The fate of EMU is a policy variable

In polite conversation one often tends to moderate one’s view, in deference to the “golden mean” — the notion that the truth in any debate must lie between the two extremes. This is clearly not always appropriate. In a debate over astrology, for example, there’s no point taking a middle road. Indeed this would be dangerous, if it encourages people toward seeking solutions from falsehood. The danger is greater still when it’s the editorial staff of a major news organisation who follow the golden mean, reporting semi-sympathetically the objections of a physician to the MMR vaccine (BBC) or the murderous scare-mongering of chicken hawks (NYT).

The fate of EMU is a policy variable. I’ve been circumscribing my comments about this, both here and in other fora, to keep the focus on Greece and to keep the attention of sceptics. It’s time to be categorical. There is a path to an EMU that works for its members and its neighbours, but this (call it Plan A) is not it. The private and public debt of Greece, Spain and Portugal to external creditors is estimated at 2 trillion euros (FT citing RBS). Outright default would land these creditors in serious difficulty, and the EU leadership are right to have moved quickly to forestall this. But full repayment is out of the question. That’s why it is gratifying that the likes of George Magnus openly call for a friendly restructuring. This is part of the right path, call it Plan B. Like Plan A, it also includes structural reforms. Unlike Plan A, it calls for the re-introduction of national currencies in one or more of these countries, so that structural reforms can occur in a growth environment. After a further time period, and at the urging of the pubic rather than the elite, monetary reunification will be possible, on much firmer foundations. This will include an EU Treasury to float the first 60% of members’ outstanding debt, with the residual financed by members themselves; and centralized budgeting.

Where does Plan A lead? There are no official estimates of the wage cuts needed to push the euro-debtor economies into external surplus (equilibrium is not enough; they need to shift into surplus because there will be no financing other than self-financing; it is akin to retained earnings for a firm when it cannot access finance).  Krugman has put the wage cut necessary in Greece at 20%, relative to Germany. The IMF programme calls for wage cuts to be explicit in the public sector, but not the private sector (it is to take its cue from the public sector). The 750 billion euro “rescue” package keeps the creditors at bay for two years, but the creditors are still made whole. It’s the perfect anti-growth strategy, and the markets know it. It’s a bit like saying to the emergency room patient,

Here’s a blanket. We are going to suffocate you. We’ll be back in two years’ time. By then you had better have mutated into a butterfly. Because your debt/GDP ratio will be 150% (IMF). Come to think of it, your debt will still be 120% of GDP at the end of the decade. Assuming everything goes to plan

Globally, it’s time to take an extremely broad and realistic view. The credit boom from which we are all contracting was epic. We’ve made some valiant efforts to offset the beginning of the de-leveraging — fiscal stimuli in US, China, Germany, UK and elsewhere; policy rates at zero or near-zero; and expanded central bank balance sheets. But the will has flagged and the ‘hard money’ crowd are in the ascendant. Hell, they’re in power in the UK and Germany, and making inroads in the USA. The implication of the rectitude and austerity prescribed by this crowd is contraction.

There is an alternative. Start in Europe. Get a debt solution over with. It won’t be pretty but it won’t be nearly as bad as the hard money people will have you believe. AS SOON AS the overhang of debt is addressed in a realistic way, and a way which explicitly countenances a realistic growth path for the debtors, the markets will start discounting high growth. Because this is a bullish platform. Take the hyperinflationistas with a pinch of salt: paper money is not going to go up in flames. There is over-ample supply capacity in the global economy, and the worth of money comes not from the intrinsic value of the medium but the technology it serves: money is a means-of-exchange and has tremendous transactions utility. That’s why paper money has value. Come to mention it, this is the only way to explain why gold coins circulated at far in excess of their intrinsic metallic value in the 19th century. They fulfilled a transactions utility. You could have as easily looked at the gold standard back then and cried “fiat money!” as you can now. Not quite … but that’s a pandora’s box for later.

The following is from Q&A on “EMU as reprise of the gold standard”:

What is the right thing to do, part 1 (policymakers)
  1. Convert the eur 750 bn rescue fund to a re-capitalisation fund for the banking system.
  2. Force a restructuring of Greek sovereign debt; 70% write-down.
  3. With an EU imprimatur, forcibly redenominate Greek contracts in drachma, including cross-border contracts.
  4. Greek central bank exchanges euro for drachma at the rate of 1 for 1. There is no need to make it 1 to 5 or whatever. The point is that the drachma will depreciate against the euro and other currencies in the fx market, whilst still being used like a euro at home.
  5. Gain the agreement of Greek unions not to index wage demands to expectations of inflation for a fixed time period of four years.
These steps are crucial, and I’m surely missing a bunch. They are also not very pleasant (esp. EU assent in forcible debt re-denomination, and Greek labour agreeing to tie its hands). But they are not unprecedented. Labour agreements like this are a staple of “exchange-rate based stabilisation” policy and have been done dozens of times. On the forcible re-denomination: FDR devalued the gold value of the dollar in 1933 and forcibly abrogated the gold clause in all US debt contracts (which abrogation was upheld by the Supreme Court). I can understand how odious this sounds, but in fact it was crucial and US recovery got underway once FDR devalued the dollar. Look at just about any time-series graph of activity in the 1930s. It’s unmistakable.
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