The doomsday device
Here’s a scene from Dr.Strangelove:
The Ambassador reveals that his side has installed a doomsday device that will automatically destroy life on Earth if there is a nuclear attack against the Soviet Union. The American President expresses amazement that anyone would build such a device. But Dr. Strangelove (Sellers), a former Nazi and weapons expert, admits that it would be “an effective deterrent… credible and convincing.” However, a recent study by an American think tank had dismissed it as being too dangerous to be practical.
It turns out that the biggest problem is that the machine cannot be deactivated if something goes wrong. And something did go wrong; a single rogue bomber attacked the Soviet Union at the instructions of General Jack D. Ripper:
From his wheelchair, Strangelove explains the technology behind the Doomsday Machine and why it is essential that not only should it destroy the world in the event of a nuclear attack but also be fully automated and incapable of being deactivated.
Recently I’ve been wondering about the EU’s backup plan if the euro didn’t work out. One option would be to go back to the previous national currencies. But that’s easier said than done. Presumably it would be costly and time consuming, but even that isn’t the main problem. After all, the countries previously converted to the euro without much problem. It’s not the end of the world.
But there’s a much bigger problem with deactivating the doomsday device euro. Unlike when it was first set up, some of the new currencies would be introduced at different (lower) exchange rates. And the expectation of devaluation is extremely destabilizing for financial markets. That’s how George Soros got rich—he knew that the UK pound was under stress in 1992, and that the only two likely possibilities were a steep devaluation or no change. He bet on devaluation, and won a billion dollars. So devaluations are quite destabilizing. Even so, they’ve been done before; it’s not the end of the world.
Unfortunately, there is no currency to devalue in this case. So it’s not as easy to do as when a country has its own currency, and decides to suddenly change the par value. There would probably have to be a decision to call a bank holiday, and impose all sorts of capital controls, to prevent everyone from smuggling euros out of the country into Swiss banks right before the official changeover. That’s not easy. But it’s not impossible. The US did a bank holiday in the 1930s, and other countries have imposed capital controls. So it’s not the end of the world.
Unfortunately, we are not just dealing with one country. If it was just Greece, the government could meet in secret and work out an emergency transition plan. Then suddenly spring it on the public. But things have gone way beyond just Greece. We are looking at the possibility of a complete breakup of the eurozone. So the 17 countries would have to independently reach the conclusion that the euro was done, and then get together and meet in secret, without the meeting leaking out to the press. And recall that right now these countries are getting along about as well as the US and Soviet Union during the cold war. Still, it’s not . . .
On second thought, time to cue up Vera Lynn’s “We’ll Meet Again.”
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23. November 2011 at 18:03
The thing is, all this was known but considered a good thing, since it made the doomsday denarius “credible and convincing.”
23. November 2011 at 18:24
At this point, the ECB is so locked in its present framework that I wonder whether publicly committing to a newer, better, policy framework wouldn’t just cause more confusion. The markets seem to be hopeful, in that they’re not completely imploding, but hopeful for what? If the ECB suddenly announced they were doing NGDP targeting, or becoming lender of last resort, or whatever, what would you make of it? I’d wonder whether the policy would last a week, before returning to the current minimize-inflation-no-matter-what policy. And I’d be even more uncertain about what their future policies would look like, given the sudden, sharp, unexpected reversal. It’s hard for me to see how this ends without a bang, and so it’s hard for me to understand why the markets are not in a full blown panic at the moment.
23. November 2011 at 18:30
Scott,
There was no “Doomsday machine” at work in the 30’s during the serial gold standard exit. Somehow, the devaluations back then were a positive for the global financial system. So why not argue that we repeat the process in the Eurozone, country by country?
I suspect the answer is that today’s shadow bank-dominated financial system is much more fragile than the 1930’s system. This is a supreme irony given the presence of deposit insurance in most countries. It is fragile not because it is globally interconnected, but instead because it is both undercapitalized and large relative to GDP (see the recent Hyun Song Shin paper). This financial Goliath is the true Doomsday machine. Just one example of the unintended consequences of stability-seeking regimes.
23. November 2011 at 18:43
John, Yes, it wasn’t well thought out.
Ram, I wonder about that too. What do the markets see?
David. I think you missed something, it’s much worse than the gold standard. In those days a single country could devalue instantly, because they had their own currencies. That’s no longer true, so it’s much harder to devalue.
In addition, the devaluations back then were a positive for the country that devalued, BUT A HUGE NEGATIVE FOR THE COUNTRIES STILL ON GOLD. That’s because it led to a run on the currencies of countries still on gold. So the 5 year collapse was not a good period for the world economy.
23. November 2011 at 19:14
Right, the obvious response if one suspects a devaluation is to move some of your money out of the country, first withdrawing it from your bank. In the whole sale market that seems like what we’re seeing already. If the banks in Greece or Belgium collapse their sovereigns can’t bail them out with Euros, so I would think leaving the Euro becomes much more attractive.
Since markets are forward looking the expectation of possible devaluation makes devaluation nearly inevitable, which is nearly where we are.
23. November 2011 at 19:26
Any form of capital control is against the EU treaty on free movement of capital. (Article 63-66)
23. November 2011 at 20:29
Point fully taken, but the real biggest problem with the device was they didn’t tell anyone about it.
Dr. Strangelove: “The whole point of a Doomsday Machine is lost if you keep it a *secret*!”
Soviet Ambassador: “As you know, the Premier loves surprises.”
My favorite movie ever.
(Shall we ever see “How I Learned to Stop Worrying and Love the Euro”?)
One might note that when the founders drafted the Constitution of the USA they decided to avoid the vexing question of whether a state could leave the union and punted it into the future for a later generation to resolve.
We know how that worked out.
24. November 2011 at 00:01
The Fed can still save the day. Even for Europe. Looser monetary policy in US would mean more growth and would have positive effects on Europe and might just drag Europe out of financial armageddon.
24. November 2011 at 01:27
Scott Nice touch with Vera Lynn!
Anything´s doable and not the end of the world. Brazil has “rescaled” the currency (devided by 1000) 4 or 5 times. Changed the currency name as many times again, frozen prices, closed gas stations on weekends, charged a “overseas travel tax”, banned imports of cars, computers, software,and the highlight was a “laboratory hyperinflation” in 1990. I say Lab because it was calibrated to “turn into ash” only 80% of liquid assets. You got to keep 20% of your bank deposits!
We survived and now are even being asked to help capitalize the ESF!!!
24. November 2011 at 03:20
Jim, it’s my favourite movie too. I actually used the “keeping it a secret” line in a recent comment on the Bank of England’s alleged secret NGDP targeting.
I’m actually a bit more of a euro-optimist than is fashionable these days. The adjustments in Italy and Greece are painful, but they’re no worse than what Britain had to do in the 80s or what Germany had to do during reunification, except that the timing is poor. To paraphrase Machiavelli, economic reform cannot be avoided, it can only be postponed to the [relative] advantage of others. Italy and Greece are merely facing the inevitable adjustment, but the evidence of their north European neighbours is that reform pays off in the long run.
24. November 2011 at 05:23
Trivia question: who can name a political, fiscal and currency union which, less than 20 years ago, split into 15 different countries with 15 different currencies?
The largest successor state is now, like Brazil, being called upon to bail out the new currency union.
24. November 2011 at 05:59
Let’s forget about the juxtaposition of doomsday and Thanksgiving for a minute. (Think cornbread dressing and baked chicken).
In your early posts, I unearthed a nice David Hume quote: “If the coin be locked up in chests, it is the same thing with regard to prices, as if it were annihilated.”
Coin = knowledge. They are exactly the same. I have to figure out what that means.
24. November 2011 at 06:09
Off-topic, but Tyler posted a link to “energy intensity of GDP”. Basically, GDP rises with energy consumption.
http://marginalrevolution.com/marginalrevolution/2011/11/assorted-links-286.html
My thoughts were that two artifical mechanisms can explain a large part of the correlation.
First, NGDP is measured, whereas real GDP and inflation are calculated. Energy prices are a very large component of these calculations. I.e. the actual economy might grow faster than energy consumption, but if rising energy consumption causes increased energy prices this increase will be subtracted from measured RGDP growth, thereby ensuring the two measured entities don’t diverge much.
Additionally, central banks retard economic growth when energy prices increase in order to keep inflation down (as we have seen the past three years). With a 2% inflation target our economies are forced to exhibit the following behaviour (assume inflation is equivalent with energy price increases): If energy prices increase less than 2% the economy is allowed to grow freely. However econmic growth is retarded as much as is necessary to ensure that energy prices do not rise by more than 2%.
I would be interested in your thoughts on the matter: do you think economic growth is possible without necessarily increasing energy consumption by an equal amount?
24. November 2011 at 06:16
Happy Thanksgiving all! I think the EU has to do one of two things: either move to greater integration (including a common EU bond; don’t tell me about how this damages Germany’s credit, as we saw it’s credit is already starting to be damamged) or they need to end it totally. This compromise between the Europhiles and Europhobes is the worst of all worlds
I should also say that I think Geramny least wants to leave or it is least in its benefit-whatever the sanctimoniuous German people may think-as Germany has disproportionately gained from the EU in the form of a trade surplus while most membver countries are in trade defciit.
On this festive day please see http://diaryofarepublicanhater.blogspot.com/2011/11/happy-thanksgiving-to-all-my-readers.html
24. November 2011 at 06:33
Happy T-Day! As a public service announcement, let me suggest to all “No Knead Bread” for your weekend.
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They should all be invited to join the dollar! And put up their land as collateral.
24. November 2011 at 07:28
OGT, Good points, although I admit to not having a good sense of where we are going, these are uncharted waters.
kai, Good point, a further barrier to dismantling the doomsday device.
Jim Glass, I used the “surprise” aspect in a different post. I can’t recall which one.
Kubrick directed two of my 5 favorite films (both in the 1960s.)
Liberal Roman, I agree.
Marcus, Good points, although note that the multiple countries involved makes the euro demise more tricky.
Rob, That’s an excellent point.
John, That’s easy, the Soviet Union, which wasn’t a market economy.
Becky, Yes, or textbook models of how to boost NGDP at the zero bound.
JL, Yes, we can grow without more energy consumption, but you are right that the Fed often prevents that.
Mike, I don’t agree that the trade surplus is a benefit to Germany. If I were Germany I’d leave before accepting a fiscal union (which would be a disaster 10 times worse than the euro in my view.)
24. November 2011 at 07:46
(1) “In those days a single country could devalue instantly, because they had their own currencies. That’s no longer true, so it’s much harder to devalue.” Yes, there are technical difficulties to leaving the euro, but they can be exaggerated. All each euro country would have to do to devalue would be to declare a new temporary currency, the “Greek euro,” “German euro,” etc. would now float against all other currencies, including the “official” euro (if anyone kept using it). Paper currency could be converted on a temporary basis by overstamping it or issuing a quickly-printed substitute (has been done). Financial assets and liabilities re-valued by fiat, Roosevelt style. More details of how to overcome technical barriers here: http://tiny.cc/hvceh
(2) Answer to Haskell question (very relevant to euro) is ruble area. Details can be found here: http://tiny.cc/o6nbq
24. November 2011 at 10:14
Scott I don’t see how they don’t benefit it, I mean intuitively the country with the surplus is normally going to be assumed to be the one benefitting.
Maybe i should ask you if they are benefitting in any way being in the Union and if so how. If there is no benefit to them then they should leave anyway. It seems to me that if they left they will see a very large loss of trade.
As to fiscal union if we need the Euro to survive-as I phrased myself I’m leaving the possiblity that maybe it shouldn’t survive on the table-they seem to me to need fiscal union. This current structure is the worse of all worlds where each member country lacks a currency and therefore monetary control of their own economy but on the other hand the EU is not responsible for each member state’s economy the way the Fed is for the U.S. econony.
Is it still in your mind a morality tale-you see the perphiphery countries in having sinned and now you cant bear to think they get off with no pain at all? Such a moralistic attitude I think you’ll agree doesn’t belong in economics. What is clear is that the trouble in the EU is not about fiscal discipline as the fiscally disciplined countries like Spain, Ireland and now even the Netherlands are being punsihed by the bondholders too.
I think Germany is being very penny wise and pound foolish. So worried about some how being “used” by the periphery where even their own borrowing costs may go up without a union and while they continue to push austerity.
24. November 2011 at 11:00
” Unfortunately, we are not just dealing with one country.”
We would be if Germany unilaterally exited (or effectively would be, if it left with Finland, Austria & the Netherlands). No other disaggregation of the existing eurozone might be required.
25. November 2011 at 06:09
Re: “textbook models”: There is still the uncharted continent (and frontier) of knowledge that we might be able to reach if our ships do not get destroyed first. Thank God for that.
25. November 2011 at 07:57
Ed, I agree that the scenario you describe might work for a single country, but as I said it doesn’t solve the problem, because it only works if a single country is in trouble. But many are in trouble, and you’d need a coordinated response, which I think would be very difficult to do in secret.
Otherwise if Greece started doing that overprinting then there’d be panic in other countries.
Mike, You said;
“Scott I don’t see how they don’t benefit it, I mean intuitively the country with the surplus is normally going to be assumed to be the one benefitting.”
Come on now, we’ve known for 200 years that common sense intuition is worthless in international trade; Ricardo discredited that mercantilist view long ago. Indeed it would be only a slight exaggeration to say that the discrediting of mercantilism was the bedrock on which all of modern economics rests.
The only purpose of exporting is to earn money so that you can import the things you really want.
You said;
“It seems to me that if they left they will see a very large loss of trade”
I don’t see why, both Sweden and Switzerland are outside the euro, and both have highly successful export industries that are quite similar to Germany’s.
You said:
“Is it still in your mind a morality tale-you see the perphiphery countries in having sinned and now you cant bear to think they get off with no pain at all?”
This is rather absurd given that I usually get the opposite criticism. My call for much easier money would greatly help borrowers in the US and Europe. I’m accused of wanting to paper over real problems, or encouraging irresponsibility.
BTW, most of the PIGS did make serious errors (the term ‘sin’ is irrelevant here.) They made huge fiscal errors. Including Ireland, which foolishly bailed out bank creditors. Spain is different, being punished for crazy labor market policies and a corrupt banking system. But my policy would help them all by dramatically boosting NGDP.
I agree Germany is making a huge mistake–they should support a policy of much higher eurozone NGDP.
David, But that’s even less likely than the PIGS leaving.
Becky, Yes, someday we may discover our textbook models!
26. November 2011 at 00:58
I wonder if we would be seeing more expansionary monetary policy in the Euro if the UK had adopted the currency, given the policy the Bank of England has followed in the crisis and how Bank of England officials like Adam Posen have commented about needing more monetary stimulus for Europe.
I would think greater British representation in the ECB would probably lead to, at the very minimum, the guarantee that the ECB is the lender of last resort, and perhaps more expansionary policy (though I doubt it would be along the lines of a higher inflation target or a shift to an NGDP target).
It’s definitely to the UK’s benefit that it did not adopt the currency when it was first instituted – but it is the Eurozone’s loss that they don’t have guys like Adam Posen working in the ECB.