Saturday, March 19, 2016

Keynes Would be Spinning in His Grave

If he could see what is going on in the Euro Zone.

There are deep structural and policy problems in the Euro Zone which have prevented or muted its recovery from the recession. The policy problem, similar to ours, is a lack of stimulus spending to put an end to general deflation and recession. The structural problem is that the individual countries, while sharing the same monetary unit, can not adjust their levels of general economic activity relative to each other, or have independent monetary policy, except through trade. And their trade relationships are hopelessly unequal, with Germany in the lead, and the peripheral countries like Greece and Spain uncompetitive, at least in fixed Euro terms.

While the going was good, Germany was willing to lend the money which flowed in through trade back out to the southern and peripheral countries. But these were only loans, not fiscal transfers as would happen in a  more integrated country/zone. So then we had the drama of creditors asking for the money back, arranging for debt forgiveness, bailouts, etc., all when the debtor countries were on their knees.

In essence, the Euro Zone operates like an old-fashioned gold standard international system. A common unit of exchange and value is kept stable across supposedly independent countries which each have their own policies of trade, employment, corruption, public services, etc. This unit is not really shared out from the central bank on a per-country basis, let alone to correct specific trade imbalances, but generated in response to economic growth in sum across the whole zone, managing issuance and interest rates with the overarching goal of low inflation (since the Germans are running the ECB, more or less). Thus each country needs to accumulate what is to them a fixed unit of exchange through trade, lest they run into chronic debt to the other countries. Each country is moreover on the hook for its various economic disasters like insolvent banks, unemployment, and social unrest.

Here is what Keynes wrote about this kind of system, as opposed to a system of floating exchange between sovereign nations:
"Never in history was there a method devised of such efficiency for setting each country's advantage at variance with its neighbours' as the international gold (or, formerly, silver) standard. For it made domestic prosperity directly dependent on a competitive pursuit of markets and a competitive appetite for the precious metals. When by happy accident the new supplies of gold and silver were comparatively abundant, the struggle might be somewhat abated. But with the growth of wealth and the diminishing marginal propensity to consume, it has tended to become increasingly internecine."
"I have pointed out in the preceeding chapter that, under the system of domestic laissez-faire and an international gold standard such as was orthodox in the latter half of the nineteenth century, there was no means open to a government whereby to mitigate economic distress at home except through the competitive struggle for markets. For all measures helpful to a state of chronic or intermittent under-employment were ruled out, except measures to improve the balance of trade on income account."
".. those statesmen were moved by a common sense and a correct apprehension of the true course of events, who believed that if a rich country were to neglect the struggle for markets its prosperity would droop and fail. But if nations could learn to provide themselves with full employment by their domestic policy (and, we must add, if they can also attain equilibrium in the trend of their population), there need be no important economic forces calculated to set the interest of one country against that of its neighbors. There would still be room for the international division of labor and for international lending in appropriate conditions. But there would no longer be a pressing motive why one country need force its wares on another or repulse the offerings of its neighbor, not because this was necessary to enable it to pay for what it wished to purchase, but with the express object of upsetting the equilibrium of payments so as to develop a balance of trade in its own favor. International trade would cease to be what it is, namely a desperate expedient to maintain employment at home by forcing sales on foreign markets and restricting purchases, which, if successful, will merely shift the problem of unemployment to the neighbor which is worsted in the struggle, but a willing and unimpeded exchange of goods and services in conditions of mutual advantage."

One might add that this need for markets and trade also drove European countries toward colonialism which was so destructive, especially in the latter phases as laggards like Belgium, Italy and Germany got into the game. It is a wonder (of a negative kind) how, eighty years after Keynes's lessons were introduced in response to the Great Depression, and after several postwar decades during which they were put to such prosperous use, we, and especially his own continent, are struggling in the mire of older orthodoxies that he had laid to rest. I was about to note that we can at least be thankful that none of the current leaders advocate a return to an actual gold standard, but that turns out to be incorrect.


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