Saturday, June 23, 2012

Beware of professors and other wise men & women!

The intellectual war over which economic policies ought to be pursued (and which other ones are plain stupid) is being won by those wise men and women who consider everyone else plain stupid. Hands down! Whenever the likes of George Soros, Mohamed El-Erian, Paul Krugman, Wolfgang Münchau, Thomas Fricke, Yanis Varoufakis (to name just a few) bless the world with their latest thoughts, one almost feels that one ought to stand attention in the face of so much intelligence and wisdom. And they all have the ability to make you feel dumb if you don't share their opinion.

Prof. Krugman Himself recently felt that the time had come to declare Greece as the victim. Shame on everyone who could not immediately see his point. A young Greek blogger didn't quite agree with his analysis and dared to write a piece where he took apart much of what the Nobel Prize Winner had said. Refreshing!

The French/UK writer Philippe Legrain called the publisher of Die Zeit, Josef Joffe, "monstrously stupid, economically illiterate and a moron". Why? That apparent master of ignorance had dared to write a piece in the Financial Times suggesting that Europe was perhaps not witnessing extreme austerity yet.

I recently wrote a piece on the hubris of Prof. Yanis Varoufakis where I criticized him for only talking about the EU's responsibility for fixing problems without making a single suggestion what Greece could do on its own to improve its situation. Instead of disagreeing with my criticism, Prof. Varoufakis confirmed to me "Dear Klaus, you are right. I am intentionally ignoring all treatises how to fix Greece. As long as it is the first carriage on the train derailment that is the eurosystem, Greece cannot be reformed. It is like asking Ohio in 1930 how it could escape the Great Depression by its own means. It could not. Period. As for hubris, it appears to us the audacity with which some Europeans keep blaming the canary for the methane leak and explosion”.

There was an INET-Conference in Berlin in April where the IQ of those attending must have averaged in stratospheric levels. The majority seemed to be completely like-minded in their attempts to promote "new economic thinking". When someone wasn't so like-minded, like the former Chief Economist of Deutsche Bank, whose additional handicaps were that his English wasn't very classy and, God forbid, that he was/is a German - well, one almost had to feel sorry for such an outsider. The Chief Economist of Financial Times Deutschland had it much easier. Since he has credited himself for having introduced new economic thinking in Germany, and since he obviously felt that everyone attending shared that feeling with him, he didn't have to use his time to make much of a presentation. Just chatting a bit about this, that and the other was naturally good enough. Poor former Chief Economist of Deutsche Bank! What a small thinker! He had really prepared something like a dissertation! Obviously, not a cool type! 

The very last speaker was a former Finance Minister of Chile, Prof. Andres Velasco. Now, just to listen to his presentation would have made it worthwhile to attend the 3-day affair. Given that he was the last one to speak, one wonders how many still listened to him. They should have!

None of the reforms which EU-leaders had expected the periphery to make once they joined the common currency took place because, according to Prof. Velasco, "when you fix your exchange rate (i. e. join the Eurozone), you look very safe to the world, people want to lend money to you, asset prices rise, credit is plentiful, and whoever saw a country reform when money is everywhere. When you are floating in Euros, you don't reform. Think of Greece, think of Belgium, think of Spain, think of Italy, think of Portugal!" Velasco 1, Soros 0.

Prof. Velasco had the nerve to state that the Eurozone was not really experiencing "much of a crisis" yet. "The very essence of a crisis is a sudden stop in capital flows. You are going along merrily but suddenly people stop lending to you. As a result, and if you are running a large current account deficit, you have to close that deficit overnight, you cut imports massively and you go into a huge recession. Well, Europe has been in a crisis for 4 years but Greece, Italy, Spain and Portugal still have current account deficits over 4%. So the basic requirement of a crisis has never happened here. Which, by the way, is perhaps an indication that German citizens have perhaps not been quite as ungenerous as some people in this meeting made them out to be because somebody has been lending to these countries".

Regarding the current situation where countries of the periphery are told to become competitive, Prof. Velasco warns that "you really have to watch out for the real exchange rate. When a country like Greece, which has had a massive recession for 4 years and unemployment around 20%, still has massive external deficits, then that country has a real exchange rate problem. What does the economic literature have to say about such situations? I am sure that this will be unpleasant music to most ears - it is very, very, very hard, perhaps even impossible, to carry out a large real exchange rate depreciation without touching the nominal exchange rate".

Prof. Velasco laments that today's wise men and women have not taken any lessons from the experiences which countries outside of Europe and the USA have had. He says fittingly "the sociology of economic thinking is such that if it happens in Chile, if it happens in Taiwan, etc., it is not worth thinking about. So", Prof. Velasco concludes with a recommendation for INET, "you should have a subsidy for the writing of new papers but you should also have a subsidy for the reading of old papers!"

It is not known what George Soros thought of Prof. Velasco's speech but, then, he and his like-minded thinkers may already have been discussing new economic thinking amongst themselves at the bar while Prof. Velasco gave his talk.


  1. As you quoted, in a nutshell " is very, very, very hard, perhaps even impossible, to carry out a large real exchange rate depreciation without touching the nominal exchange rate"."

    The frustration is that during the 1990s nobody listened to "professors and other wise men", ( neoclassic, Keynesian, post-Keynesian, Austrian etc.) warning against the Euro's flaws and how it would unravel. These criticisms, apart from within the UK which suffered its own exit from the EMS in 1992, never entered public debate. In fact, the old IS/LM macroeconomic model which we used to teach our students in the early 1990s (now abandoned by university courses), describes how the Euro would fall apart. In a way I can understand how Krugman has gone back to the past.

    Many academic economists were resigned to the fact the Euro was a political excise. Criticism was viewed as being anti-European or, in my case, for being Anglo-Saxon in mentality. I can perfectly understand why some academics are now shouting or bullying.

    Likewise, we could also be angry for few Europeans paying attention to the financial crisis that occurred in South America and Asia in the 1980s and 1990s. Prof. Velasco warns, with experience, what we were warning 20-50 years ago. Warnings can be traced as far back as Milton Friedman in the early 1950s - flexible exchange rates, as an adjustment mechanism of last resort in tidying up internal market inefficiencies of countries.

    In 1998 M Friedman warned

    "...the more likely possibility is that there will be asymmetric shocks hitting the different countries. That will mean that the only adjustment mechanism they have to meet that with is fiscal and unemployment: pressure on wages, pressure on prices. They have no way out. With a currency board, there is always the ultimate alternative that you can break the currency board. Hong Kong can dismantle its currency board tomorrow if it wants to. It doesn't want to and I don't think it will. But it could. But with the Euro, there is no escape mechanism.
    Suppose things go badly and Italy is in trouble, how does Italy get out of the Euro system? It no longer has a lira after whatever it is - 2000 or 2001 - so it's a very big gamble. I wish the Euro area well; it will be in the self-interest of Australia and the United States that the Euro area be successful. But I'm very much concerned that there's a lot of uncertainty in prospect.

    (Professor Milton Friedman interviewed by Radio Australia, 17 July 1998)

    and also

    I shall finish with a quote from a misunderstood Austrian

    "The curious task of economist is to demonstrate to men how little they really know about what they can imagine they can design F. A.Hayek The Fatal Conceit 1988) - this I use with respect to the design of the Euro"

    1. Thanks for your contribution. I am not an economist; a banker instead (retired). Even a banker must understand some basics as to how an economy works...

      Still remembering a couple of things from Economics 101 four decades ago, I had always been baffled how the creation of the currency union completely did away with discussions about current account balances. Sort of like current accounts and balances of payments didn’t matter anymore now that we had the currency union. I think that was a small mistake, to put it mildly.

      Even today, one only talks about sovereign debt and not at all about cross-border debt. You could forgive Greece its entire sovereign debt and the country would still be in enormous economic problems because of its structural current account deficit without any perspective of direct foreign investment.

      The creators of the Euro were so concerned with state performance that they apparently forgot about national performance. Sovereign debt was limited and the budget deficit, too. But the fact that Greece whose GDP averaged probably around 200 BEUR in the 2000s spent 199 BEUR more abroad than it earned there (accumulated current account deficit 2001-10) didn’t seem to worry anybody. After all, the Eurozone was a currency union…

      There is a tale by Warren Buffett linked in the below article. Personally, I think this tale should be given to every EU policy maker to be memorized by heart (and hopefully to be understood as well…).