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Economic Populist: Why Is Europe's Economy Imploding?

by BruceMcF Tue Jul 17th, 2012 at 05:00:20 AM EST

Burning the Midnight Oil for Economic Populism

crossposted from Voices on the Square

The European Union is in a world of hurt right now, as economies go. The crises in Greece and elsewhere are becoming famous, and latest confidence surveys from Germany (pdf) suggest Germany is risking recession.

The problem? The system was built broken, based on unfounded fantasies about how real world economies actually work. Or, as John Maynard Keynes said nearly a century ago:

"The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist."

front-paged by afew

So, what is the idea of the defunct economists?

So you got these markets, see. And buyers will be more interested in buying stuff at lower prices, and sellers will be more interested in selling stuff at higher prices, so if you just step back, there will be a price that 'clears the market'.

That's the 'equilibrium' price, the "equal weight' price, where the weight of surpluses pushing prices down and shortages pushing prices up come into balance.

Now, pretend (1) that the markets are not brought into existence by social institutions, many of them relying on the force of law, (2) and that people have more information to make more far-sighted decisions than people really have, and you can pretend that the economy is made up of a bunch of these markets, all connected together, and if "the government" just steps back out of the way, there will be an equilibrium for the whole economy.

Now, the "labor market" is just one more of these markets, and unemployment is just a bunch of labor markets failing to get to equilibrium, so if we just step back, and let things sort themselves out, unemployment will go away.

Now, its not just that: you also have to describe the connected systems of markets and the decisions of people with a whole lot of multi-dimensional calculus. Whatever is said in English is just a rough "intuition" of the "real" analysis, which is all hidden safely away in mathematical equations.

But this interconnected system of markets, with "the government" stepping back: that's a big chunk of what those equations are describing.

Who Builds New Systems?

Real monetary systems are inconvenient for these mathematical systems, so instead pretend that "money" is just one of many things that is traded in markets, and we measure the prices in that commodity for convenience.

As it so happens, these mathematical systems cannot describe the creation of new systems. Genuinely new technology, genuinely new social institutions, would require the actions of people ~ who have largely disappeared off the page ~ to be able to change the mathematical relationships of the system of models, and doing that makes the whole damn thing impossible to solve analytically. So for "tractability" genuine innovation, cultural change, technological invention, are assumed away and replaced by simulations of innovation.

This is tremendously useful for transnational corporations, since if you build a system in which it is assumed that government should "not interfere with the economy", that includes not getting involved in designing new systems. And since markets cannot design new systems, and individuals can only design new systems of a certain size ...

... that clears the field for transnational corporations to be the ones designing big new systems.

Now, Build a New Economic System

Under this fantasy economy, in the face of economic crisis, there may be short term and temporary interventions that government needs to make to stabilize things in an economic crisis. But the best thing that government can do is to push down the interest rate, to tell "the market" that now is the time to borrow and spend, and faced with that discounted funds, market will shift to a new equilibrium and the economic storm will pass.

All of this is a system that automatically tends toward full employment anyway so all this is really doing is speeding up that shift.

Now, go back to the real world and the 1990's. Pragmatically, a bunch of shifting exchange rates were screwing up with the process of spreading production processes across the borders of different European States in the European Common Market. So first they tried to stabilize exchange rates, but that fell apart. So then they settled on the decision to have a common currency. After all, a common currency will always have a 1:1 exchange rate ~ one German Euro will equal one French Euro will equal one Polish Euro will equal one Italian Euro.

And around the turn of the century, they put it into place. The Eurozone has grown since first established, and it now covers the majority of the European Union economy.

Sovereign Monetary Economies In the Real World

The United States is a monetarily independent economy. If US bonds come due, and the US government decides to, the bonds can be paid by just creating more US dollars. The UK is the same, Japan is the same, Australia is the same, Sweden and Norway are the same, etc.

But a state in the United States can't do that. Its not "California" dollars just because the money was created by a bank banking at the San Francisco Federal Reserve Bank, nor "Ohio" dollars because it was created by a bank banking at the Cleveland FRB. Its Federal money, if it is in bank accounts that settle payments through the Federal Reserve system.

A state that borrows has to pay back.

Also, in the real world, the economy is not always busily heading toward full employment. If people in the private sector as a mass try to save more money than they try to borrow, that puts a drag on the economy, which can only be offset by export surpluses, or by the government running a deficit.

Now, the people with money to save tend to have more money than the people that lack money to save, so that "decision" to have a depressionary private sector imbalance is one made fairly high up the income ladder. Especially now, in the aftermath of a financial crisis, with the fundamental underlying problems not yet fixed and so a credible fear among the wealthy that there are more financial crises coming.

So we have an imbalance, and need deficits. And the Federal level is the level that ought to be running those deficits, because the Federal level cannot be forced into bankruptcy (setting aside that political lunatics could decide to refuse to pay the Federal debt).

And the Federal government kind of did as it should in late 2009 and early 2010, though not at the scale required, and so we covered some, though not all, of the depressionary imbalanced.

In the past year and a half, the Federal government has failed in its responsibility to even run deficits sufficient to cover budget cutbacks at the state and local level. It has completely failed to come anywhere close to the level of deficits a responsible national government would run in the face of our current private sector imbalances.

But ... it could be worse.

What happens when you design a boat assuming that boats cannot sink?

Why is the Eurozone in particular and the EU in general in worse shape than we are?

They built their system broken. In the Eurozone, it has been state governments, acting the way they have been used to acting in a recession, who have been responding to the downturn by trying to pay out unemployment insurance, other social safety net programs, and also to bail out their banking systems.

But state governments can only go on deficit spending as long as someone with the ability to lend will lend to them. Its the sovereign government that can spend without running into a threat of going bankrupt. But when they built the Eurozone, they built it broken: they did not build a sovereign government with the power to spend the Euros at the Eurozone level.

What has the result been? The "central" economies have been trying to punish the naughty "peripheral" economies into cutting their deficits by cutting government spending. In the face of a cutback in government spending, the economy slows down. As the economy slows down, tax receipts fall. So the expected surplus does not arrive, and its time to dig the hole deeper.

There are only two long term outcomes: either a system is created at the Eurozone level with the power to issue Eurozone bonds and finance the amount of deficit spending that the Eurozone required ... or else the Eurozone will collapse, as populations subjected to neo-Herbert Hoover policies rebel against them.

As far as whether the Eurozone can arrive at the first solution, which would be the far better of the two in my view ~ I have no idea. Certainly the US administration economic team labors under the same misconceptions about how national economies work that led the Eurozone to be built broken, so its not as if the Europeans are going to fix their broken system under pressure from the US.

Where to learn more

An excellent source of daily news collected from around Europe is the European Tribune. There are several bloggers and commentators at the Eurotrib who are clued into the economy of the real world, so they also feature excellent posts such as their recent: Sen: Europe Betrayed By Austerity.

And for more on this approach to understanding the economy, search for "Modern Monetary Theory". For a fairly intensive, weight approach, see billy blog. For an academic but topical approach on this side of the Big Pond, see New Economic Perspectives. And on twitter, #MMT will give breadcrumb trails to all manner of interesting stuff.

And of course, your humble correspondent will continue occasionally reporting from the front.

Message from Marley: Get Up, Stand Up!

Preacher man, don't tell me,
Heaven is under the earth.
I know you don't know
What life is really worth.
It's not all that glitters is gold;
'Alf the story has never been told:
So now you see the light, eh!
Stand up for your rights. come on!

NB. Economic Populist is deliberately not written quite at the level of economic geekery that I would ordinarily write at.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Mon Jul 16th, 2012 at 11:22:50 PM EST
by afew (afew(a in a circle)eurotrib_dot_com) on Tue Jul 17th, 2012 at 01:31:01 AM EST
[ Parent ]
I didn't know,
you could sink so low,
to reduce economics
to common sense.
If economics made sense
everyone would be doing it
and where's the market in that?
Where's the profit
without scarcity,
and scaremongering,
and unequal distributions in knowledge?

Index of Frank's Diaries
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Tue Jul 17th, 2012 at 06:23:43 AM EST
[ Parent ]
Its Federal money, if it is in bank accounts that settle payments through the Federal Reserve system.

This is not really the case for loans originated by The Bank of North Dakota, is it? Would it be the case that for needed infrastructure in any state, were that state to charter a state bank through which all state financial transactions are routed, that bank could then finance, without resort to Wall Street of the Fed, all self-liquidating projects the state wishes to authorize? Could they use the US$ as a reference of value while being able to create state bank dollars without being constrained by the US Treasury or Federal Reserve. And could they, if they wished or needed, hold the value of their state bank dollars separate from the value of the US$?

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Jul 17th, 2012 at 09:20:43 AM EST
I believe money is an exclusive domain of federal level. The Constitution uses 'coin money', but I believe taht a the time paper bills were not that common and I think it is a reasonable interpretation that 'to coin money' covers any creation of physical representation of money.

res humà m'és aliè
by Antoni Jaume on Tue Jul 17th, 2012 at 09:33:56 AM EST
[ Parent ]
Is and ought be. There are various different experiences and several schools of thought on that subject in US history. An early pair were Hamilton and Jefferson. Both were familiar with the example of The Bank of England. Hamilton got a similar privately owned bank, The First Bank of the United States:
The First Bank of the United States was a national bank, chartered for a term of twenty years, by the United States Congress on February 25, 1791. Establishment of the Bank was included in a three-part expansion of federal fiscal and monetary power (along with a federal mint and excise taxes) championed by Alexander Hamilton, first Secretary of the Treasury. Hamilton believed a central bank was necessary to stabilize and improve the nation's credit, and to improve handling of the financial business of the United States government under the newly enacted Constitution.

Officially proposed to the first session of the First Congress in 1790, Hamilton's Bank faced widespread resistance from opponents of increased federal power. Secretary of State Thomas Jefferson and James Madison led the opposition, which claimed that the bank was unconstitutional, and that it benefited merchants and investors at the expense of the majority of the population.

Both Jefferson and Hamilton turned out to be right in many of their assertions about the bank. The charter for the First Bank of the United States was allowed to expire in 1811. The Second Bank of the United States was chartered by Congress in 1817, famously opposed by President Andrew Jackson, saw its charter expire in 1836, becoming a private bank, and was liqudated in 1841. Over its term it demonstrated both the benefits and the risks arising from a national bank.

There was no other national bank until the Federal Reserve System was created and came into effect on December 23, 1913. However  United States Notes were issued directly by the US Treasury from 1862 until 1971. Initially, these Notes were fiat money, legal tender by law and not convertible to gold. After the Civil War banking interests convinced Congress and much of the population that convertibility should be restored. Doing so arguably led to The Long Depression, 1873-1879 and the enrichment of some of the largest banks in the USA. As the population of the USA was still heavily agrarian and only partly dependent on the market economy, The Long Depression was felt less acutely than was The Great Depression of the 1930s.  

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Jul 17th, 2012 at 12:57:04 PM EST
[ Parent ]
The regulation of interstate commerce clause implies the power to regulate the payments systems used between states. That is, Reserve Notes, and Treasury Notes (greenbacks) before them, operate under the legal force of an act of Congress declaring them to be legal tender in settlement of debts both public and private. A state power to over-ride that would be a state power to discriminate in favor of in-state debtors and against out-of-state debtors, and so would be a regulation of interstate commerce, which is a power reserved to the Federal government.

A state could accept anything they want to accept, but they cannot refuse to permit the acceptance of Federal currency.

Federal restrictions on local money systems have normally been under a later layer, the power to tax incomes (16th: Income Tax, 1913), wherein income received in a local currency must still be declared and income tax paid on it as if it had been received in Federal currency. "The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration."

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Tue Jul 17th, 2012 at 04:04:31 PM EST
[ Parent ]
There is that.

There is also the fact that the SEC and FDIC and other three- and four-letter agencies might have Words to Say about such a scheme. Rude ones too.

And when push comes to shove and you need to send a couple of chaps with wire cutters to a server room somewhere, the FBI beats the local sheriff's office.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Jul 22nd, 2012 at 03:10:10 PM EST
[ Parent ]
Not sure what beef the FDIC or SEC would raise, so long as offers of North Dakota vouchers were voluntary.

That is, if you've let out a road contract, and then say, "By the way, 20% of your pay will be in North Dakota vouchers", that would not fly. If you advertised in advance that those bidding to be paid in a combination of US$ and NDV will have the NDV portion of the bid weighed 2:1, and the bid was to be paid 20% in NDV, then that's just the terms of the voluntary contract between two parties.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Mon Jul 23rd, 2012 at 11:50:53 AM EST
[ Parent ]
The problem is that North Dakota imports things from out of state, and payments for those things would have to clear from the Bank of North Dakota through the Federal Reserve system.

So the Bank of North Dakota would have to obtain Federal Reserves for those payments to clear.

What North Dakota could do is to issue vouchers that are accepted in payment of state taxes, ... but the degree to which they would be accepted in payment in general would be more limited, because the US$ is good for payments of Federal, state and local taxes and settlement of contractual obligations anywhere in the United States, so if, say, timber is imported to build a house, the source of the timber might not accept North Dakota tax vouchers.

North Dakota cannot force people to use North Dakota tax vouchers as a medium of exchange in the state by forcing people to accept them for all debts, public and private, because that violates the Federal prerogative to issue currency. North Dakota can only issue a voucher for the debts owed to it ... and then it can run into trouble if it needs to make US$ payments and only have vouchers being paid to it in taxes.

This is the same as the "local moneys" question, and while a state could stretch its ability to help those in need with a well planned "state bucks" system matched with hiring people to provide for basic needs paying a mix of dollars and vouchers and accepting vouchers in payment for the basic needs ... it cannot use a local money as a general substitute for national currency.`

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Tue Jul 17th, 2012 at 01:02:23 PM EST
[ Parent ]
It would seem that The Bank of North Dakota could also require that no more than half of payments of state taxes from any individual for any payment be made in North Dakota dollars. It was founded in 1919 but:
Though initially conceived by populists in the Non-Partisan League as a credit union-style institution to free the farmers of the state from predatory lenders, the bank's functions were largely neutered by the time of its inception by the business-backed Independent Voters Association. The recall of NPL Governor Lynn Frazier effectively ended the initial plan, with BND taking a more conservative central banking role in state finance.

It should not be too hard to imagine which kinds of businesses were foremost in supporting the Independent Voters Association. More here.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Jul 17th, 2012 at 05:44:29 PM EST
[ Parent ]
Yes, local currency systems that would gain a boost from the local government power to tax would also normally only accept local dollars up to a certain proportion of taxes due, such as 20%.

Its only a modest easing of the constraints on the local government to spend, but in a situation where that constraint is binding, a modest easing of the constraint could well be of use.

As I've noted in the Greek case, a New Drachma at, eg, a fixed 1:1 rate to the Euro would have a lot more leeway if China and some oil exporter on the outs agreed to accept New Drachmas as a portion of payments due for shipments to Greece.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Tue Jul 17th, 2012 at 06:01:05 PM EST
[ Parent ]
Congratulations, Bruce, on a highly readable summary, with links, that can serve to introduce almost anyone who has been following events to an understanding of what has been and is going on in the world. When we are being strangles by finance and the act is being disguised by economics it behooves us all to get a better understanding of both.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Jul 17th, 2012 at 01:02:34 PM EST

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