Bill Black, the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. Cross posted from New Economic Perspectives.
While the Occupy Wall Street (OWS) movement set its sights on occupying a financial center, Germany has accomplished the vastly more impressive feat of occupying an entire nation – Greece. Germany has experience at occupying Greece having done so during World War II. The art of occupying another nation is to recruit a local puppet to do the dirty work required to repress the citizens. Germany used several puppets, most notoriously the murderous Ioannis Rallis, to (nominally) rule Greece and terrify the Greek people during World War II. (After Germany’s defeat, Rallis was executed for his treason.)
This time around, Germany has been far more successful in recruiting and using a puppet to (nominally) rule Greece and terrify the Greek people before the German occupation. It was able to put its puppet, Lucas Papademos in place and have him “request” that Germany reoccupy Greece. Papademos is not elected. He is in power because his elected predecessor, George Papandreou, announced that Greece would hold a plebiscite on whether to agree to the terms of a deal on Greece’s sovereign debt that would have the effect of surrendering Greece’s remaining sovereignty and consigning the Greek people to an even deeper depression. The inevitable German reaction to the plebiscite was: Democracy in Greece – inconceivable! Germany threatened to destroy Greece’s economy if there were a plebiscite. Germany’s extortion led to the collapse of Papanderou’s elected government and Papademos’ appointment as Greece’s de facto prime minister.
Papademos is a banker and shares the theoclassical economic views that caused the global crisis and then led the ECB and many European leaders to adopt austerity strictures that have hurled the Eurozone back into recession. He has been wrong about the most important economic issues of his time. His economic dogmas, track record of failure, and disdain for democracy and the Greek people made him the perfect puppet to the Germans. For reasons that pass all understanding he is called a “technocrat. His record of economic policy failure demonstrates that “faux shaman” would be a more accurate label.
Germany and Papademos have ended Greece’s political sovereignty, but Greece gave up its economic sovereignty long ago when it adopted the euro. Two aspects of national economic sovereignty were inherently lost with nations that gave up their own currency and adopted the euro. A member nation could no longer have a monetary policy and it could no longer revalue its currency. The designers of the euro required a measure sharply curtailing the member nations’ remaining economic sovereignty. The demand that the euro nations surrender the last vestige of their economic sovereignty was deliberate. The euro’s designers viewed national economic sovereignty as the gravest threat to the euro’s success. Their great fear was that inflation could lead to a weak euro, so they adopted the “Stability and Growth” Pact to sharply limit the member states’ ability to control their fiscal policies. The Pact forbade member nations from running material budgetary deficits even during a severe recession or depression.
The European Central Bank (ECB) was created with a single mandate – preventing even benign inflation. It was directed not to try to counter even severe recessions, mass unemployment, and extreme poverty. It was not even designed to function as a lender of last resort. But the equally important aspect of the ECB was not written into its charter – but understood by everyone. The ECB would be subservient to Germany’s economic views (with an ever diminishing French fig leaf). Germany’s economic view was that hyper-inflation always lurked around the corner and the ECB must act like a eternally vigilant raptor. The nations of the periphery had no realistic hope of influencing ECB policies.
There were three key implications for nations that adopted the euro and surrendered economic sovereignty by giving up their sovereign currency. First, the member nations gave up their only reliable means of recovering from a serious recession or depression. Second, the member nations rendered themselves defenseless to devastating attacks by the bond markets if they fell into economic crisis. Third, the nations of the periphery placed their political sovereignty at grave peril should they fall into economic crisis.
The proven tool kit for recovering from a serious recession includes three policies. The policies are not mutually exclusive. They are typically used in conjunction. A nation that retains its economic sovereignty can speed its recovery from a severe recession by adopting a stimulative fiscal policy, a stimulative monetary policy, and by devaluing its currency. A nation that adopts the euro cannot use any of these methods. The Stability and Growth Pact allows nations to run only a tiny budgetary deficit that is grossly inadequate to replace the lost private sector demand.
A nation that has a sovereign currency whose value floats and whose debts are denominated in its own currency makes an exceptionally poor target for currency attacks. It always has the capacity to repay debts denominated in its own currency, so it makes an even worse target for attacks by the credit markets. A nation that uses the euro is not an issuer of a sovereign currency. It uses another entity’s currency. Its sovereign debts, therefore, are inherently denominated in another currency – typically the euro. When a nation falls into recession or a debt crisis the debt markets produce a vicious cycle. As the sovereign debt increases the rating agencies cut the ratings, which raises the interest rate on the sovereign debt, which increases the debt costs, which leads to further rating downgrades. Note that when the credit rating agencies downgraded the United States the credit markets proceeded to loan vast sums to the U.S. at even lower interest rates. The credit markets rightly view the U.S., in no small part because it has a sovereign currency, as a “safe haven.”
The dynamics of sovereign currencies drive the deficit hawks to distraction. They eagerly await the day, and invent fictional debt ratio “tipping points”, when the credit markets will adopt their Austrian economic views and refuse to lend to the United States. Even Japan’s financial leaders, still able to borrow vast amounts at virtually zero interest rates despite long having one of the highest debt ratios in the world, are so Austrian in their economics that they are unable to understand their monetary system. Modern Monetary Theory (MMT) scholars have repeatedly demonstrated analytical and predictive success in explaining the inexplicable (from the dominant theoclassical economics perspective).
The result of the destruction of economic sovereignty is that a nation that adopts the euro and sinks into a severe recession can be forced into an unrecoverable spin. The euro system had no means to deal with such a death spiral that would lead to default and forced withdrawal from the euro. The default of one member nation on its euro debt would cause the debt costs of other euro members trapped in recessions to spike and could lead to a series of defaults and withdrawals from the euro.
The only established institution to assist way out lay outside the euro system, the International Monetary Fund (IMF). The IMF provides loans to nations and demands austerity, privatization, and deregulation in return. Austerity makes recessions worse and deregulation is one of the causes of financial crises, so IMF loans often prove destructive to the recipient nations. The IMF was unwilling to take on the loss exposure of becoming a dominant lender to the periphery. This forced the European Union (EU) and ECB to create a fund that worked in conjunction with the IMF to lend to euro members that went into crisis. The EU lent to periphery nations under austerity, privatization, and deregulatory terms that were even more destructive than those imposed by the IMF. Theoclassical economic dogma has forced the Eurozone back into recession and much of the periphery into depression. This is one of the most destructive and spectacular “own goals” in history.
The ECB’s theoclassical dogma leaves only one means of escaping a severe recession or depression – ending the European safety net and slashing working class wages such that every member state in economic difficulty becomes a major net exporter of goods and services. This is why we call the dogma the “New Mercantilism.” Adam Smith, of course, was motivated to write largely by his desire to expose the folly of mercantilism. Economics is the only “science” I am aware of that has deteriorated dramatically in its predictive ability over the course of 150 years. The ECB’s dogma is premised on a fallacy of basic logic (and is economically illiterate and vicious). One nation’s export is another nation’s import so we cannot all be net exporters. The success of one nation (Germany) in becoming a net exporter in part through substantial reductions in working class wages does not prove that the periphery can emulate its “success” by slashing working class wages. Indeed, the more Germany becomes a net exporter the harder it is for the periphery nations to become net exporters.
In practice, the ECB strategy means that the Irish are trying to substantially reduce working class wages so that they can out export the Portuguese. The Portuguese are trying to cut their working class wages so they can out export the Greeks. The Greeks are slashing working class wages to try to out export the Turks. We call this the “Road to Bangladesh” strategy. Recessions mean that demand is severely inadequate. Cutting working class wages and public sector demand through austerity – simultaneously – during a Great Recession (a depression in the periphery) must reduce demand further and increase unemployment. Indeed, the head of the ECB, Mario Draghi, conceded this in his extraordinary interview in the Wall Street Journal.
Draghi went on to promise that at some unknown point what Paul Krugman aptly derides as “the confidence fairy” would appear and private sector demand would spontaneously surge and drive a robust recovery in the periphery. The defining characteristic of dogma is that because it is not rooted in fact or logic it cannot be refuted by facts or logic. We are left to debate how many confidence fairies can dance on the head of an ECB pinhead.
This was the context that led thousands of regular Italians to invite, and pay the travel costs, to bring a leading MMT scholar, Stephanie Kelton, to Italy and expose the ECB’s most destructive myth – TINA (“there is no alternative”). Stephanie Kelton is a professor of economics at the University of Missouri – Kansas City, the home of other leading MMT scholars. Randall “Randy” Wray, along with Australia’s Bill Mitchell, are the most prominent academics specializing in the development of MMT. (James Galbraith is a prominent MMT scholar, but MMT is not his specialty.) Professor Mathew Forstater runs the Center for Full Employment and Price Stability (CFEPS) at UMKC. CFEPS was created and maintained for years with funding from Warren Mosler, a hedge fund owner who is a leading intellectual contributor to the creation and development of MMT.
The Italians also invited Marshall Auerback, an investment analyst who works closely with MMT’s developers, particularly Warren Mosler and UMKC scholars, in the development of MMT. Auerback writes frequently in top financial blogs, including the UMKC economics blog “New Economic Perspectives” (created and led by Kelton).
The organizer of the Italian “MMT Summit” was Paolo Barnard, a journalist who became convinced that MMT was correct and offered an alternative that Italy needed to embrace. He invited three other speakers, whose specialty is not MMT, to add their views at the Summit in Rimini, Italy. The three speakers were the French economist Alain Parguez (Professor Parguez is best known for the development of the Theory of the Monetary Circuit), the American economist Michael Hudson (an expert on finance), and an American criminologist, lawyer, and former senior financial regulator teaching courses in economics and law at UMKC (me).
We presented and fielded questions from the audience over the course of three days (Friday, was only a 90 minute salute to the attendees, but Saturday ran from 10:00 a.m. to 11:00 p.m., and Sunday was a full day). I cannot summarize such extensive presentations, from differing conceptual and disciplinary perspectives, in a brief article. I will note only five aspects of Kelton’s presentation. First, she explained the points I have made above about how entering the euro removed the member nation’s economic sovereignty and left them vulnerable to the bond market death spiral. Second, she showed how the euro designers and the ECB sought to create a condition in which there is no alternative because they systematically sought to eliminate the superior alternatives for recovering from a severe recession or depression. The EU claims to have created a self-fulfilling prophecy of TINA. Kelton showed graphically how the ECB, the bond markets, and the Stability and Growth Pact cumulatively, and increasingly narrowed the policy space within which euro member nations could operate. Third, she showed that there were alternatives, far superior alternatives, for nations with sovereign currencies even in severe economic distress. By explaining the alternative she gave the Italians hope. They have suffered a deluge of national media that buys into TINA hook line and sinker and blames Italians for the crisis. Fourth, she explained why a sovereign currency allowed a nation new policy options, including job guarantee programs that would pay the unemployed to take productive jobs. (The “guarantee” is that one will be offered a job. An employee who fails to perform or engages in misconduct on the job can be fired and refused work.)
Fifth, she explained that the EU’s twin theoclassical dogmas, budget austerity and becoming net exporters through severe cuts in working class wages, are not in fact “alternatives” to recession but means of deepening recessions. Kelton explained that EU nations could not simply “decide” to run a budget surplus or become net exporters. There are two major impediments. “Deciding” to run a budget surplus during a severe recession or depression means some combination of raising taxes (Draghi calls that bad austerity if it involves taxing corporations) and cutting social expenditures. Both actions reduce demand, already inadequate in a recession, and normally act to contract the economy and expand unemployment and poverty, which reduces tax receipts and increases budgetary expenditures. The result is that austerity can increase budgetary deficits rather than cause them to shrink. Under austerity and the euro a member nation has the illusion of control of its budget deficit.
Nations using the euro also lack the ability to ensure that they run a balance of trade surplus (much less the very large surpluses essential to Draghi’s preferred “export driven” strategy). They cannot devalue their currencies (the most effective means of producing a trade surplus) because they do not have a sovereign currency and the ECB, dominated by Germany, insists on a “strong” euro – a major impediment to an export driven strategy. I have explained that the export driven strategy rests on the logical “fallacy of composition” because we cannot all be net exporters. That fallacy is particularly strong for EU members with whom Germany is a significant trading partner. More generally, the export driven strategy ignores essential interaction effects. Other nations with sovereign currencies can devalue them and many of them follow export driven growth strategies (also subject to the fallacy of composition). Even if the EU’s periphery slash working class wages to third world standards they cannot guarantee that other nations will fail to react to the strategy by some combination of import barriers, export subsidies, devaluation, and competitive slashing of (already lower) working class wages. Note that this strategy threatens to create the “trade wars” that can also exacerbate recessions and depressions. Once more, the “only alternative” that Draghi purports to exist to drive a recovery in the periphery turns out to be illusory because a nation using the “strong” euro cannot follow policies that are certain to produce large net trade surpluses even if it reduces its workers’ wages to third world levels.
There were several extraordinary aspects about the MMT Summit from our perspective as speakers. We were astounded by the number of people attending the Summit – over 2100 by a hard count of entrants. (There are a series of YouTube videos showing the attendees.) Paulo Bernardo had to move the forum for the Summit to a basketball stadium because no conference facility was available that could seat so many people. Many of them drove for hours to attend and all of them paid to attend so that they could fund our travel costs. (We were not paid any fee or honorarium and we flew coach, but we stayed in a very nice hotel in Rimini.) This huge number attended despite a major Italian media blackout on the event. The attendees were regular Italians from every walk of life, not elite policy wonks. The people attending were beyond enthused. They sat, in not very comfortable seats, for hours to listen to economists talk economics and while we pitched the level of our presentations to be what we guessed to be appropriate for a general audience, there were plenty of graphs and some sophisticated analytics. They also had to listen to us in translation, and while the professional translators were excellent some things are inevitably lost in translation. We spent hours doing Q&A, and the members of the audience asked us overwhelmingly about economics topics, including specific implementation measures. At breaks, one could see members of the audience engaged in substantive policy discussions and debates with each other. I had somewhat similar experiences in Ireland and Iceland talking to general audiences about the causes of their crises, but the numbers were far smaller. In each country one reaction has been common – they are delighted to hear scholars who do not believe the failed dogmas that caused the crises, who have real alternatives that offer hope, and who are not looking to make a buck off their misfortunes.
I was left with a profound respect for the Italian people and renewed hope that they would say no to TINA and the self-destructive troika dogmas that have caused the Eurozone to spiral back into recession. Thousands of Italians are eager to work to recover Italy’s full economic and political sovereignty and adopt economic policies that were humane and efficient and constrained by real resources – not bad currency choices. MMT opened their eyes to a world of more desirable alternatives that would work well for Italy.