Back to 1693
Economic historian Martin Hutchinson, below, is having a lot of fun using his knowledge of history to enlighten us about the world financial crisis. But while he agrees with many other economists in foreseeing much gloom immediately ahead he has a vision for the medium-term future which is positively radiant by libertarian/conservative standards.
I think he over-eggs the pudding and I cannot see that a return to the gold standard is on the cards but he is probably broadly correct. The money-printing binge in the USA and the UK combined with the un-repayable debt run up in much of Europe has got to lead to massive asset-destruction sooner or later. If I were an American right now, I would be taking a trip to Canada and converting my holdings of greenbacks into deposits of Loonies. Anybody who did so a couple of years ago would certainly be laughing now -- JR
The eurozone crisis, which could have been defused initially by allowing Greece to depart the euro, has now taken on a much more serious aspect. If as seems possible Italy, Spain and even France lose the confidence of the international debt markets and are forced to write down debt, then government debt of prime countries will no longer be considered a risk-free asset. That will take markets back beyond the traumas of the 20th century, beyond the relatively serene 19th century, beyond even the institution-forming 18th century. It will undo the 1751 triumph of the forgotten financier Samson Gideon in forming the immortal Consols, will undo the sterling if self-serving 1721 work of Sir Robert Walpole in preventing the South Sea crash from destroying the British government bond market as the Mississippi crash did the French one, and will even undo the 1694 foundation of British credit, the formation of the Bank of England. Life for government bond dealers will revert to a primitive Hobbesian state of nature, nasty, brutish and short. But will the rest of us suffer, except in the short term?
Based on the bond market as we have known it over the last century or two, only Greece was bound to default. Its problem was not so much its starting ratio of debt to GDP, but the fact that its GDP was over-inflated, being based on hopelessly unrealistic living standards for the Greek people. Once the Greeks were paid at a level at which the country’s economy would balance – no more than $15,000 or so in GDP per capita compared to 2008’s overinflated $32,000 – Greek GDP would be halved, and its debt/GDP ratio doubled to a level approaching 300%. That would have been beyond the highest levels ever successfully reduced without default – 250% of GDP by Britain after 1815 and again after1945. Since Greece is a notoriously undisciplined society, with poor tax enforcement and an open economy whose citizens keep much of their wealth abroad, a Greek default was and is inevitable in the best of circumstances.
The same is not however true of Italy and Spain. Italy’s competitiveness has declined by about 20% against Germany’s in the last decade. However its debt level is only 120% of GDP, or say 150% of GDP if Italy’s living standards and GDP declined by the necessary 20%. Since its budget deficit under the competent management of Silvio Berlusconi’s finance minister Giulio Tremonti was only about 3-4% of GDP, Italy’s position by the standards of the last two centuries is perfectly manageable without default being more than a distant threat. Similarly Spain has a budget deficit of around 7% of GDP, and a housing finance sector that is a mass of bad debts, with house prices still to descend to market-clearing levels, but its official debt is only 61% of GDP, and its economically odious Zapatero government is on the way out.
The level of market panic about Italian and Spanish debt indicates that the comforting parameters of 19th and 20th century sovereign debt finance no longer hold. The principal reason for this is the determination by the eurozone authorities to break the rules by which debt markets have traditionally been governed. Instead of allowing Greece to default or rescuing it completely, they arranged an inadequate debt-financed bailout that simply postponed Greece’s inevitable exit from the euro and increased its debt. Then they arranged a “voluntary” writedown of Greek private sector debt, which was subordinated in repayment to the monstrous institutional and government debt created by the bailout.
When the Greek government attempted to get referendum or electoral support for the “reforms” imposed by the eurozone authorities, they replaced it by a eurozone stooge, without democratic legitimacy. They repeated this stooge imposition process with the long-lasting and economically capable Italian government of Silvio Berlusconi, who they regarded as euro-skeptic and excessively devoted to free market, low-tax principles, replacing him with a government dominated by europhiles and the left, who had been decisively defeated in the previous election.
Finally and most damagingly, the eurozone authorities prevented the modest $3.5 billion of Greek credit default swaps from paying out, thus drastically devaluing the CDS of Italy, Spain and France, whose volume is of the order of $40 billion each. They have thus called the entire CDS market into question, at least for sovereign names, and have badly shaken the security of international contracts. By doing this, according to Gillian Tett of the FT, they removed the protection that Deutsche Bank, for example thought it had obtained this year by buying CDS on $7 billion of its $8 billion Italian exposure.
Investors in PIIGS debt thus now face the reality that they have been subordinated arbitrarily to the international and eurozone institutions. Their ability to protect themselves by CDS purchase has been removed. The security of their debt contracts themselves has been called into question. Finally, investors’ protection against coups and revolutions, that monetary and fiscal policy were being set by democratically elected governments acceptable to their people, has been removed by the imposition of governments wholly lacking in democratic legitimacy. If those governments impose policies that the populace finds intolerable, as is very likely, there is now far more chance of outright popular revolt or coup d’etat, since ordinary democratic change has been blocked.
In short, the protections given to government debt progressively in the last three centuries have been removed. The rationale for the Basel committee rating government debt at zero in banks’ risk calculations has been exposed for the fraud it always was. Since government levels of taxation are close to the Laffer Curve yield peak in most countries, the protection given to investors by the taxing power has also been rendered nugatory. Investors are no longer in the position of investors in the solid, well managed government debt of Walpole and Lord Liverpool, in which the phrase “as solid as the Bank of England” made British debt sell at the finest international rates. Instead they are in the position of the goldsmiths lending to Charles II, charging 10% for their money and liable to be ruined at any point by a Great Stop of the Exchequer like that of 1672.
I have written before in some detail about the likely effect on the global economy of the removal of government debt markets. In general, it should improve financial availability for the private sector, while starving profligate governments of the means to implement “Keynesian” stimulus and other wasteful policies. Thus it may well improve economic performance in the long run, certainly compared to the anemic growth and high unemployment suffered in most countries since 2009. Needless to say however, the 2010s will be a grim decade, since the transitional and wealth effects of eliminating the government debt markets that have formed the centerpiece of the last three centuries will be enormous – a Reinhart/Rogoff depression of spectacular severity.
However there is another effect of transporting the world financial system back to 1693. The European Central Bank will be bankrupt, because of its holdings of worthless PIIGS debt, and it is most unlikely that German taxpayers will consent to recapitalize an institution that has failed so badly, after first eliminating their beloved deutschemark. The Bank of England, the Federal Reserve and the Bank of Japan will also be legally insolvent, since in their policies of quantitative easing they have acquired gigantic quantities of assets that will drop catastrophically in price once interest rates rise.
The Fed for example is leveraged 60 to 1, and it was recently calculated that a rise in long-term interest rates of only 40 basis points – 0.4% -- would be sufficient to wipe out its capital. Needless to say, a rise of 4-5% in long-term interest rates, back to a historically normal level 2-3% above the true level of inflation, would put a hole in the Fed’s balance sheet that in current stringent budgetary conditions would be politically impossible for the U.S. Treasury to fill. Thus if a debt default in the eurozone spread even partially to the over-indebted economies of Britain, Japan and the United States, not only will government bond markets be wiped out, but central banks in their current form will disappear also.
In the long term, this should also prove a blessing. My colleague and co-author Kevin Dowd has been trying for some years to persuade me that the ideal monetary system is not only a Gold Standard, but one entirely without a central bank. I had always resisted this, believing in the positive qualities of the privately owned Bank of England of the 1797 Old Lady of Threadneedle Street Gillray cartoon, the 1844 Bank Charter Act and the elegant inter-war Montagu Norman, the hero who removed the 1929-31 Labour Government by omitting to tell that bunch of economic illiterates that leaving the Gold Standard was an available option.
However lovers of central banks cannot deny that the Fed bears a substantial share of the responsibility for creating the Great Depression and an even greater share of the responsibility for creating the 2008 crash and the period of grindingly high unemployment that has followed. Thus the existence of a central bank is no longer a battle won and lost in 1694, but must be considered to have become a live question.
If government debt markets across Europe collapse and central banks worldwide are rendered insolvent, the fiat currencies of the world are no longer likely to command enough public confidence to be workable. Like successive generations of Argentine pesos and Ecuadorian sucres, they will have to be junked. Further, since there is unlikely to be a figure like Weimar Germany’s Gustav Stresemann, able to create a new and workable fiat “rentenmark” out of a mythical monetization of land values, a return to a Gold Standard will be not only inevitable but irresistible, since it will have been imposed on the ruins of the current system by the global private sector.
With a Gold Standard, and central banks in ruins, a truly free banking system will also be inevitable. Most large existing banks will have failed along with their central banks, with no more money for bailouts and their regulatory institutions thoroughly discredited. The new central bank-less Gold Standard banking system that arises from the ashes of the old will be perfectly workable, as in 18th century Scotland, 19th century Canada and the United States between 1837 and 1862. It will permit only minimal government, but will allow the private sector, particularly the small scale private sector, to flourish as never before. As after 1945, from the chaos of monetary ruin will emerge a new global economy that is stronger and healthier, provides better living standards for its citizens and imposes far fewer taxes, scams and state-aided rip-offs on their wealth than does the current system.
But the intervening decade is certainly not going to be easy or pleasant.
The authoritarianism, simple-mindedness and failure of America's pundits
That liberty might be the answer doesn't seem to occur to them
Consider for a moment the paradoxical pain of being a best-selling political pundit so successful that American presidents don’t just seek but heed your advice. You have lobbied in your columns for the commander in chief to deploy your signature catch phrases, and he has. You have, in times of both crisis and sloth, advocated robust federal action in the name of national “greatness,” and the people in power have mostly followed suit. You have been flattered by invitations to the White House and pecked at by lesser partisans, yet you’ve maintained your critical distance in the patriotic spirit of post-ideological problem solving. All this influence and success, and somehow the country still sucks.
“Are we going to roll up our sleeves or limp on?” an exasperated Thomas L. Friedman asked the nation in a September 20 New York Times column. Friedman, the three-time Pulitzer Prize winner, influential Iraq war supporter, champion of “green jobs” industrial policy, and backer of President Barack Obama’s public education initiatives, is threatening to secede from a status quo he helped create.
“Given those stark choices,” he wrote, “one would hope that our politicians would rise to the challenge by putting forth fair and credible recovery proposals that match the scale of our debt problem and contain the three elements that any serious plan must have: spending cuts, increases in revenues and investments in the sources of our strength. But that, alas, is not what we’re getting, which is why there remains an opening for an independent Third Party candidate in the 2012 campaign.”
These are glum times not just for the 23 million working-age Americans without steady jobs but for hyper-employed commentators who have built comparative fortunes whispering into and occasionally bending the world’s most powerful ears. “I’m a sap,” a morose-sounding New York Times columnist David Brooks confessed the day before Friedman’s outburst. “I believed Obama when he said he wanted to move beyond the stale ideological debates that have paralyzed this country. I always believe that Obama is on the verge of breaking out of the conventional categories and embracing one of the many bipartisan reform packages that are floating around.” But now that the president had unveiled a dead-on-arrival, soak-the-rich jobs package in a televised address designed more to please his progressive base than to actually solve problems, even David Brooks—who in March 2010 deemed Obama “the most realistic and reasonable major player in Washington”—was forced to admit the unbearable: “This wasn’t a speech to get something done.” But noble dreams die hard. “I still believe,” Brooks insisted, “that the president’s soul would like to do something about the country’s structural problems.”
Do something. Is there a two-word phrase in politics more loaded with disguised ideological content? Embedded within is both an urgent call for powerful government action and an up-front declaration that the policy details don’t matter. The bigger the crisis, the more the urgency, the sparser the detail. On September 30, 2008, in a classic of the do-something genre, Brooks argued that the Troubled Asset Relief Program should be rammed through Congress over public objections because the federal government needed “to give people a sense that somebody was in charge, that something was going to be done.” Did that “something” involve buying up toxic assets? Introducing or relaxing certain banking regulations? Taking over or winding down Fannie Mae and Freddie Mac? Not important. “What we need in this situation,” Brooks declared, “is authority.”
American discourse is saddled with a large and influential do-something school of political punditry, a cadre of pragmatists from Meet the Press to your local editorial board who are forever seeking to solve the country’s problems by transcending ideology, demanding collective citizen sacrifice, and—always—empowering authority. In their new book That Used To Be Us: How America Fell Behind in the World It Invented and How We Can Come Back, Friedman and Johns Hopkins foreign policy professor Michael Mandelbaum lament that people “in positions of authority everywhere have less influence than in the past,” due to a “corrosive cynicism” preventing “the collective action that is required.” America, David Brooks wrote in March 2010, “is suffering a devastating crisis of authority,” resulting in a “corrosive cynicism about public action.” The similarities are not accidental.
Brooks and Friedman may be the most prominent practitioners, but the do-something school is evident just about anywhere the political class is talking shop. Here is former George W. Bush speechwriter David Frum at CNN.com on September 26, lamenting that the “old rules” of bipartisan cooperation “have broken down,” unlike those bygone days when “the imperatives of the Cold War inspired a spirit of deference to the president.” There is centrist Matt Miller at Washingtonpost.com the day before, writing an imaginary speech (a favored tactic of the do-something set) for an imaginary independent presidential candidate (ditto) who rejects “the Democrats’ timid half-measures and the Republicans’ mindless anti-government creed” in favor of “a bold agenda equal to the scale of our challenges.” That agenda is virtually indistinguishable from the Brooks/Friedman playbook: higher energy taxes, more money for infrastructure and schools, and national service for the young, all while somehow cutting government spending over the long term.
There are some obvious rejoinders to this fictitious excrescence of the “radical center” (Friedman’s preferred term). As The Washington Post’s Greg Sargent pointed out in response to Miller, “many of those calling for a third party are refusing to reckon with an inconvenient fact: One of the two parties already occupies the approximate ideological space that these commentators themselves are describing as the dream middle ground that allegedly can only be staked out by a third party. That party is known as the ‘Democratic Party.’ ” By dreaming up a third way to deliver ideas and rhetoric already associated with Barack Obama, the centrists are making the implicit admission that the president is ineffectual in the face of GOP intransigence.
But there is an even less charitable explanation. Because do-something punditry inevitably appeals to whoever holds power—what president doesn’t want to rise above partisanship to get things done, particularly if the solution amounts to a blank check to government?—pragmatic centrism has been implemented to a much greater extent than any of the “rigid” ideologies it abhors, whether they be trade unionism, social conservatism, or across-the-board libertarianism. Put another way, we live in a David Brooks/Thomas L. Friedman world, but now that the results have come in they are trying to wash their hands of the whole experiment.
Much more HERE
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