my euro essay from 2001

I wrote this in 2001, the euro has been an accident waiting to happen.

It’s an unstable equilibrium, as Mike just reminded me I used to say.

Like balancing a marble on top of an upside down bowl, if it starts to go it accelerates downward

Vs the dollar, a stable equilibrium system, which is like placing a marble in a bowl right side up, and any movement meets forces which brings it back to the starting point.

And like many ponzi schemes, it works just fine on the way up, and can go on a long time before it crumbles.

Rites of Passage

The Child of Consensus

Conceived in post WWII politics, and baptized in the political waters of the 90’s, a new common currency- the euro- assumed its position on January 1, 1999. Representatives of the prospective member nations masterfully achieved political consensus by both the absence of objectionable clauses and the inclusion of national constraints, as manifested in the Treaty of Maastricht. During that tumultuous process, with deep pride, the elders grasped and shielded the credit sensitive heel of the infant euro. The ‘no bailout’ directive for the new ECB (European Central Bank) emerged as a pillar of the political imperative to address the ‘moral hazard’ issue that so deeply concerned the political leadership, and, two years later, that same rhetoric of fiscal responsibility continues to ring at least as loudly when the merits of the EMU (European Monetary Union) are proclaimed. Unfortunately, however well intended as protection from a genetic proclivity toward fiscal irresponsibility, the naked heel is but a magnet for the financial market’s arrows of our hero’s mortal demise.

As Apollo’s chariot adeptly carries its conflagration from east to west, the European Monetary Union carries its members on the path of economic growth. Unlike the path of the sun, however, the path of an economy continuously vacillates, including occasional dips into negative territory. And, like the sign most rental car agencies post by the entrance for returning cars about to drive over a one way bump strip, the new EMU, with its lurking unidirectional bias, could do a service to it members with a similar posting – WARNING- DO NOT BACK UP!

The Dynamics of the Instability

The euro-12 nations once had independent monetary systems, very much like the US, Canada, and Japan today. Under EMU, however, the national governments are now best thought of financially as states, provinces, or cities of the new currency union, much like California, Ontario, and New York City. The old national central banks are no longer the issuers of their local currency. In their place, the EMU has added a new central bank, the ECB, to manage the payments system, set the overnight lending rate, and intervene in the currency markets when appropriate. The EP (European Parliament) has a relatively small budget and limited fiscal responsibilities. Most of the governmental functions and responsibilities remain at the national level, having not been transferred to the new federal level. Two of those responsibilities that will prove most problematic at the national level are unemployment compensation and bank deposit insurance. Furthermore, all previous national financial liabilities remain at the national level and have been converted to the new euro, with debt to GDP ratios of member nations as high as 105%, not including substantial and growing unfunded liabilities. These burdens are all very much higher than what the credit markets ordinarily allow states, provinces, or cities to finance.

Since inception a little over two years ago the euro-12 national governments have experienced moderate GDP growth, declining unemployment, and moderate tax revenue growth. Fiscal deficits narrowed and all but vanished as tax revenues grew faster than expenditures, and GDP increased at a faster rate than the national debts, so that debt to GDP ratios declined somewhat. Under these circumstances investors have continued to support national funding requirements and there have been no substantive bank failures. Furthermore, it is reasonable to assume that as long as this pattern of growth continues finance will be readily available. However, should the current world economic slowdown move the euro-12 to negative growth, falling tax revenues, and concerns over the banking system’s financial health, the euro-12 could be faced with a system wide liquidity crisis. At the same time, market forces can also be expected to exacerbate the downward spiral by forcing the national governments to act procyclically, either by cutting national spending or attempting to increase revenue.

For clues to the nature and magnitude of the potential difficulties, one can review the US Savings and Loan crisis of the 80’s, with the difference being that deposit insurance would have been a state obligation, rather than a federal responsibility. For example, one could ask how Texas might have fared when faced with a bill for some $100 billion to cover bank losses and redeem depositors? And, once it was revealed that states could lack the borrowing power for funds to preserve depositors insured accounts, how could any bank have funded itself? More recently, if Bank of America’s deposit insurer and lender of last resort were the State of California rather than the Federal Reserve, could it have funded itself under the financial cloud of the state’s ongoing power crisis and credit downgrade? And, if not, would that have triggered a general liquidity crisis within the US banking system? Without deposit insurance and lender of last resort responsibilities the legal obligation of a non-credit constrained entity, such as the Federal Reserve, is systemic financial risk not ever present?

The inherent instability can be expressed as a series of questions:
*Will the euro-12 economy slow sufficiently to automatically increase national deficits via the reduction of tax revenues and increased transfer payments?
*Will such a slowdown cause the markets to dictate terms of credit to the credit sensitive national governments, and force procyclical responses?
*Will the slowdown lead to local bank failures?
*Will the markets allow national governments with heavy debt burdens, falling revenues and rising expenses the finance required to support troubled banks?
*Will depositors lose confidence in the banking system and test the new euro-12 support mechanism?
*Can the entire payments system avoid a shutdown when faced with this need to reorganize?

Conclusion

Water freezes at 0 degrees C. But very still water can be cooled well below that and stay liquid until a catalyst, such as a sudden breeze, causes it to instantly solidify. Likewise, the conditions for a national liquidity crisis that will shut down the euro-12’s monetary system are firmly in place. All that is required is an economic slowdown that threatens either tax revenues or the capital of the banking system.
A prosperous financial future belongs to those who respect the dynamics and are prepared for the day of reckoning. History and logic dictate that the credit sensitive euro-12 national governments and banking system will be tested. The market’s arrows will inflict an initially narrow liquidity crisis, which will immediately infect and rapidly arrest the entire euro payments system. Only the inevitable, currently prohibited, direct intervention of the ECB will be capable of performing the resurrection, and from the ashes of that fallen flaming star an immortal sovereign currency will no doubt emerge.

Warren Mosler
May 1, 2001

blog comments


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Tom Hickey Says:
January 21st, 2010 at 2:29 pm

Same thing happened to me, although I was a progressive (radical, actually) and knew that something was wrong with neoliberalism from Chomsky’s Politics and Neoliberalism andHegemony and Survival. But I hadn’t seen through the veil and was still under the spell of the Wizard and the gold brick road. (Did you know that The Wizard of Oz was an allegory against the gold standard?)

I happened to read a comment by Ramanan on a blog, although I no longer remember which one. It sounded a bit far-fetched but he provided references and I checked them out. This led to my reading Randy Wray’s Understand Modern Money, and the scales fell from my eyes. I realized that I had just discovered the holy grail of economics! Then everything began to fall into place. Reading the blogs of Warren, Bill Mitchell, Randy, Scott Fulwiler, Winterspeak, Marhall, etc., and going through the comments carefully, especially those of JKH, I began to get how everything fits together with MMT as the foundation. Eureka. Thank you all.

America, wake up before it is too late.

Jason Says:
January 21st, 2010 at 4:42 pm

It’s true that’s it’s a paradigm shift that changes everything, because there is so much of what we hear from political parties (including up here in Canada) and on the media that is just whacky once these pieces start to fall together. I’m like Tom above, very progressive and i’m the guy that before would have said tax business and that cutting the GST (again in Canada) is stupid because it will be harder to get to a surplus situation…etc etc..and one year later I have had to abandon so many ideas I believed. But it’s very liberating. I make many more comments now in online print media and have many more discussions about economics and try to point people to this site. I think there are many phases of outreach about this that need to occur to the general public, but certainly one that comes to mind is economic textbooks need to be challenged. I happen to have my old 1993 intro economics textbook open. Central banks borrow for deficits. Central banks control inflation by changing the money supply. Velocity of circulation theory. Tax as a source of revenue for federal govt. it’s all here and now all seemingly wrong.


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Canada ready to buy $US on weakness


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From: Mario Seccareccia
Date: Sat, Oct 24, 2009 at 10:58 AM
Subject: RE: *Canada ready to buy $US on weakness
To: Warren Mosler

Warren,


I was at a conference in Quebec City on the issue of financialisation and I just got back literally during the night because of a nasty storm that caused flight delays last night.

However, the Governor of the Bank of Canada is under a lot of pressure from the export sector to do something about the high Canadian dollar because of the Dutch disease effects on the Canadian manufacturing sector. In fact, I have been invited to participate in a conference organized by the Quebec Federation of Labour and various employers’ associations in Montreal right at the beginning of December on exactly this question of the Canadian dollar.

As you know I stand with the Bank of Canada in defending a floating exchange rate but the Bank is under a lot of pressures from both those on the Right and on the Left of the political spectrum to institute some Chinese-style low (Can) dollar pegged exchange rate! This has been an on-going battle over the last few years every time the Canadian dollar is approaching parity with the US dollar. My position has always been to advocate fiscal (and monetary) policy to keep the economy on its full-employment path and I have proposed interregional transfers to deal with the problem of the Dutch disease. But it is very difficult for them to think in those terms because of their fixation with deficit spending and also because of the high constitutional fragmentation of the country that makes a policy of interregional transfers via the taxation of provincial natural resource revenues a political hot potato in Canada. Indeed, there have been even supreme court challenges from Newfoundland and others over the system of equalization payments because of the inclusion of provincial oil revenues in the formula for calculating the current regional transfers.

In any case, as you can see, given the current downward evolution of the US dollar, this might trigger competitive devaluations much as in the style of the 1930s.

Best,

Mario


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Carney Says Intervention Needs Policy to Back It Up to Work


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CIBC Says Canada Should Consider ‘Bounded Float’ of Currency

This would help support exports. (But my first choice would instead be funding an $8/hr job for anyone willing and able to work and a tax cut to sustain domestic demand and optimize real terms of trade.)

Carney Says Intervention Needs Policy to Back It Up to Work

Oct. 27 (Bloomberg) — Bank of Canada Governor Mark Carney said today that central banks that try to affect the level of their currencies through market actions need to back the transactions with monetary policy to be effective.

Speaking to lawmakers, Carney said the bank could use tools, including quantitative easing, to implement policy with

the bank’s key interest rate as low as it can go.

Selling your own currency is the back up to your other, export oriented policy.

There is no limit to the amount of your own currency you can sell into a bid at that level.

The (operational) limit is how much the rest of world wants to buy at your selling price.

Quantitative easing has nothing to do with this.


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Canada ready to buy $US on weakness


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While he’s a bit shaky on his understanding of monetary operation his intentions are clear enough:

Bank of Canada talks tough on rising dollar

By Kevin Carmichael

Oct. 3 (The Globe and Mail ) — Bank of Canada Governor Mark Carney is done with nuance. His new message for those who doubt he’s prepared to weaken the dollar if Canada’s recovery veers too far off track: Just watch me.

Despite stronger than expected growth in the second half, the central bank has actually reduced its outlook for the next two years, saying that’s when the current appreciation of the currency will show up in growth figures.

Given that backdrop, Mr. Carney said he would have no choice but to act if international investors continue to push the dollar higher – something they’ve been quite willing to do, in part because most analysts and investors are skeptical a central bank that hasn’t intervened in currency markets since 1998 is willing to back up its talk with action.

But if the currency continues to surge, Mr. Carney stressed that he retains “considerable flexibility” to stoke the demand required to get inflation back to the 2-per-cent target. His options would include creating money to buy U.S.-dollar denominated assets or direct intervention in foreign exchange markets.


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Plutonomies


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>   
>   (email exchange)
>   
>   On Sun, Oct 18, 2009 at 12:01 PM, Russell wrote:
>   

Plutonomies

>   
>   I don’t know if the very wealthy support consumption.
>   

As a point of logic yes, it can be done, and we’ve been moving in that direction.

>   
>   I was always under the impression it was the mass of the people
>   not the mass of wealth. Gillian Tett supports your thinking on this.
>   

Yes:

The essential thesis is that plutonomies arise when there are factors such as “disruptive productivity gains, financial innovation, capitalist-friendly governments, overseas conquests and dopamine-heavy immigrants, the rule of law, patent protection and great complexity exploited by the wealthy of the time”.

This description has applied to countries such as the US, UK, Canada and Australia recently: in the US, for example, the top 1 per cent control almost a quarter of the wealth. And that has big implications for consumer spending or global financial flows.

For while economists tend to watch factors such as unemployment to predict consumption, Mr Kapur thinks this can be misleading because it is the elite rich – not the middle class – who tend to drive consumption.

Last year, for example, this elite cut spending and raised saving because their assets plunged in value. However, in the next year, Mr Kapur is expecting plutonomists to make a comeback. As a result, he expects spending to reappear.


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OECD Calls an End to the Global Recession


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Guess it wasn’t as bad as most of the doomsday crowd thought?

They never give sufficient credit to the automatic stabilizers and fiscal policy in general.

I suppose that were understood there would have been a policy response at least a year ago to avert the damage that resulted by their lack of appropriate action.

Nor is a double dip out of the question, with proposals to tighten fiscal looming and interest rates very low.

OECD calls an end to the global recession

By David Prosser

September 12 (The Independent) — The global downturn was effectively declared over yesterday, with the Organisation for Economic Co-operation and Development (OECD) revealing that “clear signs of recovery are now visible” in all seven of the leading Western economies, as well as in each of the key “Bric” nations.

The OECD’s composite leading indicators suggest that activity is now improving in all of the world’s most significant 11 economies – the leading seven, consisting of the US, UK, Germany, Italy, France, Canada and Japan, and the Bric nations of Brazil, Russia, India and China – and in almost every case at a faster pace than previously.

Composite Leading Indicators point to broad economic recovery

September 11 (OECD) — OECD composite leading indicators (CLIs) for July 2009 show stronger signs of recovery in most of the OECD economies. Clear signals of recovery are now visible in all major seven economies, in particular in France and Italy, as well as in China, India and Russia. The signs from Brazil, where a trough is emerging, are also more encouraging than in last month’s assessment.


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more weak July data


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>   
>   (email exchange)
>   
>   On Wed, Aug 19, 2009 at 9:38 AM, Morris Smith wrote:
>   
>   Really lousy economic data continues about July
>   

Yes, looking awful from a lot of angles.

This latest govt. attack on bank capital, especially small banks, might be biting deeper than the media is on to.

Amazon (AMZN-Hold)

Yesterday, comScore released July online retail data, showing total online spending falling by 7% y/y including a 5% y/y decline in non-travel spending. This data, combined with soft July retail and same-store-sales (SSS) and a weak outlook from Wal-Mart (WMT-Not Rated), reinforces our opinion that consumer spending may be slower to recover than anticipated. We reiterate our Hold rating on Amazon (AMZN) and our $83 per share price target.

comScore reported that July non-travel spending declined by 5% y/y, a sequential deceleration from the 1% y/y decline experienced in June and below the 4% y/y decline witnessed in May. Key category results were somewhat soft, with only Books & Magazines growing by 4% y/y and Consumer Electronics up 5% y/y.

eMarketer released data from the National Retail Federation (NRF) at the end of July indicating that nearly 50% of participating consumers were cutting spending on back-to-school supplies. Additionally, only 22% of respondents said that they would purchase back-to-school supplies on the web, down from 25% a year ago, with 75% opting to shop at traditional discount retailers.

July SSS fell 5% y/y, with the large majority of retailers posting greater than expected declines. The US Census Bureau reported that July total retail sales were flat sequentially but down 8% y/y, with sales down 9% y/y from May through July.

We now estimate that the impact on US eCommerce sales will be a 4% y/y decline in 3Q09 versus a 2% y/y decline in 2Q09, with low single digit growth in 4Q09. Ecommerce spending may decline by 1% y/y in 2009. This lack of consumer demand recovery represents a bit of an overhang on stocks like Amazon.

Amazon’s stock carries a premium valuation to other ecommerce, retail, Internet stocks and the S&P 500 Index, trading at 50x 2009E EPS and 21x 2009E OIBDA. The S&P 500 Index trades at 16x 2009E EPS of $60. Our ecommerce peer group averages 23x 2009E EPS and 10x OIBDA. Using a PEG ratio of 2.0x or 50x our 2009E EPS of $1.65, which equates to 21x our estimated 2009 OIBDA of $1.7 billion, our price target is $83 per share. We rate Amazon.com a Hold.

Orbitz (OWW-Buy)

We are reiterating our Buy on Orbitz (OWW) and raising our price target from $6 to $8 per share. We anticipate that Orbitz will be able to grow EBITDA by 20% y/y in 2009 and could nearly triple free cash flow through increased transaction volume growth and a sustainable cost savings program.

Transaction volumes improved 22% sequentially in Q2, helping to offset the removal of bookings fees on single-carrier flights, resulting in a better-than-expected gross bookings decline of 12% y/y. The removal of booking fees has stimulated consumer demand and shifted share from airlines to online travel agents (OTAs) like Orbitz. We expect further improvement in Q3, forecasting gross bookings to decline by 10% y/y. Q4 may only show a mid-single digit y/y decline in gross bookings, given an easier comparison and some potential price stabilization.

Despite the capacity cuts made last September, all of the major airlines have increasingly turned to the OTAs to shed excess inventory and generate revenue. Given the poor outlook published by the International Air Transport Association (IATA) for the global airline industry ($5 billion in losses, and normal traffic growth not returning until 2011), we anticipate that this trend will continue and may be very difficult to reverse.

Looking forward, Orbitz has committed to expanding its under-indexed hotel business globally. We believe that both Europe and Asia remain growth opportunities for Orbitz. Despite both Priceline (PCLN-Buy) and Expedia (EXPE- Buy) already establishing meaningful franchises on both continents, Orbitz should be able to capture a fair share of the rapidly growing international hotel market.

The cost savings program implemented in 1Q09, reducing expenditures by $40 million to 45 million annually, has driven EBITDA growth of 28% y/y through 1H09. Debt leverage has fallen from 5x to 4x based on our recently raised 2009E OIBDA of $160 million. Interest coverage has improved from 2x to 3x. Free cash flow is also forecast to nearly triple from $0.31 in 2008 to $0.88 in 2009.

Orbitz trades at 10x our 2010E EPS of $0.50, below a market P/E multiple of 14x. Our domestic e-Travel group reflects an average 2010E EPS trading multiple of 14x. Using a PEG of 1.1 or 16x 2010E EPS of $0.50, our 12-month price target is $8 per share. We rate Orbitz a Buy.

Yahoo (YHOO-Hold)

Recent data support our concerns about a sustained slowdown in online advertising. We continue to believe online advertising will remain muted in the third quarter as there has been no evidence of an advertising recovery to date. Yahoo remains vulnerable to declining fundamentals and a long complex integration process with Microsoft. We maintain our Hold rating.

Yesterday, comScore reported that July e-commerce non-travel spending declined 5% y/y and 6% sequentially. This was the largest monthly annual decline in 2009. We do not believe this bodes well for an online advertising recovery in the third quarter, particularly when combined with the University of Michigan’s preliminary consumer confidence sentiment number for the month of August, which showed a continued decline from July.

Yahoo continues to experience a continuous search market share loss in the US. According to comScore, Yahoo’s US search share stood at 19.3% in July, which represents a consistent monthly decline from 21.0% in January.

Data suggests Yahoo’s search ad coverage is down significantly y/y and dropped materially month/month in July. Ad coverage data coincides with a poor July e-commerce report.

This news does not bode well for Google, which also experienced a sequential decline in ad coverage during July. Google also saw a slight US search market share loss to Bing in July to 64.7% from 65.0% in June.

Our channel checks and the comScore data do not support Yahoo’s commentary at last week’s investor conference, where the Company remarked that it saw “green shoots” in ad sales and saw near-term ad budgets coming back. In addition, this commentary is inconsistent with Yahoo’s weak third quarter guidance.

Yahoo continues to battle departures amongst its executive team. Last week, Yahoo’s VP of West Coast sales announced his departure after three years at the Company. Yahoo also recently lost its VP of sales in New England and Canada.

We maintain our cautious view of the online advertising space as we forecast no growth in online advertising during 2009. Yahoo trades at 7x 2009E OIBDA, which is fairly valued in our view, particularly given expectations of a long drawn-out integration process with Microsoft and our concerns about Yahoo’s strategy and growth.


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Hong Kong recovery ‘made in China’


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Yes, this further supports the notion that some of the world economic improvement was due indirectly to ‘one time’ inventory building and additions to capacity in China, including the eurozone, where exports nudged France and Germany to positive GDP reports.

Hong Kong Climbs Out of Recession as Trade Improves

August 14 (Bloomberg) — Hong Kong climbed out of a yearlong recession as trade improved, adding to signs that the global economy is recovering.

Gross domestic product rose a seasonally adjusted 3.3 percent in the second quarter from the previous three months, after dropping 4.3 percent in the first quarter, the government
said today. The median estimate in a Bloomberg News survey of seven economists was for a 1.2 percent gain.

The Hang Seng Index has gained 84 percent from this year’s low in March as China’s record lending and 4 trillion yuan ($585 billion) stimulus package help the city, which is a hub for
trade and finance. Hong Kong’s government raised its forecast for this year’s GDP to a contraction of between 3.5 percent and 4.5 percent today from a previous estimate of a 5.5 percent to
6.5 percent decline.

“This rebound has largely been ‘Made in China,’” said Brian Jackson, a senior strategist at Royal Bank of Canada in Hong Kong. “Exports to the mainland have picked up, while easy
liquidity conditions there have contributed to recent gains in Hong Kong’s asset prices, providing a strong boost to Hong Kong consumers.”

The economy shrank 3.8 percent in the second quarter from a year earlier, after a 7.8 percent drop in the previous three months. The first-quarter contraction from the previous three
months was the worst since data began in 1990.

Singapore Retail Sales Post Smaller Drop as Recession Recedes

By Stephanie Phang

August 14 (Bloomberg) — Singapore’s retail sales fell the least in three months in June as the nation emerged from its worst recession since independence 44 years ago and an annual island-wide sale supported spending.

The retail sales index dropped 8.2 percent from a year earlier after sliding a revised 10.4 percent in May, the Statistics Department said today. The median estimate of 11 economists surveyed by Bloomberg News was for a 9.2 percent decline. Adjusted for seasonal factors, sales rose 2.3 percent from May.

Singapore’s economy expanded for the first time in a year last quarter as manufacturing and services improved. The government raised its 2009 export forecast this week as policy makers around the world predict the worst of the global recession is past after pledging about $2 trillion in stimulus measures and cutting interest rates.

“We should generally expect gradual improvement in retail sales from hereon,” said Kit Wei Zheng, an economist at Citigroup Inc. in Singapore. He cited “firmer signs of a turnaround in labor markets, and perhaps some positive spillovers on confidence from the buoyant property and equity markets.”

Singapore’s benchmark stock index has climbed 49 percent this year and home sales by developers including Frasers Centrepoint Ltd. rose 9.1 percent in June from May, according to the Urban Redevelopment Authority.

Singapore employers fired fewer workers last quarter, cutting 5,500 jobs compared with 12,760 in the first three months of the year, the Ministry of Manpower said July 31. The seasonally adjusted unemployment rate held at 3.3 percent.


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