Monday, September 26, 2011

A Reader Asks ...

Comment from Brent on previous post:

In contrast to this presumably US-supported intervention via the IMF, I am interested to read Mélenchon's charge that the US is engaged in 'aggressive destabilization' of the Euro:
Can someone with more economics training that mine weigh in with some evaluation of this rather vehement accusation?

Oy, where to begin? Mélenchon's analysis ignores the fundamental fact that Europe's crisis is largely a story internal to Europe. Diverging unit labor costs (Germany became more efficient while other countries, including but not limited to Greece, allowed their labor costs to rise) during the era of cheap credit led to large trade imbalances within the EU. These imbalances were financed by lending from rich countries. In essence, German banks lent Greek importers what they needed to pay for German products. So Germany boomed, and Greece became indebted. French and German banks lent to Spain to finance a building boom, which temporarily improved the lot of Spanish workers but ended in an unemployment boom when credit collapsed.

None of this has anything to do with the US money supply. Mélenchon is right to observe that M2 has increased rapidly in the US, but he is totally wrong to say that demand for US Treasury bills and bonds has collapsed. Demand is stronger than ever, as the current 1.97% interest rate on 10-yr bonds shows. It is true that US money market funds have become reluctant to lend to European banks in the repo market, because the health of European banks is in doubt, but this is not some sort of US conspiracy to bring down the euro. It's a panic, like the panic that gripped US and international markets in 2008 with the Bear and Lehmann collapses.

Mélenchon's reasoning is sustained by anti-American bias, a belief in the conspiratorial nature of capitalism, and general ignorance of international economics. To be sure, left-wing economists in the US do not agree on the adequacy of the latest European bailout plan. I got the previous link from Jared Bernstein, a former White House advisor, who thinks the plan has a chance, but Paul Krugman thinks that neither this nor any other plan that focuses solely on stabilizing the banking system can succeed if policymakers remain committed to austerity in fiscal policy. Note that the IMF does not figure in Krugman's argument: the IMF is on the side of the angels here, favoring monetary easing and fiscal stimulus in the short run. It is one of Mélenchon's many blind spots that he cannot see this.

Latest Euro Bailout Plan

This one might have a chance to work. 1.7 trillion euros is real money:

The package is expected to involve a quadrupling - from the current projected level of 440bn euros - in the firepower of Europe's main bailout fund, the European Financial Stability Facility (EFSF).
This would be done by putting in place an arrangement that would allow the European Central Bank (ECB) to lend alongside the fund.
The EFSF would take on the main risk of lending to governments struggling to borrow from normal commercial sources - governments like Italy.
The political fallout remains to be seen, especially in Germany.

Banks and States

Nicolas Véron argues that European banks must sever their ties with individual states and be placed under a transnational European Banking Authority with "supervisory and resolution authority." In other words, the EU should regulate banks, insure deposits, and be empowered to shut down undercapitalized banks and wipe out their shareholders. He argues that it has become clear that one of the routes by which fiscal instability in one country spreads to other parts of the Eurozone is via the "banking channel." (h/t Martha Zuber)

One-Two Punch

One remarkable aspect of the unfolding Takieddine investigation is that it may not only destabilize the current president but also knock a future contender, Jean-François Copé, out of the running. The latest allegation is that both men took expensive vacations paid for by the arms dealer. Until now, one of the marvels of Sarkozy's long political career is that he has avoided any hint of corruption, even though he came up in the rough-and-tumble environment of northwest suburban Paris, where political corruption was a way of life. Somehow he avoided the missteps of Pasqua et cie., but here he is caught up in a scandal of his own, and one of his chief intraparty rivals along with him.

Of course, nothing is yet proven. My French friends, who so often reminded me during the DSK affair that we Americans "don't believe in the presumption of innocence," are now witnessing how irresistible it is to leap from allegation to condemnation, especially when the leaked evidence is so juicy. It may not be justice, but it is one heck of a spectacle.