Monday, October 31, 2011

Choosing the worst possible alternatives

One of the least pleasant experiences in life is to run into a "true believer"—someone who believes something so strongly that no amount of good evidence will get them to change their minds.  Such people are pretty common in religious circles but it turns out, religious crackpots are probably the least of our worries.  I mean, if you should ever stumble on two people debating whether physical body and blood of Jesus are present during Holy Communion or whether that presence is merely symbolic, chances are you will be mostly amused because the outcome means so little.  Well, yes, there probably have been historical examples where people were burned at the stake for getting this argument "wrong" but that doesn't much happen anymore.

On the other hand, the theological debates that swirl around a subject such as "Is fighting inflation the only concern of central banking?" have massive impacts on the rest of us—how we live, how we are employed, how we educate our children, etc. etc.  And these fierce debates continue until this day.  Witness the fight of the true believers over the monetary crises in Europe.

Some Pretty Good Evidence That European Leaders Are Insane
Joe Weisenthal | Oct. 29, 2011

Paul Krugman is correct here about the inadequacy of the latest European bailout scheme, and what it will take for Europe to save itself:

It’s still looking impossible to save this system without a drastic change in both the ECB’s actions and its philosophy. If that’s impossible, as so many people claim, the euro will be a failed experiment.

Reforming the ECB -- turning it into an institution that funds European governments -- may ultimately prove to be impossible not because of any technical reason (that is, after all, what central banks do) but because of the European obsession with ECB independence, and the German obsession with hard money/not monetizing debt.

And while you might be able to defend this stern view of the ECB's role based on some kind of "principle" of whatnot, it's crazy to think that the alternative is a loss of sovereignty for Europe!

Think about it: European leaders right now think it's preferable to have the head of the EFSF travel cap-in-hand to China and Japan asking for investments. There's even talk of Europe paying back China in yuan. It's basically impossible to imagine China participating in a bailout fund as a pure "investor" and not as an entity that will want some influence in Europe's future strategic decisions.

The preference for loss of sovereignty (however minor) over a more flexible ECB (which would be a perfectly satisfactory solution) boggles the mind. more
Trichet—the true believer's true believer.
Humiliating Trichet
No Party For Europe
by DEAN BAKER   OCTOBER 25, 2011

Jean Claude Trichet will be retiring as head of the European Central Bank at the end of the month. He will step into retirement having wreaked the sort of destruction on the European economy that hostile powers can only dream about. Tens of millions of people across the eurozone countries are unemployed or underemployed because of his mismanagement of Europe’s economy. Meanwhile the world teeters on the brink of another financial crisis because of the ECB’s failure, along with the IMF, to effectively address the sovereign debt crisis. Most incredible of all, Trichet probably thinks he has done a good job.

This last point really is central because the ECB, like much of the economics profession, continues to be controlled by a bizarre clique that believes that the most important, and possibly only, goal that a central bank should pursue is a 2 percent inflation target. By this measure, the ECB has done reasonably well, even the as the euzo zone economy has crumbled around it. After all, inflation in the eurozone economies rarely exceeded 3 percent and averaged well under the 2 percent target over the last decade.

However, the low and stable eurozone inflation rate is not going to provide much help to the 21.2 percent of the Spanish work force that is unemployed or the 14.6 percent of the Irish workforce, nor the millions more elsewhere in the eurozone who have lost their jobs as a result of the collapsed of the housing bubbles that the ECB let grow unchecked. more
The conflict caused by the Euro crises is really between the German taxpayers and the German banks but it has been cast as an example of a fight between the German citizens and the Greek citizens over who should pay the un-payable Greek sovereign debt.  The guilty banks are somehow given a free pass.  And now Mrs. Merkel has been portrayed as an SS guard (quite flatteringly, I might add.)  The Germans who are being forced to pick up the tab are just as furious—only they haven't found such a good picture to Photoshop.
Furious Greeks lampoon German 'overlords' as Nazis with picture of Merkel dressed as an SS guard
Street poster depicts German Chancellor wearing a swastika armband bearing the EU stars logo on the outside
By DAILY MAIL REPORTER   28th October 2011

click to enlarge
Greeks angry at the fate of the euro are comparing the German government with the Nazis who occupied the country in the Second World War. 
Newspaper cartoons have presented modern-day German officials dressed in Nazi uniform, and a street poster depicts Chancellor Angela Merkel dressed as an officer in Hitler’s regime accompanied with the words: ‘Public nuisance.’ 
She wears a swastika armband bearing the EU stars logo on the outside.
The backlash has been provoked by Germany’s role in driving through painful measures to stop Greece’s debt crisis from spiralling out of control.

Greeks are furious at the deal, even though it means the banks will write off 50 per cent of the country’s debt and Socialist prime minister George Papandreou said Greece had ‘avoided a mortal national danger’.
Opposition parties blasted the landmark agreement, with conservatives warning it condemned the country to ‘nine more years of collapse and poverty’. more
Because the ECB won't monetize the debt, some of the craziest ideas imaginable are being floated to solve a problem that literally could be made to disappear with a few keystrokes.
Controversial Leverage Plan
Europe Opting For Discredited Tools to Solve Crisis
By Stefan Kaiser  10/26/2011

Not long ago, European governments were blasting the financial products which contributed to the 2008 meltdown. Now, in an attempt to save the common currency, they are turning to those methods themselves. They have become no less dangerous in the intervening years.

It was one of the central lessons of the 2008 financial crisis: Banks and their customers, so went the political consensus, should only invest in products that they were able to understand. That meant that banks should stay away from special purpose vehicles and structured products that used finance tricks to transform questionable debt into sure-fire investments.

That was then. Now, however, just three years later, the tune has changed dramatically. Indeed, it isn't the banks that are eagerly developing new products in an effort to transform large sums of money into even larger mountains of cash. It is the politicians themselves.

At issue is the euro bailout fund known as the European Financial Security Facility (EFSF) which is the focus of a critical European Union summit on Wednesday evening in Brussels. The fund is designed to provide needed funding to heavily indebted euro-zone member states, prop up wobbling European banks and buy sovereign bonds of struggling countries to help keep risk premiums as low as possible. But it's not big enough. With a lending capacity of €440 billion -- backed by €779 billion in guarantees -- the EFSF would be insufficient should Italy or Spain run into trouble. 
The German parliament will vote on Wednesday on whether to allow Chancellor Angela Merkel to approve a leveraging of the fund to boost its effectiveness to up to €1 trillion. A test vote on Tuesday indicated that passage of the measure is assured, with just 11 rebels among coalition parliamentarians and broad opposition support. 
Don't Totally Understand 
Yet it is unclear whether all those voting in favor of leveraging the EFSF totally understand what it means. The original idea behind the EFSF is that the fund would provide 100 percent of any aid necessary for an endangered euro-zone country or would be exclusively responsible for buying up sovereign bonds. Should a country need €100 billion, for example, it would all come out of the EFSF. 
Once the fund is leveraged, however, the country in need will still get its €100 billion, but the EFSF will only be responsible for a fraction of that total. The rest will be contributed by private investors that the EFSF attracts using guarantees or other tools. As a result, European leaders hope, the €440 billion lending capacity can be spread much further.
European heads of government, however, still haven't decided exactly how they want to do that. One idea that had been backed by France, that of granting the EFSF a banking license so that it could then loan money from the European Central Bank, has been rejected due to passionate German resistance. more
This isn't only about the Euro, Greece, and Europe.  The true believers are causing havoc throughout the world.
Right Now Inflation Hawks Are Threatening To Destroy The World
Simone Foxman | Oct. 28, 2011

Not only do we have the most divided Fed since 1992, we've watched the European Central Bank repeatedly refuse to cut interest rates all year despite the clearly flagging eurozone economy.

But honestly, it just doesn't make sense.

Obviously, no one is about to deny that inflation can bring with it damaging consequences. It makes sense for central banks to maintain a strict watch over price stability. And both the ECB's and the Fed's success at sticking to inflation rates around 2% has — on the whole — been been exemplary for the last 12 and 20 years, respectively.

The fact remains that inflation is the lesser of three evils when compared with deflation and recession.

Deflation Is Dangerous 
Morgan Stanley's Global Economics Team explains the evils of both deflation and premature monetary tightening:

There is still no consensus today about how to escape deflation once the economy falls into such a state. Cognisant of this, economists’ single most important policy recommendation regarding deflation is: do not allow it in the first place! The practical monetary policy implication of this is to be aggressive and, perhaps more importantly, to be proactive in the face of downside risks...

The past also offers insights about what not to do...The policy prescription therefore is to avoid premature tightening, as this could tip the economy (back) into recession or deflation. The way we would put it is: err on the side of caution when exiting – in other words, it’s better to exit too late rather than too early.

A Little Inflation Isn't That Bad And It's Easier To Control 
And exiting an easy monetary policy too late is not the end of the world. In the United States, where inflation stood stable at 2.0% in October, the reality is that modest inflation growth will not throw the economy down the tube, and has not proved difficult to bring under control in the last 20 years. Since 1991, the longest continuous period of inflation over 3% was just 14 months.

Again, from Morgan Stanley:

Erring on the side of caution likely implies exiting too late, which in turn means elevated medium-term inflation risks. Yet, it is rational for a risk-averse central bank to prefer the lesser of two evils: if inflation is the price for avoiding deflation, then so be it – because central banks know how to deal with inflation.

Recent Economic Data Is Not Great 
In that vein, the economic data coming out of both the United States and Europe right now suggests that the Fed's hawks and the ECB are being too stodgy about price stability. more
For those who are confused over the issues surrounding the European (bankster) bailout, here is a cute animation that sums the craziness up pretty well.

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