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Paradigm Lost, The Euro in Crisis (great read)
Carnegie Endowment ^ | 06/02/10 | Uri Dadush

Posted on 06/05/2010 5:18:24 AM PDT by TigerLikesRooster

Paradigm Lost: The Euro in Crisis

Uri Dadush Paradigm Lost: The Euro in Crisis, June 02, 2010

Paradigm Lost: The Euro in Crisis

The acute phase of the global financial crisis was short, lasting from the collapse of Lehman Brothers on September 15, 2008, to the day the Dow hit a trough on March 9, 2009. But, like a violent heart attack, the interruption of credit—the economy’s life blood—lasted long enough to permanently damage the industrial countries at the center of the crisis. The damage took three main forms, each of which poses a major risk to the stability of the global economy today: high and rising public debts, fragile banks, and a huge liquidity overhang that will need to be eventually withdrawn.

The Euro crisis, which strikes at the heart of the world’s largest trading block, contains only two of the three fateful elements—problematic sovereign debt in Greece and other vulnerable countries, and fragile European banks, which hold a large part of that debt. Monetary policy in the Euro area and in industrialized countries more generally, remains expansionary and, if anything, the crisis pushes back the time when tightening can occur safely. As a result of the problems in Europe, the world economy has become even more exposed to the three mega-vulnerabilities. The Deeper Causes of the Euro Crisis

While ballooning public debt may be the clearest manifestation of the Euro crisis, its roots go much deeper—to the secular loss of competitiveness that has been associated with euro adoption in countries including Greece, Ireland, Italy, Portugal, and Spain (GIIPS).

The sequence of events that led to the secular loss of competitiveness is depressingly similar among the GIIPS countries:

(Excerpt) Read more at carnegieendowment.org ...


TOPICS: Business/Economy; Extended News; Foreign Affairs; News/Current Events
KEYWORDS: currency; euro; europe; finance; piigs; spartansixdelta
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To download the full report, click the following link:

http://www.carnegieendowment.org/files/Paradigm_Lost1.pdf

For the great multimedia version, click this link:

http://carnegieendowment.org/publications/special/misc/EuroCrisis/

1 posted on 06/05/2010 5:18:24 AM PDT by TigerLikesRooster
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To: TigerLikesRooster; PAR35; AndyJackson; Thane_Banquo; nicksaunt; MadLibDisease; happygrl; ...

P!


2 posted on 06/05/2010 5:18:54 AM PDT by TigerLikesRooster (The way to crush the bourgeois is to grind them between the millstones of taxation and inflation)
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To: Desdemona

for later


3 posted on 06/05/2010 5:33:51 AM PDT by Desdemona
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To: TigerLikesRooster

Maybe an economist can explain it to me, but I don’t understand why massive amounts of debt and credit are a good thing. So people, businesses, and governments have more debt than they could ever conceivably repay, and government wants even more credit? Why?

Isn’t credit supposed to increase productivity? For example, a company needs a new machine. It could wait years to buy the new machine on its own resources, or it could take a loan, buy the machine immediately, boost production, and increase profit. However, this assumes there’s a market for the increased production.

How much of this new credit goes toward improving productivity and the economy, and how much is simply going to service existing (bad) debt? I’ve read we’re already up to over 300% of GDP in existing debt (public and private), but government wants to loosen credit even more???? It boggles the mind.


4 posted on 06/05/2010 5:38:19 AM PDT by CitizenUSA (Is Sarah Palin REALLY a conservative or just another Republican?)
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To: TigerLikesRooster

I have found this website to be a very useful source of information on the economy, gold, and silver.

http://goldismoney.info/forums/


5 posted on 06/05/2010 5:40:50 AM PDT by Silver Sabre
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To: TigerLikesRooster
The author diagnoses the problem well, but then

Remedies

As a rough guide, countries have to engineer a fiscal adjustment of 5 to 12 percent of GDP, and claw back a unit labor cost disadvantage of between 15 and 30 percent, though the precise figures vary by country.

Won't happen.

...unless the deflationary effect is offset by a combination of the following: a continued recovery of world trade; expansionary monetary policy; a lower euro; and expanding domestic demand in Europe’s surplus countries, including Germany and the Netherlands, which are likely to benefit most from a lower euro

Won't really help. An inflationary bubble won't be sustainable and will just create the same credit excess conditions elsewhere. If someone said "hey borrow all these Euros cheap and we will guarantee that you can pay them back cheaper..." I would take those Euros and loan them to Australia at ~6% and count on Australian dollar appreciation (they have lots of resources which are going to be in more demand in an inflationary bubble). Someone else would say "that's a stupid investment choice because the unwind will cause the opposite (Euro will skyrocket against Aussie $, etc)" I would simply respond that the market is telling me to do this and when the unwind happens I will race out the door with everyone else which will make things worse that more quickly, but that's the consequence of malinvestment-inducing market signal.

6 posted on 06/05/2010 5:53:35 AM PDT by palmer (Cooperating with Obama = helping him extend the depression and implement socialism.)
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To: CitizenUSA
How much of this new credit goes toward improving productivity and the economy, and how much is simply going to service existing (bad) debt? I’ve read we’re already up to over 300% of GDP in existing debt (public and private), but government wants to loosen credit even more????

Even worse, the new credit is used in a carry trade where one country (e.g. Euro, then Asia/Australia, soon Canada) guarantees a strong currency and another (e.g. Japan, then U.S., now Euro) deliberately weakens theirs to spur credit-based consumption and exports. The world is ping-ponging between the various strong currency countries (lending at realistic interest rates) and the weak currency countries lending at unrealistically low rates. As they shift, the malinvestments they create unwind, sometimes rapidly (e.g. 2008) and cause enormous deleveraging that toasts the banks involved in the trades.

7 posted on 06/05/2010 5:59:52 AM PDT by palmer (Cooperating with Obama = helping him extend the depression and implement socialism.)
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To: CitizenUSA
Isn’t credit supposed to increase productivity?

Some credit does.

If a manufacturer uses credit to buy a new new machine to increase productivity by more than the loan costs him, that's good.

If a person borrows money to buy a reliable car so they can get to work on a regular basis, increasing their income by more than the total-cost-of-ownership of the car, that's good.

If a person borrows money to buy a new car because they want a new car even though they've got a perfectly servicable car, that's not good.

If a person takes out a second mortgage, which they can't really afford, to take the kids to Disneyland, that's bad.

Karl Denninger at the Market Ticker periodically covers things like this very well

8 posted on 06/05/2010 6:06:20 AM PDT by DuncanWaring (The Lord uses the good ones; the bad ones use the Lord.)
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To: palmer
This sounds like what the likes of Roubini may want to do. Become a grand master of EU(or world) economy and juggle the whole economic system in the continent, and, presto, problem is gone.

He must have felt that he should create some remedy policy to 'remain credible'(i.e., keep employed.) It is probably just too much for him to tell everybody point-blank that this thing has to run it course and there is not much we can do.

9 posted on 06/05/2010 6:07:21 AM PDT by TigerLikesRooster (The way to crush the bourgeois is to grind them between the millstones of taxation and inflation)
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To: TigerLikesRooster

Paradigm Maintained - Europeans at each other’s throats for the last millenium.


10 posted on 06/05/2010 6:07:25 AM PDT by DuncanWaring (The Lord uses the good ones; the bad ones use the Lord.)
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To: palmer
More remedies:
Based on the experience of the GIIPS, if and when they enter, they must discourage a flood of investment from going into non-tradable sectors and they must maintain large fiscal surpluses

Won't happen without:

Countries with ... tight capital controls have dealt with the dislocation caused by the Great Recession better.

That's basically because domestic politics and interference in the market (e.g. China) can trump the false economic signal from low rates. But the author can't seriously think that China is in good shape, they have huge overcapacity and are unable to spur domestic demand for that capacity. Chinese are instead pouring vast amounts of credit (and capital) into overpriced real estate which will eventually crash and cause their own huge deleveraging. Meanwhile every two-bit local Communist party boss is building a new rivet factory in their district irregardless of the fact that it isn't needed.

11 posted on 06/05/2010 6:08:15 AM PDT by palmer (Cooperating with Obama = helping him extend the depression and implement socialism.)
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To: DuncanWaring
Cold War froze the history in Europe and EU project tried to refreeze it. Now EU is breaking up and history marches along its natural course. A bunch of deluded Utopian intellectual should never intervene history to impose their pipedream. It cost lots of blood and grief. They should disappear into history. We don't want them in our lives ever.
12 posted on 06/05/2010 6:13:02 AM PDT by TigerLikesRooster (The way to crush the bourgeois is to grind them between the millstones of taxation and inflation)
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To: TigerLikesRooster
Unless he (Roubini) or whoever is going to buy up all the overpriced Spanish real estate, pay off the personal loans of Eastern Europeans, and prop up or expand all the other bubbles, it won't work. Deleveraging has to run its course and we cannot pump out cheap credit to slow it because that will only create bubbles elsewhere to crash later.

The answers are pretty simple, lower taxes particularly for long term capital, let rates rise to properly reflect the value of that capital, and let the chips fall that must fall and support those who wind up in dire need (e.g. destitute Eastern Europeans).

13 posted on 06/05/2010 6:15:06 AM PDT by palmer (Cooperating with Obama = helping him extend the depression and implement socialism.)
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To: palmer
domestic politics and interference in the market (e.g. China) can trump the false economic signal from low rates.

I noticed that some economic honchos are envious of China. Unlike other countries, not only they can print money but also force enterprises to spend it because one way or another all business are on Chinese regime's short leash. However, it is doomed as you said. They cannot spend money efficiently. It will go to party hack's pocket to bankroll their own speculation binge for quick bucks. Even in the best case, it will cause mal-investment to compound overcapacity problem. Actually because of this second problem, their stimulus money cannot be efficient.

Lately, these policy experts are entertaining ever more complicated and infeasible 'solutions,' which can only work in the best possible scenario ever, based on most optimistic assessment. That is, everything should unfold exactly they predicted in time and magnitude. No margin of error.

14 posted on 06/05/2010 6:23:51 AM PDT by TigerLikesRooster (The way to crush the bourgeois is to grind them between the millstones of taxation and inflation)
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To: DuncanWaring
If a person borrows money to buy a reliable car so they can get to work on a regular basis, increasing their income by more than the total-cost-of-ownership of the car, that's good.

If they borrow from a local bank at a realistic rate to improve their house to match local demand (their own or what the local market will bear) that's good.

If some multinational bank borrows from a low rate country to build 10,000 new condos in sunny Spain, that's very bad although it may seem great during the bubble.

15 posted on 06/05/2010 6:25:45 AM PDT by palmer (Cooperating with Obama = helping him extend the depression and implement socialism.)
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To: TigerLikesRooster

Their stimulus money is the same carry trade except that it flows through the Communists. It’s not much of a choice we are given, either support the multinationals who pump the carry trade until the whole world is too big to fail, or support various command and control freaks such as Chinese Communists who want to add their own political or socialist goals into the malinvestment.


16 posted on 06/05/2010 6:30:06 AM PDT by palmer (Cooperating with Obama = helping him extend the depression and implement socialism.)
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To: CitizenUSA

Credit that is made possible by fiat or via fractional reserve banking is a form of dilution of the value of the currency it is issued in. It is a form of theft by counterfeiting instruments that represent wealth.

Expansion of credit is the basis of the boom-bust business cycle.

see: Business Cycle Primer by Llewellyn H. Rockwell Jr.
Link: http://mises.org/daily/606


17 posted on 06/05/2010 6:34:00 AM PDT by theBuckwheat
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To: CitizenUSA

All good points. Credit is not per se a bad thing. Regulated by market forces, interest rates tend to make the system self regulating. They tend to balance long term investment vs short term spending. Not always. Markets by themselves produce bubbles. But the markets, historically, recover pretty quickly (after pain) when the government butts out.

Governments mess this up in at least three ways: (1) When the government becomes a huge debt creator (Obama, Pelosi and Reid); (2) When government policies distort interest rates and credit to achieve political goals (printing gobs of money, quantitative easing, Fannie Mae policies, Community Reinvestment Act—all designed to increase private debt by decreasing the cost and availability); and (3) When government distorts distributed risk decisions (FDIC removes constraints on banks to invest deposit monies wisely because customers know the government will make up for any losses).

Number 2 and 3 got us where we are. Numbers 1 and 2 are now being frantically employed to prevent the market from correcting the bubble. It won’t work. It will only make things worse. In the end, the bubble will burst and our kids will have 10 trillion dollars in debt to show for it.


18 posted on 06/05/2010 7:31:59 AM PDT by ModelBreaker
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To: CitizenUSA

If a business borrows too much money, the prices of its shares will drop-shareholders realize that the company may not generate the cash flow to service the debt. Unhappy shareholders means the possibility of a takeover etc.
So corporations have some restraints on too much borrowing.

Any entity, individual, business, or government that borrows continually to pay for day-to-day expenses is in trouble. If one borrows to build a factory,or dam etc that will general future cash flows to service the debt, then the use of debt and credit is fine.
Many businesses borrow because the timing of cash receipts differs from cash payments.


19 posted on 06/05/2010 7:33:08 AM PDT by Maine Mariner
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To: TigerLikesRooster

“I noticed that some economic honchos are envious of China.”

Of course they are. China is fascist. Although they would never admit it, fascism—a system where government tells businesses what to do in minute detail—is the economic system they long for. They really think they are wise enough to make all the decisions.


20 posted on 06/05/2010 7:34:47 AM PDT by ModelBreaker
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