MERKEL: WE WILL NOT BE BULLIED BY THE MARKETS

Angela Merkel is sending a pretty clear message this weekend – EMU leaders will not be bullied into action just because the markets are throwing a fit about the speed of their actions.  Bloomberg provides some highlights of her recent comments:

“At this time — we’re in a dramatic crisis — euro bonds are precisely the wrong answer,”

“They lead us into a debt union, not a stability union. Each country has to take its own steps to reduce its debt.”

“Politicians can’t and won’t simply run after the markets,”

“The markets want to force us to do certain things. That we won’t do. Politicians have to make sure that we’re unassailable, that we can make policy for the people.”

These are pretty staggering comments.  If you’re a market speculator you can basically read her comments as such:

“We are in no rush whatsoever to solve the crisis in Europe.  We will not be swayed by market crashes or panics.”

In other words, they are 100% behind the curve.  The markets are sending them a very clear message.  There is a very serious risk of a banking crisis in Europe.   And it all stems from the fact that the Euro is inherently flawed.  As Merkel and her friends fail to provide markets with a solution, they will continue to push the envelope.  Let’s see who blinks first.  Rich politicians have a tendency to pay attention when their personal wealth starts sinking into a blackhole that they could have closed….

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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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Comments

  1. Totally agree Cullen, my biggest concern was the political risk, and unfortunately, Merkel hasn’t disappointed on that front so far, on the contrary.

  2. If the quote(s) are accurate then it appears that the highest levels of the economic and political elite in Germany have concluded that the Euro Project has failed and have taken the decision to allow the Euro to dissolve one way or another.

    Its every man (or country) for himself now.

  3. Merkel said no bail outs in the beginning as well.
    Then she went ahead and did precisely that.
    Right now the markets have not tanked enough. It will take another 20% stock market decline for the eurobonds to become reality.
    I doubt that will be the solution taken though.
    I personally expect the ECB to go into full debt monetisation mode in the coming months. It is the path of least resistance and it shall be taken. And the common people will find it more acceptable (they wont understand what is happening)than eurobonds.
    We just need more strains in the market for those things to happen.

    I concur with Merkel that this way of markets bulling politicians into action has to stop. We are becoming oligarchies run by the mood of the markets.
    And with all the financial instruments out there, it is easy to inflict large market moves with little money.
    This has to sop and democracy has to reassert itself.
    Markets are there to serve the people and improve our economic well being, not vice versa.

  4. Markets don’t “bully” anyone or anything. They are pricing mechanisms and crude predictors of the near term economic future. Merkel is engaging in an anthropomorphic and rhetorical fallacy.

    Casanova is correct; it is the ECB that will have to deal with the crisis. This is Merkel’s real message: “if it is becoming a banking crisis we have a central bank to deal with it via keystroke money, and if it isn’t then go ahead and mark to market and get it over with.”

  5. Yeah but what if those politicians own triple a government bonds and gold? Then they will make money.

  6. If the ECB is to continue monetizing the debts of its member countries, how is this to occur without additional paid in capital by those same countries? The weakest members will be unable to contribute and the stronger ones Germany, France(?) Norway, etc) currently don’t have the political concensus from within their own constituents to buck up.

  7. I think Merkel is tired of the German people paying for greece and everyone else simply because those countries bond yields are sky rocketing.

  8. Exactly. Debt monetization is the only viable option in the near term. This is precise reason for Weber’s withdrawal from the ECB president’s race, he made it clear that he will not be supporting such policies when they were needed. Cullen has conveniently omitted from his quotation where Merkel says that Eurobonds would take years to be implemented even if there were political will for them. They do not address the fact that some countries just do not want to change their (borrowing) ways and balance their budget and an Eurobond solution just makes the problem more accute: ones have to borrow to meet the needs of others. I guess the moral hazard imbedded in the Eurobond solution is none of Cullen’s interest though.

  9. As if the republicans and democrats playing chicken with the debt ceiling was much different, than Merkel’s comments..

  10. “Markets don’t “bully” anyone or anything. They are pricing mechanisms and crude predictors of the near term economic future.”

    In theory, there is no difference between theory and practice, in practice there is. Nowadays markets are constantly manipulated. They are anything but free markets where price discovery takes place.
    Take for instance chartalist theory of endless printing or FED policy of not allowing deflation to take place.
    Who is the FED to dictate laws of supply of demand?
    Why would free market need such policies? What do we make of basic laws of supply and demand?
    I have no political bias , but I try to predict future market trends and profit from it more or less successfully.
    My theory is the law of the least resistant path. It works in nature, it works in economics. It has made money for me every time I correctly identified it.
    The important thing is to identify the least resistant path. It is not always obvious.

  11. There’s another possibility. As business people, the Germans are the best of the lot. I think they would be open to any approach that secures or collateralizes any further funding. The bargaining process is ugly, and threats can lead to concessions. Their threats and procrastination could easily be a bluff. Whatever happens, in the end, the Germans will not be fooled twice.

  12. The saddest part to her statement is that she must be getting awful economic advice – is this how bad mainstream economic has become? Even if you were unfamiliar with MMT as an economist you still should be wise enough to understand national income accounting which applies to everyone regardless of the monetary system they operate…

    Net Spending of Government Sector MUST EQUAL the net savings of the Private Sector + Net Savings of Foreigners (inverse of balance of trade)

    Merkel is committing to HIGHER German unemployment when she says, “Each country has to take its own steps to reduce its debt” because the only way the periphery can balance its budgets over the long haul is to have zero private debt growth and zero trade deficit! That means a lower trade surplus for Germany (and not because Germans are buying more periphery goods) and higher unemployment.

    Sadly I doubt anyone has pointed this out to her.

  13. Since when is throwing more credit at a credit contraction a solution ? Eurobonds won’t work without a good european federal plan (e.g. taxation, and money distribution etc.) and that plan is lacking at the moment.

  14. “zero private debt growth” should read “zero net private savings”. I was getting ahead of myself… The periphery could fund a trade imbalance with more private sector debt theoretically, but that too would end badly.

  15. Well said. The constrant frustration that stupid Europeans don’t do what Americans think is best for them is bemusing.

  16. maybe eurobonds that will fail.

    more good money after bad happens all the time.

    can kicking none the less,eur is toast.

    no way any fiscal union.

  17. 1. Norway is not part of the EMU and not even member of the EU. Other countries (Sweden, Denmark, England) are EU members but still have their own currency (SEK, DKK and GBP). Same story for a number of East European countries.
    2. The strongest countries in the Eurozone are Germany, Netherlands, Finland, Belgium (, Austria ??). In that order. Because these countries have a Current Account Surplus. France is large industrial country but it has a (small ?) Current Account Deficit and that’s why I consider France to be one of the weaker (not weakest) Euro countries.
    3. If Germany would leave the Eurozone today then the Netherlands WILL leave the eurozone tomorrow as well and then the Euro WILL become a third world currency the day after. So, watch Germany.

  18. I don’t know what your problem with her statement is. Without a european treasury, there will be no eurobonds. Would you take a huge credit with your neighbour when you can’t control at all how he spends the money? That would be fatal and would in final carry down germany with the rest.

  19. “Strongest” is a pretty relative term if you understand the dynamics. If Germany left the EMU, its rich citizens could continue to vacation on Mediterranean beaches but its working class citizens might find themselves unemployed as all those periphery nations wont be able to afford any of those German goods they were making any longer.

  20. My problem is that the EMU leaders have displayed no understanding of the fact that they’ve created a fundamentally flawed monetary system. And now as it crumbles all around them and causes mass hardship they appear to be in no rush to fix it. I don’t really care how they create an autonomous state (by complete dissolution or by full unity – clearly, the latter appears more rational and stabilizing), but they don’t even appear to understand that there is an INHERENT flaw in their construction of this system….

    It’s like an automaker making cars that explode and saying “well, consumers just need to suck it up and accept that you might die in our cars”. No, you acknowledge the fundamental flaw and fix it. The EMU leaders have essentially done a recall of the cars and reissued them without fixing the problem….In the meantime, millions of people are getting hurt.

  21. Operationally I think (someone correct me if I’m wrong) EuroBonds are suppose to be sorta like Treasury bonds. The treasury can’t receive a direct loan to the FED but it can get an in-direct one. That’s how the US net spends today. Eurobonds would be some sort of indirect money lending/money creation. This way the government that needs to net spend can without the ECB directly lending to them. It really isn’t much different than “monetizing” the debt as Casanova mentioned above.

  22. If Germany would leave the Eurozone then that massive C.A.D. would shrink dramatically, yes. And the economy will contract as well. But then the rising DEM/EUR (and NLG/EUR) will aleviate inflationary pressures.
    Germany has profited from the Euro, so when it leaves the Eurozone its economy will be hit, without a shadow of doubt. But in the current situation there’re simply no solutions any more without any pain. Not for Germany, Greece, Spain or the US. MMT or no MMT.

  23. I agree for the most part, but again the pain is “relative”. Economically the pain could end tomorrow with fiscal union, but of course the political pain getting there wont be light.

  24. I don’t think that you are right at this point. Everybody knows that there has to be some kind of transfer union at some time, but that won’t happen quickly. Btw I don’t know how familiar you are with he EU, but we already have some kind of transfer union in the EU because the EU has some funds that transfer money from the north to the south, mainly through agricultural- and infrastructure-funds.

    The problem is that this will take years, the realistic time horizon is a decade or more to install such a thing. Nearly all countries need to change their constitutions, several countries need a public referendum, guess how likely that is that all this will happen rapidly. It’s 0%, no matter what the markets think.

  25. It’s really, really weird. The conventional wisdom in Germany seems like one-half WSJ editorial page, one-half hardened social democrat – operating by rule of thumb with no attempt at an internally consistent analytical framework. So they’re inflationphobic austerians, but they don’t want to fire anybody and go all kurzarbeiter when the !@#$ hits the fan. Everything they’ve done right, economically, appears to have been a complete accident. They’ve brought this same approach to the currency union.

    They’re really giving us a run for the money.

  26. Daniel,

    You have to understand that MMTers predicted this all over 15 years ago. So in our minds, it’s not as of the Europeans haven’t had enough time. They’ve just been ignorant for decades.

  27. Why do you need a transfer union?

    Why not issue bonds backed by the EU instead of individual countries to equal sum total deficit of EU countries up to a certain % of GDP, then let the individual countries issue debt in excess of that. The majority of their debt would be at the EU-issued rate, the excess at a higher rate. What kind of transfer union is needed for that? And it doesn’t take years.

    It’s basically what the ECB is doing via bailouts, but less expensive and more democratic.

    Having a common currency and not a common debt is stupid, stupid, stupid.

  28. OK. The ECB simply printing up a few trillion Euros is obviously the least resistance path to the sovereign debt problem, but how about the banks? What will the EU do when a few big Eurozone banks become insolvent and a massive run starts?

  29. European banks weakness is their government bond holdings. Once that is taken care off their balance sheet is not so bad.
    Private debt in Europe is nowhere as high as in the anglosaxon countries.

  30. Cullen:

    “It’s like an automaker making cars that explode and saying “well, consumers just need to suck it up and accept that you might die in our cars”. No, you acknowledge the fundamental flaw and fix it.”

    And if I could add both – the automaker and the consumers notice too many crashes with that particular brand, only that neither of them realizes the crashes are caused by flawed car design.

  31. I think the Euro’s founders understood the flaws perfectly well. They anticipated that the final unification would require a real crisis. Germany accepted the Euro as a quid-pro-quo for German Unification – which could not happen without France’s OK (US, UK, France, and USSR had to agree to it). I don’t know exactly how the final endgame plays out, but it is a good bet that either Angela Merkel gets with the program of “ever closer union”, or gets rolled over and replaced.

    I think it is also a good bet that when final unification happens, the UK has to either become a full partner or leave the EU entirely. The EU will become a single sovereign entity like the USA. Staying in the EU but not in the Eurozone will no longer be possible.

  32. His comment that the Fed should not only use interest rates to target inflation but also for “credit expansion” (to stop bubbles in the bud) is unique. Even with low inflation, he would have the Fed raise interest rates if there was excessive consumer borrowing that may find its way to asset speculation (housing appreciation) rather than for productive lending purposes. Interesting, in that not many mainstream economist consider credit expansion in their economic models.

  33. I believe a variation on the Eurobond theme might solve several issues in one go (IANAE).

    Eurobonds would of course have to be issued by a common debt agency.

    Interest rates this debt agency charges to the participating countries could vary according to a formula depending on

    a) the interest rates for the bonds issued commonly
    b) amount of debt to be issued
    c) public debt level
    d) public deficit
    e) economic policy set by a European department of economics (e.g. desired debt and/or deficit levels)

    Advantages
    1) Germany could still enjoy lower interest rate.
    2) interest rates for the weaker Eurozone members could remain at a more affordable level.
    3) a much lower probability of liquidity issues. Any liquidity issues would impact the entire Eurozone, and could be answered to by the ECB
    4) an automatic feedback mechanism to penalize profligate or stingy Eurozone member states.

    Any solvency issues would remain of course.

    Solvency issues because of bank bailouts could be avoided by allowing member countries to transfer supervision of their major finanncial institutions to the European level.

  34. Yabut the vast majority of Europeans aren’t affected by short-term volatility in the markets. They don’t trade stocks.

    They are, however, affected brutally by socialization of risk (actually, the socialization of failure): that causes debt that the taxpayers have to pay back as taxes for the rest of their lives, without getting any social benefits back in return.

    The violence and unrest in Europe has begun because the people see their countries’ debts skyrocket (and their own taxes increase while their social services are eliminated) all in order to bail out some greedy bankers – who then don’t bother to learn their lesson and instead start coming back for more free candy.

    The ultimate endgame for all this, guys, is for politicians to STOP intervening and let risk return to markets. Til then you can never get another secular equity bull.

    As for what happens with Greece – best thing to do is tie them off, and announce FDIC-like on a Friday afternoon after market close that Greece is being expelled from the Eurozone and will be back on the drachma by Monday. I guarantee you that the bond vigilantes will immediately back off from Portugal, Spain and Italy if that happens.

  35. The flaw in the system is debt. More debt does not fix the problem of having too much debt. If I become insolvent by blowing all my money, only an idiot would give me more money knowing full well I would just blow it. Hopefully, Merkel is not an idiot.

  36. Read this politically.

    We need more and a deeper crisis, included in the core, for European empire rise. THE EU is NOT a real democracy, implementing any sort of fiscal policy through it is a dangerous path. One path European population only will swallow if “The End Of The World As We Know It” happens (aka Paulson moment).

    So politically we need recession in Germany and France, only then they will change political will and Merkel will be allowed to do something without paying a political price.

  37. Unfortunately, Leverage is right. The only path to a lasting solution – whether through unification or dissolution – lies through a crisis. We in Europe will have to have our Paulson moment.

    It may be that chaos then reigns and the peripheral nations lead a larger break-up of the Eurozone. But neither the politicians nor the people will contemplate full fiscal union – and the loss of national sovereignty that entails – until the alternatives are obviously, and painfully, worse.

  38. It is absurd that a country rent its own money supply from the private sector.

  39. After reading all of these good comments I must ask:
    Understanding that the ECB can take on sovereign European debt at will, I still don’t see how countries such as Greece could still make it out of their debt whole? They will be forced again and again to apply austerity measures but it is very likely that they will keep disappointing on their fiscal targets (because they will understand that their dependence on the ECB will never be in jeopardy).
    I guess my real question is:
    can we technically get out of this European debt mess quietly (with no pain for those who started it), given the ECB takes on all this debt indefinitely?

  40. MMT exposes the truth behind the legal and regulatory facade of monetary operations in the fiat system in the USA, and uses sectoral balance equations as part of its methodology, and now I see a site stating equations for the quantity of money’s influence on the real economy, reliant on the presumption that credit is money, which of course it is (although horizontal NFAs are not as potent as vertical NFAs–I think). Leigh Harkness, thank you for giving me a lot more to think about. It is too bad the world’s central bankers weren’t thinking about these things during the “Great Moderation” of 1994-2008, which turned out to be an orgy of Ponzi borrowing and lending in the Minsky sense.

  41. “The markets want to force us to do certain things. That we won’t do. Politicians have to make sure that we’re unassailable, that we can make policy for the people.”

    OK.

    1) What are those policies?
    2) In what way are they good for the people?

    Because I see very little evidence of either.

  42. “The ultimate endgame for all this, guys, is for politicians to STOP intervening and let risk return to markets. Til then you can never get another secular equity bull. ”

    Amen.

    But risk HAS returned to the markets. It’s just that it’s risk for you and me, no risk for the elites. That is the problem. The politicians have no problem with the PEOPLE getting taken to the cleaners when risk blows up. However, surely you didn’t think that those rules apply to the chosen ones?

    This is still the reason why all these interventions are taking place. The wrong people would lose too much money if things were left to collapse and then reset.

  43. Thanks Leigh. I needed to start at the overview to understand your definitions.

    What is impressive is that a large fiscal stimulus may not necessary to solve the employment issue. Do you expect US exporters would be hurt by following the “optimal exchange rate policy”?

    You mention that in the mid 90s there, a dramatic increase in debt relative to GDP. I’m not sure if it is related but 1994 was the beginning of NAFTA, which would support your thesis that increased exports would increase domestic debt.

    Also one thing I’m wanting clarity on is the term “foreign debt”, in your work is this debt held by individuals/corporations or simply the trade deficit of government?

    BTW are you familiar with Steve Keen, he is another Australian economist with focus on consumer debt and I noticed some similarities. http://www.debtdeflation.com/blogs/

  44. There was important point in the comments that I’d like to repeat – most europeans don’t care about stock market, they don’t own stocks. They care about bailouts and taxes. Beleive it or not, but this upheaval over Europe affects captive americans ( captive to the financial industry) with their 401Ks far more than an average european. From standpoint of a european workets they have all time in the world to sort this out.

  45. Ocean

    “What is impressive is that a large fiscal stimulus may not necessary to solve the employment issue.”
    You are right. A large fiscal stimulus can only be a temporary fix. If it is financed by borrowing, it may do nothing to overal economic activity.

    “Do you expect US exporters would be hurt by following the “optimal exchange rate policy”?”

    The optimum exchange rate would benefit exporters. It lowers the exchange rate to make domestic products more competitive. Also, the lower exchange rate means that exports earn more money for their exports.

    “You mention that in the mid 90s there, a dramatic increase in debt relative to GDP. I’m not sure if it is related but 1994 was the beginning of NAFTA, which would support your thesis that increased exports would increase domestic debt.”

    I am not sure it was NAFTA. I think in about 1986, the US managed its float. This appears to have been discontinued in 1994 or 1995.

    “Also one thing I’m wanting clarity on is the term “foreign debt”, in your work is this debt held by individuals/corporations or simply the trade deficit of government?”

    The foreign debt I refer to is private (individuals/corporations) and public debt.

    If the country (government and individuals/corporations) buys more than it produces, it causes the country to go into debt.

    I am familiar with Steve Keen. He comes from an academic background whereas my background was initialy as an economist for a very small country in which I was responsible for both fiscal and monetary policy.

  46. Well the solution to your thoughts is rather obvious though. Just create European federal services in the areas needed. A few areas that come in mind are defense an social security. Do you really think Greece would have this kind of deficits if social security and defense was provided by the EU?

  47. “Rich politicians have a tendency to pay attention when their personal wealth starts sinking into a blackhole that they could have closed”

    Hmm that would not apply to Merkel than at least, cause she’s from a pretty humble background (eastern German, scientist… 2nd marriage, also to scientist…) Berlusconi & co on the other hand, yeah, theyll be worried.

  48. Cullen Roche: “My problem is that the EMU leaders have displayed no understanding of the fact that they’ve created a fundamentally flawed monetary system.”

    Exactly! However sloppy constructed Euro-Bonds without political union are just worsening the problem, as I pointed out several times.

    Eurobonds alone simply fix not this flaw.

  49. Indeed, inflation is more dangerous to the average European saver than a drop in the stock market.

    That’s why people is hawkish about inflation.

  50. Merkel is under pressure from her coalition partner. The german voters are getting more and more opposed to bailing out Greece. Everyone who has read the newspapers in the last months knows Greece is going down the drain, no matter what. Greek interest rates at 30% (10 year) and 15% (two year) are tell tale signs.

    This is NOT the first time the german public is opposing (reckless) government plans. There were a number of ambitious building plans (costing billions) in Germany and the german public simply said: NO. One could call it the german Tea party.

  51. There needs to be a european federal structure as well. E.g employees working for the EU/EMU. (Police, border guards, customs etc. Like in the US). That structure needs to be build first. That would require federal funding by a european federal tax. Not the other way around. But that’s precisely the most sensitive point. Giving up national tasks. (think jobs, influence).

    Doing it the other way means that the quarrel(s)/struggle over who receives how much money from the european federal till every year will continue/intensify. Setting up european structure would require years and years but time is currently not on the side of Europe.

    In that regard countries breaking away form the Eurozone is actually VERY beneficial. Then a (much) small(er) group of countries could establish such a federal cooperation structure and then other countries could (re-)join one by one, if they like what they see.

  52. Even if there is a new Banking Crisis, the Euro will not just vanish. I dont think Merkel has the guts but the right thing to do is let everyone fail that would fail.

  53. “As businesspeople, they’re the best of the lot.” Read Lewis’ Vanity Fair article on Germany. The Germans were the most gullible folks around when it came to buying CDO junk. If it’s not inside the box, they don’t get it. I have little faith in their ability to devise creative solutions out of this mess.

  54. The US Fed will ultimately be forced to act to save Europe.

    Bend over fellow citizens.

  55. To cullen

    Once eurobonds are accepted what is to stop greece from going to 52 yr retirement age and back to old ways? You compare Euro states to US states but within US federal syystem we have things like healthcare and sociial security that apply to all member states. europe would not. So one country could have great welfare benefits while the other has harsh ones but they all enjoy the eurobond.

    Other than legislation that sayd u need to behave…which has failed tremendously the past 15 yrs what’s to stop bad behavior

  56. The Germans have made good money off the euro, but I don’t think they will try to save it in its current form. When a reorganized version presents an acceptable price point they could step in. Eventually pain will cause the euro zone to accept German terms.

  57. translation: “my electorate will not support fiscal unity and the PIIGS electorate will not support what they would have to do to get their house in order”

    ever seen anyone in detox….strapped down….virtually insane….

    i have seen others this way.

    PIIGS not going there voluntarily…..blood in the streets before that happens.

  58. There are two experiments going on in the west. “Borrow and spend” to cure debt problems seems to be the mantra in the US. Mix in a healthy dose of voodoo by Bernanke and we get dysfunctional economy and markets. If the US were actually addressing the problems of bad debt, I would support these policies. But every policy maker just wants to extend and pretend.

    Europe, on the other hand, is pursuing a different path – actually trying to correct imbalances in demand and borrowing.

    I am not sure who is going to fare better. But so far, my money is on Europe.

  59. What’s brilliant about your idea is that it elegantly aligns banks lending (and currency supply that rightfully belongs to US citizens) away from “at any cost” bank profit maximization to bank profit maximization consistent with the best interest of the domestic economy (i.e. maximal bank profits when the y achieve low inflation and full employment). We tend to forget that the sovereign currency is a public utility for the benefit of the country and not for the sole sake of profit of the banks. And so your proposal is geared at the “greater good” of the country and rather than maximization of profits for shareholders.

    MMT (and not that I completely agree with it) comes from a different context and I quote Mosler so I can reproduce the thinking as accurately as possible. MMT believes the real wealth of a nation (increase in standard of living) is the sum “of all it produces and keeps for itself, plus all it imports, minus what it must export”. They would argue that a trade deficit is positive for all parties. That is, US receives desired goods and services from imports, foreign countries received “desired pieces of paper with pictures of dead presidents” (savings) and the bank receives desired loan arrangement and therefore everyone is satisfied. The fact that there is a trade deficit is a byproduct of accounting and in itself not negative.

    They would argue this situation is stable. First because “proper” government deficit spending and taxation can always produce full employment with limited inflation. Secondly, with this full employment, it is possible for an economy to consume more than it produce (so long as the exchange rate maintains its relative strength). That is, this arrangement is sustainable provided the “exchange rate remains high enough that American’s can buy all the imports other countries want to send us and we can consume all the domestics goods and services we produce at full employment”.

    Whereas MMT would focus on government spending and taxation (as well as interest rate targeting) to drive full employment (and exchange rate would be a byproduct), your thinking would focus on exchange rate to drive employment (and does not require nor exclude fiscal stimulus nor interest rate targeting). Of course the MMT policy choice is still prone to abuse by banking cartel. However, it appears there is similarity in terms of the outcomes (full employment with low inflation) with the main difference being “how” this goal is achieved.

  60. I do have some questions on the application of this in global context.

    As I understand, a banks foreign reserves would drive exchange rate (and interest rates). So if a bank had few foreign reserves than they would be restricted from providing lending facilities for imports and hence imports would fall. This could direct them to raise interest rates would rise to attract foreign reserves. When sufficient foreign reserves exist than banks could begin lending. Conversely if reserves are high, rates would fall to encourage imports.

    That said, if the whole world is in recession than how does this work? Wouldn’t we see currency wars as each country tries to export more and stimulate domestic production and consumption by exchange rate manipulation? And also wouldn’t the China peg continue to be problematic? Unless it is as simple as not permitting the banks from issuing loans for imports when their foreign reserves fall beneath some threshold. So than imports can only be serviced from increases in exports income and conversion of domestic income and the attraction of foreign capital from higher interest rates, but not from increases in bank credit.

    Also you mention hot money flows that can lower reserves. Is it not possible to completely deplete reserves at some point (maybe this is the case for a smaller country but nonetheless)?

  61. I’m inclined to agree with Merkel, as untenable as the situation is, there must be a line in the sand, the last thing anyone needs is a closer union, and more devolution of political power. Default if that is whats needed, in a few years the pain will begin to pass, but the EU will still be comprised of sovereign states.
    I want the EU to survive, but I don’t want to be bounced into a fiscal union on the back of a crisis.

  62. Europe, on the other hand, is pursuing a different path – actually trying to correct imbalances in demand and borrowing.

    If you’re sort of looking at it from a sectoral balance perspective, the problem in Europe is with Germany and the problem in the United States is with our big trading partners.

  63. Default if that is whats needed, in a few years the pain will begin to pass, but the EU will still be comprised of sovereign states.

    Basically, Euro nations ceded the most important element of sovereignty when they created the Eurozone. They can raise “revenue” and pass traffic laws, but economically they’re as sovereign as Wyoming, without enjoying the benefits of a fiscal union as Wyoming does.

    The choices are fiscal union or a bunch of super Argentinas – complete with bank runs – across Europe, including France. And enormous bank bailouts across the board, including the rump Eurozone that will remain – Germany, Austria, the Netherlands. All parties will get to enjoy strikingly lower national incomes, which they will foolishly subordinate to the reparation of what’s basically an accounting problem.

  64. “Basically, Euro nations ceded the most important element of sovereignty when they created the Eurozone.”

    EXACTLY.

    Why is it that my dumb-@ss can understand this but people in power of there can’t?

  65. And most of the plans are realized anyways. The German voters have no say in matters…

  66. It’s so weird. In our system, national party control is really loose, so all sorts of people can get elected to office – when you hear something crazy, there’s no compelling reason to think the person doesn’t actually believe it. But it’s not plausible that Merkel, et al are stupid or crazy (I think), or else they couldn’t have risen through the CDU/CSU (I think).

    They could still soothe an angry electorate by saying that they don’t want to take the measures being discussed, but could frankly explain to the people why and how things are screwed up, and why and how they have to be fixed. Instead, they offer nonsensical bluster about not bending to “the markets”, reinforcing dangerous and self-destructive conceptions about the Eurozone among its citizens.

  67. I’m a little excited and sufficiently scared because I’m starting to think you can read my mind.

    “They could still soothe an angry electorate by saying that they don’t want to take the measures being discussed, but could frankly explain to the people why and how things are screwed up, and why and how they have to be fixed”

    Couldn’t agree more- and from a political standpoint they have all the ability in the world to ‘pass the buck’ while doing so (not that I agree with the idea, but it makes it easier for a politican to do something). They weren’t in power when the Euro was developed and adopted, they can look like the heros swooping in to fix the broken system that the people didn’t even understand was broken until they pointed it out.

    And even more so, when the can finally hits a wall and they have to pay the piper, if they’ve sufficient fixed the euro by then (setting up a functioning unified treasury by then: unlikely, but they could at least say they tried) they would be able to say that without their actions there would be no way to shore up the banking system. They could take the responsibility, directly, for slapping one of those monster band aids on the entire european banking system and thereby preventing the shockwaves of a collapse from affecting the world economy.

    Instead? Merkel wants to look like she won’t bow to evil stock brokers and their nasty markets.

    #Id-e-uts

    (Of course, this diatribe is written in my standard idealistic tone and logic. It would be a huge step if they just admitted there’s a flaw in the euro)

  68. Exactly – succinctly, blame it on the socialists! How is that not, like, on page one of their playbook?

  69. Agree Daniel, and agree wtih Merkel as well. Americans do seemt o think that the Eu has to evolve like they did.

  70. Leigh Harkness, would you mind thinking about a Trading Bank e.g. Bancor system? It seems to me that separate currency loops for the internal economies, verses a bancor loop for external trade makes the equations much simpler. It also puts the trade balances front and center for political authorities to see and act upon. Mercantile countries that acquire excessive bancors due to inflows from all their trading partners can be punished through agreed upon legal mechanisms.

    In other words, I struggle with the need for floating exchange rates, when a conceptually simpler and fairer system has been conceived.

  71. I disagree. Germany recognizes that Greek overconsumption needs to go down. In the US, we are trying to treat overconsumption with more consumption.

  72. Dear Cullen,
    I leave the above learned scholars to their economic theories. I am just simple trader. You know from my previous comments that I live in Heidelberg,Germany, but I am an Australian. And I am an observer of what I see around me, and I have made my living for the last 6 years trading the DAX Index futures exclusively. From where I stand, I don’t think it matters what Angela Merkel will or won’t do with regard to the markets. The DAX index passed through its 1000 day EMA two weeks ago, and is making no headway back, and has lost more than 2100 points since 2 May when it topped at 7602 points, and when it sinks past its March 2009 low sometime in the next 6 months, as it will surely do, Ms Merkel will lose the upcoming election, and we will have a coalition of the Greens, the Links and the SPD, probably with the Greens dominating! Wait til you see what kind of politics that will bring to the EU. Ms Merkel will seem like the consumate diplomat by comparison! Ms Merkel likes to keep her head when those around her are losing their’s, but keeping her head together is not what will put an end to this crisis. And it is a huge crisis. It needs the kind of leadership that she is not capable of providing. And there is no one on the horizon to take it over. Sooner or later, something too big to handle is going to happen, and the EU will implode with a mighty roar. If you keep the risk alive for long enough, sooner more likely than later………!!! And Ms Merkel likes to think she has time on her side in abundance. I hope she’s right, but I fear she will be proven wrong.

  73. Boatman,

    I tend to agree on blood in the streets. The sterile, non-human analysis that pervades the detached comments here totally ignores the proletariat. Of course, there is going to blood in the streets in America as well but after that in the Europe, probably, but who knows. Europe does have tremendous resources.

    I think the idea that millions of European people of different nationalities are going to stand-by elected leaders if these leaders attempt to disrupt their everyday life as they know it, is absurd. So, there will be a solution that maintains everyday life or things will grind to halt, literally. Before that point however, people will have gone in to siege mentality. There will then be bargaining or more probably fighting………..Obviously, this will also affect most of the rest of the world in many ways.

  74. I struggle with the need for floating exchange rates, when a conceptually simpler and fairer system has been conceived. REN

    Why not just abolish the private money monopoly and let international currencies develop as they will? Then, instead of a single balance of trade account, there might be dozens, each capable of separate adjustment by private monetary action.

    Single national currencies are too blunt a tool to be used effectively. A monetary policy that might help one sector of the economy could easily harm another sector.

  75. In the US, we are trying to treat overconsumption with more consumption. ReturnFreeRisk

    IF our money supply was not debt-based, then why could not the consumption (and corresponding high employment) have continued? It is not overconsumption that is the problem but debt and some waste from speculation.

  76. There’s another possibility. As business people, the Germans are the best of the lot.
    I dunno, that Oskar Schindler lost his shirt.

  77. Yeah but you didn’t provide 6 links to its etymology….. you’re losing your edge beowulf :)

  78. Politically, in Germany, fiscal union or eurobonds are definitely not the path of least resistance. Merkel’s latest comments back that up as do the comments about what might happen in Germany after the next election.

    I just don’t see either of the above scenarios happening so at some point it has to come to a head when the Germans will say enough is enough. We are no longer backing everyone elses debt. That will signal the end of the Euro. I can’t see a Euro without Germany.

    Within a couple of years I reckon Germany will be regretting the decision as demand for their exports plummet.

    Thats my guess for what its worth.

  79. But how will she incorporate that into the butterfly, tribal pattern and poorly transliterated Chinese maxim that I like to think she already has?

  80. FB, a bancor system has a trading bank account for each country. In this way each country has its own fiat money system, and is insulated from machinations of foreign powers. If Germany’s account is in surplus, but Norway’s is in defict, then no big deal, you can transfer surplus bancors to the deficit account. But if all of your trading bank accounts go into deficit, then you have to make adjustments to devalue your currency.

    In biological terms, the blood circulatory system is kept separate from the spinal cord system. In this way they cannot mix and infect each other. IMHO, we need a similar system for the world money systems. Individual country currencies should be encouraged as they provide the fast feedback an economy needs, yet trade can be encouraged as well with a properly constructed bancor trading bank system. Floating exchange rates don’t do the trick to my mind.

    An example: WW2 was caused by intergovernmental debt left over from ww1 and high U.S. trade barriers. Debtor countries like Germany couldn’t export across tariff walls to pay their U.S. debts, so they turned inward to Nationalism. Germany, for example borrowed from U.S. Commercial banks, to send dollars to pay off debt at the Government level. Effectively, they transfereed debts in America from the government to commercial banks. When Germany’s currency became weak, more credit money was borrowed to bear raid the economy, further driving them into hyperinflation desperation. Politically, fascism arose as the trading system broke down and the people had their assets wiped out. War broke out to acquire the resources that couldn’t be gained through trade.

    There are parallels to today with the PIIGs borrowing from commercial banks to fund their government operations. Individual national currencies with bancor systems in Europe would have prevented today’s situation.

    Surveying monetary history, I don’t see much to recommend floating exchange rates. A trading bank system provides a level of insulation and also exposes trade weaknesses so they can be dealt with.

    As an aside, the private money power you advocate always attempts to usurp political control for itself. It has to be restrained with checks and balances. The bank of england takeover in 1694, the First and Second U.S. banks, the FED, among others are good examples of private money power attempts at usurping political control.

    Political authority can also overcome private money power, witness Jews being kicked out of Europe approx 200 times, and the Templar’s forced to flee by the King of France.

    Only a legal framework with checks and balances will control money power, as money itself is a legal construct.

  81. expediency is just not the way of humans.

    we are a very stubborn lot.

    i feel like they do,lluvator, i am an american…..not a north american with canada and mexico—i do not want to fund mexican retirement with my sweat.

    and i am not a citizen of the world.

    let them have their own cultures and individual money….viva la difference’

    the eur is frankenstein.

    the blood will be FROM the eur.

  82. Ocean

    I can understand where Mosler is coming from but it is a view that I do not share. It appears to be the approach of the prodigal son, living off his inheritance until he has nothing, or living off the credit card until your credit goes bad. It is only a short-term option.

    Other countries are not holding “pieces of paper with pictures of dead presidents”. They are mostly holding shares, bonds and other securities. They are not fools.

    The rise of foreign debt is not a desired objective of the market. It is the result of a systemic flaw in the monetary system.

    My approach to government debt is that there is a place for it. It may be desirable to share the burden of an investment in infrastructure over the life of that asset. However, it should not be used to finance recurrent expenditure, particularly in the longer term. If it does, the government is limiting its options for the future. Even if it never repays the debt, it must service that debt and that cost is real.

    The problem that is causing the failure of US manufacturing and other industries is also causing the US fiscal deficits. These are both symptoms of the same problem. They are not the cause.

    In the light of that, I do not see that raising the fiscal deficit is going to solve the problem. It only exacerbates the problem and puts off dealing with the real problem.

    I have estimated that the wages of American production workers would be about 80% higher and overall national income about 60% higher if Americans had continued to spend 94% of their income on American products. Buying “all the imports that other countries want to send” has made Americans poorer. The shift to imports has also caused high levels of unemployment. Furthermore, this loss of income reduces government revenue and raises the cost of social security, resulting in high fiscal deficits.

    We share the goals of full employment with low inflation. In addition, I seek to achieve a balanced current account to ensure that prosperity is sustainable over the long term.

  83. i was wanting to retire and the economy did it for me…..the boat business is the first to go……mama will borrow for a pool not a boat…..and we know who runs the show round most places(not in my place,tho)….investing wayy more fun than dealing with boat owners tho….they are WORSE than parents over children.

    the theoretical ‘melting pot of europe’ is almost as far from reality in our lifetime as the ‘federation of planets’….with no apologies to gene roddenberry.

  84. Ocean

    Responding to your second comment.
    Under the optimum exchange rate system that I promote, foreign reserves are used as an indicator of the level of national savings. If there are plenty of foreign reserves, the nation has surplus savings that the banking system can lend.

    The idea of managing bank lending is not to reduce imports so much as to prevent imports exceeding exports. The system can facilitate increased imports by first increasing exports.

    It is just like you managing your credit card spending. If you have plenty of money saved, then you do not mind using your credit card.

    The national savings of the country are its foreign reserves. Linking bank lending to those savings is a perfectly sound policy, if you are seeking to balance the current account.

    Bank can raise interest rates to attract foreign savings. However that is a stabilizing outcome. Higher interest rates attract foreign savings. But they also discourage domestic borrowing. As lending requirements are satisfied, interest rates will fall. Eventually, interest rates will fall to a level that no longer attracts foreign funds. At that point, the capital account will be balance and the current account will be balanced.

    You ask:
    “Wouldn’t we see currency wars as each country tries to export more and stimulate domestic production and consumption by exchange rate manipulation?”

    This is the beggar thy nation problem that the Breton Woods agreement sought to overcome.

    The primary problem we have to deal with is that bank lending converts debt (an obligation to increase supply in the future) into money (an entitlement to demand goods at the current time.) Excessive bank lending causes current account deficits.

    Under the fixed exchange rate system, there was a limit as to how much banks could lend because it depleted gold and foreign reserves.

    However, by floating the exchange rate the banks could lend without having to worry about foreign reserves. Bank lending continues to cause the country to buy more than it has produced, but someone else has to borrow the foreign money to pay for the excessive imports. It is no longer the Federal Reserve’s responsibility.

    The floating exchange rate system was introduced during a financial crisis to protect the Federal Reserve and a liberal approach to bank lending (implemented to stimulate the economy and enable Richard Nixon to win the 1972 election). It is a system protects the banks. But it destroys industry. It is not a fair market system.

    Therefore we can think of the floating exchange system as a form of “exchange rate manipulation”. It manipulates the exchange rate so that international transactions do not affect foreign reserves.

    The optimum exchange rate system that I propose does not relying on one set of countries being made poorer to allow others to be richer. The foreign reserves are used only as a signal. That is, when foreign reserves (national savings) rise, the banks are allowed to increase lending and so run down those savings. The net result is that only a small amount of foreign reserves (savings) are left over and they do not need to be held as cash. For example, those savings could be held as foreign government bonds. In essence, the country with the reserves would be lending the money back to the original country. All countries can have relatively balanced outcomes.

    You ask: “wouldn’t the China peg continue to be problematic?”

    Excessive demand in the US that leads to foreign debt is caused by the US, not by China. The world, including China and America, would be better off if the US increased its output and increased exports. This would allow the US to increase its imports in a sustainable manner, and we would all profit from the increased trade.

    If China sells its products below a fair market value, it reduces its own wealth and it reduces the amount it can earn from the rest of the world. The US has to look after its own economy and ensure that its exchange rate provides sufficient demand for US products to bring about full employment. It has to be responsible for its own economy and let China be responsible for its own policies.

    You question hot money flows. Banks were the worst offenders engaged in speculation against central banks. Under the optimum exchange rate system the central banks are not open to speculation. If anyone wants to speculate, they must speculate against the commercial banks in a world of flexible exchange rates.

    The rigidities of the fixed exchange rate system are removed. Hence there is little opportunity for anyone to cause any instability by speculating. Banks would be setting the exchange rate at the optimum level to achieve full employment without inflation. Someone would need to be better informed and have deeper products to bet against them.

  85. As an aside, the private money power you advocate always attempts to usurp political control for itself. It has to be restrained with checks and balances. REN

    Private money needs to be totally ignored by government. Once government recognizes private money in any way then yes it will eventually take over as you say. But there is absolutely no need for government to recognize private money since government can easily create, spend and tax back (some of) its fiat.

    Thanks for the info on the bancor system.

  86. “Private money needs to be totally ignored by government”

    The private sector will have to create its own framework to handle their money power. They will also have to deal with the impossible contract problem, because interest is built into the system. In effect, a private economy will have to create its own shadow government. Said shadow government will then have to come under control of the people, and you are back to the primary questions. Who holds the money power and how are you going to restrain it?

    Yes, governments cannot be trusted when they are fascist, or have built in statism. But, a Federal Republic can restrain the money power. It is the only form of government that can.

    Bancors are an extension of the idea that legers should be single entry and not double entry. Assets should not swap back and forth with liabilities. Also, money supplies should not mix, which is your position and mine.

    We tried the private money public money system with the tally sticks in England. That system was usurped by the Gold Men.

  87. They will also have to deal with the impossible contract problem, because interest is built into the system. REN

    My bet is that large scale usury requires government support and that without that support that usury-free money forms such as common stock would prevail.

    We tried the private money public money system with the tally sticks in England. That system was usurped by the Gold Men. REN

    After 726 years!

    I might agree with an all public money system if only we had a class of throughly righteous men to run it. However, those won’t appear till the Second Coming. Till then, I reckon competition (plus strict enforcement of fraud and insolvency laws) to be our best hope for high performance and honesty.