Sunday, February 7, 2010

Trouble Ahead

Back in 1831, as cholera was sweeping across Europe, French authorities confidently announced that France, with its advanced medical knowledge and modern public health system, was safe, and indeed the crisis seemed to strike all around while leaving France unscathed. But the next year the epidemic came to France and killed, among many others, the prime minister, Casimir Périer. Now it is 2010, and we have all heard how France has avoided the worst effects of another crisis. But here is a warning from a former chief economist of the IMF, Simon Johnson:

What are the stronger European countries, specifically Germany and France, doing to contain the self-fulfilling fear that weaker eurozone countries may not be able to pay their debt – this panic that pushes up interest rates and makes it harder for beleaguered governments to actually pay?

The Europeans with deep-pockets are doing nothing – except insist that all countries under pressure cut their budgets quickly and in ways that are probably politically infeasible.  This kind of precipitate fiscal austerity contributed directly to the onset of the Great Depression in the 1930s.
As this pressure mounts, we’ll see cracks appear also in the private sector.  Significant banks and large hedge funds have been selling insurance against default by European sovereigns.  As countries lose creditworthiness – and, under sufficient pressure, very few government credit ratings will hold up – these financial institutions will need to come up with cash to post increasing amounts of collateral against their derivative obligations (yes, the same credit default swaps that triggered the collapse last time).

Remember that none of the opaqueness of the credit default swap market has been addressed since the crisis of September 2008.  And generalized counter-party risk – the fear that your insurer will fail and this will bring down all connected banks – raises its ugly head again.
In such a situation, investors scramble for the safest assets available – “cash”, which actually (and ironically, given our budget woes) means short-term US government securities.  It’s not that the US is in good shape or even has anything approaching a credible medium-term fiscal framework, it’s just that everyone else is in much worse shape.

Another Lehman/AIG-type situation lurks somewhere on the European continent, and again our purported G7 (or even G20) leaders are slow to see the risk.  And this time, given that they already used almost all their fiscal bullets, it will be considerably more difficult for governments to respond effectively when they do wake up.


Anonymous said...

you don't even have to go back so far as 1831. when the government tries to assuage the French that contagious problems won't hit France, you'll hear many French cite the Chernobyl disaster when the government, through the mouthpiece of the TV newscasters, said that the radioactive clouds were to stop at the Rhine and not enter French territory thanks to winds & a favorable weather front...

MYOS said...

I've heard that Chernobyl reference countless times. It is astounding that a democratic governement would say such things to its citizens. Then again it explains why French people trust their governments so little.

In keeping with the "trouble ahead" theme:

Cartesian said...

There is not only economy which is a problem for the existence of Europe, but as well the moral foundations which in political theory are not acceptable in order to build something resistant. Here are some excerpts of Montesquieu and Tocqueville, I let you translate :) (thank you for this) :

Voici un extrait de "De l'esprit des lois" (livre 7, chapitre 8) : « Il y a tant d'imperfections attachées à la perte de la vertu dans les femmes, toute leur âme en est si fort dégradée, ce point principal ôté en fait tomber tant d'autres, que l'on peut regarder, dans un Etat populaire, l'incontinence publique comme le dernier des malheurs, et la certitude d'un changement dans la constitution.
Aussi les bons législateurs y ont-ils exigé des femmes une certaine gravité des moeurs..."

Voici une citation de Tocqueville dans « De la démocratie en Amérique » :
« Je suis convaincu que la situation (géographique) la plus heureuse et les meilleures lois ne peuvent maintenir une constitution en dépit des mœurs, tandis que celles-ci tirent encore parti des positions les plus défavorables et des plus mauvaises lois. L’importance des mœurs est une vérité commune à laquelle l’étude et l’expérience ramènent sans cesse. Il me semble que je la trouve placée dans mon esprit comme un point central ; je l’aperçois au bout de toutes mes idées. »

Leo said...

Since we are into quotes, here's another:

"A democracy is always temporary in nature; it simply cannot exist as a permanent form of government.
A democracy will continue to exist up until the time that voters discover that they can vote themselves
generous gifts from the public treasury.
From that moment on, the majority always votes for the candidates who promise the most benefits from the public treasury,
with the result that every democracy will finally collapse due to loose fiscal policy..."

Alexander Fraser Tytler, Scottish lawyer and writer, 1770