More on the Eastern European Economic Crisis

As a follow-up to my previous post on the future of the Euro, here is John Mauldin discussing the economic crisis in Eastern Europe:

Another Look at the Collapse of U.S. Domestic Demand

The big headline today is that real GDP in the United States actually contracted at annualized rate of 6.2%--versus the initial estimate of 3.8%--in the 2008:Q4. Buried in this GDP revision is an even more chilling number: U.S. domestic demand collapsed at annualized rate of 10.3%. This can be seen in the figure below. (Click on figure to enlarge.)


This means nominal spending is crashing in the United States. Addressing this collapse should be one of the top--if not the top--objectives of macroeconomic policy as recently noted by Scott Sumner, Samuel Brittan, and Martin Wolf. Such a large drop in domestic demand means either (1) a collapse in real spending and thus real economic activity and/or (2) deflation. Obviously the former is not good news, but the latter is also bad news since it can set off a deflationary spiral that leads to further real declines.

Another Unexpected Outcome of this Recession: More Art

Tyler Cowen and Dan Drezner have documented some of the unexpected outcomes from this recession. According to NPR there is one more item they should consider:

Tough times can often be a springboard for creativity; when no one's job is safe, no one's house is secure and no one knows exactly what to do about it, artists get to work.

"That kind of stress often results [in] the need to scream, and art is a way of screaming," says Miles Orvell, an English and American studies professor at Temple University. "Difficult times like the one we are experiencing today can really bring out a kind of expressive culture in an interesting way."

I am looking forward to this development.

The Future of the Euro (Part VI)

As readers of this blog know, I have been following the debate on whether the Euro can survive the current economic crisis. Most recently, I noted that this crisis may actually lay the foundation for a real fiscal transfer mechanism in the Euro area, something that is sorely needed to make this currency union a true optimum currency area. Such a development, of course, presumes the current economic crisis makes the Euro-area institutions stronger rather than tearing the region apart. The latest news coming out of out Europe suggest the big fear now is that the financial meltdown in Eastern Europe is making the latter scenario more likely. The Europeans are concerned enough about this development that they have called for an emergency summit. Even the typically Euro-sanguine Wolgang Munchau of the FT is concerned that the "Eastern crisis...could wreck the Eurozone." Back here in the United States the mood is equally gloomy according to this article in Bloomberg:

Feb. 27 (Bloomberg) -- Hayman Advisors LP, the firm that earned $500 million betting on the U.S. subprime mortgage-market collapse, says Europe’s monetary union is about to fall apart.

Richard Howard, a managing director for global markets at Dallas-based Hayman, said Germany may opt to shore up its own economy, Europe’s biggest, rather than bail out fellow euro nations such as Austria, Italy and Spain as their banks sag under the weight of bad debts. That might lead to defaults and compel Germany to renounce the euro, he said.

“People said subprime could never blow up but it did and now they’re saying the exact same thing about the eurozone,” said Howard. “There’s no stopping what is now a downward spiral.” He declined to discuss his investments.

Hayman joins a growing number of investors seeing the possibility of a breakup of the $12 trillion euro bloc, conceived more than 10 years ago to cut unemployment, tame inflation and create a rival to the dollar. Societe Generale SA said this week Germany may refuse a bailout in an election year. ABN Amro Holding NV said Feb. 17 the crisis is “Europe’s subprime.”

[...]

The breakup may occur as investors shun all but the safest government bonds, said Hayman, which in 2006 was among the first to bet against Wall Street’s rush to securitize the debt of the least creditworthy U.S. borrowers, correctly predicting a slump in home values that sparked the global credit crisis.

Investor demand for the lowest-risk securities already drove the difference in yield, or spread, between Greek, Austrian and Spanish 10-year bonds and German bunds, Europe’s benchmark government securities, to the widest since the euro’s debut.

So a "growing number of investors" are seeing a greater likelihood of the Eurozone breaking up. If so, you would think these investors would be adjusting their portfolios accordingly. There is an intrade contract that indicates the probability of a nation dropping its use of the Euro by December 31, 2010 has not change much since July 2008 (see figure below). This contract suggests that a "growing number of investors" may be a bit of an overstatement. Or maybe this contract is to thinly traded to truly reflect the increased fear about the Eurozone. Any thoughts?

Clive Crook on Long-Term U.S. Fiscal Costs

While supportive of the short-term fiscal stimulus, Clive Crook cautions that we should be thinking seriously about the long-term fiscal health of the United States. He is glad, therefore, that President Obama is spending so much time this week discussing this issue, but wonders if the conversation will be frank on the tough fiscal choices the nation faces over the long-haul:

This year’s budget deficit will be about $1,400bn (€1,090bn, £977bn) or roughly 10 per cent of gross domestic product. This comprises $1,200bn, as recently estimated by the independent Congressional Budget Office, plus another $200bn from the first year of the fiscal stimulus. What happens after that? A new analysis for the Brookings Institution by Alan Auerbach and William Gale estimates that the deficit will average at least $1,000bn a year over the next decade – and this on the basis of some pretty optimistic assumptions.

It assumes an orderly recovery, much as from previous recessions: no lost decade of slow growth. It assumes that the provisions in the stimulus law expire when the act says, even though the administration and Congress hope to make many of them permanent. It takes no account of new outlays under the housing plan or the forthcoming financial stability plan. And it assumes the administration does not embark on comprehensive healthcare reform, even though the White House insists it will.

Even under these favourable assumptions, an annual deficit of $1,000bn or more persists. The Auerbach-Gale study also looks further ahead and estimates a “long-term fiscal gap” – “the immediate and permanent increase in taxes” that would be needed to keep the ratio of government debt to GDP constant at its current level. Under those same favourable assumptions, the necessary tax increase is between 7 per cent and 9 per cent of GDP, about equal to the take of the present federal income tax.

Stephen Colbert on Religion & the Business Cycle

Stephen Colbert talks about turning to religion during the recession and cites an interesting study on the issue:

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About That Economic Downturn of 1873...

It did not last until 1879 and it is not the longest U.S. economic contraction on record. One would not know this, though, by looking at the NBER's business cycle dates. These dates show this economic downturn lasted a record 65 months from October 1873 through May 1879. Therefore, it is understandable why observers like Paul Krugman, Matthew Yglesias, and Robert Shiller continue to invoke this period in their discussions of the current economic crisis. These dates, however, are wrong according to a series of papers published by Joseph H. Davis ( 2004, 2006 ). Using a new and more robust measure of industrial production for the Postbellum period, Davis shows most of the NBER recessions during this time are overstated. In the case of the 1873 downturn it only lasted 2 years. The popular Balke and Gordon (1989) real GNP series for this period similarly shows only a 2-year recession following the 1873 economic downturn while the famous Romer (1989) real GNP series shows no recession at all during this time. Unfortunately, the NBER has not revised these dates and, as a result, it continues to add confusion.

The figure below shows the log version of these three series for the Postbellum period. Nowhere in this figure is there 5 year + economic downturn in the 1870s. (Click on figure to enlarge.)