that have become extremely profitable. The most successful ones are in
the list of the top ten most valuable companies in the world. Valuable here
means the monetary value of all outstanding shares of these companies; their
capitalization as economists call it.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Alphabet (better known as Google), Amazon, Microsoft,
Facebook, Alibaba, are each worth $ 400 billion or more in the stock markets. They
produce hardly anything tangible. They "make" information. These
information companies are extremely successful. They also give rise to new
problems. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The most salient characteristics of information companies is
that the marginal cost of the information they produce is zero. To make a YouTube
movie you have some fixed costs, such as a camera, a laptop and an Internet
connection. But once the video has been made, you can broadcast it without
increasing costs. Whether there are 10, 100 or 100,000 viewers of the movie
does not change the costs of the movie producer anymore. The marginal cost (the
cost of one additional unit viewed by someone) is zero.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
That’s not all. The more viewers the moviemaker reaches, the
more valuable his YouTube movie becomes. If he/she reaches an audience of, say,
1 million viewers, advertisers will be interested and will be willing to pay
the creator of the video for placing ads. The more viewers there are, the more
the advertiser is willing to pay. The YouTube producer thus produces something
that has a marginal cost equal to zero and a marginal revenue that increases
with the number of viewers. The more people reached with the movie, the richer the
moviemaker gets without having to do something special.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Such a business model creates a number of problems. The first one
is that information companies create a lot of economic value without the use of
many production factors. You hardly need employees to generate a lot of income.
Facebook with a capitalization of $ 400 billion employs 21,000 people. Walmart,
which has a capitalization of 220 billion, has 2.1 million employees. Thus Facebook
that is almost twice as large in terms of capitalization than Walmart counts
only one percent of the number of employees of the latter. This means that a
very high level of economic value is distributed to very few people. An
inequality time bomb.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
A second problem has to do with the fact that the people who
join such an information platform (for example Facebook) actually give away
information about themselves for free. This information becomes more valuable
as more people join the platform. The big data on private information makes it
possible to place highly targeted ads. The dream of all advertisers.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
So companies like Facebook produce information that generates
a lot of revenue using as ”raw material” the private information that they
acquire for free from their users. They are great money machines generating
huge wealth that hardly has to be shared and can be kept by the happy few in
these companies.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Such a situation is untenable. More and more economic value is
distributed to less and less people. What can be done about this? Here is my
proposal. Facebook realized $ 26 billion in advertising revenue in 2016. This
revenue was actually made possible thanks to the free "raw material"
of the information provided by Facebook users. The government could apply a tax
of 50%, for example, assuming that at least half of that income is due to the
free information. That means 13 billion dollars. There are now about 1.23
billion Facebook users. So that means (rounded) $ 10 per user and per year.
That seems to me to be a good estimate of the yearly value of the information
provided by the individual user to Facebook.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
So my proposal becomes: a 10-dollar tax per user to be paid by
Facebook. Zuckerberg will be a little less rich after this tax, but will still
have a lot of money left.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
There are many issues with such a proposal. It should
preferably (but not necessarily) be coordinated internationally. Not an easy
thing. There is also the issue of what the government should do with the
revenue. One possibility would be to return 10 dollars to the Facebook users
every year. Alternatively, the government could use the revenue to invest in
education, the environment or sustainable energy. <o:p></o:p><br />
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<span style="font-family: "cambria"; font-size: 12.0pt;">I think these are separate issues that can be
resolved and that do not stand in the way to tax Facebook and other information
companies (e.g. Google, Amazon) that use private information freely and
transform this into a fabulous money machine that benefits only a few. </span><!--EndFragment-->escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com42tag:blogger.com,1999:blog-5142810875039273029.post-36094720633399052272017-10-04T06:04:00.000-07:002017-10-11T05:17:40.999-07:00Catalonia and Brexit: the same nationalism<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The British Prime Minister, David Cameron, will not enter the
history books as an enlightened leader. However, when in 2014 he had to decide
to allow the Scottish referendum, he used his brain and opened the door for the
referendum. It took place on September 18, 2014. Only 45% of the Scotts voted for
independence.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The contrast with the referendum in Catalonia could not be
greater. The Spanish Prime Minister Rajoy stupidly decided to use violence to
prevent a referendum in Catalonia, despite the fact that a peaceful referendum
would most probably have led to a similar outcome as in Scotland. Spain and
Catalonia are now on collision course; a situation that could have been avoided
if the Spanish Prime Minister had not suffered from dogmatism and a degree of
nationalism equaling in intensity the Catalan version.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The Catalan nationalists now have been given a fantastic boost
thanks to Rajoy's stupidity. The TV images of Spanish robotic police officers hitting
old and young to prevent them from voting create a perception of an oppressed
people fighting for their freedom.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Nothing could be further from reality. The Catalans are not an
oppressed people. They have a high degree of autonomy. They can organize their
own education in their own language. No obstacles exist for the cultural
development of Catalonia. It is the most prosperous region of Spain. Barcelona
is a bustling city like no other in Spain. The Catalans are heard at the
regional, national and European level. The image of an oppressed people is ludicrous.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Catalan nationalism is of the same kind as British nationalism
that led to Brexit. It is based on a number of myths.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The first myth is that there is an external enemy. For the
Brexiteers these are the European authorities (the European Commission, the
European Court, etc.), which impose their arbitrary will on Britain. For the
Catalan nationalists the enemy is the Spanish government oppressing the Catalan
people. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The second myth is that the people who fight for their
independence have a clearly defined identity. The task of national politicians
is to listen to the will of the people. There can be only one voice. There is
no room for different and opposing voices. The British government is now
calling for patriotism. The opponents of Brexit are not true patriots.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The third myth is that independence will generate unsuspected
economic prosperity. When the people “take back control” they will have the
tools to achieve maximum economic prosperity. That is today the argument of Brexiteers
like Boris Johnson. When Brexit will be realized (preferably as soon as
possible), Britain will have achieved its true destiny. "Global
Britain" will take over from the protectionist EU. Great Britain will merrily
conclude free trade agreements with the rest of the world, which will lead to
unprecedented prosperity. A similar argument of more prosperity for an
independent Catalonia is heard from Catalan nationalists today.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The reality is that globalization undermines national
sovereignty. This happens in many ways. One example. Large multinationals blackmail
national governments in Europe, with the result that corporate taxes decline
almost everywhere. In no country, however, is there a will of the people in
favour of reducing these taxes. Yet this is the outcome because governments act
as national entities. Were they to decide jointly on corporate taxes in Europe,
multinationals would be unable to blackmail these governments and there would
be no creeping decline in corporate taxes. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Another example. International trade today is not influenced so
much by tariffs but by non-tariff barriers. Large countries decide about
standards and the regulatory environment that will govern trade. There are now
essentially three countries, the US, the EU and China that can aspire to decide
about the nature of these standards and rules. The other countries play no role
in this game. Thus when Great Britain exits from the EU so as to gain more
sovereignty (“to take back control”), this gain is only formal. In fact its
real sovereignty declines. Obviously the same holds for Catalonia. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
We arrive at the following paradox in a globalized world: when
nationalists pursue more <i style="mso-bidi-font-style: normal;">formal</i>
sovereignty they achieve less <i style="mso-bidi-font-style: normal;">real</i>
sovereignty of the people. They want to take back control and they end up with
less control. That’s what Great Britain will end up with. That’s also what the
Catalan nationalists will achieve if they pursue their nationalistic dreams.<o:p></o:p></div>
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<!--StartFragment-->
<span style="font-family: "cambria"; font-size: 12.0pt;">This paradox has a corollary: when countries in
Europe renounce <i>formal</i> sovereignty this
leads to more <i>real</i> sovereignty of the
peoples of Europe. </span><!--EndFragment-->escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com74tag:blogger.com,1999:blog-5142810875039273029.post-32889041398630510272017-03-28T08:05:00.000-07:002017-03-28T08:05:12.187-07:00Brexit creates window of opportunities for the EU
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<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The British government has officially started the
"divorce" procedure from the European Union. This procedure must be
completed within two years. In April 2019 the UK will cease to be a member of
the EU.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Most divorces are painful affairs mainly because an agreement
has to be found on who pays whom. The same will be true for the divorce of
Great Britain and the European Union. The European Union intends to present a stiff
bill to the British Government. According to some estimates this could go up to
60 billion euros. The hard line in the Conservative government of Theresa May does
not want to pay a cent. These are the people who during the referendum campaign
promised that Brexit would create massive budgetary means to be used to save
the National Health Service from bankruptcy. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Between 0 and 60 billion there are many numbers waiting for a
possible compromise. But the latter will be very difficult because the hard
camp in the British government considers each number above 0 as an act of
treason to the British people.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The Brexit Ministers continue to repeat that a new trade
agreement between the UK and the EU is easy stuff and can be completed in two
years, at least if the Europeans are "reasonable". If they are, they
will see that it is in their own interest to meet British demands. If they
don’t it will be proof of their vindictiveness. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The British demands are derived from the very successful
referendum slogan: "to take back control of our borders, our laws and our
money." This means full control over immigration; the end of the jurisdiction
of the European Court of Justice on British soil; and not a penny more for
Europe. The prime minister has made it clear that the first two demands cannot
be negotiated away. About the third one a compromise is possible but no one
knows how much negotiating space the British prime minister has.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
These UK demands imply that the UK excludes itself from the
internal market. The UK government, as the representative of a fully sovereign
nation, will therefore have to negotiate a new trade agreement. And like any
trade agreement this will drag on for years. As a result, one can say with
great certainty that in April 2019 there will be no trade agreement between the
UK and the EU. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
What is striking in this drama is that under the spell of
nationalism the British government has based its policies on a big illusion. It
is the illusion that, as in the past when Britain ruled the waves, it can be
fully sovereign and freely trade with the rest of the world without having to
accept rules that are decided elsewhere. This was possible when Britain was the
master of the world and decided about the rules that the other nations would
have to accept to trade. Today, however, Britain is a small country. Its GDP is
only 15% of the EU’s GDP. If this small country wants to trade with the
European Union it will have to accept the rules that are decided on the
European continent, not in Britain. If it wants to trade with the rest of the
world, it will also have to accept rules drawn up elsewhere. It will be a
painful awakening for the British who have been misled by their government into
believing that they can have free trade and full sovereignty.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
For the EU Brexit creates a window of opportunities. When the
British joined the European Community in 1974 their intention was not to make
Europe stronger. On the contrary, the British strategy was to weaken the
European integration effort from inside. Since their accession the British
governments have opposed attempts to apply majority rule in the union, and
instead have tried to force an inter-governmental approach where each country
maintains a veto power. The British entered the European house not to
strengthen it, but to halt its further construction and even to deconstruct it.
<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The fact that Britain now leaves the house creates new
possibilities to take steps towards further integration. In the tax field, for
example. This is an area where, at the
insistence of Britain (but not only Britain), veto power of national
governments has been maintained. As a result, multinational companies have
exploited the lack of coordination in setting corporate income taxes to
blackmail individual governments. This has led to a race to the bottom where
major multinationals pay almost no taxes, although they profit from public
goods provided by European governments. This problem can only be solved by
jointly deciding about corporate income taxes. This will not be easy, as there
are other countries that benefit from not having a common approach to taxation
(Ireland, Luxembourg). But at least the major obstacle to a common policy will
have been removed. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Thus the decision by the UK government to leave the European
house should be welcomed by EU-member states instead of being deplored. It
creates a window of opportunities for further integration on the European
continent. This window of opportunities, however, can only be exploited if the
EU makes her negotiating position clear. This should be one in which the EU
recognizes that the UK wants to be fully sovereign. The EU therefore should
make it clear that this makes UK access to the internal market impossible. This
is not a choice of the EU but the logical consequence of the UK’s quest for
full sovereignty. <o:p></o:p></div>
<span style="font-family: Cambria; font-size: 12.0pt; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: "MS 明朝"; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-fareast; mso-hansi-theme-font: minor-latin;">Business lobbies both in the UK and the EU will
push for a different outcome. One in which the UK will be allowed to enjoy
exceptions to the rules governing the internal market while maintaining access
to it. The EU should resist these lobbying efforts. Failing to do so will open
the door for other nations to do similar “cherry-picking”. This would undermine
the integrity of the union and would contribute to its disintegration. </span><!--EndFragment--><br />escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com8tag:blogger.com,1999:blog-5142810875039273029.post-7998427805521994462016-10-31T16:05:00.000-07:002016-10-31T16:10:54.070-07:00How far should we push globalisation?<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The discussions about CETA, the trade agreement between Canada
and the European Union, have focused almost exclusively on two questions. They
are important but certainly not the most fundamental ones. <span style="mso-spacerun: yes;"> </span>In this article I first discuss these two
questions and then turn to the more fundamental question of how far we should
push globalization.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The first question at the center of the debate around CETA concerns
the way national regulations on environment, safety and health are made
consistent with each other. To make trade possible in a world where trading
partners have different rules about the environment, health and safety, a
procedure must be followed to make these rules mutually acceptable. When, for
example, two countries wish to trade in poultry, they must agree on what
constitutes a healthy chicken. The attitude of many opponents of CETA in Europe
is that European regulation is superior to the Canadian (or American in the
context of TTIP), and that as a result Canadian and American chicken are
suspect, if not poisonous. The implicit hypothesis of this attitude is that
European governments care more about the health and safety of their citizens
than the Canadian and American governments do about their citizens. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Such an attitude makes trade agreements very difficult. Moreover,
it is not based on facts. There is no reason to assume that European legislation
of health, safety and the environment is superior to the North American one. If
that were the case, the European regulators would long ago have curbed the
harmful emissions of rigged European-made diesel cars. They did not, the US authorities
did.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The second question at the forefront of the CETA negotiations
had to do with the legal procedures to resolve disputes between foreign
investors and national authorities. The CETA trade agreement, like many others,
provides that foreign investors who feel harmed by new environmental, health, and
safety regulations can turn to a special arbitration procedure. This is indeed
a problem. It would be better to accept the jurisdiction of national courts in these
matters, rather than allowing international investors to turn to special
arbitration courts. The feeling in many countries that this is an unacceptable
discrimination favoring mostly multinational corporations should be respected.
It is better to rely on the national courts to settle disputes. Yet I have the
impression that the opponents of CETA (and TTIP) have blown this problem out of
proportion, even arguing that the ratification of these trade agreements would
undermine the foundations of our democracy. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
A more fundamental issue that arises here and which has not
sufficiently been addressed in the discussions around CETA has to do with the
question of<span style="mso-spacerun: yes;"> </span>how far we should push
globalization?<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
In my academic career I have always been an advocate of free
trade. Free trade provided the basis of the phenomenal material prosperity we
have achieved in Europe in the postwar period. It has also made it possible for
hundreds of millions of people, especially in Asia, to be pulled out of extreme
poverty and to live a decent life.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
But it now appears that globalization reaches its limits. These
limits exist for two reasons. Firstly, there is the environmental limit. Globalization
leads to very strong forms of specialization. There is of course nothing wrong
with specialization as it provides the condition to create more material
welfare. But specialization also means that goods are transported around the
globe a lot. The lengthening of the value chains that has been made possible by
the reductions of trade tariffs means that the same goods can travel back and
forth between many countries before they achieve the final consumers. All this
transporting around creates large environmental costs (e.g. CO2 emissions) that
are not internalized in the price of the final product. As a result, the prices
of these products are too low and too much is produced and consumed of them.
Put differently, globalization has made markets freer but these<span style="mso-spacerun: yes;"> </span>markets do not function properly, giving
incentives to produce goods that harm the environment. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
When the proponents of CETA (and TTIP) argue that trade
agreements will lead to higher GDPs they are right, but they forget to say that
this will be accompanied by rising environmental costs. If we subtract the
latter from the former it is not certain that this leaves something positive.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The second limit of globalization has to do with the highly
unequal distribution of benefits and costs of globalization. Free trade creates
winners and losers. As argued earlier there are many winners of globalization
in the world. The most important winners are the hundreds of millions who used
to live in extreme poverty. There are also many winners in the industrial
countries, e.g. those that work for or are shareholders in exporting companies.
But there are also many losers. The losers are the millions of workers, mostly
in the industrialized countries, who lost their jobs or have seen their wages
decline. These are also the people that have to be convinced that free trade
will ultimately be good for them and their children. Not an easy task. If,
however, we fail to convince them the social consensus that existed in the
industrial world in favour of free trade and globalization will deteriorate
further. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The most effective way to convince the losers in the
industrial world that globalization is good for them is by reinforcing
redistributive policies, i.e. policies that transfer income and wealth from the
winners to the losers. This, however, is more easily said than done. The
winners have many ways to influence the political process aiming at preventing
this from happening. In fact since the start of the 1980s when globalization
became intense most industrial countries have weakened redistributive policies.
They have done this in two ways. First, they have lowered the top tax rates
used in personal income tax systems. Second, they have weakened the social
security systems by lowering unemployment payments, reducing job security and lowering
minimum wages. All this was done in the name of structural reforms and was
heavily promoted by the European authorities.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Thus, while globalization went full speed, industrial
countries reduced the redistributive and protective mechanisms that were set up
in the past to help those that were hit by negative market forces. It is no
surprise that these reactionary policies created many enemies of globalization,
that now turn against the policy elites that set these policies in motion.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "cambria"; font-size: small;">I come back to the question I formulated earlier:
How far should we push </span><span style="font-family: "cambria";">globalisation</span><span style="font-family: "cambria"; font-size: small;"> My answer is that as long as we do not
keep in check the environmental costs generated by free trade agreements and as
long as we do not compensate the losers of globalisation or worse continue to
punish them for being losers, a moratorium on new free trade agreements should
be announced. This is not an argument to a return to protectionism. It is an
argument to stop the process of further trade liberalization until the moment
we come to grips with the environmental costs and with the redistributive
effects of free trade. This implies introducing more effective controls on CO2
emissions, raising the income tax rates of the top income levels and
strengthening social security systems in the industrialized countries.</span></div>
escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com8tag:blogger.com,1999:blog-5142810875039273029.post-61111131043340257532016-07-21T02:07:00.001-07:002016-07-21T02:07:17.350-07:00How to prevent Brexit from damaging the EU<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The UK has a new government under the leadership of Theresa
May. The mandate of the new government, as the new prime minister stated, is to
"make a success of Brexit". Although the detail of what success here
means is unclear, there can be no doubt about what it means in general. It
should be interpreted as keeping access to the EU single market while gaining
concessions from the EU about the rights of the United Kingdom to control
immigration. In other words: trying to square the circle. Something the Brexit
campaigners have led millions of British citizens to believe can be done
easily.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
What negotiation strategy should the European Union take? Here
is the choice that must be presented to the UK. Either the UK government takes
over the Norwegian model or it stands alone and negotiates new trade agreements
with the EU and about fifty other countries (or group of countries) in the
framework of the rules of the World Trade Organization (WTO). The EU must make
it clear that there is nothing between these two choices. There can be no
"special deal" with the United Kingdom.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
If the UK accepts the Norwegian model, it retains full access
to the single market. In that case there are no obstacles for British goods and
services in the EU and for EU goods and services in the UK. But the price the
UK pays in this model is the free movement of EU citizens in and out of the UK.
Without the free movement of people there can be no free movement of services.
This is the core of the single market. Moreover, the Brits will have to accept two
other things in the Norwegian model. <span style="mso-spacerun: yes;"> </span>First, they will have to abide by the rules on
standards, health and safety that are decided in Brussels without being involved
in the decision making process. Secondly, they will have to contribute to the
European budget.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
It is very unlikely that the UK government will accept this
model. The Brexit camp considers free migration and Brussels legislation as diabolic
and will revolt if the UK government accepts these conditions. True there is an
important faction in the new government that is attached to maintaining full
access to the single market and sees few problems in accepting free movement of
people and Brussels regulation. But this faction is probably too weak to
counter the demands of <span style="mso-spacerun: yes;"> </span>Brexit
supporters.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
I assume, therefore, that the British government will reject
the Norwegian model and will try to obtain concessions from the EU that reduce
migration flows, while ensuring access to the single market. Here, the EU must
make it clear that a special deal with the UK is excluded. The EU must insist
that the only other option for the UK is to stand on its own feet, and to start
negotiating new trade deals with the EU and other countries after Brexit is
completed. In other words, the UK must be treated like the US, China, Brazil,
etc., i.e. as sovereign nations that insist on maintaining full sovereignty over
their trade agreements. The trade negotiations between the UK and the rest will
take years, if not decades. Their outcome is uncertain. It is not clear, for
example whether the UK will be able to maintain free movement of services with
the EU as this freedom is intimately linked to the free movement of people. But
that is a problem for the Brits who have chosen to embrace full sovereignty.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Here are the reasons why the EU should not accept to be
dragged down in negotiating a special deal with the UK. Some EU-countries are
tempted today to also organize referenda. I have no problem in principle
against such referenda. If citizens of a country dislike being member of a
club, they should be able to leave. This will be better for all. There is no
point in living together with people who intensely dislike each other. However,
it is in the interest of both parties that the terms of the divorce should be
made clear in advance. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
That is why the EU should make it clear what potential exiters
should expect. It will be either the Norwegian model or a “standalone-model” in
which the newly sovereign nations will face the difficult task of establishing
new trade agreements on their own. Clarity is essential for those who consider
leaving the EU. This clarity can only be achieved by excluding a privileged
trade agreement with the United Kingdom.<o:p></o:p></div>
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<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
When the UK joined the EU in 1973 its main strategy was to
prevent the union from becoming too strong. The UK political elite decided that
this could best be achieved from inside the union. Now that the UK is departing
the century old British strategy remains the same, i.e. to weaken the forces
that can make Europe stronger. The UK can achieve this by insisting on a
special deal between the UK and the EU whereby the UK maintains the benefits of
the union while not sharing in the costs. Such a deal, if it comes about, will
signal to other member countries that by exiting they can continue to enjoy the
benefits of the union without the costs. Such a prospect would fatally weaken
the European Union. <o:p></o:p></div>
escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com13tag:blogger.com,1999:blog-5142810875039273029.post-41837927816548640372016-07-01T08:56:00.002-07:002016-07-01T08:56:54.889-07:00The EU should take the side of the losers of globalization<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
How should the European Union react to the decision of the
British people to withdraw from the union? This is the question that is at the
center of the political debate in Europe. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The starting point in trying to answer this question is the
observation that the European Union has a very negative image today, not only
in the UK but also in other parts of the EU, leading to dissatisfaction about
the European project. I will argue that this dissatisfaction has to do with the
inability of the European Union to set up a mechanism that protects the losers
of globalization. Worse, the EU has reduced the capacity of national
governments to take on the role of protector, while little has been done to
create such a mechanism at the EU-level.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Free trade creates an incredible dynamic of innovation and
material prosperity. That prosperity, however, does not benefit everyone. Many are
better off thanks to globalization. But many others are not. Some even see
their welfare decline because they lose their jobs or because their incomes
fall.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
As globalization creates material welfare in the countries
that participate in it, it is in principle possible to compensate the losers
from globalization. That is the argument that most economists find strong
enough to defend globalization. But the political obstacles against organizing redistribution
towards the losers of globalization are large. This is a problem in most
industrialized countries, but it is made even more intense in the EU. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The European institutions have become major promoters of
globalization. The single market and the trade agreements reached by the
European Commission have widely opened up the European gates to globalization. There
is nothing wrong with that per se. Except that there is a complete failure to
organize the necessary compensation towards the losers of the globalization.
The European institutions have no power over social policy, which has been kept
in the hands of the national authorities. However, the hands of these
authorities have been shackled by the same European institutions’ fiscal rules.
<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The European fiscal rules not only make it extremely difficult
to compensate the losers from globalization. What is worse, they have amplified
the hardship of the losers from globalization. Since at least five years the
European Commission has pushed all member-countries of the Eurozone into an
austerity straightjacket that has produced economic stagnation and rising
unemployment mainly of those who had already been hit badly by globalization. It
will be no surprise that many turn their backs towards the European
institutions that are seen as cold and ready to punish when millions live in
hardship. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Not only the fiscal rules but also the structural reforms that
have been imposed by the same European institutions are to blame for the
rejection of the European Union by millions of people. <span style="mso-spacerun: yes;"> </span>European policy makers have adopted the
neo-liberal discourse. According to this discourse, workers must be flexible
(read: they should be happy when their wages fall, when they can be dismissed
quickly and when they receive less unemployment benefits). The neo-liberal
policymakers that now dominate the European Union preach that social security
is unproductive and should be downsized. These policies are euphemistically
called structural reforms. They are imposed on millions of people, mostly the
losers of globalization, by European institutions and national governments
alike. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The problem of the European Union today is that, instead of
helping those who suffer from globalization, it has set up policies that hurt
these people even more. It is no surprise that the losers revolt. If the EU
continues with austerity and structural reforms, revolt will spread and will
take the form of attempts to exit the Union. It is time the European Union
takes the side of the losers of globalization instead of pushing for policies
that mainly benefit the winners. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
This can be done in two ways. The first one is to stop
imposing structural reforms on the member-states. The rationale for these
structural reforms has been that they promote economic growth and therefore
should benefit everybody. The empirical evidence of a positive link between
structural reforms and economic growth, however, is very weak. Recent
econometric analysis of the OECD countries fails to find evidence that reforms
in the labour markets and in the product markets boost economic growth (De
Grauwe and Ji(2016), IMF(2015)). These studies, however, find that investment,
both private and public, has a strong positive effect on economic growth. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The latter result points the way to the second change in
economic policies that the European policymakers should initiate. This should
consist in boosting public investment. The latter have suffered severe
collateral damage from the ill-conceived austerity programs imposed by the
European institutions. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
A boost in public investment can only be achieved by changing
the fiscal compact that imposes structural budget balance in the member-states
of the Eurozone. This compact has the unfortunate implication that public investment
can only be financed by current revenues. A more destructive rule for economic
growth has rarely been imposed.<span style="mso-spacerun: yes;"> </span>When
politicians are told that the cost of public investment should be fully borne
by present taxpayers (voters) while the benefits will accrue to future
taxpayers (voters) it will not surprise that the political incentives to engage
in public investment will be weak. This is what happens today. Thanks to an
ill-conceived rule, public investment in the Eurozone is at a historic low
level. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
It is often said that allowing public debt to increase will
saddle our children with an unbearable debt burden. This criticism confuses
gross and net debt. When productive public investments are undertaken by
issuing government bonds, our children will inherit both productive assets and
government bonds. Today the cost of issuing government bonds is close to zero
in many Eurozone countries. If governments manage to invest in productive
assets that have a return higher than zero, our children will inherit assets
that create revenues exceeding the cost of borrowing. As a result, their net
debt burden will have declined. They will not understand why we have not increased public investment when borrowing was so cheap.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
I am a proponent of more political integration in Europe. But
today grand schemes for “more Europe” should be put on the back burner. Instead
European politicians should change their economic policies and, in so doing,
show in the facts that the European Union can produce welfare, also for the
losers of globalization. <span style="mso-spacerun: yes;"> </span><o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<b style="mso-bidi-font-weight: normal;">References:<o:p></o:p></b></div>
<div class="MsoNormal" style="margin-bottom: .0001pt; margin-bottom: 0cm; margin-left: 22.7pt; margin-right: 0cm; margin-top: 6.0pt; text-align: justify; text-indent: -22.7pt; text-justify: inter-ideograph;">
De Grauwe, P. and Ji, Y., (2016), Crisis Management and
Economic Growth in the Eurozone, Chapter 2, in Francesco Caselli, (ed), Prospects
for Growth in the European Union, Oxford University Press. <o:p></o:p></div>
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<span style="mso-bidi-font-family: Times;">IMF World Economic Outlook, (2015), Ch. 3, Box 3.5 on <i>The Effects of
Structural Reforms on Total Factor Productivity</i>, 104–7. <o:p></o:p></span></div>
escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com21tag:blogger.com,1999:blog-5142810875039273029.post-28627316003543227692016-02-22T09:15:00.001-08:002016-02-22T09:15:48.231-08:00Why the European Union will benefit from Brexit<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The discussions about Brexit have centered around the question
of whether it is in the national interest of the United Kingdom to remain in
the EU or to leave it. It appears today that the British public is split about
this question, so that the outcome of the referendum remains highly uncertain. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The question of whether it is in the interest of the EU that
the UK remains a member of the union has been discussed much less intensely.
The conventional wisdom in Brussels is that the answer to that question is
positive.<span style="mso-spacerun: yes;"> </span>The UK should remain a member
of the EU. A Brexit would be very harmful for the future of the European Union.
But is that so?<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
There is a deep-seated hostility of the British media and
large parts of the political elite against the European Union. This hostility
has found its political expression in the Brexit movement. The proponents of
Brexit cannot accept that the UK has lost sovereignty in many areas in which
the EU has competences. They abhor the fact that Britain has to accept
decisions taken in Brussels, even if it has opposed these. For the Brexit-camp
there is only one ultimate objective: to return full sovereignty to
Westminster. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Those who believe that a referendum will finally settle the
issue have it wrong. Let us suppose that the Brexit-camp is defeated and the UK
remains in the EU. That will not stop the hostility of those who have lost the
referendum. It will not reduce their ambition to bring back full sovereignty to
the United Kingdom. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Having found out that they cannot leave the EU, the
Brexit-camp <span style="mso-spacerun: yes;"> </span>will shift its strategy to
achieve the objective of returning power to Westminster.<span style="mso-spacerun: yes;"> </span>It will be a Trojan horse strategy. This will
imply working from within to undermine the union. It will be a strategy aiming
at shrinking the area of decision making with majority rule and replacing it
with an intergovernmental approach. <span style="mso-spacerun: yes;"> </span>The
purpose of the British enemies of the EU will be a slow deconstruction of the
union so as to achieve the objective of returning power to Westminster. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
One may argue that having lost the referendum, the Brexit-camp
will lose influence. That is far from certain. The agreement achieved by
Cameron with the rest of the EU has not transferred a shred of sovereignty back
to Westminster. This will be seen by the Brexit-camp as a huge failure, leading
them to intensify their deconstruction strategy.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
I<span style="mso-spacerun: yes;"> </span>conclude that it is
not in the interest of the EU to keep a country in the union that will continue
to be hostile to “l’acquis communautaire” and that will follow a strategy to
further undermine it. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
I therefore also conclude that it will be better for the
European Union that the Brexit-camp wins the referendum. When Britain is kept
out of the EU it will no longer be able to undermine the EU’s cohesion. The EU
will come out stronger.</div>
<div style="text-align: justify;">
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<!--StartFragment-->
<span style="font-family: Cambria; font-size: 12.0pt; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: "MS 明朝"; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-fareast; mso-hansi-theme-font: minor-latin;">Britain will be weakened and will have to knock
at the door of the EU to start negotiating a trade agreement. In the process it
will have lost its bargaining chips. The EU will be able to impose a trade deal
that will not be much different from what the UK has today as a member of the
EU. At the same time it will have reduced the power of a country whose ambition
it is to undermine the cohesion of the union. </span><!--EndFragment--></div>
escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com132tag:blogger.com,1999:blog-5142810875039273029.post-10418329814924062182015-12-02T06:52:00.001-08:002015-12-02T06:52:43.755-08:00QE and public investment<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: Tahoma;">Since the start of this year
the ECB has been applying “quantitative easing” (QE), i.e. a program injecting
large amounts of money in the economy. Every month the ECB is buying 60 billion
euros of government bonds and in so doing injects the same amount of money in
the economy. Up to today the total amount of liquidity injection approaches 700
billion euros. <o:p></o:p></span></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: Tahoma;">There can be little doubt
that this massive injection of liquidity by the ECB has had a positive effect
on exports. It led to a depreciation of the euro vis-à-vis the major currencies
(dollar, pound sterling) and boosted competitiveness of Eurozone exporters to
the rest of the world. <o:p></o:p></span></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: Tahoma;">However, it becomes
increasingly clear that QE alone is insufficient to pull the Eurozone economies
out of their lethargic growth. In fact, in the second quarter of this year,
growth slowed down again. There is a fear that in the next few years economic
growth will remain subdued. An expanded version of QE will not solve this
problem. <o:p></o:p></span></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: Tahoma;">All this should not come as a
surprise. Economists have been warning for a long time that when interest rates
are close to zero, quantitative easing alone will not be able to stimulate the
economy. The reason is that when the interest rates are close to zero the
liquidity that the central bank is creating does not easily filter into the
real economy. Most of it is hoarded because the opportunities to find
attractive rates of return are limited. Many financial institutions then prefer
to accumulate the extra liquidity created by the ECB without doing anything
productively with it. This is the well-known liquidity trap.<o:p></o:p></span></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: Tahoma;">Thus while QE was and is
necessary, it is insufficient. It has to be seconded by fiscal policies. Here
is the real problem in the Eurozone. Fiscal policies are not helpful. First,
too many countries continue to be kept into the austerity straightjacket.
Second, and most importantly, public investment continues to decline. But it is
public investment that is key to the recovery in the Eurozone. <o:p></o:p></span></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: Tahoma;">There are two reasons why
public investment is central for promoting economic growth. First, the private
sector is still very risk averse and fails to invest enough. This has to do
with the lack of confidence in the future. The way to deal with this is for the
public authorities to show the way and to kick-start public investments. This
will increase economic growth and create more confidence in the future which
will stimulate private investment. <o:p></o:p></span></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: Tahoma;">Second, public investment is
needed to achieve long-term objectives of a green economy. The latter requires
investment in alternative energy sources and in public transportation. <o:p></o:p></span></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: Tahoma;">Unfortunately, public
investment is discouraged by a stupid rule that the members of the Eurozone
have imposed on themselves, i.e. that public investment cannot be financed by
bond issue. It has to be financed by current tax revenues. This prevents public
investment from taking off, from sustaining the recovery and from developing a
green economy. <o:p></o:p></span></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: Tahoma;">It is often argued that
public authorities should not increase their debt; on the contrary that they
should reduce it. Some countries of the Eurozone periphery undoubtedly have
limited capacities to add to public debt. But other countries, like Germany,
France, Belgium and the Netherlands surely can. The governments of these
countries today can borrow at very long maturities almost for free. There are
certainly many investment projects that have a rate of return of more than 0%. <o:p></o:p></span></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: Tahoma;">A government that issues
bonds at close to 0% and channels the money into projects that will have rates
of return by far exceeding 0% promotes economic growth and makes the future
repayment of the debt easier. <o:p></o:p></span></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: Tahoma;">Put differently, what matters
in not gross debt, but net debt of governments. Debt issue that makes it
possible to invest in assets with a much higher rate of return than the cost of
borrowing (now close to 0%) will reduce net debt in the future. Unfortunately,
Eurozone countries continue to be mesmerized by gross debt numbers and as a
result fail to do the obvious. <o:p></o:p></span></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: Tahoma; font-size: 12pt;">It is often said that governments today should not issue more debt because this will place a burden on our grandchildren. The
truth is that our grandchildren will ask us why we did not invest in
alternative energy and public transportation, and thereby made their lives
miserable, when we faced historically favorable financial conditions to do so. </span></div>
escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com11tag:blogger.com,1999:blog-5142810875039273029.post-64645053788664059452015-11-23T10:28:00.000-08:002015-11-23T10:28:43.572-08:00The Euro and Schengen. Common flaws and common solutions<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
What do the Euro and Schengen have in common? Both are
projects that have the same flaw: they're unfinished business. And therefore
they risk falling apart.<span style="mso-spacerun: yes;"> </span><o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The Eurozone is a monetary union, with one currency, the euro
circulating in the Union and managed by one central bank, the European Central
Bank. What’s wrong with that? One may ask.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The fundamental problem of the Eurozone is that national
governments have their own budgets and issue their own debt. When recession
strikes, the system gets into trouble. During a recession government budget
deficits automatically increase. Countries that are hit hardest by the
recession show larger budget deficits and debt increases. Financial markets
that are fully integrated in a monetary union are lurking, ready to strike when
observing signs of weakness. Countries hit hardest by the recession experience
“sudden stop”: investors massively sell the government bonds, raising the
interest rates and pushing these countries into illiquidity. The other
countries in the system profit from this, as investors in search of a safe haven
buy these countries’ government bonds. Thus during recessions, free capital
movements destabilize the Eurozone and plunge the weaker countries into a “bad
equilibrium” of ever deeper recession and rising unemployment.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
What about Schengen? As the Eurozone, it is an unfinished
project. The residents of the Schengen Area move freely within the area. The
problem is that the architects of that area forgot to integrate the police and
the intelligence services. Moreover, they forgot to transfer the authority to
control the external borders to one European body.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
As a result a problem arises in the Schengen Area that is
similar to what happens in the Eurozone. Criminal gangs move freely within the area.
They commit burglaries in one country and flee to another one. In contrast
police forces have to stop at borders. Terrorists are planning from Brussels
how to attack Paris and escape from the radar of the national police forces and
intelligence services. National police forces and intelligence services are not
integrated and can no longer guarantee the security of their citizens.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The danger of unions that are unfinished is that they will disintegrate.
Without a fiscal union free capital movements will create great instability when
the next recession strikes the Eurozone. In the long run, governments that can
no longer guarantee a minimum of economic stability to their citizens will be
tempted to leave the Eurozone.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
In the absence of integrated police and intelligence services,
nation states in the Schengen zone can no longer take care of the safety of
their citizens. They will be tempted to opt out of the zone. In fact this is
already happening today.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The choice we have today is simple. If we want to keep the
Euro we will have to create a fiscal union. This implies that a significant
proportion of national budgets and national government debts will have to be
centralized. A formidable transfer of sovereignty from the nation states to
European institutions. If we want to preserve the Schengen area, we will have
to integrate police forces and intelligence services while creating a joint
control at the external borders. Failure to integrate further dooms both
projects, the Eurozone and the Schengen area.<o:p></o:p></div>
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The Eurozone and the Schengen area have fundamentally weakened
national governments while nothing has been put into place at the European
level to offset this loss of power of nation states. The euro and Schengen can
only be saved if we create European institutions that can do what national
governments no longer can do, i.e. to ensure economic stability and security
for the citizens of Europe.<o:p></o:p></div>
escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com8tag:blogger.com,1999:blog-5142810875039273029.post-28356505394738558252015-08-20T08:29:00.000-07:002015-08-20T08:29:23.990-07:00Low oil prices: good and bad news. And how to deal with the bad news.<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Since the start of the summer, crude oil prices have started a
steep decline again. From more than $60 a barrel in June the crude oil price
has dropped to approximately $42. One year ago the crude oil price exceeded
$100 a barrel.<span style="mso-spacerun: yes;"> </span>These are fantastic price
declines rarely seen in the oil market. They have helped the many European
Countries to climb out of the recession. This is not surprising. A price
decline of this magnitude means that consumers who spend a significant part of
their total budget on gasoline now find out that after filling their cars with
fuel they have purchasing power left over to buy other things. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Put differently, the oil price decline is equivalent to a reduction
in taxes. As a result, disposable income has increased. This effect has been
strong enough to more than offset the austerity policies pursued in many
European countries. It is responsible for the economic recovery that we have
seen in most of Europe. Thus, it appears that the oil price decline is good
news. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
While the short-term effects of the oil price decline are
positive, the long-term effects are not. One year ago crude oil prices stood
above $100 a barrel. This created a powerful incentive to develop and expand
the use of alternative sources of energy such a solar and wind energy. The
latter had become profitable at such high oil prices. Today with low oil prices
this may not be the case anymore in many countries. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
In addition, low oil prices also have as a pernicious effect
of making transportation by car, trucks and planes much cheaper again. As a
result, this will give renewed incentives for excessive worldwide
specialization intensifying the massive transportation of goods and commodities
from one corner of the world to the other. This will increase the emission of
CO2 and will further speed up the global warming. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Our conclusion therefore is that if the low oil prices are
maintained the long-term effects for the world are very negative. These long-term
negative effects most likely outweigh the positive business cycle effects
experienced today. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
How can this conflict between the short-term positive and
long-term negative effects be solved? The economic answer is easy; the
political one is difficult. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
It would be easy for governments of the oil importing
countries to solve this problem by raising taxes on fuel so as to keep gasoline
prices at the level existing one year ago and to use the additional tax revenues
to lower other taxes, e.g. personal income taxes. As a result, consumers would
continue to enjoy a higher purchasing power. This higher purchasing power would
not be the result of lower gasoline prices, but of lower income taxes. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Thus, such a tax shift (more fuel taxes and less income taxes)
would make it possible to maintain the positive short-term effects on the
business cycle, as consumers would have more money to spend. At the same time,
because it keeps the fuel prices high for the users, it avoids all the negative
long-term consequences of low oil prices for the environment.<span style="mso-spacerun: yes;"> </span>Simple, wouldn’t you think? Yes, but
unfortunately the politics is more difficult. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The political problem arises from the fact that the higher
fuel taxes that the governments have to introduce create many enemies. These
are the car companies and the transportation industry. They all profit from the
present low oil prices and are likely to resist any tax increase on fuel. In
contrast consumers are mostly indifferent whether the increase in purchasing
power comes about by lower gasoline prices or by lower income taxes. The net
effect is that it will be difficult for governments to overcome the political
resistance that will be organized by the car companies and the transportation
industry. <o:p></o:p></div>
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The only way out of this political problem is through an
opposing political force. Such an opposing force can come about when large
segments of the population recognize that low oil prices increase the risk of
global warming and that this can be stopped at little cost in terms of economic
growth today. <span style="mso-spacerun: yes;"> </span>Such a force can twist the
arms of the politicians to act and to safeguard the interests of the general
population, today and in the future. <o:p></o:p></div>
escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com4tag:blogger.com,1999:blog-5142810875039273029.post-41988549432803320042015-07-16T07:16:00.001-07:002015-07-16T07:17:38.744-07:00The ECB does not learn from its past mistakes<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
In 2011 at the height of the sovereign debt crisis when
investors panicked, the ECB announced its “Securities Markets<span style="mso-spacerun: yes;"> </span>Program” (SMP). This aimed at stabilizing the
government bond markets. Unfortunately the SMP program was structured in the
worst possible way, i.e. the ECB announced it was ready to buy a <b style="mso-bidi-font-weight: normal;">limited</b> <b style="mso-bidi-font-weight: normal;">amount</b> of bonds during a <b style="mso-bidi-font-weight: normal;">limited
time</b>. This backfired immediately for obvious reasons. When hearing this
announcement panicky investors decided to sell their Greek, Italian, and Portuguese
bonds as quickly as possible to be sure they would beat the other investors
before the ECB closed the window.<span style="mso-spacerun: yes;"> </span>As a
result, the ECB had to buy a couple of hundred billion of government bonds
without pacifying the markets. The spreads continued to increase. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
It took the ECB a year to learn from this mistake. In
September 2012 the ECB started with the OMT program. In contrast with the SMP
program the ECB promised to buy <b style="mso-bidi-font-weight: normal;">unlimited</b>
amounts of bonds for an <b style="mso-bidi-font-weight: normal;">indefinite</b>
period. The unlimited nature of the commitment made all the difference.
Investors were pacified and expected that bond prices would not drop further.
As a result, they started buying government bonds of the periphery country. The
beauty of the OMT program is that the ECB pacified the market and did not have
to buy one euro of government bonds. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Now fast forward to Greece.<span style="mso-spacerun: yes;">
</span>The banking crisis in Greece started when the ECB announced that it
would cap the amount of liquidity available to the Greek banks. Customers ran
to the bank to withdraw cash from their accounts as quickly as possible before
the cap became effective. Today (16<sup>th</sup> July) the ECB announced that
the cap will be increased by €0.9 billion. This will accelerate the desire of
the Greek depositors to withdraw cash from the bank, as they know that the
available cash is limited. Instead of reducing the banking crisis, the ECB is
in fact intensifying it, pretty much like in 2011 when the SMP program
intensified the panic sales of government bonds. <o:p></o:p></div>
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The correct announcement of the ECB should be that it will
provide all the necessary liquidity to the Greek banks. <span style="mso-spacerun: yes;"> </span>Such an announcement will pacify depositors. Knowing
that the banks have sufficient cash to pay them out they will stop running to
the bank. Like the OMT, such an announcement will stop the banking crisis
without the ECB actually having to provide much liquidity to the Greek banks. <o:p></o:p></div>
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These are first principles of how a central bank should deal
with a banking crisis. I would be very surprised if the very intelligent men
(and one woman) in Frankfurt did not know these first principles. This leads me
to conclude that the ECB has other objectives than stabilizing the Greek
banking system. These objectives are political. The ECB continues to put
pressure on the Greek government to behave well. The price of this behavior by
the ECB is paid by millions of Greeks. <o:p></o:p></div>
escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com5tag:blogger.com,1999:blog-5142810875039273029.post-41590632575104384612015-06-17T14:01:00.000-07:002015-06-17T14:01:29.053-07:00Greece is solvent but illiquid. What should the ECB do?<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
One feature of the Greek sovereign debt crisis, which is
widely misunderstood, is the following. Since the start of the crisis the Greek
sovereign debt has been subjected to several restructuring efforts. First,
there was an explicit restructuring in 2012 forcing private holders of the debt
to accept deep haircuts. This explicit restructuring had the effect of lowering
the headline Greek sovereign debt by approximately 30% of GDP. Second, there
were a series of implicit restructurings involving both a lengthening of the
maturities and a lowering of the effective interest rate burden on the Greek
sovereign debt. As a result of these implicit restructurings, the average
maturity of the Greek sovereign debt is now approximately 16 years, which is
considerably longer than the maturities of the government bonds of the other
Eurozone countries. These implicit restructurings have also reduced the
interest burden on the Greek debt. The effective interest burden of the Greek
government has been estimated by Darvas of Bruegel to be a mere 2.6% of GDP.
This is significantly lower than the interest burden of countries such as Belgium,
Ireland, Italy, Spain and Portugal.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
As a result of these implicit restructurings the headline debt
burden of 175% of GDP in 2015 vastly overstates the effective debt burden. The
latter can be defined as the net present value of the expected future interest
disbursements and debt repayments by the Greek government, taking these
implicit restructurings into account. Various estimates suggest that this
effective debt burden of the Greek government is less than half of the headline
debt burden of 175%. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
From the preceding it follows that the effective debt burden
of the Greek government is lower than the debt burden faced by not only the
other periphery countries of the Eurozone but also by countries like Belgium
and France. This leads to the conclusion that the Greek government debt is most
probably sustainable provided Greece can start growing again (so that the
denominator in the debt to GDP ratio can start increasing instead of shrinking
as is the case today). Put differently, provided Greece can grow, its
government is solvent. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The logic of the previous conclusion is that Greece is solvent
but illiquid. <span style="mso-spacerun: yes;"> </span>Today Greece has no access
to the capital markets except if it is willing to pay prohibitive interest
rates that would call into question its solvency. As a result, it cannot
rollover its debt despite the fact that the debt is sustainable.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
There is something circular here. If Greece is unable to find
the liquidity to roll over its debt it will be forced to default. The expectation
that this may happen leads to very high interest rates on the outstanding Greek
government bonds reflecting the risk of holding these bonds. As a result, the
Greek government cannot rollover its debt except at prohibitive interest rates.
The expectation that the Greek government will be faced with a liquidity
problem is self-fulfilling. The Greek government cannot find the liquidity
because markets believe it cannot find liquidity. The Greek government is
trapped in a bad equilibrium.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
What is the role of the ECB in all this? More particularly,
should the OMT-program be used in the case of Greece? The ECB has announced sensibly
that OMT-support will only be provided to countries that are solvent but
illiquid. But, as I have argued, that is the case today for Greece. So what
prevents the ECB from providing liquidity? There is a second condition: OMT
support is only granted to countries that have access to capital markets. This
second condition does not make sense at all, because it maintains the circularity
mentioned earlier. Greece has no access to capital markets (except at
prohibitively high interest rates) because the markets expect Greece to
experience liquidity problems and thus not to be able to rollover its debt. <span style="mso-spacerun: yes;"> </span><o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The explicit aim of the OMT-program was to prevent such
self-fulfilling expectations that can push countries into a bad equilibrium. It
is appropriate to quote Mario Draghi when he announced the OMT-program on 6<sup>th</sup>
September 2012: “<span style="mso-bidi-font-family: Arial;">The assessment of the
Governing Council is that we are in a situation now where you have large parts
of the euro area in what we call a “bad equilibrium”, namely an equilibrium
where you may have self-fulfilling expectations that feed upon themselves and
generate very adverse scenarios. So, there is a case for intervening, in a
sense, to “break” these expectations”<a href="https://www.blogger.com/blogger.g?blogID=5142810875039273029#_ftn1" name="_ftnref1" style="mso-footnote-id: ftn1;" title=""><span class="MsoFootnoteReference"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span style="font-family: Cambria; font-size: 12.0pt; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: Arial; mso-bidi-language: AR-SA; mso-fareast-font-family: "MS 明朝"; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-fareast; mso-hansi-theme-font: minor-latin;">[1]</span></span><!--[endif]--></span></span></a></span>
Greece today fulfills the conditions for liquidity support as spelled out by
Draghi in 2012. Yet Greece is excluded from this support, and as a result it is
kept in a bad equilibrium. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The use of OMT to provide liquidity support to Greece is made
difficult by the fact that public authorities hold the largest part of the
Greek debt. To solve this problem it would be necessary that these public
authorities recognize that the market value of their claims on Greece debt is
worth a fraction of the nominal value. These public claims could then be sold
in the market at a price that comes close to the net present value of the
future disbursements (interest plus capital). At that moment the ECB could
extend its OMT-promise to these assets (bonds) thereby creating a market for
them. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
I am aware that this solution creates a political problem.
Governments of the creditor countries will have to recognize the losses they
have already made on their claims on Greece. Politicians prefer to live in a
fictional world allowing them to pretend no losses have been made so that they
can hide the truth to their own taxpayers. The solution proposed here forces
these governments to come out with the truth, i.e. the losses have already been
incurred. I conclude that providing liquidity to Greece is possible provided
governments stop hiding the truth.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
All this teaches us two lessons. First, the objectives of the
creditor nations, including the ECB, that today add tough conditions for their
liquidity support is not to make Greece solvent but to punish it for
misbehavior. The punishment is deemed to be necessary to avoid moral hazard
risk. It is perfectly understandable that creditor nations are concerned about
moral hazard. But it is precisely the desire to punish Greece by imposing
additional austerity that makes it so difficult for Greece to start growing
again and to extricate itself from the bad equilibrium. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
A second lesson concerns the credibility of the future use of
OMT.<span style="mso-spacerun: yes;"> </span>It clearly appears from the Greek
experience that the willingness of the ECB to use the OMT program is very
circumscribed. It is circumscribed by the ECB’s desire to solve a moral hazard
problem. The ECB seems to be saying that OMT will only be used when it can be
certain its liquidity support will not trigger misbehavior. And this can only
be achieved by imposing tough conditions. Behind the gloves of OMT is hidden a
big stick. It is doubtful that future governments that experience payment
difficulties will accept to be beaten up first before they can enjoy the OMT
liquidity support. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Now that the European Court of Justice has given the legal
clearance for OMT, the question arises whether the moral hazard hurdle to the
use of the OMT will easily be overcome. I conclude that the credibility of the
OMT-program to be used in times of crises is limited. <o:p></o:p></div>
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<a href="https://www.blogger.com/blogger.g?blogID=5142810875039273029#_ftnref1" name="_ftn1" style="mso-footnote-id: ftn1;" title=""><span class="MsoFootnoteReference"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span style="font-family: Cambria; font-size: 12.0pt; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: "MS 明朝"; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-fareast; mso-hansi-theme-font: minor-latin;">[1]</span></span><!--[endif]--></span></span></a> http://www.ecb.europa.eu/press/pressconf/2012/html/is120906.en.html<span lang="NL" style="mso-ansi-language: NL;"><o:p></o:p></span></div>
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escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com9tag:blogger.com,1999:blog-5142810875039273029.post-50112389558365179162015-04-28T06:53:00.001-07:002015-04-28T06:53:59.822-07:00Are creditors pushing Greece deliberately into default?<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The Greek drama has entered its endgame. The Greek government
has to repay loans to the IMF and other public institutions in the near future
but does not have the cash to so. The lenders refuse to come forward in
providing liquidity as long as the Greek government does not accept the
conditions they impose.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
We now hear from the finance ministers that the Greek
government is unreasonable because it does not want to accept these conditions.
These are that austerity be fully implemented and that the structural reforms
that have been agreed to by the previous Greek government, be fully carried
out.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
But are these conditions reasonable?<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The austerity measures that were imposed since 2011 led to devastating
effects on the Greek economy. They drove millions of people into unemployment
and poverty, and produced intense political instability that is responsible for
the rise of Syriza. Insisting on further austerity does not seem reasonable
when the failures of this strategy have become so obvious. The surprising thing
is that ministers of finance continue to hold the moral high ground and preach
to the Greek that they should be more reasonable. Being reasonable is equated
to accepting the conditions of the creditors even if these conditions have
failed to produce positive results. It is even more surprising that most of the
media have now accepted this story.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Some of the structural reforms the creditors insist on are
badly needed. Tax reform that would lead the rich to pay taxes, is one. But
surely this is a reform that the Tsipras government, in contrast to the
previous government, is willing to introduce. But other structural reforms are patently
unreasonable. The privatization program that was agreed with the previous
government and that the creditor nations insist should be implemented does not
make sense. A country should not be pushed into disposing of its valuable
assets in a forced fire sale. This will lead to very low revenues for the Greek
government and will mainly profit the buyers, some of which are companies in
the creditor nations.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
We are now being told that the responsibility for failure
rests entirely with the Greek government that remains unreasonable and
unreliable. It is exactly the opposite. The intransigence of the lenders and
the unreasonable demands they impose on a country are responsible for the drama
that unfolds.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
There is a big contradiction in this intransigence. As is well
known, Greece has profited from debt rescheduling in the recent past.
Maturities on the debt were extended and interest rates were lowered. According
to the Brussels think tank, Bruegel, the effective Greek public debt represents
only about 60% of Greek GDP. This appears to be sustainable, provided the Greek
economy can function normally. Put differently, Greece can be said to be
solvent but illiquid. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The lenders, however, keep the money tap closed. As a result, financial
markets are now speculating that the Greek government will not be able to
respect the next repayment deadline and will be forced to go into default. The
interest rates on Greek government bonds have shot up to levels that make the
debt service unsustainable and that make it impossible for the Greek government
to refinance itself in the bond market. Speculation has become self-fulfilling
and is driving the Greek government into default. But note that this is the
outcome of the decision of the creditors not to provide liquidity to the Greek
government. It is precisely because the lenders do not want to provide
liquidity that Greece may be forced to default. <span style="mso-spacerun: yes;"> </span>It looks like the creditors are pushing Greece
deliberately into default.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The ECB is carrying a great responsibility.<span style="mso-spacerun: yes;"> </span>By providing liquidity it could unlock the
stranglehold the Greek government is kept in. Refusing to provide liquidity would
make the ECB the single most important actor responsible for a Greek default
and a possible Grexit. <o:p></o:p></div>
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escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com9tag:blogger.com,1999:blog-5142810875039273029.post-11336601798450959202015-01-03T07:14:00.000-08:002015-01-03T07:14:32.876-08:00Revolt of the debtors<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The Greek debt crisis that erupted in 2010 is back, and again
threatens the stability of the Eurozone. That crisis was the result of two
factors. First, an unbridled spending drift of both the private and the public
sectors in Greece during the boom years of 2000-2010, which led to unsustainable
large levels of debt. Second, reckless lending to Greece by Northern Eurozone
banks. At no time the Northern bankers asked themselves the question of whether
the Greeks would repay the loans.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The European Unions chose to resolve the debt crisis by punishing
the Greeks and by saving the Northern banks. A punitive austerity program was
imposed on Greece, whose effects are now visible everywhere in this country. A
decline in GDP of close to 25% since 2010, a rise in unemployment to a level we
have not seen since the nineteen thirties, and impoverishment of large parts of
the Greek population.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The banks went largely unpunished. True there was a debt
restructuring of the Greek debt held by private investors. Some banks paid the
price of excessive credit granted to Greece, but most banks escaped this fate
by dumping their Greek claims onto the public sector. Those claims are now in
the hands of national governments and the European Central Bank. And these want
to have their money back whatever the consequences may be for the Greek people
and the Greek political system.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The official narrative of this approach is that the intense austerity
that was imposed on <span style="mso-spacerun: yes;"> </span>the Greek population
is inevitable and in the end will bear fruit.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Inevitable? Yes, of course, if the intention is to safeguard
the interests of the creditors then there is indeed only one possibility: the
Greeks have to pay the full price.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Will it pay off in the end? Yes, of course if austerity is
maintained long enough it will succeed in creating surpluses and transfers of
resources from Greece towards the rich North of the Eurozone.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
This narrative, however, loses sight of the political
upheavals triggered by the human misery that results form intense austerity. The
millions of people who are pushed into misery by the creditors from the North
of Europe are not passive subjects. They not only protest in the streets,
something the creditors can easily live with. They also vote for those
political parties that promise them that there is a better way to deal with the
problem. And these are the parties that are out to break the established
political and social order.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
It is appalling to see that the European political elite has
been living in a cocoon, failing to take into account the political and social
implications of the intense austerity programs they imposed in countries like
Greece (but also in other countries of the periphery). This political elite
still has not learned the lessons. The first reaction of the German minister of
finance after the announcement of new elections in Greece was that the
discipline needed to be continued rigorously.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
What is to be done? Much will depend on the election results
in Greece. The far-left party, Syriza, seeks to weaken the intensity of the austerity
programs and to negotiate a debt restructuring with the European authorities.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
It is quite surprising to find out that these demands, in
fact, are based on a correct analysis of the Greek problem. Despite the austerity,
that has been extraordinarily intense, the Greek public debt has increased and now
exceeds 170% of GDP. The burden of this debt is so high that future Greek
governments will not be able to continue to service it. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Instead of denying this reality the EU finance ministers should
start facing it. They should begin to think about how they can ease the debt burden
of Greece. Denying this reality condemns Greece to many more years of misery
and will encourage extremist political movements in the country even further. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The risk today is that the political leaders of the Eurozone
refuse to relieve the Greek debt (and that of other countries of the
periphery). In that case, a fundamental crisis in the Eurozone is inevitable.
Even if Syriza does not make it at the coming election, extremist parties will gain
the upper hand in future elections. This will be very disruptive for the
Eurozone as a whole.<o:p></o:p></div>
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History teaches us that after a debt crisis a balance must be
found between the interests of creditors and debtors. The unilateral approach that
has been taken in the Eurozone in which the debtors have been forced to bear
the full weight of the adjustment almost always leads to a revolt of these
debtors. That is now underway in Greece. It can only be stopped if creditors dare
to face this reality.<o:p></o:p></div>
escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com12tag:blogger.com,1999:blog-5142810875039273029.post-27963152256437865222014-12-23T02:32:00.000-08:002014-12-23T02:32:37.806-08:00The dangerous ambitions of the European Central Bank<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-GB" style="mso-ansi-language: EN-GB;">Last week the
European Central Bank published the letter it sent on August 5, 2011 to the
then Prime Minister of Spain, Mr Zapatero. That was at a time of intense crisis
in the Eurozone. Many thought that the Eurozone would implode. <o:p></o:p></span></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-GB" style="mso-ansi-language: EN-GB;">The ECB’s
letter to the Spanish government is not the only one the ECB sent to Member
States' governments. A similar letter was sent to the Italian Government. The
letter is of great significance because it reflects the ambition of the central
bank to determine macroeconomic policies in the Eurozone. This ambition should
be checked, for two reasons.<o:p></o:p></span></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-GB" style="mso-ansi-language: EN-GB;">First, the
letter illustrates the intensity of <span style="mso-spacerun: yes;"> </span>the micro-economic
management the ECB intends to apply in crisis countries. The letter contains a
detailed list of what according to the ECB needs to be done in the labor
market. Thus, collective agreements should be abolished and should be organized
at the level of the individual firms. In addition, these agreements should not
contain indexation clauses, even when these are entered into freely. Two things
stand out here. First, there is the detail of the measures that the ECB would like
to impose. In doing so, it substitutes itself to national governments in the
formulation of national economic policies. <o:p></o:p></span></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-GB" style="mso-ansi-language: EN-GB;">Second, it is
striking to find that these policy prescriptions are based on an economic
theory for which there is actually no serious empirical evidence. On the
contrary, there is a strong empirical research suggesting that the degree of
decentralization of wage bargaining should not go too far. The consensus among
economists is that wage bargaining at the level of individual companies harms the
economy, because it can easily give rise to a wage-price spiral when an
external shock such as an oil price increase occurs. Yet extreme decentralisation
of wage bargaining is what the ECB wants to impose in member-countries of the
Eurozone. The policy that the ECB seeks to impose is not based on evidence but
on ideology. <o:p></o:p></span></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-GB" style="mso-ansi-language: EN-GB;">The second
reason why the ECB’s ambitions in setting the policy agenda in the Eurozone
must be checked has to do with governance. The ECB is a public institution,
which has been given a strong status of political independence. The latter
implies that politicians should abstain from interfering in monetary policy.
They should certainly not give instructions to the central bank on how to
conduct monetary policy. The reverse, however, is equally true. The political
independence of the ECB can only be safeguarded if that institution keeps itself
aloof from the political process and abstains from giving instructions to
governments about how economic policies should be conducted. The ECB sins
against this principle. In doing so, she puts her own independence at stake. <o:p></o:p></span></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-GB" style="mso-ansi-language: EN-GB;">The ECB has
set itself the target of keeping inflation close to 2%. It is failing
spectacularly in reaching that objective and as a result, creates a risk of
deflation that today increases the debt burden of national governments. An
institution that fails to achieve its own objectives cannot afford to impose
its ideas on national governments, lest these governments will turn themselves
against the ECB. <o:p></o:p></span></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-GB" style="mso-ansi-language: EN-GB;">The
instructions the ECB gives in its letter to the Spanish government lead to an
even more fundamental governance problem. The ECB consists of civil servants
who bear no political cost of the decisions they try to impose on national
governments. The latter bear the full political costs of these decisions. They
risk to be thrown out of office when they implement policies forced upon them
by the ECB. The civil servants of the ECB go home unharmed. This is a
governance structure that is unsustainable and that will be rejected. It is
important that the ECB realises this and reduces its ambition to rule the
politicians. Failure to do so will greatly harm the ECB.</span><span lang="NL" style="mso-ansi-language: NL;"><o:p></o:p></span></div>
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escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com9tag:blogger.com,1999:blog-5142810875039273029.post-29267594027176585272014-10-29T09:26:00.001-07:002014-10-29T09:26:06.216-07:00Stress-testing the banks. A difficult balancing act
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The European Central Bank is becoming the singe supervisor of
the large and medium-sized banks in the Eurozone. Before taking on this
responsibility it was important for the ECB to be well informed about the
health of the Eurozone banks. This health report was released last Sunday. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
What is most striking is that relatively few banks failed the
test, i.e only 14 out of 130. That is
quite a success. Was the exam too easy? At first sight this does not seem to be
the case. The ECB examined, for example, what the effect would be of a decrease
of GDP by 5% spread over two years on the value of the banks’ assets. That is
quite a steep recession, comparable to the one that hit the Eurozone in 2008-09.
Of course, the ECB could have investigated more pessimistic scenarios. For
example, it could have asked what would happen if a new crisis erupted in the
government bond markets? The ECB investigated only mild increases (2 to 3
percent) in the government bond yields. During the period 2010-11, these
increases were much larger, reaching 10 percent or more. Should the ECB not
have been tougher and simulated more intensely negative economic shocks? <o:p></o:p></div>
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This is like asking how pessimistic a central bank should be?
There are negative scenarios that are so unfavorable that not even half of the
banks would survive these. A new debt crisis like the one we experienced in
2010-11 is such a scenario. Such a negative scenario is not even very unlikely.
But should a central work out the consequences of a disaster? <o:p></o:p></div>
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The ECB walks on a tightrope. An overly pessimistic scenario
that would lead to the conclusion that more than half of the banks are at risk would
be the equivalent of a terrorist suicide attack. The publication of such a scenario by the
central bank would lead to an immediate banking crisis. A central bank that
cares about financial stability should not place a bomb in the market place. The
ECB has not done so. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Yet the ECB did not fall into the other extreme. It did not
let <i>all</i> the banks pass the test. Fourteen
banks failed. This is not a high number. But neither is it a ridiculously low
number that would have harmed the reputation of the central bank. The ECB
carefully considered how far it could go in balancing the need to maintain
financial stability with the desire to keep its reputation intact. The ECB
seems to have succeeded in this balancing act.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Should we expect that the bank stress-test now is the
beginning of a new era and that banks will be willing to expand bank credit, as
the Vice-President of the ECB, Vítor Constâncio, suggested? This is highly
unlikely. The depressed nature of bank credit today has much to do with the
fact that economic activity in the Eurozone has slowed down again. As a result,
the demand for credit by firms and consumers remains low. In order to overcome
this, it will be necessary to stimulate aggregate demand. The best way to do
this is by increasing public investment.
Put differently, the stress-test was necessary to create the conditions
for banks to start lending again. But such an increase will only be possible if
the Eurozone ends the period of austerity and starts stimulating investment
again. Unfortunately, the resistance
towards fiscal stimulus is the highest in those countries that face the least
financial constraints to engage in such policies. <o:p></o:p></div>
<!--EndFragment-->escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com5tag:blogger.com,1999:blog-5142810875039273029.post-8304107608600634602014-09-30T08:53:00.003-07:002014-09-30T08:53:34.911-07:00How to stop aggression
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<br />
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The Russian military invasion of Ukraine has paid off. The
Crimea is now part of Russia. Some Eastern regions of Ukraine also risk
becoming incorporated into Russia in the near future. Where will this end? <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Putin knows that the West is not willing to send soldiers to
Ukraine to defend the sovereignty of that country. This gives him a strategic
advantage over the West. In addition, it gives him an incentive to continue his
aggressive and expansionary policies. We
should therefore not be surprised that new aggressive moves will be initiated
elsewhere (in the Baltic countries for example where large Russian minorities
live).<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Up to now the West has reacted in a feeble way. Financial
assets of important Russian individuals have been blocked. Russian companies
are prevented from borrowing in financial markets or from transferring assets.
These things hurt but insufficiently so. Putin will not be stopped by the
West’s half-baked sanctions that have little impact on the Russians economy.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
In order to stop aggression a policy must be implemented that
will really hurt the Russian economy. This policy can only work if it hurts the
Russian revenues from exporting oil and gas. How can this be done without
hurting the West? <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Today, imports of Russian crude oil account for 34% of total
EU imports of crude oil. For gas this percentage is 32%. So we are very
dependent on Russia for our energy imports. What about the Russian dependence
on us?<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The export of crude oil from Russia to the EU now accounts for
84% of total Russian oil exports; the percentage for gas is 80%. Those exports
are of great importance for Russia and for the Russian budget. In fact the
sales of Russian oil and gas to the EU provide for more than half of all
Russian government revenue. Thus it can be said that Russia is more dependent
on its exports to the EU than the EU is dependent on Russian oil and gas
imports. That creates an opportunity to put pressure on Russia in order to
increase the economic cost of aggression. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Here's what I would do if I were European policymaker. I would
impose a tax on oil and gas from Russia. Such a tax would have the following
effects. First, EU importers would have to pay more for Russian oil and gas and
would therefore look for alternative sources of supply. This would reduce the
demand for Russian oil and gas. Since the EU is a very big player this effect
would be big also. Second, and this follows immediately from the first effect,
Russia would have to lower the price of its oil and gas so as to find other
buyers in the world. This would create an important shortfall in Russian
government revenues, reducing the capacity of Russia to wage wars. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
One may object here that this tax would also hurt us because
it would raise the price the EU consumers would have to pay for oil and gas. This
is not the case, however. The import tax generates revenues for the
EU-governments. These revenues could be used to compensate the EU-consumers.
Alternatively, they could be used to promote policies aiming at making us less
dependent on fossil fuel. Whatever we chose to do with the tax revenue, we
would not be harmed by it. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
This is an application of what economists call an “optimal
tariff”. By the very fact that we are more important for Russia than the other
way around, we can exploit our strong economic power and impose an import tax
that maximizes our welfare and reduces Russia’s. We should do just that. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
Some will argue that Russia could retaliate by stopping the
export of oil and gas to the EU. My contention is that Russia would not do
this. Such a retaliation would lead a decline of government revenues of more
than 50% leading to a paralysis of the Russian government. It would hurt Russia
much more than it would hurt the EU.<o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
The European Union has the economic power to confront and to
stop Russian aggression. It must use this power. <o:p></o:p></div>
<div class="MsoNormal" style="margin-top: 6.0pt; text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<!--EndFragment-->escoriallaanhttp://www.blogger.com/profile/12877212081037298803noreply@blogger.com8