Auerback/Parenteau: Coming to a Country Near You: Let a dozen Latvias bloom?

By Marshall Auerback, a fund manager and investment strategist and Rob Parenteau, CFA, sole proprietor of MacroStrategy Edge, editor of The Richebacher Letter, and a research associate of The Levy Economics Institute

Want to see the real consequence of smash mouth economics? Forget about Greece and take a look at Latvia. Its 25.5 per cent plunge in GDP over just the past two years (almost 20 per cent in this past year alone) is already the worst two-year drop on record. The country recently reported a 12% decline in annual wages in Q4 2009 versus Q4 2008. The IMF projects another 4 percent drop this year, and predicts that the total loss of output from peak to bottom will reach 30 percent. The magnitude of this loss of output in Latvia is more than that of the U.S. Great Depression downturn of 1929-1933.

Policies and systems built for failure

Mainstream economics insists that one path to full employment is via lower wages. If you want to sell more labor services, lower the price of them, namely wages. This is a classic fallacy of composition argument. What might work for one firm is unlikely to work for all firms. Wage cuts in the aggregate simply destroy aggregate spending power, unless the lost demand is made up for in other ways.

But even though Latvia’s external balance is improving (largely through a collapse of imports as a result of the collapse of domestic demand), the country is unable to deploy fiscal policy effectively due to the external constraints of its monetary system, which is predicated on the existence of a currency board system. True, the current account is now turning positive, but to suggest that every single country can “internally deflate” its economy via wage destruction of this magnitude to achieve this state of affairs is another fallacy of composition argument. The whole world cannot run trade surpluses, especially not if policy is designed to destroy demand via massive wage destruction.

More importantly, the very structure of a currency board is wrong. It requires a nation to have sufficient foreign reserves to facilitate 100 per cent convertibility of the monetary base (reserves and cash outstanding). Under this system, the central bank stands by to guarantee this convertibility at a fixed exchange rate against the so-called anchor currency. The government is then fiscally constrained and all spending must be backed by taxation revenue or debt-issuance. Pegging one’s currency, then, means that the central bank has to manage interest rates to ensure the parity is maintained and fiscal policy is hamstrung by the currency requirements (which is why organizations like the IMF love them so much; it ties governments’ hands). Latvia pegs its currency at 0.71 lat per Euro and joined the ERM in 2005 with the intent of qualifying for the euro zone. It operates a system similar to Argentina in the 1990s which ultimately collapsed and led to its default in 2001 (Argentina pegged against the US dollar).

The country’s debt is projected to be 74 per cent of GDP for this year, supposedly stabilizing at 89 per cent in 2014 in the best-case IMF scenario. A devaluation, however, would substantially raise the debt service ratios, given the high prevalence of foreign debt (about 89% of Latvia’s debt is euro denominated). The currency peg, then, not only restricted the Latvia government’s freedom of fiscal maneuver, but also created huge financial fragility because Latvians operated under the mistaken assumption that the peg was inviolable, encouraging borrowers to act with no sense of exchange rate risk. As in Argentina nearly a decade ago, a devaluation would, in all likelihood, lead to a default on external debt. Argentina did eventually manage a 25% recovery in output in the two years following Q1 2002, but only after a 190% devaluation (which was 300% at its maximum)

As Michael Hudson and Jeff Sommers have noted, “these debt levels place Latvia far outside the debt Maastricht debt limits for adopting the euro. Yet achieving entry into the euro zone has been the chief pretext of the Latvia’s Central Bank for the painful austerity measures necessary to keep its currency peg.” They also point out that maintaining that peg has burned through mountains of currency reserves that otherwise could have been invested in its domestic economy. It has also precluded the use of fiscal policy, since (by virtue of Latvia’s peg to the euro), the country operates under the same constraints as if it were already working within the Stability and Growth Pact rules.

‘Internal devaluation’ is a toxic remedy

With no room to adjust the exchange rate, the only other way to make the currency lose value is to engineer a real depreciation — that is, reduce labor costs and prices in order to make its tradable products more attractive. This is euphemistically being described as an “internal devaluation” — a one-off coordinated reduction of wages and prices across the board. It is, in reality, more like an “infernal devaluation”. It amounts to a domestic income deflation as wages are crushed in order to get the prices of tradable goods down enough so the current account balance increases sufficiently enough to carry the next wave of growth. The hidden assumption is that a debt deflation spiral does not do the host country in as domestic private incomes are deflated. The argument to justify this toxic remedy is that a reduction in nominal wages and salaries can help Latvia accomplish a boom in net exports, thereby enhancing an economic recovery which would quickly attenuate or short circuit any accompanying debt deflation dynamics that might have been set off at the inception of the internal devaluation.

Here, in a nutshell, is a country which shows us all of the misery that is enacted through the creation of self-imposed political constraints on policy. The Latvian government has voluntarily abandoned the policy tools that could make the lives of their citizens better. Policy makers have tied both their hands and their feet behind their backs so that markets could work their self-adjusting magic. They have pegged their currency; they are furiously slashing their net fiscal spending (under the IMF agreement they are due to cut their net position by 6.5 per cent of GDP — a huge fiscal contraction), and the economy continues to deteriorate.

This is something likely in store for Greece, which has recently introduced a new round of austerity measures in order to ensure the success of its latest bond offering. Greece and other countries now face the prospect falling private sector incomes – that is, after all, the direct and immediate result of higher taxes on businesses and households, and lower government expenditures. Euro area nominal GDP is already estimated by the OECD to have fallen over 3% in 2009. Unless the trade deficits of the nations pursuing fiscal retrenchment can swing sharply into surpluses (as lower domestic incomes lead to less import demand, and lower costs of production lead to higher exports), private debt defaults will now start to multiply and cascade through the system. Last week, as we mentioned, Moody’s placed 4 Greek banks on downgrade watch. This is just the start – the fiscal retrenchment has only just begun to take effect. By taking these steps to avoid a public debt default, we would suggest these economies are now poised for more private debt defaults.

We believe private investors do not yet get this connection, but it will be made very clear in the months ahead. Latvia, with a GDP collapse of nearly 25%, will become the poster child of the region in this regard. This private debt distress will back up into higher loan losses at German banks. Germany’s hard won current account surplus will continue to fade Loan growth is already dead in the water in Europe, and if the above analysis is correct, banker perceptions of private sector creditworthiness are about to go “pear shaped”, as they so delightfully put it in London.

Paradox of public thrift

But that’s not all. Each of these countries are about to discover what we will call the paradox of public thrift. Argentina discovered this in 2001-2. Latvia and Estonia have recently rediscovered it. Ireland is rediscovering it, and within the next three months, Greece will no doubt discover it as well. We will let Bill Mitchell’s comments depict the nature of this paradox for you, because it really does capture the essence of the dilemma at hand:

From Ireland: Gov’t took billions of €’s out of the economy in the form of public service pay cuts, pensions cuts, dole cuts + wave of private employees replaced by agency workers at minimum wage rates… Guess what? January tax receipts crashed yet again below projections. After two systemic budget cuts, the tax receipts keep tanking. The mainstream consensus? We need more cuts (except for bankers and top civil servants who don’t have to take wage cuts)! And the international bond market is happy with Ireland. One day we shall be able to compete with China on a level wage scale, and generous tax incentives for Multinationals. In the meantime, say hello to all the Irish immigrants for me.

This is the future discovery awaiting Greece, Spain, Portugal, Italy…and the UK…possibly Japan…and perhaps the US, although it could manage to skirt the issue for another year. In each of these nations, if the private sector is retrenching already, and the public sector tries to retrench on top of that, unless a massive swing in foreign trade can be accomplished, policy makers are unwittingly inviting falling private nominal incomes and private debt distress into the picture as they reverse fiscal stimulus.

As private incomes fall, tax revenues fall. In order to hit fiscal targets promised to global bond holders, further expenditure cuts must be implemented, and further tax hikes must be rolled out. As the Irish blogger reveals above, this is not a theory — it is already happening, but policy makers and investors are not willing to acknowledge it. Yet for those who understand the fiscal balance cannot be changed without influencing the cash flows and financial balances of the remaining sectors of the economy, the paradox of public thrift at this juncture is far too evident.

We are by no means defending the generous pension benefit levels of euro zone government workers, the early retirement ages, the corrupt tax practices, etc. These are decisions the citizens of each nation need to make on their own, preferably in full awareness of their consequences, both short and long run. It is not our place to dictate the trade-offs citizens chose in each nation.

The question we are raising, however, is whether the private leverage ratios in many of these countries will allow them to withstand the pressures of transitioning back to growth in the absence of fiscal autonomy. The now prevalent global quest for “fiscal sustainability” may place these economies on a path of private debt default, which is ultimately unsustainable for the economy as a whole. If fiscal retrenchment is to be enacted, then orderly private debt renegotiation and private asset liquidation must be accomplished at a large scale and in a timely fashion. Yet our experience is that this is no easy trick, as the near locking up of various financial channels following the Lehman debacle illustrated in no uncertain terms. Usually such a recipe delivers a financial implosion.

Even the Honorable David Walker, CEO of the Peter G. Peterson Institute, former Comptroller General, and ardent foe of government waste and reckless spending is coming to understand the precarious nature of the current situation. In a February 24th piece on with Larry Mishel, Walker insists on the primacy of job creation at this juncture, and recognizes this may actually serve his goal of reducing fiscal deficits in the long run:

President Barack Obama is in a difficult position when it comes to deficits. Today’s high deficits will have to go even higher to help address unemployment. At the same time, many Americans are increasingly concerned about escalating deficits and debt. What’s a president to do?

The answer, from a policy perspective, is not that hard: A focus on jobs now is consistent with addressing our deficit problems ahead.

We have seen this movie before

That, dear readers, is the real deal, and it is not being reported or openly discussed. We have seen this movie before in Argentina almost a decade ago. They eventually got out with a massive “external” currency devaluation of 300% and an equally massive swing in the trade balance. But the costs of delay were enormous: from 1998-2001, Argentina suffered its worst recession ever and pushed 42% of its households into poverty.

And not every country can do what Argentina has done. Again, the whole world cannot run trade surpluses, the first mover has an advantage until the second mover moves, etc. Plus, Argentina had an explicit debt repudiation and a 300% “external” devaluation that was timed right with global recovery, hardly the sort of conditions that pertain today.

The US has so far managed to resist anything of this magnitude. But as the voices of fiscal retrenchment intensify, a future not unlike Latvia, Greece and Argentina could await. It has taken the people of Iceland to make the first stand against this growing neo-liberal madness. In a historic referendum, over 90 per cent of the population has rejected a proposal for the repayment of billions of pounds lent by Britain and Holland to compensate depositors in a failed Icelandic bank.

The deal would have saddled citizens of Iceland with an additional $16k in debt to compensate the UK and Holland with a $5.3 billion note for the failure of their local banks. This, in a country of a mere 300,000 citizens. The vote failure has already prompted the ratings agencies to downgrade the country to junk, as well as leaving an IMF-led loan in limbo. The “experts” are declaring this a disaster for Iceland, but they and their banking allies must secretly be dreading the result, demonstrating as it does that an international bailout watchdog is truly powerless when the people of the bailout recipient nation want to have nothing to do with a poisoned chalice of an economic “rescue”, which does nothing but create a country of indentured serfs.

It is now time for the rest of us to follow the Lilliputians of Iceland: to take the rentier juggernaut down before it completes the task. Time to pry the vampire squid off our faces so we can see the light of day again. Hopefully, Iceland represents the future, not Latvia.

Print Friendly, PDF & Email


  1. Matt T

    “Mainstream economics insists that one path to full employment is via lower wages… Wage cuts in the aggregate simply destroy aggregate spending power, unless the lost demand is made up for in other ways.”

    This is nonsense – boy, do economists love those “aggregates” – and the author descends into outright incoherence about halfway in.

    His premise boils down to a vicious attack on rational economic policy; the equivalent of lambasting folks who tried to withdraw money from Madoff. After all, they caused the scheme to collapse and made all the other investors $50 billion poorer! Never mind that the wealth wasn’t there in the first place.

    If countries cannot service debt, they need to default. The rest of us need to eat the losses and shift to rational spending policies before it’s too late (though in Japan’s case, the patient’s just about flatlined).

    Now… does Mr. Auerback think this is a good idea, or doesn’t he? Hard to tell. On the one hand, he advocates a policy of reckless spending (“fiscal autonomy”), further debt accumulation, and a continuance of ruinous global imbalances, yet lauds the Icelanders’ decision to avoid precisely this fate and accept the consequences. Which is it, exactly?

    1. Greg

      “Boy do economists like those aggregates”

      What? You DONT!?

      Dow Jones Industrial average……..An AGGREGATE!
      Gross Domestic Product……………An AGGREGATE!
      Commodity prices ………………….. AGGREGATES!

      Would you prefer we all simply concentrate on ourselves? Ignoring our place in a bigger thing which provides us with so much we take for granted?

      Tell you what, next time you are at a stadium and cant see stand up, but before you do tell everyone else to stand up too cuz theyll be able to see better. See if your perspective changes.

      Where you misread Mr Auerbach is that he would agree with you that the countries that cannot pay their debt need to default, but they also need to leave the European currency union.

      What he is criticizing is the idea one can IMPROVE their current situation within the current currency restrictions by listening to FINANCIAL MARKETS.

      Thinking you will make your situation BETTER (if you measure better by GDP or deficit levels) by cutting everyones salary is CRAZY! Worsening deflation is not the answer to a deflationary situation.

      Now, you may think deflation is good (I would argue with you about that) but it is INARGUABLE that any of the measures being proposed will actually reverse the deflation and improve any govt balance sheet.

      Again, the folks arguing this way REFUSE to acknowledge that govt debt (in its own currency) is not anything like private debt. They are in no way shape or form the same. Govt debt (when issued within its own currency) is ALWAYS a private asset. For our govt to get out of debt WE will have to give up financial assets. There is no other way to accomplish this.

      Those that argue that our debt now will have to be paid by our children are misleading you. It can be paid right now by debiting the bank accounts of every American, but no one will advocate that. Why should we expect that our children or grandchildren will “decide” to take some of their financial assets away later. They can just as well say “No, we’ll keep the money in our accounts thank you you”. They will be able to make those choices for themselves.

      A negative number on the govts balance sheet does not need to be restored to positive. Its a sham of those that tell you otherwise.

      1. MyLessThanPrimeBeef

        If deleveraging needs to happen, the sooner we get it over with the better we all will be.

        As for gov’t debt being always a private asset, if a state gov’t borrows from counties in that state, where is the private asset?

        Why don’t we just reverse the situation and let every private debt be a government asset.

        1. Greg

          I do not mean state debts. States are currency users not currency issuers. There is a difference. States here are like Greece. I am referring to the federal govt deficit/debt.

          1. MyLessThanPrimeBeef

            What about when the Treasury borrows from the Social Security Trust Fund?

  2. Boris

    The Iceland comments in that piece are way off the mark. The key here is that EEA rules required British and Dutch regulators to accept the (totally inadequate) Icelandic regulation of the Icelandic banks. The same EEA rules require Iceland to treat all depositors in banks headquartered in Iceland identically, no matter what their citizenship, as long as they’re in the EEA.

    Iceland’s government has guaranteed 100% of its natives’ deposits in said banks. At the same time, the foreign depositors aren’t getting the payments that Iceland’s deposit insurance scheme promised them.

    All of which comes down to Icelandic depositors profiting at the expense of foreign depositors by applying EEA rules only when it suits them.

    Now I happen to think the EEA rules in this instance are daft, but the right answer to that is NOT to selectively not follow them yourself while holding everyone else to following them. At least not if you want to have any credibility left and want to have someone ever deal with you again.

    Given the behavior of Iceland’s banks, government, and populace in this instance, the junk rating is well deserved. I personally wouldn’t lend anything to any Icelander who actually understands what their country has done and approves.

    1. carol

      Boris, thanks for clarifying.

      The president of Iceland has INCORRECTLY stated that British and Dutch central banks should have jointly regulated the Icelandic banks. As you correctly point out above, there was a regulation (a stupid one, but a regulation non the less) that prevented other central banks from regulating these Icelandic banks.

      Why are the Icelandic taxpayers trying to force British and Dutch taxpayers to foot the bill of failure of Icelandic banks?

      Why aren’t they forcing their government to go after the previous owners of their banks? These multi-billionaire claim they are not at fault, but surely some money could be gotten back (RICO-style).

      A sort of special prosecutor, Eva Joly, has expressed utter frustration for not receiving cooperation from the Icelandic government and other persons in power, to get the banksters behind bars and some of the looted money back. Why aren’t the Icelanders supporting her more fully?

  3. Boris

    One more note on Iceland: the $5.3 billion is gross, not net. Some fraction of that sum will almost certainly be recovered by selling off the assets of the failed bank in question. How much is up in the air, of course, and if the $5.3 billion is in fact just defaulted on then the assets could be used to pay Icelandic depositors that 100% guarantee mentioned above. But that just reinforces the point that what’s going on here is Iceland stealing from other countries’ taxpayers, pure and simple.

    1. carol

      No! Icelander taxpayers to UK and Dutch taxpayers: “we don’t care; you pay our bills”

      1. Greg

        Those are not “bills” of Icelandic citizens.

        The Dutch and British govts need to return whatever money to their citizens they think they have been jipped out of. British and Dutch citizens are the responsibility of British and Dutch govts not Icelands govt.

        1. Boris

          Greg, unfortunately the EEA regulations in this instance do in fact make British and Dutch citizens the responsibility of Iceland’s deposit protection scheme. While Iceland’s government is not technically obligated to support such a scheme, in this instance it has chosen to do so for some subset of EEA citizens. Those same EEA regulations require them to not discriminate on the basis of national citizenship.

          Of course those same EEA regulations also required the British and Dutch governments to accept the say-so of Iceland’s government as to the solvency and leverage levels of the Icelandic banks. Iceland was quite happy with the privileges the regulations gave it, but is balking at following the ensuing obligations. It’s a classic case of heads-I-win-tails-you-lose.

  4. attempter

    Mainstream economics insists that one path to full employment is via lower wages. If you want to sell more labor services, lower the price of them, namely wages. This is a classic fallacy of composition argument. What might work for one firm is unlikely to work for all firms. Wage cuts in the aggregate simply destroy aggregate spending power, unless the lost demand is made up for in other ways.

    “Mainstream economics” is kind of funny in how desperately it has to strive to come up with “theories” to justify the robbery, and the very existence, of the parasites who pay economist salaries.

    The workers both create everything (except for natural resources, which of course nature itself provides, though certainly not for “free” the way fraudulent “theory” says) and are the only consumption base for this output. The parasites create nothing and only use lies and violence to steal.

    Yet we have these rotten-eggheads who devote their wretchedness to figuring how its worker wages that should be a variable, dispensable part of the equation.

    (And then there’s the loathesome MSM, as exemplified yet again in the other post.)

    The truth is that it’s the parasites who are existentially dispensable. Let’s get rid of all rentiers and then see if we still have any problem with “wages”.

  5. Andrew Bissell

    As private incomes fall, tax revenues fall. In order to hit fiscal targets promised to global bond holders, further expenditure cuts must be implemented, and further tax hikes must be rolled out.

    There’s a simple solution being glossed over here, which is to default on the public debt and tell the bondholders to stuff it. I mean, governments don’t even need to borrow from the bond market anyway, right?

    1. Andrew Bissell

      And if the bondholders don’t like it, they should be instructed that next time they should direct their capital to institutions that won’t seize the money at the barrel of a gun to pay them back.

  6. blagroll

    I would add one countervailing assessment against the Irish observation cited. During the boom years, billions of tax receipt Euros were also “redistributed” by the govt through a special savings scheme (which ran for five years at 25% gauranteed interest rate, and also incidentally disburst the monies at the time of the General Election); one time payment to landowners for infrastructure projects; huge cost over runs on infrastructure projects; tax loopholes for wealthy citizens; and other numerous quango boondoggles. As a result, there is a significant amount of saved cash which can be spent to drive a recovery of sorts. So, yes the Irish govt has targeted certain sections of the population for retrenchment which is currently showing up in the poor tax revenue figures, but we shouldn’t be surprised that a lift in confidence will result in more spending and attendant tax revenue intake some time in the future. As always, we’re happy to game the international tax laws for multinational and financial corporations to attract some jobs and shadow tax revenue.

    The simple strategy outline is that Ireland, being touted as a small and open island economy, will export itself to wealth and super league status in the future. A low wage production cost base coupled with a relatively well off middle management stratum is sufficient to drive the economy to long term recovery. The bottom line is that every Irish person of working age either needs to be self-employed, in a profession or become part of managment. Those who find themselves on the lower rungs of the production and service economy have only themselves to blame. Plus ca change, c’est la meme chose.

    1. DownSouth


      You say: “The bottom line is that every Irish person of working age either needs to be self-employed, in a profession or become part of managment.”

      This is an iteration of the core myth that lies at the heart of liberal and neo-liberal theology, and makes it so beguiling to the common man.

      Traditional religion holds out the promise of an other-worldly paradise. Neo-liberalism holds out the promise of a this-worldly paradise. Both are equally supernatural, but nevertheless enjoy great appeal.

      A revival of the middle-class creed popularized by Horatio Algier in the 19th century was necessary to give neo-liberal ideology a more universal pull. As Wikipedia explains: “Many of Alger’s works have been described as rags to riches stories, illustrating how down-and-out boys might be able to achieve the American Dream of wealth and success through hard work, courage, determination, and concern for others.”,_Jr.

      Following this logic to its natural conclusion results in the belief that we can all be millionaires, or in a more toned-down version that we can all be self-employed, professional or management. This is an idea that is, upon closer examination, of course nonsensical. But it is nevertheless an idea embraced by a surprisingly large number of Americans. Eddie Chiles summed the creed up succinctly when, in a commercial for the Western Corporation back in the 1980s, he implored: “If you don’t have an oil well, get one!” A more recent example might be the Nike refrain: “Just do it!”

      As Reinhold Niebuhr observed in Moral Man and Immoral Society:

      This middle-class creed sprang so naturally from the circumstances of middle-class life that it ought perhaps to be regarded as an illusion rather than a pretension. But when it is maintained in defiance of all the facts of an industrial civilization, which reveal how insignificant are the factors of virtuous thrift and industry beside the factor of the disproportion in economic power in the creation of economic inequality, the element of honest illusion is transmuted into dishonest pretension.

      Depressions destroy the mythology that underpins liberal and neo-liberal ideology. Perhaps no one put it better than Frederick Lewis Allen:

      For the Depression had wrecked so many of the assumptions upon which the American people had depended that millions of them were inwardly shaken.

      Let us look for a moment at the pile of wreckage. In it we find the assumption that well-favored young men and women, coming out of school or college, could presently get jobs as a matter of course; the assumption that ambition, hard work, loyalty to the firm, and the knack of salesmanship would bring personal success; the assumption that poverty (outside of the farm belt and a few distressed communities) was pretty surely the result of incompetence, ignorance, or very special misfortune, and should be attended to chiefly by local charities; the assumption that one could invest one’s savings in “good bonds” and be assured of a stable income thereafter, or invest them in the “blue-chip” stocks
      of “our leading American corporations” with a dizzying chance of appreciation; the assumption that the big men of Wall Street were economic seers, business forecasters could forecast, and business cycles followed nice orderly rhythms; and the assumption that the American economic system was sure of a great and inspiring growth.

      Not everybody, of course, had believed all of these things. Yet so many people had based upon one or more of them their personal conceptions of their status and function in society that the shock of seeing them go to smash was terrific. Consider what happened to the pride of the business executive who had instinctively valued himself, as a person, by his salary and position–only to see both of them go; to the banker who found that the advice he had been giving for years was made ridiculous by the turn of events, and that the code of conduct he had lived by was now under attack as crooked; to the clerk or laborer who had given his deepest loyalty to “the company”–only to be thrown out on the street; to the family who had saved their pennies, decade after decade, against a “rainy day”–only to see a torrent of rain sweep every penny away;
      to the housewife whose ideal picture of herself had been of a person who “had nice things” and was giving her children
      “advantages,” economic and social–and who now saw this picture smashed beyond recognition; and to the men and women of all stations in life who had believed that if you were virtuous and industrious you would of course be rewarded with plenty–and who now were driven to the wall. On what could they now rely? In what could they now believe?

      Following the Great Depression, corporate America went about resurrecting the middle-class creed. It took them a number of decades to do so, but the endeavor has been phenomenally successful. Not only have most Americans forgotten the lessons of the Great Depression, but these American cultural and social ideals, so useful to America’s ruling elite, have now gone global.

      1. blagroll

        Nicely put, as always, Down South. I’m not arguing that the case outlined should prevail. It’s just the general story that’s generally accepted by many if not most people, even those who don’t or can’t aspire to enter the promised land.

  7. michel

    Basically an incoherent rant. Heaven help anyone who relies on these guys for investment advice. If the premiss is correct, then the argument is that there is no solution to the current indebtedness. The argument ought to be that countries cannot continue to borrow and spend, because that way debt rises till it defaults, and many are at that point now, at which point borrowing is forcibly stopped. They cannot cut spending, because that way tax revenues fall and they enter the Argentinian spiral. So the conclusion ought to be, in either case we will see large amounts of defaulting, and this will lead to deflation on a large scale as money is taken out of the system.

    It is totally unclear what the authors propose to do about this either from a public policy point of view, or as investors. The two are quite different of course. The argument for public policy ought to be that some explicit measures should be taken to recognize the problem and deal with it. It probably has to include large amounts of debt writeoff. The authors appear to argue for continuing borrowing and spending as an alternative, but they give no reason to think this is a possible policy.

    What will in fact happen is what Greece is doing. Governments will engage in fiscal austerity in the middle of a recession, because there is nothing else they can do.

    As to individual investors. Well, this is a conundrum, and if I knew the answer to this one… The answer may be, trade pragmatically in assets that rise, and get out in time. So liquidity is likely to be all. But who knows, these times are really unprecedented.

    However, hysterical rants, which, if you can even make out what they are saying, appear to recommend impossible policies, they are not helping anyone.

    1. Greg


      Just because you do not understand the rant does not make it incoherent.
      Maybe the problem is with you. In fact judging by the rest of your comment I’m quite sure its with you.

      In no way have they argued there is no solution to the current indebtedness? In fact if you really paid attention you would see that the problem is not one solely of debt, but debt in a currency you cant control the issue of. They further illustrate that listening to those who got you into this situation (the people behind the EU and their currency board) are not the ones to listen to to get out of it. These entities are captured by financial markets and are simply looking out for them selves.

      The one thing that should be obvious to any sentient being is that the real economy is fine. We still have plenty of resources to mine, plenty of land to farm, plenty of buildings to live in and store surpluses in, plenty of capable people to care for us when we are sick and plenty of unused labor to get stuff done that we all think needs doing. We are being FORCED into austerity by a financial system that pretends to BE the economy when in fact it should be OF the economy. It has grown out of proportion to its usefulness and is now becoming a danger to entire nations.

      1. michel

        The logical conclusion which follows from their argument is that there is no solution. Why? Because if you argue that we are all in a mess because we have too much debt in currencies we do not control, then the assumption is that if you control your currency there is something you can do. And there is, you can devalue. Except that we all have too much debt, and we cannot all devalue at once.

        The problem with the argument is that what would make sense if the issue were one country has got itself hopelessly into debt, does not make sense if it is all of us.

        If one guy is going on a dangerous voyage, he can insure himself with other people in his village. But if everyone in the village is taking the same trip, they cannot all insure themselves with each other.

        So the question for the authors is, what do they expect everyone to do? Never mind that one particular country could devalue, what if they all follow the advice and all devalue at once?

        And that is why we will end up with what the authors condemn by implication: austerity in the midst of recession. No, it will not work. That is because nothing will work except general impoverishment. That is what is coming towards us. No amount of controlling our own currency will change it.

        1. Greg


          Think about what you are saying. I think you might recognize the “truth” in there if you look.

          Their argument certainly does NOT argue that there is no solution it clearly says the solution is to not FORCE austerity on one group while keeping another group relatively whole. The debt terrorists want to do everything to make sure everyone keeps paying their bills TO THEM while spending less on everything else. As if paying the debt should be first and foremost in our minds. If you believe (erroneously) that govt debt payments must come from taxes then any move which lowers incomes and lowers taxes will make the debt payment more unpayable. If you believe that forcing austerity on a deflationary situation will improve it in any way I think you are crazy.

          The authors do not think that leaving the currency union will make things all better for the Euro countries, but it will give them options which they do not have now. It gives them more control of their fate.

          Why is general impoverishment the only end game? Why do we have to “pretend” there isnt any wealth? We have many mispriced assets out there but we are as wealthy in real terms today as we were two years ago. Certainly priorities need to be set straight (as they always should have been) but for us to suddenly say that another 10-15% of our population has to live in near squalor because of the excesses of a few (many of which will see NO reduction in their living standards) is not only untrue but completely unjust.

          1. Andrew Bissell

            Why is general impoverishment the only end game? Why do we have to “pretend” there isnt any wealth? We have many mispriced assets out there but we are as wealthy in real terms today as we were two years ago.

            “Pretending” is what we were doing several years ago when we thought we were a whole lot wealthier than we actually were. Half-finished subdivisions in the Nevada and Arizona deserts, or new commercial real estate towers in Manhattan, it turns out, are not the high-value assets we had previously thought. At that point, we actually were wealthier than we are today because capital resources had not yet been wasted on those projects. There is no amount of mindset shift, Chartalist or otherwise, that can undo these mistakes or conjure that wealth back into existence.

  8. Badtux

    Krugman snarks that it appears that Europe is coming down with the Andrew Mellon Flu where the solution appears to be to liquidate everything, and notes that the net effect of deflation is to raise real interest rates. How, exactly, is raising real interest rates supposed to spur economic activity? I mean, even Milton Friedman would have shook his head in disgust over such nonsense, and Uncle Milt wasn’t exactly Keynesian, y’know. But I suppose Irving Fisher never existed in the universe that Europe’s politicians grew up in, where undoubtedly unicorns are pink and cotton candy grows on trees.

    I’ve already pointed out on my own blog the key Keynesian observation that it is demand that drives employment, not the price of labor. If I need only three workers in my sandwich shop to make all the sandwiches I need for my customers, that’s all I hire, no matter how cheap they are. My wage costs are going to be as high (or as low) as my competitor across the street, so the fact that I dropped my prices by dropping my wages does me no — zero — good if my competitor across the street does the same thing. I still only need three workers.

    But then, we’re talking about folks who probably agree with Hayek that buying a coat during a recession causes unemployment. Utterly disconnected from reality. SIiiiiigh!

    1. Andrew Bissell

      Krugman snarks that it appears that Europe is coming down with the Andrew Mellon Flu where the solution appears to be to liquidate everything, and notes that the net effect of deflation is to raise real interest rates.

      Andrew Mellon would not have supported pursuing the course of Latvia in order to prop up unsustainable and unpayable debt burdens that need to be defaulted upon. He would most assuredly have included today’s oceans of bad public and private debt in the list of things that need to be “liquidated.” But I suppose that distinction is lost when he is now invoked only in the same way and to achieve the same effect that one would invoke the bogeyman.

      The notion that the federal government can exert a significant meliorative effect on interest rates is a flattering one to technocrats like Paul Krugman, but there’s nothing in the financial or historical record to suggest it’s the case.

    2. Attitude_Check

      If you and your competitor drop prices, I think that will effect demand. It is certainly true that if you both doubled prices demand would drop. So if you both dropped prices and demand increased, you might both need to hire a additional employee die to increased AGGREGATE demand, not merely a change in demand distribution.

    3. Eric

      A nice lecture on the sandwich business, but it does not square with my experience in the 2 shops I owned and operated. Making sandwiches was the principle labor in the shops, but the profits were more in soft drinks, bottled drinks and packaged goods (cookies, potato chips). Because there was abundant competition within convenient walking distance, the reduction in labor costs through lower wages or increased sandwich making productivity (or both) was passed along pretty directly to the consumer, relying on the sandwich sales to drive the more profitable purchases. Demand was clearly elastic with price, so lower relative wage costs/sandwich reliably increased sandwich volume and profits. Wage levels in the sandwich business were close to, or at, the minimum wage. After getting into the business it occured to me that offering higher wages wasn’t particularly good for anyone: the costs of training new workers were actually pretty minimal (if you ever made a sandwich at home you are about 80% trained walking in the door) and it was impossible to offer anything like a wage that would sustain even one person, let alone a family. I really liked most of my workers, but if they were still there 12 months after I hired them I would encourage them to leave, since there was nothing really in it for them to make a “career” out of it. There were exceptions.

      My point is: why are you talking about the sandwich business as if you knew anything about it?

  9. Swedish Lex

    Most previous comments focus on details in the blog post (Iceland) and/or describe it as a rant or horror story. I would disagree with those comments.

    The post has the benefit of demonstrating, through the examples of Latvia and Ireland, that other European and non-European states soon probably will be traversing the kind of hell the former states are undergoing, and that the latter states appear to have no or little preparedness for that eventuality.

    There is no way to reverse the global deleveraging, which will go on for a number of years. Its effects can be mitigated through policy initiatives and by maintaining a basic degree of international co-operation in order to prevent global economic cannibalism.

    1. Adam

      I agree. The world has to get used to the fact that way too many people borrowed way too much money for things that are not producing income. The world also has to get used to the fact that they lent way too much money for things that are not producing any income to repay them. All of that poorly lent money ended up creating a massively imbalanced world economy. We can’t then implement policies that try to prevent default and try to keep the old imbalances going. And we can’t all export our way out of this. Any policy that doesn’t acknowledge that default is the only solution (or inflation which implies default) is in denial. The money has already been lost; it’s just a matter of realizing it and moving on. Policies meant to prevent this are only delaying the inevitable and actually likely to increase the final losses as productive debts become unproductive as the system falls apart – that’s the problem with debt deflation and a deflation spiral.

      The best example is China’s $2T in dollar reserves… When the Yuan is eventually revalued China will take a massive hit in the value of its reserves. However the loss was build into the currency peg; the revaluation only makes them realize the loss. Preventing the revaluation doesn’t prevent the loss; it just allows you to continue to deny the loss. Another great example is the recent news that the FDIC is auctioning off assets and banks are upset because they will be forced to revalue assets and may be forced to record losses. The fact that the loss isn’t currently recorded on the books does not mean the loss didn’t occur.

    2. MarcoPolo

      No way to reverse global deleveraging.  I wouldn’t know. But I do know that policy in Argentina, Greece and Iceland (& US) don’t reverse the deleveraging but only put it off. And putting it off only builds more unsustainable stresses. Bailouts of US banks by Argentines, German & French banks by Greeks and British & Dutch banks by Icelandics has an historical parallel in the war reparations placed on Germany nearly a century ago. Now generally thought to have been a bad idea.  But I’m tired of what is generally thought – the conventional wisdom of the charm-school educated.  Wealth is created through enterprise. And enterprise has a monkey on its back. Time to move on. Jubilee.   

      1. DownSouth


        Argentina did default on its non-IMF and non-World Bank debt, which it eventually settled for 25 to 35 cents on the dollar. In this way Argentina “deleveraged.”

        There is no painless way to deleverage.

        The trick is to make it so that everyone shares in the pain, rich and poor alike; that the failed ideologies and policies be seen for what they are; and that those most responsible for the failures be punished. If these simple steps are not followed, public trust and cooperation, the glue that holds society together, cannot be restored. The goal here is to create a one for all, all for one team spirit. If I’m not mistaken, the military the term for this is unit cohesion.

        Obviously this is not what is happening in Greece. If we take a look at the austerity package announced last week, it is clear that it is the Greek poor and working classes that are intended to bear the pain, and the Greek elite and international bankers, who are the ones responsible for creating this monster, get off scot free.

        1. Stuki Moi

          The goal ought most cetrainly not be to ensure everyone shares in the pain, but rather to get out of the way so those who made the wrong decisions (borrowed and or lent too much) gets stuck with the downside of their decisions.

          Dragging third parties down along with those Jim Rogers call the incompetents, only leads to more incompetence down the road.

  10. blagroll

    Like most economic arguments these days, we have a tendency to forget the sequence of events that lead us to our present situation, and more importantly the policy decisions of governments that now “demand” an exclusive fiscal response stemming from the sequence of events. Yes, too many governments, Ireland more so than most, relied on non-recurring tax receipts from construction to pay for the boondoggles, which have come home to roost. We certainly need to restructure the public sector and find cost efficiencies, but we shouldn’t forget that Ireland’s debt burden is a result of policy decisions which protected bankers, equity holders and bond holders above the nation’s interests. Rather than taking down the bad banks or even trying to negotiate a bond for equity swap in bad banks, the tax payers had a new national debt foisted upon them in the form of NAMA, while the ECB keep the banks afloat at the most minimial level in order too meet their capital requirements. Suddenly the Irish nation’s debt sky-rocketed due to taking on all the bank’s bad debt. Next step was the arrival of the of the international bond market spectre which required Ireland to take the necessary fiscal steps to ensure Ireland could repay this new national debt. We have to cut services and the wages of the most vulnerable to satisfy the bond holders, but the high eschelons of the public service didn’t take drastic pay cuts becuase they’re too valuable to society! The current bankers, for the most part, are the same bankers from the past and on similar salaries.

    What, imo, most people haven’t cottoned onto is that nations are not run for the benefit of national populations. In an era of globilisation and unregulated money flow, any nation at best becomes a mirror image of a multinational corporation, and is run on the same basis and with the same objectives. In Ireland it is common to hear such phrases describing Ireland as a product or as Ireland Inc in the MSM media and from politicos. Our images and narratives in relation to government are being subsummed into corporate cultural framework. So, should we be surprised that govt policies are geared to the short term; that those currently ruling the roost feel entitlement by virtue of their rise to prominence; or that the perceived winners such a equity and bond holders should be favoured above the wage earners or the entire nation’s well being?

    1. Mickey Marzick in Akron, Ohio

      “What, imo, most people haven’t cottoned onto is that nations are not run for the benefit of national populations. In an era of globilisation and unregulated money flow, any nation at best becomes a mirror image of a multinational corporation, and is run on the same basis and with the same objectives.”

      Well said! I would add:

      1) Decoupling of investment from production;

      2) Decoupling of the nation from the state; the primary function of the STATE is to provide the preconditions for capital accumulation. If the latter happens to benefit the NATION – the people – so much the better. But it would appear that the STATE is increasingly at odds with the NATION with the global corporation playing one state off against another.

      You’re points are well taken. The NATION must be sacrificed to the needs of the ALMIGHTY MARKET. The only thing left to feed on is the nation… If the massive transfer of wealth to the holders of the nation’s debt can no longer be sustained then pull out the AUSTERITY hammer and pound it out of them! But the MARKET for both must be maintained at all costs.

      Right now, the US is engaged in the former – a transfer of wealth via debt and deficit spending – with the first phase of AUSTERITY [debt deleveraging and credit lockout] affecting aggregate demand in predicatable ways with declining revenues at all levels of government. The result is massive retrenchment in the public sector – state and local government – consistent with that already witnessed in the private sector. But it can’t happen here, right? We’re ALL in this together, right.

  11. Brick

    I guess I partially agree with the concept that any stimulus should be directed towards jobs. Where I would differ is that the stimulus should be short term and would rather see a restructuring of government expenditure so that there is a permanent stimulus towards job creation rather than a stimulus to build bridges to nowhere. Here I am thinking along the lines of tax allowances for venture capital directed at job creation. I also think restructuring government expenditure can curtail deficits without reduction in jobs and without affecting the immediate economy. Here I am thinking about pensions, retirement ages, certain entitlements and spending outside of the US.
    As for the Icelandic banks problem then the problem is not quite as simple. That the regulators in the Netherlands and the UK failed to ensure Iceland had sufficient deposit insurance coverage points partially to the UK and the Netherlands. You could also argue that savings contracts were broken and advertising was inappropriate to the extent that the Icelandic government could face legal consequences. For me there are two faces to those who lost out with there savings with the Icelandic banks. The first is retired people who put their life savings into the Icelandic banks to get the high interest rates and the second is local government (councils) who should have known better. Guess which the governments of the UK and the Netherlands are fighting on behalf of.
    My personal view is that the Icelandic people should not have to pay up but the Icelandic government is responsible for making up the savings minus interest of small time savers. This I think could be achieved by selling off those Icelandic banks to external banks.

  12. bb

    i really hate calling people things but this marshal auerback is utterly ignorant of the causes of the crisis in the baltic states. they are all very small economies with some of the highest home ownership rates (above 80%, relative to 60% in the US), very low mortgage indebtness and a property bubble was blown by the very ‘prudent’ and much touted on this blog swedish banks who lent mainly to foreigners money to send sky high property prices. rich russians helped as well with cash deals.
    no currency regime, floating, fixed, or gold standard can recover economic growth in a country so massively overbuilt where the main economic driver was building.

  13. DownSouth

    Rob & Marshall,

    Thanks for this post. You guys do a great job of exposing the ideological juggernaut that the common people of the world confront.

    Confucius once said that “a wise man learns from his experience; a wiser man learns from the experience of others.”

    “Neo-liberalism is a deathtrap, a deathtrap that first affects the weak, but eventually, in one form or another, eventually arrives to the powerful,” Nestor Kirchner warned at the IV Summit of the Americas back in 2005. Kirchner’s prediction is now coming true in spades.

    Neo-liberalism has proven so virulent and difficult to eradicate because it serves the interests of the elite, both within and without the victim nations. The solidarity between local and foreign elites leads to an alliance that overwhelms any natural balance of internal interests. The historical pattern is that neo-liberalism light is first imposed upon a nation. When this creates a crisis, which it always does, then the crisis is used as a rationale to usher in industrial strength neo-liberalism. Social chaos is the final result–a total breakdown of social order.

    Argentina and Mexico serve as laboratories where neo-liberal policies were implemented and road tested. Neo-liberalism has been a dismal failure everywhere it has been tried. Latin America has almost 40 years of failed neo-liberal experiments.

    Anyone who ignores these experiences of Argentina, Mexico and other Latin American countries does so at their own peril.

    The paladins of neo-liberalism are absolutists and extremists. Nevertheless they have been highly successful at portraying themselves as the “reasonable” and “scientific” ones, while anyone who questions them is branded as being irrational and unreasonable.

    In order to stop the neo-liberal juggernaut, it is incumbent upon the common people of each nation to get their own house in order. This means ousting local neo-liberal politicians and installing people who represent the interests of the common people. Normal democratic channels have proven ineffective in this regard. In Argentina, it took massive demonstrations and public protests to bring about the needed changes in political leadership. At least 40 people were killed by government security forces during this civil unrest. But eventually the president and his top economic adviser were forced out, making their escape by helicopter in the wee hours of the morning. Unfortunately, this is the only sort of action that has proven effective in rolling back neo-liberalism.

  14. yoganmahew

    I was interested until this bit:
    “From Ireland: Gov’t took billions of €’s out of the economy in the form of public service pay cuts, pensions cuts, dole cuts + wave of private employees replaced by agency workers at minimum wage rates… Guess what? January tax receipts crashed yet again below projections. After two systemic budget cuts, the tax receipts keep tanking. The mainstream consensus? We need more cuts (except for bankers and top civil servants who don’t have to take wage cuts)! And the international bond market is happy with Ireland. One day we shall be able to compete with China on a level wage scale, and generous tax incentives for Multinationals. In the meantime, say hello to all the Irish immigrants for me.”

    This is plainly not what is happening in Ireland.
    1. “government took billions of €’s out of the economy” – eh, right. A whole 4 bn. Nothing to do with the property bubble collapsing and construction (which had accounted for up to 25% of GNP) collapsing?
    2. “wave of private employees replaced by agency workers at minimum wage rates” – nothing to do with the government and no evidence of it anyway.
    3. “January tax receipts crashed yet again below projections.”
    Tax receipts are 60mn below projections at the end of February. Hardly a crash.
    4. “After two systemic budget cuts, the tax receipts keep tanking.” I’m not sure what a “systemic” cut is, but Ireland built a huge bubble economy from 2001 onwards fuelled mostly by personal debt. That debt has got to be paid back. That’s gotta hurt the economy, pulling all that credit and the repayments out.

    1. blagroll

      The general gist of the quote is substainly correct. The Irish govt is pursuing a deflationary policy. They’ll more or less admit to pursuing a deflationary budgetary policy if cornered. Well, they waffle around the issue, as always re: hard choices and so on, but the policy is very apparent to anyone with a bit of economic nous. As regards to budgets, they have set several in a row, lowering the revenue targets along the way, with the apparent objective of pursuing delfationary policies; so I’d say systemic is observable.

      The general argument that private debt is being repaid and that such action must be painfully taken rings true, but it isn’t an argument which disguises the fact that the Irish govt has protected equity and bond holders by transferring banks bad debts to the citizens of Ireland through NAMA. It is the nearly instantaneous creation of national debt that is at issue with regard to international lenders, credit ratings and spreads. This is the issue which illustrates the so-called logic of deflationary policy but where govt deficits are now used as a smoke screen to limit policy decisions so ensuring that int’l bond holders receive preferential treatment over citizens once again.

      The upshot is that three budget projections with regard to revenue have been revised and all missed their revenue targets, thereby being revised ever downward. The upshot is that people who are most vulnerable, and who for the most part didn’t greatly benefit from the great Celtic Tiger experience, are asked to take on the burden of the failed executives, policy makers and speculators. With a 12.7% unemployment rate, leaving aside emmigration and those pursuing yet more education, the situation for wages and tax intake isn’t looking particularly pretty for the foreseeable future.

      As regard agency employees, there are no hard stats. The govt isn’t required to publish such stats by the EU and they don’t wish to do so themselves. Ignoring the obvious Irish Ferries case and others, it only takes an examination into the continuing issuance of works visas and a casual examination into work practices in many basic factory operations that one can rather quickly acquaint oneself with the practices used to lower wages. Anyway, I don’t think anyone really argues that wages, especially of semi and low skilled employees are under servere pressure. Isn’t that part of the MS deflationary meme anyway? (If the govt isn’t involved in the employement market, why do they claim their govt agencies will create 250,000 jobs over the next 10 years or so?)

      Personally, I see some growth in activity this spring and we may see a pick up in tax revenues. There is still plenty of cash laying dormant in some subsections of society. It’s just that certain other subsections of the labour force won’t be recovering any time soon, if at all.

      I often think we live in a quantum world where at least two, if not more, realities exist. Those who are doing alright, or hope to do better or just generally believe the MS narrative despite their circumstances, see the world one way, and interpret data and issues in a particular manner. Others, whatever their circumstances, see and interpret data in a diametrically opposed way. Myself, I think the MS narrative is wearing painfully thin.

  15. MarcoPolo

    FINALLY!  Thank you Marshall (& Rob). It can be lonely out here.  I just finished something in Econned about how issues raised by the great unwashed are not taken seriously. Maybe this can now get some air, but it’s likely up to the great unwashed  Icelandic, Greek & Argentine, to move it forward.  Soon it will be our turn.    

  16. anon

    “Under this system, the central bank stands by to guarantee this convertibility at a fixed exchange rate against the so-called anchor currency. The government is then fiscally constrained and all spending must be backed by taxation revenue or debt-issuance. Pegging one’s currency, then, means that the central bank has to manage interest rates to ensure the parity is maintained and fiscal policy is hamstrung by the currency requirements”

    It might be helpful to readers for you to clarify the precise operational nature of this constraint versus a fiat system.

    E.g. Is the constraint ultimately about interest rates? And how exactly is “fiscal policy hamstrung by currency requirements”?

    1. pebird

      In summary, a pegged currency is constrained similar to that under a gold standard, whereas as fiat currency is free to float.

      Operationally, the central bank constrains reserves to maintain an interest rate level intended to avoid foreign currency capital flight and to defend against speculative attacks. It is hard work and often does not succeed, but the major effect is to restrict fiscal spending.

      1. anon

        But the central bank determines the interest rate level under a fiat system as well, according to whatever other criteria it follows. So what’s the real difference? It’s still constrained if its following some criteria or other for setting interest rates.

      2. anon

        i.e. I mean the central bank doesn’t just forget about interest rates just because it doesn’t have a currency rule to defend. It still sets interest rates based on something.

        1. Greg

          I think the question you are asking can be answered like this;

          When your currency is pegged to something you must acquire more of what it is pegged to before you can issue more of your currency. So in the case of a gold standard. Someone has to mine more gold OR you acquire gold in trade from another country before you issue more currency. In the case of pegging to another currency you must sell something to the person with the currency you seek before issuing more of your own. Either way you need to do lots of work FOR SOMEONE ELSE in order to do something for yourself. This leads to beggar thy neighbor trade policies.

          Issuing your own currency is not a guarantee of unending prosperity, nothing is, but it allows you more plolicy tolls when your domestic economy has a crisis.

  17. Jim in MN

    But you see, the key thing is the decision not to haircut bonds, especially mortgage bonds. That’s the Big Giant Firewall. It’s what makes this a Japan strategy on steroids.

    And the powers that be think honestly that they have to do this. The reason is that the next dominos in line aren’t so much the banks and the global superrich as the pension and insurance industries.

    I believe the single most underreported, underanalyzed and underappreciated fact in this whole global nightmare is the exposure of health insurance firms (and therefore health care systems) to massive writedowns and risk of failure.

    Think about it. Your health insurance premium gets deposited someplace. A good friend of mine spent much of their career (when not working for the Federal Reserve or the Treasury) “parking assets” in Latin America and Asia for life insurance companies. Ditto for health insurance. Yes, much of it is in bad real estate bonds.

    Now, imagine you are in the White House or some concrete bunker in Brussels. What do you think you would do if they told you that allowing an orderly or disorderly series of ECONOMICALLY EFFICIENT bond haircuts could collapse the entire health care system? Not to mention the pension and life insurance industries. The kitchen table conversation in middle America gets very serious, the last perceived nest eggs have been pooped upon (of course they actually HAVE been pooped upon, but the point is to keep little fact that from blowing open).

    So: Nothing the state systems are doing is really based on economic theory. Economic theory has been destroyed. It serves at most as a convenient set of rhetorical props.

    We simply have a Leviathan now. The only questions are, 1) who benefits (raw power politics, stop kidding yourselves) and 2) is there any tiny bit of breathing space for proper capitalist structures. I think these are rapidly breathing their last, see the posts on small business. Multinational corporations seem to have only a facade of competition, not the real thing. Debatable.

    The problem now is….us. Ordinary people, professionals, workers, parents, consumers….we still believe in competition, a fair price, truth in advertising. We don’t want to take our coupon books of state scrip to the meat store and hope it’s not rotten scraps again this week. We don’t want to be told that the low interest rates the government forced on us, and the debt that resulted, have destroyed what our forefathers and today’s patriots have fought and died for.

    But, please, in your analysis understand that the overriding fact is that the governments are trapped, are checkmated, and simply are afraid. The bond haircut, the real deleveraging, has been taken off the table. That is fact numero uno.

    Use all the arguments you want, but spare us the sanctimonious market/efficiency language. That is over. It’s knives out time and as far as I am concerned not one dime comes from the lower rungs until the upper rungs are shorn clean. You will see how this plays out; true leadership now consists of seeing the truth and going after the wealthy first, rather than enduring the delay and destruction of going after the middle class.

    To those who whine that the middle class shouldn’t have borrowed the cheap money: Should the elites have restrained themselves? If so then it is all good. Cough it up. And hey how about some retroactive 100% corporate tax on Iraq war profits while we’re at it? Such unimaginative times we live in…the middle class will still suffer but they WILL NOT do it alone.

    Will we get true leadership? I give it no better than 15% odds. It’s going to be a long and ugly slog, with periods of boredom like the current one where ‘we’ are supposed to be lulled into sleep. Then the next dam fails (oh, ooooopsie) and the next, and the next…

  18. Mickey Marzick in Akron, Ohio

    “Coming to a Country Near You: Let a Dozen Latvias Bloom?” is apropos even though it’s at what level the ensuing discourse takes place. For many it’s staying on point and decrying the policies pursued by peoples in Iceland, Latvia, and elsewhere. But taking the bait, if you will, obfuscates the larger message: the whole planet is quickly becoming Latvia as a result of the SUCCESS of neoliberal economic policies over the course of the past 40 years or so.

    It was NOT the FAILURE of neoliberalism, but rather, its SUCCESS that brought US to this point. So long as people continue to believe the former a modicum of “reform” with a tweak here and there is all that’s required to fix it and we’ll all live happily ever after. This is nonsense! Ask yourself why the MSM have treated this debacle as merely a failure and begrudgingly suggested that a reform here and there is all that is needed to right the ship? Who stands to benefit from deficit spending and debt as a way of life in the long term? Are people in debt more free than those who aren’t? Never heard of a “savers’ prison” but do recall that the term “debtor’s prison” is grounded in historical fact!

    Only when the current fiscal crisis of the state and overall state of the economy is seen as the direct historical result, the SUCCESS, of neoliberal political/economic policies will there be any lasting change. It’s not a question of REFORM but the wholesale REPUDIATION of such policies! Whether AUSTERITY comes in the form of wage/benefit cuts, plant closings, and/or unemployment in the private sector, decreases in social expenditures for pensions, unemployment, workers compensation, disability, reduced hours/furloughs, etc. in the public sector, STARVING the BEAST – of revenue – is and remains one of neoliberalism’s central tenets. The logic implicit in such policies is obvious. Tax cuts without commensurate decreases in spending incurs deficit spending over time with the result that the state becomes little more than a structured investment vehicle for the transfer of “public” wealth to the holders of the debts incurred – private bondholders and sovereign wealth funds – over time. Eventually, the bill comes due and then, absent a default, AUSTERITY in one form or another becomes the rule as “market confidence” must be restored. Latvia and Iceland are merely two case studies to add to the list. [Naomi Klein’s DISASTER CAPITALISM is a good place to round out the list.] The “sins” of the past – debt and deficit spending – must be purged from the system in obeisance to the new all powerful omnipotent MARKET. God IS dead and we now worship at the alter of the latter. In the private sector, production moves to the lowest cost producer as investment seeks to maximize ROI. The theory behind the logic is inescapable and real time consequences hard to deny. Only if one subscribes to the virtue of selfishness will this make any cents, but then that’s what neoliberalism was predicated on to begin with. It’s merely a secularized variant of Calvinism. It is god’s work on earth, right?

    Ideas have consequences and the success of neoliberalism is playing out before us. The deception lies in the belief that neoliberalism failed when it actually succeeded beyond some of its architects/practitioners wildest dreams.

    1. Jim in MN

      I won’t disagree, merely point out that the neoliberalism you reference has no economic theory worthy of the term. It is simply an organic blob of power, essentially an attempt to erase history and the people who have dared to dream about freedom. Any economic theory will be used to pursue power and then discarded if it threatens power.

      As for Calvinism, again, the philosophical and the spiritual are to be used for corrupt purposes. One can also base an argument for freedom and even revolution on a Calvinist base–it has been done in the past. King George notably derided the American revolt as “that Presbyterian revolution”.

      We Presbyterians have not forgotten. Tyrants will be tyrants….

      I hope we don’t throw ideas in the dustbin just because pigs have dirtied them. What would we do with all the flags?

      Just a good washing, that’s all it takes.

      1. Mickey Marzick in Akron, Ohio

        Whether described as Liberal or Neoliberal, the ideas of Ayn Rand, Milton Friedman, Friedrich Von Hayek, and Ludvig Von Mises come to mind in this regard. Of course, Hayek allowed for more state intervention than any free market utopian anarchist would care to admit…

        Religion can be either revolutionary or reactionary. Harold Laski’s “The Rise of European Liberalism” testifies to that! Liberation Theology is another example.

        When Goldwater uttered “Extremism in defense of liberty was no vice” he was wrong because as I’ve said before, FUNDAMENTALISM – secular and/or religious – when taken to its logical conclusion is TOTALITARIAN. Ideas are merely the conceptualization of intention, some good and some bad, but the road to hell is paved with such intentions.

        Washing them may serve to clean them, but the irremovable stains of blood still stain the cloth/fabric, even after several rinsings.

  19. Tortoise

    The article is rather idealistic and disregards the conditions in the “dozens of Latvias”. In Greece, for example, the head of the union of public servants said that the austerity measures bring living standards back by three decades. Slight exaggeration: Incomes were reduced to their levels of 1-2 years ago. Greece has no evidence of deflation — au contraire! There is plenty of money around. Greece’s problem is lawlessness and inequality (in incomes, privileges, and before the law), not the austerity measures.

  20. Jim

    The question is what to do with neoliberalism? The MMT boys (Marshall and Robb) are part of a relatively new grouping in economics which has brilliantly exposed the false claims of the neoliberal elites.

    But it is Marshall and Robbs solutions which unnerve me.
    First, they pride themselves on simply descrbing how our monetary system actually operates. Prescriptions are involved (according to them) only in choosing policy options–never in their descriptions of the actual financial architecture.

    The assumption behind this perspective is that there are no prescriptions in their descriptions. I would argue to the contrary, following both Hume and Hobbes, that there is a radical impurity in their “is” statements about financial architecture.

    The initial order of causality by which they have chosen to portray the logic and detail of the monetary system reveals the prescriptive bias in their description. They start from the top down (st the vertical or control level) with strategic casuality flowing from the fiat money producer (the state) which initiates the rule making that supplies the ultimate operational integrity of our monetary system.

    They could have chosen to start their description in the horizontal structure, at the private banking level, where the endogenous lending and desposit activity of the bankers drives the reserves supplied by the fiat system (the state)
    Starting at the horizontal rather than the vertical would at least have opened the descriptive possibility of endogenous credit creation reversing fiat logic.

    In such a manner do all of us build our prescriptions (for MMT– a more active state involvement in fiscal policy and society in general) into our descriptions.

    Stated anothe way–all of us, including MMT, fashion a world in which premise, inference and conclusion feed into each other in a way that works to enusre that the prescriptive lurch of our stock of descriptions (the positive role of the state in smalshing neo-liberalism) is realized and sustained.

    Secondly, MMT, tends to ignore the corruption of the state sector, and ends up advocating increased spending to that sector despite its corruption.

    So when you have a real crisis, as we did in September of 2008, MMT ends up endorsing a financial sector bailout, where two corrupt sectors (private finance and the Treasury and Federal Reserve–linked by the revolving door–are preserved.

  21. MyLessThanPrimeBeef

    I think what we have here is the classic Kobayashi Maru test – should we be turning Japanese or turning Irish?

  22. scraping_by

    “Mainstream economics insists that one path to full employment is via lower wages.”

    Remember always that mainstream economics was manufactured by the elite for their own benefit. The ideas that are messing up the world are the work of the corporate foundations and other wealthy right wingers financing “think tanks” and academics to build a vocabulary that masked sociopathy and denigrated common sense. Quick histories of this process, say in the book Citizen Coors, don’t do justice to just how relentless and wrong-headed they were.

    As to the latest incarnation of the Laffler Curve, it’s silly. Poorer people buy less, leading to lower economic activity leading to poorer people. They’re also more likely sociopaths, so that’s another government expense. No, the deleveraging process should look to the people who have benefited most from the speculation storm that created the mess. Just like that socialist Adam Smith said.

  23. gordon

    Old people like me remember “Captive Nations Week”, the annual festival of anti-Soviet propaganda celebrated by the US every year since 1953. The Baltic states used to be stars of this Cold War jamboree, and speeches were made lamenting their subjugation and exploitation by the evil communists. Nothing seems to have changed except the identity of the subjugators and exploiters.

    I just hope there weren’t too many Latvians taking the whole thing seriously!

  24. Gaucho

    I think you need to discuss the implications of your policies? I’m going to tell you what they are: destruction of the currency, destruction of savings, risk of sovereign default and Japan-style stagnation (no major pain for people, but no prospects either). it just doesn’t work.
    we ran excessive leverage for many years. excessive leverage created excessive demand which in turn created higher than sustainable GDP growth and higher assset prices. We ran out of leverage capacity to support demand, GDP and asset prices. the process has to revert, which means less consumption and a lower GDP with more reasonable levels of debt. private demand collapse requires cuts in supply to re-balance, it’s painful, creates bankruptcies, unemployment and bank losses, but it’s the result of excessive leverage in the past. a necessary adjustment. Govts should only provide unemployment benefits and health insurance to everybody to mitigate the adjustment on people. Don’t destroy savings, trillions of dollars saved around the world are the best stimulus we can get. once asset prices get to reasonable levels, savings will flow back into the economy. they always do. It’s three years of necessary pain for a brighter future as opposed to 10 or 20 years of slow death. I’m from Argentina, believe me I know what I’m talking about, first hand experience.

  25. Rob Parenteau

    John –

    Yes, the Mauldin article, you might notice, is mine. But I am not an Austrian economist. I do work with Austrian School insights, as well as the insights of Keynes, Minsky, Fisher, and many contemporary Post Keynesian economists. Some people may find that an odd mix, but the handful of us who work with it find it very rich territory.

  26. Hugh

    Reading the article and the comments, it strikes me that what is being discussed is the ongoing dominance of the paper economy at the expense of the real economy. The paper economy is essentially a rentier bubble being kept pumped up to the detriment of everyone else. (Yes, I know that pensions play into this but their chronic underfunding is what sends them chasing evanescent profits.) What needs to happen is that the paper economy, and the vast debt overhang, it represents has to be dismantled. Some socially benenficial entities, like private pensions will have to be rethought, refinanced, and let’s face it, reduced, but the wealthy have to be slammed. The wealth redistribution to them of the last 30 years needs to be erased, and that largely by writing off the debt of the lower 90% owed to them.

  27. scharfy

    Thought provoking article.

    The article posits that austerity measures are wholly ineffective, even destructive, to economies that have private sectors that are de-leveraging. Ok. I’m on board to that point. The paradox of Thrift. I get it. Everyone can’t stop shopping at once.

    So if Public and Private debt levels (close cousins), got too high relative to output – then I fail to see how that can be remedied by artificially maintaining that existing structure, via expanding the debt. It just keeps the game going, no?

    If output was artificially high from easy credit, then trying to hold it at unsustainable levels seems to repel the mind.

    Maybe, just maybe, the world will not end if we have flat global GDP growth (a bunk metric anyhow) for 10 years, but in doing so improve the capital foundation, integrity, and sanity of the system, priming it for real growth. Maybe we were not as rich as the ledgers said, theres no getting around that fact, from my view.

    The following line from the article gnawed at me and nibbles at the solution, I believe..

    If fiscal retrenchment is to be enacted, then orderly private debt renegotiation and private asset liquidation must be accomplished at a large scale and in a timely fashion.

    its the winners and losers of the inevitable defaults that are gonna tell the tale i think…..

    1. Greg

      You make one error in your comment scharfy.

      You say that private and public debt are close cousins. Not so. They are not even the same species.

      Public debt is a private asset. It never HAS to be paid back. The US govt never has to borrow money, its a flawed concept. As currency USERS private entities must at times borrow to consume. As a currency ISSUER the govt never has financial constraints on its spending. There are only real constraints on govt spending (Is what they want to purchase available and can it be purchased without being inflationary?)

      Otherwise I agree with your post.

Comments are closed.