Monday, April 28, 2014

And the euro crisis rolls on ...

Bloomberg Businessweek has a short article raising the alarm about the flaws of the European banking union, Europe's Deeply Flawed Banking Union 04/24/2014:

In approving a raft of banking union legislation, the European Parliament has ratified an important understanding: If the member states of the euro area want to share a currency, they’ll have to share some risks and responsibilities. Among other things, they must create a central authority to supervise banks throughout the euro area and pool resources should there be the need to rescue a bank whose collapse could overwhelm a government’s finances.

The new laws fall short.
The piece observes that the Single Resolution Fund that should serve to recapitalize failing banks doesn't have nearly enough funding to play that role effectively; insufficient authority for the ECB in dealing with failing banks; and, the lack of a eurozone deposit insurance. The latter means that "it could happen again that a euro in a Greek bank would be worth less than a euro in a German bank. That isn't what 'common currency' was supposed to mean."

Gary Shilling has been writing for Bloomberg View about the dangers of deflation in Europe in a series of three articles: Deflation Is About to Wallop Europe 04/22/2014; The Economic Monster Called Deflation 04/23/2014; Might Be Time to Short the Euro 04/24/2014. (Sweden is already there even though they're not in the eurzone; see Paul Krugman, How Do You Say “Nobody Could Have Predicted” In Swedish? 04/18/2014.) He recounts some of the prominent warnings:

Bankers and policy makers worldwide are deeply worried about trivial inflation in the euro area turning into chronic deflation. Christine Lagarde, the chairman of the International Monetary Fund, said in a January speech: "We see rising risks of deflation, which could prove disastrous for the recovery. If inflation is the genie, then deflation is the ogre that must be fought decisively."

This month, Olivier Blanchard, the IMF chief economist, said deflation "would make the adjustment both at the euro level, and even more so for the countries in the periphery, very difficult. We think that everything should be done to try to avoid it."

Kenji Yumoto, vice chairman of the Japan Research Institute Ltd. and a former adviser to the Japanese government, said recently that the Bank of Japan "didn't think Japan was going to be entangled with deflation" until it was too late. "The ECB still can't be complacent. Europe is lucky to have Japan's case study," he said.
It's important for the ECB to recognize the seriousness of the problem and do whatever it can, as Krugman has been urging for quite a while now. But, as Krugman cautions, there are real limits to how much central banks can do in the current situation, with interest rates up against the zero lower bound. (How much central banks actually do to stimulate the economy under more favorable conditions is another question.) Shilling rather discretely explains that problem this way:

... real interest rates are always positive [under deflation], even with zero nominal rates. That’s been the case in Japan for two decades. This means that central banks can’t create the negative real rates they desire to encourage borrowing. To be effective, they need to pay borrowers, in real terms, to take money.
Respectable opinion assumes the Federal Reserve and other central banks exercise a mystical, esoteric power over economic growth. That's an especially off-base assumption in current conditions of interest rates at the zero lower bound and deflation threatening even on a worldwide basis, as Shilling warns. (See Krugman's Euphemistic At The IMF 04/04/2014 on what central banks can try.)

Shilling's conventional description of deflation, though, is misleading in an important way:

... deflation breeds deflationary expectations, which results in a sluggish economy. That’s been the case in Japan since the early 1990s. Buyers wait for lower prices before purchasing, so excess capacity and inventories mount, pushing prices down. That confirms prospective buyers’ expectations, so they hold off further, creating a self-feeding cycle of buyer hesitation, which spawns excess inventories and capacity that depresses prices and encourages further restraint by purchasers, and so on.
This is the standard assumption of neoclassical economics, often ignoring as it does in the real world. In a depressed economy, prices start falling because people out of work or with lower wages don't have as much money to buy things.

And, as Krugman notes, "low inflation reduces the rate of nominal income growth one for one" and thus feeds a downward spiral of depressed aggregate demand. (Blaming the Messengers, Euro Edition 04/15/2014) Even an economy caught in a deflationary spiral will see aggregate demand hit bottom and begin growing again. But in the trap the euro currency zone represents for so many countries right now, that could take years, decades even. And human costs are already enormous and unconscionable.

Krugman breaks down the depression/deflation problem this way in

I know that many people just hate it when economists talk about liquidity traps — it all sounds like mumbo-jumbo to them — but the zero lower bound isn’t hypothetical, it’s staring us in the face.

And if you want to insist that some other kind of flexibility would save us if only markets were perfect and pure enough, tell me how. A fall in the overall price level would do nothing to raise real incomes, but it would increase real debt, increasing the pressure to deleverage. If for some reason wages were to fall while prices didn’t, it would reduce real wages — but firms would have less, not more, incentive to hire workers, because their real sales would fall too. And so on down the line. [my emphasis]
The goldbugs pooh-pooh the dangers of deflation because, well, who knows what crack-powered crystal balls they're consulting?

The Real News has an interview with Costas Papavitsas on France, the euro crisis and the rise of the far right in France, The Rise of the Far Right as the Euro-Crisis Hits France 04/26/2014:

His comments on politics are interesting. But Papvitsas' analysis of the euro crisis is not very good. His description here basically agrees with the neoliberal analysis of the problem being "competitiveness." Nor does he convey any good sense of what the realistic alternatives to the current policies are for the eurozone. He also doesn't convey any sense of the central role that German Chancellor Angela Merkel's Herbert Hoover/Heinrich Brüning austerity policies have played in bringing matters to such a bad pass.

This Real News interview featuring Rob Johnson is more helpful in understanding the danger of Angie's Hoover/Brüning policies for the EU and European democracy, starting just after 3:10, The Breakdown of Democracy 04/26/2014:

You're doing a heckuva job, Angie, heckuva job!

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