Archive for the 'Angela Merkel' Category

What Hath Merkel Wrought?

In my fifth month of blogging in November 2011, I wrote a post which I called “The Economic Consequences of Mrs. Merkel.” The title, as I explained, was inspired by J. M. Keynes’s famous essay “The Economic Consequences of Mr. Churchill,” which eloquently warned that Britain was courting disaster by restoring the convertibility of sterling into gold at the prewar parity of $4.86 to the pound, the dollar then being the only major currency convertible into gold. The title of Keynes’s essay, in turn, had been inspired by Keynes’s celebrated book The Economic Consequences of the Peace about the disastrous Treaty of Versailles, which accurately foretold the futility of imposing punishing war reparations on Germany.

In his essay, Keynes warned that by restoring the prewar parity, Churchill would force Britain into an untenable deflation at a time when more than 10% of the British labor force was unemployed (i.e., looking for, but unable to find, a job at prevailing wages). Keynes argued that the deflation necessitated by restoration of the prewar parity would impose an intolerable burden of continued and increased unemployment on British workers.

But, as it turned out, Churchill’s decision turned out to be less disastrous than Keynes had feared. The resulting deflation was quite mild, wages in nominal terms were roughly stable, and real output and employment grew steadily with unemployment gradually falling under 10% by 1928. The deflationary shock that Keynes had warned against turned out to be less severe than Keynes had feared because the U.S. Federal Reserve, under the leadership of Benjamin Strong, President of the New York Fed, the de facto monetary authority of the US and the world, followed a policy that allowed a slight increase in the world price level in terms of dollars, thereby moderating the deflationary effect on Britain of restoring the prewar sterling/dollar exchange rate.

Thanks to Strong’s enlightened policy, the world economy continued to expand through 1928. I won’t discuss the sequence of events in 1928 and 1929 that led to the 1929 stock market crash, but those events had little, if anything, to do with Churchill’s 1925 decision. I’ve discussed the causes of the 1929 crash and the Great Depression in many other places including my 2011 post about Mrs. Merkel, so I will skip the 1929 story in this post.

The point that I want to make is that even though Keynes’s criticism of Churchill’s decision to restore the prewar dollar/sterling parity was well-taken, the dire consequences that Keynes foretold, although they did arrive a few years thereafter, were not actually caused by Churchill’s decision, but by decisions made in Paris and New York, over which Britain may have had some influence, but little, if any, control.

What I want to discuss in this post is how my warnings about potential disaster almost six and a half years ago have turned out. Here’s how I described the situation in November 2011:

Fast forward some four score years to today’s tragic re-enactment of the deflationary dynamics that nearly destroyed European civilization in the 1930s. But what a role reversal! In 1930 it was Germany that was desperately seeking to avoid defaulting on its obligations by engaging in round after round of futile austerity measures and deflationary wage cuts, causing the collapse of one major European financial institution after another in the annus horribilis of 1931, finally (at least a year after too late) forcing Britain off the gold standard in September 1931. Eighty years ago it was France, accumulating huge quantities of gold, in Midas-like self-satisfaction despite the economic wreckage it was inflicting on the rest of Europe and ultimately itself, whose monetary policy was decisive for the international value of gold and the downward course of the international economy. Now, it is Germany, the economic powerhouse of Europe dominating the European Central Bank, which effectively controls the value of the euro. And just as deflation under the gold standard made it impossible for Germany (and its state and local governments) not to default on its obligations in 1931, the policy of the European Central Bank, self-righteously dictated by Germany, has made default by Greece and now Italy and at least three other members of the Eurozone inevitable. . . .

If the European central bank does not soon – and I mean really soon – grasp that there is no exit from the debt crisis without a reversal of monetary policy sufficient to enable nominal incomes in all the economies in the Eurozone to grow more rapidly than does their indebtedness, the downward spiral will overtake even the stronger European economies. (I pointed out three months ago that the European crisis is a NGDP crisis not a debt crisis.) As the weakest countries choose to ditch the euro and revert back to their own national currencies, the euro is likely to start to appreciate as it comes to resemble ever more closely the old deutschmark. At some point the deflationary pressures of a rising euro will cause even the Germans, like the French in 1935, to relent. But one shudders at the economic damage that will be inflicted until the Germans come to their senses. Only then will we be able to assess the full economic consequences of Mrs. Merkel.

Greece did default, but the European Community succeeded in imposing draconian austerity measures on Greece, while Italy, Spain, France, and Portugal, which had all been in some danger, managed to avoid default. That they did so is due first to the enormous cost that would have be borne by a country in the Eurozone to extricate itself from the Eurozone and reinstitute its own national currency and second to the actions taken by Mario Draghi, who succeeded Jean Claude Trichet as President of the European Central Bank in November 2011. If monetary secession from the eurozone were less fraught, surely Greece and perhaps other countries would have chosen that course rather than absorb the continuing pain of remaining in the eurozone.

But if it were not for a decisive change in policy by Draghi, Greece and perhaps other countries would have been compelled to follow that uncharted and potentially catastrophic path. But, after assuming leadership of the ECB, Draghi immediately reversed the perverse interest-rate hikes imposed by his predecessor and, even more crucially, announced in July 2012 that the ECB “is ready to do whatever it takes to preserve the Euro. And believe me, it will be enough.” Draghi’s reassurance that monetary easing would be sufficient to avoid default calmed markets, alleviated market pressure driving up interest rates on debt issued by those countries.

But although Draghi’s courageous actions to ease monetary policy in the face of German disapproval avoided a complete collapse, the damage inflicted by Mrs. Merkel’s ferocious anti-inflation policy did irreparable damage, not only on Greece, but, by deepening the European downturn and delaying and suppressing the recovery, on the rest of the European community, inflaming anti-EU, populist nationalism in much of Europe that helped fuel the campaign for Brexit in the UK and has inspired similar anti-EU movements elsewhere in Europe and almost prevented Mrs. Merkel from forming a government after the election a few months ago.

Mrs. Merkel is perhaps the most impressive political leader of our time, and her willingness to follow a humanitarian policy toward refugees fleeing the horrors of war and persecution showed an extraordinary degree of political courage and personal decency that ought to serve as a model for other politicians to emulate. But that admirable legacy will be forever tarnished by the damage she inflicted on her own country and the rest of the EU by her misguided battle against the phantom threat of inflation.

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Le Boche Payera Tout

Despite the belated acquiescence of the Greek government to Eurozone demands that further austerity measures be imposed, the latest news updates from Brussels continue to sound ominous, Eurozone officials now insisting on even tougher measures than previously demanded as evidence that Greece is finally getting serious about carrying out its commitments to bring its finances under control. All participants in this tragicomedy have plenty to answer for, but as I, along with many others, have said before, the primary blame rests with the policy of the European Central Bank, which, obeying the dictates of Mrs. Merkel and her government, has a policy that has allowed nominal GDP in the Eurozone to grow by just 5% since 2011, an average rate of growth of only 1% a year. For Greece, this policy has meant a catastrophic fall in nominal GDP since 2008 of about a third. No country could survive such a sustained reduction in its nominal GDP without irreparable damage to its economy.

The responsibility of successive Greek governments for the current disaster is palpable and universally recognized, but the responsibility of the ECB and its German masters for the damage to the Greek tragedy is equally palpable, but scarcely mentioned, at least outside of Greece. What is even less mentioned is how contrary this policy has been to Germany’s own self-interest, because, in devastating the Greek economy through the – dare I say it, yes I will say it – INSANE policy of the European Central Bank, Germany has, in what might easily be construed as a policy of deliberate and sadistic torture, doled out to Greece just enough in the way of loans to prevent its default over the past five years, even as it has systematically destroyed the capacity of Greece to repay the very loans that Germany has extended to Greece.

It is worth recalling that just over 90 years ago, another European country was in the midst of a debt crisis, a crisis that country had brought upon itself by its own irresponsible — indeed reckless and even criminal – policies. In case you don’t already know which European country I am referring to – and even if you don’t know, you should be able to guess – I am referring to Germany, which, in its pursuit of its goal of European domination and a colonial empire to match, if not, overshadow those of Britain and France, provoked the start of World War I, leading to the deaths of 17 million military personnel and civilians. The outrage against Germany after the War was such that, after the collapse of the German government and the flight of Kaiser Wilhelm, the subsequent Versailles Treaty of 1919 imposed punitive terms on Germany, obligating Germany to pay war reparations to the allies, primarily France on whose soil the Western front was largely fought.

In what was his most famous work until he wrote the General Theory, J. M. Keynes, who was on the British delegation to Versailles conference, wrote The Economic Consequences of the Peace in which he accused the allies of imposing a Carthaginian Peace on Germany, because the burden of reparations was beyond the realistic capacity of Germany to bear, thereby making Keynes a kind of national hero in Germany (“sic transit gloria mundi,” as they say). The next decade seemed to confirm Keynes’s warning, because Germany was either unable or unwilling to make the reparations payments required of it, and the United States and the rest of the world, by raising tariffs throughout the 1920s, showed little inclination to accept the trade deficits that would have been required if Germany had made the reparations payments it was obligated to pay. As if to demonstrate its incapacity to pay its debts, Germany in 1923 opted for a hyperinflationary meltdown of its economy — the political equivalent of a hunger strike — in a kind of passive-aggressive show of defiance toward its debt obligations.

Meanwhile, the prospect of receiving reparations payments proved to be equally unsettling on the chief prospective beneficiaries of those payments, the French. While most of the rest of Europe was struggling to restore their currencies back to gold convertibility, by adopting austerity measures aimed at reducing public expenditures and raising revenues, the French felt that they could adopt afford to increase public expenditures, because after all, “le Boche payera tout” (the Hun will pay it all), “Boche” being a French slang term of endearment for Germans that has somehow come to be translated in English as “Hun.”

The notion that it would be the Germans who could be made to pay for their self-indulgent extravagance had a poisonous effect on the French economy in the mid-1920s, causing a rapid inflation, and capital flight, which not halted until Raymond Poincare formed a national unity government in 1926 and Emile Moreau was appointed Governor of the Bank of France, together managing to halt the inflation and stabilize the franc, setting the stage for their own disastrous gold accumulation policy starting in 1927, thereby precipitating, with a huge assist from the Federal Reserve Board, the Great Depression.

There are really two points that I want to make by recounting this sad history of the aftermath of World War I. First, one might have expected that, having once been victimized by the demands of its European neighbors that it pay the debt obligations it owed them, the Germans might have some feeling of empathy or understanding for the national suffering imposed when creditor nations try to collect debt obligations beyond the capacity of the debtor nation to repay. But there is hardly any sign of such an awareness in Germany today. Rather the attitude seems to be “the Greeks must pay whatever the cost.”

Now one might say, in defense of the Germans, that the debts incurred by the Greeks were voluntarily undertaken, while the debts imposed on Germany were imposed against the will of the Germans. But that seems to me to be a distorted view of the war reparations imposed on Germany. The German nation went to war enthusiastically in 1914 in hopes of achieving European, if not world, domination, the same ambition that led to another war enthusiastically supported by the German nation only 20 years after the end of the previous war. The war reparations imposed on Germany after World War I may have been excessive, given the economic realities of the situation, but there is no reason to think that, given the appalling suffering caused by German aggression in World War I, the war reparations imposed upon them were less legitimate obligations than the current debts owed by the Greeks to the Germans.

The second point that I would make is that there is certainly nothing noble or uplifting about the French attitude “le Boche payera tout.” Indeed, the attitude was both irresponsible and ultimately self-defeating, for two reasons. First, there was never a realistic way of compelling the Germans to pay, and second, even if the Germans could have been compelled to pay, the consequence would likely have been damaging to the French economy, because transfer payments on a large scale tend to undermine incentives to produce (the “Dutch disease”). Nevertheless, there was a certain selfish logic underlying the French attitude that is not hard to understand.

However, the current German attitude that the Greeks must pay whatever the cost is, at a very deep level, irrational. Forcing the Greeks into national bankruptcy or to leave the Euro will only guarantee that the Greeks will never pay the Germans back what is owed to them. If the Germans want to be repaid, the only possible way for that to be accomplished is to ease the current debt burden sufficiently to allow a reconstruction of the Greek economy, thereby enabling the Greeks to produce enough to service their debt obligations. As long as Greek nominal GDP is growing less rapidly than their debt obligations, that will never happen. That simple truth seems beyond the power of German comprehension.

What are the Germans even thinking? Who knows what they could possibly be thinking? Maybe Donald Trump could tell us. Or consider the fable of the scorpion and the frog:

A scorpion and a frog meet on the bank of a stream and the scorpion asks the frog to carry him across on its back. The frog asks, “How do I know you won’t sting me?” The scorpion says, “Because if I do, I will die too.”

The frog is satisfied, and they set out, but in midstream, the scorpion stings the frog. The frog feels the onset of paralysis and starts to sink, knowing they both will drown, but has just enough time to gasp “Why?”

Replies the scorpion: “It’s my nature…”

Mrs. Merkel Lives in a World of Her Own

I woke up today to read the following on the front page of the Financial Times (“Merkel highlights Eurozone divisions with observations on interest rates”).

Angela Merkel underlined the gulf at the heart of the eurozone when she waded into interest-rate policy, arguing that, taken in isolation, Germany would need higher rates, in contrast to southern states that are crying out for looser monetary policy.

The German chancellor’s highly unusual intervention on Thursday, a week before many economists expect the independent European Central Bank to cut its main interest rate, highlights how the economies of the prosperous north and austerity-hit south remain far apart.

What could Mrs. Merkel possibly have meant by this remark? Presumably she means that inflation in Germany is higher than she would like it to be, so that her preference would be that the ECB raise its lending rate, thereby tightening monetary policy for the entire Eurozone in order to bring down the German rate of inflation (which is now less than 2 percent under every measure). The question is why did she bother to say this? My guess is that she is trying to make herself look as if she is being solicitous of the poor unfortunates who constitute the rest of the Eurozone, those now suffering from a widening and deepening recession.

Her message is: “Look, if I had my way, I would raise interest rates, forcing an even deeper recession and even more pain on the rest of you moochers. But, tender-hearted softy that I am, I am not going to do that. I will settle for keeping the ECB lending rate at its current level, or maybe, if you bow and scrape enough, I might, just might, allow the ECB to cut the rate by a quarter of a percent. But don’t think for even a minute that I am going to allow the ECB to follow the Fed and the Bank of Japan in adopting any kind of radical, inflationist quantitative easing.”

So the current German rate of inflation of 1-2% is too high for Mrs. Merkel. The adjustment in relative prices between Germany and the rest of Eurozone requires that prices and wages in the rest of the Eurozone fall relative to prices and wages in Germany. Mrs. Merkel says that she will not allow inflation in Germany to go above 1-2%. What does that say about what must happen to prices and wages in the rest of the Eurozone? Do the math. So if Mrs. Merkel has her way — and she clearly speaks with what Mark Twain once called “the calm confidence of a Christian holding four aces” – things will continue to get worse, probably a lot worse, in the Eurozone before they get any better. Get used to it.


About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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