Prodded by Prodi
by
Pater Tenebrarum
When the euro was introduced, socialist EU commission president Romano Prodi said the following in an interview he gave to the Financial Times:
“I am sure the euro will oblige us to introduce a new set of economic
policy instruments. It is politically impossible to propose that now. But
some day there will be a crisis and new instruments will be created.”
In short, Prodi was convinced from the outset that the
adoption of the common currency would eventually lead to an economic crisis. As
we noted in the article we linked to above, Prodi (who himself is sitting
pretty, well-supplied with a fat pension and fat perks courtesy of EU and Italian
tax payers), still doesn't care one whit that the crisis he wished for has
caused misery for millions of people across the EU who have lost their jobs and
savings. He continues to believe it is all 'worth it'. In 2012 he said:
“Well, the difficult moments were predictable. When we created the euro, my objection, as an economist (and I talked about
it with Kohl and with all the heads of government) was: how can we
have a common currency without shared financial, economical and political
pillars? The wise answer was: for the moment we’ve made this leap forward. The
rest will follow.
(emphasis added)
A friend pointed us to a recent article by Ambrose
Evans-Pritchard (AEP), who lately appears to be hell-bent on single-handedly
saving the euro from his perch at the Telegraph, mainly by generously
dispensing inflationist advice. The article in question informs us that Romano Prodi is once again piping up to give us his two cents.
“The plot is thickening fast in Italy. Romano Prodi – Mr Euro
himself – is calling for a Latin Front to rise up against Germany and force
through a reflation policy before the whole experiment of monetary union spins
out of control.
"France, Italy, and Spain should together pound their fists on the
table, but they are not doing so because they delude themselves that they can
go it alone," he told Quotidiano Nazionale
Should Germany persist in imposing its contractionary ruin on Europe –
"should the euro break apart, with one exchange rate in the North and one
in the South", as he puts it – Germany itself will reap as it has sown. "Their exchange rate will double and they will not sell a
single Mercedes in Europe. German industrialists know this but all
they manage to secure are slight changes, not enough to end the crisis."
(emphasis added)
Naturally, AEP, who once viewed Prodi as the devil's
representative on earth, sotto voce approves. What could
possibly be better than abandoning the 'failed German model' and instead
adopting the Southern policy of devaluation, inflation and deficit spending
that has been so astonishingly effective and successful over the decades?
Should Germany wave good-bye to this 'Latin Block', it
won't sell a single Mercedes anymore! Of course the people buying Mercedes cars
won't be able to buy them from Greece either, even if a putative 'Southern
Euro' were to predictably collapse into a heap.
At the core of all this are mercantilist fallacies
about the miracles of devaluation. What is seemingly never considered is that
any gains that may be accruing from currency debasement in the short term are
quickly erased again as domestic prices adjust. In today's globalized world
with its extremely fast exchange of information, such adjustments tend to occur
even quicker than in the past. There also seems to be a considerable degree of
confusion about who the 'winners' and 'losers' actually are. If people in
France or Italy can no longer afford German cars, have they somehow 'gained'?
Will their standard of living be improved once they can no longer buy what they
were able to buy in the past?
However, judging from what we have heard about the
latest ECB rate decision – namely that about 25% of the voting members led by
Germany voted against the latest rate cut – it seems the 'Latin revolution'
Prodi has been calling for is well underway already.
AEP's article continues:
“German public opinion is by now convinced that any economic stimulus for
the European economy is an unjustified help for the 'feckless' South, to which
I have the honour of belonging.They are obsessed with inflation, just like teenagers obsessed with sex.
They don't understand that the real problem today in deflation, as I have been
saying for a year," he [Prodi, ed.] said.
This is the nub of the matter. The policy regime has become
maniacally restrictive because every decision is filtered through "game
theory" calculations, the belief in Berlin that the naughty Latins will
somehow cheat unless their feet are held to the fire.”
(emphasis added)
What, pray tell, was 'maniacally restrictive' about a
50 basis points record low repo rate, a zero percent deposit rate, combined
with LTRO financing and a repeated lowering of the credit rating standards the
ECB employs in determining which assets it accepts in open market operations?
If that is 'restrictive' policy, what will be considered 'loose' policy in
AEP's fevered mind?
Incentives Matter – The Euro
System's Tragedy of the Commons
As to the suspicion that “the naughty Latins will
somehow cheat unless their feet are held to the fire”, it is well
founded. After all, it has already happened. While Greeks are not 'Latin' but
Greek, does AEP need to be reminded that Greece's government lied about its
debt and deficits for years, starting from the very day it acceded to the euro
area?
Indeed, unless the governments of these countries are
given a strong incentive to stick to their treaty obligations, why should they not cheat?
It is after all a core problem of the euro that it represents a variation of
the 'tragedy of the commons' problem. As Philip Bagus has pointed out in his
excellent book 'The Tragedy of the Euro':
“Although the external effects of a monopolistic money producer and a
fractional-reserve banking system regulated by a central bank are common in the
Western world, the establishment of the euro implies a third and unique layer
of external effects. The institutional setup of the Eurosystem in
the EMU is such that all governments can use the ECB to finance their deficits. [11]
[...]
The mechanism works as follows: Banks create new money by credit expansion.
They exchange the money against government bonds and use them to refinance with
the ECB. The end result is that the governments finance their deficits with new
money created by banks, and the banks receive new base money by pledging the
bonds as collateral.
The incentive is clear: redistribution. First users of the new money
benefit. Governments and banks have
more money available; they profit because they can still buy at prices that
have not yet been bid up by the new money. When governments start spending the
money, prices are bid up. Monetary incomes increase. The higher the deficits
become and the more governments issue bonds, the more prices and incomes rise.
When prices and incomes increase in the deficit country, the new money starts
to flow abroad where the effect on prices is not yet felt. Goods and services
are bought and imported from other EMU countries where prices have not yet
risen. The new money spreads through the whole monetary union.
In the EMU, the deficit countries that use the new money first win.
Naturally, there is also a losing side in this monetary redistribution. Deficit
countries benefit at the cost of the later receivers of the new money. The
later receivers are mainly in foreign member states that do not run such high
deficits. The later receivers lose as their incomes start to rise only after
prices increase. They see their real income reduced. In the EMU, the benefits of the increase in the money supply go to
the first users, whereas the damage to the purchasing power of the monetary
unit is shared by all users of the currency. Not only does the purchasing power
of money in the EU fall due to excessive deficits, but interest rates tend to
increase due to the excessive demand coming from overindebted governments.
Countries that are more fiscally responsible have to pay higher interest rates
on their debts due to the extravagance of others. The consequence is
a tragedy of the commons. Any government running deficits can profit at the
cost of other governments with more balanced budgetary policies.
(emphasis added)
These are not merely abstract worries 'run through
game theory calculations by Berlin' as AEP asserts. The worries are firmly
rooted in reality.
In fact, the mechanism described by Philip Bagus above
is precisely the mechanism used by euro area governments and the banking system
to overcome the crisis situation that seemed to overwhelm the euro area in
2011. Today we find that credit default swaps on the sovereign debt of the
“PIIGS” have declined to levels close to multi-year lows:
5 year CDS on the sovereign debt of Portugal, Italy, Greece and Spain –
close to multi-year lows – click to enlarge.
How was this accomplished? Commercial banks in the
crisis countries have bought up oodles of debt issued by their own governments
(and presumably re-discounted much of it with the ECB), as this chart posted by Zerohedge in September shows:
Italy's commercial banks' holdings of Italian sovereign debt – a 300% increase
since 2008, and a 200% increase since late 2011, the peak of the sovereign debt
crisis (for the time being) – click to enlarge.
The ECB's LTRO's have made this gorging on
sovereign debt by commercial banks possible. As we reported in December of 2011 in the context of Italy, a veritable Ponzi scheme was concocted when
the ECB offered these long term financing schemes to support European banks. In
brief, Italy's government issued guarantees on all sort of securities held by
banks, which made them eligible as collateral that could then be presented to
the ECB. In short, one insolvent entity 'guaranteed' the debts of other
insolvent entities so as to make the monetization of this debt by the central
bank possible. It was as though WorldCom had offered to bail out Enron. We
published this chart from the WSJ that showed how the process worked in the
case of government-owned property:
How Italian state-owned
property was transformed into cash printed by the ECB.
So this in short is the essence of the 'maniacally
restrictive' ECB policy that AEP bemoans. Of course it is never enough
– he wants more of the same, and in spades:
“As readers know, I have been arguing for a long time that the Greco-Latin
Bloc and those with shared interests such as Ireland should seize control of
the European institutions and dictate the policy with a very sharp knife held
to the throat of Berlin's über-bully Wolfgang Schauble.
They have the majority votes in the EU Council of Ministers. They have a
majority on the ECB's Governing Council, and indeed on other bodies such as the
European Investment Bank, which could be mobilised for a Marshall Plan (that
empty promise from some wretched and now forgotten EU summit, never delivered
like all those New Deal EMU pledges that came before).
They have natural justice, economic authority, and the EU treaties on their
side. They can and should deploy their combined political power to impose a
full fiscal and monetary reflation strategy on the EU, Abenomics for Europe. Germany might find that a few years of 3pc inflation and a mini-boom
are not so painful after all. But if it finds this outcome so intolerable, the
exit door is wide open. It can leave EMU.”
(emphasis added)
And who should 'provide leadership' when this cunning
plan to impose the John Law solution of 'Abenomics' on Europe is implemented?
None other than the bungling socialists running France! Best reach for a barf
bag before continuing to read:
“In the end, the leadership must come from France, still the great and
generous heart of Europe.That may happen yet, even if
Francois Hollande gives every impression of being a vacillating amateur,
buffeted by events, incapable of saying boo to a mouse. Record
unemployment must ultimately stiffen his spine, and if he cannot rise to the
challenge, his governing authority in France will collapse, and perhaps the
Fifth Republic will collapse with it. We must not let this happen to France.
But the fact that Italy's Mr Euro is saying such extraordinary things is
itself a sign of the tectonic rumblings in the Latin world. Every
week it seems that yet another towering figure of the European cause joins the
rebels. For me personally, it is refreshing to be part of
consensus at last.”
(emphasis added)
Yes, France is definitely a 'generous heart' – a bit too generous
in fact, as attested to by that fact that government spending in France amounts
to 57% of GDP, the highest level among industrialized nations. France is so to
speak only 43% away from adopting a full-scale communistic command economy.
Obviously, the ideal candidate to provide Europe with leadership!
Europe would actually be a lot better off without all
these 'towering figures' AEP drools over, but unfortunately he has no reason to
worry anyway. Every indication is that the inflation and debasement
'revolution' he is pining for is well underway, with the silent acquiescence
and connivance of Germany's political leadership (which ultimately only lodges
token protests to appease its restless citizenry now and then).
Conclusion:
Europe has joined the global debasement train long ago
already. However, it appears now that the inflationary policies are about to be
taken up by another notch. The dispute between the political elites running the
EU which AEP chronicles and worries about is mostly political theater anyway.
There is no disagreement in principle. The bureaucratic monster in Brussels and
everything it has given birth to – including the euro – will be 'defended at
all cost'. The cost will of course be borne by Europe's citizens, not the
elites imposing these 'solutions'. The only hope the EU's citizens have at this
point is that the whole project will simply become politically and financially
untenable. Unfortunately the road promises to be quite rocky, and it is by no
means certain that a future dispensation will be preferable to the current
one. The original dream of the EU's founders – to restore the blessings
of the age of classical liberalism to Europe – has been completely perverted by
now.
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