Bubbling Up...8/7/12

1) The week when Mr Draghi greatly diminished the office of ECB President and sacrificed the fiscal-monetary policy distinction (in a manner that does not even help the euro in the short run!) by Yanis Varoufakis

What was the ECB’s position before Draghi’s heroic declarations? It was that it cannot arrest the crisis unless member-states act as part of a Grand Deal on how to effect a Eurozone-wide fiscal policy. Then and only then, the ECB would bolster their efforts through its own monetary operations. Clearly, that position led markets to believe that the Eurozone had no credible plan for dealing with the Crisis, as the cart (fiscal union) was being placed before the horses (serious ECB-centred intervention to stop the death embrace between insolvent banks and insolvent nations).

And what is the Draghi position after Thursday’s crucial ECB board meeting? That the ECB is ready to buy bonds in the secondary market once member-states act as part of a Grand Deal on how to effect a Eurozone-wide fiscal policy. In other words, no change whatsoever. None!

Woj’s Thoughts - Yanis and I are clearly on the same page. See ECB's Changing Philosophy is Good for Bond Holders but Bad for the Economy and ECB's Means (Lost Decade With High Unemployment) To An End (Structural Reform)

2) Draghi’s comments about the ECB doing “whatever it takes” are irrelevant by Edward Harrison

There is only one issue here: how many reforms the periphery will undertake. There will be no support unless we see reforms. If the periphery capitulates and slashes government jobs, raises pension ages, and makes it easy to fire people, Germany and the ECB will give them anything they want. Until they go whole hog, they won’t get full support.

This is blackmail, of course. But Monti, Samaras, and Rajoy are neoliberal reformers. So they want this too, just not the domestic political loss that goes along with it. Germany is obliging them by playing the fall guy for their domestic cutting agendas.

But, in my view, Europe is screwed. Eventually the neoliberals will have to cave and try to reflate in order to save their own hides when the debt deflation moves to the core or the Great Depression begins. They think they can extract the reforms they want before depression becomes firmly entrenched. I think they’re wrong.

3) Michal Kalecki on the Great Moderation by Steve Randy Waldman

Here is Kalecki describing with preternatural precision the so-called “Great Moderation”, and its limits:

"The rate of interest or income tax [might be] reduced in a slump but not increased in the subsequent boom. In this case the boom will last longer, but it must end in a new slump: one reduction in the rate of interest or income tax does not, of course, eliminate the forces which cause cyclical fluctuations in a capitalist economy. In the new slump it will be necessary to reduce the rate of interest or income tax again and so on. Thus in the not too remote future, the rate of interest would have to be negative and income tax would have to be replaced by an income subsidy. The same would arise if it were attempted to maintain full employment by stimulating private investment: the rate of interest and income tax would have to be reduced continuously."

Dude wrote that in 1943.

Let’s check out what FRED has to say about interest rates during the era of the lionized, self-congratulatory central banker:

Yeah, those central bankers with their Taylor Rules and DSGE models were frigging brilliant. New Keynesian monetary policy was, like, totally a science. Who could have predicted that engineering a secular collapse of interest rates and incomes tax rates (matched, of course, by an explosion of debt) might, for a while, moderate business and employment cycles in a manner unusually palatable to business and other elites? Lots of equations were necessary. No one would have guessed that, like, 70 years ago.

Woj’s Thoughts - Wow! Could Kalecki have been more correct?! Sadly our current policies are still attempting to induce further growth through a interest rate reductions (despite the zero lower bound) and lower income taxes (despite a substantial portion of the population already receiving an income subsidy). Maybe these policies can still produce another debt led boom but, the end of the road is fast approaching.

4) The Crisis in 1000 words—or less by Steve Keen

The causation behind this correlation is that money is created “endogenously” when the banking sector creates loans, and this newly created money adds to aggregate demand—as argued by non-orthodox economists from Schumpeter through to Minsky. When this debt finances genuine investment, it is a necessary part of a growing capitalist economy, it grows but shows no trend relative to GDP, and leads to modest profits by the financial sector. But when it finances speculation on asset prices, it grows faster than GDP, leads obscene profits by the financial sector and generates Ponzi Schemes which are to sustainable economic growth as cancer is to biological growth.

When those Ponzi Schemes unravel, the rate of growth of debt collapses and the boost to demand from rising debt becomes a drag on demand as debt falls. In all other post-WWII downturns, growth resumed when debt began to rise relative to GDP once more. However the bubble we have just been through has pushed debt levels past anything in recorded history, triggering a deleveraging process that is the hallmark of a Depression.

 

Woj’s Thoughts - The extreme levels of private debt can alter an economic system from being robust to fragile. In this manner, the chance that shocks destabilize the system and the magnitude of the ensuing deleveraging both increase dramatically.