His basic claim is that “Europe is as full of bad ideas as it is of bad debts”.<\/p>\n
I agree. The political leadership is corrupted by Chicago-style economic thinking and the private sector has debts that are crippling aggregate demand growth. The creation of the problem was a direct result of Chicago-style economic thinking although I wouldn’t want to give them the full credit. We can add them to the mainstream profession – they are not that special after all. All of them are droogs after all – in the ideological sense.<\/p>\n
John Cochrane is against the Euro nations being “bailed out” by the ECB (or any other source). He says:<\/p>\n
\nBailouts are the real threat to the euro. The European Central Bank has been buying Greek, Italian, Portuguese and Spanish debt. It has been lending money to banks that, in turn, buy the debt. There is strong pressure for the ECB to buy or guarantee more. When the debt finally defaults, either the rest of Europe will have to raise trillions of euros in fresh taxes to replenish the central bank, or the euro will inflate away.\n<\/p><\/blockquote>\n
The ECB has been doing that which has been the difference between the parlous “muddling through” austerity we are witnessing at present and total collapse of the Eurozone monetary system.<\/p>\n
Without their Securities Market Program (SMP) several governments including big ones like Italy would have failed to cover their daily deficits. There would have certainly been defaults. I agree with him that a default doesn’t necessarily mean that Greece (or any other state) would have to leave the Eurozone. But that is not the point.<\/p>\n
But there is no reason for inevitable default if the SMP was accompanied by a growth strategy. The problem is that the SMP is chasing its tail. By forcing nations to invoke pro-cyclical austerity programs which negate any possibility of growth even via net exports given that they are all doing it – the ECB is either locking itself in to a more or less permanent SMP with devastating consequences for the people who actually live outside the Eurotower<\/a> or guaranteeing a default once they ease up the SMP.<\/p>\n
But that doesn’t mean anything for future taxes or inflation. The EU could simply agree to write all the ECB bad debts off without any further consequence. The ECB creates the currency as a monopoly issuer and it faces no applicable concept of a “loss” that a private bank might encounter if its capital gets wiped out. <\/p>\n
There would have to be some accounting gymnastics needed but if we can put a person on the Moon we can surely juggle some books (of largely meaningless numbers) to create some zeros.<\/p>\n
Yesterday’s blog – Mainstream macroeconomics textbooks do not impart knowledge<\/a> – should disabuse you of believing the mainstream line that rising bank reserves lead to inflation then hyperinflation.<\/p>\n
John Cochrane then claims that:<\/p>\n
\nLeaving the euro would also be a disaster for Greece, Italy and the others. Reverting to national currencies in a debt crisis means expropriating savings, commerce-destroying capital controls, spiraling inflation and growth-killing isolation. And getting out won’t help these countries avoid default, because their debt promises euros, not drachmas or lira.\n<\/p><\/blockquote>\n
Yes, leaving the Eurozone would necessitate a “default” – or rather a conversion of debts into local currency. It wouldn’t be easy. But we have data to show that rather than enduring “growth-killing isolation” a nation can return to growth very quickly once it takes back control of monetary and fiscal policy and is able to deal with bond markets directly without having to succumb to enforced penury courtesy of the Troika (aided by the ECB’s SMP).<\/p>\n
We also have data that shows that there will not be enduring “spiraling inflation” in such cases.<\/p>\n
I will come back to that in a moment. But more of John Cochrane’s self-aggrandizing hyperbole. He says:<\/p>\n
\nDefenders think that devaluing would fool workers into a bout of “competitiveness,” as if people wouldn’t realize they were being paid in Monopoly money. If devaluing the currency made countries competitive, Zimbabwe would be the richest country on Earth. No Chicago voter would want the governor of Illinois to be able to devalue his way out of his state’s budget and economic troubles. Why do economists think Greek politicians are so much wiser?\n<\/p><\/blockquote>\n
Illinois is not a nation and cannot leave the US at the stroke of a government decision. Greece is a nation that made one big mistake – surrendering their currency sovereignty. They could restore it if they chose to and restore their full nationhood.<\/p>\n
Moreover, unless my Greek friends mislead me, I am not aware that the Greek government has deliberately trashed up to 50-60 per cent of Greece’s productive capacity in the same way as the Zimbabwean government managed to do as they tried to implement a well-motivated but poorly conceived policy of rewarding the freedom fighters who helped them break the yoke of British colonialism.<\/p>\n
From John Cochrane’s comments I conclude he is either very poorly informed about what actually happened in Zimbabwe, or,if he does know the true story, then he is deliberately misleading readers with these statements.<\/p>\n
Please read my blog – Zimbabwe for hyperventilators 101<\/a> – for more discussion on this point.<\/p>\n
What about the data I mentioned?<\/p>\n
Think about Argentina about a decade ago. I am very familiar with its crisis and I have dealt with this example before. It scares the hell out of the first world financial markets because the nation demonstrated that a major default doesn’t have to have the consequences that are threatened by the elites (and John Cochrane). Wikipedia provides a brief overview of Argentina’s Economic crisis 1999-2002<\/a> (although I would discount some of the “opinions” expressed).<\/p>\n
Argentina, in part, provides a model for all nations that have surrendered their currency sovereignty courtesy – either via a peg of some sort of outright use of foreign currencies (as in the Euro case). I was talking to a Jordanian yesterday (hello Ala!) who is trying to work out how to counter the mainstream economics dogma in his nation (which has a currency peg) and the following discussion is relevant there.<\/p>\n
In April 1991, Argentina adopted a rigid peg of the peso to the dollar and guaranteed convertibility under this arrangement. That is, the central bank stood by to convert pesos into dollars at the hard peg.<\/p>\n
The choice was nonsensical from the outset and totally unsuited to the nation’s trade and production structure. In the same way that most of the EMU countries do not share anything like the characteristics that would suggest an optimal currency area, Argentina never looked like a member of an optimal US-dollar area.<\/p>\n
For a start the type of external shocks its economy faced were different to those that the US had to deal with. The US predominantly traded with countries whose own currencies fluctuated in line with the US dollar. Given its relative closedness and a large non-traded goods sector, the US economy could thus benefit from nominal exchange rate swings and use them to balance the relative price of tradables and non-tradables.<\/p>\n
Argentina was a very open economy with a small non-tradables domestic sector. So it took the brunt of terms of trade swings that made domestic policy management very difficult.<\/p>\n
Convertibility was also the idea of the major international organisations such as the IMF as a way of disciplining domestic policy. While Argentina had suffered from high inflation in the 1970s and 1980s, the correct solution was not to impose a currency board.<\/p>\n
The currency board arrangement effectively hamstrung monetary and fiscal policy. The central bank could only issue pesos if they were backed by US dollars (with a tiny, meaningless tolerance range allowed). So dollars had to be earned through net exports which would then allow the domestic policy to expand.<\/p>\n
After they introduced the currency board, the conservatives followed it up with wide scale privatisation, cuts to social security, and deregulation of the financial sector. All the usual suspects that accompany loss of currency sovereignty and handing over the riches of the nation to foreigners.<\/p>\n
The Mexican (Tequila) crisis of 1995 first tested the veracity of the system. Bank deposits fell by 20 per cent in a matter of weeks and the government responded with even further financial market deregulation (sale of state banks etc)<\/p>\n
These reforms loaded more foreign-currency denominated debt onto the Argentine economy and meant it had to keep expanding net exports to pay for it. However, things started to come unstuck in the late 1990s as export markets started to decline and the peso became seriously over-valued (as the US dollar strengthened) with subsequent loss of competitiveness in the export markets.<\/p>\n
Lumbered with so much foreign-currency sovereign debt the decline in the real exchange rate (competitiveness) was lethal.<\/p>\n
The domestic economy by the late 1990s was mired in recession and high unemployment.<\/p>\n
And then the “Greek scenario” unfolded. Yields on sovereign debt rose as bond markets started to panic – a vicious cycle quickly became embedded.<\/p>\n
In 2000, under direct orders from the IMF (with the threat of refusal to maintain financial assistance – ring a bell?), the government tried to implement a fiscal austerity plan (tax increases) to appease the bond markets – imposing this on an already decimated domestic economy.<\/p>\n
The government believed the rhetoric from the IMF and others that this would reinvigorate capital inflow and ease the external imbalance. But at the time it was obvious that it was only a matter of time before the convertibility system would collapse. They couldn’t hold back the flood waters.<\/p>\n
Why would anyone want to invest in a place mired in recession and unlikely to be able to pay back loans in US dollars anyway?<\/p>\n
In December 2000, an IMF bailout package was negotiated but further austerity was imposed. No capital inflow increase was observed. That was also an obvious prediction apparently not in the IMF forecasting model’s capacity to provide.<\/p>\n
The government was also pushed into announcing that it would peg against both the US dollar and the Euro once the two achieved parity – that is, they would guarantee convertibility in both currencies. This was total madness.<\/p>\n
Economic growth continued to decline and the foreign debts piled up. The government (April 2001) forced local banks to buy bonds (they changed prudential regulation rules to allow them to use the bonds to satisfy liquidity rules). This further exposed the local banks to the foreign-debt problem.<\/p>\n
The bank run started in late 2001 – with the oil bank deposits being the first which led to the freeze on cash withdrawals in December 2001 and the collapse of the payments system.<\/p>\n
The riots in December 2001 brought home to the Government the folly of their strategy. In early 2002, they defaulted on government debt and trashed the currency board. US dollar-denominated financial contracts were forceably converted in into peso-denominated contracts and terms renegotiated with respect to maturities etc.<\/p>\n
This default has been largely successful. Initially, FDI dried up completely when the default was announced. However, the Argentine government could not service the debt as its foreign currency reserves were gone and realised, to their credit, that borrowing from the International Monetary Fund (IMF) would have required an austerity package that would have precipitated revolution. As it was riots broke out as citizens struggled to feed their children.<\/p>\n
Despite stringent criticism from the World’s financial power brokers (including the International Monetary Fund), the Argentine government refused to back down and in 2005 completed a deal whereby around 75 per cent of the defaulted bonds were swapped for others of much lower value with longer maturities.<\/p>\n
The crisis was engendered by faulty (neo-liberal policy) in the 1990s – the currency board and convertibility. This faulty policy decision ultimately led to a social and economic crisis that could not be resolved while it maintained the currency board.<\/p>\n
However, as soon as Argentina abandoned the currency board, it met the first conditions for gaining policy independence: its exchange rate was no longer tied to the dollar’s performance; its fiscal policy was no longer held hostage to the quantity of dollars the government could accumulate; and its domestic interest rate came under control of its central bank.<\/p>\n
At the time of the 2001 crisis, the government realised it had to adopt a domestically-oriented growth strategy. One of the first policy initiatives taken by newly elected President Kirchner was a massive job creation program that guaranteed employment for poor heads of households. Within four months, the Plan Jefes y Jefas de Hogar (Head of Households Plan) had created jobs for 2 million participants which was around 13 per cent of the labour force. This not only helped to quell social unrest by providing income to Argentina’s poorest families, but it also put the economy on the road to recovery.<\/p>\n
A key Argentine government official (advising the Minister of Employment) who was instrumental in the implementation of the Head of Households Plan had earlier attended a Conference in Chicago in 1998 and attended a session where Randy and myself presented papers outlining the way in which a Job Guarantee would operate and provide macroeconomic stability. We have stayed in touch ever since.<\/p>\n
Conservative estimates of the multiplier effect of the increased spending by Jefes workers are that it added a boost of more than 2.5 per cent of GDP. In addition, the program provided needed services and new public infrastructure that encouraged additional private sector spending. Without the flexibility provided by a sovereign, floating, currency, the government would not have been able to promise such a job guarantee.<\/p>\n
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.<\/p>\n
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<\/a> – which directly benefit the population by insulating the most disadvantaged workers from the devastation that recession brings.<\/p>\n
By pegging a currency to another, guaranteeing convertibility and then allowing the financial sector to “dollarise” your economy (drown it in foreign currency-denominated debt) – is a sure way to force a country into financial ruin or more or less permanent austerity.<\/p>\n
Please read my blog – Why pander to financial markets<\/a> – for more discussion on this point.<\/p>\n
But what about the data?<\/p>\n
You can get data from the Instituto Nacional de Estad\u00edstica y Censos<\/a> (Argentina’s Central Statistical Office). For National Accounts look for Cuentas Nacionales on left menu.<\/p>\n
I graphed real GDP growth from the March quarter 1994 to the September quarter 2011. The period before their crisis delivered relatively lower and unstable growth rates compared to the period after the crisis.<\/p>\n
The economy dived into a deep recession from December 1998 and then endured 17 successive quarters of negative growth culminating in the real output free fall in the year starting with the December 2001 quarter (-10.5 per cent), March 2002 (-16.3 per cent), June 2002 (-13.5 per cent), and September 2002 (-9.8 per cent).<\/p>\n
Once they abandoned the peg and concentrated on domestic policy (and job creation) they began growing again robustly in the first quarter 2003 and continued that pattern for several years until they became caught up in the current global crisis.<\/p>\n
During the current world crisis Argentina endured a very modest recession (contracting -0.8 per cent in the June quarter 2009 and -0.3 per cent in the September quarter 2009 – before bouncing back to fairly robust growth.<\/p>\n
![\"\"](\"https:\/\/billmitchell.org\/blog\/wp-content\/uploads\/2011\/12\/Argentina_real_GDP_growth_1994_2011.jpg\" "\\"Argentina_real_GDP_growth_1994_2011\\"")
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