A Primer on the Eurozone Crisis and How It Could Affect Us

A Primer on the Eurozone Crisis and How It Could Affect Us

May 16, 2012

The economic viability of the Eurozone continues to slowly leech away. The latest iteration of the crisis originated again in Athens. Last week, voters there chose parties on the left and right that agreed on one thing: No more austerity, including measures already agreed to in exchange for another bailout this summer from the European Union (EU) and the International Monetary Fund (IMF).

The popular revolt against austerity could not have been a surprise. Greece has seen its GDP shrink 20 percent, its unemployment rate reach 22 percent, its state pensions and government salaries slashed by 30 percent, and the real hourly wages of Greek workers decline 15 percent. Yet more austerity, designed to assure global investors that Greece will not default on its debts, could mean another 15 percent decline in wages and another 10 to 15 percent drop in GDP. The Eurozone plan, in short, asks the Greek people to accept an extended depression and sharply lower incomes in order to reassure European bankers.

To be sure, most governments have to reassure global investors that their bonds are sound and their private sectors produce healthy returns. What is unique here is that until the financial crisis blew Greeces cover, it had deliberately misled global markets about its deficits and debt. Using a scheme concocted by its Goldman Sachs advisors, the Greek government moved a significant part of its deficits and outstanding debt off its balance sheets. And Goldmans scheme was so complex and exotic that nobody grasped the deception. Without hard guarantees from the Eurozone, foreign investors are unlikely to trust Greece for a long time.

This Eurozone crisis has other singular features. Most important, the basic arrangements of the Eurozone hobble Greeces efforts to recover. In good times, the euro gave Greece greater access to capital markets than it could ever manage on its own. But in the bad times that have followed, Greece has found itself carrying crippling debt and unable to devalue its way to competitiveness. So, Greece is forced to depend on EU bailouts and the willingness of the European Central Bank (ECB) to accept Greek bonds as collateral for new loans to European banks. The price for these concessions has been drastic austerity. Imposing more austerity on an economy already in a deep downturn was a formula for economic depression and political upheaval and Greece now has both.

What does this mean for the U.S. economy? The crisis could reach a climax in matter of weeks, dealing another nasty shock to the recovery. Both sides, however, have good reasons to delay the day of reckoning at least one more time. That means that it is just as likely that the next president will have to deal with this shock. So, if not next month then early next year, the Greek government will formally reject more austerity. With their credibility on the line, the EU and IMF will almost certainly suspend future bailout payments, and the ECB will dial down its indirect supports for Greek bonds. Without those measures, Greece will default on its sovereign debt in a matter of days.

Even if the result is inevitable, a delay of several months will let everyone prepare for a Greek default and exit from the Eurozone. The Eurozone has no rules or provision for kicking out a member. But without the Eurozones continued support, Greece will have to quit: Only by leaving can Greece reissue the drachma and let it devalue sharply. Everything Greek will be available at fire sale prices, which will attract foreign investors and make Greek exports price competitive. Greece and its people will be left a lot poorer, but thats also now inevitable.

For everyone else, the main danger is contagion. Once the Eurozone lets Greece go, global investors may decide it is time to get out of all risky, European sovereign debt. That would include the huge markets for Italian and Spanish sovereign debt and if that happens, the crisis would quickly go global. Every bank in Spain and Italy carries large portfolios of its own governments bonds. Thats why many big depositors at those banks are already shifting funds to German banks. Already weakened, the Italian and Spanish banks would be bankrupted by a sharp drop in the value of their government bond holdings. The Eurozones emergency bailout facility can spend up to ?¬¢‚Äö?Ñ??¬¨¬® 500 billion buying up falling government bonds and providing capital to faltering banks. But if Italy or Spain teeters on default, that wont be nearly enough to rescue them.

That would bring the world, including the United States, back to 2008. French and German banks also have huge holdings in Spanish and Italian government debt. Our banks do not. But once again, nobody knows how many credit default swaps our institutions have issued for European sovereign debt and the Eurozone banks that hold them. If U.S. financial institutions issued those swaps in large numbers, or simply have large transactions going with European banks caught up in the contagion, the meltdown could lead to a new American financial crisis. After this weeks revelations about the reckless bets taken out and lost by J.P. Morgan Chase, there should be little doubt that our financial system would be very exposed to a full-blown Eurozone crisis.

The Eurozone could have resolved all of this some 18 months ago, and at relatively modest cost. That would have required that German Chancellor Angela Merkel accept the basic rule of every monetary union, that the full faith and credit of the whole stands behind the full faith and credit of its parts. And the instrument for doing so would have been the ECB. But that posed short-term term political costs for Merkel,

Last week, the President of the Federal Reserve Bank of Kansas City, Esther George, noted in The Globalist that, the current [Eurozone]crisis is following much the same pattern of previous financial crisis an inability or unwillingness to see the warning signs and take preventive action, followed by massive damage ?¬¢‚Äö?ᬮ¬¨¬? So, we have been have been here before, substituting the ideological blinders of Henry Paulson and his colleagues in the Bush administration for those of Merkel and her confederates. We all know how that worked out last time.



A New Way to Boost Job Creation and Help Save the Planet

May 7, 2012

U.S. growth slowed sharply in the spring of both 2010 and 2011; but it looks like this year, the economy may have shaken off its good-weather jinx. New home sales are up and foreclosures are down. Housing prices are still falling, but at a progressively slower rate which may signal that home prices are bottoming out. Businesses added only 130,000 new jobs last month, but the jobless rate and first-time jobless claims keep falling. Perhaps, its a case of, been down so long it looks like up to me. But it is a recovery. Yet, it can still use a boost. As the Financial Times wrote last week, in the US, the case for fiscal stimulus is strong.

That case is based on what economists call the output gap. An output gap is the difference between the value of everything the economy produces, and what it would produce if it operated at peak efficiency, making the best use of its available labor and productive capacity. This output gap today is probably 5 to 6 percent of GDP, or a growth shortfall of $770 billion to $930 billion. Thats why the Federal Reserve continues to keep short-term interest rates near zero, and why global investors have kept U.S. long-term rates at historical lows.

Such a large output gap also helps explain why job growth is so slow. In the 34 months since U.S. growth first resumed in July 2009, private-sector jobs have increased by just 3 percent. Compare that to nearly 12 percent gains in private sector jobs in the first 34 month following the deep recession which ended in November 1982. Part of the reason for much slower job creation this time lies in the batten down the hatches response by most middle-class Americans to the destruction of much of their wealth in the housing crash. However, another part of the reason lies in structural problems evident in the last expansion. In the first 34 months following the 2001 recession, private sector employment grew by less than one percent and whatever caused such tepid job creation has not gone away.

So, the American economy needs today a dose of short-term stimulus plus initiatives to help spur job creation on an ongoing basis. And whatever is done cannot make long-term deficits worse. The candidate who can solve that puzzle would earn the White House.

Here are some ideas as a start. First, shift the tax burden off of job creation and work, with a big, permanent payroll tax cut. That will reduce what employers pay when they create jobs and what workers and companies pay when people work. Over the next ten years, payroll tax revenues for Social Security retirement will average $770 billion per-year. Cut that in half, and you reduce the tax burdens on job creation and work by some $385 billion per-year.
The government can raise that kind of money in only three ways higher income taxes, a new value-added tax, or a new energy tax. Nobody has ever claimed that higher income taxes or a new VAT help create jobs but the right energy tax just might do so.

The right energy tax here is a carbon-based fee. It could be phased in over several years, which combined with lower payroll taxes would give the economy some short-term stimulus targeted to both job creation and consumption. It could be phased up until it replaced all of the lost payroll tax revenues, ensuring that it wouldnt make deficits worse over the long-term. And most Americans would be no worse off with the higher energy prices, because their payroll tax payments would shrink by at least as much.

Business, including big energy companies, also could come out ahead. One of the few things that economists, energy experts and environmentalists generally agree on is that a carbon-based tax is the most efficient way to limit climate-warming, greenhouse gases. That means a broad carbon tax program could preempt future EPA regulation of greenhouse gases just like the cap-and-trade program that passed the House of Representatives in 2009 did.

A broad carbon-based tax would make all low-carbon fuels solar, wind, biomass, and nuclear more price-competitive. Embed those price changes in an economy as innovative as ours, and entrepreneurial resources and energy would quickly flow into ventures to improve those fuels and make them widely available. All of those new ventures would create new jobs.

Finally, we could give this whole process a turbo-charge. Today, any family or small business can generate its own energy by installing solar panels, as can farmers and larger businesses with larger solar or wind facilities. And when they generate more energy than they can use, they can sell the excess back to the local utility. Few families, farmers or businesses do so today, because fossil fuels are still relatively cheap, and the alternatives require hefty initial investments.

The carbon tax itself will make those fossil fuels less price-competitive, relative to the cleaner alternatives. Moreover, as Germany and Britain have demonstrated, entrepreneurs will buy and install solar or wind energy for homes and businesses at no charge so long as government guarantee that the utilities will pay a decent rate for the excess power, and the entrepreneurs can get a reasonable cut of those payments.

The mechanism to create those conditions is called a feed-in tariff, and Germany and Britain borrowed it from a U.S. program enacted under Jimmy Carter. It didnt work here last time, because alternative fuels werent sufficiently developed, and oil prices fell sharply in the 1980s and 1990s. Both of those stumbling blocks no longer apply today.
In a country as innovative and entrepreneurial as the United States, the combination of a carbon-based tax and a feed-in tariff should drive enormous new investments and advances in renewable energy, with unknown but possibly large-scale economic benefits. And a widespread dose of decentralized, renewable energy production would create a lot of new jobs just to install and maintain the equipment.

Everybody wins. The economy gets a short-term boost as taxes on job creation and work go down. The revenues for social security are replaced with a new arrangement that reduces the risks of climate change, without restrictive new regulation. Innovation accelerates in areas likely to generate lots of new jobs down the line. In a sensible political environment, it could be the kind of idea that a smart politician might use to win the presidency.