Scott Sumner writes:
Stocks crashed 4% today because people are increasingly worried about the macroeconomy. Yes, there are real aspects to the Greek crisis. Greece will need to engage in austerity over the next few weeks. But Greece, Portugal, and Spain are not big enough countries to knock 25% off the price of oil in one month. Oil prices are plunging for the same reason as US equity prices are plummeting–fear of a sharp fall in AD (and hence economic activity) all over the world.
I don't yet follow Scott's reasoning. If anything, in very recent times the ECB has shown it is willing to abandon independence to monetize various national debts. How much that will boost nominal GDP I am not sure, but I don't take it as negative news for nominal GDP, relative to previous expectations.
I am usually reluctant to play "market psychologist," but I see potentially insolvent banks as a major issue, plus their connection to money market funds. That has an AD link to be sure, but the uncertainty of another major bailout, and its fallout for intermediation, would be paralyzing to financial markets. Most of all, the fear is that "Europe-as-we-knew-it" was a bubble of sorts, and that other people's digestion and comprehension of that possibility will create adjustment problems around the world, including China.
I'm not convinced that the "end of the tunnel" for Europe on this one has to be so dire. (Imagine the 1987 world, with Greece not on the Euro, and extrapolate it, with Greece in default a lot of the time but with most of Europe simply being Europe; is it so bad?) It's the uncertainty about the transition path and what that path means for broader notions of European cooperation. It's like imagining a man committed to driving from here to there, yet with no paved road in between or maybe also no unpaved road. Yet Europe is committed to the journey.
When you have a hammer…
Everything looks like a nail.
The problem that we (and the world) are facing is that the first cut at
guaranteeing retirement, health care, financial security, housing and
employment created far more promises than can be delivered.
Similarly governments, at all levels, have outspent and outpromised the
ability of the tax-producing sector to create. Their budgets, including
pension and retiree health care costs, can’t be funded.
The tide of baby boomer retirees (both here and abroad) are beginning.
The Fed and the ECB can pour out as much paper as you and they want. Social
Security and the income tax are indexed. Health care costs will float up
along with the paper tide. The U.S. debt has such a short maturity that it
can’t be inflated away. A tide of government paper is going to decrease
certainty with the result that there won’t be significant job and investment
growth.
3. Another problem. Cowen doesn’t think he is smarter than markets, so he is surprised that stockmarket crash can signify diminished nominal GDP expectations. Cowen has received only one piece of news (ECB’s stimulus), stockmarkets have received two pieces of information – one small positive (ECB is stimulating), one big negative (everybody knows that financial system might be insolvent).
Sorry Tyler, leaving aside your nonsense macroeconomics ( an extension of SS’s nonsense macro), I cannot ignore your last sentence “Yet Europe is committed to the journey”. It belongs to the “you must be joking” category. You don’t need to visit all European countries, just visit Spain’s Comunidades Autónomas to understand how different their commitments and their journeys are, regardless of the values they may share with many other people in Europe, America, Asia and even Africa. I hope your Hayekian colleagues can explain you that even small societies have hard times to undertake “journeys” –a word that makes sense at best when discussing a couple’s plans. And I hope your Public Choice colleagues can explain you that even small societies have hard times to commit to anyting –a word that makes sense at best when discussing the decisions of an individual or a well defined group of people, that is, a committee.
Ah, don’t you think that the market is reacting to the anticipated reduction in European aggregate demand caused by the German’s call to “balance the budget”, coupled with the likelihood of a liquidity trap?
The little Hooveress of Europe might win the Andrew Mellon award.
Tyler: Weren’t you the one pointing out a couple of weeks back that the ECB was promising to sterilize the impact of the debt purchases? (http://www.marginalrevolution.com/marginalrevolution/2010/05/not-scott-sumner.html)
John Bailey: deficit gloom is not consistent with long-term interest rates at historic lows.
“The Money Demand Blog”: I think Scott’s view is more nuanced than you imply. In particular, I think he would agree that the linkage between financial system insolvency and AD crashing can run both ways. He just happens to favor broad monetary accomodation over targeted financial system bailouts or a Hooverish “let them fail”.
When one begins to consider the precariousness of the European situation as one centered in the need to understand the impact of change on broader European cooperation, it is important to keep in mind that there is great historical tragedy in the “paths” to European cooperation. The Eurozone is in part a creation of that specific historical memory of tragedy rooted in the economic conflict of the early 20th century. To limit the critique of the direness of the situation to a world as it existed in 1987 is far too limited of a historical memory to accurately reflect the sorts of momentum that are behind the fragility of markets in Europe. It seems that to limit these considerations to cold economics and even psychological economics does not do justice to the larger precariousness present in these financial and fiscal concerns.
Sumner is right, but I’m glad noone believes him.
The creators of the euro have (unadvertently I guess) outsmarted everyone. Yes, some sovereigns in the southern part of the eurozone would be running up more debt, as they could borrow at near-German rates. And yes, that may mean occasional bail-outs of these countries by surplus countries.
Thing is, the exchange rate of an imaginary Deutsche Mark or Guilder in these times would have skyrocketed, boosted by investors looking for safe havens. That would have destroyed German and Dutch industries relying on exports – they together account for 13% of global surplus, more than half of China’s.
Yet, thanks to this partly manufactured euro ‘crisis’ (created not in small part by American banks hoping to short eurocountries after helping them cheat the stability pact, as well as the usual europhobic smallminds in Britain, particularly the media) these countries are now much more competitive than they could have dreamed to be, while still being able to borrow at low rates. Great deal, so far.
Of course, Asians are getting worried now. The US deficit will continue to be unsustainable. The eurozone will now export itself to economic health, even if they have to bailout some rather insignificant partners.
Decoupling from the US will continue as consumption in emerging markets is on the rise, and confidence in US assets has taken a big, so far largely unaccounted for hit from the subprime debacle. Even more, the euro will finally settle in as reserve currency alternative, if only because Chinese monetary authorities among others will have to protect themselves from a depreciating euro by buying more euros.
Still, the prejudice, arrogance and sheer depravity of the anglosaxon campaign against the euro will leave no sympathy for them on the continent when the shit hits the fan. Which it will, quite soon.
I like what Bild said: We (Germans) are the schmucks of Europe!
…by fundamentals.” Now oil is around $70/barrel.
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