Market Overview

Five Angry Elephants


Robert Hockett

What is by far most remarkable about discussions of the Eurozone's difficulties over the past twenty-four months is what goes unremarked. At least five angry elephants, siblings all, stand in the room stomping beside most of the commentators - especially those who congratulate Germany while hectoring Greece.

And yet there they all sit, quietly stroking the cats in their laps while wagging their fingers at those in the south.

Who are the restive elephants to whom we should be attending instead?

Elephant 1 is the fact that the northern European nations now hectoring the south owe their prosperity not to austerity, but to the putative profligacy of the southerners themselves. How can that be?

It's not supernatural: the northerners' goods and services are priced in a currency that, were it their currency alone, would be much higher priced in the currencies of others. The northerners' surpluses, in other words, owe precisely to the fact that their currency is shared with the 'spendthrifts' they lecture, whose ways lower the price of the Euro.

In this sense, in other words (and there's another sense to come), northern surpluses just are southern deficits - and vice versa. Northern urgings of 'belt-tightening' down south are accordingly down on all fours with the counterpart urgings by China, accompanied of course by continued binging on Treasurys so as to keep the yuan underpriced, that the US save more and spend less. The proper reply to both school marms here is, be careful what you wish for. And to think, defenders of the latest ad hoc solution to the crisis, in the face of market skepticism, castigate markets for short-termism. That takes us to Elephant 2.

Elephant 2 is the fact that austerity and balanced budget imperatives pressed on the south are at present the problem, not the solution - as the markets and indeed all but the northerners and Chinese now realize.

Where southern European nations such as Greece, Portugal, Spain, and Italy experience declining public revenues owing in significant part to deflation-induced sluggish growth, austerity unaccompanied by fully compensatory expenditures from the north on the south - ideally on the south's goods and services rather than more of its peonage-inducing debt - are no better than flames doused with petrol.

Financial market participants seem to be noticing this even as northern officials manage somehow to miss it. And that is all that's required to explain markets' not being enthused by the slough of 'agreements' agreed among Eurozone nations since last December. That takes us straight to our next several elephants.

Elephant 3, like its sibling Elephant 1, feeds in part on the fact that the southern Euro's deficits are the northern Euros's surpluses: it is the fact that a Euro that's overvalued relative to southern European conditions means both that southern exports have been systematically disadvantaged (with northern ones correspondingly advantaged), and that southern borrowing has been systematically too inexpensive.

Combine these twin facts with the fact that the southern states have been lax in - if not indeed sometimes corrupt about - collecting tax revenue from their wealthier citizens, and you have a nearly complete explanation for the Eurozone's plight. (What explaining remains to be done is forthcoming from Elephants 4 and 5, just below.) Yet none of the vaunted longterm 'structural reforms' claimed by Mr. Regling and others to be poised to render the south more 'competitive' in the long run does anything at all about any this.

Rather than addressing the inherent pricing disadvantage facing southern exports, and the relative tax disadvantage faced by middle and lower income southerners relative to their wealthier compatriots, the present measures simply worsen the Eurozone crisis by draining, in the name of 'restructuring' austerity, more purchasing power from those with the highest relative propensities to consume.

Against that backdrop, markets would be crazy not to price long-term, rather than critics' imputed myopically short-term,pessimism about Europe into bond yields.

Elephant 4 is, like Elephant 3, a creature of distribution - in this case, global distribution. As just mentioned, defenders of the post-December settlements and other Eurozone officials routinely speak very glibly, if not sanguinely, about curing the Eurozone's ills by forcing restructuring on the south that they claim will render it 'more competitive' in the manner that the northern economies already are.

Even leaving to one side Elephant 1 - the undervalued currency explanation for northern 'competitiveness' - one must wonder what these folk are on about. For they never explain who they assume will be purchasing all those miraculous new prosperity-boosting exports from the 'restructured' and newly competitive south. Will it be the north? Not likely under current arrangements, since the south's goods still will be priced in Euro and the north could have been purchasing them already under those terms.

Will it be the BRICs or other developing nations? Please; those nations are playing the same zero-sum, export-led growth game as the north. All right, the US? Not a good idea, given that its trade deficits - along with their flipside, China's surpluses - already present the main drag upon sagging global demand. How about China, then? Nope, already explained why not that. Which takes us finally to the fifth elephant.

Elephant 5 in a sense leads all of the previous four elephants as their eldest sibling. It is the fact that current global trade and currency arrangements, particularly in conjunction with the current global wealth and income distribution between capital and labor with which those arrangements are in causal symbiosis, render each of the piecemeal measures now in vogue in most policy circles - including the Eurozone - futile.

That will be so till the mentioned arrangements and distributive conditions are themselves addressed head on. Daniel Alpert, Nouriel Roubini and I have endeavored to limn the structure of this problem in all of its salient detail elsewhere. Suffice it for now to say simply this: liberalized trade in the absence of more or less automatic relative currency adjustment, combined with the recent addition of over 2 billion new underpaid laborers to a global workforce that 20 years ago numbered but 500 million, has ensured,> global absorptive capacity's falling chronically far short of productive capacity absent deep structural corrective measures (measures that Messrs. Alpert and Roubini and I have proposed).

Therein lies the source not only of all of the globe's excess credit, but also of much of the globe's need of that credit - in order to stave off imbalance-caused drooping demand. This is precisely why not only Europe's, but all of our gooses are cooked - unless and until we address both those global distributive and currency dysfunctions themselves.

If we are to save the now cooking geese, we must next feed the elephants.


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