Everything New Is Old, Everything Old Fades Away

The Grexit as a Product of Fundamental Flaws which Could Break Up the European Union

by Jeffrey Ding, undergraduate at the University of Iowa


 Grelections, Grexits, and Greepartures

 On Jan. 25, the election pitting Prime Minister Antonis Smaras’ conservative New Democracy party against AlexisTspras’ Syriza opposition party, which has promised canceling austerity measures, could determine whether Greece leaves the euro zone. Unnamed sources in Germany’s government have said Greece’s creditors, led by Germany, would view the reneging on bailout promises as incompatible with Greece staying in the monetary union.  Thus, the Great Grelection of Jan. 25 could lead to the Grexit – a decision by the European Central Bank to cut off Greek banks from its liquidity operations and payment systems.  To start, can we reconsider the term Grexit?  I humbly submit the Greeparture as a worthy alternative. It conveys a more elegant version of impending doom.


Only in the EU – A Greek Dilemma

Let’s actually begin with an odd proposition. Could Greece exit the euro zone while still remaining in the European Union? This may seem weird, but the German news magazine Der Spiegel offered an enlightening explanation by quoting a currency expert saying “resourceful lawyers” would provide a clarification. What would the world come to without resourceful lawyers? Perhaps a resourceful undergrad will have to suffice for now.

To better understand the distinction, let’s take a look at the European Union in a historical and global context. Over the past couple of decades, global free trade agreements have given way to more regional groups, in the form of customs unions (EU, Mercosaur and Andean Community of Nations in South America) and free trade areas (NAFTA, the TPP— which can be considered a prequel to the proposed Free Trade Area of the Asia Pacific). But the EU is special, because it transformed from the European Economic Community (solely a customs union) to the European Communities (establishing a single set of institutions that encouraged economic cooperation between the communities) and then culminating in the politico-economic union of 29 member states fondly known as the EU (developing a single market and common currency along with supranational institutions that determine economic and foreign policy). In other words, the EU has established governance in 28 distinct sovereigns. It’s sui generis incomparable. One of a kind.

But with sui generis comes lack of precedent. And that’s where the interesting LESE (leave Eurozone stay EU) situation comes into play. One prominent barrier to this scenario is Article 140 of Treaty on the Function of the European Union, which says members must “irrevocably” replace their old money with the euro.  Still, while I poked fun at the resourceful lawyers quote earlier, there could be a possibility that Greece convert their obligations to the drachma while staying with the EU. And then there’s always the possibility of completely withdrawing from the European Union. Many Greek economists and politicians believe this would be the better longer-term policy and that joining the EU was a mistake, given the structural deficiencies in the Greek economy at the time.

In fact, Greece was the only country whose per capita GDP would have been higher if it had not joined the EU in 1981, according to a model based on synthetic counterfactuals method to estimate EU membership benefits.


Two Contagions, One Fundamental Problem

 I won’t go further in to the will-they-or-wont-they leave the EU question, leaving that up to the anonymous sources in the German government and poll projections (as of Jan. 9, Syriza held a 4% lead in the polls). The more salient question is what would be the effect of the Greeparture?

Merkel and her Finance Minister Schaeuble seem to believe the effect on the euro zone would be manageable. The main concern is the contagion effect – Greece’s departure leading to other distressed countries like Portugal, Ireland, and Spain following suit. Germany has negotiating power with the tools like quantitative easing through the European Central Bank along with the European Stability Mechanism, the euro zone’s bailout fund. But the negative perceptions due to political uncertainty may be taking place before these policy proposals to quell them.

The outflow of capital from the Eurozone, spurred by investors concerned about value of financial assets after redenomination of bank accounts and bonds, is preventing the transition from austerity policies toward growth and economic reform.  It’s a nasty feedback loop in which fears about these countries leaving the EU cause these countries to have to continue to adopt the austerity measures that are causing political unrest, ultimately resulting in even more capital flight. So the simplified litmus test for whether the Eurozone would be able to weather the storm of Greece’s departure is to compare the offset policy tools to the detrimental impacts to the banking sector. Catherine Dobbs, a Wolfson Prize finalist, and Michael Spence, a Nobel Laureate, argue that while the Eurozone would likely be able to offset a country the size of Greece, it is less clear whether they could handle the exits of countries nearly 10 times the size of Greeze, such as Italy or Spain.

Lost in the focus on the sovereign debt crisis has been the fundamental contagion in the Eurozone economy that comes from its sui generis beginnings. Germany’s hegemony in Europe is restrained by its obligations to the EU collective at the cost of austerity measures. The EU’s obsession with austerity, marked by the balanced budget golden rule spearheaded by Germany, can be traced to Germany’s preference for the low inflation/high unemployment tradeoff. This trend is sustained by Germany’s dominant position in the EU as the largest population, economy, and, most importantly, creditor.

Here’s a scary sampling of quotes from Roman Prodi, the ex-president of the European Commission. “Germany is exercising an almost solitary power…President Obama telephones Mrs. Merkel, not the British prime minister…the bureaucracy is adapting to the new correlation of forces.”

This shouldn’t be a shocking trend, even from the beginning of the European Central Bank, its constitution was worded very closely to that of Deutsche Bundesbank. And now Germany’s focus on limiting inflation, bolstered by its current economic health and perhaps influenced by past crises of hyperinflation, has created conditions of more unemployment than is acceptable to other Eurozone members, leading them to borrow Euros, and eventually triggering the debt crises.

History tells us hegemony always triggers counterbalancing. The lesson applies just the same for economic, regional hegemons as it is for global, military empires. And while it hasn’t come from the expected rival Britain, countermeasures have definitely been occurring slowly and broadly. How else to explain the rise of Syriza? The starting point has to be the completeness of economic dysfunction in Greece where 60% of young people aged 18-24 are unemployed.

In my overview of protests as political power, I left out the occupation of squares in 2011 by Syriza, a small protest party that could, by the end of the month, take power as a coalition of socialist/ecologist/euro-communist parties. And momentum may be swinging their way. The protests spread to Spain in September of 2014, as two million pro-independence Catalans marched in Barcelona, cited as the largest demonstration ever seen in Europe.  The same month, Scotland also held an independence referendum.

Break-ups of Britain and Spain could also break up the European Union, especially when France is added to the mix. Marine Le Pen’s far-right National Front, which has received increased support for its anti-religious-extremism and pro-death penalty policies after the tragic magazine attack in Paris, will be a strong challenger for France’s presidential election in 2017. Marine Le Pen has stated, leaving the EU, we could allocate 15 billions of euros to our agriculture.”


Maybe both Grexit and Greeparture are the wrong terms. Exits and departures articulate a deviation from a certain norm or path. But the problems with the Eurozone have always existed; they were just masked by the benefits of trade and increased efficiencies from a common market.  Now, with Greece’s potential exit from the European Union, the problems are being revealed and the people are forcing elites to recognize the flaws.

Call it the Greckoning.

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Jeffrey Ding – Resident Policy Wonk

Written by Jeffrey Ding, undergraduate at the University of Iowa

As the resident policy wonk of Economics Forum (mostly due to my lack of technical knowledge in finance rather than any particular expertise in politics), I will be contributing articles at the margin (see what I did there?) of politics and the economy. But in some ways, it’s not a margin at all. It’s just one big blob, and there’s different ways of viewing that blob. One way to view that blob: all economics is political.


 

Trade policy sits at the intersection of politics and economics. On the one hand, economic models and theories – from Ricardo to Heckscher-Ohlin –seem to generally conclude that free trade results in overall gains for the countries involved. But for political scientists, protectionism seems like the reasonable norm so as to protect domestic factors and the electorate. Then one would predict an impasse, or a pendulum that swings back and forth over time, and one would be right for much of history. Yet, for the past 30 years, the overwhelming trend in trade policy has been the widespread liberalization of trade policies, resulting in economic interdependence with even more widespread effects on the part of both the global economy and global politics.[1] Milner argues for an explanation based on democratization and internationalism, but others offer a more cynical view.

 

Giovanni Facchini from the University of Illinois at Urbana-Chamapaign writes in an article, entitled, “The Political Economy of International Trade and Factor Mobility”:

 

In turning our attention more specifically to the distortions which arise in international trade, we have noticed the emergence of a paradigm, in which trade policy is modelled as the result of influence driven contributions by organized groups. Although this framework faces some theoretical challenges, it has found strong and robust evidence in the empirical tests performed so far, conducted using both US and international data.

 

The role of influence driven contributions is especially noticeable in a post-Citizens United World. Organized interest groups donate exorbitant amounts, often to both candidates, in an election to buy influence. Grossman and Helpman (1996), who wrote the seminal paper on the subject, argue that these interest groups continue to lobby after the election in order to influence policy choices.


 

With this background context, let’s examine the hot button trade issue at the moment – the Trans-Pacific Partnership (TPP). The difficulty of examining the explanations behind the TPP is that negotiations are being kept secret to the public, but not to the 600 lobbyists who are involved in the TPP negotiating process as “corporate trade advisors”. Leaked texts show key tenets – expanded patent rights for pharmaceutical companies and private enforcement actions which would allow corporations to sue governments for regulations – would serve the interests of corporate entities.[2] These “gains from trade” may end up as a net disservice to the general population. Recent estimates show the total U.S. economic gains from the TPP may only be .13% of GDP by 2025. The Center for Economic and Policy Research has found the median wage earner will probably lose as a result of the TPP, while those with the highest wages will gain more as they are more protected from international competition and gain from the expansion of terms and enforcement of copyrights and patents. [3]


 

I’ll be back with more, but that’s a little aperitif in the meantime; and keep in mind, for the sake of my role here, that all economics is political.

 

[1] http://web.stanford.edu/class/polisci243c/readings/v0002017.pdf

[2] http://www.theguardian.com/commentisfree/2013/nov/19/trans-pacific-partnership-corporate-usurp-congress

[3] http://www.cepr.net/index.php/publications/reports/net-effect-of-the-tpp-on-us-wages

A Look Into Low Cost Oil

by Taylor Beguhn, undergraduate at the University of Iowa


Looking back on the last quarter of 2014 the utter collapse of oil prices has led to instability in several countries, high profits in others, soon-to-be bankrupt companies, and extra presents under the Christmas tree. Over the next several weeks I will walk through the economic consequences a long term low price of oil will have on the consumer, businesses, and countries. However, I would like to start with a simple analysis on why the price of oil has collapsed.


The market for oil, like most goods, can be analyzed with a simple look at supply and demand. Looking at the demand side of the equation we have seen slow to declining global demand from oil due to slow economic growth in Europe, Japan, and several emerging markets. Since the demand for oil is largely understood to be inelastic near .061 in the short run, think basic macroeconomics, typically the main driver for increased demand for oil will be a shifting of the demand curve by a growing or shrinking economy. With demand not rising as much as anticipated the market for oil has seen a supply glut.

The influx of US shale production into the global oil market has destabilized the balance of supply and has directly led to this supply glut. Since 2011 we’ve begun to see US shale production have an effect on the global market for oil as oil prices in Cushing, Oklahoma (the measure for the price of oil produced in the US via shale production) began to deviate from Brent. From 2011 until now, US shale production has not had a tremendous impact on global prices because global demand has remained near global supply. This whole dynamic began to change in August/September as demand growth slowed and supply growth did not. In order to relieve the growing pressure in the oil market one of two things had to give, someone had to give up market share and cut production, or the price of oil would have to drop drastically to equate supply and demand.


In the last week of November OPEC opted for the latter option as they announced that that they would not cut production. OPEC entered this defensive stance to maintain their existing market share and curb future production of oil in the United States by making it unprofitable for companies to further expand production capacity. As soon as the announcement was made, and as subsequent announcements have affirmed the decision, the price of oil collapsed and have been unable to find any semblance of support and/or a price floor, as of the time of this writing. So far, with oil nearing $60 OPEC’s decision has not had the impact originally intended as US oil companies have cut budgets for 2016 and ‘17, not ‘15. Indicating that we will continue to see excess supply in the oil market for considerable time, and no potential bottom for the price of oil, as its highly inelastic sensitivity to price will not support much more demand, even as prices drop. Going forward I expect the price of oil to continue dropping until it reaches $50 a barrel and producers will seriously consider cutting production, or else be forced to produce at a loss. Going forward, I do not expect to see the price of oil rise substantially until global growth stabilizes and demand can once again exceed supply.

Over the next few weeks I will continue to explore the effect a continued low price of oil will have on consumer demand, business, and countries.

 

1http://15961.pbworks.com/f/Cooper.2003.OPECReview.PriceElasticityofDemandforCrudeOil.pdf

TLTRO- The Ephemeral Long-Term pt 1

by Adam Millers, University of Iowa

Regarding disjointed musings over a dark roast at Java House, Dec 13 2014

So, to begin with, I guess the pertinent question here is not the what of the ECB’s Targeted Long Term Refinancing Option, but rather the why.  I.e. why is this deus ex machina central bank intervention the answer yet again?

Now it’s European disinflation concerns, then it was the Great Recession in the US… I have no doubt that the timeline trends back to the primordial ooze of accommodative monetary policy, but when is that? what is that? is there actually any logic to the vicious liquidity cycle, and whose logic is it? (namely, who stands to gain)?  Ok, so maybe there is no single “pertinent question,” and maybe there isn’t necessarily a question at all…


 

That being said, here’s somewhat of an answer, preceded by a skeleton of the source material:

  • Ricardian equivalence theorem, primary source material by David Ricardo
    • …and relevant discussions courtesy of the Library of Economics and Liberty ([italics mine] & truly a nice pair, albeit seemingly unrelated in, like, an epistemological sense)
  • Marx, on capital accumulation and overproduction, Capital
    • …and the more or less faithfully opposed, if not generally biased, reiteration of the aforementioned by the Mises Institute
  • “After Mill: Bastiat and the French laissez-faire tradition”; haven’t read it yet, but it looks promising from a quick skim, and is also from the same Mises Institute publication on the history of economic thought
    • …and Bastiat’s witty fables regarding the ills of protectionism and statist economics
  • Various research and other stuff about TLTRO and QE, skewed as much as possible to rational, quasi-objective perspectives because: Library of Economics and Liberty [italics remain mine] and the Mises Institute are the other two perspectives (not to mention Marx)

First, three quotes:

“The superficiality of Political Economy shows itself in the fact that it looks upon the expansion and contraction of credit, which is a mere symptom of the periodic changes of the industrial cycle, as their cause.” – Marx, Capital

“The imposition of a tax directly reduces the net worth of the taxpayer, but the issue of an equivalent amount of government debt generates an equal reduction in net worth because of the future tax liabilities that are required to service and to amortize the debt that is created.” – James M Buchanan, Richard Wagner, Democracy in Deficit: The Political Legacy of Lord Keynes

“Karl Marx created […] a veritable tissue of fallacies.  Every single nodal point of the theory is wrong and fallacious.” – the Mises Institute (just for LOL’s)


 

The Targeted Long Term Refinancing Option (TLTRO) is to Quantitative Easing what a man at his bachelor party is to that same man the day of his wedding– this man, whose parents made the questionable decision to name him TLTRO, has already committed to his wife QE in spirit, but wants to experiment a little bit before he makes that kind of commitment.  The chronology is similar too; European QE (QECB lol) is waiting at the altar, pretending that the groom hasn’t seen the dress yet.

Essentially TLTRO consists of reallocating massive amounts of capital with the objective of distributing liquidity to the European money supply.  While QE achieved this through direct purchases of securities on the open market in a pretty obvious liquidity swap, the TLTRO manages to hide the same fundamental principle in a policy less likely to rekindle memories of Weimar hyperinflation and etc.  By way of TLTRO, the European central banking apparatus finances the ability of non-central banks (though in the spirit of Too Big Too Fail, the distinction becomes increasingly arbitrary) to loan at lower rates, by loaning to them at lower rates, the assumption here being that this will solve the problem of a weak economy by… creating inflation?

Well no, that’s not actually the rationale.  Let’s break it down.  Lower borrowing costs should lead to increased borrowing.  This has something to do with user cost of capital and required rates of return, I think.  But those readings are from awhile ago.  Anyway– it should go like this.  People that make things borrow more money and expand their ability to make things, which involves using the borrowed money to build new places for other people to work and more equipment for them to operate.  So the expanded ability of some people to make things actually expands the ability of other people to buy those things because now they have new jobs in new places and new equipment.  And, to quote Vonnegut: so it goes.


 

So now to tie in two new ideas.

The Ricardian equivalence theorem explains that when the government finances its operations by way of debt issuance, it is effectively imposing a future tax.  It goes on to say that this should be acknowledged in market movements, because David Ricardo actually seems to think that people intuitively understand his equivalence theorem.  I mean, I think I mentioned this already elsewhere but it’s such a convenient reference– the Dutch tulip bubble…

Karl Marx spoke extensively on the subject of capital accumulation and concentration in the hands of an increasingly small portion of the population.  There is something called the Gini coefficient, used primarily by sociologists to quickly compare the levels of inequality in different places, and it provides fairly solid empirical evidence in support of Marx’s contention.  But if you remain unconvinced, I am feeling confident that I will return to discuss that idea in greater depth after getting a few things out of the way here first.

I am also feeling confident that my somewhat of an answer is becoming somewhat more of an answer, despite there still not being much of a question.


 

So if the Ricardian equivalence theorem states that sovereign debt is really a future tax, then would it be fair to say that QE and TLTRO basically constitute two really convoluted paradoxes wherein the government pays a future tax to itself in buying back its own debt so that it will be able to sustain future taxation in the form of more debt?  Wait– is this where lower interest rates and the glorified inflation become truly useful to the economy?  Now the denominator of your PV calculations has been modified, the cost of debt is much lower, and that money that you did owe just shrunk in terms of its own relative value.  So share repurchases and M&A abound, and the government slyly reduced its debt burden, which means it cut down the future tax burden of its constituents.

Is it okay with you if we call that tax burden “the cost of financing the portion of output arranged/facilitated/intermediated by the government?”  No?  Oh well, we’ll call it that anyway, because that allows us to say the following:

If the government, by way of the central bank, is engineering growth by way of manipulating liquidity so that the cost of present solvency is a financial black hole event horizon that consumes its own future insolvency– if the government, by way of the central bank, is taxing itself with its own debt when it performs QE and TLTRO and whatever manifestation of QEternity is next in line, and expanding its own proportion of the proportion of output that it arranges/facilitates/intermediates– if the government, by way of the central bank, is facilitating economic growth by way of effectively growing itself, well then how exactly are we supposed to believe in a free market?  And how exactly are we supposed to interpret the “LT” in “TLTRO?”


 

Some fables and aphorisms from Bastiat about laissez-faire economics seem applicable here.  Like Bastiat’s candlemakers union, seeking protection from the sun– only here it is the withered market seeking to insulate itself from… itself?  And here I think it would be appropriate, or at least fun, to draw a parallel to the Copernican revolution, but we’ll do that later.  For now: the fable of the broken window.

Bastiat’s fable of the broken window demonstrates a point of contention between the Austrian proto-market and the pre-Marxist “market-market” (both terms I just made up, to be characterized further as you see fit).  A boy throws a brick through a shop window.  Regarding this event, there are three potential levels of economic analysis, arranged hierarchically according to how well they conform to Bastiat’s model: 1) the destruction is inherently bad, and that is the end of it; 2) the destruction itself may be bad, but the stimulation of the economy that stems from the need of the storeowner to hire window repair specialists, and the subsequent multiplier effect that stems from the proceeds of that repair, are inherently good; 3) the stimulative effect of the window repair is inherently good, but relative to the stimulative effect attached to the lost opportunity for the storeowner to invest in incremental capital, it is “net-inherently” bad.  Hm, very interesting.

I’ll be the first to admit that I don’t actually know what I’m talking about here.


 

So capital accumulation results in overproduction, time and again, whether it’s a bubble or whatnot– then is not the extension of credit more or less analogous to the breaking of the window by the boy?  Then, counterintuitively, the accommodative monetary policy, the QE, the TLTRO– these are not remedies.  They are, in fact, the window repair specialists hiring the boy to break the windows so that they can be hired to repair them.  Do you see what I am getting at?

Increased interest rates here equal the repair of the broken window.  It is the restoration of value to the market, which was crippled by the relative distortion of currency, the foundational unit in this random dialogue… the restoration of value to the market in terms of the same metric used in determining the relative value of the currency… i.e. liquidity breaks the window and liquidity is the window repair.  

So now, the crucial question… whose logic repaired the window, and who was the window repair specialist?


 

Well I’m out of coffee so stay tuned for part two if you thought there was anything valuable to be gleaned from all that  ^^ 

 

*this post has yet to be edited