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It's interesting to note that what is happening today in Europe is similar, in many ways, to what occurred during the early 1930s (as described by Garet Garrett in The Bubble That Broke The World). Several Central European countries, especially Germany, were facing the prospect of not being able to pay back on their debt, so the solution was to bail it out by helping the Reichsbank inflate the currency. This resulted in a scheme were ultimately most of the new money was coming from the Federal Reserve Bank of New York, and so when Germany defaulted it disrupted the solvency of banks in the creditor nations.

Admittedly, today's situation is different in many ways. But, it nevertheless remains similar in key areas. This includes Europe's attempt to bailout Greece, and the fact that Greece is likely to default on loans. The effects of Greece's bankruptcy will ripple not only through other insolvent governments, but also through the creditor nations, such as Germany.

Jonathan -
Except this time there seems to be no prospect of inflating their way out at all. The ECB is not the Reichsbank. Indeed, it is largely the lesson of the Reichsbank that has made the ECB what it is today.

Peter -
Do you make any distinction between sustainable deficit finance and other deficit finance? I had this reaction to your earlier post on the deficit problem as an expenditure problem - my question was "is he thinking of the same 'deficit problem' that I'm thinking of?". You write: "government administrations at all levels have a natural proclivity to spend more than they bring in (deficit finance), this results in accumulated public debt, which the current political generation has a strong incentive to pass on to future generations" - but it only results in accumulated public debt burdens if the deficit grows faster than GDP. Granted, that's only one measure of debt burden - but it seems to be a decent one to me.

The EU authorities are caught between a rock and a hard place.

On the one hand, if the bail out a couple of the PIIGs then the others will demand bailing out too. There will be a race for EU and IMF money. Governments with restless populations will be positively stimulated to bankrupt themselves so they become eligable for aid.

On the other hand if the countries are set free of the Eurozone and ordered to refloat their own currencies then that will cause chaos and imperil the euro project.

The only other option is inflation, and it is unlikely that significant inflation really is an option.


You write,

Except this time there seems to be no prospect of inflating their way out at all. The ECB is not the Reichsbank. Indeed, it is largely the lesson of the Reichsbank that has made the ECB what it is today.

Well, I wouldn't be so sure. While the ECB cannot inflate Greece out of its debt, because it also has to focus on monetary policy beneficial to Germany and other relatively 'healthy' European governments, what happens when Greece defaults on debt held by German creditors? What happens when Spain, Portugal, Ireland, Italy and Hungary also default on their debt to German creditors?

How will the ECB respond to a damaged German banking industry? I figure it will respond with a loose monetary policy, much like it responded to the current crisis.

But, it's not as if the ECB's policy to date has not been inflationary. The euro's monetary base has been growing at an accelerating pace. The ECB, furthermore, currently already has a loose monetary policy in its attempt to stimulate German and French exports.

In that sense, it is similar to what occurred during the 1930s. The Federal Reserve Bank of New York, apart from directly monetizing German debt, also lent out vast amounts of credit to English banks, including the Bank of England. These banks risked bankruptcy since they were some of the major creditors to the German government, at the time. This strikes me as similar to relationship between the ECB, Germany/France, and the marginal EU countries (PHIIGS).


Sorry to go off-topic, but I can't find a contact email.

Anyway, I wrote an article Dodd's new financial regulation bill, and I think everybody here might like it.

Thanks. Hope things are going well.


The recent Buiter's paper on sovereign indebtedness shows that Greece is close to hopeless, and the next worse are UK and US, with France closely following and Germany and Italy in fairly good shape (in Italy there are not many off-balance sheet liabilities becasue the welfare state does not guarantee anything, besides private assets are fairly high due to high savings).

In the future the off-balance sheet liabilities of sovereign entities, mostly social security promises, will need to be cut drastically, not before, of course, having hampered capital accumulation and fostered capital consumption for a long time.

The news is not that social democracies are trying to commit suicide, the problem is to explain how did they succeed in surviving for so long.

The surprising news, although it doesn't comes as a surprise to me, is, the myth of Neoliberalism notwithstanding, the US is no better, and often worse than, continental Europe.

With the least credible monetary framework in the civilized world (the Fed is a inch better than Zimbabwe), a fiscal policy worthy of a banana republic, a personal saving rate which can be justified only assuming that the world is coming to an end very soon, and a financial market based on the systematic socialization of the costs of capital and risk taking (without forgetting an overextended, and often inefficient and ineffective, military), only radical and couragious reforms will save the country from its future decline in relative and absolute importance. But at the moment it is unlikely that democrats or republicans will be able to pursue clever and farsighted policies.

Reagan at least solved some of the structural problems of the US economy in the '80s, although creating a fiscal black hole and putting a demagogue at the head of the Fed... a fiscal, monetary and social (I don't mean homophobic creationist christian fundamentalists) libertarian (there are no longer reasons to dub "conservative" those who are for responsible policies, of course) will be necessary.

This morning may grammar is worse than usual. I'm sorry for the collection of mistakes.

Default by Greece would be colourful, but do not get your hopes up for salutary lessons.

There is a long history of defaulters, near and far, including various American states in the 1840s, slipping back into the markets to borrow again not too long later.

Loan premiums adjust and the term of loans reduce to account for revised default risks and a greater chance of surprise inflation

The news is not that social democracies are trying to commit suicide, the problem is to explain how did they succeed in surviving for so long.

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