Another precedent for the EMU travails is the Great Depression. The point of my original thread was that the medicine being prescribed during the Depression was austerity.
In this post I note parallels between 1931 and 2010. The global business cycle peaked in 1928, three years before 1931. The cyclical peak from which we are currently falling was 2007. As the cycle turns down, the weakest debtors begin to default, in a process explained cogently by Hyman Minsky (a good introduction by Pimco’s Paul McCulley is here). Sovereign credits began to sour in the current cycle with Dubai’s default in autumn 2009 and then the Greek rescue was arranged in May 2010.
In the 1929-33 downturn, the first to default were the agricultural exporters: Australia, Argentina, and others in Latin America. The crisis then moved closer to the European core; the common denominator was net debtor status. By May 1931 continental Europe was under acute pressure. Policy responses were vital. By the end of that year, the global economy had taken the key steps toward splitting into three distinct groups:
- stay the course (keep on the gold standard, but with tariffs)
- retreat to autarky (government authorisation for any trade transaction)
- devalue (introduce tariffs but still remain part of the open world trade system)
- The Devaluation Group (Group 3) performed the best during the rest of the decade. Group 1 (Gold Bloc) performed the worst — their currency was increasingly overvalued with time and their economies uncompetitive. Germany (in Group 2) grew strongly. What Group 2 and 3 had in common was leaving the gold standard; Group 3 stayed plugged into the world economy, Group 2 unplugged.
- If this story is anything to go by, Club Med are not going to follow the gold bloc route. They can’t afford it. Only Germany and Northern Europe can do that. And they well might, which is bad news for them and for us. Club Med and the Eastern accession members of the EU have to choose between the Autarky and Tariff routes.
- The devaluations during the Great Depression were an aid to growth. However, what really got the global economy going again was the USA devaluation 1933 and resolute German expansion (also 1933). The Gold Bloc finally joined the party with devaluations in 1935-36, but too tentatively and anyway too late: The US again staged a horrific downturn, when Congress tightened the fiscal position by 2.5 percentage points of GDP, the Fed twice increased the reserve ratio, and the Treasury sterilised gold inflows.
- Interestingly: the countries which had devalued around 1931 (some earlier, some later) had by 1937 built up such large reserves that they could ride out the US recession by spending down those reserves — no resort to austerity (and almost no devaluations).
This might suggest that in 2010 Club Med won’t go the Gold Bloc route. But this means only that they won’t choose austerity ad infinitum. That doesn’t necessarily mean they go the Group 3 route (devalue and keep trading). The 1931 story suggests that another route would be to stay in EMU and resort (somehow) to pretty massive external barriers. In fact, this is already happening. European banks have consented to restrictions on the disposal of Greek assets on their books. These are capital controls. But Greece (Club Med, really) will also need trade controls. That looks a lot trickier. But who is ready to rule anything out? If the emphasis on “saving the euro” is sufficiently attractive within the EU, then perhaps there can be some countenance of trade controls. Surely the Great Depression teaches us that nothing is off the table when push comes to shove. (It also teaches us that paranoia over upsetting the established monetary order — perhaps especially in Europe? — is one hell of a strong motivator. And, in that episode, was proven to be not only wildly exaggerated but absolutely unhelpful.)
- The retreat of USA short-term private capital from continental Europe from 1928+ undermined their currency pegs to gold. The consensus view is that USA private short-term capital was drawn back by a rising Fed discount rate as the Fed leaned into the stock market boom.
- The 1931 disturbance travelled from continental Europe to Britain in part because of British losses on credits to those debtors. A similar transmission between Greece and France/Germany is possible today. Which is why, I think, EU needs to set up a TARP/recapitalisation fund for those banks…