A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Tuesday, June 26, 2012

We face the onrushing dissolution of the Eurozone with all the fortitude of flying chickens in the barnyard.

It is, of course, all about the banks. In the months past we were told that the banks had hedged their exposures. Now we know that the hedges – so-called hedges – were like the credit default swaps that blew up in the U.S. These actually multiplied and spread the risk. They are bets. If the writer writes a lot, he makes money in the current quarter, and he can be the next AIG. Nobody knows the totals. Tens of trillions notionally. Nobody knows. They write them in the back rooms. Playing, of course, with house money.
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There is now a frantic wave of advocacy for a banking union, deposit insurance, making a bank in Athens or Madrid as safe as a bank in Munich. Maybe people won't pull their money out. It's like, "Let's weave a net and quickly throw it under the falling train. Here! You hold that corner. As if.

There is an idea we'll get to later in the podcast that is a solution, though it won't save the banks, it might save the euro.

It would be interesting to go back just a year to hear how trivial the risks were to Spain, Italy, the Eurozone as a whole. You couldn't find an economist saying the banks were the problem. I wish I had the time.

Today on the podcast, a rating agency with credibility, a flying chicken, a solution—yes, from Paul Davidson—and first Nouriel Roubini from 2006, excerpted from Demand Side the Book, out soon in its first edition, much better for its revisions. The rush version can still be had, with this Roubini in it, but we may have pushed it out too soon, a proud parent. needed some more practice and we really needed to tune the piano.

But here, from Chapter 13, Nouriel Roubini and Crisis Economics, quoting from a speech at Davos. One year before his three ugly bears speech on the impending housing finance meltdown. This is now five and ... six! Six and a half years ago.
“[The] lack of serious economic reforms in Italy implies that there is a growing risk that Italy may end up like Argentina. This is not a foregone conclusion, but if Italy does not reform, an exit from EMU within five years is not totally unlikely. … Italy faces a growing competitiveness loss given an increasingly overvalued currency and the risk of falling exports and growing current account deficit. The growth slowdown will make the public deficit and debt worse and potentially unsustainable over time. And if a devaluation cannot be used to reduce real wages, the real exchange rate overvaluation will be undone via a slow and painful process of wage and price deflation. But such deflation will keep real rates high and exacerbate the growth and fiscal crisis. Without necessary reforms, eventually this vicious circle of stag-deflation would force Italy to exit EMU, return to the lira and default on its euro debts [by way of unilaterally converting its debt from euro to lira].…

[A] sovereign nation is able to follow such policies — EMU exit, return to national currency and effective default on euro debt — regardless of any legal or formal constraints that the EMU treaty imposes in terms of no exit clauses. This is not science fiction, as Argentina was forced to do the same.

“What would be the systemic effect of such Italian exit from EMU? They would be extremely severe on EU capital markets as Italy would default on some of its external debt — the part of its euro debts held by non-residents. The contagion effects to other EU capital markets and banks would be severe. And the no bailout rule of the ECB would become effectively threatened as the ECB would be forced to monetize both liquidity and solvency induced runs to avoid a systemic effect on EU financial markets.

“In conclusion, my view is that EMU can work and has worked for the Eurozone countries that have reformed and are reforming. But, unless Italy and other Eurozone laggards change their policies to pursue serious economic reforms that restore competitiveness and growth, they will eventually be forced to exit EMU. This would be a disaster, but a disaster that may become unavoidable unless policies change. And I am currently pessimistic about the chances that such changes may occur given the policy makers and policies currently in place in countries like Italy.”

(Roubini N. , 2006)

Here from 2011,

Roubini writes: (also in the book)
“The bitter medicine that Germany and the ECB want to impose on the periphery ... is recessionary deflation: fiscal austerity, structural reforms to boost productivity and reduce unit labor costs, and real depreciation via price adjustment as opposed to nominal exchange-rate adjustment.

“The problems with this option are many. Fiscal austerity, while necessary, means a deeper recession in the short term. Even structural reform reduces output in the short run, because it requires firing workers, shutting down money-losing firms and gradually reallocating labor and capital to emerging new industries. So to prevent a spiral of ever-deepening recession, the periphery needs real depreciation to improve its external deficit. But even if prices and wages were to fall by 30% over the next few years (which would most likely be socially and politically unsustainable), the real value of debt would increase sharply, worsening the insolvency of governments and private debtors.

“In short, the Eurozone’s periphery is now subject to the paradox of thrift: increasing savings too much, too fast, leads to renewed recession and makes debts even more unsustainable. And that paradox is now affecting even the core.

“Of course, such a disorderly Eurozone break-up would be as severe a shock as the collapse of Lehman Brothers in 2008, if not worse. Avoiding it would compel the Eurozone’s core economies to embrace the fourth and final option: bribing the periphery to remain in a low-growth uncompetitive state. This would require accepting massive losses on public and private debt, as well as enormous transfer payments that boost the periphery’s income while its output stagnates.

“Italy has done something similar for decades, with its northern regions subsidizing the poorer Mezzogiorno. But such permanent fiscal transfers are politically impossible in the Eurozone, where Germans are Germans and Greeks are Greeks... [The] monetary union’s slow-developing train wreck will accelerate as peripheral countries default and exit.

“With Italy too big to fail, too big to save, and now at the point of no return, the endgame for the Eurozone has begun. Sequential, coercive restructurings of debt will come first, and then exits from the monetary union that will eventually lead to the Eurozone’s disintegration.”

(Roubini N. , 2011)

Nouriel Roubini, years ahead of the flying chickens in the barnyard. Read it in print. Rush version still available at Demand Side Books dot com. First Edition... soon.

Now a little bit of audio and then to the solution from Paul Davidson that could save the euro, but not the banks. The banks are dead. The only question is whether they will drag the rest of us under.

First a digression into the economy. Here we have Sri Kumar speaking to Bloomberg on the Economy after one or another stock pullback.


That was Sri Kumar after a recent stock pullback.

This might be a good place to remind you of the forecast, now out these many months. Bouncing along the bottom, downside risks from Europe, still in recession. Isn't that funny I could say three years after the official end that we are not in recovery and still not get a laugh?

Now to a ratings agency with credibility, Yikes, do we have time? Not really.

Sean Egan of Egan Jones, beginning with the question, "Why are the bond yields ballooning in Spain?"


So, that was a little choppy and we've run out of time for Paul Davidson. It's becoming the Demand Side Tease. We'll get to Davidson in the next few days. The solution is an International Monetary Clearing Union, which would get control of capital flows, even within the Eurozone, and would put the onus on the export surplus nations where it belongs, encouraging if not forcing these nations to balance trade and lose this grind to nowhere that comes when the Chinas and Germanies insist on siting employment within their borders and collecting debt instead of trading goods.

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