Europe's Leaders Must Say "Stimulus"
When it comes to regulating the financial sector, Europe's leadership is on the right track. We clearly need to rein in the masters of the universe so that they don't have the opportunity to do even more damage. It would be great if Sarkozy could convince Obama of the need to rein in hedge funds, private equity funds, and the other non-bank institutions that still play by Wild West rules in the United States. It would be even better if everyone agreed on a modest financial transactions tax (like the 0.25 percent stock transfer tax in the U.K.) so that we can all profit from the speculation that does take place. Such a tax could produce more than $100 billion in annual revenue in the United States.
However, when it comes to stimulus, the Europeans seem to be missing the boat. Their economies will be mired in slow growth unless their governments are prepared to spend more money. This is just simple arithmetic.
Unlike the United States, France and Germany have very high household saving rates. While the U.S. saving rate was negative until the housing bubble burst, saving rates in both countries are well into the double digits.
If households don't spend, then the demand must come from elsewhere. While both countries have somewhat higher rates of private investment than the United States, this does not come close to making up the gap in household saving rates. The major difference is that these countries have enjoyed near balanced trade or more often trade surpluses, in contrast the large trade deficits in the United States.
However, these two situations are related. The trade deficit of the United States and other bubble countries was the surplus of France and Germany. Now that the bubble has burst, the United States and the other bubble countries no longer have the wealth to support their high levels of consumption. This means that France and Germany will not be lifted out of this downturn by export demand.
If France and Germany want to get on the path to recovery any time soon, they have no choice but to do it via increased domestic demand. It will help the whole world if France and Germany, along with the rest of the Europe, do their part to boost demand with large stimulus packages. However, first and foremost, it will help the economies of Europe and reduce their unemployment rates.
It would also be helpful if someone told the European Central Bank (ECB) about the recession. If the ECB knew about the crisis, it might lower its interest rate close to zero, thereby providing some additional boost to the European and world economy.
Well, people in America have been making these arguments for some time, so I'm sure the Europeans have heard them and have counter-arguments of their own. I think we need to take the discussion deeper.
April 2, 2009 8:01 AM | Reply | Permalink
Suppplying the ECB with unsolicited information would be a grave threat to its independence, nicht wahr?
Happy days.
April 2, 2009 9:12 AM | Reply | Permalink
Germany did put through a stimulus plan.
But more importantly EMU doesn't allow a country to run a deficit larger than 3 % of the GDP (€75 billions for BRD).
April 2, 2009 9:41 AM | Reply | Permalink
The thinking represented by this article is outmoded, fallacious, and is the type of thinking that has gotten the world into the financial mess we are in today.
One very basic economic fact that is ignored here is that individuals, corporations, and governments cannot borrow and spend their way out of debt, that process only produces more debt and an increasing amount of income is then needed to pay the interest on that debt.
The US government is engaged in the biggest ponzi scheme in history amounting to over $11 Trillion dollars at last count and rising faster and faster. That involves using new debt to pay off old debt plus interest. This results in even greater debt, more interest, and more money is needed to pay off the new debt.
The argument that governments are different because they have the option of printing money is also fallacious. Printing money without a corresponding increase in the value represented by the total supply of that money only serves to dilute the value of the previously existing money. That is called inflation since any value the new money has is taken from the value of the previously existing money.
TANSTAAFL - There Ain't No Such Thing As A Free Lunch. Somebody, somewhere pays for it. In this case it is the American taxpayer. Money is fungible. It is not destroyed by a transaction, it is used over and over, one transaction after another. Follow the trail of how much money went from where to where and keep following it out to the tenth or more transaction. See who has it now.
The one thing missing (deliberately?) from all the investigations and hearings is: "Where did all the money go that was stolen via all these dubious financial transactions?" Several large pension funds have lost Billions of dollars in value as a result of investing in AIG and other financial institutions. Where did that money go? It was not paper profit, it was the savings, deductions from paychecks, and matching funds by employers represented by millions of people who now have their retirements wiped out.
This whole financial mess reminds me of a chain letter asking you to put your name on the top of a list, remove the name at the bottom of the list and send that person $1.00, then send the letter to 10 people. If it works, you will eventually get $1,000 for your $1.00 "investment".
The "toxic assets" were packaged, sold (for a profit), and then resold (for a profit). This process continued until the "assets" were so overvalued that nobody would buy them. Each person along the line realized massive profits and now the American taxpayer is being forced to purchase these "toxic assets" at a price set by their latest purchasers - not at any realistic value.
The question which should be asked is "Who profited during the increasing "value" of these "toxic assets"?". Unfortunately, this question is missing from any discussions or hearings.
April 2, 2009 9:44 AM | Reply | Permalink
One very basic economic fact that is ignored here is that individuals, corporations, and governments cannot borrow and spend their way out of debt, that process only produces more debt and an increasing amount of income is then needed to pay the interest on that debt.
That's not at all always true. If I am in debt for $10,000 and then borrow $10,000 dollars more, use it to dig an oil well, and strike oil, then I might be very quickly out of debt. That's only the most obvious kind of case, but that's how wealth creation works. You need to spend money to make money, and sometimes the initial money spent is borrowed.
The argument that governments are different because they have the option of printing money is also fallacious. Printing money without a corresponding increase in the value represented by the total supply of that money only serves to dilute the value of the previously existing money.
True. But sometimes the government spending succeeds in stimulating the growth of real wealth, so there is an increase in the value represented by the total supply of the money. Also, increased government spending is not all financed by printing money but by borrowing - something the US government has been able to do lately at exceedingly low rates of interest.
April 2, 2009 11:03 AM | Reply | Permalink
True, but if instead, you build a solar plant that produces electricity at $0.30 / KW-hour when electricity is selling for $0.10 / KW-hour, you will just get farther in debt.
A lot of stimulus is being spent on boosting consumption or on uneconomic investments. Paying the interest and principle on the debt will be a drag on the economy for years, unless the debt is reduced through inflation.
April 2, 2009 11:23 AM | Reply | Permalink
--- or via Jubilee and/or bankruptcy.
April 2, 2009 1:01 PM | Reply | Permalink
I was thinking about private debt; not the same thing at all.
Nevermind!
April 2, 2009 1:18 PM | Reply | Permalink
Moreover, the Financial Times reported on Monday that the Eurozone is facing possible DEFLATION rather than inflation at the moment, and thus inflationary measures like printing money are wise policy.
April 2, 2009 1:00 PM | Reply | Permalink
Dan K:
"Also, increased government spending is not all financed by printing money but by borrowing - something the US government has been able to do lately at exceedingly low rates of interest."
Have you considered that the money the government is borrowing at those exceedingly low interest rates is being printed by the Federal Reserve? They can afford those low interest rates as long as they can print money for the cost of the ink and paper.
What happens then when those new printed dollars get into circulation and begin competing for goods and services with the dollars that were already in circulation?
also:
"the Financial Times reported on Monday that the Eurozone is facing possible DEFLATION"...
Does this mean that the Euro is becomming more valuable? Compared to what? If it is in terms of dollars, that just means that the dollar is being inflated (becomming less valuable) in relation to the Euro.
April 3, 2009 11:24 AM | Reply | Permalink
"Have you considered that the money the government is borrowing at those exceedingly low interest rates is being printed by the Federal Reserve?"
Not exactly. Yes, dollars are created by the Fed, in general. No, not all borrowing is based on legal counterfeiting by the Fed. Some of the borrowing is the Treasury borrowing real money from private or sovereign lenders who already have the money. However, some money in circulation now is clearly counterfeit in the sense that the Fed has been "buying" corporate paper etc. for over a year now to the tune of $2T or so. While some of that has been paid back in "real money" by the borrowers, some of that excess liquidity is still out there showing up as real money but in fact is an IOU on a corporate IOU based on Fed funny money "printed" over the past year.
This funny money could turn out to be inflationary, and is so to the extent that it is not paid back. That is, the Fed has created what looks like a huge monetary bubble by lending on corporate paper at insane interest rates and without, to my knowledge, sufficient collateral.
If the bubble bursts, every dollar lent out by the Fed is pure inflation. If the bubble unwinds and all the loans are paid back, then the Fed is richer for it and there will have been no net inflation of this kind.
April 3, 2009 3:39 PM | Reply | Permalink
"It would be even better if everyone agreed on a modest financial transactions tax (like the 0.25 percent stock transfer tax in the U.K.) so that we can all profit from the speculation that does take place."
How could there be a profit from such a tax? Net revenue would be negative. How did a trader of stocks, and a 401(k) participant create the real estate financial crisis and why are they being forced to pay for all of it, where the ones that created the crisis are receiving bailouts, reduced tax rates etc?
66% to 90% of high frequency trading will cease. There is no way those kinds of trades will make more than a half percent to overcome that "modest" trans tax. Most brokerages will fail, hedge funds and individual traders will cease operations, resulting in only more bankruptcies and bailouts. The whole point of the tax is to stop short term trading, not the long term speculation that causes such huge bubbles and huge crashes like the current crash in real estate.
Which only leaves the long term stock investors, you know, the ones that need some kind of additional retirement. They will be the only ones left to pay the tax. What is much more cost significant than the tax, they will be paying for wider spreads, higher brokerage fees, and most of all a lack of compounding over the years. I would say an individual would lose a quarter of their retirement thanks to this "modest" tax.
Most everyone that does not need to raise attention to sell their book on economic theory, knows that a securities transaction tax will not produce positive revenue. Globally, the tax has been on its way out for decades as countries have found that the negatives far outweigh anything positive. Most trading will cease, the capital gains revenue will be severely reduced, hundreds of thousands of US revenue creating jobs will be lost. To an economist with a theory where a miracle happens, those are just numbers, not workers with families to feed.
April 2, 2009 9:56 AM | Reply | Permalink
NOFTT,
I'm not as optimistic as you about the tax completely wiping out all the short-term traders. After all the size of the tax that I've proposed would just raise transactions costs back to where they were 20 years ago. There were plenty of speculators back then, as there are in the U.K. today.
April 2, 2009 10:41 AM | Reply | Permalink
Yep...just what we need. To re-inflate the bubble...NOT!
C
April 2, 2009 10:02 AM | Reply | Permalink
Dean the next time you push your transaction tax by using the UK as an example don't forget to mention that virtually all of the major institutions and exchange members in the UK are exempt from paying the tax. The individual investor carries the burden of the transaction tax in England.
Socking it to the little guy is not what I call a success story.
April 2, 2009 11:11 AM | Reply | Permalink
I just posted about how the German's have already spent money on the major investments in our stimulus (clean energy, transport infrastructure, social safety net, etc.).
http://tpmcafe.talkingpointsmemo.com/talk/blogs/samrash21/2009/04/to-stimulate-or-not-what-would.php?ref=reccafe
If you were advising Angela Merkel, how much would you tell her to spend and what would you advise her to spend it on? I'm not being cheeky, I'm just trying to think about what a good German or French stimulus would look like.
April 2, 2009 11:39 AM | Reply | Permalink
Mr Baker,
What i fail to understand is why some commentators and economists see short term speculation as having zero economic value. I have often heard the question "So what do you guys do that actually makes any difference to anyones life", or somethig along those lines. The answer is provide liquidity to the markets so that anyone who needs to buy or sell, can do so at a fair price. I take on their risk, and earn economic profits for doing so. If short term traders did not provide liquidity to the financial system, the costs of trading would be higher for the so called 'legitimate' investors. Knobel prize winning economist Milton Freidman has argued for some time that rational speculators may in fact help stabilize prices.My experience is certainly that less liquidity = more volatility. Take a look at any small cap stock. Liquidity is very low in most of these issues, and consequently, pricing efficiency and transaction costs are very high. These stocks are also much more susceptable to manipulation and speculative raids.
In 'The Contribution of Speculators to Effective Financial Markets'by Geert Bekaert, Marcio G.P. Garcia & Campbell R. Harvey (NBER National Bureau of Economic Research) the authors present critical examination of the role of the speculator in market-based economies, and find that ".... speculators provide additional liquidity to the market and, in general, enhance the operational efficiency of the market. This serves to reduce the cost of capital which has broad positive implications for the welfare of the whole society. However, we argue that the presence of speculators alone does not guarantee these benefits. Indeed, the presence of a small group of speculators may lead to a distortion of market prices. Hence, in order to ensure the positive benefits, there must exist a sufficient number of speculators both domestic and international."
I suppose the point i am trying to make is this...any trading activity that improves liquidity is a good thing for everyone, and the vast majority of short term trading provides liquidity. Anyone who thinks raising the costs of short term trading is good, has not considered the economic costs of reduced liquidity for everyone. None of these ideas have their foundation in empirical data, or market experience.
There is also the implicit assumption that short term traders always make money at the expense of legitimate investors. This is patently false. Like any risky business activity, some make money, but many loose.
Additionally, and i cannot repeat this enough, HIGH TURNOVER TRADERS/SPECULATORS DID NOT CAUSE THE CURRENT FINANCIAL CRISIS. THE CURRENT CRISIS WAS CAUSED BY EXCESSIVE SPECULATION BY BANKS AND OTHER LARGE FINANCIAL INSTITUTIONS IN THE CREDIT DERIVATIVES SPACE.
There is also a misconception that an FTT will discourage 'undesirable' activities, and be bourne by the wall street incompetents. The reality is that anyone who has a balance sheet large enough to move markets (i would agree this is undesirable), would probably not pay the tax. Any of the larger institutions in the UK are either exempt from the tax as exchange members/market makers, or use swaps to get around it (by trading a swap, or CFD with a tax exempt party). Thats right, those who pay this transaction tax will not be the big boys on wall street, it will be the small investors. By the way, the tax will not only be paid as an upfront cost when you trade, the value of your investment portfolio will fall, as market participants discount the future tax liability.
Additionally, the empirical evidence suggests that your FTT revenue estimates are overoptimistic. A CRS report for congress stated,"Assuming a 0.5% rate on over $13 trillion in stock and options transactions, the static revenue estimate is $65.6 billion, but most likely actual revenues would fall far short of this figure. The revenues depend on transaction volume, and it would fall because of the negative relation of turnover to transaction costs..."(CRS Report for congress "Transaction Tax: General Overview". Maxim shedov http://assets.opencrs.com/rpts/RL32266_20041202.pdf )
Figures from british Inland revenue show Only roughly £3.75 billion was raised from securities transactions(2007 numbers I think), the rest came from stamp duty on properties. Of that, 40% was collected from investors abroad. Of that 40%, a quarter was charged at the higher rate of 1.5% due to conversion transactions in ADRs so nothing to do with local securities transactions.
These estimates just don't stack up.
April 2, 2009 1:27 PM | Reply | Permalink
No, liquidity is not a sacred cow.
Some liquidity is good. Optimizing for liquidity is not good.
April 2, 2009 4:59 PM | Reply | Permalink
'Some liquidity is good. Optimizing for liquidity is not good.'
Can you expand your point. Why is this?
April 3, 2009 4:17 AM | Reply | Permalink
Liquidity is only a means to an end.
If you optimize for a means, you [tend to] exclude optimizing for the end. We can agree that illiquidity is bad for trade without having to create a system which turns liquid assets into gases, for instance. A practical economic system only needs sufficient liquidity, not absolute liquidity. The ability to convert an asset into cash is hardly the end-all and be-all of human existence!!
There might or might not be an optimal liquidity in various parts of an economic system. But even if there were, the optimal liquidity would not be a matter of optimizing the system FOR liquidity.
Enuf?
April 3, 2009 3:31 PM | Reply | Permalink
"The trade deficit of the United States and other bubble countries was the surplus of France and Germany."
How does France have a surplus? According to the Economist, its current account deficit for the past 12 months was -56 Billion Dollars, or -2.2% of its GDP. Over the same period, the US current account deficit was -3.3% of GDP. Germany, on the other hand, had a current account surplus of +5.3% GDP. Germany, Japan, China, and the Netherlands are the big surplus countries, not FRance.
April 2, 2009 2:00 PM | Reply | Permalink
Brad DeLong Hits Home run!
April 2, 2009 2:41 PM | Reply | Permalink
As an American, I think the European approach makes a lot more sense, and I wish like hell that American economists would listen to their more advanced and competent European peers. Deficit financing is absolutely disastrous. There isn't a single case anywhere in the world, or anywhere in history, where it didn't result in a calamity. In the real world, you simply have to pay your bills or do without. Anyone who's ever taken freshman economics, or even had to pay their rent, could tell you that. About the only thing worse for an economy than deficit financing is 0% interest rates, which does nothing but encourage wasteful speculation and promotes bubbles. Again, there isn't any case in the world, at least not in the last 30-40 years or so, where it helped an economy. It's totally destroyed Japan's economy, and the Japanese will be stuck in recession until they begin raising interest rates.
The arrogance of American economists and policy makers is quite frightening. They clearly don't know what they're talking about, and their incompetence has plunged the world into recession. (Have you heard about the recession, Dr. Baker?) They need to listen to the experts from other countries and do what they suggest.
April 2, 2009 3:53 PM | Reply | Permalink