Friday, April 15, 2011

Here We Go Again...

Desmond Lachman has a new article where does a great job comparing the current failures of ECB with those of the Fed in 2008-2009.  One comparison I would add is that the ECB's tightening of monetary policy this month over concerns about inflation is very similar to the Fed's decision not to cut the target federal funds rate in the September, 2008 FOMC meeting because of concerns about inflation. One would hope that the ECB would learn from the Fed's passive tightening of monetary policy in 2008. Here is Lachman:
Mark Twain famously observed that history does not repeat itself but it does rhyme. Considering how Europe's sovereign debt crisis is playing out, one has to be struck by Mark Twain's prescience. For the Europen sovereign debt crisis bears an uncanny resemblance to the 2008-2009 U.S. financial crisis. And it gives every indication of having the potential to shock the global economy in a manner not too dissimilar from the way in which the U.S. subprime crisis did.


Apparently not learning from Mr. Bernanke's monetary policy mistakes in the run up to the U.S. crisis, Mr. Trichet now appears intent on compounding the Eurozone's sovereign debt crisis by having the ECB start an interest rate tightening cycle. For the last thing that Europe's periphery needs right now is higher European interest rates and the associated Euro strengthening at the very time when the periphery is engaged in draconian budget tightening and in a major effort to restore international competitiveness.

Yet another disturbing way in which the Eurozone debt crisis resembles the earlier U.S. subprime crisis is the way in which European policymakers are engaging in self delusion. They do so by fooling themselves that the problems with which they are dealing are ones of liquidity rather than solvency. And at each stage of the crisis they manage to convince themselves that they have ring-fenced the crisis.


In May 2010, at the time that the U.S.$140 billion IMF-EU bailout package for Greece was announced, markets were asked to believe that Greece's case was sui generis. They were also asked to believe that the Eurozone's periphery was suffering from only liquidity problems and that these problems would soon dissipate once market confidence was restored. Yet six months later the IMF and EU had to bail out Ireland. And today nobody doubts that Portugal will soon have to be bailed out as well.

Despite record high interest on the sovereign bonds of Europe's periphery even after massive IMF and ECB support, European policymakers keep up the charade that Greece, Ireland, and Portugal do not need a debt restructuring. And despite Spain's serious problems of external over-indebtedness, a major housing bust, and a highly troubled savings and loan sector, European policymakers are asking markets to seriously believe that Spain will not be the next domino to fall.

Perhaps the most disturbing aspect of the Eurozone debt crisis today is how little European policymakers are asking of the European banking system to raise additional capital to cushion itself against the inevitable large write down in the periphery's sovereign debt. In that respect too they are providing additional evidence for George Santayana's adage that those who do not learn from history are bound to repeat it.


  1. David
    Check Weber!

  2. Good post. I cannot fathom this drive for monetary tightness and fiscal austerity in current circumstances.

    It reminds me of people who engage in self-flagellation as part of some sort of religious practice.

    We have to suffer for our excessive sins.

    Fine--but suffering at this point won't jumpstart the recovery.

    Ask Japan how tight money has worked out.

  3. Yes, you are right that the Federal Reserve appears to have got itself into a bit of a bind. The excess supply ofliquidity has fed through to higher commodity prices, which is crimping the ability of homeowners to make their payments, potentially weakening the housing market further. So the theory that a monetary inflation would cure debt deflation problems lies bleeding. And this was always in the cards given that new money courses unpredictably through the economy.
    Fiscal policy could help now, but even it is only a palliative. The US economy is so deeply structurally impaired that policies acting to increase the money expenditure flow are just bandaids.