The eurozone crisis and the Great Depression — lecture slides and audio track

Click here for the PDF of slides of my talk on the Euro-area crisis and its parallels in the Great Depression. 

Click here for the MP3 audio file accompanying these slides. 

Note: After the first couple of minutes, I do state which slide I’m referring to — at around Slide 5.
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Finally a difference of opinion with Krugman

There’s a reason he’s been called Krugtron. Oppose him at your peril. 

Nevertheless, I’d personally play down the ‘financial catastrophe’ angle of failure to raise the debt ceiling. 

Krugman in today’s NYT: “it looks quite possible that default would create a huge financial crisis”.

I think it would certainly hurt from a GDP point of view, through the cuts and the fiscal multiplier, but I don’t think it would trigger a flight from the Treasury market / dollar, since the Treasury market’s main virtue is liquidity. Yes, that liquidity was probably founded on (lack of) repayment risk (although I’d be open to arguments otherwise), but it is probably self-sustaining, at least for a while yet. And that’s a shame. Because if there’s one thing the US economy needs, its less of the “exorbitant privilege” of cheap financing for trade deficits. The economy needs a weaker dollar.
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The jobs problem: structural mismatch, or inadequate demand?

Is the high unemployment rate something we have to get used to? “Yes” say the ‘structuralists’ who view the problem as one of mismatch between the jobs needed by the modern economy and the skills offered by the workforce. Since this is a gap that would take a long time to close, we may as well get used to a higher rate of unemployment than we used to do. 

One key implication of this position is that the economy’s capacity is much lower than we thought — in which case there’s no point trying to run it any faster, because that would only translate into higher inflation. 

This has always struck me as a defeatist attitude and more importantly dismissive to those out of work and those soon to be seeking work. Luckily, it’s also hogwash. The economy is not adding enough new jobs because there isn’t enough demand to justify them. In this vein, two Federal Reserve economists yesterday released results from their research attempting to prove the ‘structural mismatch’ position (1/). They find: 

All told, while some skilled labor shortages are being reported in the manufacturing sector, the extent to which these shortages are restraining production appear about in line with the current sluggishness in the labor market and the degree of slack in the manufacturing sector. Furthermore, the finding that skilled labor shortages are not a significant and widespread restraint on production is consistent with other data continuing to show subdued increases in the wages and salaries of manufacturing workers.

1/ Looking for Shortages of Skilled Labor in the Manufacturing Sector 
Jessica Stahl and Norman Morin
September 26, 2013
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Bring on the (USA) downgrade

I think Krugman essentially has it right about the apparent lack of bond-market excitement over a possible US debt repayment event (which might arise if Congress refuses to authorise a higher debt ceiling). 

To paraphrase him: why should the markets worry when it has been made crystal clear that the Fed is capable and willing to ensure liquidity in the US Treasury market?  This is QE. Moreover: if big spending cuts are to be implemented, then that will be extremely bullish for bonds even in a world without QE. But it also pushes back the anticipation of tapering to some day in the far future. Maybe holding Treasuries in the face of a credit event isn’t so dumb after all. And remember what happened last time the big bad credit raters passed judgement on the Treasury market. 

The Treasury market is attractive not for its payment streams but for its liquidity. It is the safe place to hold your US dollars. I don’t think a default or downgrade will change that — unfortunately. Why “unfortunately”? Because the US dollar’s status as global numeraire currency is a burden on the economy. It is one of the reasons why we’ve had a super-sized financial sector, which isn’t a priori helpful for the real economy. Rapid financial sector growth  (i.e. above and beyond ‘financial deepening’) has an asymmetric (negative) impact on the real sector via instability and probably also by over-valuing the currency.
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A sideways thought on de-coupling

I’m a hardcore pessimist on the euro-area — perhaps because I’ve spent too much time on the Great Depression. As the saying goes, give a person a hammer, and everything looks like a nail. 

But I’ll concede one thing: if de-coupling is real (and I am sure it is), then the eurozone story makes a bit more sense (not enough sense to make it worthwhile; this is a positive rather than normative post). Here’s why.

Emerging markets should be absorbing capital; developed markets should be providing it. The euro-story is about pushing Europe’s periphery from the former to the latter. Now, you could argue that switching the euro-area’s periphery from net absorbers of international capital to net providers could be accomplished lickety-split if they could devalue (i.e. exit the euro). But the point is that a developed economy should be competing on quality, not price. So ideally they should emerge as net providers of capital on the basis of quality-competitive goods and services. And to do that, nothing better than a transformation of the economy without resort to a devaluation. 

So the euro-area story is about dragging the entirety of Europe into modernity. Neat little story. 

And the de-coupling bit? Well, this version of transformation (i.e. sans devaluation) is going to take a long time. This is an acceleration of the decoupling process, since decoupling in practice means faster growth in the emerging markets than in the developed ones. De-coupling is another word for ‘income convergence’. And we can all see that the global economy is in the throes of a ‘great convergence’ in prosperity, after many centuries of a Europe-led great divergence.
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How not to do ‘forward guidance’

What is the only option for a central bank up against the ‘zero lower bound’ (i.e. the policy interest rate has been set to zero) and whose asset purchases (‘quantitative easing’) have little traction? Answer: inflation expectations. The whole point is that, for better or worse (largely for worse), monetary policy has been given the job of revitalising the economy. This is true across the OECD and especially so in the United Kingdom, where the government has instructed the central bank to do whatever necessary to deliver growth. How can the central bank prod the economy into growth? Answer: through a meaningful reduction in the real interest rate. Since the nominal component of that rate is already at zero, the only thing left is to push up inflation expectations. As a refresher: the real interest rate is approximately the nominal rate minus expected inflation. What has the Bank of England done today? The opposite! Instead of saying, ‘We commit to keeping rates at zero come hell or high water, so long as unemployment is above X’ (where X is 7% in this case), it has said, ‘We commit to keeping rates at zero, so long as unemployment is above X — unless “medium-term inflation expectations no longer remain sufficiently well anchored” (pdf). What? You’ve just told the market that you won’t tolerate a rise in inflation expectations! It’s actually worse. There are three escape clauses attached to the interest-rate commitment: the aforementioned inflation-expectations; signs of frothiness in asset prices; and signs that inflation might rise to 2.5% over the coming 18-24 months.

I have been sceptical about the traction any central bank can attain in conditions such as faced in the OECD today. Far from worrying that central banks (like the Fed, the Bank of England, BoJ, ECB etc) are doing too much through their QE, I’ve been much more sceptical of them achieving much at all. Too much is attributed to QE which doesn’t follow from the actual mechanics of the thing. My view for some time has been that central banks will come round to nudging up inflation expectations precisely in order to get some traction. But, along with many others, I’ve been sceptical that they can do so. This is because most central banks have worked for decades precisely to prove that they will never allow such a thing, i.e. a rise in inflation expectations. In essence, they have a reverse-credibility problem. And the Bank of England just proved this point in spades. 

It is for this reason that Nick Crafts suggests governments themselves regain control of monetary policy – they have the credibility to deliver on higher inflation — it’s in their self-interest as net debtors. That wouldn’t be the first time central banks lost their independence. 
I am reminded of a passage in Eichengreen’s Golden Fetters about monetary policy mindsets in the midst of the Great Depression: “There is no little irony in the fact that inflation was the dominant fear in the depths of the Great Depression, when deflation was the real and present danger.” (Golden Fetters, 24).
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Secondary school historiography

I want to know how the secondary school students in your area are taught history — specifically the Great Depression. 

The form to capture your feedback is located at Alternatively, you can simply email me photographs of the relevant pages of your textbook. (To get in touch, please first use the “contact” button above.)


I’m working on a lengthy paper for a policy journal, due to be published in 2014. The paper talks about the euro-crisis and suggests that we need to be wary of ignoring our own history — particularly the Great Depression. The paper includes a brief review of how the Great Depression is treated in secondary school textbooks. I want to compare this to the mainstream international finance literature. 

I’m looking for examples from far and wide — any and every country I can get. What I’m looking for is just a snippet or two from a secondary school 20th century history or social sciences textbook . I’m happy to keep your contribution anonymous if you prefer. You can literally just snap a photo of the relevant pages and let me do the rest.

Please help send this link to whomever you think can help. 

Please also feel free to get in touch with me personally.  You can email me here.


Scott Urban
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Why don’t sovereign wealth funds (SWFs) invest in education?

Serious question. Why don’t sovereign wealth funds (SWFs, the managers of a nation’s commodity windfall, usually) invest in other people’s education? 

Note that I am specifying other people’s education. I don’t mean this to imply that education levels in the SWF nations are “high enough” (I don’t even know what that would mean, and anyway it certainly isn’t true). No. The point of a SWF is to keep the external earnings of the economy external, thereby helping to avoid the consequences of converting all those earnings to domestic currency (“Dutch disease” in the jargon). 

It dawned on me today reading about the Qatari external investment fund. These funds seem to be increasingly noticeable, whether due to PR campaigns like Singapore’s in the Economist (Temasek) or to news reports of their latest challenges and strategies

Hey, maybe when you find yourself owning 1.25% of every listed company in the world, it’s time to think out of the box. Here’s an idea: why not devote 100% of all new increments to the SWF into foreign public-goods assets? Once  again, the condition is that these need to be someone else’s public goods. But hey, in a globalized world, we’re all in it together. So, some other country’s increase in welfare is your increase, too. (This doesn’t really depend on globalization; mere humanist values, for one, will do.)

If you’re worried about how the SWF will capture the income from this investment i.e. make a return on it, then you’ve overlooked the second benefit of this idea. (The first benefit being a fillip to global well-being.) This scheme will avoid exacerbating the problem faced by the SWF in the first place: doing something with all those balance-of-payments credits. Think about it: on any other kind of investment, the SWF will eventually be creating yet another source of inflows, via the returns on that investment. Foreign public goods investment — no problem!

I’ve not researched this, so maybe SWFs are already doing it. I expect they probably are. But I’m talking about something big — like 100% of all new revenue streams. I don’t think I’ve seen anything like that.
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Positioning for the risk-on

Will the Fed really be able to carry through with its pledge to begin “tapering” QE from this autumn? Almost certainly not. This means that the higher yields being paid on US debt represent a buying opportunity. 

It also means that the present moment is a good time to seek exposure to emerging market assets. Ditto for some of the hard-hit commodities (and miners) and, gulp, gold.  Basically, it will soon be time to position oneself for the risk-on trade. We probably haven’t reached bottom yet, but I suspect we’re not far away. Very intuitively, I would guess August 15 at the latest. Why? Because once we’re much beyond August, the markets will surely start doubting the Fed’s nerve. Combine this with some kind of big reflation from China, and you have the makings of a big reversion to the de-coupling / risk-on theme. 

What if China’s reflation effort comes in the shape of an RMB devaluation? What that implies for the dollar is not good. In fact, the greenback is already uncomfortably rising. Does the Fed want to accentuate that rise with a tightening? Unlikely. 

This post was motivated by the FT headline, “US bond yields soar on robust jobs growth“.
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Paris update from the Economist, 25-July-1931

On French bargaining power with Germany over concessional loans to keep Germany in the euro area gold standard:

“The strength of the French situation, it is universally recognised here, is that France possesses an abundance of capital available with which to help Germany, that her present commitments in Germany are enormously less important than those of Great Britain or the United States, and that she stands less risk of direct loss than any other Power from another German collapse.”

That, and the Maginot Line

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