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Michael Pettis on the Euro Crisis

Michael Pettis provides an excellent analysis of the crisis in the Euro zone. The historical parallels to the French indemnity of 1871-73 are fascinating and counterintuitive. The crisis is driven by macroeconomic forces:

Germany exported capital because by repressing wage growth, Berlin ensured the high profits and low consumption that forced up its national savings rates. Instead of employing these savings to invest in raising the productivity of German workers (in fact domestic investment actually declined) it offered them either to fund German consumption at high real interest rates (and there were few takers), or through German and Spanish banks this capital was offered to other European households for consumption or to other European businesses for investment. The offers were taken up in different ways by different countries. In countries where the offered interest rates were very low or negative, the loans were more widely taken up than in countries where real interest rates were much higher. To ascribe this difference to cultural preferences rather than to market dynamics doesn’t make much sense.

Cui bono:

The “losers” in this system have been German and Spanish workers, until now, and German and Spanish middle class savers and taxpayers in the future as European banks are directly or indirectly bailed out. The winners have been banks, owners of assets, and business owners, mainly in Germany, whose profits were much higher during the last decade than they could possibly have been otherwise

Plus ça change…

In fact, the current European crisis is boringly similar to nearly every currency and sovereign debt crisis in modern history, in that it pits the interests of workers and small producers against the interests of bankers. The former want higher wages and rapid economic growth. The latter want to protect the value of the currency and the sanctity of debt.

John Kenneth Galbraith on monetary policy in the 1930s

“Consistent with Fisher’s formula, but not much considered, was a terrible possibility.  It was that the supply of money could not be increased.  The largest part of the supply of money, as by now will be adequately understood, is deposits in banks.  These come into existence as people and firms borrow money.  If business is sufficiently bad, profit prospects sufficiently dim, gloom sufficiently deep, businessmen may not borrow money.  Then no deposits are created, no money comes into existence.  The banks can be provided with cash for reserves by purchases of government securities by the Federal Reserve Banks from the banks or their customers.  This cash will then lie fallow in the banks.  Without borrowing and deposit creation there is no effect on prices or through prices on production.  This, it now developed, was not a hypothetical possibility but one that was intensely, miserably real.” (209)

“Money had dealt impartially with both those who feared inflation and those who wanted some — or, more precisely, wished to recoup past price reductions.  All had been shown to be wrong.  A country seeking inflation was like a woman of exceptional virtue deciding, after many adverse warnings of conscience and friends, to take a lover, only to discover that the lover was both unwilling and unable.” (212-213)

Money: Whence It Came, Where It Went. Boston: Houghton Mifflin Co. 1975.

Self-interest vs. Greed and the Limitations of the Invisible Hand

This is why we need Public Interest Capitalism:

Markets can only function well if there is an appropriate legal framework to restrict the behavior of market participants; however, the legal framework is inevitably inadequate. A “greedy” market participant that seeks to gain at the expense of others can usually findsome way to do so.