The war of politics and finance

by on November 26, 2010 at 7:42 am in Current Affairs, Economics, Political Science | Permalink

There is talk of upping the euro bailout fund:

European Central Bank council member Axel Weber said governments can increase the size of the European Union-led bailout fund if necessary to restore confidence in the euro.

“Seven hundred and fifty billion should be enough to assure the markets,” Weber said at the German embassy in Paris late yesterday. “If not, it will have to be increased.”

The Spanish approach the same issues with another tone:

Spain has warned financial traders betting against its debt that they will lose money, in a defiant challenge to the markets which are driving Madrid’s cost of borrowing sharply higher.

José Luis Rodríguez Zapatero, Spanish prime minister, on Friday ruled out any rescue package for the country even as the premiums demanded by investors to hold Spanish sovereign debt over that of Germany’s rose to euro-era highs.

You can find more detail at ElPais.com; most significantly it is a much bigger headline in the FT than in the Spanish paper. 

In a nutshell, we’re watching the most pitched, highest-stakes, most determined battle between politics and finance which has been staged. I am expecting finance to win. It’s not just about PIGS and the future of the eurozone, it’s settling a very general question about the relative power of politics and finance.  Either way, it is an event of momentous importance.

1 Bill November 26, 2010 at 4:29 am

You are absolutely right. A battle between finance and politics.

And, when finance wins, the public pays for it through austerity to protect bondholders and shareholders.

The drive for European "austerity" last spring was to set the stage for public coffers to have enough money in them so that the banking industry could dip in the well at a later time. Notice that "austerity" has now been for someone else's benefit.

2 endorendil November 26, 2010 at 4:48 am

A battle between politics and finance? GG, get real. There would be no financial system left if the governments of the world hadn't intervened (mistakes and all). If the politicians cock up in the end, we'll return to the banks falling like so many dominoes. If that is a victory for finance, I'm hard-pressed to define what a defeat would look like.

3 Andrew Lale November 26, 2010 at 9:09 am

'We need to go to war with the parasitic, predatory banking interests that are robbing ordinary folks blind.' Up the Republic, comrade!

'And, when finance wins, the public pays for it through austerity to protect bondholders and shareholders. '

Er, who forced the governments to issue bonds and take money from banks in the first place? The tooth fairy? 'protecting bondholders and shareholders' is protecting the system which allows wealth to be grown.

I take it that the way Bill and Paco see it as this: all wealth created is at the mercy of governments to take either through taxation or through fraudulent 'bond' offerings, which they will renege on when times are inconvenient. And as long as that wealth is used to make sure Greek public servants can retire at 34, then bully!

4 Carles November 26, 2010 at 9:39 am

Politics vs Finance? Are you kidding? This is Politics&Finance vs People

5 Passing By November 26, 2010 at 10:48 am

"In a nutshell, we're watching the most pitched, highest-stakes, most determined battle between politics and finance which has been staged. I am expecting finance to win."

Are you counting the ECB as "politics" or "finance"? It's ultimately accountable to the political leaders of the Euro-zone countries, so I'd say "politics". And the ECB can print as many euros as needed to win the supposed "battle" against finance. No contest.

The real "battle" is between politicians opposed to doing just that (Mrs. Merkel and her constituency) and those more willing (most of the rest of Europe). If things get bad enough, I'm betting on the latter.

6 Ken Pierce November 26, 2010 at 12:08 pm

I think some people are misunderstanding what is meant here by "Finance." The war between politics and finance isn't a war between politicians and bankers, and certainly not a war between politicians and the sorts of bankers who make terribly stupid loans at the instigation of a central bank and then try to get politicians to bail them out at taxpayer expense. It's a war between (a) in this corner, the politicians and their banking cronies, against (b) in that corner, the independent investors in the rest of the world — including the little guys whom nobody ordinarily considers a "financier" but who still try to figure out what to do to protect the value of their savings when they realize that the politicians and crony bankers are about to use the central bank and printing press to steal the value of said savings. For example, in the following quote from a Frankfurt University professor, who are the people fighting on the "finance" side?

This is frightening people. You cannot find a bank safe deposit box in Germany because every single one has already been taken and stuffed with gold and silver. It is like an underground Switzerland within our borders. People have terrible memories of 1948 and 1923 when they lost their savings.

That's right, the ordinary citizens of Germany, who are fleeing the Euro, are the "financiers" here, and the Irish banks desperately seeking an IMF bailout are the "politicians."

Thus I think the post would have been better had Mr. Cowen used ronnieb's phrasing of politics vs. economics rather than the politics vs. finance phrasing of the title.

Passing By, on the other hand, misses the point disastrously. "And the ECB can print as many euros as needed to win the supposed 'battle' against finance." Of course the ECB (which most definitely is on the side of politics rather than economics) can print all the Euros it wants. What it can't do, is force people to want them. The more Euros it prints, the less a Euro will be worth. There is a critical inflection point that all dying fiat currencies pass, in which every Euro (or whatever) that is printed causes a loss of value to the purchasing power of the Euro stock that is greater than one Euro — and at that point, the ECB cannot print "as many euros as needed," because an infinite number of euros are needed. I presume the ECB could print Confederate dollars as well, since there is no Confederacy around to indict them for counterfeiting; but it could never print "as many Confederate dollars as needed" because Confederate dollars are, you know, worthless, and fifty quadrillion units of a worthless currency are…um…worthless. The point of the current Euro crisis is precisely that Europe is in danger of seeing the sort of flight from the Euro that makes the Euro essentially worthless.

Don't believe me? Ask the ghost of Friedrich Ebert whether it's possible to just print "as many marks as needed" and see what his answer is.

7 pension transfers November 27, 2010 at 4:27 am

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8 J Thomas November 27, 2010 at 7:48 am

Every debt is owed to somebody. Sometimes it's circular. I owe you money, you owe me money, it cancels out. Sometimes it is unitary. I owe myself a whole lot of money. Sometimes there is a source and a sink.

Rich people own more of everything than they used to. More and more. Poorer people have debts. And the government has increasing debts, which it can continue to pay interest on, or somehow pay off.

Obviously we don't want to tax the rich. They earned their money the hard way, by doing things like lending money to the government and collecting interest, and by owning banks. But the government owes a whole lot of money to rich people, and to their banks. What can possibly be done? Obviously the only solution is to stop spending government money unless it mostly benefits the rich, and tax everybody but the rich heavily so the government can pay back some of what it owes.

Some of the banks are in trouble. They owe too much money to other banks. We could let those banks fail, and their creditors will own their assets, and the wealth will be even more concentrated. Or we can bail them out, and protect some fraction of the richest people who might be in trouble. Which should the government do? Does it particularly matter to me? Well, the bailout results in even more government debt to pay interest on. Do I care about the rich people who'd lose if their banks go bust? I don't know. Maybe they're my secret friends who do good things for me without my knowledge. How would I even find out? Or maybe the winners are foreigners. They could be saudis or chinese bankers or the russian mafia or whoever. I'd rather bail out rich americans than see their money go to foreigners who don't even like the USA.

If the government puts more money into circulation then the money that already circulates is less valuable. Existing government bonds are worth less and are easier to pay off. Of course, new bonds will pay more. Or will they? Supply and demand, if there aren't many new debtors who want to borrow money so they can invest in the recession, the rates won't rise. Pay off the loans cheaper. Rich people will be upset. Dammit, it's their government and it's their money, and if the government tries to tax them or inflate their money or otherwise take away part of their property — the USA which they own lock stock and barrel — why should they put up with it?

It's like when I play a monopoly game and I win. People say "Let's divide up the property and start over with a new game.". Hell no! I won the game fair and square. I'm the winner, I own everything. You aren't going to take anything from me and play again, everybody's going to do what I want because we had a free market and I won!"

9 Yancey Ward November 27, 2010 at 10:58 am

An unfortunate choice of phrasing-Politics vs. Finance.

Read Ken Pierce's comment above, if you read no other.

10 Tracy W November 29, 2010 at 7:41 am

J Thomas: Obviously we don't want to tax the rich.

A surprising assertion. How come the rich pay the majority of income tax, then?

Obviously the only solution is to stop spending government money unless it mostly benefits the rich, and tax everybody but the rich heavily so the government can pay back some of what it owes.

Actually, from observation, most of the governments' motivation is to keep paying back enough of what it owes, so they can keep borrowing. Doesn't government default tend to happen when the government's primary budget is in balance, so it doesn't need at that point to keep borrowing?

We could let those banks fail, and their creditors will own their assets, and the wealth will be even more concentrated.

Ah, how does that work? Isn't the reason the banks are in trouble is that they don't have sufficient assets to cover their debts? So if the government doesn't bailout the banks, and they fail, then the creditors to the banks will be out of pockets, and thus will have less wealth than compared to the state with the government bailout.

Supply and demand, if there aren't many new debtors who want to borrow money so they can invest in the recession, the rates won't rise.

Umm, econ 101 tells us that the relationship between interest rates and quantity is theoretically undetermined. How have you therefore come to this conclusion that rates will rise if the demand for money falls? Isn't it also possible that the interest rate could fall? And what are you assuming happens to the lenders? Does their willingness to lend come into matters?

Plus, of course, half of the problem is that the governments want to keep on borrowing money.

Rich people will be upset. Dammit, it's their government and it's their money, and if the government tries to tax them or inflate their money or otherwise take away part of their property — the USA which they own lock stock and barrel — why should they put up with it?

It's not just the rich. A general observation throughout history is that if governments try to tax people or inflate their money, or otherwise take away part of their property, people will alter their behaviour to try to get around this. The higher the tax/inflation/stealing, the more avoidance it generates. Indeed, sometimes governments tax things or lay penalties with that end in mind – eg cigarette taxes to decrease smoking, legal fines to discourage law-breaking. (Sometimes of course these efforts have unintended consequences, eg cigarette smuggling). If all else fails, people can work less.

It's like when I play a monopoly game and I win. … You aren't going to take anything from me and play again, everybody's going to do what I want because we had a free market and I won!

Well a bit like that. The particular bit I'm thinking of is the one where people, in response to you, shrug their shoulders and say "okay, you sit there and enjoy your bits of paper, and we'll go elsewere and do something else". Governments of course, can respond to this by threatening to shoot anyone who doesn't work, but even that gets them limited effort, and they have to give some of their wealth away to the police and/or armed forces.

11 J Thomas November 29, 2010 at 9:38 pm

"Supply and demand, if there aren't many new debtors who want to borrow money so they can invest in the recession, the rates won't rise."

Umm, econ 101 tells us that the relationship between interest rates and quantity is theoretically undetermined. How have you therefore come to this conclusion that rates will rise if the demand for money falls?

As so often happens, you read that backward. When demand for money falls and the Fed increases the supply, isn't it predictable that rates will fall too?

Isn't it also possible that the interest rate could fall? And what are you assuming happens to the lenders? Does their willingness to lend come into matters?

If there are enough of them to compete, some of them will be willing to lend to the few borrowers — unless the few borrowers are not good credit risks either, in which case there are even fewer loans and the increased supply of money is even less important.

"You can't push on a string."

Increasing the money supply at a time when there are few credit-worthy borrowers, is pushing on a string. Decreasing the money supply can be important to moderate a boom, when there are lots of people who want to borrow money including a lot who really shouldn't. But it isn't so useful the other direction.

It's like monetary policy is a good brake. And when you want the car to go faster, it doesn't help to see how hard you can pull upward on the brake. Once you stop pushing down on it, that's about as much as you can do that way.

Plus, of course, half of the problem is that the governments want to keep on borrowing money.

Government wants to *spend* money. So they borrow it. That's fiscal policy. If the economy has a problem that there aren't enough people making money to want to spend much, government spending can help. If the government uses too many scarce resources that other people want and need to buy, then it hurts. Is it half the problem or part of the solution? It depends.

Our current problem is something that neither fiscal nor monetary policy can help with much. We faced it before with Japan, and I think that story is clearer.

Japan had a whole lot of people who wanted to save and invest. So they put the money into the best money-making ventures they could find. They built modern steel-making facilities, far better than anything we had. They built modern shipyards. They built the best electronics, including the best computer chips and particularly memory chips. All this soaked up a lot of capital, and it promised to pay off handsomely. They could sell cheaper than anyone else and still make a fine profit.

We couldn't compete at that. It wasn't just that our labor costs were higher and our workforce less skilled and less diligent. Also, if we tried to compete with them the market would be way oversaturated. There would be price wars and prices would drop to variable cost, and our investment in those expensive modern factories would be sunk costs. It did not make sense for us to compete with them. So they made a lot of money at first, and some other countries did try to compete with them. Then there was a recession. Their exports dropped. Even when they cut prices to variable cost demand was not high. Their expensive investments were useless. Their expensive shipyards were sunk costs. And by the time the recession was over, those investments had depreciated. The factories were no longer the most modern and they were not the cheapest producers. Should they invest heavily again? Their people did not want to. They had been burned before, and now they had an idea to spend some of their money on what they wanted rather than gamble it on production and lose it again. Some of them had debts to recover from.

While the Japanese were flying so high, would it have made sense for us to compete with them? We would have shared their losses when the losses came. On the other hand, when we didn't try to compete we lost market share and we lost jobs etc. Anything we did was wrong. Could the japanese government have persuaded their people to save less? Maybe. But how could they know that was the right thing to do?

Now China is stuck in the same trap. They have a lot of people who have seen hard times and who expect hard times to come again. They want to save for the hard times and not spend. Some of them buy gold and hide it. Some of them save their money, or invest in their stock market. The chinese government does not produce a lot of consumer goods for them to buy anyway. If it did, they probably would not buy all that much.

China has a lot of investment money and must find profitable investments. So they buy or build the newest factories etc. We cannot compete, and it would not make sense for us to compete. Will we compete to see who can lose their shirts the fastest? On the other hand we use 25% of the world's oil for 5% of the world's population, and we must import a lot. We import a lot of consumer goods that we can't compete at making. How will we pay for all that while we wait for China to fail?

It's no good providing loan money for US companies to tool up. The markets are saturated, what good is it to put in a lot of money upfront and then sell at variable cost? It's no good for the government to spend a lot of money hoping the people they pay will spend and jumpstart the economy. The people who get government money buy it on importado, or "invest" it. If we sit back and wait we could get very bad results before we have waited long enough. Anything we do is wrong.

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