From George Santayana;
Those who cannot remember the past are condemned to repeat it.
Which perfectly describes Europe. In 1947, after the end of WWII, Europe was in total disarray. You could at least accept that they might have had a half-way legitimate excuse for this mess.
Essentially the problem boiled down to Europe adopting the Nazi economic plan. The name Hjalmar Schacht was our chappie who called the economic shots in Nazi Germany, but in 1947 he was safely doing some serious porridge.
Schacht implemented the system of price control, wage control, profit control, interest control, exchange control, foreign trade control, bi-lateral treaties, rationing, priorities, allocations, quotas, special licenses. The government interfered in and with every aspect of the economy. Total control. This type of economy can only hold if the government engages in a policy of conquest and expropriation, which of course, they did.
After the war, in 1947, various countries undertook the Nazi economic model, which mandated an unbalanced budget: heavy sums were spent on food subsidies, increasing pensions, family allowances, etc. None of these social programs could have their expenditures curtailed. Taxes were raised on the “wealthy” and upon luxuries. Meanwhile money expansion accelerated significantly, increasing the money in circulation, that due to the lack of internal production of goods and services, sought an outlet in imports. This money/credit expansion was fueled by low interest rates, so that government could afford their expenditures.
Through price controls etc, production was forced not to necessities demanded, which went into massive shortages, and sent black market prices soaring, but into luxuries that could be sold, if demanded, at a profit. But of course, the luxuries went into surplus, as the demand simply wasn’t there.
Add to the fact of legal limits or par values on currencies, and you have a situation of massive over-valuations. These prices existed as of April 28 1947 against the Swiss Franc:
……………………………..Market Price…………Official Price
It should be clear that with an over-valued currency relative to other currencies, even if those other currencies are themselves over-valued, imports become relatively cheaper than domestic goods, and imports are bought. Of course to gain foreign currency with which to purchase the imports, exports must be sold. What exports existed to be sold? Only the surplus of luxury goods that could actually produce an accounting profit. With all of Europe in this situation, bi-lateral agreements became the only way to actually trade for essential imports, through mandating that a certain level of luxury exports were also purchased. This is pure mercantilism, which Adam Smith in the 1770’s had criticised as prohibitive to wealth.
For Europe to be able to afford American imports, the industrial powerhouse in 1947, America had to provide loans. These loans then purchased American production. Of course, without the ability to sell exports to America, Europe couldn’t hope to pay the interest on the loans, never mind the principal, without further devaluations, which pushed them deeper into the internal inflationary hole, as the par value of the currency was maintained.
Today, have Europe learned anything?
I wrote so much about the eurozone (EZ) last year that I gave myself a condition called “euro fatigue”. Now I see that all of the same problems that existed for the last two years are rearing their ugly heads once again. As usual the ECB is well behind the curve – yesterday someone tweeted “If the ECB wanted to cause a major series of bank runs I really can’t see what they would be doing differently”. Sad but true.
Let’s cut to the chase: Europe is still a mess and the LTRO sugar buzz has faded, now it is time to get down to real business. We all know that the eurozone needs to become more fiscally integrated while implementing sweeping structural reforms throughout much of the periphery. However, bank runs have begun and people are rapidly losing confidence; therefore, Draghi must take bold action NOW not in six months when the genie is out of the bottle. Here is what must be done:
ECB guarantees of up to 250,000 euros on all euro bank accounts within the euro area. Large bank recapitalisations aided by ECB financing to the sovereign treasuries
Which has done what in the US? First it further encourages banks to violate, as if they needed any encouragement, to violate the demand deposit contract. Second, in violating that contract, they seek ever riskier investments as they essentially are guaranteed a bailout.
Large scale ECB purchases of sovereign debt in an indication that the ECB is serious this time and will not back down in easing stress in financial markets
Increase the inflation. But here it is: with the Euro at parity all over the Euro area, you again have fixed exchange rates. These exchange rates, depending on the level of individual members internal inflation, create real discounts and premiums, which inhibit trade, and production. God forbid they start throwing in additional price controls to augment the price controls that already exist on wages.
Begin a credit easing operation with purchases of mortgage/credit instruments to help take some strain off banks’ balance sheets
Has this worked in the US? Not even close. Why would it work in Europe? Answer it won’t. All it does do is extend the day of reckoning, and anyway, the banks are expected to turn the money around immediately purchasing government debt.
About that government debt: debt is incurred against production, viz. the production provides profit by which the principal + interest is serviced, until the debt is extinguished. The second form of loan is the consumption loan. This loan is only made where the income that is surplus to living costs etc, is sufficient to service the loan.
Are European governments taking a production loan or a consumption loan? Obviously a consumption loan. Do they have surplus revenues to pay for the increased consumption?
I fear that the ECB won’t do any of the above and that it will remain badly behind the curve as it holds interest rates at 1% while much of the EZ is mired in a deflationary downward spiral. There was a lot of hope when Mr. Draghi took the helm at the ECB, the LTROs were creative but clearly weren’t enough – bank runs are the oldest manifestation of economic crisis and the people’s loss of confidence in their financial system. Surely the ECB can’t sit by idly and watch this play out.
Get a grip chap’s, there is no pain free answer. The pain now has to be endured the best it can.