Crackpot realism—German style

According to C. Wright Mills the man who coined the phrase, crackpot realism is term to describe someone who likes to think himself the essence of sober responsibility but who is in fact, hopelessly insane.  The movie Dr. Strangelove was a wonderful depiction of the Cold War crackpot realists who managed to put themselves in charge of the nation's defense machinery but subscribed to a 'reality' that was dangerously apocalyptic.  Such people as Robert McNamara and Curtis LeMay came damn close to blowing up the world during the Cuban Missile Crises of 1962.

Economics has had more than its share of crackpot realists.  These days, the easiest way to spot one is by their crazed insistence that austerity is the most credible way to address the problems caused by an economic depression.  The current German Finance Minister is such a person and in fact, comes from a long line of such people.  The most notorious German austerian was Heinrich Brüning, the academic economist / Chancellor whose mismanagement of the economy from 1930-32 was so terrible it led directly to the rise of Hitler.  Of course, Wolfgang Schäuble's austerian economics is only doing minor damage to the German economy but his crackpot realism has plunged much of the EU into the worst depression since the heady days of Brüning himself.

Unlike Brüning, Schäuble is not an academic economist.  So he picks and chooses from a wide array of austerian "intellectuals" available to re-enforce his biases.  It is quite telling in my mind that one of those he chose is the notorious Harvard guy Kenneth Rogoff whose "important" book Growth in a Time of Debt was exposed this spring for its sloppy research, deliberate falsifications, and comical Excel spreadsheet errors.  That was April.  It's now September and yet one of the most important politicians in Europe seems either to have not gotten the memo on Rogoff or he doesn't care because in his mind, outright academic fraud doesn't discredit the great concept of austerity in the time of crises.

One other thing.  Schäuble's crackpot realism is VERY likely doing major long-term damage to the German economy.  Austerian economics has transferred many of Europe's crippling financial obligations to the German taxpayers.  When those bills come due, it is likely that Schäuble will be remembered as fondly as old Heinrich Brüning.

Architect of Austerity: Schäuble's Search for a Way Forward

By Ullrich Fichtner and Alexander Smoltczyk

As Germany's Finance Minister, Wolfgang Schäuble is one of Europe's most influential politicians -- and one of its most hated. Many hold his austerity policies responsible for mass poverty and unemployment in the south. How does he know his decisions are right?



At the Federal Ministry of Finance on Berlin's Wilhelmstrasse, working home to one of the most powerful men of our time, the corridors are up to 700 meters (2,296 feet) long. They lead to 2,100 offices, whose stone doorframes form seemingly endless rows reminiscent of the set of a grim, futuristic film.

The layout of the building, designed by Nazi architects, looks like the drawing of a complex machine part. Those who enter the building inadvertently find themselves whispering, as if to avoid disturbing the power concentrated inside. History is constantly being made, day after day, in this building. Senior Nazi leader Hermann Göring once strode through its corridors. It was occupied by the Soviet military administrators after World War II, and it was the setting for both the establishment of the German Democratic Republic (East Germany) and, decades later, its liquidation by the Treuhandanstalt, the agency that privatized former East German state-run enterprises.

Wolfgang Schäuble's office is in room 4358, an unadorned corner office on the fifth floor. Many people in cities like Athens and Madrid hold this man responsible for their misery. For them, he is hardly less contemptible than the other men whose offices were once in the same building. They blame him for the plight of retirees reduced to scavenging for food in garbage cans. They claim that the Teutonic furor behind his austerity measures has impoverished Europe and turned it into a place of decay. They believe that no one bears more responsibility for such policies than the man in room 4358 at the German Finance Ministry. Does this man in a gray suit actually know what he is doing?

'Into a Dark Forest'

Schäuble isn't one for small talk. He seems to have no objection to getting right to the point -- to the question of what constitutes the basis of his political decisions, and how academic insights enter into the political process. "As Bismarck said, from one second to the next, you suddenly find yourself walking into a dark forest," he says.

The minister is referring not only to his particular branch of government, but also to the system of finance, global transfers and hypersensitive expectations in an era of chronic crises. Many voters act on little more than the hope that their elected representatives in the parliament and the administration have a pretty good idea of what they are doing. But what exactly serves as the basis for their decisions?

Schäuble points to a man sitting with him at the table: an unobtrusive, alert man whom the minister, with a hint of sarcasm, calls his "chief economist." His name is Ludger Schuknecht, and his head resembles that of a nervous bird. As the Finance Ministry's director general for economic policy, a position referred to as "AL I," Schuknecht serves as the link between the world of economic theory and the world of the feasible, between knowledge and power.

"He is an outstanding academic," says Schäuble, although he is unable to resist adding a "but…" He doesn't complete the sentence, and yet it is clear what Schäuble means to say: Politics is a whole different game. Schuknecht laughs nervously.

Staying One Step Ahead

Schuknecht's job is to provide answers to all technical and specialized questions on the spur of the moment. Schäuble sometimes even calls him at night to resolve questions that are on his mind. Could you explain to me, once again, the "balance sheet crisis" in Spain, he might ask? Or: Which laws govern the shadow banks in the US state of Delaware? Schäuble expects to receive immediate input, material to contemplate.

Schuknecht's economic policy division employs about 140 people, most of them economists, whose job is to provide the state secretaries and the finance minister with the latest figures. They are expected to be consistently well informed about the latest academic debates, or preferably even a step ahead of them. Schuknecht is convinced that there isn't a single important thought that escapes his team. They represent the concentrated expert knowledge of the powerful.

Each employee in the economic policy division has access to specialized knowledge and contacts at universities, banks and associations, as well as think tanks in Brussels and Washington. Schuknecht's staff members invite professors to write concept papers or, at times, to pay a visit to the minister in room 4358.

One of those academics was Kenneth Rogoff, a Harvard economist and one of the world's foremost economic thinkers. He stopped by Schäuble's office on March 2, 2011, just after having given a talk in the ministry on his latest book, "This Time is Different," a 500-page tome on the financial crises of the last 800 years. The book, a massive collection of figures derived from archives, forgotten books and documents presumed lost, became a global bestseller and required reading for finance ministers and central bankers alike. It helped to explain the anatomy of financial crises.

Schäuble, who had read the book, met with Rogoff for an hour. "It wasn't a narrow advice-giving session," says the minister. "I asked him to explain to me what he said in his talk." As it turned out, Rogoff's views conformed to what Schäuble had always known: Ever since money has existed, there has been debt and there have been crises. And when they expand into sovereign debt crises, and when the entire structure of global finance begins to totter, there are no longer any easy answers. After the meeting, the name Rogoff began popping up in Schäuble's speeches.

The Real World

"Academics are important," says Schäuble, "because one has to constantly make an effort to understand things." And yet there is still a wide gap between all the models and theories, and actual political decisions. The world doesn't submit to theories, and history does not offer quick lessons for the future. Suddenly what the experts believe is the right thing to do diverges from the reality of what is feasible -- a reality characterized by political compromises in Brussels, unrest in Lisbon and the power struggles within the steering committee of a coalition party in Athens.

Greece is only one example, but a good one nonetheless. Schäuble often mentions Greece, and when he does he breathes heavily and pauses frequently, rubs his eyes and clasps his hands together in front of his face as if he were praying. Should the country have withdrawn from the euro zone in 2010? The possibility was discussed in the Finance Ministry, even though these discussions were never mentioned publicly. The numbers were clear, and they made a mockery of the Maastricht criteria.

"But then I get a call from (former US Treasury Secretary) Timothy Geithner," says Schäuble, "and he says, 'You do know that we wouldn't have made the decision to allow Lehman Brothers to go bankrupt if we had been asked 24 hours later, don't you?'" Schäuble shrugs his shoulders and falls silent. He cradles his head in his hands and narrows his eyes, using body language to ask: Well, what do you do in that situation? What's the right thing to do? What isn't? What's going to blow up in your face tomorrow?

"Or take the debate in 2011 over the debt haircut for Greece," Schäuble continues. He shrugs his shoulders once again. What would be the consequences of debt forgiveness? What would it mean for Portugal? And for Ireland? And how much of a haircut should private creditors be forced to accept? 20 percent? 22? 30? Or at least 50, as Schäuble had proposed from the very beginning?

'That Terrible Feeling'

It wasn't because he was sure about the number, but almost on the basis of a gut feeling derived from year after year of dealing with the feasible. In those situations, someone like Schuknecht is no longer helpful. In those situations, politicians get together late at night, drink wine and talk -- not about the specific details and not about methodology, but about all the things they have already experienced, and about what works and what doesn't.

Schäuble talks about how Jean-Claude Trichet, the then-head of the European Central Bank (ECB), warned him that by rigidly calling for a 50-percent debt haircut he was risking the worst crisis since the Great Depression. "Thank God he wasn't right," says Schäuble. "It ended up at 53 percent. In the end, you can't reach a decision like that based on scientific methods. Nevertheless, you have to make the decision as difficult as possible, weighing all the options with the help of experts. Then you reach your decision and assume it's the right one and hope, just a little, that you're not wrong."

Schäuble exhales loudly and shrugs his shoulders. He is honest enough to admit that he wasn't envious of his predecessor, Peer Steinbrück, when Lehman failed in 2008 and the global financial crisis erupted, nor did he envy Steinbrück for "that terrible feeling you get when you realize that this could turn into a panic." more, much more