Saturday, October 12, 2013

Reading Up On Keynes...

A few weeks ago, I began doing something which I hadn’t done since my College days – I did some reading of writings of and about John Maynard Keynes. Among others, I am just finishing the book “The Battle of Bretton Woods” by Benn Steil. And I am amazed! Two principal issues dominated the negotiations lead by Keynes on the UK side and by Harry White on the US side, namely: the flow of trade and the flow of capital as a result of a new monetary system.

Now I, for one, had not heard much about the flow of trade and capital as the Eurozone evolved since inception. Instead, I seemed to always hear two principal themes: the convergence of interest rates and the external strength of the Euro. Since both developed very favorably, the Euro simply had to be considered as a success.

It was only after Lehman that I began looking more closely at the world-wide flow of trade and capital, albeit not within the Eurozone but, instead, between the US and the rest of the world. And I was overwhelmed by the enormous current account deficits which the US had been running for years and decades. It seemed that the obsessive and no-fear-of-debt-having American consumer had created jobs and wealth in the rest of the world and I started wondering how long that could go on.

Thus, when the Greek crisis began erupting in late 2009, the first thing I looked at were Greece’s Balance of Payments figures (particularly the Balance of Trade) since the Euro – and I couldn’t believe what I was seeing. Everyone seemed to be worried about Greece’s budget deficit and sovereign debt whereas in actual fact it was clear that the Greek economy was essentially driving itself out of its value-generating activities since the Euro. And none of the discussions focused on that problem. Instead, the logic shared by most everyone was that the budget would have to be gotten under control, reforms made and then everything else would automatically fall into place.

I am simply baffled how, prior to Bretton Woods, leaders would have understood that the issues are trade and capital flows and, since the Euro, no one paid attention to them. All the numbers showed the scary development since the Euro but no one seemed to deem them important.

The dogma for the EU and Eurozone were the 4 freedoms, including the free movement of trade and the free movement of capital. As long as that was assured, everything would be fine. And now I read that even Keynes was meandering on these issues: believing in the benefit of free trade and capital flows but questioning their ultimate success at the same time (I guess Keynes realized that Great Britain was not ready for completely free trade and capital movement).

In retrospect, I think that Greece, for one, simply was not ready for the free movement of trade and capital; certainly not after the introduction of the Euro. Furthermore, despite being a great believer in the workings of free market forces within an adequate policy framework, I am beginning to wonder whether the completely free movement of trade and capital is a workable proposition within the Eurozone in its present structure (which is why I recently gave up hope that the Eurozone could survive in its present structure).

The opposite to free movement of trade and capital is not necessarily the control of trade and capital. I, for one, believe that the Eurozone, in its present structure, needs a ‘managed flow’ of trade and capital whereby the ‘management’ takes the form of incentives. I remember reading, back in my College days, about the concept of ‘infant industry protection’. The idea is that one cannot expose an economy to world-wide competition if that economy is not yet ready to compete. In the case of Greece, I am not even sure that a return to the Drachma would change all that much. Ok, Greece would immediately become a lot cheaper (‘more competitive’) in foreign currency terms. But being cheap alone doesn’t automatically build up a productive capacity. That requires a long term economic development plan.

Regarding the alternative of a Grexit, I don’t see the operational challenge as unsurmountable at all. If handled well, a one-week bank holiday (at the most) should suffice for that. But I don’t believe that, in a redesign scenario, it is the weaker countries which should leave the Euro. It would be of greater benefit to the weaker countries if the stronger ones (Germany & Co.; i. e. the North) left the Eurozone. That would leave the South with a cheaper currency relative to the North. The South would not only become more ‘competitive’ pricewise but its Euro-denominated debt would devalue relative to a Northern currency.

That, however, is guessing. What is not guessing is the realization that the free flow of trade and capital, combined with a common currency, has deprived a country like Greece of its productive capabilities and until that issue is properly addressed, the losers of the Euro-structure can have little hope to ever utilize their economic potential.


  1. The economic imbalance within the Eurozone can be overcome by financially strong countries creating a new strong TEuro or by weak countries introducing their weaker local currencies in parallel.

    I first read that 2nd possibility in your blog and wonder now why you already seem to have abandoned that brilliant idea?

    The big differences in between weak countries imho does not allow them to have a _common_ (devalued) Euro.


    1. The only thing which I have abandoned so far is the idea that the Eurozone in its current structure with current policies can survive in the longer term. There may be things which I have forgotten (but not abandoned).

      Yes, a couple of years ago, I first wrote about parallel currencies (see below “Thinking aloud”). Returning to that thought, yes, I would still consider it as an interesting avenue to pursue. After all, there have been several instances in my lifetime where countries had 2 currencies, for example a ‘commercial Schilling’ and a ‘financial Schilling’. This is a time where no new idea is so stupid that it should not even be discussed. I object to this notion that there are no alternatives (I believe even the German AfD has also talked about parallel currencies as possibilities).

      I think the real issue is that many people have not realized what the Euro is. Before the Euro, a country like Austria had Schillings as the local currency and the rest was foreign currency. Every Austrian could have foreign currency accounts if he had a need for them. When the Euro came, we thought that it simply replaced the Schilling as the local currency. Terribly wrong thought! The Euro is what the foreign currency used to be before, and the local currency was wiped out.

      In this scenario, one doesn’t have to think that Greece should return to the Drachma and get out of the Eurozone. Instead, one should think that IN ADDITION TO THE EURO, Greece will introduce the Drachma as a local currency. That would return Greece to a situation in which it was before joining the Eurozone. One wouldn’t have to open new Drachma accounts. Instead, all Euro accounts would simply be renamed as Drachma accounts and those who still want Euros have to open new Euro accounts. And to get the new system started, all that would be required is for the government to say that it will make, effective immediately, all domestic payments in Drachma. I add another link below where I suggested how this could work operationally.

  2. Hello Klaus

    Not to sound like a broken record but the problems in Greece have nothing to do with the Euro or with the flow of capital.

    Organic systems (assuming no outside/artificial) interference always tends towards equilibrium

    Take a city as an example. It has no restriction on the flow of labour, capital or goods.

    Yet the areas where there is more money, i.e. the areas where there is a surplus the more expensive things are.

    The system finds a balance. It is impossible for the system to be out of balance. It would be like saying houses in expensive areas are cheap. It is simply not a situation that could occur in a free system.

    Greece would have adapted to the government's debt problems. Things would get cheaper or cheaper products/service would come on to the market (as they are)

    However, any benefits in the reduced cost of living are wiped out, and more, by the increase in the cost of living imposed by the Greek government.

    Greeks are not seeing the benefits or the stabilizing effects of free trade with China, or the benefits of the explosion in cheap take away food outlets. To give two examples.

    The money Greeks are saving with these new products and services has more than been taken away by the government.

    The only thing these new products and services have done it to make the tax increases more bearable.

    In summary capital flows always tend towards equilibrium in free markets. It is impossible for it to be otherwise.

    In the case of Greece and the Euro, capital outflows would lead to less money in Greece leading to lower costs for products and services, lower property costs and lower operating costs. Just like it does inside a country and inside a city.

    This effect is happening in Greece but in a way that is hindered massively due to the increases in the cost of living imposed by the Greek government.

    The cost of living increases are more than cancelling out the savings in lower prices.

    The Troika bailouts are further inflaming the situation. By pouring billions of Euros into supporting the government's policies, it is creating a false reality, which is disguising the true damage being done to the Greek economy by artificially inflating the government and economic figures.

    In summary, the currency is irrelevant; a free system will always tend towards equilibrium. Regulations and taxes hinder the system from adjusting to reality. This amplifies and disguises small issues and turns then into systemic problems which occur years later.

    It is also important to be aware of the vested interests who must push the idea of instability in free systems in order to protect and inflate their bottom line.


    1. To be perfectly honest with you, I am not sure that I can follow your argumentation (not all, but for the most part). Greece's problems have EVERYTHING to do with the EU, the Euro and the resulting excessive capital flows. Had Greece not joined the EU nor the Euro, there would have been only limited capital flows to a Drachma-country with a messy political/economic system. Put differently, 'free market forces' would have forced Greece to remain a relatively poor country with a lot less cars, motorbikes, smartphones, etc. And - that would have been the equilibrium.

      That equilibrium was totally kicked out of whack by Greece's joining the EU and, particularly, by its joining the Eurozone. Yes, if no one had intervened in the last years, Greece would have returned to its former equilibrium but at a much lower level that before. In short, Greece would have become like Cuba after the Soviets cut their funding and before Chavez provided new funding.

    2. Klaus, forgive me but you are combing two separate things and treating them as one.

      "Greece's problems have EVERYTHING to do with the EU, the Euro and the resulting excessive capital flows.”

      The EU & the Euro are one thing, the capital inflows are something entirely different.

      The EU and the Euro are institutions/rules/physical entities...... etc however you want to refer to them.

      The capital inflows are actions carried out by people.

      The ECB was by far the largest provider of these capital inflows.

      Firstly because it manipulated the Greek government's books to get them into the Euro

      Secondly it monetised the debt of the Greek government based on figures which it knew were cooked because they themselves are the ones who did the cooking!

      For these reasons the EU and the Euro have nothing to do with the government crisis in Greece. You could argue they enabled the ECB to do what they did but fundamentally, the ECB is the bad actor.

      The ECB is the one that has wrought the damage on the Greek economy.

      The principles of the Euro did not create a massive bubble in the Greek economy and balloon the Greek government’s debt.

      Do I agree with the Euro? If it is a defacto Gold standard yes.

      But the currency has only been going for 13 years and it has already been completely compromised by "Keynesians/Money Printers/Currency Manipulators"

      Better, for there to be independent currencies, sure it is nowhere near perfect but at least there is a semblance of competition between countries rather than the Despotic regime we have for the Euro

    3. I am afraid I must totally disagree with you! The ECB provided exactly zero capital to Greece until the crisis erupted. Virtually the entire foreign debt of Greece was provided by private creditors. Only when the private creditors pulled back, the ECB had to start filling the hole via target2 and then the Troika paid out the private creditors. What ECB and Troika did since 2009/10 is a completely different matter and on that issue I once wrote a post titled "A Nueremberg trial for EU-elites".

      Yes, the capital flows were carried out by people. There were private foreign lenders who were intoxicated with throwing money at Greece and there were Greek politicians who couldn't get enough of it to spend it. However, one of the principal reasons why private foreign lenders were intoxicated with throwing money at Greece is because Greece had become a member of the EU and once Greece was a member of the Eurozone, the private lenders determined that the no bail-out clause was a fairy tale and that the EU would never be able to enact that threat. On that they gambled and, for the most part, their gample paid off. Had Greece remained a Drachma-country, that is most unlikely to have happened. Below is a tale explaining how so much money flowed to Greece. It is based on my own experience in international banking. Trust me that it is rather accurate.

    4. Hello Klaus

      Forgive me but you cannot disagree with facts.

      This is a link to the same video as above but this link highlights the exact moment in the video that covers the ECB-Private Bank-Government mechanism in the Euro

      The ECB monetised the Greek government debt by purchasing the Greek government debt off the private banks (wherever they may be in the Eurozone). The banks could only buy the government debt because they knew the ECB was going to accept it.

      Do you disagree with anything I have just said or anything about the ECB mechanism highlighted in the video? If so, could you please let me know the errors.