naked capitalism

Yves here. Notice how someone in the officialdom actually said “There is no alternative”. Nothing like being explicit.

By Delusional Economics, who is horrified at the state of economic commentary in Australia and is determined to cleanse the daily flow of vested interests propaganda to produce a balanced counterpoint. Cross posted from MacroBusiness.

Overnight, Greek Leftist leader, Alexis Tsipras, gave up on his attempts, or at least pretence of them, to form government. The gauntlet has now been handed to PASOK leader, Evangelos Venizelos, who again has 3 days to attempt the same.

Given that New Democracy, Venizelos’s potential coalition partner, has already failed to create a workable coalition it is doubtful PASOK will succeed. Neither Tsipras or Samaras used their fully allocated time suggesting there is little point dragging out talks as no comprises could be reached.

Greece appears to be heading back towards an interim technocrat government and new elections unless the Greek President is able to muster a workable coalition in the coming days. New elections may bring new alliances, but it is yet to be seen what the new political strategies will appear after the demolition of the centrist parties.

Overnight the EFSF board agreed to make an additional payment to Greece in order to keep it technically solvent for a few more weeks:

After a conference call, the board of the European Financial Stability Facility, the 700 billion euro bailout fund administered by the 17 countries that use the euro, agreed to make the scheduled payment, which will allow Greece to meet near-term bond redemptions and other obligations.

An initial 4.2 billion euros will be paid on Thursday, while the remaining 1 billion will be paid out later, “depending on the financing needs of Greece,” a statement said.

It said the remaining 1 billion was not needed before June.

This may appear as a back down but realistically it is just a payment in order for Greece to hand the money back again. Greece has approximately €3 billion worth of bonds held by the ECB maturing this month and also the non-greek law PSI bonds to sort out. This is very much a case of drip feeding money in order to protect greater Europe from the contagion of a default.

In the meantime the rhetoric from outside of Greece has ramped up a notch with European Central Bank Executive Board member Joerg Asmussen quoted as saying:

Greece has to be aware that there is no alternative to the agreed consolidation program if it wants to remain a member of the euro zone

The ECB currently holds €40 billion of Greek bonds and its banks have €140bn in repos. In that regard Mr Asmussen appears to be having an argument with a loaded gun, and this has very much turned into a game of chicken.

But members of the ECB aren’t alone in publicly announcing Greece’s choice. Until recently, speaking of a Greek departure from the Euro was completely out of bounds. But, as Bloomberg reports, the economic and political realities of the situation appear to have changed all of that:

From the monetary fortress of the European Central Bank to the pro-European duchy of Luxembourg, policy makers are beginning to air their doubts that Greece can stay in the euro.

Post-election tumult in Athens has put the once-taboo subject of an exit from the 17-country currency union on the agenda, lifting the veil on possible scenario planning afoot behind the scenes.

“If Greece decides not to stay in the euro zone, we cannot force Greece,” German Finance Minister Wolfgang Schaeuble said at a conference sponsored by German broadcaster WDR in Brussels today. “They will decide whether to stay in the euro zone or not.”

After 386 billion euros ($499 billion) in aid pledges for Greece, Ireland and Portugal, 214 billion euros in ECB bond purchases and another trillion euros in low-interest loans for banks, plus 17 high-level crisis summits, Greece’s political chaos thrust Europe into a perilous new phase.

The world is witnessing an “important moment in European Union history, a moment of crisis,” EU President Herman Van Rompuy said in Brussels on the 62nd anniversary of the declaration by Robert Schuman, then France’s foreign minister, that launched postwar European integration.

Let’s hope there is some form of compromise on both sides, but at this point in time it is very hard to say what is going to happen either way.

Greece, however, wasn’t the only problem overnight. Spain once again came to the fore as its 10 year bond yields rose 4.02% to reach 6.078%. Meanwhile the Spanish stock market indicator, the IBEX 35, closed down 2.77% overnight which took it back to levels not seen since October 2003 and it now sits lower than it did at the height of the GFC:

om/wp-content/uploads/2012/05/Screen-shot-2012-05-10-at-2.19.02-AM.png” alt=”" title=”Screen shot 2012-05-10 at 2.19.02 AM” width=”313” height=”144″ class=”aligncenter size-full wp-image-28256″ />

Overnight rumours of plans to attempt to bolster the banking system, including huge jumps in capital requirements, hit the news wires:

Spain plans to partly nationalize BFA- Bankia group as Prime Minister Mariano Rajoy tries to restore investor confidence with his second overhaul of lenders in three months, a government official said.

The government will become the largest shareholder in the bank that has the biggest Spanish asset base, said the official, who declined to be named because the plan hasn’t been announced.

It’s also working on a plan to force banks to set aside more provisions on real estate loans that are still healthy, said a person familiar with the situation, who also declined to be identified. The rules, to be approved on May 11, will increase provisions on the loans to about 30 percent from 7 percent, creating an additional buffer of about 30 billion euros ($39 billion), the person said.

Rajoy, who said for the first time this week he may use public money to shore up banks, is trying to restore trust in the financial system without overburdening public finances.

As I have explained previously, Spain’s major economic issue the loss of private sector wealth from over exposure to a deflating housing bubble which, in the absence of a major push in counter cyclical fiscal policy, is leading to a surge in bad debts in the banking system.

Spanish house prices accelerated downwards in April with the YoY falls hitting 12.5%. The accumulative falls since the peak are now 29.8%

With asset devaluations like that it is very difficult to see how the Spanish taxpayer is going to stay unencumbered under any new plan.

By Marshall Auerback, a hedge fund manager and portfolio strategist. Cross posted from New Economic Perspectives

Nearly one Spaniard in four is unemployed, according to data released on Friday, as the country’s economic and financial predicament prompted a government minister to talk of a “crisis of enormous proportions”.The data from the National Statistics Institute showed 367,000 people lost their jobs in the first three months of the year. At this pace, Spanish job losses are equivalent to 1 million per month in the United States. That means more than 5.6m Spaniards or 24.4 per cent of the workforce are unemployed, close to a record high set in 1994.

Spain has become the new Greece. Actually, in many respects Spain is now worse than Greece. The Spanish unemployment rate is already so high and unlike Athens, Madrid has made no headway in reducing its public debt levels (whereas the Greeks are close to running a primary fiscal surplus at which point they could leave and turn the problem back on to Brussels). Moreover, Spain has a huge private debt burden that is twice that of Greece.

Although I have warned on these pages before that Spain’s austerity program was leading the country to disaster, my reaction to this economic catastrophe has been one of amazement. Just take a look at this employment data

Spain First Quarter Unemployment: Summary (Table)
2012-04-27 07:00:00.13 GMT

Yet, until now Rajoy Administration has been saying that the marginal decline in GDP estimated by the Bank of Spain for the first quarter was exaggerating economic weakness. Now we have the spectacle of the Spanish government suggesting that the Bank of Spain estimate of a .4% decline in Q1 Spanish GDP is too pessimistic. But in light of these numbers, what kind of GDP decline should one realistically expect when employment falls two percent non annualized in a quarter? At least a four percent annualized decline. more likely much higher. Yet who is talking discussing that as a real possibility in Brussels? Nobody. Everybody remains asleep at the wheel.

For years, the Spanish GDP figures have been hard to square with the underlying collapse in industrial production and rise in unemployment, both of which were more realistically reflecting the scale of the country’s collapse into depression.

When I said a few months ago that the Spanish government was lying about their numbers, I was attacked by a few Spanish readers of this blog, who claimed I was a nefarious hedge fund manager, likely loaded up to the gills with CDSs on Spanish debt who was trying to foment panic. For the record, I have never bought a credit default swap in my life. If anything, I was trying to foment panic because I was horrified by the new ultra austerity stance adopted by the recently elected Rajoy Administration.

Now consider the reality: the economy is crashing, hence the unemployment rate rise. Yet German Chancellor Angela Merkel and the ECB President, Mario Draghi, continue to insist that one can have both fiscal restriction and a lower domestic price level despite the fact that Spain has a non financial private debt to GDP ratio of 230%.

Interestingly enough, Dutch levels of private debt to GDP are even higher, at 249%, the highest in Europe. By contrast, the Italians still have net household savings. So who are the real “profligates” in Europe?.

Those who embrace these ruinous austerity policies will soon be seeing the experiencing much the same kinds of conditions as the Spanish (albeit from less depressed levels) including the moralistic Dutch, whose finance minister has been a crusader in favour of even harsher fiscal rules than those embodied in the Stability and Growth Pact.We have also recently witnessed a big surprise decline in the German consumer confidence index last week as well as a collapse in an Italian retailing sentiment index. The austerity disease is intensifying the crisis, even in the core.

It is inconceivable to me that Super Mario Draghi won’t be changing his tune soon, in spite of what he and the Merkel government are now saying for public consumption. To continue with this present course will not only precipitate a collapse of the euro, but a political collapse across Europe.

There is no question that larger deficits are needed to support aggregate demand at desired levels. However, as all of us who have contributed to this blog have long noted, the problem is the national governments are currently like US states and as such are revenue constrained because they are USERS, rather than ISSUERS of the currency (as opposed to, say, Canada or the US, both of which are sovereign issuers of their own currency).

So relaxing the deficit limits without some kind of ECB funding guarantees can cause markets to abstain from funding the national governments, which creates a solvency crisis of the kind we are experiencing today. Said another way, without the ECB the euro members are currently deep into ‘Ponzi’, as my friend, Warren Mosler has described it. In reality, they have all been in ‘Ponzi” since day one. But it took a crisis of the magnitude of 2008 to make this manifest for the markets.

At some level, the ECB understands that, as it always”writes the cheque” when a systemic crisis pushes the system to the brink. It can be no other way, as it is the sole issuer of the euro. But for the most part, Europe’s policy making elites remain in denial, as they continue to turn away from the one entity that could address the insolvency issue.

And let’s be clear once and for all. The US government does not face the same kind of crisis as the Spanish, the Greeks, the Dutch or even the Germans. The US government has expanded its public debt ratio considerably in recent years but yields remain low and when the ratings agencies downgraded their assessment of the US sovereign debt the demand for it rose. Whither the so-called “bond market vigilantes”?

The Euro governments are in a different camp altogether. All those who actually understand that the member governments are using a foreign currency and thus are not at all like Japan, the US or the UK governments, appreciate that their is default risk attached to the paper issued from the EMU governments.

They also appreciate that with the non-elected eurocrats of Brussels insisting on a decade or more of austerity and implementing fiscal rules that these would ensure a crisis every time there has been a serious downturn in aggregate demand. And with that, the risk of default with government debt has risen. That is what we are seeing today across the euro zone. And in Spain it is writ large.

The mainstream austerity line is trapping Spain (as well, as Greece, Portugal, Italy, Ireland and soon the core of the euro zone) in a dangerous downward spiral of lost income and increased unemployment. I still think Francois Hollande’s likely election could well change the political dynamics in the euro zone, even though he generally buys into the mainstream neo-liberal euro line. Hollande is an “austerity lite” character, as opposed to being a genuine reflationist. But even he cannot be oblivious to the looming political and social dangers which await France, if he continues to pursue the policies embraced by the current President, Nicolas Sarkozy.

So far, Brussels has not let facts get in the way of a good neo-liberal theory, but it’s getting increasingly hard to ignore this emerging horror show.

Lately, the US has been winning the investment beauty contest among Cinderella’s ugly sisters. Europe’s addiction to austerity, rolling rescues, and inability to address internal imbalances means at best a wild ride and at worst a crisis resurgence. China still has its perennial fans, but long-standing bears like Jim Chanos have been joined more recently by Marc Faber, who foresees 3% growth, which is tantamount to a recession. Japan is struggling with a mile high currency. The US, by comparison, does not look too bad.

Or does it? One of the lurking worries in the background is the so-called fiscal cliff. At the end of 2012, a whole passel of tax breaks and special programs expire, from lower payroll tax rates to extended unemployment benefits. This has been lurking in the background for a while (indeed, the US would have faced a contraction in fiscal spending at the end of 2012 had various breaks not been extended).

Ben Bernanke brought the issue to the fore in Congressional testimony today, stating that consumer spending would suffer if Washington continues on an inertial course. Estimates of impact vary considerably. Normura puts the effect at nearly 5% of GDP in the first half of fiscal 2013, which starts October 2012. Deutsche Bank estimates the drag at only 1% of GDP, but the consensus seems to be 3% to 5%.

Needless to say, Wall Street does not want its punchbowl taken away (they really don’t care about the impact on ordinary people) and Uncle Ben also said clearly that he can’t compensate for the contractionary impact, so we have a flurry of alarmed reports tonight. (Mind you, I’m not saying this isn’t a big deal, but what it takes to precipitate coverage is amusing).

Some recent commentators are worried that it isn’t possible to get a deal done post election (the trigger date for most of the changes is calendar year end). For instance, FT Alphaville pointed to this column by Stan Collander a few days ago:

Even if there were an agreement on what that should include — and there absolutely isn’t ­— it would take longer than four to seven weeks just to draft the basic legislation, let alone debate and pass it in committee, debate and pass it in the full House and Senate, come up with a compromise agreement between the two chambers, redraft the compromise and pass the conference report. Add in the need for transition rules, which took a year to draft when the 1986 tax act was adopted, and it’s ludicrous to think that tax reform has any chance of going anywhere during the lame duck.

Keep in mind this is the wrong frame. The issue is whether Congress will decide to renew EXISTING initiatives, not fundamental tax overhaul (in fairness, Collander predicts that stopgap measures are all that will result). Tax maven Lee Shepperd points out that a surprisingly large portion of the tax code is renewed every year, and she is sanguine about the fiscal cliff turning out to be a non-issue.

But as we so far away from business in usual in DC that all bets are off? The Republicans are keen to cut the deficit, or at least like to pretend to be, and if the economy is more or less where it is now or a smidge better, they’ll certainly be champing at the bit to drop the extended unemployment benefits. The Dems would posture that they’d want different breaks eliminated, such as ones like the Bush tax cuts that would hit the well off more. Normally, the expected resolution would be simply to extend the whole shebang, since neither side would give up its half a loaf. But this is a Congress already beset by intransigence, and lame-duck sessions aren’t great for rallying the troops. And on top of that, the budget ceiling will come into play, which will further complicate agreeing on stopgaps.

The lack of focus on the issue in Congress is not a good sign. As Sebastian Mallaby writes in the Financial Times:

….the omens are bleak. Rather than seek a mandate to eliminate tax loopholes and discipline health spending, which are the two central components of any intelligent budget fix, candidates on both sides resort to sound bites

The better way to frame this might be: will all the talk of grand bargains get in the way of some fixes to keep the US from unwittingly going the austerian route? I’d hazard it is too early to tell. While Congress can often squeak legislation through just before deadlines, the ascendancy of the deficit hawks may mean the non-fix is in.

.

By Pavlina Tcherneva, Assistant Professor of Economics at Franklin and Marshall College, Research Scholar at The Levy Economics Institute, and Senior Research Associate at the Center for Full Employment and Price Stability. Cross posted from New Economic Perspectives

Our mainstream colleagues keep banging their heads against the wall. “Why, oh why wouldn’t Chairman Bernanke do more to rescue the economy?” Today Paul Krugman took on this question again, arguing that Chairman Bernanke should listen to Professor Bernanke who had far more sensible ideas about rescuing an economy from a deflationary environment, as seen in his research on Japan during the 90s.

Krugman revisits a 2000 paper by then professor Bernanke, which many of us have scrutinized before, titled “Japanese Monetary Policy: A Case of Self-Induced Paralysis?” Krugman faults Bernanke for not following his own advice arguing that what he should do instead is 1) change expectations about the future by declaring and sticking to an explicit inflation target and 2) intervene even more aggressively in financial markets through alternative open market operations to deal with the nation’s massive unemployment problem.

Why Bernanke doesn’t do what he prescribed for Japan baffles Krugman who points to one of two explanations. The first was provided by his colleague Larry Ball, who recently claimed that Bernanke has become a victim of “groupthink” and has lost the ability to think for himself. The second is that the power lobby at the Fed and the political bullies in Congress are far too strong for the mild-mannered and soft-spoken Chairman, undermining his ability to act more aggressively.

In 2010, I wrote a paper Bernanke’s Paradox (JPKE version, April 2011) which examines his monetary policy prescriptions for Japan in detail. I have been asking myself the same question: why isn’t Bernanke following his own advice? But the answer I give is that it’s because he cannot, literally. Whatever policy options he believes to be genuinely effective actually depend on Congress and not on him.

The difference is that, unlike Paul Krugman, I actually read Bernanke’s paper from start to finish. See, what Krugman is missing is that Bernanke did not prescribe two policy options to deal with deflations (1. stick to an inflation target and 2. engage in alternative OMOs), but four.

I have discussed these in the paper above and in shorter blogs here and here. Here are the four options Bernanke recommends:

1. Commit to an inflation target and a long-term low interest rate environment;

2. Depreciate the currency through open market purchases of foreign currency;

3. Engage in non-traditional OMOs – including purchases of long term government securities and other private sector liabilities such as non-performing loans, commercial paper, corporate bonds, asset-backed securities and other;

4. Last but not least, finance various fiscal transfers (e.g., tax cuts) to boost consumption demand

Take the time to read Bernanke’s Japan paper and you will find that indeed he did follow this prescription as closely as he could, but he could not do so 100% because the core of the recipe lies in what Bernanke calls the fiscal components of monetary policy. Such fiscal components can be found in the Fed’s actions to depreciate the currency, purchase private sector assets, or finance tax rebates, all of which require an act of Congress or approval of the Treasury for the Fed to execute.

Of the four policy options above, Bernanke clearly prefers the latter – money financed tax cuts. Only the money drops that occur from deficit spending (e.g. via tax rebates) financed by the Fed are able to increase net financial wealth in the private economy, help with faster deleveraging, and hopefully boost aggregate demand.

So much ink has been spilled on Bernanke’s research on Japan and I am still amazed that the mainstream refuses to discuss the importance of these fiscal components in Bernanke’s work. They are the essence of monetary policy effectiveness, as Bernanke understands it.

Fiscal components of monetary policy, of course are a euphemism for fiscal policy proper. The reason why Bernanke calls them “components” of monetary policy and why the mainstream refuses to acknowledge them is because they are still blindly wedded to the idea that monetary policy is omnipotent in rescuing the economy from recessions. Well, it’s time to give up this old notion. How many years of low interest rates, aggressive QE1, QE2, Operations Twists, swaps, and $trillions and $trillions of lending do we need to recognize that these policy actions do not provide proper channels for dealing with the unemployment problem? In fact, in 2000 the Professor thought that:

Nonstandard open market operations with a fiscal component, even if legal, would be correctly viewed as an end run around the authority of the legislature, and so are better left in the realm of theoretical curiosities” (Bernanke 2000, p. 164)

But in the absence of Congressional action to fund aggressive fiscal transfers to the real economy, Bernanke left the ‘realm of theoretical curiosities’ and engaged in as many nontraditional OMOs as he could, some of which were of questionable legality.

Monetary policy just can’t do it alone. Fiscal policy must come to the rescue. Professor Bernanke understood this. Why he prefers tax cuts as opposed to any other type of fiscal policy is a function of his ideological preferences. But the bottom line is this—the way to rescue the economy is through aggressive fiscal stimulus where the Federal Reserve stands ready to finance it. That’s the substance of Professor Bernanke’s message, which has clearly eluded Paul Krugman and Larry Ball.

I titled my paper Bernanke’s Paradox, because I did see a conundrum in Bernanke’s writings, a different conundrum from the one Krugman suggests (that Bernanke seems to believe one thing as an academic but implements another as a policy maker). No, the conundrum is much deeper, much more important than what Krugman identifies.

Bernanke understands well that for monetary policy to be effective, fiscal policy must be aggressive (which the Fed always finances). Without bold Congressional action and a large fiscal stimulus package to boost demand and employment, nominal GDP cannot and will not rise to desired levels, no matter what the Fed does. Bernanke knows that despite his commitment to low interest rates and alternative OMOs, what he really needs is big fiscal components, but those can only come from Congress, not the Fed. Bernanke also knows that the US has infinite ability to finance these fiscal components, that there is no solvency issue and that the policy rate and both ends of the yield curve are under the direct control of the Fed. All of this is clear both from his academic writings and policy actions.

What I find absolutely paradoxical is that, despite all this, he still appears before Congress and makes ominous statements about the unsustainability of the US debts and deficits and their upward pressure on interest rates, failing to distinguish between nations like Greece which do not have their own currency and those like the US and Japan which do.

Having a large and increasing level of government debt relative to national income runs the risk of serious economic consequences. Over the longer term, the current trajectory of federal debt threatens to crowd out private capital formation and thus reduce productivity growth. To the extent that increasing debt is financed by borrowing from abroad, a growing share of our future income would be devoted to interest payments on foreign-held federal debt. High levels of debt also impair the ability of policymakers to respond effectively to future economic shocks and other adverse events.

Even the prospect of unsustainable deficits has costs, including an increased possibility of a sudden fiscal crisis. As we have seen in a number of countries recently, interest rates can soar quickly if investors lose confidence in the ability of a government to manage its fiscal policy. Although historical experience and economic theory do not indicate the exact threshold at which the perceived risks associated with the U.S. public debt would increase markedly, we can be sure that, without corrective action, our fiscal trajectory will move the nation ever closer to that point. (Bernanke, Congressional Testimony, February 2, 2012)

This is the conundrum: either he believes (as indicated by his research of the late 90s and early 2000s) that deficits are sustainable and cause a crowding in effect where the policy rate is under the direct control of the Fed, or he believes that they are not (as in his Congressional testimonies). Bernanke simply cannot argue it both ways. And we know well that in practice the operational reality is the former. In sovereign currency nations as in the US, deficits are infinitely sustainable, do not crowd out, and do not put upward pressure on interest rates.

So yes, I too have been unable to resolve Bernanke’s paradox. How is it possible for someone to hold two completely incongruent intellectual positions? Either he has been intellectually dishonest when appearing before Congress fueling the deficit phobia of policy makers, or he has become intellectually lazy and has not taken the time to rethink the crowding out dogma he has learned in grad school in the face of his later academic work and practical experience, which point all evidence to the contrary.

Thomas Palley is has served as the chief economist for the US – China Economic and Security Review Commission. He is currently Schwartz Economic Growth Fellow at the New America Foundation. His latest book From Financial Crisis to Stagnation is available at a 20% discount here [Select country location (top right hand corner) & enter code "palley2012" at checkout]

Interview conducted by Philip Pilkington

Philip Pilkington: At the beginning of your book From Financial Crisis to Stagnation you refer to the 2008 crisis as a ‘crisis of bad ideas’. Could you please briefly explain why you refer to the crisis in this way?

Thomas Palley: A central and critical element of my book is its emphasis on the role of economic ideas in generating the crisis. This feature fundamentally distinguishes it from mainstream explanations that tend to represent the crisis in terms of surprise events and economic shocks (e.g. black swans).

My book starts with the fundamental idea that economies are made, not found. The way economies are organized and function is significantly the product of social choices, not the product of nature. Over the past thirty years we (society) have embraced a set of economic ideas that shaped economic arrangements – including the pattern of income distribution, the power of corporations and finance relative to labor, and the way in which the economy generates demand.

This shaping of economic arrangements was obviously driven by political forces acting on behalf of corporate and financial elite interests, but economic ideas also played a critical role. First, the ideas of mainstream economists provided justification for the re-shaping of the economy in ways that elite interests wanted. Second, mainstream economists put forward additional ideas that were picked up and incorporated into the policy project of corporate and financial elites. Third, the monopoly capture of economic discourse by mainstream economics served to exclude other competing economic ideas from making it on to the policy table, into classrooms, and into the public debate.

The implication of this view is the crisis is at a deep level the product of a flawed economic policy paradigm derived from a set of flawed economic ideas. Escaping the crisis means replacing that policy paradigm and the ideas from which it derives. That is a massive challenge involving both a political contest and an intellectual contest. We need to win both. One without the other will be useless. It is no good winning the political contest if you simply replace Tweedledum (hardcore neoliberals) with Tweedledee (softcore neoliberals). Likewise, it is no good winning the intellectual contest if you do not win the political contest to implement different economic policy ideas.

PP: In the book you distinguish between two sorts of alternative approaches to the crisis. One you term ‘Textbook Keynesianism’ and the other you term ‘Structural Keynesianism’. Could you briefly delineate the differences between the two approaches? Also, should it be understood that the two approaches overlap with different schools of economic thought?

TP: Textbook Keynesianism and structural Keynesianism both emphasize the significance of total (aggregate) demand for the determination of economic activity. That is what makes both of them forms of Keynesianism.

However, textbook Keynesianism sees the microeconomic structure of the economy as intrinsically healthy. If demand falls off, all that is needed is for policy to step in and temporarily fill the demand gap until private sector demand revives. That is the logic behind temporary fiscal stimulus and temporary easy monetary policy.

Structural Keynesianism argues that the economy’s underlying income and demand generating process can be structurally flawed. For instance, income distribution can become badly skewed, creating a permanent shortfall of demand. In that case, private sector demand will not revive and the solution is structural remaking of the economy’s income and demand generating process.

Textbook Keynesianism can be identified with neo-Keynesianism (what Joan Robinson less politely called bastard Keynesianism). It identifies the principal macroeconomic problem as price and wage rigidity. This way of thinking gradually morphed into so-called New Keynesianism, which means textbook Keynesianism and New Keynesianism overlap. However, we should be clear that New Keynesianism has little to do with Keynes’ original logic and it is more a theory of market imperfections in the spirit of Arthur Pigou, Keynes’ great rival.

Structural Keynesianism links with the work of Michal Kalecki who joined Keynes’ insights about aggregate demand with Marx’s insights about class conflict and income distribution. That means structural Keynesianism overlaps with Marxist sociological and economic analysis. However, classical Marxism views capitalist economies as destined to crisis because of a falling rate of profit. Structural Keynesianism does not.

PP: In the book you discuss various mainstream theories of the recent collapse. Without going into too much detail perhaps you could say something about the mainstream explanations of the crisis?

TP: In principle there are two alternative competing mainstream explanations of the crisis. The first is the hardcore neoliberal perspective, which can be labelled the “government failure hypothesis”. In the U.S. it is identified with the Republican Party and with the economics departments of Stanford University, the University of Chicago, and the University of Minnesota. The second is the softcore neoliberal perspective, which can be labelled the “market failure hypothesis”. In the U.S it is identified with the Obama administration and half of the Democratic Party. In Europe it is identified with the Third Way. Among economics departments it is identified with those such as Harvard, Yale and Princeton.

The government failure hypothesis maintains the crisis is rooted in the U.S. housing bubble and its bust. That bubble was due to failures of monetary policy and government intervention in the housing market. With regard to monetary policy, the Federal Reserve pushed interest rates too low for too long in the prior recession. With regard to the housing market, government intervention via the Community Reinvestment Act and Fannie Mae and Freddie Mac, drove up house prices and encouraged homeownership beyond peoples’ means. The neoliberal perspective therefore characterizes the crisis as essentially a U.S. based phenomenon.

The market failure hypothesis maintains the crisis is due to inadequate financial regulation. First, regulators allowed excessive risk-taking by banks. Second, regulators allowed perverse incentive pay structures within banks that encouraged management to engage in “loan pushing” rather than “good lending.” Third, regulators pushed both deregulation and self-regulation too far. Together, these failures contributed to financial misallocation, including misallocation of foreign saving provided through the trade deficit. The market failure hypothesis is therefore slightly more global than the government failure hypothesis, but it views the crisis as a purely financial phenomenon.

PP: Your interpretation of the present crisis is a little different, right? Could you explain it briefly please?

TP: Yes, my interpretation is different – very different. I call it the destruction of shared prosperity hypothesis. This view is not represented in mainstream economic discussions because it challenges the fundamental theoretical foundations of mainstream economics which are shared by both hardcore Chicago School (freshwater) and softcore MIT School (saltwater) neoliberal economics.

My argument is that around 1980 the U.S. adopted a fundamentally flawed economic paradigm. From 1945 through to the mid-1970s the U.S. economy was characterized by a “virtuous circle” Keynesian growth model built on full employment and wage growth tied to productivity growth. The political triumph of Ronald Reagan enshrined a new economic paradigm that abandoned full employment and severed the link between wages and productivity growth.

The new paradigm was fundamentally flawed. One flaw was that it relied on debt and asset price inflation to fuel growth instead of wages. A second flaw was the model of globalization which created an economic gash in the form of leakage of spending on imports (the trade deficit), leakage of investment spending offshore, and leakage of manufacturing jobs offshore. These twin flaws created a growing demand gap.

That is where finance enters the picture as its role was to fill the demand gap. Financial deregulation, regulatory forbearance, financial innovation, financial mania, and plain vanilla financial fraud kept the economy going by making ever more credit available, However, as the economy cannibalized itself by undercutting income distribution and accumulating debt, it needed ever larger speculative bubbles to grow. The house price bubble was simply the last and biggest bubble and was effectively the only way around the stagnation that would otherwise have developed in 2001.

The house price bubble delayed the onset of stagnation but at a cost. When it burst it created a financial crisis because of the scale of financial excess. Moreover, it also makes it harder to escape stagnation now because of the scale of debt burdens and the extent of destruction of credit-worthiness.

PP: Your interpretation seems to make a lot more sense than the competing theories, which appear to me reductionist. Why do you think that your colleagues – especially your left-leaning colleagues – are missing the bigger picture?

TP: Thanks, Philip. That is a very good and difficult question. It is key to understanding why the crisis has so far generated little change in economics and economic policy.

There are many mainstream (orthodox) economists who have progressive values but they miss the big picture because their theory cannot accommodate it. Moreover, they can’t abandon their theory for a host of psychological and sociological reasons. At the psychological level it would involve a devastating admission that they have been wrong; that they’ve been teaching their students a lot of nonsense for thirty years. At the sociological level it would mean giving up the trappings of power and pay that go with their current intellectual monopoly because the paymasters of the system would quickly replace them with others.

That said, many mainstream economists are starting to admit income distribution has played a role in fermenting the crisis (you have to be willfully blind not too see it). Consequently, they are busy trying to incorporate income distribution into their narrative. However, they do so in a way that leaves their core theory about markets and market efficiency unchanged. Unfortunately, journalists and the general public cannot see this and are taken in by this tactic. One of the contributions of the book is it unmasks these obfuscations by showing how these stories don’t stack up and are inconsistent with the evidence.

Finally, this discussion shows why it is very important the general public be capable of distinguishing between “values” and “analysis”. If not, people risk being fooled by the rhetoric of progressive values that provides cover for policies that are actually conservative.

PP: In the book you provide a very clear description of what actually occurred in the financial market in 2008. Reading it I thought that a lot of people – myself included – have never really put the pieces together in their own minds. Maybe you could summarise the key events briefly?

TP: The mechanics of the crisis within the U.S. financial system are actually quite simple and can be understood as a six step process. Step one was the build-up of toxic loans over several years. Step two was when loans eventually started turning sour with the bursting of the house price bubble in 2007, causing loan losses. Step three was the destruction of bank equity caused by mounting loan losses. This process began in the so-called “shadow banking system” and then moved into the Wall Street investment banks and the established commercial banking sector. Step four was the resulting threat of bank defaults triggered by equity destruction. Step five was the rush to cash spurred by the threat of default. That caused a liquidation trap as agents tried to sell financial assets to raise cash, which deepened the extent of asset price declines and caused further equity losses. Step six was the run in the commercial paper market immediately after the collapse of Lehman brothers (September 2008) whereby banks and financial institutions became unwilling to lend to each other. That put every bank (including Goldman Sachs) on the verge of default, prompting the Federal Reserve to step in and de facto take over the commercial paper market by acting as lender of last resort.

PP: In the book you mention the commodities bubble that blew up in the 2008 financial crisis a number of times. Many commodities – oil included – are nearly back at their 2008 levels. Do you think that this could be due to speculation? If so, why on earth are the US government allowing this?

TP: I firmly believe speculation is a significant part of the run up in commodity prices, particularly oil. Over the last decade there has been tremendous change in the character of commodity market participants. In the past, the market consisted of producers, end-users, and traders intermediating between these groups. Now, the market has been invaded by financial investors in the form of pension funds, endowment managers, hedge funds acting on behalf of high net worth individuals, investment bank entities trading on their own account, and exchange traded funds (ETFs) for ordinary punters who want to speculate on commodities. This transformation represents the ‘financialization’ of commodity markets and it has resulted in a tsunami of money chasing commodities as a speculative investment vehicle. After causing a bubble and a bust in 2008, it has again pushed up oil prices.

The fingerprints of speculation are all over the oil market: large one day price spikes and plunges that cannot possibly be explained by changes in economic fundamentals; high prices in the face of large and growing inventories; storage in unconventional forms like idle super-tankers; and investment banks like Goldman Sachs purchasing oil storage capacity in places like Cushing, Oklahoma.

Why have the Federal Government and Congress done little about this? Two reasons. First, Wall Street, the banks, and oil companies are big beneficiaries from these developments and they (as everyone knows) are some of the most powerful vested political interests. Money talks in politics and they have the money. Second, economists have been disastrous on this issue, continuously denying the role of speculation. The depth of this denial is evidenced by the fact that even the often critical and insightful Paul Krugman has consistently denied the role of speculation. This provides yet another example of the role of bad economic ideas in the destruction of shared prosperity.

PP: Many economists and politicians seek to blame the Fed for the housing bubble and the financial crisis. In your book you say that this is misleading. Why do you think this?

TP: In my view the Fed is both to blame and not to blame for the crisis.

The Fed is to blame because it strongly supported the over-arching neoliberal economic program that is the ultimate cause of the crisis. Its support for the neoliberal program is most evident in its support for financial deregulation, support for self-regulation, and opposition to regulation of financial innovations such as derivatives. Had the Fed not held these beliefs and done its job properly, the excesses of the sub-prime market and the house price bubble would likely have been significantly prevented. Alan Greenspan was the booster-in-chief but almost every member of the board of governors and the roster of economists working in the Fed deserve blame. They all sung from the same song book and were deaf to other music saying inflation targeting was not enough and needed to be accompanied by tough oversight and balance sheet regulation.

However, the Fed is not to blame for pushing interest rates too low and holding them there too long, which is the charge levelled by neoliberal economists like John Taylor of Stanford University. After the recession of 2001 the economy was stuck in jobless recovery and showed signs of falling back into recession. This was despite significant stimulus provided via the Bush tax cuts and Iraq war. From the point of view of escaping stagnation, the Fed did the right thing.

Unfortunately, most of the public discussion has focused on the Fed’s interest rate policy after the 2001 recession. It should be focused on the neoliberal economic thinking that still permeates the Fed. Though there has been some change in attitude toward regulation, the Fed’s fundamental thinking about the economy remains unchanged. This failure to go after deep failures of understanding is part of the mechanism that protects the policy establishment, and it explains why the people in charge of the Fed (and other central banks like the Bank of England and European Central Bank) are the same people who failed so disastrously before the crisis.

PP: Regarding the economic thinking about the broader causes of the crisis you are particularly critical of the ‘savings glut hypothesis’ that has become popular, especially with the Federal Reserve Chairman Ben Bernanke. My impression from the book is that you see this as ad hoc economic thinking that seeks to avoid the real issues. Would I be right in saying that and could you briefly outline what is wrong with the savings glut hypothesis – which, in my reading, is as pervasive on the left as it is on the right?

TP: In my view the savings glut hypothesis is nonsense economics. Looking at it from the big picture, you see it is just another in a series of explanations of the US trade deficit by mainstream economists. My book shows clearly how these explanations evolve to fit the political moment rather than to explain the phenomenon. And the enduring common feature of all these explanations is they avoid blaming globalization as the cause of the problem or having any downside.

That is absolutely staggering. Mainstream economists blind themselves to the most obvious explanation, and that is a pattern that repeats over and over again in other areas of economics. And because the explanation is so obvious and simple you can never write about it in journals which are fixated on complexity. The story about the emperor’s new clothes really does apply for much of modern economics.

With regard to the saving glut hypothesis, it ignores the fact that the US trade deficit has been rising for 30 years, long before China emerged on the scene. And there is much other evidence and argument against it – but that is in the book.

PP: The book ends on a slightly pessimistic note. It appears that, given the entrenched dominant policy paradigm governments are likely not to begin the process of economic rebalancing. Do you see any light at the end of the tunnel? Are there any social or political forces you think might move the policy debate forward, both in the US and worldwide?

TP: You are right. I am pessimistic which is why the book predicts stagnation. And by the way that prediction was made in 2010 when the book was written, so it has already been proven right. I had great difficulty finding a publisher because 2010 was the time of “green shoots” and “V-shaped” recovery and there was widespread denial about the systemic nature of the crisis. Princeton University Press who published my prior book turned it down.

I am guided by Gramsci’s aphorism regarding pessimism of the intellect and optimism of the will. My intellect tells me that as of now there is no significant political force for progressive change that moves the political and policy debate in the direction I would like to see it go. At best, we are muddling through in a way that contains the economic crisis at its current level. Moreover, if anything, the risks are to the downside from contraction in Europe, risks of trouble in China, slowing growth in emerging market economies, and the prospect of fiscal drag in the US.

In many ways the economic die have been cast. We are now moving into the stage where political risk starts to assume a bigger role. I begin my book with some comparisons with the 1930s and I believe those comparisons remain valid. Mark Twain talked of history rhyming rather than repeating, and today’s rhyme is clearly with the 1930s.

That said I am an optimist of the will. Why else write a book that contains a map for change of economics, politics and economic policy. One has to be an optimist if one believes in constitutional democracy, and I do.

By Dan Kervick, who does research in decision theory and analytic metaphysics. Cross posted from New Economic Perspectives

The recent exchange on the nature of banking among Paul Krugman, Scott Fullwiler, Steve Keen and others has been feisty and instructive. But some readers might be left wondering whether the whole exercise is too wonky by half. The anatomical details of banking systems might be juicy and interesting for the academics who like to dissect those systems and dig deep into their entrails. But how significant are the details for practical questions of public policy? They are in fact very significant.

The functional details of institutions matter, and without understanding how the banking system actually works it is impossible to distinguish causes from effects in our attempts to guide that system toward the service of the public good. Conventional textbook models of banking and monetary systems are responsible for widespread commitment to the money multiplier and loanable funds models of the relationship between central bank reserves and the volume of bank lending. Relying on these models, some prominent economists and pundits have been telling us throughout our recent economic crisis that we can address the problems of a stagnating economy and persistently high unemployment with the reserve management tools of monetary policy alone.

Even worse, some monetary policy hyper-enthusiasts seem to view the Fed has having vast powers to manage the nation’s overall spending level and adjust the nation’s money supply up and down though mysterious and occult mechanisms that extend well beyond the grubby plumbing of the credit system. The Wizard of Fed, it seems, can control the economic minds of Americans though imperious pronouncements on his expectations for the future. Hundreds of millions of Americans, one is led to believe, pay close attention to the Beloved Leader and await his determinative dicta, and then adjust their own behavior accordingly. L’État, c’est Ben. The nation’s central banker is the glass of financial fashion and the caller of the economic tune.

Incongruously, this picture of an America enthralled under a slavish devotion to the oracular sayings of Chairman Ben is often brought forth as an instance of the “rational expectations” approach in economics. Allegedly, the lemming-like congruence of expectations precipitates its own self-generating rationality. Since we all know that we have all tacitly agreed to enslave ourselves to the nation’s central banker, when we then proceed to conform to the general goose-stepping we are behaving quite rationally.

Now I ask you: speak to several of your neighbors tonight and ask them who Ben Bernanke is and what he does, and then consider whether this precious conceit of the court theorists of the financierati has the slightest grounding in empirical reality. I have no doubt that this picture describes the attitudes of some relatively small number people. My guess is that most of the people in question watch CNBC and Bloomberg all day, and manically shuffle their money hither and thither in the asset markets as the tipsters tip and the news items roll in. But down on Main Street where the real economy lives, and where people are too busy working all day – or at least trying to get work – to spend time playing games in the markets? Does the average citizen’s step either quicken or slacken to the cadences called by the Fed chairman? Does the average consumer go to the store looking for a washing machine or an iPad on the Fed’s say-so? It’s doubtful.

This inordinate faith in and reverence for the power of the central bank and the Central Banker has had a profound effect on national policy over the past several decades. The US Congress has assigned to the Fed the “mandate” to achieve full employment, and many now routinely excoriate the Fed for failing to fulfill that mandate. And yet, while there may be more the Fed can do, there is little evidence that the Fed actually has any substantial degree of control over demand and employment in the real economy, at least in a circumstance in which interest rates have fallen as low as they can go. In fact, as various adventures in conventional and unconventional monetary policy have continued to fail, the evidence mounts that faith in monetary policy is misplaced, official mandates notwithstanding. We might as well assign to the Air Force a mandate to deliver pink ponies to every child in America. Just as there is no reason to think that Air Force brass and fighter pilots are particularly well-prepared for satisfying the equine needs of America’s eager tots, it seems increasingly clear that the Fed is not the agency of government best suited to parachuting real jobs down across America.

The problem in America is not bankers who won’t lend. Corporations are already sitting on record-setting amounts of profits and cash, but production and hiring are not booming. The problem is that ordinary people at the foundation of our economy, the people whose desires for goods and services drive the production that employs our resources, are lacking income. They do not want more credit and more debt. They want more income.

Yet it’s not as though we don’t know how to promote economic production, deliver income and boost unemployment when the private sector fails to deliver as much of these social goods as we need. As a monetarily sovereign country, the US government can finance an expansion in spending that does not require either new taxes or burdensome debts left to posterity. What people want the Fed to do – somehow push new, spendable monetary assets into the real economy – the political branches of the government can do better, and in a much more direct and effective way. What is called for is a renewed commitment to fiscal policy, not more exercises in conventional and unconventional central bank policy. We need to return fiscal policy to the front and center of our national discussion of economic policy.

Fiscal policy and the political branches of government are needed to do what the central bank can’t, and to restore our sick economy to health. But there is another reason that we need to rediscover the power and capabilities of fiscal policy. The incessant debates about the virtues of monetary policy tend to encourage people to take an excessively technocratic and abstract view of our nation’s economic policy needs, and to reduce those needs to the rubric of “macroeconomic stabilization.” But our nation doesn’t just need jobs in general; we have specific national needs for specific kinds of work. We don’t just need more production and spending in general; we need to produce and buy specific kinds of things to advance urgent public purposes. The macroeconomist sometimes views spending on a bridge or a school as spending in the abstract; spending that is justified by the mere fact that we need more spending of some kind. But the citizen sees these actions mainly as spending on a bridge or a school – something we do mainly to buy something we need. That’s why monetary policy is a lame substitute for engaged fiscal policy in a democracy. A central bank can, at best, only concern itself with the public purpose of managing the flow of money and credit in general; but the public has very specific purposes in mind.

We are faced with imposing national problems of social decay, public underinvestment, incoherent and feckless national purpose and unconscionable underemployment of people and resources. These are problems that can’t be fixed by Fed money management and expectations setting, and many of them are challenges of national scope that manifestly exceed what we can expect from the hurly-burly and hustle of private sector entrepreneurialism. Solving these problems is going to take an activist national government, and a politically engaged and committed public, directing serious resources toward unmet public purposes. We’re way beyond the point where the only macroeconomic policy we need from the national government is the limited kind of “stabilization” that can be provided by the Fed. Our country is broken and our future prosperity is in deep jeopardy. We need to define large goals, set challenging tasks and get to work. It is time to get people to stop looking to the Fed to do the jobs that can only be accomplished effectively by the American people acting with purpose through their legislative representatives. There is no pure monetary policy cure for what ails us.

One prominent current enthusiast for monetary policy is Scott Sumner, who uses his blog The Money Illusion to promote an approach to monetary policy called “market monetarism”. The core policy recommendation of market monetarism is that the Fed should target the aggregate level of dollar spending in the country, and maintain a stable rate of increase in that level, which includes engineering catch-up spending in subsequent years if spending in prior years false short. Sumner has no doubt at all that the Fed could hit this target if it truly sets its mind to it.

Sumner recently launched a blistering attack on a new paper by J. Bradford DeLong and Lawrence Summers. DeLong and Summers argue in that paper that “discretionary fiscal policy where there is room to pursue it has a major role to play in the context of severe downturns that take place in the aftermath of financial crises.” But Sumner is having none of it. Here is part of his tirade:

So let’s start over. The Fed is unwilling to provide enough monetary stimulus. OK, now what is the point of this paper? Is this to train our future econ PhD students? Are we trying to teach them the optimal policy regime? Obviously not. The optimal regime relies on monetary policy to steer the nominal economy, and fiscal policy to fix other problems. So we are going to defend the model how? A blueprint for failed states? For banana republics? Fair enough, but ask yourself the following question: In a failed state, which is more incompetent branch of government; the central bank or the legislature?

Yes, the Fed is bad. But Congress is downright ugly. Deep down most economists are technocrats. They see the central bank as being the best and the brightest, the guys who are above politics, who will “do the right thing.” And how do economists view our Congress? The terms ’stupid’ and ‘incompetent’ don’t even come close to describing the disdain. So are we supposed to change our textbooks in such a way that the fiscal multiplier is no longer zero under an inflation targeting regime (as the new Keynesians had taught us for several decades?) And on what basis? Because the Fed might be so incompetent that we need Congress to rescue the economy? In what world does that policy regime actually work? If you have a culture that has its act together, such as Sweden or Australia, the central bank will do the right thing. If not, then all hope is lost.

I find Sumner’s assault on fiscal policy and Congressional action to be both economically misguided and politically disturbing.

First, it is hard to understand the practical difference between “steering the nominal economy” and “fixing other problems”. The economy consists in the production and exchange of things of value, and one can measure those values in various ways. One way is to measure goods and services by their current market values as expressed in dollars. But economists have also devised various methods of abstracting away from the fluctuating current dollar as a measurement standard, so as to get at some more stable measure of value that allows for meaningful comparisons across times and places. They thus distinguish between nominal and real measures of value. But while one can distinguish analytically between nominal and real measures of economic activity, there is no such thing as the “nominal economy” that can be separated out for the “other things” and steered independently of those other things. It’s all the same economy, whether its values are measured in nominal terms or real terms.

Perhaps what Sumner has in mind is not dollars as a nominal measure of value, but as a medium of exchange. We live in a monetary economy, and dollars are one of the things that are produced and exchanged in that economy. So the proposal might be that it should be left to the central bank to steer the part of the economy involved in the production and exchange of dollars, and leave it to fiscal policy to steer the part of the economy in which other things are produced and exchanged. But the fact is that almost every transaction that takes place in the United States takes place in dollars. The dollar economy is the real economy, and the real economy is the dollar economy. The economic system which consists of both money and the things money buys is an organic whole of integrated human activity. There is no plausible way of regulating or managing one without regulating or managing the other.

Nor is there a real-world way of institutionally separating the macroeconomic stabilization functions of government from public investment and redistributive operations of government. It’s all part of the same job.

But what is really disturbing about Sumner’s attitude is his haughty and unembarrassed contempt for democratic processes. Sumner actually believes the US should be seen as a failed state and banana republic if it fails to devolve responsibility for it economic fate onto the shoulders of an unelected, elite-governed and autocratic central bank, and away from its stupid and incompetent elected representatives. But my guess is that most Americans, schooled in reverence for democratic traditions and citizen responsibility of self-government, would view things from quite the opposite perspective.

Members of Congress might be corrupt, bungling and in some cases outright incompetent – and these three traits make their sorry presence felt in some eras more than others. But as democratic citizens we know where our obligation lies in such circumstances: Throw the bums out, get a better Congress and then hold their feet to the fire to serve the public interest. If we simply pack it in instead, neglect our obligations, and dispose of our democratic institutions when they are not functioning properly, and then hand everything over to cadres of arrogant and aloof technocrats with minimal democratic accountability, we will have lost more than a few jobs.

Lately, in their zeal to defend to powers of the central bank, we have been getting some truly radical, and frankly dangerous, calls from central bank enthusiasts to allow the Fed to appropriate to itself all sorts of broad spending powers that every American schoolchild has learned are the prerogative of the United States Congress and the people who elect them. And sure, if we allow the central bank to become a second, unelected Congress that can conduct a second channel of fiscal policy by crediting bank accounts and buying things, without any direct democratic accountability or debate over its spending decisions, then it can no doubt have the same kind of macroeconomic impact that an unleashed Congress and Treasury could have. But if we do cross that Rubicon and go down that authoritarian road, turning the Fed into some kind of neo-Soviet Stroibank empowered to spend and command real national resources outside the normal democratic process at the behest of a technocratic elite, we will probably never get our democracy back.

People frequently rail against the pork barrel spending and earmarks that result from the legislative process. But the pork barrels don’t worry me nearly as much as handing our economy over to another generation of theory-addled elitists like Alan Greenspan. As part of the democratic process, representatives come from all over the country to look for the resources to deliver the things their constituents want and need. They wrangle and haggle. And yes, in the process they land a few “bridges to nowhere.” But most of what they get are bridges to somewhere. The people in New Hampshire might not like the way the people in Georgia use their share of our national resources, and the people in Georgia might feel the same way about the people in Oregon. But the end result is that things get built; people are hired; public goods are created; national and local needs are met; things get done.

My sense is that Americans are dead tired of a corrupt and aimless government that can’t or won’t do anything important anymore; that works energetically to deliver resources to its masters in the plutocracy, but then holds up its hands and says “Sorry, out of money!” when suggestions for the pursuit of major public purposes are advanced. It doesn’t have to be this way. America hasn’t always had a Congress full of can’t-do seat-warmers, small thinkers and penny pinchers determined to castrate the national government and let bankers and CEOs run the world. There have been times in our history when we have actually managed to organize our vast resources to accomplish important things and invest public resources in our future.

We have an election this year. I suggest we use it to ditch the empty suits, the plutocratic shills and the small minds, and fill their spots with people ready to act.

Edward Harrison here.

We seem to be moving forward with this discussion on monetary policy, banking, and reserves. Things seemed to be veering wildly off track but I have seen a huge number of good comments in the last 24 hours. Now, John Carney does a good job of summarising some of the initial forays in this back and forth that started between Steve Keen and Paul Krugman but that has since branched out. I am going to try my hand at framing the discussion here in order to weed out a lot of the extraneous stuff. Where there are mistakes, I will fix them accordingly as they are pointed out. I think this is pretty important, so please pay attention to this one.

The comments from the last post I wrote and from a follow on post by Tom Hickey at Mike Norman’s blog got at the heart of the debate and so I will try to characterise what was said.

Framing

We have been living in a world predominated by floating exchange rates and currency non-convertibility for forty years now. Nevertheless, most of economics world seems to take a fixed exchange rate, Bretton Woods, or gold standard view of money and banking. In that world, as Warren Mosler quipped, bank lending is reserve constrained with the interest rate an endogenous variable via bank competition for reserves.

I put it this way in December [emphasis added]:

In the old gold convertible system, the central bank had to jack up rates to prevent an outflow of gold. Interest rates were the release valve. But in those old days, only by adjusting the gold peg i.e. depreciating the currency, could countries under attack get away with low rates once the vigilantes were on to them. That’s what happened during the Great Depression. Once the conversion was broken, the currency depreciated and depression lessened immediately.

Today the release valve is always the currency because there is no gold tether. So the currency gives way, not interest rates.

-Bond vigilantes and the currency relief valve

What this in effect means for the domestic banking system is that in a nonconvertible floating exchange rate system, lending is not reserve constrained as banks can create reserves by making a loan that creates a deposit. Any one institution can always borrow reserves from other banks or from the Fed itself if it finds itself short of reserves (See this BIS paper from 2010 for further discussion).

The US government, as monopoly issuer of its own sovereign currency, has given the Fed monopoly power in the market for base money. The Fed then exercises this monopoly power by targeting the overnight rate for money, the fed funds rate. That is to say, the Fed targets a rate or a price, not a quantity. Almost all modern central banks of today operate with explicit interest rate targets, allowing the overnight rate to fluctuate within a range. Any monopolist can only control either price or quantity, not both. Now, central banks could target something else like reserves to transmit monetary policy into the economy; and they have done in the past. The Fed targeted reserves from 1979-1982. What the Fed found was that it had only a controlling influence on base money because targeting the monetary base meant volatility in interest rates (see this 2004 ECB paper for further discussion). But, more importantly, because bank loans create deposits that actually need reserves to maintain the integrity of the payments system, the Fed is forced to supply them according to its legal mandate.

In short, reserves are about helping set interest rates, not about pyramiding money on a reserve base.

Under present institutional arrangements, the Fed Funds rate is dependent on the Fed’s supplying the required amount of reserves at any given reserve ratio to keep the interest rate at its target or within its target band.  The Fed can’t target a rate unless it supplies banks with all the reserves that the banks need to make loans at that rate. This means that central banks must be committed to supplying as many reserves as banks want/need in accordance with the lending that they do subject to their capital constraints. Failure to supply the reserves means failure to hit the interest rate target. So in practice, if a banking system as a whole is at the reserve limit, central banks always increase the level of reserves desired by the system in order to maintain the interest rate. Not doing so means at once that the Fed cannot hit its target or that transactions fail as the payments system breaks down.

In sum: In a nonconvertible. floating exchange rate system, the amount of credit in the system is determined by the risk-reward calculations of banks in granting loans and the demand for those loans. Banks are not reserve constrained. They are capital constrained. Financial institutions grant credit based on the capital they have to deal with losses associated with that activity.

I don’t think anything I wrote is particularly controversial for those with banking and money as their primary economic discipline or area of study. But if you read textbooks like the one I got in business school by Glenn Hubbard, you find sentences like "The monetary base sometimes is called high-powered money because a given amount of base allows creation of a multiple amount of money" (p. 420, Money, the Financial System and the Economy, Hubbard, 1995). This suggests that the banks in fact are pyramiding credit/money creation on the back of reserves when this is not the case. I checked my intro college economics textbook by Baumol and Blinder from 1985 and it’s exactly the same kind of stuff. The reality is that banks are not reserve-constrained because the Fed must supply reserves to back loans already granted. Only if and when the Fed decides to raise the fed funds rate to curtail credit growth will reserves be constrained. And they will be demand-constrained, not supply-constrained.

Central Bank Flexibility – tactics, strategy, and policy

Given that framing above, the question everyone is asking is whether any of that matters over the long-term. Here’s how I explained Nick Rowe’s objection to the concept of endogenous money:

I think the real difference between what Nick Rowe is saying and what people like Scott Fullwiler and Steve Keen are saying is that Nick believes over the medium-term, central bank interest rate policy is endogenous. What I think Nick means is that Scott Fullwiler’s view is reasonably clear and straightforward in his view that central monetary policy is exogenous but that it only matters over a short-term time horizon because central bank interest rate policy adjusts endogenously over the medium-term to commercial bank and other economic variables such that it is really endogenous rather than exogenous.

Further, I think Nick Rowe is saying that it creates an expectation of central bank interest rate policy merely by announcing its target rate and the market moves to accommodate that target, knowing the central bank is the monopoly supplier of reserves. In that sense the central bank has control. But what he seems to suggest is that the central bank policy rate cannot be determined independent of macroeconomic variables (like inflation specifically) and that central bank may be forced to change policy based on these, making it possible to treat the central bank policy rate as medium-term endogenous.

Nick Rowe says my view of his previous commentary is fairly accurate. Scott Fullwiler doesn’t like the terms short- and medium-term. He would rather see us talk about Fed tactics, strategy and policy.

Scott frames it this way (with minor edits for readability):

1. Tactics – can the central bank directly target reserve balances, monetary base, etc?
2. Strategy – what sort of rules/discretion balance does the central bank follow in adjusting the target it has set tactically. How often? How big of an adjustment each time? By what criteria?
3. Policy – How does the macro economy work and what role can or should the central bank play in stabilizing it?

Scott goes on to say that:

The debate between Krugman/Keen once it got to issues related to the money multiplier and loanable funds was about tactics–can banks individually or collectively create loans without regard to deposits or reserve balances? This is closely linked to an understanding of what banks are/do and hence Krugman’s view that they didn’t need to be included since inserting them didn’t change how one should view the money multiplier or loanable funds models. This is where I jumped in, because Krugman in my view was completely wrong on these points.

But Krugman’s reply to me, and Rowe’s post, brought in strategy and policy–”the central bank must change the interest rate target by adjusting to events and expectations” which is about how the central bank should adjust its target (strategy) within the context of how the macroeconomy works and interacts with monetary policy (policy)…

The MMT view is that we need to understand how the tactics work to inform our strategy and even our understanding of how the economy works. Krugman tried to suggest understanding the tactics is irrelevant to these two. This is a very significant distinction between the approaches.

Further, in MMT, we keep these three (tactics, strategy, policy) separate when we discuss them. Neoclassicals generally don’t–so, when I say the central bank must set an interest rate target (tactics) but can move that target wherever it wants (the possibilities for strategy), Nick says no the cb must set a target that responds to the economy and thus must be endogenous (strategy in the context of view of macroeconomy). We end up talking past each other as I have not invoked yet at all how central banks “should” set strategy with regard to how the macroeconomy works. While we will disagree on the latter, in our view jumping to that without clarifying and setting a common language for tactics and strategy complicates the discussion unnecessarily.

This is progress.

Translation: we agree on the basics here but semantically there are differences. 

• MMT’ers believe the central bank, as monopoly supplier of reserves has monopoly power and therefore full discretion to act as an exogenous actor.
• Nick Rowe says a central bank must set a target that responds iteratively to the economic variables like inflation and thus must be endogenous as a overarching strategy in the context of a macroeconomy).

I think that’s where we stand.

My Conclusions

• We have been living in a world of floating exchange rates and currency non-convertibility but the economics world very often – and wrongly – takes a Bretton Woods view of money and banking.
• The Bretton Woods world is one in which bank lending is reserve constrained with the interest rate an endogenous variable via bank competition for reserves.
• In a nonconvertible floating exchange rate system, lending is not reserve constrained (over the short-term) as banks can create reserves by making a loan that creates a deposit. Any one institution can always borrow reserves from other banks or from the Fed itself if it finds itself short of reserves. If a banking system as a whole is at the reserve limit, central banks always increase the level of reserves desired by the system in order to maintain the interest rate.
• But questions remain about what a central bank can target and to what effect and as to the discretion a central bank has in adjusting any target it has set "tactically". Some say that over the long-term a central bank must respond iteratively to macro economic variables. Others believe the central bank has full discretion to set policy as an exogenous actor.
• My question is whether the above suggests banks MUST be including in any realistic economic model for it to have predictive power even in more extreme economic circumstances like the ones that existed during the great credit bubble. The Great Financial Crisis would suggest yes. yet, many in the economics field resist this notion. Hopefully, we can get more answers on this question as a result of this post.

By Delusional Economics, who is horrified at the state of economic commentary in Australia and is determined to cleanse the daily flow of vested interests propaganda to produce a balanced counterpoint. Cross posted from MacroBusiness.

Back in November last year I posted on my confusion over the jubilation shown by the citizens of Spain as they elected Mariano Rajoy as their new political leader. Mr Rajoy’s strategy during the election campaign was to say very little about what he was actually intending to do to address his country’s financial problems, preferring to simply let the incumbent party fall on its own sword so that he could take the reins. It became obvious soon after the election that, despite his party’s best efforts to dodge questions, the intention was simply to continue with even more austerity.

Since that post I have continually warned that although Spain is obviously a different country to Greece in regards to how its problems have manifested, it still faces significant macroeconomic challenges that were not being correctly reflected in the bond market.

…. Spain which I consider to be the major unrecognised problem. The country has seen its yields tumble since December on the back of the ECB’s 3-year LTRO but there hasn’t been anything in the economic metrics of the country to support such action. Spain has 23% unemployment and still rising, the banking system is under-capitalised and still has unknown exposure to the country’s housing market collapse. On top of that the rising unemployment rates is pushing up bad loans in the banking system to 7.4%, a 17-year high, and is still rising.

As I mentioned this week, since I made those comments bad loans have risen further , house prices have continued to fall and the government’s debt position has worsened.

So it should come as little surprise to MacroBusiness readers that overnight the bank of Spain announced that the country has now fallen back into recession:

Spain’s economy is suffering its second recession since 2009, the Bank of Spain said, obstructing the government’s efforts to reorder public finances as it prepares the budget for this year.

“The most recent information for the start of 2012 confirms the prolongation of the contraction in output in the first quarter of this year,” the Madrid-based central bank said in its monthly bulletin today.

Spain’s gross domestic product declined 0.3 percent in the fourth quarter of last year, less than two years after emerging from the last recession. Prime Minister Mariano Rajoy will present his 2012 budget on March 30, amid growing pressure from investors and European peers to rein in the deficit, which was 8.5 percent of GDP last year.

And so, once again, we see failings of economic logic creeping back into Europe. The reason that Spain’s economy is suffering is because the government sector is attempting to de-leverage in the face of the same behaviour from the private sector after the collapse of the Spanish housing market. You can obviously point to all sort of things that happened in the past and claim they never should have been allowed to occur. Where were the bank regulators? the macro-prudential oversight ? the fiscal policy in order to push against the housing bubble?. All good questions, but none of them change the fact that the Spanish economy is demonstrating its current behaviour because of the government sectors attempt to lower its deficit.

As I have explained previously in terms of national income, a country with a long running current account deficit has been borrowing goods and services from the rest of the world. In order to support this one, or both, of the non-external sectors of the economy will have expanding debt positions and due to this the economy tends to restructure around consumption over investment and production. Because the external sector is a net drain on capital from the country, the government and/or private sector must continually expand their debt in order to maintain economic growth.

In many cases this debt accumulation leads to asset bubbles, because the expanding debt drives asset prices which attracts speculation and in doing so accelerates the external borrowing. This in turn drives up national income, which in turn drives higher prices and further speculation. In the EuroZone, if either sector’s debt is accumulating faster than its income then at some point in the future a limit will be reached and the rate of debt accumulation will fall. This leads to falling asset prices and national income, which ultimately leads to a crisis as accumulated debts start to sour.

This is what we have seen in Spain. The private sector accumulated large debts on the back foreign capital inflows leading to a housing bubble. This bubble has since collapsed leaving the private sector in a position of significant wealth loss and indebtedness, the banking system holding significant and growing levels of bad debts and the economy structured around the delivery of a failed industry.

Prices for Spanish homes fell 3.4 percent in the first quarter from the previous three months as the euro area’s fourth-largest economy shrank and reduced mortgage lending crimped demand, according to Idealista.com.

Sellers cut asking prices for existing homes by an average of 2.9 percent in Barcelona, 1.9 percent in Madrid and 2.2 percent in Valencia, Idealista, Spain’s largest property website, said in an e-mailed statement today.

“Prices have continued to fall due to difficulty in obtaining mortgage financing,” said Fernando Encinar, co- founder of Idealista. “Legislation passed by the government in February to push banks to provision for real estate will result in similar declines over the remaining quarters of the year.”

Prime Minister Mariano Rajoy is battling to turn around a slump in the real-estate industry. His government forecasts an economic contraction of 1.7 percent this year that will push Spain’s unemployment rate, the European Union’s highest, to 24.3 percent. The government passed a decree in February forcing Spanish banks to make deeper provisions for losses linked to real estate in an effort to push down prices and boost sales.

The growing unemployment is leading to a slowing of industrial production, which means that even though the country is importing less it also appears to be exporting less. Combine this with the interest payments on borrowings from the rest of the world and at this point Spain continues to run a current account deficit which, in the most basic terms, means Spain is still paying others more than it is being paid back. That is, the external sector is still in deficit.

So with the external sector in this state and the private sector unable and/or unwilling to take on additional debt as it attempt to mend its balance sheet after an ‘asset shock’, the only sector left to provide for the short fall in national income is the government sector. If it fails to do so then the economy will continue to shrink until a new balance is found between the sectors at some lower national income, and therefore GDP.

It may appear logical to you that this must occur, and I don’t totally disagree, but that doesn’t change the fact that under these circumstances there is simply no way that the private sector will be able to continue to make payments on the debts it has accumulated during the period of significantly higher income. This is a major unaddressed issue.

This is why we continue to see a rise in bad and doubtful debts in the Spanish banking system which, under direction from the Government, banks continue to merge.

Spain’s biggest bank in terms of assets has been created after CaixaBank bought Banca Civica for 977m euros ($1.3bn, £817m). The government has amended laws to encourage mergers between banks, many of which collapsed following the bursting of the property bubble.

Banca Civica itself was formed by combining four troubled “cajas”, or regional savings banks. The merged bank will have 14 million customers.

CaixaBank will have 342bn euros in combined assets, deposits of 179bn euros and loans totalling 231bn euros, the bank said. The CaixaBank deal will be completed by the third quarter and will generate cost savings and other benefits of 540m euros by 2014.

The problem is that, apart from economies of scale, merging banks doesn’t actually help that much because impaired assets don’t suddenly disappear. The other issue is that Spanish banks have been large users of the ECB’s 3 year LTRO facility which means they have continued to load up their balance sheets with their own countries sovereign debt in order to participate in the carry trade.

It is quite possible, as I explained above, that the LTRO was masking the true value of those sovereign bonds and that Spanish banks have made a terrible decision by making those purchases. Here are the current 10 year yields for Spanish government bonds, courtesy of Bloomberg:

If yields continue to rise, and I see no reason to discount this possibility, then Spanish banks are eventually going to have to front-up more capital to cover those ECB loans. Where exactly is this going to come from?

And so I am starting to get a bit of deja vu.

The eurozone’s public debt crisis is not over despite calmer financial markets this year, the OECD said on Tuesday, with a warning that the bloc’s banks remain weak, debt levels are still rising and fiscal targets are far from assured.

As the eurozone heads into its second slump in just three years, the Organization for Economic Co-operation and Development (OECD) said the 17-nation area needed ambitious economic reforms and there could be no room for complacency.

“Market confidence in euro area sovereign debt is fragile,” the Paris-based economic think tank said in a report on the state of the eurozone’s health. “The outlook for growth is unusually uncertain and depends critically on the resolution of the sovereign debt crisis,” it said.

….

OECD chief Angel Gurria has called for “the mother of all firewalls” – some 1 trillion euros – but finance ministers look more likely to agree to a level nearer 700 billion euros.

I’m sure we’ve been here before.

By Delusional Economics, who is horrified at the state of economic commentary in Australia and is determined to cleanse the daily flow of vested interests propaganda to produce a balanced counterpoint. Cross posted from MacroBusiness.

Anyone who has been following my European commentary for any length of time will know that I have been running a number of risk themes on Europe due to what I consider to be misguided and one-sided policy which will ultimately be counterproductive.

These themes come under the major trend that I see in the Eurozone:

.. Periphery nations weakening, France in the middle, Germany outperforming, but the whole ship slowly sinking.

This analysis is based on the sectoral view of the European periphery which I explained on Monday in a discussion of the Australian economy:

As we have seen from nations like Greece and Portugal, a country with a long running current account deficit and a private sector with a desire – or no choice to save (austerity) – has significant problems trying to reach a government surplus. Once you understand that the external sector and the private sector are a net drain on national income it isn’t hard to see the problem. Under these circumstances there is simply no room left in the economy for savings in the government sector and attempts to reach government surpluses become counter-productive as this simply accelerates the decline.

If a country’s current account deficit is structural ( I’ll explain this later ) then these efforts are very dangerous because this can easily develop into a damaging feedback loop. The loss of income through the external sector leads to a loss of income in the private sector, this then drives the stronger desire to save, meaning government revenues fall further. This inevitably leads to calls for higher taxes, which once again drain income from the private sector … and around we go. The result of this dynamic is a rise in unemployment, therefore national production and income, meaning once again the government sectors revenue decline while private sector spending and investment fall further.

And the story is the same if you look at this from the perspective of national income. A country with a long running current account deficit has been borrowing goods and services from the rest of the world. In order to support this the non-external sectors of the economy will have expanding debt positions and due to this an economy structured around consumption over production. Because the external sector is a net drain on capital from the country, the government and/or private sector must continually expand their debt in order to maintain economic growth.

In many cases this debt accumulation leads to asset bubbles, because the expanding debt drives asset prices which attracts speculation and in doing so accelerates the external borrowing. This in turn drives up national income, which in turn drives higher prices and further speculation. If a sector’s debt is accumulating faster than its income then at some point in the future a limit will be reached and the rate of debt accumulation will fall. This leads to falling asset prices and national income, which ultimately leads to a crisis as accumulated debts start to sour.

This is what we have seen across the European periphery, although the debt has accumulated in different sectors of the economy across different countries. Ultimately, however, once a European country falls into crisis the debt has ended up in the government sector, even if it didn’t start there, because Europe has chosen to keep banks alive at all costs. This ideology, however, is the major issue with the “Austerity” plan.

After a financial crisis the private sector tends to have lost significant amounts of wealth which leads to both the loss of demand for, and ability to support new borrowing. The debts to the rest of the world still exist which tends to mean the external sector is still in deficit even with lower demand for imported goods. This means that in order for the nation’s income to remain at the previous level the government sector must go into deficit to offset the fall in private sector credit creation. If this does not occur then the economy will shrink until a new balance is found between the sectors, which basically means the economy will try to find equilibrium at some lower national income, and therefore GDP.

This is the sort of deflationary policy that Europe is endeavouring to implement in the European periphery. There is just one BIG problem. At a lower national income the country has no ability to service the debts that it accumulated on its previous income, yet that is what Europe expects to occur. This is simply delusional, because it is a mathematical impossibility and in trying to break these basic laws of arithmetic Europe is slowly destroying the economies of the European periphery which will, in turn, bring down the stronger economies.

Which brings me to last night’s Flash PMI data.

Flash Germany Composite Output Index(1) at 51.4 (53.2 in February), 3-month low.
Flash Germany Services Activity Index(2) at 51.8 (52.8 in February), 4-month low.
Flash Germany Manufacturing PMI(3) at 48.1 (50.2 in February), 4-month low.
Flash Germany Manufacturing Output Index(4) at 50.5 (53.9 in February), 3-month low.
Flash France Composite Output Index(1) falls to 49.0 (50.2 in February), 4-month low
Flash France Services Activity Index(2) remains unchanged at 50.0
Flash France Manufacturing PMI(3) drops to 47.6 (50.0 in February), 4-month low
Flash France Manufacturing Output Index(4) declines to 47.0 (50.8 in February), 7-month low
Flash Eurozone PMI Composite Output Index(1) at 48.7 (49.3 in February). 3-month low.
Flash Eurozone Services PMI Activity Index(2) at 48.7 (48.8 in February). 4-month low.
Flash Eurozone Manufacturing PMI (3) at 47.7 (49.0 in February). 3-month low.
Flash Eurozone Manufacturing PMI Output Index(4) at 48.8 (50.3 in February). 3-month low

And so you can see that the major theme continues. Stemming from that major theme ,and associated analysis, I have had some major expectations.

1. That Portugal would follow Greece.

This now appears to be occurring in ernest:

Portugal’s core public deficit nearly tripled in the first two months of 2012, showing a deepening economic slump is denting tax collection and stoking concerns the country may miss its budget targets and follow Greece in requiring more rescue funds.

The gap widened to 799 million euros ($1.06 billion) from 274 million euros a year earlier, when the deficit had slumped by more than 70 percent, the finance ministry’s budget office said on Tuesday.

2. Spain was a large unrecognised problem that would return to the spot light:

The country has seen its yields tumble since December on the back of the ECB’s 3-year LTRO but there hasn’t been anything in the economic metrics of the country to support such action. Spain has 23% unemployment and still rising, the banking system is under-capitalised and still has unknown exposure to the country’s housing market collapse. On top of that the rising unemployment rates is pushing up bad loans in the banking system to 7.4%, a 17-year high, and they are still rising.

Since I made that statement bad loans have risen further, house prices have continued to fall and the government’s debt position has worsened.

3. Italy could grow out of its economic slump but was unlikely to owing to history, structure and demographics:

The real problem in Italy is that its economy has been stagnant for nearly the entire decade. According to the IMF, among all countries in the world between 2000-2010 Italy only grew faster than Haiti and Zimbabwe. In 2010, Italian GDP was only 2.5% higher than in 2000. This problem is actually made worse by the fact that this is such a long term trend. Italy’s per-capita GDP growth was 5.4% in the 1950s, 5.1% in the 1960s, 3.1% in the 1970s, 2.2% in the 1980s and 1.4% in the 1990s. Since the new millennium the country has hardly moved forward and if we extrapolate out that trend Italy will spend the next decade in contraction.

On top of stalling growth, Italy has a demographics issue. With a debt to GDP ratio at 120% along with a population with a median age of approximately 45 Italy really does look like the Japan of Europe. The only problem is Japan is competitive, runs a trade surplus and is sovereign in its own currency. Italy has none of these things.

The latest stats from Italy appear to show that the economy continues to weaken and GDP continues on its long running downward trend.

4. Although the ECB’s emergency response to the crisis may have averted the crisis in the short term, it is likely to lead to a zombification of the periphery banking system and therefore add to the downward pressure on periphery economies.

The jury is still out on this one because we need to wait for the ECB’s Quarterly bank lending survey to get the results. This was noted by FTAlphaville overnight:

The effectiveness of the LTROs, and other extraordinary operations of the ECB, can at the moment be judged by some metrics (and general sentiment) positively. However, it seems a bit rash to call them an “unquestionable” success until the liquidity is actually shown to improve bank funding markets, and ultimately land in the real economy.

So we will just have to wait and see on that one. Overnight we also saw news that Ireland, the strongest of the periphery in terms of export potential, fell back into recession due to falling trade volumes.

In total, it is fairly clear to me that Europe’s troubles are far from over because the area continues to meet my predictions. That, however, didn’t stop Mario Draghi from trying to convince the world otherwise:

European Central Bank President Mario Draghi has said the worst of the eurozone crisis is over. In an interview with Germany’s Bild newspaper, he said the situation in Europe was “stabilising”.

Mr Draghi also said that some economic data, including inflation and budget deficits, showed that Europe was doing better than the United States.

The European crisis and the associated delusional rolls on.

By Philip Pilkington, a writer and journalist based in Dublin, Ireland. You can follow him on Twitter at @pilkingtonphil

Last Friday the BBC’s economics editor Stephanie Flanders ran one of the most terrible economics articles I’ve ever read: ‘The Truth About UK Debt.’ The problem is that it contains very little truth.

The reason it contains so little truth is because, not to put too fine a point on it, Flanders comes off as having quite literally no idea what she’s talking about. In fact, the piece comes across as less an article and more a smattering of graphs and uncontextualised facts. To say that it reads like something on the Zerohedge website would be unfair. But in terms of sheer incomprehensibility and vagueness it is certainly poised in that direction.

The article sets out to convince the reader that the UK does not have a problem with private sector debt. Sounds pretty fishy, right? Well, it is fishy. Very fishy. Especially given that the author starts out with the following graph:

That chart, to me, looks pretty damning – and it doesn’t even take into account the financial sector (more on that in a moment). Clearly the private sector has been leveraging itself up to the eyeballs. You can also see that after 2008 they started slowing their accumulation of debt.

None of this is particularly hard to interpret. As private sector debt increases more money is spent into the economy. As it decreases we must assume that, all else being equal, less money is entering the economy. When less money enters the economy we must assume that less people are spending and investing. This should lead to a fall in economic activity.

Of course, that’s exactly what we’re seeing in Britain right now. Unemployment is up. GDP growth is down. And everyone’s feeling a bit miserable.

The Australian economist Steve Keen wrote a piece for the London School of Economics website the other day entitled ‘Ignoring the Role of Private Debt in an Economy is Like Driving Without Accounting for your Blindspot’.

The first thing to note about the article is that Keen estimates that British private sector debt is much higher than some 210% of GDP which seems to be the figure that Flanders is working off. Keen discussed estimations in another piece entitled ‘Everyone is Starting to Realise the Size of Britain’s Debt Crisis’. There he noted that when the financial sector is taken into account the UK government estimates that the total private sector debt is around 450%. Meanwhile, independent observers like Morgan Stanley put the total figure at about 950%. Sheesh!

Applying the official measure Keen provides a chart of his own that juxtaposes the rate of the change in private sector debt and the rate of unemployment. Unsurprisingly there is a pretty strong correlation.

Again this makes perfect sense if you think about it. When a household or a firm, financial or non-financial, takes on debt this is then used to either spend, invest or speculate on asset prices. Assuming that not all of it is going into speculation (a good deal might be, of course) then any debt taken out by the private sector becomes an income for another person or firm.

It seems perfectly obvious that, like much of the rest of the world, Britain’s fairly decent economic growth in the 1990s and 2000s was driven primarily by an unsustainable private sector debt binge. Now that the binge is over it appears equally obvious that Britain can no longer rely on huge injections of private sector debt to ensure economic growth.

Flanders ignores all this. Instead of providing analysis and contextualisation she goes on to talk about how much debt is owed to other countries. This is an interesting topic primarily from the point-of-view of the exchange rate, but it is not a central issue.

She also talks about causation: do house price rises lead to debt booms or vice versa? What does this have to do with anything? Not much. But such is the rambling nature of Flanders’ article. Indeed, it doesn’t mean much to say that the question of causation has little to do with the central point of her article when her article, in fact, has no central point.

Finally she makes vague allusions to the government debt being ‘unsustainable’ and slowing growth. Of course, as any economist that isn’t completely dim will tell you government deficit spending actually leads to increased growth. That’s not a theory. That’s an accounting statement. When the government spends money it becomes an income for the private sector. This is then entered into the GDP accounts at the end of the year. If the private sector agent then spends within the country another entry is made in the GDP accounts at year end (this is known as the ‘multiplier effect’). This is all pretty basic stuff, but Flanders doesn’t seem to have a clue.

The worst part of all this though is that she didn’t come up with this contrarian nonsense herself. She took it on from Ben Broadbent, an economist and member of the Monetary Policy Committee.

Broadbent’s argument is more logically consistent than Flanders’ scattergun-style article, but in saying that it is more logically consistent is not to say that it makes much sense.

Broadbent recognises that there was a property bubble but claims that this didn’t have any real effects on the economy because it was primarily a transfer of wealth between those trading up in the market and those trading down. This is pretty weird stuff altogether.

How much economic activity was undertaken during the property boom due to rising house prices? How many new houses were built or refurbished in those years that otherwise wouldn’t have been? The Cautious Bull provides us with this handy chart which should give us some idea of how much economic activity was being generated from home building alone:

And that doesn’t even take into account the various other sectors being driven by home construction OR the wealth effect generated by the uptick in property prices OR the multiplier effect such economic activity had. Any economist worth his salt should know the importance of the housing sector as a driver of the economy.

Broadbent ignores the simple fact that the housing and credit boom was clearly generating high levels of unsustainable economic activity. Instead he goes on to argue that the British credit crunch was mainly caused by the blowing up of various investments made abroad. How this dampened British economic activity so severely, he’s not exactly clear on. But the reader gets the strong impression that Broadbent isn’t really concerned with real economic activity – or reality, for that matter. He’s more interested in his strangely disconnected theories about balance sheets and their interrelations.

Broadbent’s her article is sloppy and manifestly confused. And we can’t blame Flanders for that. She has tried to grasp Broadbent’s argument and failed – but that’s mainly because Broadbent’s argument is weird, counterintuitive and most likely wrong. As a journalist Flanders should know that if she cannot summarize an argument succinctly then she has either not understood it properly and needs to try again, or it is no argument at all and the person making it is either having her on or too confused to be trusted.

Wow, the AARP must be taking lessons from the Democratic Party, that you can afford sell out your putative base if you do the bidding of really big moneyed interests.

In case you missed this saga (it wasn’t one we posted on till now) in June last year, AARP’s board approved supporting Social Security cuts. That followed a multi million dollar ad campaign against the very same stance. They planned to sell the future of old people living off dog food to the membership via a series of town hall meetings.

The backlash from the membership led to the purge of the policy chief John Rother, who was made a scapegoat.

The latest development, reported in the Huffington Post, shows the housecleaning didn’t go far enough. AARP members need to demand resignation of all directors who are behind this scheme, which is probably all of them. Protests at their homes might be necessary to rein in an board which is so insistently defying its members wishes and interests.

And to add insult to injury, the AARP plans a “listening tour” which is of course not at all about listening but selling a “Grand Bargain” which is more Newspeak, in this case the idea of a budget deal that includes retirement program cuts. The Huffington Post does a great job of exposing how the leadership of the AARP is flat out lying to its members about its conduct:

An AARP invitation to a secret “Relaxed and Robust Evening of ‘Salon Style’ Conversation” to be held at a Capitol Hill home on March 27, obtained by The Huffington Post, indicates that the organization is still very much interested in a “grand-bargain” style deal that puts Social Security and Medicare cuts on the table…

The list of invitees to the salon event includes a gallery of powerful Washington establishment figures who are on record favoring cuts to Social Security and Medicare. The only firm opponent of Social Security or Medicare benefit cuts on the list, the Economic Policy Institute’s Larry Mishel, said he wasn’t planning to go and wasn’t sure why he was listed as a featured guest. (AARP also responded to the request for comment by inviting HuffPost to attend the off-the-record gathering, an offer we plan to accept.)

Other listed invitees included business leaders and deficit hawks who have long argued for the cuts, including Tom Donohue of the U.S. Chamber of Commerce, John Engler of the Business Roundtable group for corporate CEOs, and David Walker, a noted deficit alarmist and former head of the Government Accountability Office.

Yet the AARP wants its members to believe this sort of tripe:

“AARP is not pursuing any closed door deals or grand bargains,” said an AARP spokeswoman. “Our main focus is hearing from our members, and all Americans, what they think about ways to strengthen Social Security and Medicare. That’s precisely why we’re launching ‘You’ve Earned a Say.’ We are interested in hearing from all sides and having civil discourse on these issues.”

This isn’t even a good con. The AARP has no business “hearing from all sides.” Its mission is to represent its members, and they’ve made it clear they have no interest in having their benefits cut. Indeed, having the AARP stand firm would serve to put focus on the right issues which is that the real problem is Medicare, not Social Security, and the problem with Medicare is a broad social problem, that health care costs have and continue to rise much faster than inflation. Determined pushback from seniors and other parties could put focus on the real issue and serve as an important counterweight to the health care lobby.

The HuffPo article points out the fallacy of the leadership’s turncoat logic:

“They want to be at the table when a deal is cut,” said one person who declined to be named because he continues to work closely with AARP. The irony is that while AARP’s legislative team may be convinced that a deal is inevitable, a grand bargain actively opposed by AARP would be effectively impossible for Congress to pass.

If you are a member of the AAPR or have relatives who are members, send this article on and tell them to call or write and tell the organization that you aren’t standing for this. Nor should you. You are about to be sold out by incompetent lobbyists unless you make a stink. You can also join the campaign at Firedoglake to cancel the event.

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.

This Real News Network interview with William Crotty provides a useful overview of the current Obama stance on the Federal budget. Crotty does an adept job of delineating the gap between the President’s rhetoric and his policy stance.

By Cathy O’Neil, a data scientist who lives in New York City and writes at mathbabe.org

A bit more than a week ago I went to a panel discussion at the Met about the global financial crisis. The panel consisted of Paul Krugman, Edmund Phelps, Jeffrey Sachs, and George Soros. They were each given 15 minutes to talk about what they thought about the Eurocrisis, especially Greece, the U.S., and whatever else they felt like.

It was well worth the $25 admission fee, but maybe not for the reason I would have thought when I went. I ended up deciding something I’ve suspected before. Namely, economists don’t understand the financial system, and moreover they don’t get that they don’t get it. Let me explain my reasoning.

The panelists all were pretty left-leaning guys, and each of them talked about how the U.S. government should stimulate the economy in one way or another. Krugman kept saying that hey, this isn’t too hard, we’ve seen financial crises before, and this is no different: we should immediately pass a massive stimulus package, that’s the one and only thing that we should be discussing. Sachs was very consistently saying we should do something else: namely, start planning long-term for the future. He focused on the percent of tax dollars going into infrastructure and basic education and research. Phelps also wanted stimulus, but he consistently referred to his own economic models in how exactly it should work. I didn’t completely follow his train of thought.

Soros was the most interesting of the four, in my opinion. He started by saying that we should all acknowledge that, as nice as it would be to think we can model the economy and feel control over the situation, this is a pipe dream and we should get used to not really knowing what will happen when we do one thing versus another. He suggested that we should instead work together to develop a theory, or perhaps even an philosophy, that assumes uncertainty itself. He ended by saying that, even with the three colleagues on the panel with him, who are essentially all united in thinking we need to be proactive, his ideas are essentially being ignored.

The rest of the evening essentially consisted of everyone ignoring Soros and arguing about how Keynesian they all were and how exactly different kinds of stimulus would work and which way they should use 2% of GDP to jumpstart the world’s economy. So basically exactly what Soros said would happen.

It got me more and more riled up. Here are these expert economists, two of whom have Nobel Prizes and the third who runs the Earth Institute at Columbia and is considered a huge swinging dick in his own right, and they don’t seem to acknowledge how much power they actually have over the situation (specifically, not much). For that matter, they clearly don’t know the nitty gritty of the financial system. To listen to them, all you need to do is spread a thick paste of money on the system and it would revive whole cloth. Soros is the exception, probably for the reason that he actually traded and made money inside the system.

At the end I asked a question, since they allowed a few questions, and as you know I’m not shy. I asked how we are going to make the system simple enough to actually make it possible to regulate it. Krugman basically said that Dodd-Frank is going to do it. My conclusion from that is that Krugman must really have only an outline in his head of how this stuff works- the devil, as we know, is really in the detail, and I’m too acquainted with the Volcker Rule’s list of exemptions to have a lot of hope on this score. To be fair, Phelps mentioned Amar Bhide’s book A Call for Judgment, which I’m reading and seems pretty good and at least addresses this exact issue head-on.

Overall, the evening brought me back to the credit crisis, and working at D.E. Shaw, when Larry Summers was consistently quoted at the firm as saying that the “magical liquidity fairy” needed to come and “spread some magical liquidity dust” in the markets to make everything better. No, I’m not kidding.

What I felt then and what I still feel is that these super influential economists are so high on their clean, simple economic models of the world (about the only variables of which are GDP, stimulus, and tax rates) that they focus on the model to the exclusion of the secondary issues. Sometimes you get important results this way: simplifying models can be really useful. But sometimes it’s really truly misleading to do so, and I believe this is one of those cases.

I’m left thinking that they (the economists) are so entranced with their simplified world view that still don’t understand what actually fucked up the world in 2007 and 2008, namely the CDO market’s implosion. Message to Krugman: this is not exactly like other financial crises, because it’s partly caused by complexity, and nobody seems to have the balls to fix it. The problem is that the financial system has been allowed to get so complicated and so rigged in favor of the people with information, that normal people, including homeowners, credit card users, politicians, and regulators have been left in the dark, and many of the little guys are still stuck in ludicrous contracts left over from the outrageous securitizations that took place in the CDO market.

What is especially enraging is how these same economists are still the experts that people turn to to help figure out how to get out of this mess, when they don’t actually understand the mess itself. Why else would a large audience be willing to pay $25 a piece to hear them talk about this? Why else would Obama be considering Larry Summers to lead the World Bank?

As an aside: please, Mr. President, do not let Summers lead the World Bank. He does not understand the system well enough to lead it. And he is too arrogant to admit what he doesn’t know. I can introduce you to a bunch of people that may be less imposing but are more informed, more ethical, and wiser. Give me a call any time and we can chat and form a short list of candidates.

By the way, I’m not saying we shouldn’t have a major stimulus, or that we shouldn’t do longer term planning and invest more in infrastructure. I think we should do both. But I also think those efforts will be futile unless we enforce a basic system that is simple enough to be regulated. Otherwise we will be reliving this entire ordeal in another 15 years.

By Philip Pilkington, a journalist and writer living in Dublin, Ireland

Vote or die muth#%#^*#, muth#%#^*# vote or die,
Rock the vote or else I’m gonna stick a knife through your eye,
Democracy is founded on one simple rule,
Get out there and vote or I will muth#%#^*# kill you.

– P. Diddy ‘Vote or Die’

The Irish Taoiseach Enda Kenny has announced that a referendum will be called so that the Irish people can vote on the new and oh-so-suicidal fiscal compact. If it is voted for Ireland will be subject to years of harsh austerity. Nothing new there. But, perhaps worst of all, if the vote goes through this austerity will crush the Irish economy into ruin wearing the mask of democratic consent.

Last week we reported murmurings coming from within the opposition party calling for a referendum. The senior opposition party adviser that I spoke to indicated that he might try to push for a referendum, calling the fiscal compact “madness”. Fair enough, we’re all agreed there. But this was probably a political manoeuvre plain and simple.

The opposition thought that they could have a few swipes at the government by questioning the democratic legitimacy of their decisions. But apparently the government have called their bluff and agreed to hold a referendum.

My reading is that the government are perfectly confident that they can push the vote through. The Irish people are against austerity, but they have a vague inclination that ‘There Is No Alternative’. The government are confident that they can play on this fear in order to push the public into voting the way they want them to.

The previous government did something similar with the Lisbon Treaty. The Irish people had originally voted it down much to the annoyance of the Eurocrats, so the Irish government repackaged it and made people vote again. They then launched a massive campaign scaring people into thinking that if they didn’t vote ‘Yes’ to the treaty they would see mass unemployment in the country. The campaign was called ‘Yes to Lisbon, Yes to Jobs’.

In Ireland at the time people joked around that we had voted ‘wrong’ last time and that we must now vote ‘right’ this time. Many people who had voted ‘No’ to the original treaty either did what they were told because they believed the government’s blatant lies about the link between the Lisbon Treaty and Irish employment or they simply stayed at home on voting day. Most people I know who voted ‘No’ the first time around were too cynical to vote a second time, resenting the fact that they were being treated like children by their government.

The PR campaign that was launched during the Lisbon campaign was carried by most major media outlets, most businesses and most political parties. Put simply, almost the entire Irish elite got behind it. The voices pointing out the hypocrisy of having the Irish people vote twice on the same issue were drowned out in a flood of misleading soundbites and ideological op-eds that poured forth from almost every outlet.

With the coming referendum on the fiscal compact the government and the media will ramp up the rhetoric to an even higher pitch. We already see business groups and major political parties coming out in support of the fiscal compact.

What’s more, the government won’t have to lie this time around. They will be able to quite honestly say that if the Irish people don’t vote the compact through our funding will be cut off. This will be far more effective than he nonsense they tried last time linking Irish employment to the Lisbon Treaty – and remember, even that worked when it was shoved down peoples’ throats at the time.

Put simply: this isn’t a real vote because no one in their right mind would vote for their own suicide. If the Irish people do dare to vote against the fiscal compact they will be told to vote again and battered with ever more serious threats (no doubt backed by European leaders who will come up with all sorts of awful things they will do to us if we don’t accept the terms). The democratic legitimacy gained by the vote will then be used in the coming years to justify the slow and painful death that our economy will be subject to.

After this referendum the Irish people will be seen to have made a real decision and will be said to have no reason to complain. This reminds me of an old point of logic.

A mugger approaches a man in a dark alley points a gun at him and says “Your money or your life”. Of course, the mugger is being dishonest because if the man refuses to fork over the cash the mugger will shoot him and take the money anyway. So, he really has no choice – if he doesn’t give over the money he will lose both his money AND his life.

Ireland will soon be put in a similar position. We will be given the false choice to either vote for immediate economic destruction or gradual economic destruction. No prizes for guessing what we’ll choose. And afterwards commentators and politicians will insist that we have no right to complain; after all, we handed over the money voluntarily… right?