The Euro: A perfect case study in political economy: Krugman vs the other Gordon

One of the problems with economics is that it tends to narrowly parse its objects of inquiry. That is, it suffers from a deranged elegance: too few factors are considered and the ones that are get so rendered that they rarely resemble the original beast. It is curios in this respect that Paul Krugman should play the church mouse and Stephen Gordon the Scrooge. But hey I come from an Anabaptist tradition so what do I know. Between simply getting for free through a culture of potential heresies in the margins and a culture of perfecting the reformed holy writ something almost always creeps in.

Shit happens and in this, the Euro, Gordon is closer to the mark than Krugman.

As Gordon (Stephen not to be confused with the other venerable Gordons: different breed I gather) argues:

The euro project had much more to do with advancing the goal of promoting an ever-close political union than implementing a sensible monetary policy. As the current crisis has shown, a common currency is hard to sustain without a central government that is able to redistribute income from one region to the other. It seems to me as though the people who pushed the common currency hoped that by the time the euro was put under pressure, the central government with the necessary powers of redistribution would be in place.

I think Mr. Gordon is on to something but he does not go far enough. Both right and left in Europe feared the Euro was part of a broader project of cajoling EU countries towards a more neo-liberal policy paradigm (perhaps one which Gordon would support). The point was to force an independence between the central banks and potential or actual “political” interference (again something Gordon would probably support). Note that in Sweden the fight over the adoption of the Euro played itself out in somewhat this way. Interestingly, both the social democrats and the “bourgeois” parties wanted the Euro. The popular left did not because despite the functional independence of the SCB the popular left wanted the possibility of a bank that could be capable (if forced) of taking everything from exchange to inflation rates into consideration.

The other side of the Euro debate was the desire to make sure that the EU was not plagued by beggar-thy-neighbour monetary policy–reasonably understanding that a race to the bottom could be negative sum. And I think this is why the putative left establishment in Europe supported and continue to support the Euro.

Krugman is thus naive; the Euro was never a mere technocratic exercise designed to reduce transaction costs. Yet Gordon is equally naive for different reasons. The Euro was only in part about transaction costs and only in part about redistribution (although as Gordon notes redistribution is the spoonful of sugar that was supposed to make the medicine go down) it was also in large measure a plan to take the perceived candy jar away from the children–politically accountable national central banks.

In this regard Canadian central banking works because politically speaking it is free to rest just above whatever the FED decides. Thus this why the BOC never goes offside: it takes its cues and dues from the FED not parliament. The EC could not guarantee this unless all were brought to heel: thus the Euro.

If we had a less independent central bank in Canada I suspect Gordon would be singing a different tune.

Selected Central Government Debt Ratios: An image begs a thousand questions

When discussing with my undergrad students why I thought Japan Inc. was bust I trotted out the graph below.  However, this morning while looking at the graph several questions came to mind.

1) From 1998 – 2008 what was average real interest rate in Japan and how does that compare to the ten years previous to 1998?

2) What has been the average level of inflation in Japan since 1998?  Again how does that compare to the 10 years previous to 1998?

I already know the answer to those questions but I would have not arrived there by any HAT (highly accepted theory).

3) Why are we even talking about programs cuts in Canada before it is clear that the world economy and the US economy has started a robust recovery? And why especially when Canada is way below the advanced capitalist curve (in terms of debt to GDP)?

Click for larger image

Lunacy on Loonie spreads to the Department of Finance via the Bank of Canada

At some point we are going to have to throw in the towel and conclude that there is a concerted effort to promulgate the noble lie.  It was one thing when the business press argued that the BOC faced technical limits to their capacity to retrench the value of the Canadian dollar, and yet another thing when almost every commercial bank economists pushed the same fallacy.  But now no less than the BOC and the Department of Finance, respectively incarnate in Carney and Flaherty, are pushing the same argument.  The FP reports:

Bank of Canada Governor Mark Carney said on Tuesday that foreign exchange intervention did not usually work without complementary policy moves.

“I agree with what the governor of the bank said yesterday …. that it is a limited tool,” Mr. Flaherty told reporters.

At least Carney was smart enough to add the vague qualification “complimentary policy moves.”  Flaherty of course stripped it down to the most elegant version of the Nobel Lie.  For those looking for further detail about why it is simply not true that the BOC is constrained in its capacity to devalue the dollar go over to worthwhile Canadian and read the series of posts on this subject.

So I am curious why would the BOC who most definitely knows what Worthwhile Canadian knows be misleading the public?  The only thing I can come up with (because I do not assume people are dumb) is that the neither the BOC nor the Canadian government has any interest in a policy that would be largely regarded as one of competitive devaluation.  So instead of fight the policy issue out in public on its merits they are attempting to smother it under a “technically not feasible” argument.  That is, they are doing what the BOC always does.  Depoliticize and dispense .

The most noble lie

Tough talking Carney retrenched dollars rise. Or did he?

You would be really mad if you took my analysis and went long on the Canadian dollar especially if you found out I had taken a short position.  None of what you hear, half of what you see.  But seriously can we credit Carney with the non-trivial ( near 5 cent) decline in the Canadian dollar.  Maybe, but only if you can give him credit for talking down the TSX as well.

charting dollar TSXSource: Globe Investor

We do not do spin…We don’t lose our focus: Carney the rain maker

Listening to Mark Carney talk tough is like watching Stephane Dion pound his fists on the table.  Well ok a little more credible than that.  Being a former GS man you know he knows people who know people.  Some of which I should think are quite unpleasant characters.  Problem is there is not really a robust connection between the value of the Canadian dollar and inflation or deflation.  Currency traders probably know this…at least more than they have some version of the standard (and empirically dubious) model in their head.  So when Carney says “we take our inflation target seriously.”   Currency traders likely shrug and say: “we are banking on it.”

Mr. Carney said he has a range of tools and he can use to dampen the blow of the currency’s rise, and signaled that any investor who thinks he’s shy to use them is making a mistake.

“Markets should take seriously our determination to set policy to achieve the inflation target,” Mr. Carney said. “Markets sometimes lose their focus. We don’t lose our focus.”

Carney’s problem (well actually the manufacturing sector’s problem) is that the BOC does not care about the level of activity in exports. It only cares about their target.  Full stop.  So unless deflation increases in some way that can be definitively linked to the appreciation of the CAD–which is doubtful–the BOC is not going to do anything.

Are currency traders and Bank economists dumb as a sack of hammers?

The short answer is no despite what has been argued here and here.  Bank economists may be a comfortable and no doubt arrogant bunch (imagine combining the natural arrogance of economists with the comfy smugness of Canadian bankers… thankfully a cocktail party I will never be invited to).  But do we really believe they do not understand the difference between raising and lowering the value of a currency and the different mechanisms required for each?  I think they probably do.

So does Erin Weir over at the Progressive Economics Forum.  He makes a cogent case why bank economists may be arguing (erroneously) that the BOC does not have the resources to intervene in fx markets to depreciate the CDN dollar.  In a nut-shell Erin argues that the CDN banks are looking to do a little foreign financial asset shopping and that a high CDN dollar makes that prospect even more lucrative.  I like this explanation because it does not rely on bank economists being stupid, but, rather, hard-working employees serving their employers to the best of their abilities.  And I if that requires misdirection so be it.  Let me put it this way: I think they are bank employees before they are economists.

When it comes to economists and bankers I always prefer rational actor models.  But hey ad hoc explanations are always amusing. And insinuating that people are stupid does allow one to feel superior I suppose.

Next comes currency traders.  Are they as dumb as a sack of hammers?  Again I think not.  Aggressive if jittery risk takers…you bet…stupid nope.  They have played this game before and it is called chicken.  I bet they do not think the BOC has the nerve to go into the fx markets in big way, that the BOC does not want the precedent; that it does not want to fuel the notion that the value of the CDN should be set be fiat etc., etc.

Sure, yesterday the loonie lost two cents on Marky Marc’s: “I really mean it this time, I just might do something.”

Today it was back up a cent by noon trading.


The game of chicken is on.

Forget the Bank of Canada: We need an INVITE program to stem appreciation of the CDN Dollar.

If what we are worried about is an overvalued CDN dollar which is caused by speculative flows then why the focus on the Bank of Canada?  Exchange rates are not really in the BOC’s mandate.  Sure in the case where an appreciating CDN dollar is causing further deflationary pressures it could be argued that exchange rates are within the purview of the Bank’s mandate.

But the BOC is a conservative (in both the ideological and cultural sense) institution.  Canada does not face the same structural dynamics (problems) as the UK and the US.  And thus I doubt arguments for non-conventional monetary policy responses are going to get very far with the Bank.  Moreover there are downside risks to pursuing unconventional monetary policy.  We might get a lower exchange rate at the expense of perverse side-effects.  So forget the BOC; leave them out altogether.

Thankfully, however, when it comes to exchange rates there are policies available to the government. On such policy could be called an  Investment Inflow Tax Equilibration  program (INVITE).  It would work like this.  A simple 2% tax on all inward portfolio investment (as Brazil just announced) would help stop appreciation in its trax.  Second if we really think much of the dollar’s appreciation is being driven by gas and oil then an additional 2% tax on all oil and gas investment inflows regardless of the type (portfolio or direct) would help further dampen the speculative plays in that sector.  The terminator seed on the INVITE program would be when Canada’s manufacturing sector returned to some degree of health.

Bank of Canada Beats a Retreat on Optimism

Well I do not mean to brag but I did argue at the time, along with others, that Mark Carney and the BOC were being overly optimistic to which the usual suspects countered that the BOC had super superior models and modelling acumen. So it was, as it is now that Super Mark and the BOC are beating a hasty retreat from their rosy optimism. The globe reports:

The Bank of Canada cut its benchmark lending rate to the lowest possible, and promised to leave it there for as long as a year in order to fight a recession that is deeper and will last longer than previously thought……

The central bank now predicts that Canada’s gross domestic product will shrink by 3 per cent in 2009, compared with a January estimate for a 1.2-per-cent contraction.

The Bank of Canada also abandoned its relatively optimistic estimate that the economy would rebound to expand 3.8 per cent in 2010. The recovery will be far more muted, with an expansion of 2.5 per cent in 2010, the central bank said.

Mr. Carney and his chief advisers on the governing council are trying to restore confidence amid Canada’s first recession since 1992. Employers have shed more than 270,000 jobs since the country fell into a recession in the fourth quarter, a period during which factories produced at only 75 per cent of their capacities, the lowest rate on record…..

Hmm…maybe we start taking fiscal policy a little bit more seriously now and not its faux ami tax cuts?


Erin Weir on BoC rate cut.  Better Late Than Never

Carney goes all in: “We dont do spin”


In the Bank’s January Monetary Policy Report Update, we projected that global economic growth will be tepid this year – just 1.1 per cent – before rebounding mildly to a below-trend rate of 3.7 per cent in 2010.


We are now in recession with GDP projected to fall by 1.2 per cent this year. The first half of the year will be particularly challenging with sharp falls in activity and increases in unemployment.

But nevertheless:

In our base-case projection, real GDP is expected to rebound in 2010, growing by 3.8 per cent.

CBC Reports:

Liberal finance critic John McCallum asked whether the forecast “goes out on something of an optimistic limb.”

“We don’t do optimism; we don’t do pessimism,” Carney countered. “We do realism at the Bank of Canada. We don’t do spin.”

I think they do do spin over at the Bank of Canada and I also think that any sign of solid growth above say 1.5% in 2010 and nobody will care.  That is, the bluff will work whether it “works” or not because the prediction will be defended as reasonable at that time with the information and model they were working with.  2010 is a long way out for a forecast.

The fatal flaw at the heart of the neoliberal growth model:update

REPRINT: Given where we are now I thought this might be worth a reread. It was written last march of this year.  It is like I was clairvoyant back then: paragraph two three and four.

Travis Fast

March 2008

This post was stimulated by Andrew Jackson’s post today

There is by now a broad consensus that the problems in the sub-prime sector were intimately linked with, on the one hand, a gush of global liquidity caused by too many investors seeking too few outlets and exacerbated by low interest rates and on the other hand, by demand underwritten by a property bubble and a deluge of consumer credit–again underwritten by low interest rates.

All of this points to the fatal flaw at the heart of, what for lack of better term I will call, «the neoliberal growth model». Namely that it is premised on the continual expansion of consumer demand at a pace that exceeds wage growth. At some point workers were going to get over leveraged and at that point a vicious cycle had to set in. We have only seen the collapse of housing thus far (in the US and starting in the UK) but there is an equal if not greater tranche of bad consumer debt floating around.

When the ‘public’ i.e., the state steps in to underwrite all this bad debt, which they have already begun in the US, we are going to see the (re)nationalisation of private debt of all kinds. This would in effect mark-off the end of the privatisation of national debt onto the backs of workers as individuals but not collectively as tax payers.

In the short term, therefore, it seems key that we would want to argue that workers cum consumers and homeowners get the first bailouts (as it is they who will have to collectively pay it all back through taxes) and secondly that any cash that does go to the financial sector comes at a high price in terms of large public ownership. AND not the kind where the public buys the toxic junk and lets J.P Morgan buy the performing assets!

We ought to recall just how savagely public assets were raided by capital during the last 20 years. Why not insist on a reverse fleecing whereby the only shareholders which get reasonable treatment are institutional investors such as pension funds the rest are left to eat cake.

In the more medium to long term something has to be done to reverse the situation whereby workers wages are stagnant and at the same time capital has so much cash on hand that they can’t find legitimate places to invest and so buy into pyramid schemes masquerading as financial innovations or bubbles or both as the case now seems to be.

All of this points in the direction of extremely strong labour rights clauses and enforcement mechanisms in trade agreements because the present imbalances are being driven by the core neoliberal imbalance between workers and capital. If workers are given the legal tools to organize and take on employers at the bargaining then some modicum of parity could be restored between wages and profits which would go some way to resolving the demand flaw at the heart of neoliberalism.