Monday, August 8, 2011

August again, leaders on holiday - what about a new Marshall-plan?

Not that it would be a typical one, with almost unbearable heat, slowly radiating from the walls of houses and even the shade of trees not offering relief without the breeze. And I don't believe in theories that for some mysterious reason August would be a month dedicated to and the most suitable for catastrophic events to happen. But after another half a year of "it is a strong recovery, fundamentals are OK, everything will be perfect, only those profligate Greeks should make themselves more accommodated to the inevitable decline of their living standards and work more" narrative suddenly the whole world seems to accept that we are on the verge of absolute collapse and disaster. (So much for the rationality of markets. ;) ) Well, according to the most capable economic leadership in any country of the world Hungary is a safe haven, China will defend it from anything that would happen. But otherwise, the world is doomed. (Just look at exchange rate and the bond yield curve of the last days, no sign of Chinese buying Hungarian debt at least not with discount.)

In a sense it is undeniable, but - I hope for many - not exactly the events are the most worrying, but the apparent lack of any kind of leadership and ideas,
what to do and how to act in order to avert the worst. What we only have is a renewed argument whether neo-Keynesians have it wrong or not, whether we should eliminate deficit now and at once or not, whether tax cuts will bring the so urgently needed growth. But as the events unfold no one seems to make an attempt to exert control over them. Those, who are supposed to be leaders, are just gaping at the incoming storm. However, even if sometimes the situation seems to be the contrary, it is lack of invention and new ideas that lies at the root of the sudden outburst of the crisis, everyone hoped (and thought) to have buried very deep. As the debates show the faith in the capacity of the states to act is shaken but there is no other entity to turn to in distress. To leave it for the market is a good idea but it would surely be suicide. Sovereig default would certainly bring down banks and companies, wiping out their - real or imaginary - wealth and resources, and of course individuals too, leading to the - at least temporary - death of those very markets we should turn to. The markets would like to see the states resolving the crisis, but abhor from most of the solutions offered. As long as the present crisis is seen singularly as a competitiveness issue - and not a lack of sufficient demand in the world- the markets will demand more and more austerity, leading to even less demand and so on. It is certainly a delusion from the recovery that the possibility of growth is associated exclusively with competitiveness as if Say's law would be unconditionally true. Despite the fact that in the light of recent revelations the performance of some economies in the last more than one year was probably driven by Chinese and US quantitative easing, creating a favorable environment at the emerging markets. Probably it is really not so easy to accept that extreme high German growth was not something given because the Germans are industrious workers but because there was demand somewhere for their products. (Even if the significant slowing in the last months would suggest otherwise.) The problem is that as long as the demand side is not really taken into account no one is really ready to accept: austerity might bring about the classic deflationary spiral.

Furthermore, the addressing of the international imbalances, the rebalancing of economies has not even begun. Even in Germany with its vigorous growth internal demand remained suppressed, and show only modest strengthening, while the German industry  has till not reached its peak output before the crisis. Not to speak of the other major and minor economies. According to the last IMF report on China even the authorities accept the necessity to direct the country to a more balanced economic model, with better social services, comprehensive pension and health care system, cheaper social housing, all costly and serving as automatic stabilizers but hopefully enhancing internal demand - for imports as well. With the turnaround of emerging economies the developed one could probably better rely on external demand, making plans of debt reduction based on exports via growing competitiveness more realistic, and not only them: there is the Eastern periphery of the EU too. Anyhow, one thing is clear: reform and spending cuts are no quick fix for the problems and even if there would be capacity and determination to implement them at once it would need a lot of time to change the course of those economies and generate growth that would make debt reduction credible.
Unfortunately there are complementary problems concerning the possible resolution of the crisis, structural ones but this time not on the labour market nor in the tax system, but at the very heart of economic governance, and well beyond the all-too-known issue of the Eurozone being a monetary union without a fiscal one. These structural problems mean serious constraint on the possible path of action for politicians and central bankers and accompanied with the lack of imagination makes the successful escape from the crisis one of the least possible outcomes.

The classic panacea for debt is threefold:
- faster growth
- austerity
- inflation
and these are often interlocked and interwoven.

The austerity is only viable in a benign and favorable international environment; when growing export markets offer a substitute for weakening internal demand fast enough to avert a long lasting economic slump. In case of an independent currency the fastest and easiest way is devaluation, otherwise harsh cuts in production costs are needed (and austerity to make it credible that the declining budget revenues won't lead to soaring deficit) and thus the restored competitiveness would enable producers to outbid their rivals. However, at the end the whole process could turn out to be a classic beggar-thy-neighbour policy, reducing cost in competition forcing others to do it and making gains in export at the cost of others and not as a result of a expansionary economic environment.
In order to avoid such successes being short-lived sustainable faster growth at the end needs more demand from somewhere, therefore the first option is very much constrained by the international environment again, if there is no opportunity to generate internal demand. Thus the present economc situation  is anything but favorable to these options: no chance of a devaluation as it is either impossible due to the lack of own currency or due to the practical peg in currencies of countries where significant part of individual, corporate and state debt is foreign currency denominated. And with a markedly slowing world economy - according to some it is almost certainly will be in recession in the second half of the year - there is no internal demand to rely on while austerity wipes out internal.

There is of course the third option - inflation. Most of the debt problems in the last century (actually even before that) were eliminated with this option. Whether it is fair or not, it is an effective way to reduce debt-to-GDP ratio and reduce the value of claims on the state and on the individual as well. Not inflation indexed debt will soon lose its real value when facing 4-5-6% or even higher inflation with negative real interest rates. The problem here is twofold: without the chance to devalue (that is inflationary per se) it can only be achieved by issuing money (and/or directly monetizing debt). But money issuance is usually the privilege of Central Banks that are independent of government, exactly for this reason: not to let the latter monetize their debt and inflate away the problem. 

There are of course psychological factors here in play too. Many fear - and it is not unjustified - from high and protracted inflation as it can be very destructive and usually distributes the burden unfairly across social groups. Furthermore it can push upwards bond rates, just aggravating the sovereign debt situation, making the financing of a country more and not less harder. And there is the much dreaded phenomenon of stagflation, when inflation fails to bring growth and while prices are soaring, the economy still flatlines. So, even if it can really offer a solution - as recently the IMF's chief economist, Olivier Blanchard suggested - it requires desperation and leadership and it can probably achieved only at the price of giving up ideas like the independence of central banks. (As it would need the revocation of their independent right for setting rates and issuing money. But as an ultimate solution at the edge of complete disaster it is still an option - an option that also needs time, at least a bill should be passed in parliament.)

There is of course a substitute for inflation, implemented in the last years too, quantitative easing. This time the central bank pumps money into the financial sector, either buying assets - sovereign bonds etc. - at the market. It is presumed that this money will find its way to companies who want to invest or to individuals who will spend it, because the more money is circulating in the system the less constrained are the banks to lend them. (In a sense it is again Say's law...) Sometimes it works, but in the last years it only had some unintended consequences and perverse effects: a rally at the emerging market stock exchanges and soaring commodity prices, at the end not enhancing the capacity of individuals and companies in the respective developed economies to spend more, but reducing it. The problem lies in the method of pumping the money in the system: through the intermediaries of banks. For companies, As long as demand is sluggish and existing capacities are underutilized (which is certainly the case now, when even Germany has not reached its peak output again) this is just cheap money to reinvest in financial assets (or in cae of a tax cut it is just additional profit).For the individuals this is not necessarily welcome. Those, who are deleveraging (i.e. paying down their debt) the main concern is not how they could take more debt on themselves, but how they could earn more money to pay their monthly rates. (And again: if it would be a tax cut, it would most probably be spent almost immediately on existing debt.) But the main problem - especially in declining economies is to produce something and sell it. (However, it also can be a problem for a rebalancing economy. For example if the US would need to export more and import less in a drive towards a more balanced economy then they also would need to produce something and sell it.) And the main reason they are not doing it is lack of sufficient demand: there are still underutilized capacities, internal demand is suppressed by austerity, external demand suffers from the end of cheap money at the emerging markets and consequently from the slowing of the global economy. So, the task for politicians and economists is twofold: they must ensure that money pumped into the economy is used to purchase - in a very broad sense - additional products in order to make output growing. And the main obstacles they have to face are: fears of sovereign default even in case of economies with an own currency (thus there is no room for fiscal stimulus); and fears of inflation (thus there is no room for monetizing debt).

At this point I’m not claiming that I would be more imaginative than our leaders. But reading Tony Judt’s Postwar made an embryonic idea growing in my mind. If states need to circumvent the obstacles of the markets who perceive every non-conventional action to lift internal demand as dangerous, while conventional action accepted by the markets was proven ineffective then what to do? It is clear that somehow money should be given to companies in order to make them produce, to individuals in order to make them buy goods… Actually something resembling of the post-war Marshall-plan can be a daring attempt but maybe not doomed to fail.

In case of the Marshal-plan goods from the US were transported to the participant countries according to their wishes that were based on plans. These could be consumer goods, investment goods, commodities etc. Usually the US delivered and paid for it, from its own treasury and the receiving countries used them. Either fed the population or built up infrastructure or plants etc. But it always created second tier effects in the receiving countries while it pumped money into US companies – who otherwise would have to face the rapid decline of military orders. Something similar could probably allow distressed countries to invest (in plants, infrastructure, services, human capital, education etc.) and thus generate not only income for their population but lay the foundations of later exports and ensure a healthy level of new orders for companies in the donor countries. (The Germans are planning something on a much lower scale in Greece, but with not much haste and with too old-fashioned methods: offering investment chances for companies.)

There are of course risks and institutional problems as well. Everything should be well-planned and at least moderately effective, i.e. there is no room for huge misallocation for investment, a reason to implement good planning, just in case of the Marshall-plan. Furthermore, few states can be the donors directly, as it would only make their debt grow. But there are ways to bypass these last obstacles. Not only would it be desirable to extend the program to the world (as a means to help addressing international imbalances and rebalancing of economies) but it would distribute the risk very broadly, Furthermore, there are institutions in the world system and in the EU that could implement such a program: the two reconstruction banks, World Bank and EBRD. For example if the EU would decide to issue Eurobonds – and they wouldn’t immediately pass on the money raised to distressed countries – they can place it into a huge reconstruction fund and finance the new Marshall-plan in Europe. They have to capitalize with it the EBRD and then let them coordinate the planning. afterwards the Germans and French can deliver the goods – paid from the fund - to the Greeks, who could earn their wages while using it or selling it or buying it… And the money would at least cover one and a half transaction and not immediately sucked up outstanding debt.
It is far from being an easy and elegant solution and it would still require a lot of human effort. It depends on the capacity and ability of a lot of individuals. But at least it offers the elimination of the main obstacles in the way of a lasting solution and addresses a real problem and not an imaginary one.

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