Monday, July 30, 2012

Krugman: "Save" the Euro by Creating Another Unsustainable Boom

In his latest column, Paul Krugman explains why he believes that the euro has been crashing, and in part, I agree. Europe, he says, is not like the United States which actually is a unified country which also has a federal government that spreads its own spending programs throughout those states. (This is not in praise of those programs, but rather an admission that there is more tying the USA together than what we see in the European Union.)

Furthermore, I agree with Krugman that the housing boom especially covered the underlying flaws of the EU and its currency. Krugman writes:
Why did the euro seem to work for its first eight or so years? Because the structure’s flaws were papered over by a boom in southern Europe. The creation of the euro convinced investors that it was safe to lend to countries like Greece and Spain that had previously been considered risky, so money poured into these countries — mainly, by the way, to finance private rather than public borrowing, with Greece the exception.

And for a while everyone was happy. In southern Europe, huge housing bubbles led to a surge in construction employment, even as manufacturing became increasingly uncompetitive. Meanwhile, the German economy, which had been languishing, perked up thanks to rapidly rising exports to those bubble economies in the south. The euro, it seemed, was working.
I even agree with Krugman's next statement:
Then the bubbles burst. The construction jobs vanished, and unemployment in the south soared; it’s now well above 20 percent in both Spain and Greece. At the same time, revenues plunged; for the most part, big budget deficits are a result, not a cause, of the crisis. Nonetheless, investors took flight, driving up borrowing costs. In an attempt to soothe the financial markets, the afflicted countries imposed harsh austerity measures that deepened their slumps. And the euro as a whole is looking dangerously shaky.
At that point, however, the agreement stops, as Krugman then decides that the best way to "fix" the crisis is essentially to engage in an economic version of "hair of the dog." He writes:
What could turn this dangerous situation around? The answer is fairly clear: policy makers would have to (a) do something to bring southern Europe’s borrowing costs down and (b) give Europe’s debtors the same kind of opportunity to export their way out of trouble that Germany received during the good years — that is, create a boom in Germany that mirrors the boom in southern Europe between 1999 and 2007. (And yes, that would mean a temporary rise in German inflation.) The trouble is that Europe’s policy makers seem reluctant to do (a) and completely unwilling to do (b).
I must admit that even though I have read Krugman for many years, something like this shocks me. The European and U.S. economies have been suffering in the aftermath of the collapse of the housing bubble, and the response of governments and central banks has been to try to recreate boom conditions somewhere else via easy credit and monetary expansion. We see how well that has worked.

So now Krugman claims that Europe and the euro will be saved if the EU Central Bank can do in Germany pretty much what it did in Greece, Ireland, Spain, and Portugal. And what happens when that boom/bubble in Germany collapses, as it inevitably would?

That's easy. Krugman will demand that the authorities create a bubble somewhere else. Maybe he wasn't joking in 2003 when he called for the creation of a housing bubble in the USA. And when the bubble crashes, then he can blame private enterprise.

23 comments:

Dune said...

You think the Fed is creating another bubble(s). Fair enough...give me an example. Where are these bubbles?

Joseph Fetz said...
This comment has been removed by the author.
Joseph Fetz said...

Shoot, how can he say that he was joking about the housing thing a month ago to just turn around subscribe the same prescription with a straight face? Krugman apparently grew watermelon-sized balls over the course this past month. Either that, or he's losing it and getting sloppy.

Joseph Fetz said...

Sorry, that should read "and subscribe to the same prescription"

William L. Anderson said...

Let's see. There is the overvalued stock market and the bubble in government bonds. We have the Fed and the EU Central Bank propping up government bond prices.

And there is the continuing effort to prop up housing prices as well as the value of the securities tied to student loans. These bubbles are not as spectacular as what we saw with the Tech Bubble in 2000 and the Housing Bubble, but they are bubbles all the same.

There is the Eternal Belief Among Progressives that government can bestow value on something by a simple order. Unfortunately, even governments cannot repeal the laws of supply and demand.

Dinero said...

Money is deferred barter - there has to be product to exchange at the end of the process.

Krugman discusses Spain Here

http://www.youtube.com/watch?feature=player_embedded&v=EX55BH97quk
linked from here
http://www.zerohedge.com/news/ultimate-krugman-take-down

Dinero said...

- Typo - a product

Dune said...

"Let's see. There is the overvalued stock market and the bubble in government bonds. We have the Fed and the EU Central Bank propping up government bond prices."

If you are certain the market is overvalued you certainly must have a massive short position and will be filthy rich in a couple of years. Have you put your money where your mouth is?

As far as housing goes, I think the evidence points to the fact that housing has deleveraged quite nicely since the height of the boom. I live in PHX and price to rent ratios seem to be about where they were before the boo. There may be minor pockets of price inflation here and there, but given your criticism I would expect much worse...wouldn't you?

As far as government bond prices, weren't Austrians predicting not long ago that Fed policy would lead to higher gov't borrowing rates? Just sayin....

Chris T. said...

Bill already has answered that silly "in your face" challenge by Dune above.

Here is a picture of this bubble, which will be the greatest ever (or is):
http://www.chartoftheday.com/20120727.htm?T

The price of the thing is at a 26 year high!
And that with an INCREASING supply of the stuff.
How is that for supply and demand and its effect on price-- increasing supply with rising prices.
Not impossible, if demand is increasing even more, but reality check please.

Anonymous said...

In Irelands case that's the case, interest rates are much higher than they were only a few years ago.

State blows all new taxes for 2013 in one fell swoop with return to bond markets at unsustainable rates

http://namawinelake.wordpress.com/2012/07/27/state-blows-all-new-taxes-for-2013-in-one-fell-swoop-with-return-to-bond-markets-at-unsustainable-rates/

Richard W. Fulmer said...

Paul Krugman argues that if Greece still had its own currency it could solve its debt crisis by printing money. The value of the drachma would fall and Greeks would enjoy export and tourist booms as foreigners flocked in to take advantage of favorable exchange rates.

But why can't Greece enjoy favorable “exchange rates” while still on the Euro? As Euros are sent out of the country, Euro-denominated prices should be dropping apace. Tourists should be traveling to Greece to spend their Euros to buy goods and services at bargain prices. That this has not happened suggests that something (government regulation? union rules?) is keeping prices and wages from dropping. Again, though, this is not a problem inherent in the Euro.

Does Greece's problem really stem from sharing a common currency with more productive countries, or does it stem from regulations that keep interest rates, wages, and prices from finding their market levels? Could a common currency work in a free market Europe?

Rick T. said...

Dune: "As far as government bond prices, weren't Austrians predicting not long ago that Fed policy would lead to higher gov't borrowing rates? Just sayin...."

Some were and some weren't. There are numerous cross currents, including the downward pressure on US interest rates from capital fleeing Europe, and the Fed printing money to buy US treasuries pushes them up in price, not down.

To me what is funny how Krugman assumes the US government can borrow and spend stupidly any amount of money and interest rates it pays will stay low forever. It reminds me how every major player - government, banks, the Fed - all assumed until five years that house prices are ordained by God to go up forever.

A few years ago Greece had low interest rates, as did the other PIIGS, and now they don't. I guess that means that Keynesian stimulation comes at negligible cost only in certain countries, not all countries. I don't remember Keynes saying his policies will only work for the US and a few other countries, but that smaller ones shouldn't try them.

Dinero said...

> Richard W Fulmer

Greece would eventually run out of Euros. You also have to consider the amount of Euros flowing into Greece via loans.

Dune said...

"A few years ago Greece had low interest rates, as did the other PIIGS, and now they don't."

The U.S. is not Greece....

Bala said...

"The U.S. is not Greece...."

The whatever-Keynesian world must be a wonderful one for where else will you find mindless, random assertions becoming gospel truth. No wonder that the zombies resist coming out of it.

Dune said...

"The whatever-Keynesian world must be a wonderful one for where else will you find mindless, random assertions becoming gospel truth. No wonder that the zombies resist coming out of it."

Saying that the US is not Greece is a mindless, random assertion? Are you being serious? Are you saying that they are comparable? I can have a statistical field day with you on this one if you wanna go there....

Tel said...

Saying that the US is not Greece is a mindless, random assertion?

It is roughly equivalent to saying, "Tomorrow is not yesterday," or "My left shoe is not my right shoe."

If you have a genuine argument about an intrinsic difference between Greece and the USA (other than just size) then I would have thought you would present that rather than telling everyone how good it would be if you did actually have an argument.

Dune said...

"If you have a genuine argument about an intrinsic difference between Greece and the USA (other than just size)"

I don't even know where to begin and I don't have time to get into the gritty details, but lets start with the Heritage Foundations economic freedom index:

US ranks 10th, Greece ranks 119th.

How about GDP per capita?

US: 48k, Greece: 26k

Productivity?

US: GDP Per hour worked: 59, Greece GDP per hour worked 35

Get it? Got it? Good

Rick T. said...

Dune: Where in Keynes did he say his theories only worked in certain countries? If they work, they work. Given that Greece's government has followed good Keynesian advice for improving its economy (spend much more than taxes to prime the pump), why didn't it work?

I don't recall Keynes saying that you have to score above a certain level in Heritage Foundation ratings before expecting wild deficit spending to stimulate the economy. The policy has bankrupted Greece and is not working anywhere else. Why should it start working here, or anywhere?

Tel said...

Dune, all your stats show is that the US is wealthier than Greece, but the debt per capita is higher too.

From Michael Hodges and the "Grandfather Economic Report" (which can easily be found, including reference material), the USA has a hard debt per capita of $190k (including public and private debt).

If you want to add contingent liabilities to that then the per capita debt goes up to nearly $600k but no one know exactly how many of those liabilities might be real. Those liabilities include things like Medicare, Medicaid, federal pensions, Social Security, and things that will somehow need to be dealt with in the near future (possibly the rules will just be changed).

In comparison, just the officially recognised Greek government debt is approx $40k per capita, and private debts are probably around $60k per capita, see the following chart for an approx ratio of public/private debt in various European countries.

http://www.greekdefaultwatch.com/2010/09/greek-debt-in-european-context.html

Therefore, the USA is facing something like double or more the debt burden per capita that Greece is up against. What's more, Greece has already headed down the process of default and restructuring, and since they are at the low end of the productivity scale they have more potential to gain.

The USA is at the high end of the productivity scale and are more likely to go backwards, at least in relative terms to everyone else. The more you have, the more you have to lose.

The basic problem is the same in both cases, but IMHO the USA will be hit worse, and stay down for longer than Greece.

Corkscrew said...

But why can't Greece enjoy favorable “exchange rates” while still on the Euro?

Downward notional wage rigidity?

C. Van Carter said...

"the German economy, which had been languishing, perked up thanks to rapidly rising exports to those bubble economies in the south"

Sure.

reasoninrevolt said...

"Dune: Saying that the US is not Greece is a mindless, random assertion?

Tel: It is roughly equivalent to saying, "Tomorrow is not yesterday," or "My left shoe is not my right shoe."

If you have a genuine argument about an intrinsic difference between Greece and the USA (other than just size) then I would have thought you would present that rather than telling everyone how good it would be if you did actually have an argument."

Well how about this for starters...GREECE DOES NOT CONTROL ITS OWN CURRENCY.