May 11, 2011
Do you remember Hurricane Katrina in New Orleans? Do you remember the devastation, the debris, the human loss of life? Do you remember the scene of the New Orleans Superdome with thousands of people — now jobless and homeless — crammed inside with no sanitation? Well how do you think the government of Louisiana, devastated by a hurricane that cost so much that it would bankrupt the State, was able to rebuild the city?
The United States cavalry rode in to save New Orleans and the State of Louisiana. The President declared a state of emergency, Treasury wrote the cheques and the Federal Reserve credited Louisiana’s accounts. They then spent those dollars on cleaning up the city. So the central bank credited the account of the State of Louisiana because emergency economic conditions meant the State needed it. The State issued no bonds; there were no IOUs, except that the deficit of the US rose. There was no effect on inflation.
Louisiana was financed without the people of Louisiana putting their hands in their pockets. This is what is done in the US –where the concept “United” is taken seriously. The Federal deficit rises and the Fed prints dollars and the region in difficulty recovers or at least is helped towards recovery.
Could this happen in Europe? In Ireland? Is there any way the Irish government could access funds without going to the bond market and, in so doing, have an orderly reduction in the budget deficit rather than something dramatic?
The question is whether there is a third way. At the moment there are only two ways out of this crisis if we want to stay in the Euro. The first way is happening now. The ECB forces the Irish, Greeks and Portuguese into drawn out austerity packages without any debt forgiveness. This is not the behaviour of a “United” Europe. The ECB lends to Ireland at a time when Ireland is overwhelmed by debt — and adds injury to insult by demanding austerity policies that make the recession worse, inflicting suffering on the Irish people. This does not happen in the US. The ECB’s anti-European response causes a toxic cocktail of problems. It means much higher levels of unemployment, increased emigration and severe drops in wages. This cocktail makes people so insecure that they save more, which is bad for an economy in recession.
The central economic difficulty with this is that if the people who have money are saving, money is being sucked out of the economy. If the banks are bust, this money that is being saved will not be recycled. So there is a credit crunch. This is what is called the balance sheet recession and this is what is happening in Ireland.
If we are saving lots and the government is not spending lots, who is going to buy anything here? If no one else buys, the economy contracts because no one is spending. The only way a country like Ireland can grow or even remain stable in this environment is through an enormous trade surplus, where we sell our stuff to foreigners because we are not buying any of it.
So the only way that we can reduce the government deficit to zero and not destroy the economy is to have a trade surplus equal to the amount of money we are saving.
On the back of the envelope, it means that our trade surplus will have to expand our current account balance by 16pc of GDP or $30 billion in the next few years because we are saving 16pc of GDP. But here’s the kicker, according to the CIA fact book in 2010, net exports increased by over â‚¬5bn, but we ended up with a current account deficit because the multinationals sent the proceeds of their exports to other nations. No export strategy can guarantee success when it depends largely on multinationals.
With world growth modest and the ECB tightening in Europe, expanding exports is going to be almost impossible, so the government will have to keep spending.
But we can’t go back to the markets to finance this spending because the markets are shut to us. So is there any way out?
Well the second option is full political integration in Europe where we go for what is called fiscal federalism. This means that we pool our parliaments, our resources and our sovereignty together into a super-state and the difficulties of the likes of Ireland and Greece will be paid out of the central EU budget. But the problem is that no one in Europe wants this. Not the True Finns or the citizens of any other country.
So is there a third way? Is there possibly a way we can inject capital into countries in danger without going to the bond markets?
Consider the New Orleans debacle. The US Federal Reserve credited the State of Louisiana and gave it the cash to spend. Now the Fed just printed that money. It printed the money, backed by a piece of paper issued by the US government. So the US deficit rose modestly.
Could something like this be done in Europe? If you could persuade the ECB to set aside a certain amount of money for emergency economic times which would be lodged into the account of the governments of those countries which are affected by an economic emergency. How could you do this without raising corresponding taxes from the richer countries to pay for the ones in crisis?
What about just printing a certain amount of money, without any backing, and setting this aside via let’s say the European parliament for each country divided up by population so that there can be funding during a crisis?
Why would anyone in creditor countries go for this? Maybe they will see the value in this because without such a mechanism, debtor countries will be at the mercy of bond market vigilantes and will always be unstable. This will force periodic crises in the Euro, with some countries like the Greeks saying they might have to leave.
So who loses? Well no one really, if you can persuade the ECB not to worry too much about its balance sheet. If you can persuade it to be a bit more like the Fed, the Bank of Japan and the Bank of England and understand that the central bank can’t go bust because it is the only entity that can print the currency. In current conditions, the ECB could establish this emergency fund without any risk of inflation.
Only with a sea change of opinion and attitude inside the ECB can Europe and Ireland escape the economic trap we have set for ourselves. Had the Fed behaved like the ECB, the hurricane in New Orleans would have devastated the city in the way cities were erased in the old days. New Orleans would have become like Carthage, a footnote.
But the interesting thing about Carthage was that it was destroyed by men not nature. The expression a Carthaginian peace comes from the Roman idea that you obliterate a city so that it can never recover and call it peace. Is this the type of financial and economic settlement the ECB and the Irish elite wants?
David McWilliams will be on a panel discussing the Euro and the ECB on May 16 with Professor Joseph Stiglitz and British Chancellor George Osborne at www.zeitgeistminds.com