Monday, July 30, 2012

The euro is like a bumblebee. Why does it not flight any longer?

In this post (Here Bee Draghi) Krugman shows his skills as reader and observer, and also the non critical flock behaviour of journalists and media. From last speech by Mario Graghi, he choose the passage below, indeed a very interesting and significant one (that did not received significant attention from the press):
  • The euro is like a bumblebee. This is a mystery of nature because it shouldn’t fly but instead it does. So the euro was a bumblebee that flew very well for several years. And now – and I think people ask “how come?” – probably there was something in the atmosphere, in the air, that made the bumblebee fly. Now something must have changed in the air, and we know what after the financial crisis. The bumblebee would have to graduate to a real bee. And that’s what it’s doing.
Krugman recalls why it did flight (the model of the crisis, see previous post, in portugese, my other blog):
  • The thing is, we know pretty well why the bumblebee was able to fly: massive capital flows from the core to the periphery, which led to an inflationary boom in said periphery, and which therefore also allowed the German economy — which was in the doldrums in the late 1990s — to experience a big gain in competitiveness and hence a surge in its trade surplus without needing to go through painful deflation. This meant, in turn, modest inflation in the eurozone as a whole — slightly above 2 percent over 1999-2007.
And what to do to make it flight again
  • To keep the thing flying, you’d need something like a reverse play along the same lines: an inflationary boom in Germany, so that the periphery can regain competitiveness without devastating deflation. And it would actually have to involve a higher rate of inflation, both because the required adjustment is bigger and because the periphery is a smaller share of euro area GDP, which by the math means that overall inflation needs to be higher to accommodate a given amount of relative adjustment.
But reality still seems far from this scenario.

Update, 30th July: Free Exchange,  The Economist blog, deals with this "bumblebee" discourse in a post entitled When Draghi isn't everything. But it raises a "non technical" issue: what does it mean to save the euro - which euro has BCE a mandate to save? The present euro configuration or a a new geometry of countries (without Greece and may be others)?
  • The ECB could take some of the pressure out of the crisis by pursuing an appropriate monetary policy: by acting more aggressively in order to push nominal output back to trend, even though that would mean higher inflation in Germany. But this is no longer the ECB's crisis to solve. It might have been, at one point. Political leaders, by acknowledging the real possibility of exits, have taken on full responsibility for whether and how the crisis is brought to an end.
 The bumblebee seems to have changed to a highly political animal. May be yes, may be not. Charles Wyplosz comments in Vox (Welcome to ECB):
  • there always is a risk of reading too much in a central banker’s unavoidably cryptic statements
Update 2: Krugman also wrote a commentary on NYT: Crash of the Bumblebee:
  • First of all, Europe’s single currency is a deeply flawed construction. And Mr. Draghi, to his credit, actually acknowledged that. “The euro is like a bumblebee,” he declared.
  • In the long run, the euro will be workable only if the European Union becomes much more like a unified country.
  • Well, why was the bumblebee able to fly for a while? Why did the euro seem to work for its first eight or so years? Because the structure’s flaws were papered over by a boom in southern Europe.
  • What could turn this dangerous situation around? The answer is fairly clear: policy makers would have to (a) do something to bring southern Europe’s borrowing costs down and (b) give Europe’s debtors the same kind of opportunity to export their way out of trouble that Germany received during the good years — that is, create a boom in Germany that mirrors the boom in southern Europe between 1999 and 2007. (And yes, that would mean a temporary rise in German inflation.) The trouble is that Europe’s policy makers seem reluctant to do (a) and completely unwilling to do (b).
  • The euro can’t be saved unless Germany is also willing to accept substantially higher inflation over the next few years
  • Should it be saved? Yes, even though its creation now looks like a huge mistake. For failure of the euro wouldn’t just cause economic disruption; it would be a giant blow to the wider European project, which has brought peace and democracy to a continent with a tragic history.
Update 3 (13 August 2012): The Economist has two important papers. The Merckel memorandum contemplates a sinister view about the future, as seen from the PICS (Portugal, Ireland, Cyprus and Spain): a plan to expel, under controlled conditions, these countries (together with Greece) from the euro zone - but not from European Union. This "bolder plan B" would be the preferential option, as seen from the German side. It would give a new geometry for eurozone ("unfortunately" including Italy and France: the political options and economic costs to expel them from the new eurozone would be too big). The new eurozone would include a banking union and some kind of debt mutualization (of course not available for the five expelled countries).  This is very much related with our previous Update 1 to this post. See also "The euro: tempted, Angela?", the other (companion) article related to the memorandum:
  • The euro could have been saved a long time ago, had the politicians agreed on who should pay what or on how much sovereignty to surrender. Rather than push forward, Mrs Merkel has waited, hoping that fiscal adjustment and structural reform will lead to economic growth in southern Europe and that the politicians could sort out their differences. 
  • The evidence, though, is that time is not on her side. Southern Europe’s economic rot is deepening and spreading north. Politics is turning rancid as the south succumbs to austerity fatigue and the north to rescue fatigue (see article). Populism only makes a grand bargain more elusive. For the moment, breaking up the euro would be riskier than fixing it. But unless Mrs Merkel presses ahead, the choice will be between an expensive break-up sooner and a really ruinous one later.
(Italics our responsability)

Wednesday, July 11, 2012

Germany reforms: reality and myths

WSJ this weekend interview is with previous german chancellor, the man that promoted the structural reforms in Germany, claimed to be the reason for the present well being of its economy. It makes  interesting historic reading and it points to some lessons: see "Gerhard Schröder: The Man Who Rescued the German Economy".
Conclusions from the interview:
1. The structural reforms programs costed him his job - but they were embraced by his successor. This continuity of public policies between different governments is unfortunately not very much apprecited in meridional countries.
2. In the german case there was much more than austerity, lower taxes,and reform of labour laws. Schroder does not mention the differences in economic climate in europe and world at that time. The same reforms would have very different results in the present environment. But he makes an important statement about the importance of union and labour relationships in Germany - and these points have not been changed. "Agenda 2010" policies in Germany were not anti-union and anti-work policies:
  • Mr. Schröder does note that Germany's present economic vigor isn't solely the result of Agenda 2010. Work-sharing programs are common in Germany. During the financial crisis, this has allowed employers, with the help of government subsidies, to keep workers on reduced hours instead of laying them off. Mr. Schröder also notes that Germany's unique system of "co-determination," under which union representatives occupy permanent spots on corporate boards, ensures that labor and management are able to negotiate terms with both sides' long-term interests in mind. 
3. Reforms without strong domestic demand do not work, and this is the drama of present "austerity" policies:
  • Aware of the political and historical sensitivities, Mr. Schröder counsels that Germany and the European Union shouldn't be encouraging Agenda 2010-style reforms as a cure for Southern Europe without concurrent measures to promote domestic spending and forestall immediate collapse. He echoes the suggestions of Mr. Hollande and others that the EU should invest in wobbling economies via the EU's regional development funds and project bonds for infrastructure. Too much pain without enough reward risks "destroying domestic demand," Mr. Schröder says. And even perfectly executed structural reforms will not yield results right away.
4. Most important of all, he recognizes how important it has been for Germany to ignore EU rules about public deficit:
  • His own attitude toward Greece is more sympathetic. ... He points to his own experience with Agenda 2010. In 2003, just as his reforms were beginning to be implemented, the European Commission deemed Germany and France to be in violation of the EU's deficit and debt ceilings. Mr. Schröder's finance minister at the time, Hans Eichel, proposed €20 billion (around $24 billion then) of additional spending cuts to put Germany in compliance with EU law.
  • Mr. Schröder refused. "I said, 'Hans, that won't work. We can't push through these reforms, for which we need to devote all our power and take every risk, and also save €20 billion on top of that.'"
  • That Germany and France were never punished for their debt transgressions is still seen as evidence that no EU rule is so important that the Continent's largest members cannot get around it. Many blame Berlin and Paris's original sin for, in effect, licensing the Mediterranean governments' borrowing sprees. But Mr. Schröder says that fiscal rules ought to be negotiable "in countries where structural reform is really taking place—where, if you like, an Agenda 2020 is being implemented."

Thursday, July 5, 2012

Innovative ideas in science: S. Wolfram and A NEW KIND OF SCIENCE

I remember when A New Kind of Science was published ten years ago (2002). It was a big, nice, strange, scandalous and very expensive book (the book is now freely available in the web). I became fascinated by the book - not only the content, but also the book itself. I remember to say in a conference at my University that it was the most well designed scholar book I had ever seen, not only with incredible images but also well organised, by levels of increasing depth and detail.
And it had a nice aroma and flavour of challenge to the classic scholar establishment (for instance, no list of references at the end of the book! and a very peculiar and challenging way to select and to present the citations included). He dare to present such a provocative, new and challenging contributions through publishing himself a book, not writing the classical papers to established peer reviewed journals. A book that is important by its own contributions is nowadays a very rare thing in the scientific community (in science and technology - not in social sciences, where the pattern in very different). "How did he dare to do it?": of course, it was the expected and natural reaction from the establishment.
Reading the book, it was easy for me to become fascinated by some of the ideas and to understand how good Stephen Wolfram is as a scholar - out of academy. To be a scholar outside the academy may be a nonsense for a lot of people (mostly in academy). Stephen is a rare case about what you can do when you do not have any need to pay homage to established people and ideas, you can work out of the box as you like (and you have plenty of resources - time and machines - to do it) and your career does not depend on it. And he is a member of the rare breed of scholars who simultaneously are entrepreneurs and top managers (Mathematica and related products talk by themselves).
Ten years later, NKN (as it is now known) is becoming a well recognised branch (methodology? framework?) of academic research and thought in very different fields, approaching simulation and modelling the real world outside the classical analytical framework of continuous physics and mathematics. The philosophical implications are still difficult to screen - but it is not difficult to anticipate some potential consequences.
Stephen Wolfram has now posted three nice and important post in his elegant blog. I very much recommend reading them. In the first one (It’s Been 10 Years: What’s Happened with A New Kind of Science?, 7th May) he reviews the first ten years of cellular automata and complexity related issues in the scholar literature during this first decade. In the second one (Living a Paradigm Shift: Looking Back on Reactions to A New Kind of Science, 11 May) he discusses a potential shift in paradigma and he discusses the reception to his ideas. In the third one (Looking to the Future of A New Kind of Science, 14 May) he speculates about future developments.
A few citations from these posts:
  • A typical issue that came up was how the book was vetted or checked. In academia, there’s the idea that “peer review” is the ultimate method of checking anything. And perhaps in a world where everyone has infinite time, and nobody operates according to their own self-interest, this might be true. But in reality, peer review is fraught with error, often quite corrupt, and even in the best case strongly biased toward avoiding new ideas and maintaining the status quo. And for a piece of work as large, broad and complex as A New Kind of Science, even the basic mechanics of it seemed completely impractical.
  • Today we are continually exposed to technology and engineering that is directly descended from the development of the mathematical approach to science that began in earnest three centuries ago. Sometime hence I believe a large portion of our technology will instead come from NKS ideas. It will not be created incrementally from components whose behavior we can analyze with traditional mathematics and related methods. Rather it will in effect be “mined” by searching the abstract computational universe of possible simple programs.
  • And my key realization was that the computational universe of simple programs (such as cellular automata) provides an immensely rich source for such modeling. Traditional intuition would have led us to think that simple programs would always somehow have simple behavior. But my first crucial discovery was that this is not the case, and that in fact even remarkably simple programs can produce extremely complex behavior—that reproduces all sorts of phenomena we see in nature.
NKS story is important stuff for sociology and philosophy of science, about emergence of new paradigmas and about the path of innovative ideas in the scientific community. Stay tuned.

    (Image: rule 101 of NKS book)

    Wednesday, July 4, 2012

    We had a dream ...

    I. WE HAD A DREAM ...

    It used to be an old dream: the union of european countries - an europe without wars, a land of peace.
    My generation surprisingly had made it: one step after the other, a deeper union of the european countries has been built along the years, and its borders have enlarged. From the initial 6 western countries to the present 27 countries - including ex- communist eastern countries, something few people in 70's and 80's (and even first half of 90's) may have dreamed to see happening during his life. From the free mouvement of goods and people to the eurozone and Schengen space. Decades of prosperity and peace, seventy years after World War II and when the wars in Balkans seem to have been sorted out largely under the influence of EU. 
    The dream had become true, and it seemed to be working. Euro seemed a unique success. Peripheral countries, like Portugal, profited handsomely from joining the euro, in part due to low cost of sovereign debt. Debt was easier and peripheral countries did what they were expected to do: to accelerate the social and physical development of their people and land. Thanks god, the stock of infrastructures improved dramatically. 
    Until crisis arrived when a sudden and dramatic change in economic climate happened. 
    But not only changes in the economic climate. Meanwhile it was not only UE borders that have enlarged. Germany itself has changed: integration of eastern Germany took years and a lot of EU solidarity. Bur the after integration Germany is proving to be a different country with a different power balance and perspective: not only larger, but different. Its geostrategic positioning may be changing: more eastern oriented, less western friendly. New generations of political leaders emerged, with very different personal backgrounds and political culture.
    Now these are hard times. Problems in the design of euro currency become visible in the present economic and financial environment. The north - south divide may be menacing EU unity, as well as euro - non euro divide. Some countries seem to be considering precautionary measures. May be Germany is or will consider exiting the euro (and EU?). Britain leaders seem to be positioning for the day after. And peripheral countries (including Portugal, Spain, Italy, Ireland and even Greece) may be paying un unfair price for the rigidities of a flawed euro currency, largely driven and leaded by Germany.
    Is this the end of the dream?
    Yesterday a very grey leader, Durão Barroso, made a unusual strong and emotional speech in European Parliament. A note should be made. This looks like an important moment.  Even NYT made a note of it:
    • Mr. Barroso’s comments broke an atmosphere of optimism and relative calm that had prevailed after the summit meeting at the end of last week
    Barroso recalled the ghost of war in europe in very clear words:
    • "Those who know European history know how negative was the role of prejudice and the complex of superiority of one part of Europe over the other”

    II. THE CRISIS as seen from America

    In the same day Barroso was addressing European Parliament, Amartya Sen, from Harvard, and Nobel prize in economics, published a strong op-ed in The Guardian titled "Austerity is undermining Europe's grand vision". Subtitle is clear: "Economic policy is triggering disaffection among nations – the very thing the pioneers of unity hoped to erase":
    • The problems we are seeing in Europe today are mainly the result of policy mistakes: punishments for bad sequencing (currency unity first, political unity later); for bad economic reasoning (including ignoring Keynesian economic lessons as well as neglecting the importance of public services to European people); for authoritarian decision-making; and for persistent intellectual confusion between reform and austerity. Nothing in Europe is as important today as a clear-headed recognition of what has gone so badly wrong in implementing the grand vision of a united Europe.
    And another Nobel Prize, Joseph Stiglitz (now at Columbia University) posted in Project Syndicate, in the same day:
    • Like an inmate on death row, the euro has received another last-minute stay of execution. It will survive a little longer.
    • It is deeply troubling that it took Europe’s leaders so long to see something so obvious (and evident more than a decade and half ago in the East Asia crisis). But what is missing from the agreement is even more significant than what is there.
    • the remedies – far too little and too late – are based on a misdiagnosis of the problem and flawed economics.
    • investment will decline – a vicious downward spiral on which Greece and Spain have already embarked. Germany seems surprised by this. Like medieval blood-letters, the country’s leaders refuse to see that the medicine does not work, and insist on more of it – until the patient finally dies.
    • Indeed, it is remarkable that there has not been more capital flight. Europe’s leaders did not recognize this rising danger, which could easily be averted by a common guarantee, which would simultaneously correct the market distortion arising from the differential implicit subsidy.
    • The euro was flawed from the outset, but it was clear that the consequences would become apparent only in a crisis. Politically and economically, it came with the best intentions.
    • Europe’s temporizing approach to the crisis cannot work indefinitely. It is not just confidence in Europe’s periphery that is waning. The survival of the euro itself is being put in doubt.

    III A VOICE from Germany

    Europe dream may be in danger. Did the spell turned against the sorcerer?
    Last January, Joschka Fischer (German Foreign Minister and Vice Chancellor from 1998-2005) wrote that
    • If Merkel’s government believes that paying lip service to growth is enough, it is playing with fire: a euro collapse in which not only Germans would be badly burned.
    End last May he wrote some unusually dramatic words in the closing of an article titled "The Threat of German Amnesia":
    • Indeed, rarely has Germany been as isolated as it is now. Hardly anyone understands our dogmatic austerity policy, which goes against all experience, and we are considered largely off-course, if not heading into oncoming traffic. It is still not too late to change direction, but now we have only days and weeks, perhaps months, rather than years.
    • Germany destroyed itself – and the European order – twice in the twentieth century, and then convinced the West that it had drawn the right conclusions. Only in this manner – reflected most vividly in its embrace of the European project – did Germany win consent for its reunification. It would be both tragic and ironic if a restored Germany, by peaceful means and with the best of intentions, brought about the ruin of the European order a third time.
    What may the real meaning and motivation behind yesterday Barroso speech? 
    We had a dream, and we have lived the dream. Too good to be true?
    I hope we can still dream.

    (Italics and bold, our responsability; Photo: embassy of Portugal in Paris, june 2011)

    (Update, 5th July: Fischer has just published a new post in Project Syndicate, Europe's winners and loosers:
    • Both sides will have to decide whether or not they want Europe – that is, full economic and political integration. Economically, they must choose either joint liability and a transfer union or monetary re-nationalization. Politically, the choice is whether to empower a common government and parliament or return to full sovereignty. What we know for certain is that, just as one cannot be a little pregnant, the existing hybrid is not sustainable.)
    (Update, 6th July: it seems that preliminary and maybe exploratory moves to test possible exits from euro common responsibilities are visible not only in Germany and UK, but also elsewhere: Finland seems to be now the case - even if claiming it otherwise. See Finland Would Rather Exit Euro Than Pay for Others, in WSJ. Finish finance minister has said:
    • "Finland will not hang itself to the euro at any cost and we are prepared for all scenarios."
    • "Collective responsibility for other countries' debt, economics and risks; this is not what we should be prepared for")

    Monday, July 2, 2012

    Can people trust banks management?

    Banking has a core role in the economic crisis under way. Last weeks banks have been at the center of news. Bailouts of banks in Spain and Italy were at the center of discussions and decision during last EU council. But UK added two very important contributions to the crisis.
    NatWest fiasco (see here, and here, as well as here) is a significant operational case about what can happen when real time information systems go wilde. It is a case that will prompt a lot of discussion and analysis in the future.
    Meanwhile the UK Libor scandal has the promise of wider implications, both in banking and politics. It is a case of business culture and management of values in the corporate world - an upper level relative to NatWest operational fiasco.  Martin Wolf posts some very critical comments about the present perversion of banking in his FT blog:
    • My interpretation of the Libor scandal is the obvious one: banks, as presently constituted and managed, cannot be trusted to perform any publicly important function, against the perceived interests of their staff. Today’s banks represent the incarnation of profit-seeking behaviour taken to its logical limits, in which the only question asked by senior staff is not what is their duty or their responsibility, but what can they get away with.
    • Finally, does anybody really believe that the fundamental model of contemporary banking, which is to operate with the barest minimum of capital, with a view to maximising expected non-risk-adjusted returns on equity, for the benefit of bankers’ remuneration, at the expense of both shareholders and taxpayers, is defensible?
    • A full retail ring-fence, which separates the investment banking from the retail banking, plus much higher capital requirements, would be a good start. This combination would, I believe, see the disappearance of much unnecessary trading activity. Good riddance, I would say. But the UK would also have to accept that the present charging model for retail banking – free, if in credit – is also one of the reasons for the endless series of scandals. The model is broken, in the current low-interest rate environment. Banks must be encouraged to charge open fees for service, rather than make money by covert means.
    There is a pending question: is it a UK only phenomena? What about manipulation of basic rates in other countries? France and Germany: are they fully innocent? We would appreciate to know. We guess next episodes are not to be very pleasant.
    Of course, this post is very much related to our previous one.

    (Italics our responsability)

    (Update, 5 July: article in The Economist, "The LIBOR affair: banksters":

    • If attempts to manipulate LIBOR were successful—and the regulators think that Barclays did manage it, on occasion—then this would be the biggest securities fraud in history, affecting investors and borrowers around the world.)