What we’ve learned from the euro crisis, part I

Matt Yglesias serves up a short and partial list, here are some of mine:

1. When the Germans say “no LOLR” they mean “no LOLR”!  Especially when they put it into print.  I already knew that, actually.

2. It is a disaster and a dead-end situation when a country uses its automatic stabilizers in a manner which supports rent-seeking and harms growth.  There is, in a time of crisis, no way out of the resulting trap.

3. The “regulation and labor law will come down really hard on larger firms” approach of Mediterranean Europe is far worse than we had thought, and we thought it was bad in the first place.  I can’t stress this point enough.  It’s cut those countries off from some major sources of growth and technical advance.

4. Don’t borrow in someone else’s currency.

5. Don’t think that “don’t borrow in someone else’s currency” is the only lesson.  Last I checked the Netherlands was doing OK.

6. International coordination doesn’t work very well unless the interests of the various countries are aligned in the first place.  If this is what becomes of the EU, what is our chance to save the world’s fish stocks?  Protect against global environmental problems?  etc.  The EU, and the eurozone, is designed for vague statements of consensus that, when faced with real problems, don’t get the job done.

7. We can suddenly imagine the so-called “first world” splitting into two parts, distinguished by the degree of conscientiousness applied to human capital formation.

8. The French-German marriage was never going to last that long anyway.  Yet without it, how do things get done in Europe?

9. The Mediterranean social welfare state model, based on lots of inefficient regulation, rent-seeking, reckless borrowing, and privilege within the local professions, is neither resilient nor robust.  It is wrong to blame “welfare states,” but it is also wrong to let “welfare states” off the hook altogether.  We’re learning a lot about how not all welfare states are created equal.

10. Don’t have government regulators let the banking system treat all government securities as riskless assets.

11. Hayek really was right about French rationalist constructivism (see chapter one).  I’m not sure there has been a better example in all of human history.

12. I’ll write more on Italy soon and what we can learn from the country in particular.  And I’ve left off some of the now-obvious, such as “no monetary union with a common fiscal authority and bank resolution mechanism,” etc.


Some pretty sweeping conclusions particularly since were still just in ACT I of this epic human drama, and since it's also a classic and a one for the ages, the final outcome is essential to understanding what is transpiring. When we look back, will this have been Greek tragedy, a lesson in the follies of human hubris and delusion, or, an American feel good story, of learning temperance via humility, unity through adversity. Early days yet in the grand theater that is Europe, after all 100 years war, Napoleonic wars, WWI, WWII, and even major ACT's of the Cold War were held here, and the show still goes on. Pass the popcorn.

the final outcome is essential to understanding what is transpiring

The difference between journalism / punditry and history?

The final outcome is essential to constructing a convincing narrative to yourself of what happened. That's about it, I think.

Yeah, considering most European nations in their present state are less than 70 years old. Europe does a good job with regime change and rasing itself. And Europeans are more so much more evolvedthan their children across the Atlantic, it will work itself out in the end.

"4. Don’t borrow in someone else’s currency.

5. Don’t think that “don’t borrow in someone else’s currency” is the only lesson. Last I checked the Netherlands was doing OK."

Catch that, Krugman?

Well you need to offset your (foreign) borrowings with (foreign) assets. And in general you need to offset liabilities (in any currency) with some kind of asset. No monetary policy innovation will change that fact.

No, what Krugman said is still true. Without the Euro, Italy and Greece would just be a bunch of sclerotic, mismanaged states. The actual crisis, the threat of default, comes from borrowing in a foreign currency, and the absence of a LOLR.

Assuming a corollary of "Don't lend in someone else's currency" how will such transactions ever clear?

Without the euro, Greece would still be borrowing in someone else's currency. With their record of inflation, devaluations, and defaults, no one would have lent to them drachma. They would be borrowing in dollars, or perhaps pounds or marks.

The vast majority nations successfully borrow in currencies they do not control. (And people! I cannot just inflate away my mortgage if I can't pay it.) All they have to do is be sufficiently prudent. It's best to simply never be in a position where you have to roll over debt.

Wel the Netherlands is of course a special situation, because we alreay were a German satelite before the euro. And besides, there might come a pretty hard time when our gigantic real estate bubble bursts.

While Hayekian macro hasn't aged well, I'll take Hayek as a political philosopher any day.

Depends what you take Hayekian macro to mean, but NGDP targeting has come back into vogue, and its fundamental advantage as I see it connects directly to Hayek's insights a la the primacy of pricing mechanisms. Also the Austrian theory of the business cycle fits quite nicely with the most recent recession.

Like Duffman, Hayek says a lot of things. Some of that is, to quote Caplan, "Hayek says the sky is blue". But there are enough other things for people to have productive careers just explicating the one idea.

Generally agree, but not totally. Quick response.

When I started reading MR a couple of years ago I just assumed that given the affiliation of its bloggers that they would agree with James Buchanan’s gentle critique of Hayek’s criticism of rationalist constructivism. It’s been an endless productive puzzlement for me.

Leaving that aside, when it comes to the welfare state let’s be clear what Hayek said in your pdf #11 (thanks):

“the state, the embodiment of deliberately organized and consciously directed power, ought to be only a small part of the much richer organism which we call "society," and that the former ought to provide merely a framework within which free (and therefore not "consciously directed") collaboration of men has the maximum of scope.”

It is not only in the Mediterranean welfare state that politics has become overloaded by bloated welfare functions that have assumed many of the individual’s risks and sought to design individual behaviour and substitute for free collaboration to an extreme degree. Paradoxically such is the political cycle dynamic of the welfare state model that perhaps only a *technocracy* could prevent a welfare state from turning obese! Sorry!

I guess in both cases it should be recognized that Hayek was criticizing socialism. He was (again your pdf #11) not *really* being critical of:

“the construction of a rational legal framework for capitalism [if] it could be realized in a pure form in which the direction of economic activity would be wholly left to competition, the planning would also be confined to the provision of a permanent framework within which concrete action would be left to individual initiative.”

Now there’s the challenge for financial risk engineering. The parametric legal framework of regulation that protects the social system as a whole while leaving concrete action to individual initiative and most of the penalties for error to the competition mechanism.

A pretty radical and positive view of the rationality of law in capitalism from Hayek himself, the euro governors should take heed.


But that was the purpose of creating the EU!
See Rachman yesterday at the FT to see possible political consequences.

#2 reminds me of this anecdote by Mark Twain where he mentions the wisdom of a man taking up a few bad habits like gambling, or womanizing early on in life. That way, if you fall seriously ill you have an easy way to make healthy changes.

It's really hard to ask a nun to live healthier.

Rahul, watch Pedro Almodovar's Dark Habits if you want to see how much healthier (Spanish) nuns could be. Totally agree about the cultivating the bad habits of misspent youth, but can be given up slowly before fall seriously ill.

First, from Matt Yglesias's post I conclude that he is learning how ignorant he was about Europe. Hope he also learns soon how ignorant and biased he is about U.S.A.

Second, Tyler's post corroborates my belief that catch phrasing is entertainment rather than knowledge (indeed a low form of entertainment in comparison with politics -- read http://www.lewrockwell.com/shaffer/shaffer19.html )

Yglesias writes I thought that the German political class would on some level welcome an opportunity to open the German pocketbook in exchange for political domination of the entire continent

That seems pretty damned clueless to me, seeing modern Germany as the same country it was in 1914 or 1939.

7. I see the primary division as being between "countries with expansive welfare states and people willing to pay the necessary taxes to support them" - the Nordic countries, Germany, maybe France- and "countries with expansive welfare states but not people willing to pay the necessary taxes to support them" - the Mediterranean countries. From a fiscal/financial stability point of view, there's really nothing wrong with the first group of countries.

It is an open question whether the US will fall into group 2 or remain with the rest of the English colonies (Canada, Australia, New Zealand) in a third group of moderate welfare state, moderate taxation countries.

The French-German marriage was never going to last that long anyway. Yet without it, how do things get done in Europe?

Germany remarried. Switzerland is the new spouse.


What happened to the old flame, Austria?

Spurned, because she doesnt admit she brought in the deceased family elder that led the whole family into a shameful union.

LOL, we all live already under a common roof (german: D-A-CH, wich National Car Signs: D for Germany, A for Austria, CH for confederatio helvetica)

For a non-economist, this whole Euro debacle is easy to understand (probably because I miss some aspects of it). The EU is preventing Italy, Greece and others from printing money and 'soft' defaulting via inflation. Instead they have to try to cut expenses and keep paying their debts in their original form (with the complication that new debt becomes more expensive). Germany allows them to print money to pay some of their debts but that will never be enough - cost cutting is always required and painful.

It is funny how in the end the EU becomes a pretty 'conservative' experiment in the sense that countries are forced to face their stupid debts instead of taking the easy way out (which btw is what the US is trying to do but for some reason is not working...).

Of course, pinkos like Krugman will always tell you that this is again just a legal/management issue. But I think this situation is finally showing to the world just how welfare can destroy your country. Someone above me mentioned that we still have the working welfares out there (Nordic countries, Germany) but I bet that this Euro crisis will reflect on them as well. I really think that the general public gets tricked by lefty polititians into believing that government spending and taxes are mostly harmless. Maybe not anymore.

In a desperate attempt to gain perspective, I offer the following observations:

1. All western 'democracies' are now structurally bankrupt due to unfunded liabilities. Some nations may be able to avoid simplification by selling assets, and while some economists refute the issue, (citing fiat currency and the irrelevance of interest payments) debt rollover itself will soon begin absorbing unsustainable percentages of world GDP. Central banking action seems only capable of delaying or obfuscating the outcome, and in the short term seems more focused on preserving themselves than fixing the problem. Reference: Stephen Cecchetii, Madhusudan Mohanty, and Fabrizio Zampolli, The future of public debt: prospects and implications (Bank for International Settlements, March 2010), http://www.bis.org/publ/work300.htm.

2. If any of these nations had chosen to fund social nets based on say, private insurance jurisprudence and investment, (Canada did this in the 90s) the whole discussion regarding modern democracy might be different. Government borrowing is not unlike giving your son a loan based on his allowance, and depending on that loan when father is out of work. Unfortunately there are now many fewer sons than fathers.

3. Hayek and others were right in this essential perspective, which complexity reinforces; central planning (especially without investment ROI), leads to brittle societies unable to adapt, most critically because of their rules. There is not enough duplication and variant exploration to mitigate error correction. Basel is a good example; standardized regulation aided and amplified the under-capitalization problem, making the explosion much worse. Also, more self-organizing societies and organisms, through frequent failure and creative destruction, naturally simplify and undo the natural propensity to over-build (e.g., significant portions of new competition come from the bottom). There is no natural incentive for government bureaucracy and regulation to simplify, until like Tainter says, the whole economy simplifies. This conversation gets no serious traction.

4. Can any modern society competently manage debt through an elected bureaucracy? I offer general debt levels as Exhibit A, and current American and EU political discussions as Exhibit B.

If all nations are bankrupt because of unfunded liabilities, then all individuals, except the independently welathy, are likewise bankrupt since they do not currently have the assets to cover their future living expenses.
Of course any bankruptcy court would laugh that theory to scorn.
And in the real world future liabilities are paif out of future income.

13. Culture matters. Greeks aren't Germans. That doesn't mean their animals or bad people, Just different. Too much of the focus is on economics. More should be on anthropology.

strongly agree to agree. The PISA tests in southern Italy, Greece and Portugal are abysmal.
"Just 28% of the Portuguese population between 25 and 64 has completed high school"-Wall Street Journal
The plain reality is that Med Europe is simply unable to live as an expanding 1rst world country under it's own power. And this has been the case for hundreds of years

But East Germans were Germans. And North Koreans are Koreans. Never mind culture and anthropology; history trumps everything.

History gives rise to culture. And there were always rumors that Adenauer was more than happy to let the Soviets have the East Germans.

i was scrolling down to write exactly that... culture, history, geography (or you might say the interaction of givens and accidents that produces a peuple).

I am not sure you are right about a lack of Laugh Out Loud Response. Our house rocks with grim chortling.

"The French-German marriage was never going to last that long anyway."

Hell, Charlemagne decided that.

Is France too PIIG to bail?

Sooner rather than later, we will be drawing up similar lists for the coming (or is that ongoing?) American crisis. Here's one item to ponder:

In Europe, politicians can usefully blame Brussels and Germany as they ram through unpopular measures that could never get passed otherwise. And when push comes to shove, Berlusconi falls on his sword, as does Papandreou, and don't forget that the Slovakian government voluntarily committed political suicide to pass the EFSF vote.

But in Washington there is no external political force that can give ultimatums, knock heads together, or herd cats. If the US ever drifts to the brink of the abyss, as Italy did last week when 10-year interest rates briefly rose to near 7.5%, there is no "Berlusconi resignation" gambit to pull out of a hat to calm the markets at least temporarily. Governments change only on a glacial and immutable four-year schedule, and even replacing a president in mid-term would accomplish nothing, given the president's very limited powers over domestic affairs.

If the US ever reaches the brink-of-the-abyss moment, it will go over. There is simply no mechanism to prevent it.

....which is true for any country not part of a currency union.

I've put out a paper that discusses a lot of these issues, particularly: "6. International coordination doesn’t work very well unless the interests of the various countries are aligned in the first place. If this is what becomes of the EU, what is our chance to save the world’s fish stocks? Protect against global environmental problems? etc. The EU, and the eurozone, is designed for vague statements of consensus that, when faced with real problems, don’t get the job done."

Avaliable here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1780591

"4. Don’t borrow in someone else’s currency."

Is the corollary to that statement "don't invest is someone else's currency"?

That is why in my mind the best hope for fish stocks is fish farming. The other alternative is dividing up the oceans by country. Each country can then target maximum substitutable yields in their own territory which is in teh interest of all who fish there.

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