In The Eurozone, If Wages Can’t Be Cut Payrolls Will – O’Rourke And Taylor In The Latest JEP

Before the Euro was introduced, each member country had its own central bank that managed monetary policy. After the Euro was introduced, the European Central Bank took responsibility for monetary policy in the Eurozone.

This article by Kevin O’Rourke and Alan Taylor in the latest Journal of Economic Perspectives looks at the internal adjustments needed within the Eurozone in order to get out of the rut where some countries are definitely hurting because they have no independent monetary policy.

They discuss how the United States is a “true” monetary union in the way that Robert Mundell discussed. High internal labour mobility, a common language and the fact that if a state goes bankrupt the Federal government is unlikely to bail it out are key factors that distinguish the United States from the European Union.

Because monetary policy needs to respond to adverse shocks, having a monetary union denies a member state the ability to respond appropriately if there is a shock that affects it alone. Shocks can be distributed asymmetrically across a monetary union – and that means that within that monetary union there can be substantial adjustment problems.

There is an argument that adjustment to macroeconomic shocks in these circumstances should take place by way of internal devaluation. However O’Rourke and Taylor highlight nominal wage rigidity and sticky prices with this brilliant illustration of how hard it can be to adjust wages downwards:



What this shows is the human cost of adjustments after adverse shocks. Look at how many people in Greece are completely screwed – but also look at how when wages can’t be cut because of either refusal to accept pay cuts or labour market rigidities that make it impossible, the number of people employed will plummet in response to the shock anyway.

This paper goes on to discuss how the core European countries are essentially on a different planet in terms of productivity and public service performance relative to the periphery countries like Greece and Spain.

But I do not agree with their argument for a stronger banking union across the European Union. The Euro was always doomed from the start. If you’ve read any French economic history, you’d realise that the politics of the European Union are essentially a cold war between French and German interests.

Whilst Germany has been able to exercise strong influence over monetary policy, France has been a key driver of the vast expansion of the European Union’s bureaucracy and legalistic interference in member countries.

France will eventually go through the reforms that Germany went through in the 1990’s but that may not happen as fast as some people think it will. The idea that completely different cultures could come together to have a single political entity was only successful for the Austro-Hungarian empire which had obedience to the Hapsburgs over silly things like voting in leaders democratically.

Anyway, this is an interest piece that explores the pitfalls of having a monetary union if all of your institutions and financial sector entities aren’t on the same page. It also highlights how money is everything and there are no guarantees of political stability when creditor countries start to force wage cuts on debtor countries. This won’t end well.

No Recovery Can Be Guaranteed


A recovery from the global financial crisis can’t be guaranteed. There’s no reason why employment, consumer spending and business confidence have to recover in New Zealand.

The unwinding of what George Soros calls the “superbubble of credit” has barely begun.

For a while there I thought that we’d start to see some sanity around housing. But prices are on an upwards march again, absolving the need for the government to address rising superannuation costs.


Banks are relaxing lending standards and setting themselves up to pass stress tests. Financial stability is apparently high, but we can’t see the models the RBA and RBNZ use because that would reveal how precarious the situation actually is.

If banks stop the growth in mortgage lending, the whole house of cards will collapse. In order for perpetual growth to shine upon their balance sheets and executives to get their million-plus bonuses they can’t afford to stop lending on housing stock.

In order for a recovery to be called a recovery, hundreds of thousands of people unemployed or under-employed have to get something out of it.

It’s not like they control any capital with which to benefit from gains in technology, automation or inflation.

For those at the top of the food chain, there hasn’t been much of a recession. Only those who borrowed far too much had their wings clipped.

All the others have kept on benefiting from asset-price inflation and successfully watered down any attempts to reign in excess.

During the 2000s, rising house prices and easier credit papered over the stagnating New Zealand economy.

But interest-free repayment periods come to an end and the flow-on effect of a protracted downturn in construction hits people on lower incomes even harder than Radio New Zealand listeners could comprehend.

The exodus to Australia, driven by the working class and skilled tradespeople, can’t be permanent. Under the Special Category Visa regime Kiwis aren’t eligible for Australian welfare payments.

This means that when the mining bubble collapses and destroys the house of cards that is the Australian economy, the reversal of emigration will turn New Zealand into an even more screwed country.

I laugh when I read articles about “average pay rises”. The only people who get pay rises are connected to the public sector in some way, shape or form.

Out there in the real world, casualisation and sub-contracting arrangements that resemble old employer-employee relationships in every which way except name, have hollowed out the labour market and turned it into a project-specific skills market where the risk is borne by the contractor.

No recovery can be guaranteed because the risk/reward equation is so heavily skewed towards people who’ve already made a bundle, having no incentive to put what they’ve earned in the boom at risk by taking on additional investment projects.

Reality Check On BRIC Stories

The Brazil-Russia-India-China acronym was first coined by Goldman Sachs economist Jim O’Neill.

Ostensibly, it’s a prediction that these four countries will take over the world because of the massive increase in their population, GDP and status as creditors to the developed world.

In reality, the BRIC economies are not as rosy as we might think.

Instead of focusing on GDP as the measure of a nation’s success, the real statistic we care about is real GDP per capita on a purchasing power parity basis.

In this statistic, the BRIC countries fall down in any reasonable assessment of their economic performance.

Let’s compare the BRIC GDP per capita with countries New Zealand would like to compare itself to economically:

What this tells us is that in order for the BRIC countries to truly say they’re economic powerhouses, they’ll need to more than double their real GDP per capita on a PPP basis to even surpass little old New Zealand.

With China currently slowing down, Russia propped up by oil prices, Brazil engaging in destructive monetary policy and India struggling to export anything other than call centre services I don’t see how this is going to happen.

Particularly when a key determinant of BRIC countries growth is demand in countries like the US, Canada, the European Union, Australia and New Zealand. If there is less demand for exports, growth plummets accordingly.

Because external debt must be repaid in foreign currency, export earnings are pretty important. So what do they look like per capita for the BRIC countries plus Greece for an illustration of relative position?

Interesting. Now, putting aside how external debt actually functions i.e. lots of rollovers and reissues from time to time, if all export earnings were applied to running down external debt, how long would it take different countries to do so?

This isn’t a completely out-of-left-field thought experiment – foreign currency has to come from somewhere.

A year has 365 days so Greece would have to apply all of its export earnings for almost 20 years in order to retire external debt whereas China would have to do so for just 8.5 months.

While this though experiment relates to gross exports as opposed to net margin made by exports – which can be enormous – it’s still indicative of how paying down external debt is almost impossible.

It has to keep on being rolled over and new debt issued to pay off the old debt. Both the public and private sector in the BRIC countries and developed countries have binged on debt for far too long.

At some point, there has to be a reckoning. It will be painful, and no amount of central bank intervention or fiscal policy responses can dull the pain of a real debt crisis.


More European Union Powers Won’t Work

The theory of Optimal Currency Area first written about by Robert Mundell had several key requirements in order for a currency union to work.

They were labour mobility, capital mobility, flexible prices and wages, similar business cycles and risk sharing that enables struggling members to get bailed out.

There is no doubt that labour is highly mobile within the EU. But there are enormous cultural and language barriers that haven’t gone away and never will. Capital is mobile, but the moral hazard involved with risk sharing has played out into “Northern” member countries having their wealth squandered bailing out “Southern” member countries.

The difference in attitudes between a German and a Spaniard with respect to work are completely different. The likelihood of an Irishman learning Polish to take advantage of work opportunities in one of the EU’s better performing member countries is trivial.

Over the past few years Germany successfully reduced its labour costs and continued to have a workforce that leaves school with very little “skills mismatch” nonsense we have in New Zealand

Most Euro zone countries have hardly budged on flexible prices and wages. Struggling countries can’t take advantage of cheaper national exchange rates because their economies are stuffed to spur any form of recovery.

Instead of earning their way out of recession, German officials are dictating to governments what they should do in order that predominantly German banks and bondholders get repaid at 100 cents on the dollar.

All the other bondholders – pension funds, retirement schemes, unit trusts and the like – are being forced to eat substantial losses on their bonds. Their losses are privatised, unlike those of “Too Big To Fail” EU banks who have cynically taken billions in additional liquidity from the ECB and parked it on their balance sheets.

Putting all examination of whether currency unions are a bad idea or not, the EU has proven beyond all doubt that they are incapable of managing a common currency and thus a common monetary policy.

Thus arguments for giving more power to EU officials and even standardising fiscal policy across member countries are so insane it is clear that EU officials are living on another planet.

Let’s recall : before the Euro there were several attempts at a “common currency”. All of them failed because no one played by the rules. The UK was one of the worst offenders at this. They paid for their sins on Black Wednesday.

The “unicorns and rainbows” theory that all member countries can sort out their mess by simply handing over the reigns of their fiscal policy and monetary policy to the unelected bureaucrats of Brussels, overseen by an incompetent and gridlocked European Parliament, needs to be examined far more closely by the media.

I regularly read opinion pieces and articles in the media that are clearly closer to European Central Bank press releases than any decent analysis of what’s at the root of all of this nonsense : the idiotic notion that an organisation that produces such varied Euro Vision contest entries could somehow co-operate on fiscal and monetary policy without making itself a laughing stock.


Greece Should Default And Leave The Euro

The truth about Greece is that staying in the EU and sticking to the Euro is impoverishing Greek citizens and amplifying the popularity of right-wing extremist parties such as Golden Dawn.

I read with interest that German officials are actually developing some of the spending cuts the Greek government must implement. With untold billions of euros worth of bailouts already gone and even more to come, a line has to be drawn in the sand.

The time has come for an immediate Greek exit from the Euro. Greek exports are clearly uncompetitive being priced in Euros. Greek culture has languished for too long with low productivity and a welfare state that knows no limits.

The adoption of the drachma and a return to an independent monetary policy would be a far better course of action than continuing to skewer the people of Greece with high prices and uncompetitive exports priced in a currency they don’t deserve to be in.

A culture of tax avoidance and debt snowballing in unison with a brain drain of Greek professionals that started back in the 1950’s means that enormous cultural hurdles must be overcome in order to get back on track.

But what does back on track mean? It surely doesn’t mean paying back the billions of dollars in debt that successive Greek governments have accumulated. It sure doesn’t mean impoverishing Greek citizens so penny-pinching German bankers can experience schadenfreude.

The elevation of the bondholders as the most important people on the planet has grave consequences for how the world works. The fact that banks had to have debt writedowns rammed down their throats does not bode well for any compassion in the great reckoning that is to come.

There is no doubt that the Greek people share some culpability for voting themselves more money without increasing productivity, exports, savings or developing any standout product or Unique Selling Point for tourism.

The bondholders are not the most important people in the world. Risk and reward should exist in every asset class, sovereign debt included. If a Greek default leads set in motion multiple bank collapses around the world, that should go with the territory.

Stripping the savings of German households and shipping them to a government propped up by a slim majority and facing almost total collapse of civil society is not the way forward for Greece. Default is not a bad call when there are no prospects whatsoever of Greece becoming self-sufficient under the Euro.

Why should we accept at face value anything boldholders claim will happen if Greece defaults? The financial sector has no credibility anymore. The global financial crisis proved what a house of cards they operate on.

“Too big to fail” means “too dangerous to keep operating”. The mess of derivatives associated with hiding Greek debt and making coy claims of compliance with the Treaty of Maastricht are yet another indication that banks want to have it both ways.

Through supporting Greece staying in the monetary union, all policymakers are doing is letting bankers win twice – once with all the fees and interest as the debt rose to unsustainable proportions and again with artificial writedowns that kick complete loan writeoffs into the future and keep banks solvent when they actually aren’t.

George Soros wrote a really good analysis of the international lending boom in the 1970’s that culminated in a bank crisis in 1984. All of the same arguments are being recycled now – too big to fail, IMF loans, World Bank led reform, central banks banding together to get things done.

The bondholders know that history repeats. Once as tragedy, twice as farce. The farcical elevation of the bondholders over human beings is the great shame of the 21st century. Too bad many economists can’t see the wood from the trees here.

The European Union was the most risky and unstable idea ever implemented in the history of global politics. It doesn’t meet any of the optimal currency area requirements espoused by Robert Mundell. Complete and utter mistake that needs to be unravelled before Golden Dawn equivalents take over throughout the EU.