Stefan Karlsson
The euro sign is seen on the side of the building of EU headquarters in Brussels in this February 2012 photo. Karlsson argues that strengthening certain EU countries doesn't necessarily have to mean weakening others. (Virginia Mayo/AP/File)
Europe can strengthen Greece without weakening Germany
For years, we have heard Paul Krugman and others assert that Greece etc. can't reduce their current account deficit unless Germany etc. reduces its surpluses. While that would have been true if the world had consisted only of the euro area nations, it is clearly not true in the world we actually live in. Krugman himself lives in a country with an economy bigger than that of the euro area and Japan and China have together a bigger economy than the euro area plus there are nearly 180 more countries including for example Brazil, Saudi Arabia, Turkey, India, Russia, Canada, Australia, Britain, Switzerland, Norway and Sweden, outside of the euro area.
With so many and in some cases so big economies outside of the euro area, and with the euro area trading so much with them it is clearly possible for the aggregate euro area to strengthen its balance, or in other words it is possible for Greece etc. to reduce their deficits without a reduction of the surpluses of Germany etc.. something that is in fact happening as during the last 4 months alone the euro area current account balance has swinged from a €17 billion deficit to a €10 billion surplus.
This shift reflects in part the effects of the euro area austerity measures, and in part it reflects the euro's weak exchange rate. Krugman now seems to implicitly acknowledge that he was wrong when he asserted that the euro area's aggregate balance can't change, because now he argues that it would be wrong if it happened.
Why would it be wrong? Because the three biggest economies outside the euro area, the United States, China and Japan aren't sufficiently strong (he could have also mentioned the fourth biggest economy outside of the euro area, Britain, which is weaker than all three of those countries). But German growth is no higher than growth in these countries, and the second big euro area surplus country, Holland, has fallen into a recession. If it is wrong to increase the U.S. deficit and reduce the Japanese and Chinese surpluses, then it should also be wrong to reduce the German and Dutch surpluses.
Finally, it should again be emphasized that regardless of how much Krugman disapproves of it, it is happening, in part due to the fact that the euro has fallen in value against the U.S. dollar and the U.K. pound. The irrational (but self-fulfilling) investor belief in American and British government bonds as "safe havens" haven't just produced the low yields that Krugman likes to talk about so much, it has also pushed up the exchange rate of the dollar and the pound, something that has contributed to the euro area's swing from an aggregate deficit to an aggregate surplus, while increasing the U.S. and U.K. deficits.
Supporters of the Greek Communist Party wave the party's flags during a rally in Athens in this May 2012 file photo. Far left political parties in Greece are losing ground amid warnings that a Greek default could mean being kicked out of the EU. But Karlsson argues that a default may not mean going back to the drachma. (John Kolesidis/Reuters/File)
Will Greek default really mean leaving the EU?
Recent opinion polls suggests that many Greeks are listening to the warnings of German leaders that if Greece cancels its austerity measures, Germany and others will stop funding the Greek budget deficit, as the parties that want to keep Greece's commitments are gaining at the expense of the far left wing parties that wants to increase government spending.
But what if the far left end up winning after all and Greece defaults? Would that necessarily mean that Greece would be forced to re-introduce the drachma? Actually, contrary what is commonly assumed that is not necessarily the case. After all, households default around the world all the time yet except in cases of death or emigration they continue to use the same currency as before, so there is no necessay connection between default and exiting a currency. And as polls show that nearly 80% of Greeks want to keep the euro and so does the leading far left party, Syriza, even a far left governments that defaults will try to avoid exiting the euro.
However, if a far left government wants to increase, or simply avoid decreasing, government spending it will have to exit the euro and re-introduce the drachma. Because if Greece tells Germany that not only will it not honor the already dramatically reduced debt commitments, it wants to "borrow" (of course, if you keep "borrowing" while declaring previous debt null and void, you're really not getting loans, you're getting gifts) more so that it can spend more, then there is no way that Germany will agree to that-and rightly so. And since no private creditor will agree to it either, this means that Greece would be forced to immediately achieve primary budget balance, forcing it not only to cancel Syriza's promised spending increases but to cut spending in a disorderly fashion.
The only way this can be avoided, apart from implausible increases in government revenue, is if Greece re-introduces the drachma and starts to finance its budget deficit directly through the printing presses. So while default per se doesn't necessarily imply euro exit, deficit spending requires a euro exit. Meaning that Syriza's pledge to both increase government spending and keep the euro can't be achieved and that if they win they'll have to choose which of these promises they will break.
Sweden's Prime Minister Fredrik Reinfeldt (R) shakes hands with European Council President Herman Van Rompuy at the Rosenbad government building in Stockholm in this May 4 file photo. Karlsson argues that Sweden has been successful in reducing government spending over the past six years. (Anders Wiklund/Scanpix Sweden/Reuters/File)
Sweden: a spending reduction success story
Paul Krugman criticizes Senator Tom Coburn for using Sweden as a good example of a country that has reduced government spending and claims that this is false using a chart showing the change in real government purchases.
But this is misleading because first of all it doesn't put spending in relation to GDP and secondly and even more importantly because it excludes transfer payments such as unemployment and sick leave benefits. The Swedish centre-right government has in fact concentrated their spending cuts to transfer payments so any analysis using only government purchases is bound to be very misleading
If we instead look at total government spending as a percentage of GDP (called "government disbursements in the OECD database) you can see that since 2006, when the current Swedish government was elected, government spending relative to GDP fell from 52.9% in 2006 to 51.8% in 2011. By contrast, during the same period, the OECD average rose from 39.7% to 44%, and in the United States it rose from 36.1% to 41.9%.
In this May 2012 file photo, trader Peter Mancuso, right, works on the floor of the New York Stock Exchange. If tax law isn't changed, next year will see a big increase in dividends taxes, which experts say will lower US stock prices. (Richard Drew/AP/File)
Will a dividend tax hike lower stock values?
Don Luskin points to how in January next years if current law isn't changed, then there will be a big increase in the taxation of dividends in the U.S., something that will send stock prices lower. Luskin believes that stocks could fall by more than a third because the top rate will increase from 15% to 43.4% anad as 56.6% is less than two thirds of 85%.
Luskin is right when he argues that this tax increase, if it isn't repealed before it is implemented, will lower stock prices. However, the effect will be a lot smaller than Luskin thinks for two reasons.
First, because some stock owners will see their after tax return reduced less ( if their total income is less than $200,000 per year) or not at all (if they're foreigners).
And secondly because the value of stocks isn't primarily based on dividends during the coming year, or even the coming few years, but on the present value of all dividends in all eternity, or at least for as long as the company will exist. If investors hope that the dividend tax will be reduced again in the future then the forecasted loss of value will be lower.
Pedestrians pass a plaque portraying a Greek one-drachma coin, which was replaced by the euro in 2002, outside Athens City Hall, on Monday, May 14, 2012. Some argue that cash strapped European countries like Greece should get rid of the euro and go back to a devalued national currency. (Petros Giannakouris/AP)
Should Greece ditch the euro?
Aside from Argentina, that I've discussed here, the most popular empirical example used to argue that Greece and other weak euro area countries would benefit from ditching the euro and introduce devalued national currencies, is the experience of the 1930.
Though there are differences between the euro and the gold standard, they are similar in the sense that both means fixed exchange rates and the inability to devalue/depreciate the currency.
And the empirical record of the 1930s is pretty clear. The faster countries got off the gold standard the faster they recovered. Britain and Sweden that devalued first recovered first, the United States devalued somewhat later and recovered somewhat later, while France and Belgium that held on to the gold standard the longest recovered latest of all countries.
This strong correlation was in fact mostly causal. The reason was that bank panics had caused wide scale collapses of fractional reserve banks creating in turn what Hayek called secondary deflation in very high doses, often as high as 10% per year, something that given the inability of nominal interest rates to go below zero meant that real interest rates was as high as 10%-far above the natural interest rate, causing not only malinvestments but also fundamentally sound investments to be liquidated. And when other countries devalued this helped aggravate this secondary deflation.
When those unnaturally high real interest rates were dramatically lowered after the gold standard was abandoned, this caused the economies to recover.
However, in the euro area today we see no secondary deflation. Price inflation is well above 2.5% in the euro area, and even in Greece it is still 1.5%. That is why we can't expect a similar development if Greece or others re-introduce their currencies. Eventually at some point during the coming years they will almost certainly see some form of recovery, but that will happen regardless whether they stay in the euro are or not.
The baltic countries have seen their economies recover strongly ( Estonia's GDP have increased a cumulative 13.9%, Latvia's by 10.5% during the last two years), albeit from a very depressed level, despite not devaluing while Britain and Iceland failed to see any recovery following the dramatic drop in the value of their currencies in 2008, illustrating that devaluations only work if it is made in the context of secondary deflation.
French president-elect Francois Hollande waves to crowds gathered to celebrate his election victory in Bastille Square in Paris, France, Sunday, May 6, 2012. France handed the presidency Sunday to leftist Hollande, a champion of government stimulus programs who says the state should protect the downtrodden - a victory that could deal a death blow to the drive for austerity that has been the hallmark of Europe in recent years. (Francois Mori/AP)
France and Greece elections: Threat to Eurozone recovery?
Both the French presidential and the Greek parliamentary elections yesterday were pretty bad. The Greek election meant a choice between on the one hand incompetent and corrupt incumbents that have wrecked the country and on the other hand extreme left wing parties and an outright neo-Nazi party who promises that Greece as a nation will continue to be able to live at the expense of other nations.
The French election meant pretty much the same choice, except that Sarkozy wasn't as bad as the Greek incumbents and Hollande isn't as bad as the Greek opposition of left-wing extremists and neo-Nazis. In both cases, a majority of voters decided to throw out the incompetent incumbents and instead go for the even crazier opposition. In a way that is understandable. As one commenter put it, it was basically insolent for Greece's two leading (until this election) parties, New Democracy and Pasok, to ask voters to give them power again after the problems they've caused. And though France has performed much better than Greece in recent years, the French economy has still been quite weak.
But just because the incumbents are incompetent fools who have wrecked the countries, doesn't mean that the opposition is better, as the people of Germany (and the rest of the world) experienced after they voted out the incompetent and corrupt Weimar German establishment and voted in the National Socialist German Worker's Party (the NSDAP in its German abbreviation) into power in 1932.
And while particularly the French but to a lesser extent the Greek opposition are nowhere near as bad as the German opposition in 1932, the fact remains that they represents even crazier policies than the incompetent incumbents, as they cling to the illusion that it will continue to be possible for everyone to use the state to live at the expense of others, as France's greatest economist of all time would have put it.
This means that unless the electoral winners break the promises they made to the voters, the European economic crisis is about to become a lot worse because of yesterday's election results.
In this April file photo, Republican presidential candidate Rep. Ron Paul, R-Texas, gestures while speaking at the University of California at Berkeley, Calif. Paul recently debated economist Paul Krugman on economics on Bloomberg TV (Ben Margot/AP/File)
The battle of the Pauls: Ron Paul talks economic theory
Most names, including "Stefan" and "Karlsson", are either exclusively first names or last names, but there are also names that could be either. One example of that is "Paul", as is illustrated by the names "Ron Paul" and "Paul Krugman". The two faced off in a debate that one can call "Paul vs. Paul" or "the battle of the Pauls".
Ron Paul managed to hit Krugman good with several of his arguments, including pointing out that late 19th century cyclical slumps are an indictment of the absence of central banks then the inflationist policies of later Roman emperor's that led to the Empire's collapse is an indictment of inflationary policies, an argument that Krugman clearly didn't anticipate, as he simply responded that he didn't endorse Emperor Diocletian's policies.
Krugman also falsely claimed that there was no coercion in the use of currency, being either ignorant of deliberately dishonest about the existence of "legal tender laws".
Ron Paul was however embarrased when he endorsed Milton Friedman, whose view of the depression is that it "should be blamed on the government" because the central bank wasn't activist enough, and also he falsely claimed that "debts were liquidated" after World War II. Perhaps the latter is meant to refer to some debts to Germany, but there was no liquidation, at least not in nominal terms, of the debts of Americans. Krugman however failed to point out Ron's inaccuracy on the latter point.
What is really clear is that Krugman himself believed he lost the debate, since he wrote a blog post arguing that such debates aren't the best way to settle such issues since one can't directly settle disputes over data. That's actually a largely valid point, such face-offs aren't the best way to settle theoretical disputes, but again illustrates that even though Krugman doesn't believe that his arguments were disproven, he does believe that Ron Paul did better in this particular debate.
Thousands demonstrate against education and health care spending cuts in Madrid, Sunday, April 29, 2012. Tens of thousands of people across Spain are protesting education and health care spending cuts as the country slides into its second recession in three years. (Daniel Ochoa de Olza/AP)
Double-dip recessions in Spain and UK. Which is worse?
As expected, Spain reported that it like Britain had slipped into a double dip recession.
There is one striking difference between the British and Spanish recession. Whereas Britain has had a drop in real wages by nearly 2.5% but has had stable employment, Spain has had stable real wages but a drop in employment by nearly 4%.
Note that in both cases, real aggregate labor earnings, which is a function of employment and average real weekly/monthly earnings, have declined more than GDP. In Britain GDP was unchanged compared to a year earlier while real aggregate labor earnings fell by nearly 2.5% while in Spain GDP fell by 0.4% while real aggregate labor earnings. There are 3 possible explanations for this:
1) GDP weakness is underestimated.
2) Labor market weakness is overestimated.
3) Corporate profits and other non-labor income is booming
There is no information available about 3) for the first quarter, but during Q4 2011 corporate profits was indeed rising in Spain so it is likely a partial explanation there, but in Britain profits actually fell meaning that this factor just makes the discrepancy even larger.
Particularly in Britain but also in Spain one factor is that the GDP deflator rose a lot less than the harmonized consumer price indexes. If you believe the GDP deflator is more accurate then that leads us to 2), but if you believe the CPI is more accurate then that leads us to 1). I personally more in the latter explanation for both.
In Britain it is also a factor that nominal labor earnings rose during Q4 2011 more than the labor statistics have reported, which is puzzling since in most countries data over labor earnings in the national accounts are based on the labor market reports. It would be interesting to know just what other data source the producers of the national accounts use.
A London taxi makes its way down the Mall, decked out in Union flags and with Buckingham Palace in the background in this file photo. Preliminary GDP numbers from the UK show it has entered a double-dip recession. (Andrew Winning/Reuters/File)
UK enters a double-dip recession
Just as I expected, today's preliminary GDP number from Britain showed that it has entered a double dip recession as GDP has fallen two quarters in a row. Compared to a year earlier, real GDP was unchanged and compared to 4 years earlier, it is down by 4.3% If you take population growth into account, the numbers are even weaker.
Some have questioned the accuracy of the data, claiming that employment data and various "surveys" give a brighter picture. Starting with the employment data, it is true that they show an increase in the number of employed, but they also show a big drop in real wages, with average weekly earnings increasing only 1.1% from a year earlier, which given the 3.5% inflation rate implies a drop of 2.4% in real terms. Aggregate real labor income is thus in fact falling even more than GDP, so these data do not paint a brighter picture of the U.K. economy.
As for the surveys, it is true that they generally give a stronger picture, but since they are only just surveys of a small number of people, one should view them with even greater suspicion than other data.
One form of really hard data that is almost certain (assuming the government don't deliberately distort like they did in Greece), tax revenue, confirms that there is a recession, as tax revenues only rose in nominal terms by 1.3%, a real decline of more than 2% despite the fact that the first quarter was 1 day (February 29) longer this year compared to last year.
It is possible that to a small extent this weakness was the result of falling inequality (in a progressive tax system, tax revenues increase/decrease more than GDP if inequality increases/decreases), but since all revenue sources increased less than inflation for the quarter as a whole, that is only a minor factor.
A Chinese boy waves a national flag at a park in Beijing, China earlier this month. Some economists think that China's slowing birth rate will seriously hamper its economic growth in the coming years, but Karlsson argues that won't happen for at least 50 or 60 years. (Vincent Thain/AP/File)
China's birth rate slows. Its economy won't.
The Economist has an article which argues that China deep future problems in its economy and society because of its low birth rate. That may perhaps indeed become true by 2050 or 2060 or so, but in the coming two or three decades, shortage of workers will certainly not prevent it from becoming the world's biggest economy.
First of all, I'm not sure whether The Economist has the fertility rates right. I can't find any official numbers from China, but in the United States it is more like 1.93 (in the link it is stated as 64.4 per 1000 woman in ages 15 to 44, so to get 1.93 you multiply 64.4 by 30 and then divide it by 1000) children per woman in reproductive age according to the latest official statistics, than the 2.08 The Economist claims it is.
More importantly, the absolute number of births was still 16.04 million in China, slightly more than four times the 3.98 million in the United States. This means that the number of native born 25-year olds in China will be slightly more than 4 times more compared to the United States in 2036. The difference in the total number of 20-year olds in 2031will probably be somewhat smaller because the U.S. is likely to have some net immigration while China probably won't , but China will still have a nearly 4 times bigger working age population as late as 2036.
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