Another Look at the Eurozone Crisis

Used the OECD stats to make those:

Investment as a share of GDP, quarterly data, seasonally adjusted

Government consumption as a share of GDP, quarterly data, seasonally adjusted

One can see the investment boom in Spain and Ireland very clearly on those pictures. That boom was fuelled with credit (created at home and coming from Germany amongst other countries) even though it doesn't show on the graph above.

And with the same graph in mind, one can understand why employment has collapsed: lower investment - contraction in wage income - lower wage income - private debt distress - liquidation - fall in asset prices - lesser investment still... and so on.

The only way to keep employment and the economy going is to call for public investment projects (included in the investment graph) and if they don't come, next in line is government consumption, such as pension funds, employment benefits, etc., to maintain cash flows to the public since people don't get investment-employment any more.

But that wasn't allowed: Ireland's and Greece's state coffers were squeezed "since it is the solution to the eurozone crisis" said the slaves of some defunct economist. Ireland and Greece were in fact squeezed so hard that now they are squeezed more than the main squeezer is squeezing his coffers: Germany. Spain is just around the corner (see government consumption graph above).

So when the State cannot meet the collapse in demand from the implosion of investment, public and private, the unemployment skyrockets.

Unemployment levels in the eurozone - Total Unemployment

Unemployment levels in the eurozone - Unemployment amongst people under 25 years

And when the unemployment goes up, as it did in the 1930s, we get to see social unrest and Molotovs flying:

A motorcycle policeman burns as his colleague (right) tries to help him after protesters threw a gasoline bomb in Athens on Wednesday, Feb. 23, 2011. Scores of youths hurled rocks and Molotov cocktails at riot police after clashes broke out during a mass rally that was part of a general strike. Photo and text from The Washington Post

And after the social unrest, the Molotovs and burned down buildings, we see nutcases and lunatics like those guys:

Leader of Golden Dawn, an allegedly neo-Nazi Greek political party, and party supporters. Stinks like early 1930s

"Progress, far from consisting in change, depends on retentiveness. When change is absolute there remains no being to improve and no direction is set for possible improvement: and when experience is not retained, as among savages, infancy is perpetual. Those who cannot remember the past are condemned to repeat it."

George Santayana

Is Keynes's Clearing Union the Solution for Europe?

The Wolfson Economics Prize, about how to fix/break up the euro, was in the news some weeks ago. After having skimmed through, certainly not read thoroughly, some of the works that were handed in (I did read the entry of the 10 year old Dutch kid, thumbs up for trying) and with this paper in mind - A post-Keynesian interpretation of the eurozone crisis - it has started started to dawn upon me that Keynes may well have the solution: his Clearing Union (CU).

The essential core of the CU was that (current account) surpluses were to be recycled, in a way, between countries. The surpluses would build up as "pool of funds" (don't think for a second that I believe in the nonsense of Loanable Funds Theory just because I use this term) at the Clearing Union. Those surpluses would then be available to countries in deficits in the form of overdraft facility, at very low rate of interest. In today's Europe, the equivalents of the surplus countries are of course Germany and other current account surplus countries. The Peripheries are the deficits countries.

If the CU would be adopted between the countries of the euro zone the surplus of the Core would be up for grabs for the Peripheries, at a very low rate of interest. The Peripheries could therefore finance employment schemes and public investment projects with money from the Core, hoping that the resulting increase in income would get the economy back on track and possibly even getting some capital-and-income convergence with the Core.

In the meanwhile, the Surplus countries would be induced to spend more at the given exchange rate of the euro since the rate of interest of the surplus, ending up being a overdraft facility at the CU, is very low. The increased spending of surpluses would, if spent outside the euro zone, send the exchange rate down, assisting the deficit countries to export their way out of recession. If the spending is euro-zone-internal the increased income of the peripheries, as the surplus is recycled into imports from there into the core, would kick them out of recession.

Note that this system basically fights against huge disbalances in the current account between countries. Today's problem arise from the fact that even though the current account of the euro zone as a whole may be in balance to the rest of the world, there are huge imbalances between countries within the euro zone. This CU system would wipe those imbalances out or at least mitigate their negative effects as the deficits can be financed at low rate of interest.

The beauty of this CU system is that there doesn't seem to be any need to breakup the euro. Obviously, the creditor countries (the Core) are being asked to spend their own money to clear up the internal imbalances. If they don't want to do that, the debtor countries (the Peripheries) get the savings at a very low rate and can do what they want with it. No need for fiscal union.

I don't expect this idea to reach the ears of ruling politicians however, they are already "slaves to some defunct economist" who thinks the way out of the current problems is to apply more and more austerity. One can only hope they realise that it's like trying to put out fire with a dash of petrol.

Guest Post: Is Iceland OK now?

Copy-pasted note from Gunnar Tomasson, ex IMF Senior Staff Member, he published on Gang8 website, answering Michael Hudson's question whether "Iceland was OK".

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RE: [gang8] Krugman's mistaken belief that devaluation saves anything, even over-indebtedness

No, Iceland is not OK now.

I’m just back in the US after three weeks in Iceland where I had an opportunity to talk to old friends from all parts of the political spectrum.

There is a strong feeling that the long-established political order has outlived its usefulness - if that is a term which can be used to describe its record.

Is Iceland really OK?

I was on the State TV program Silfur Egils on Sunday April 22.

In a 15-20 minute interview, I addressed among other things the insurmountable – on present policies – problems faced by Iceland in the monetary/balance of payments field.

Briefly, Iceland’s current foreign exchange reserves are of the order of ISK 1000 billion (US$ 1 = ISK 125).

Did I say reserves?

Yes, but they are borrowed reserves – not reserves that Iceland has accumulated from past surpluses on its balance of payments.

Iceland’s GDP is currently of the order of ca. ISK 1800 billion (my guesstimate – may be off by ISK 50 billion or so in either direction).

In October 2008 Iceland responded to the collapse of its banking system – and much else – by introducing pretty harsh foreign exchange controls.

For example, foreign owners of pre-crash Glacier Bonds were estimated to be holding ISK 400 billion which were essentially “locked in”.

Just recently, it dawned on the authorities – and, apparently, the IMF – that they had forgotten to factor in another factor.

The Icelandic currency claims of the creditors of the old banks, whose assets are being liquidated for eventual distribution to creditors.

So, to the ISK 400 billion, add another ISK 700 billion – and Iceland’s borrowed foreign exchange reserves become even less impressive than before.

That’s one part of the monetary/foreign exchange problem.

The other part resides in the globs of ISK monetary and other liquid assets left over from the “good years” prior to October 2008.

If the foreign exchange controls were lifted tomorrow, Iceland’s borrowed foreign exchange reserves would vanish in the blink of an eye.

In other words, from a macro-economic point of view, the REAL worth of foreign and domestic ISK balances waiting to exit through the foreign exchange market is a fraction of their pseudo-worth at the current ISK exchange rate.

What to do?

In Silfur Egils I made a twofold suggestion – a summary version is as follows:

1. Let the Glacier bond etc. money exit at a STEEP premium over the current exchange rate of the ISK.

2. Call in outstanding ISK balances and exchange them for New ISK at differential rates – say, one to one for household balances and something much less favorable for larger balances.

The problem at hand is clear as daylight – the chances of anything being done about it along the above lines are zilch, given the current political power structure.

What to do?

Change the current political power structure!

A general election must be held no later than a year from now and there is turmoil in the Old Guard and hopeful urgency in its would-be replacement which cuts across conventional political party lines.

I had an opportunity to meet one-on-one with leaders of two of the latter parties for lengthy and fruitful discussions.

I am hopeful that they will be able to join forces, attract a large number of voters – and

Throw out the rascals come next year!

Gunnar

Did Icelandic households receive a major debt forgiveness?

"tkn" asked me in a comment to How to create a housing bubble? whether it was true that the Icelandic households had had their debt forgiven in any major amount. This is, unfortunately, not true. The short answer is that Icelandic households had 196.3 billion ISK (about 1.0 billion pounds) "forgiven" of their debts. That's about 12% of GDP.

But that's not really it. According to the "Icelandic Broadcasting Company" (IBC instead of BBC) the write-offs consisted of:

• 43.6 billion ISK due to the 110% act: if your mortgage was worth more than 110% of the market value of your property you could apply for, but not necessarily get, debt forgiveness to the point where the rest of your debt would be 110% of the market value. This, along with the next point, was organised and, of course, hailed by the government as a "significant" act to lessen the debt burden of households.
• "Abstract debt relief" provided for 6.2 billion ISK of the total 196.3 billion. This part was for individuals and couples that were in "serious" debt difficulties.

Those two points above were public initiatives. The next two were incidental!

• According to Act no. 38/2001, linking the principal of debt to the exchange rate was illegal. This was nevertheless done. Nearly every single "foreign currency loan" (they weren't really loans in foreign currencies, they were merely loans in Icelandic krona where the principal fluctuated with the exchange rate of the krona) to households was illegal. When it was finally ruled, by the Supreme Court, that this was illegal, the banks had to recalculate the nominal value of the "foreign currency loans". The Central Bank provided the rules how to but those rules were disputable to say the least since they were retroactive! Roughly 108 billion ISK of mortgage debt was "written off" due to this but using that phrase is deceiving since the loans were illegal in the first place. In fact, two months ago a ruling was passed by the Supreme Court that touched on those loans and the result of the ruling was negative for the banks. But the banks, two months later, have not amended their debt collection methods accordingly. And people are getting frustrated. 
• The recalculation of illegal exchange-rate-linked car loans, similar to the illegal mortgages, caused households debt to be lowered by 38.5 billion ISK.

Total: 196.3 billion ISK.

So this is the debt relief that Icelandic households received. However, due to the peculiar way of indexing the nominal value of mortgages to the Consumer Price Index, the inflation in Iceland has caused the principal of those indexed loans to grow. How much exactly, I do not know, but back-of-the-envelope calculations yield roughly 360 billion ISK since September 2008.

But it's maybe unfair of me to set this figure right next to the write-offs of 196 billion that the households got, incidentally or not. After all, this 360 billion figure is just a representative of how mad the mortgage system is in Iceland.

So I am afraid I must shatter the hopes of anti-debt activists and their ideas of Iceland. Unfortunately, the debt of Icelandic households is still around and it probably amounts to roughly as much, as a share of GDP, as it did before the collapse of October 2008.

How To Create a Housing Market Bubble

You allow the banks to lend out as much as they want. Graphically, that would be something like this:

New loans to households in millions of krona (we use . instead of , to represent ,000s). In August 2004 the banks entered the mortgage market with at-that-time revolutionary type of mortgages: 25 or 40 years and 4.2% real interest rates (the principal was indexed to the CPI) which later were lowered to 4.15% due to fierce competition in getting people to borrow money. The result was a housing boom of extraordinary heights (see next graph) which is being corrected through inflation, although the recent spur of mortgage growth is halting that much needed correction. Many thanks to Thorvardur Olafsson and Karen Vignisdottir at the Central Bank of Iceland for the data.

What do the colours mean? Blue: mortgages in ISK, red: mortgages indexed to the value of foreign currencies (loans in ISK where the principal fluctuates with the value of ISK in foreign currencies), green: car loans in ISK, yellow: car loans in ISK but indexed to the value of foreign currencies. The indexation to foreign currencies was later (2011) ruled out to be illegal according to law from 2001 (a long story but rather representative of the scandalous workings of the Icelandic financial system).

Here is the house prices saga in Iceland:

House prices in Iceland according to Thjodskra

And people seriously say that we had a financial crisis because of the collapse of Lehman and other problems in international markets?! Please, this was a home-made problem, and we still haven't solved it!