Default is the way forward

A prominent Eurozone commentator at present is the Italian economist Lorenzo Bini Smaghi who is on the executive board of the ECB. He seems to pop up all over the place (in the press, at conferences, etc) lecturing everyone on how fiscal austerity is the only way to proceed. Before the crisis he held out Ireland as the exemplar of the modern European nation and growth model. What he actually knows about macroeconomics and monetary systems is another matter. On December 16, 2010 – he wrote in his Financial Times article – Europe cannot default its way back to health – that the costs of default by Greece or Ireland (Portugal hadn’t melted down at that stage) were dire:

… the liabilities of the banking system would ultimately have to be restructured as well … a further loss of confidence and make a run on the financial system more likely. Administrative control measures would have to be taken and restrictions imposed. All these actions would have a direct effect on the financial wealth of the country’s households and businesses, producing a collapse of aggregate demand. Taxpayers, instead of having a smaller burden of public debt to bear, would end up with an even heavier one … the main impact of a country’s default is not on foreign creditors, but on its own citizens, especially the most vulnerable ones. They would suffer the consequences most in terms of the value of their financial and real assets … The democratic foundations of a country could be seriously threatened. Attentive observers will not fail to notice that sovereign defaults tend to occur in countries where democracy has rather shallow roots.
So he concluded that the prospect of long-lived and significant costs of a default has been understood by governments in “Greece, Ireland and several other European countries” and that is why they “have adopted tough recovery programmes and radical reforms. And that is why the other European countries are supporting them. They know that the alternative is much worse for their citizens”. More recently (May 10, 2011), Bini Smaghi was at it again. In a speech – Monetary and financial stability in the euro area – he said that:
… default or debt restructuring is a dramatic economic and social event for the country which experiences it – I would call it political “suicide” – which leads many into poverty, as experience has shown. It is thus rather peculiar for policy-makers to design policies mainly with the aim of punishing (or rewarding) certain categories of investors, rather than considering the ultimate consequences for the people.
So we get this clash – the interests of “certain categories of investors” (banks etc) versus the interests of the “people”. But Bini Smaghi proposes that debt default punishes the people more than if the government advances the interests of the investors and maintains all liabilities intact. The evidence or in his words “as experience has shown” does not support his view. In fact, it shows that while it might be “political” suicide (meaning a government will be toppled if it defaults) it is far from being economic suicide (especially relative to the alternative). Please read my blog – Defaulting on public debt as a way to progress – for more discussion on this point. I include a case study of Argentina in that blog. In the UK Guardian (May 24, 2011) there is a wonderful article by Aditya Chakrabortty – Is defaulting really ‘political suicide’? – which notes that:
From George Bush to George Osborne, many stupid and disingenuous things have been said during the financial crisis. But some sort of prize really ought to go to Lorenzo Bini Smaghi … When it comes to spouting conventional nonsense, Bini Smaghi has a fine pedigree. In 2007, he wrote: “The Irish example shows that it is possible to prosper in the monetary union while having a higher potential growth rate than the rest of the union.” It was the spectacular wrongness of this conclusion that prompted bloggers to award the eminent central banker a new name: BS.
I concur with the writer’s assessment of Bini Smaghi and those who have similarly concluded his views amount to BS. It is clear that governments of the struggling EMU nations are listening to his viewpoint though. They have chosen the alternative to default and are implementing harsh austerity programs at the behest of the bosses and lackeys at the ECB, the IMF, and the EU – all of whom hold well-paid, secure positions of privilege. These programs will have long-lived inter-generational effects on the opportunities and prosperity of the citizens in the respective nations. Families are already being torn apart by the unemployment and lack of job prospects. The cuts to education will reverberate over several generations. The loss of income will be profound and persist for many years will never be recovered. The loss of wealth and income security for those who enter retirement will impact on their standard of living until they die. There is no small price to pay in imposing the sort of austerity programs that the establishment in Europe (and the unelected and unaccountable swill in Washington) is insisting these governments pursue. The Guardian piece quotes an academic who concludes: “It’s the triumph of the banks … The lenders in Greece and abroad are being given preferential treatment over the Greek people”. Which puts the trade-off I identified above in its correct perspective. At present the interests of the private corporate banks in France and Germany are being put ahead of the long-term interests of the Greek and Irish population. The legacy the politicians are leaving the children of these nations is so diminished relative to the other options they have (default) – that it is simply astounding that the likes of Bini Smaghi, who has enjoyed a life of privilege, can be even taken seriously. The Guardian article also provides an excellent technical assessment of the Bini Smaghi argument:
… it’s balls. More precisely, it’s the sort of everyone-says-it-so-it-must-be-true balls that’s been a hallmark of European policy-making ever since the banking crisis broke out.
What research has been done on the question of costs of default? In October 2008, the IMF released a working paper – The Costs of Sovereign Default – which identifies four different types of cost that accompany sovereign debt default. I could easily criticise the methodology and the way in which they have assembled their data but in the scheme of work that is out there the paper is relatively standard and so it is better to concentrate on its conclusions. Sometimes I wonder about the disconnect between the political statements that the IMF make and the underlying research that it conducts. This paper certainly doesn’t provide any justification to the way the Fund operates at the political level. The four categories of costs the paper identifies are “reputational costs, international trade exclusion costs, costs to the domestic economy through the financial system, and political costs to the authorities”. I have an initial problem with their terminology that should be clarified. The IMF use the term “sovereign” to refer to national government debt. From the perspective of Modern Monetary Theory (MMT) the term sovereign has a more explicit meaning. It refers to the status of the currency and the government’s financial obligations. A nation is sovereign in MMT parlance if it issues its own currency, floats it freely on foreign exchange markets and does not acquire financial liabilities that are denominated in a foreign currency. While that binary view of things is clear you may get situations where a national government borrows small amounts in foreign denominations. Small here is relative to total export earnings (which mostly add to foreign currency reserves held by a nation). While such a nation has compromised their sovereignty in the MMT sense the practical implications of that are trivial – meaning, they are never in danger of default through lack of foreign currency reserves to service the liability. But what is clear is that the nations that joined the Eurozone are not sovereign because they effectively use a foreign currency. Further, governments of countries like Argentina in the period before its default in 2001 are not sovereign because they have fixed exchange rate arrangements (and significant foreign currency liabilities) which compromise their domestic policy choices. So that clarification should be borne in mind. It is true though that the foreign-currency (Euro) liabilities held by the Greek government are real (contractual) and they are problematic because the Greek government cannot easily service them – as of yesterday – the government is largely unable to do so. So what about the costs of default? After investigating a “number of default episodes by geographical area” from 1824 to 2004 the IMF paper concludes:
… that default costs are significant, but short lived. Reputation of sovereign borrowers that fall in default, as measured by credit ratings and spreads, is tainted but only for a short time. While there is some evidence that international trade and trade credit are negatively affected by episodes of default, we could not trace it to the volume of trade credit, as the default literature suggests. Debt defaults seem to cause banking crises, and not vice versa, but we found weak evidence to suggest the presence of default-driven credit crunches in domestic markets. Finally, defaults seem to shorten the life expectancy of governments and officials in charge of the economy in a significant way.
How to they go about assembling that conclusion? They initially consider the impact of default on GDP growth and distinguish between nations who have defaulted due to insolvency and those who strategically default. This distinction is interesting. For example, the US can never default on the grounds of insolvency given the currency-issuing status of its government. But the polity might not be “willing” to honour its government’s liability and so that might be considered a strategic default. Japan at one stage – as WW2 was unfolding – defaulted strategically on debt owed to its then new enemies. The IMF paper finds that:
… on average, default is associated with a decrease in growth of 1.2 percentage points per year … [and that] … the impact of default seems to be short-lived. We estimate a large effect in the first year of the default episode (with a drop in growth of 2.6 percentage points) … [and no significant impact after that].
The last square bracket note is my interpretation of their econometric language to make their conclusion easier for readers to understand. In terms of the effect of default on GDP growth, the IMF rightly point out that the extant modelling is riddled with “causality” issues. That is, does default lead to low GDP growth or does low GDP growth strain revenues etc which forces a default? The modelling tools available to us econometricians are notoriously weak in isolating these bi-directional possibilities. The IMF paper attempts to overcome this problem and their subsequent results do not alter their basic conclusion. They also find that when the default is “strategic” (that is, reflecting a “willingness” rather than an “ability” to pay) the losses are larger. They say “(t)he markets would punish debtors in the latter case, but will be more forgiving in the former case”. The overall conclusion is that a default lowers GDP growth in the first year rather sharply but the negative consequences dissipate quickly after that. Argentina clearly shows that a domestically-focused policy can restore growth after a major default very quickly. If you compare the estimated GDP losses from the default with the actual losses we are observing in Ireland (since 2009) and Greece (as examples) it is clear the scale of GDP loss is greater in the latter case (by toughing it out and imposing austerity). Ireland has been in recession for more than 2 years and is still sliding backwards. Greece is not far behind. Further, the austerity push is dismantling longer-term growth prospects – eroding essential public infrastructure; failing to provide adequate educational and training opportunities to the youth and eroding the morale of the workforce. The IMF paper then reports on their research into reputation costs. Bini Smaghi and his gang regularly talk of default as being the pariah option – that is, that default leads to an “exclusion from international capital markets”. Bini Smaghi is among many who harp on this point. It is a constant conservative mantra designed to scare nations into continuing to pay up when times are tough. The IMF declare it a “fact”:
… that default does not lead to a permanent exclusion from the international capital market. In fact, the evidence suggests that, while countries lose access during default, once the restructuring process is fully concluded, financial markets do not discriminate, in terms of access, between defaulters and non-defaulters.
In my case study of Argentina noted above, the default has been largely successful. Initially, foreign direct investment dried up completely when the default was announced. But it didn’t take long for the investors to come back in once the stimulus initiatives that the government took (focusing on restoring the domestic economy to health) led to strong GDP growth and a rebound in confidence. Argentina demonstrated something that the World’s financial masters didn’t want anyone to know about. That a country with huge foreign debt obligations can default successfully and enjoy renewed fortune based on domestic employment growth strategies and more inclusive welfare policies without an IMF austerity program being needed. The clear lesson is that sovereign governments are not necessarily at the hostage of global financial markets. They can steer a strong recovery path based on domestically-orientated policies – such as the introduction of a Job Guarantee – which directly benefit the population by insulating the most disadvantaged workers from the devastation that recession brings. The IMF also asked whether:
… default has a long term impact on credit ratings … [and found that] … that defaults episodes do not have a long-term impact on credit ratings.
So the overall conclusion here is that defaulting nations rather rapidly regain access to international capital markets. I recall a press conference that the Argentinean Finance Minister gave during the crisis period (well after capital markets had started lending again). He was asked to explain the fact that the foreign investors were once again flooding into Argentina seeking profit-making opportunities despite the fact that the government had defaulted and refused to impose an IMF restructuring (scorch the earth) program. He said it could be explained in one word: “GREED”. The point is that the international capital markets don’t take the ideological positions that the politicians and lobby groups think. They chase the almighty return and they know that growth delivers return. Simple as that. We are also told by conservatives that a nation that defaults will face onerous borrowing costs in the future as a penalty for their untrustworthy behaviour. There is no consensus in the research literature on this question. The IMF paper find that:
… ratings have a large and statistically significant effect on spreads … [but] … that default episodes have a short-lived impact on spreads …
The point is that there is no substantive and authoritative research that shows borrowing costs to a defaulting nation are higher for lengthy periods after a default. The evidence points to the opposite being the case. Conservatives also argue that a nation that defaults will suffer trade retaliation – that is, no-one will export to them. Remember that these characters also push export-led growth models as a the primary way in which a nation should develop – which reflects their bias against public sector-led domestic oriented growth. The IMF paper finds that:
… there is little historical record of countries imposing quotas or embargos on a country that falls in default. The current structure of international capital markets, where investors are increasingly anonymous bondholders who may switch from long to short positions in minutes, makes this traditional assumption more implausible nowadays.
Having dismissed that part of the conservative argument, they recognise that it is still possible for exporting firms to suffer a “deterioration in … credit quality” which would “have consequences similar to those of retaliatory measures”. What did they find?
… the effect is negative and large only in the first and second year of the default. This result suggests that default does have a negative effect on trade credit but that this effect is short lived.
Okay, so then it once again becomes a comparison between relatively short-lived effects which might occur as the government introduces a domestic-led growth strategy aiming to get people working again and providing some income stability in local currency terms (that is, defaulting and restoring a sovereign fiat currency) and the likely long-lived costs of imposing an austerity program just to meet the profit-seeking needs of foreign capital providers. In my assessment, this comparison is not being made. The Bini Smaghi’s of the world are trying to throttle the debate and suppress the research in this area because they know that the default-domestic growth option is far superior in terms of the local population than the fiscal austerity option which benefits the international capital providers and the jobs of the politicians and elites. The IMF also investigates whether a default leads “to banking crises or a domestic credit crunch”. They note that this might arise from “a collapse in confidence in the domestic financial system and … bank runs” or negative effects “banks’ balance sheet” which “lead banks to adopt more conservative lending strategies”. Their research results:
… do not provide much support for the credit crunch hypothesis … [and they] … conclude that, unlike banking crises, defaults do not seem to have a special effect on industries that depend more on external finance.
So another plank in the conservative argument gone. The IMF paper further investigates the “political” costs. In this sense, Bini Smaghi’s “political suicide” epitome might has some currency (excuse the pun). The IMF note that:
Sometimes, politicians and bureaucrats seem to go to a great length to postpone what seems to be an unavoidable default.
Self-interest comes to mind as the possible explanation. After all the leaders and their apparatchiks are the ones who swan off to luxurious hotels in Brussels for emergency meetings and enjoy no real income loss as a result of imposing austerity on their nations. The IMF note that “a politician concerned about his/her political survival faces a tradeoff that is somewhat different from the one affecting the country itself, say, the representative citizen”. Their research shows that:
… on average, ruling governments in countries that defaulted observed a 16 percentage point decrease in electoral support … and that in 50 percent of the cases there was a change in the chief of the executive either in the year of the default episode or in the following year. This is more than twice the probability of a change of the chief of the executive in normal times … in tranquil years there is a 19.4 percent probability of observing a change of the IMF governor, but after a default, the probability jumps to 26 percent
The IMF governor relates to the senior economic officials in a nation – “the country’s IMF governor … is typically the finance minister but in some cases the governor of the central bank”. So self-interest is clearly a motivation for the governments of Greece and Ireland imposing austerity on their citizens. We should be clear that none of this discussion is of relevance to a sovereign nation (such as, the UK, the US, Japan, Australia, Norway, etc) who never face any solvency risk unless their polity becomes so dysfunctional that they actually determine they are unwilling to honour their liabilities. The public debate in the EMU is being mis-informed. The costs of the “internal devaluation” strategy are likely to be huge – a deep and prolonged recession, with unemployment driven so high that it generates significant downward pressure on wages and working conditions. Lost pension entitlements; a degraded public infrastructure and a compromised public education system – and more. It is clear to me that all the Southern European nations should immediately exit the Eurozone and that would mean that all Euro-denominated debt would have to be restructured – that is, the non-sovereign nations would have to default on previous debt obligations as part of their transition back to full sovereignty. There is a role model to follow – Argentina. Please read my blog – Hyperbole and outright lies – for more discussion on this point. It is clear that default does not amount to economic suicide. A nation that implements a domestic-led growth strategy as it restores its currency sovereignty is more likely to restore prosperity more quickly than a nation that imposes fiscal austerity (especially when austerity is being imposed in many other economies at the same time). Most of the problems that the conservatives raise with default turn out to be non-problems and are code for defending the narrow private interests of international capital and the elites that feed off it. Once sovereignty is restored that nation faces no further revenue constraints in introducing a domestic-led growth strategy. That doesn’t mean that default is costless or easy. It is painful as the IMF paper shows but the pain dissipates very quickly. The pain of an austerity program pursuing internal devaluation is huge and lasts for generations. Conclusion I think the best thing a non-sovereign government can do in terms of advancing the interests of its people is to move towards sovereignty as soon as possible. That might involve jettisoning a currency arrangement (such as in Latvia, for example). It might require exiting a monetary union that has taken the currency-issuing monopoly away (such as the EMU nations). In this instance, that might necessitate a formal default on all debt that was incurred in the currency that the nation is exiting (such as Greece at present). The reality is that a sovereign government holds all the cards in this situation. Please read my blog – Why pander to financial markets – for more discussion on this point. There would be short-term costs but by re-establishing the currency sovereignty the nation will always be able to advance the best interests of its domestic economy. This doesn’t mean that a nation that is short of real resources etc will be able to establish a high material standard of living by moving to sovereignty. The real standard of living is always determined by the access a nation has to real resources. Fiscal policy does not create these resources but can ensure they are more fully utilised and thus more effectively deployed. A poor nation will not become rich just because it is sovereign. None of this discussion applies to truly sovereign nations who never face any solvency risk. With all that said, how does the British government which is fully sovereign and has zero default risk justify imposing harsh policy regimes on its own country akin to the Greek and Irish situations? There is no justification. The latest data from the UK shows that the deficit is increasing (as tax revenue is further eroded by the damage the fiscal position is placing on growth) and private confidence is evaporating. The reality is exactly the opposite to that predicted by the fiscal contraction expansionists. We are a year in now with that government and their program of cuts is only just beginning. I also come back to the point that I left off with yesterday – risk and return is the basic creed of capitalism. Socialising private losses and privatising gains is not remotely consistent with the capitalism that the austerity merchants pretend to support. That is enough for today!]]>

This Post Has 31 Comments

  1. “It is also clear that they have lost grip of the an essential aspect of capitalism – private return means private risk.”

    Really? In my lifetime as I have observed capitalism in the wild, socialization of risk has been the order of the day. The Too Big To Fail doctrine goes back in the U. S. to 1984. Chrysler got bailed out in the 1970s.

  2. “Socialising private losses and privatising gains is not remotely consistent with the capitalism that the austerity merchants pretend to support.”

    Of course. Such capitalism is just a propaganda weapon.

    They become most hilarious when they talk of the “nanny state”.

  3. Why pander to financial markets? Indeed. The relation of a state to the financial market in its own securities is like that of a ventriloquist to his dummy. Mainstream economics tells the hackneyed story of the dummy coming to life and controlling and eventually killing the nebbishy ventriloquist. Unfortunately, such is the force of stupidity, the lack of dramatic imagination, that it gets played out in real life again and again.

    We’ve all seen this story far too many times, especially the economic version. It needs to be met with the strongest of all weapons, derision. Aimed at the “experts” like, it appears, Lorenzo Bini Smaghi, who are the dummy’s dummies.

  4. PG indeed or sucking at the state welfare teat; i.e. corporate welfare such as bank bailouts, deposit insurance, interest deductions against tax, asymmetric cost plus contracts, risk free bond market interest welfare payments.

  5. stone says:
    Wednesday, May 25, 2011 at 21:45
    “The real standard of living is always determined by the access a nation has to real resources. Fiscal policy does not create these resources but can ensure they are more fully utilised and thus more effectively deployed. A poor nation will not become rich just because it is sovereign.”

    -Isn’t it slightly more complicated than that. You’ve said before that Switzerland has the real resource of its people. But places like Switzerland or Singapore are hardly unique in having people and yet manage to be rich whilst places with immense natural wealth such as Congo are poor. Money lenders through history have become wealthy purely due to the way they understand and handle money. Isn’t it worth acknowledging that entire nations can do the same?

  6. Stone, as you know I love Singapore (its culture) and Switzerland (its system of government), but I think we have to think about the word “resources” broadly and remember Switzerland and Singapore are extremely innovative, while people in Congo are not. I think Switzerland is rich because it takes resources that are readily available to it (farm land, diary, cattle, its large investments in science and technology) and imports (metals, cash) makes something out of them: time precision watches, cheese, chemicals (e.g. LSD lol), measured investments, machines/electronics (e.g. space equipment) and so forth (the fact its a federation helps as each canton creates its own diverse good). Singapore has a similar level of innovation. You can have all the resources of the world, but you gotta know how to effectively put them to good use. Most of Swiss GDP isn’t just secret banks its manufacturing, and using funds in those banks for productive output. It is a country blessed by the fact only like a third of its citizens own their own home (a good thing in my mind).

  7. Btw, I’d like to hear Bill’s view on Spain’s youth unemployment of 45% and the current riots and fermenting revolution taking place. Why do I keep hearing monarchists tell me constitutional monarchies are beacon’s of stability and prosperity? Heh.

  8. Spadj, I agree that Switzerland and Singapore run themselves efficiently. They would not be able to be global finance sectors if they did not. I do not think it is realistic though to say that manufacturing is behind their relative prosperity anymore than it is possible to say that say the Rothschilds are wealthy because they are good at making champagne. The sad fact is that the global economic system can be hacked into and exploited by financial means. Turning a blind eye to that is a big mistake. Check out on Google stuff like:

    “Global Financial Integrity agrees with World Bank and says, “$900-billion is secreted each year from underdeveloped economies, with an estimated $11.5 trillion currently stashed in havens. More than one quarter of these hubs belong to the UK, while Switzerland washes one-third of global capital flight”.

  9. Modern capitalism aka corporatism: “Privatize the upside, socialize the downside.”

    Corporatism began roughly with the government chartered Dutch East India Company (1602-1800) and the British East India Company (1757-1874) and has gotten incrementally worse since.

  10. Congo suffers from war, lack of infrastructure, corruption and foreign companies pillaging their natural resources. Their wealth is being stolen and the citizenry are seemingly powerless to stop it.

  11. Spadj, in the US 22% of 2010 college grads are not working and 22% are working at jobs that don’t require a college degree, i.e., are underemployed. The median salary is $27,000, and total student loan debt including debt from private banks is close to $1 trillion (~7% of GDP). Ticking time bomb.

  12. Bill,

    Thanks for this. Have you ever been on TV or Radio in Ireland?? I really think we need you here now. Bill Black was here recently and made some of these points. How can we get you over here?????

    I’ve been arguing this in the case of Ireland for nearly two years now. Finally the idea of returning to the punt has hit mainstream TV. Right now it is only in order to portray those advocating it as dangerous loonies but the idea is out there now.

    The fear we have here is that our ‘Real Resources’ sill not be enough to keep us afloat as we have become accustomed in the last decade or two. Imports will become unobtainable and other luxuries like foreign travel will be a thing of the past. The reality is that most people who vote in elections are the middle classes who view these things as vital so there is an easy way to win the debate with fear. The people who suffer most from the service degradation of Austerity are the poorest and rarely vote in big enough numbers here, alas.

    What programs could Ireland implement quickly to use our resources effectively???



  13. There is a role model to follow – Argentina

    If Argentina is a role model then we are doomed. I am really tired of seeing Argentina mentioned as a role model by some MMTers. It’s not. Argentina defaulted on its own citizens, especially the middle class who had two thirds of their lifetime savings wiped out in a couple of weeks. It’s not default but devaluation that helped Argentina’s recovery and their export led growth policy followed since 2003 thanks to historically high commodity prices. Uruguay was forced to devalue as well in 2002 because of the Argentinian crisis but did not default neither on its external debt nor in its own citizens and has recovered as fast as Argentina did without losing access to international credit much cheaper than what Argentina can still find, even when they borrow from comrade Chavez.

  14. Bill

    What do you think of OECD’s assertion today (25th) that countries with higher govt debt have lower growth? Looks fishy to me.

  15. Robert “Congo suffers from war, lack of infrastructure, corruption and foreign companies pillaging their natural resources. Their wealth is being stolen and the citizenry are seemingly powerless to stop it.”

    -The system seems to be that places like Congo exchange real resources such as timber, oil, copper etc etc for electronic messages to their despotic elites informing them of the values of their Swiss or British or US accounts. I think it is hard to disentangle to what extent that system drives the corruption and war rather than just being symptomatic of it. I think people who are blessed with having a functional state have a responsibility not to exploit those who don’t. After all in the UK we have had historical experience of being in the same predicament as Africa is now. Even before the Romans invaded we went into a frenzy of selling each other as slaves to the Romans. The Romans invaded for the lead, silver and gold mines in the UK. I find it hard to stomach the MMT position that exchanging financial assets for real goods is what every one should aspire to.

  16. MamMoTh,

    I have no real knowledge of these issues but you seem to have a strongly contrary view to that of the blog so I’m interested to hear it for the sake of clarity. From what I know having read about Argentina recently.

    Argentina had tried the ‘Internal Devaluation’ for years prior to default. I think unemployment reached 20% in 2002 or so having increased steadily since 1990. It was only when the middle class began to suffer that they realised how bad things had got. Refloating the currency allowed Jobs programs which have certainly helped get people back to work.

    To suggest it’s all export/commodity based ignores this surely?

    Also, the default allowed the currency devaluation which as you concede also helped the recovery.

    No-one is claiming that this was or is pleasant. What were Argentina’s options in 2001/2? Do you think a devaluation without at least partial default was possible even with the Dollar debt?

    I’m interested in Uruguay that you mention. Did Uruguay ever have the Dollar peg?



  17. Kaiser, I have a contrary view to considering Argentina a role model. The floating of the currency was inevitable in my opinion. And I don’t care much about their default on the external debt. But they also defaulted on people’s savings when floating the currency.

    Uruguay didn’t have a dollar peg but a dirty float within a floating band. The Uruguayan peso was overvalued nevertheless and became unsustainable once Argentina devalued, with Brazil having devalued a few years before. Also the Argentinians having lost access to their savings started to withdraw their deposits in the Uruguayan banking system which eventually collapsed six months later than the Argentinian.

    Most if not all South American countries have experienced unprecedented growth since 2003 thanks to record prices of their commodities, not only Argentina, so there is nothing really special about it. Argentina is pursuing an export led growth, and they are probably keeping their currency artificially low with no inflation target. Uruguay didn’t default on anything and did pretty much as well as Argentina without losing access to international credit.

  18. tony: What do you think of OECDs assertion today (25th) that countries with higher govt debt have lower growth?

    That’s the difference between correlation and causation. The MMT take is that lower growth causes bigger deficits and hence higher debt levels, or something like that…

  19. @ Tom, I know. As you have noticed, I have little time for the US. It’s a joke.

  20. Dear Bill Michell

    I have been reading your blog since last September. I want to thank you for your views on economics, which are a world away from the majority of what I was exposed to, when studying in England. I don’t feel that I have the insight (or gumption) to publicly express my thoughts on your blog, but I do wish to share with you something I read recently. The Canadian poet and songwriter Leonard Cohen once said in an interview ” being unemployed can be one of the most corrosive emotional times of a person’s life.”

    I understand that.

    Speaking of things non-economic for a moment, did you know that Steely Dan and Steve Winwood are sharing the same bill at Bimbadgen winery in October? (I live in the Upper Hunter). Thought you might like to know, if you hadn’t already heard.

    warmest regards

    Elspeth Capper

  21. Bill

    Would you be able to write a blog about Belarus?, from what I am reading they are about to cop a nasty dose of hyperinflation, they recently devalued their currency to promote growth.

  22. Kaiser, also about Argentina’s default, they actually didn’t chose to default, they were basically forced to by the IMF which refused to bail them out. The IMF was also pushing for Uruguay to default. However, Uruguay managed to get an emergency loan from the US government (thanks to George W. Bush) which then forced the IMF to bail them out.

  23. Jack:

    Could you link us to where you read that? Economists are always predicting hyperinflation at the drop of a hat and very rarely do their predictions come true. Would be good to have a look at their reasoning.

  24. Grigory, I read a similar story here:


    They mention: The Belorussian central bank let the managed ruble weaken by 36 percent versus the dollar on May 24

  25. MamMoTh: What would your suggestion be as to how Ireland or Greece should proceed from here? Also when you say Argentina defaulted on its own citizen’s savings what was that? In the case of Ireland and Greece, they could just covert all outstanding currency and bonds from euros to drachmas/punts, (if they wanted to, buy back much of the outstanding bonds now denominated as drachmas/punts (via quantitative easing) ) and in future never issue any more bonds??? Greece might have to improve its tax collection to keep the drachma having value but Ireland has a good tax collection record as it stands. You talk about Argentina not having good access to international capital markets but why does a sovereign nation need international capital?

    By the way, there is a BBC Radio4 program at 20:30 today all about the euro crisis that has interviews with the big wigs etc.

  26. Belarus runs a fixed exchange rate system. It has already devalued by 20% about two years ago. But now it happens again. The major kicker for this round was the decision to impose severe car import tariffs in line with those in Russia. Belarus does not produce cars so any import tariffs are senseless but Russia does and it pushed really hard in this regard (Belarus and Russia formerly live in the common customs area). These tariffs come into force in July and people rushed to buy and import cars before this date. Huuuge, really huge volumes of cars are being imported at the moment. Whatever gentle balance the central bank was able to keep until now it was all smashed in this improt tzunami. That is for the background.

    The main issue however is exchange rate that has been always used as a political tool. When Russia had been supplying seriously subsidized oil and gas it all worked fine. However a couple of years ago Russia stopped. And the trade balance went into serious dive but the central bank tried to hold the exchange rate. They devalued two years ago but retained the fixing. In the mean time the central bank went seriously neoliberal and allowed large scale consumer financing business. Over the last couple of years several pure consumer finance banks with “foreign” capital were opened and they managed to build up quite significant loan books. There are also some other issues but it is enough to give you a feeling. The outcome of all this was clear and inevitable. The only question was timing (and Belarus managed to postpone it with a loan from IMF, eurobonds issue, privatization of public stakes in two telecom companies and so on). So now the time has come for another devaluation. Central bank has already effectively “legalized” a 60% devaluation. But it looks like this is not enough. Well, nobody will know until they let it all float. At such levels it can also be a pure speculation against the central bank.

    On the other hand Belarus has significant manufacturing production but mostly large scale and industrial and very little consumer goods production. The share of imported consumer goods is just incredible. Belarus imported pretty much everything starting from toilet paper. At the same time Belarus produces more than enough basic food and has been consistently exporting it. So the talk of hyperinflation is as usually non-sense unless the central bank and government will play along. So far it looks like a one-off price-level adjustment for the new market-based terms of trade. Of course, there will be second and third round effects of oil and gas prices and monetarists are now screaming full-force to make it all even worse for the general population. Well, I am almost sure they will do it.

    Bottom line: poor people. But it is far-far-far away from Zimbabwe. I personally see this crisis as a fight of a badly managed Keynesian economy with a dose of financial neoliberalism plus some monetarism. The latter was always guaranteed to win.

  27. Bill, as a Greek citizen i would be very interested to hear your opinions on a few matters, assuming some sort of debt restructuring (which will include a haircut) in Greece (or Portugal, Ireland as well):

    1) In the current situation Greek banks would need to increase their capital in order to match their bond losses. Given the private sector declining income and asset position it would be quite reasonable to assume that the IMF bank emergency fund of 10b € would be used. That would more or less mean that, at least in the short run, the Greek banking system would be administered by foreign debtors, mainly EU/IMF/ECB. What short and long term consequences would something like that have in your opinion?

    2) Do you think that Greek citizens holding Greek bonds should be included in the restructuring, even if they had more or less acquired their securities in face value at issuance?

  28. Kostas Kalevras “Greek banks would need to increase their capital in order to match their bond losses”

    I think they key thing is that the restructuring should be in the form of switching the currency and existing debt to a soverign neo-drachma. Doing so would avoid any need for a nominal haircut since the Greek gov has unlimited access to neo-drachmas. The Greek banks would then make no nominal neo-drachma capital losses. Their capital assets would become less valuable in euro terms but since they would be lending in neo-drachmas what would matter would be the capital in relation to the cost of things in Greece. The 4x? exchange rate change against the euro that would result from floating the neodrachma would reduce the euro value of all domestic wages, assets and debts in parallel. In fact the nominal neo-drachma value of the bonds would show a capital gain because the market would know that there was no longer a default risk and the currency switch was damage already done. The yield to maturity would go from 20% to <10%. Brazil did essentially the same thing when they came off a dollar peg. People who bought Brazilian gov bonds straight after that would have made a huge profit in USD terms by now.

  29. Just when you think Greece couldn’t get much wilder and crazier:

    Accusations of Treason in the Greek Parliament

    “Implicit in these most recent and quite damming accusations therefore, is that the Prime Minister not only arranged for, facilitated and possibly forced the sale of a national asset (the 1.3 billion in CDS that would turn into 27 billion – a roughly 2,700% gain – if the type of partial default priced in by markets were, in fact, to occur) to a private firm that he or members of his family had a personal stake in, but that he also did so during a period where he knew that the value of this asset would rise substantially. In fact, his own words and actions had the potential to positively affect the outcome…..”

    “This is a very urgent moment for the country. Terms of national surrender are being negotiated abroad as we speak that have existential implications for Greece herself. Her borders, her mineral and resource rights and the social and culture lining of her very womb are at stake….”

    Cheers ….

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