Sado-fiscalists, indentured servants, and an eminence grise

Here is the essential Ambrose Evans-Pritchard, one of the few journalists to see the monetary nature of the recession early on.

Nobel economist Myron Scholes first floated the idea over lunch at a Riksbank forum in August. “I wonder whether Bernanke might not say that `we believe in a harmonized world, that the Europeans are our friends, and we know that the ECB can’t print money to buy bonds because the Germans won’t let them. And since the ECB will soon run out of money, we will step in and start buying European government bonds for them’. It is something to think about,” he said.

This is not as eccentric as it sounds. The Fed’s Ben Bernanke touched on the theme in a speech in November 2002 – “Deflation: making sure it doesn’t happen here” – now viewed as his policy `road map’ in extremis.

“The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt. Potentially, this class of assets offers huge scope for Fed operations,” he said.

Berkeley’s Brad DeLong said it is time for Bernanke to act on this as the world lurches straight into 1931 and a Great Depression II. “The Federal Reserve needs to buy up every single European bond owned by every single American financial institution for cash,” he said.

The Fed could buy €2 trillion of EMU debt or more, intervening with crushing power. The credible threat of such action by the world’s paramount monetary force might alone bring Italian and Spanish yields back down below 5pc, before one bent nickel is even spent.

One presumes that the Fed would purchase both the triple AAA core and Club Med in a symmetric blast of monetary stimulus across the board, avoiding the (fiscal) error of targeting semi-solvent states. In sense, the Fed would do quantitative easing for the Europeans, whether they liked it or not.

David Zervos from Jefferies has proposed an extreme variant of this, accusing Germany’s fiscal Puritans of reducing Europe’s periphery to “indentured servants” and driving the whole region into depression with combined fiscal and monetary contraction.

“We in the US need to snuff out these sado-fiscalists and fast, they are a danger to the world. The US can force monetisation at the ECB. We should back up the forklift and buy Euro area bonds. Lots of them,” he said.

Some of the purchases could be achieved by tapping the Fed’s euro account at the ECB, flush with funds as a result of currency swaps provided by Washington to help Europe shore up its banks. Ultimately mass EMU bond purchases would cause a sudden and potentially dangerous spike in the euro against the dollar. There lies the rub. If the ECB failed to loosen monetary policy drastically to offset this, the experiment could go badly wrong.

A pioneering school of “market monetarists” – perhaps the most creative in the current policy fog – says the Fed should reflate the world through a different mechanism, preferably with the Bank of Japan and a coalition of the willing.

Their strategy is to target nominal GDP (NGDP) growth in the United States and other aligned powers, restoring it to pre-crisis trend levels. The idea comes from Irving Fisher’s “compensated dollar plan” in the 1930s.

The school is not Keynesian. They are inspired by interwar economists Ralph Hawtrey and Sweden’s Gustav Cassel, as well as monetarist guru Milton Friedman. “Anybody who has studied the Great Depression should find recent European events surreal. Day-by-day history repeats itself. It is tragic,” said Lars Christensen from Danske Bank, author of a book on Friedman.

“It is possible that a dramatic shift toward monetary stimulus could rescue the euro,” said Scott Sumner, a professor at Bentley University and the group’s eminence grise. Instead, EU authorities are repeating the errors of the Slump by obsessing over inflation when (forward-looking) deflation is already the greater threat.

“I used to think people were stupid back in the 1930s. Remember Hawtrey’s famous “Crying fire, fire, in Noah’s flood”? I used to wonder how people could have failed to see the real problem. I thought that progress in macroeconomic analysis made similar policy errors unlikely today. I couldn’t have been more wrong. We’re just as stupid,” he said.

Needless to say, reflation alone will not make Euroland a workable currency area. Nor will fiscal union, Eurobonds, and debt pooling down the road.

“Even if they do two years of fiscal transfers, and the ECB buys all the bonds, and the problems are swept under the carpet, we are still going to be facing a crisis at the end of it,” said professor Scholes.

I’m not too clear on whether “grise” (grey in French) means I’m boring or have grey hair.  But I’ll take it either way.  However I doubt that I have the required subtlety and sophistication to fulfill that role.  I got a C in high school French.

The proposal itself is not my first choice.  But it does kill two birds with one stone.  And that’s two birds more than we’re killing from our current Fed and ECB policies.  So if that’s what’s on offer, I’m strongly for it.

HT:  Tim Worstall and David Levey


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35 Responses to “Sado-fiscalists, indentured servants, and an eminence grise”

  1. Gravatar of Luis Enrique Luis Enrique
    28. November 2011 at 05:26

    le puppet master:

    http://en.wikipedia.org/wiki/%C3%89minence_grise

  2. Gravatar of StatsGuy StatsGuy
    28. November 2011 at 05:43

    I doubt it’s going to happen… The market still thinks we’re headed for 2.4% inflation over the next 5 years.

    http://www.bloomberg.com/apps/quote?ticker=FED5YEAR:IND

    Judging by this, we could still use a rate increase. You can’t even imagine the cries of horror and accusations of treason on the right if we did something like buy eurobonds. (american taxpayers subsidizing Italian socialist pensions, etc.) It’s a pipe dream.

  3. Gravatar of William J McKibbin William J McKibbin
    28. November 2011 at 06:10

    The US Federal Reserve had better consider purchasing the $6 trillion in toxic mortgage assets from US banks long before bailing out the EU — America must come first…

  4. Gravatar of Don Don
    28. November 2011 at 06:25

    Eminence grise is French for elder statesman/mentor.

  5. Gravatar of marcus nunes marcus nunes
    28. November 2011 at 06:48

    More than elder statesman/mentor, which has a nice conotation, eminence grise refers to the “power behind the throne”. Not necessarily a “puppet master”. Maybe Cardinal Richelieu is the embodiment of an “eminance grise”.

  6. Gravatar of Mattias Mattias
    28. November 2011 at 06:57

    Ambrose is a great journalist in my opinion. In general, British journalists and economist have shown a much better understanding of the euro crises than the EZ ones. Maybe that’s why they decided to no join. Personally, I voted yes to the euro in Sweden’s referendum 2003, which I regret now. I underestimated the problems with a common currency, and overestimated EUs politicians in handling it.

  7. Gravatar of Rien Huizer Rien Huizer
    28. November 2011 at 06:59

    Scott,

    Do not be silly. The Germans have created institutional barriers to constructive behaviour and the have done so through perfectly legitimate (democratic) channels. It makes it difficult for the EUR countries to create circumstances where less dynamic members with high debts can be assisted in coping with looming insolvency. That is only a problem for the US in as far as the US is not prepared to undergo the same purgatory session that most EUR countries will have to endure. But once they have, they may have labor cost at Chinese levels. Would that not be a fantastic and unintended consequence? Look: we can make garments again, for 75 cts/hr…

    In earnest: The Gremans have handcuffed themselves and done the hard yards themselves when they adopted their brethern in the East, rather than turning them into cheap labor. They know what it costs and they do not want to do it again.

    You are right that there is a game of chicken going on, and maybe that will cause a slowdown, but maybe it will result in leaner, more productive economies in the EUR. And, from a mercantilistic and corporatist point of view (that is the local culture, let’s face it, and it has survived a century of warfare and external meddling; not too different from Japan) that is the only thing that counts.

  8. Gravatar of Rien Huizer Rien Huizer
    28. November 2011 at 07:10

    Mattias,

    Your country is committed to join someday. Meanwhile it has been a free rider, while the noble Danes have none of the benefits and all of the burdens of being a EUR pegger.

    The benefits of a single currency for industrial development are obvious, especially when seen in combination with other EU integrative projects. Scale, large companies close to gvt, a gvt-finance-development nexus. Not fundamentalistically ideal market economics, but basically what other large “countries” have. But it only works if you are prepared to relax local sovereignty constraints. If you want to remain a small country -soon to be overtaken by Singapore in GDP terms) your government has to figure out how to deal with lots of issues. Those are not less difficult than the ones facing EUR policymakers, just different. Europe went through three civil wars (if you count the Franco-Prussian war) and it is still miles behind the US institutionally. THis could develop into no 4, but in economics terms.

  9. Gravatar of ssumner ssumner
    28. November 2011 at 07:32

    Luis, Yes, I saw that.

    Statsguy, I don’t agree. The Cleveland Fed says inflation expectations are running far below 2% over the next 5 years. So do the TIPS spreads.

    Both sides of the dual mandate say EASE NOW!

    William, If they buy only a part of the debt, and at market prices, then I don’t see it as a bailout.

    Don and Marcus, yes, I sort of assumed that.

    Mattias, I also underestimated the problems with a single currency in Europe.

    Rien, I don’t understand how I’m being “silly.” I also oppose German bailouts of the PIGS. Isn’t that your point? I’d just as soon see the eurozone break up. My interest is avoiding a depression. A depression might result in sensible economic reforms, or it might see the sort of “reforms” we saw in the Great Depression.

    The benefits of a single currency are not obvious, as we can see from the fact that most of the richest Western European countries aren’t in the euro.

  10. Gravatar of TravisA TravisA
    28. November 2011 at 08:01

    I am not sure how good this proposal is. Suppose that the Fed bought the EU bonds by selling some of its US bond holdings for dollars and then swapping the dollars for Euros to buy the EU bonds. There’s been no easing at all. All the Fed has got are crappy EU bonds in exchange for T-bonds, which will be worthless unless the ECB eases.

    Even if the Fed tapped a credit line with the ECB to buy the EU bonds, wouldn’t that increase in the money supply be considered temporary? That would also do nothing.

    Face it: there’s only one institution that can put an end to this nonsense and that is the ECB. If the Germans aren’t willing to tolerate 4% inflation to save the EU, then why should we bother risking a capital loss due to their stupidity?

  11. Gravatar of pct pct
    28. November 2011 at 08:29

    Scott, Now you need to become a Capuchin friar. Hope your family is OK with that.

  12. Gravatar of Peter N Peter N
    28. November 2011 at 08:30

    Sizes of banks as percent of GDP courtesy of zerohedge:

    France – BNP Paribas, Credit Agricole, SocGen: 237% of GDP
    Germany – Deutsche Bank: 84%
    Italy – Unicredit, Intesa Sanpaolo: 101%
    Netherlands – Fortis: 155%
    Spain – Banco Santander: 92%
    UK – RBS, Barclays, HSBC: 337%

    and, of course, there’s also Dexia for 100 billion Euros or so. IIR all the major US banks together are around 65% of GDP.

    Very ugly.

  13. Gravatar of James Oswald James Oswald
    28. November 2011 at 11:34

    “Ultimately mass EMU bond purchases would cause a sudden and potentially dangerous spike in the euro against the dollar. There lies the rub. If the ECB failed to loosen monetary policy drastically to offset this, the experiment could go badly wrong.”
    As per Tyler Cowen, the Fed simply needs to print euros and buy European debt with those instead of dollars. *Poof* No spike in the euro against the dollar. Heck, they could even print dollars at the same time and keep the exchange rate stable if they really wanted to.

  14. Gravatar of ssumner ssumner
    28. November 2011 at 15:41

    Travis, The proposal involves QE, not just a bond swap.

    pct, Do I have to get one of those funny haircuts?

    Peter, Good point. Still, the net losses depend on how much the governments don’t pay back. Every dollar a euro bank loses is a dollar a Euro government gains. It’s a zero sum game. The important transfer issue is more North/South, as compared to government/bank.

    James, But isn’t that counterfeiting?

  15. Gravatar of TravisA TravisA
    28. November 2011 at 17:52

    Scott — I find it impossible to believe that the Fed would do $2.5 trillion QE.

  16. Gravatar of Peter N Peter N
    28. November 2011 at 18:24

    “Every dollar a euro bank loses is a dollar a Euro government gains. It’s a zero sum game. The important transfer issue is more North/South, as compared to government/bank.”

    In theory, but they’re stuck with the bank’s other losses and derivative positions.

    France and Belgium are guaranteeing Dexia for 90 billion Euros.

    Some of the banks will have large off balance sheet losses.

    The tight money from flight to safety will do damage as it did in 2008.

    They have to recapitalize the banks. Immediate liquidation would be another Lehman only much worse. If they replace the bonds (to net and cancel them) someone has to supply replacement capital (which is what?) plus the capital to meet Basel III.

    So the governments have to spend on the banks. Bank losses become sovereign losses. Debt to GDP will shoot up.

  17. Gravatar of Rien Huizer Rien Huizer
    28. November 2011 at 19:45

    Scott,

    My point was simply that it is part of German economic&political culture to deal with the business cycle by other means than monetary policy and that has not changed despite the qualitative change in Germany’s policy space resulting from European economic integration. The present crisis shows the limits of the German model very clearly, but that has not yet become part of the economic/political culture. Given that democracy (for a democrat) must have priority over economics, we are stuck with Germany as it is. Hence it is silly to complain about that. It is like complaining about the weather. Of course they should have educated their people to perceive Germany in a large, mainly autarchic economy like the EUR area as far more contstrained in using policy tools that externalize problems, not to strangers, but to partners. But that has not happened and that means that it is hard for any policy that deviates from tradition to acquire domestic legitimacy.

  18. Gravatar of Rien Huizer Rien Huizer
    28. November 2011 at 19:54

    Scott, the rich (and economically sound) countries not in the EUR are Switzerland, Denmark and Sweden. The UK is a basket case and not very different from the weakest peripherals just look at the human development index for the UK). Switzerland is on excellent terms with the EUR area, Denmark is a EUR pegger and Sweden an opportunistic player with a long term commitment to join. Finland, Holland, Germany, Austria are all very rich countries with high HDI numbers. The benefits of the EUR are obvious for the corporate sector but have been frustrated by very poor economic governance and rentseeking in the peripherals. At least that is a plausible view (not the only one of course…)

  19. Gravatar of c8to c8to
    28. November 2011 at 20:24

    i think james second “they” is the fed.

    that is they the europeans (ECB) could print euros and buy euro country bonds, and they the fed could print dollars and buy us bonds.

    jesus, i think he’s saying letting nominal GDP collapse was a.bad.thing!

  20. Gravatar of Paul Andrews Paul Andrews
    28. November 2011 at 22:02

    So if the Fed decides to buy massive amounts of Euro sovereign bonds:

    The Fed loads up the asset side of its balance sheet with EU sovereign debt.

    This allows the PIIGS to continue to load up on more debt.

    This merely delays the inevitable defaults, after which the Fed’s damaged balance sheet needs to be recapitalized by the long-suffering US taxpayer.

    Germans are intelligent enough (so far) to realise this. Hopefully some Americans are also, despite the many who willfully sweep these possibilities under the carpet, or who refuse to critically analyse seeming “free lunch” solutions.

  21. Gravatar of Paul Andrews Paul Andrews
    29. November 2011 at 02:48

    Scott, would you agree that David Zervos could possibly have a motive other than a moral distaste for “Sado-fiscalists” when he recommends “backing up the forklift”?

  22. Gravatar of ssumner ssumner
    29. November 2011 at 06:27

    travisA, Me too. There aren’t going to do this proposal.

    Peter, Yes, to the extent the losses are from other loans, I agree. And I agree that tight money will make this problem much worse. So I think we agree, I was assuming your previous comment referred solely to the public debt problem on bank balance sheets.

    Rien, You said:

    “to deal with the business cycle by other means than monetary policy”

    I’m not quite sure what this means. I don’t want the central bank to pay any attention to the business cycle, I want them to target NGDP.

    Second, Krugman just showed that German inflation expectations ahve fallen to 0.88%. So if the Germans want to target inflation, doesn’t the ECB need to ease policy dramatically?

    Rien, You said:

    “Scott, the rich (and economically sound) countries not in the EUR are Switzerland, Denmark and Sweden. The UK is a basket case and not very different from the weakest peripherals just look at the human development index for the UK). Switzerland is on excellent terms with the EUR area, Denmark is a EUR pegger and Sweden an opportunistic player with a long term commitment to join. Finland, Holland, Germany, Austria are all very rich countries with high HDI numbers.”

    I don’t agree. It’s not true that ther UK is poor–the GDP per capita is close to German levels. It’s well above the southern countries. Britain may have various social problems, but that has nothing to do with our discussion here.

    Second, your comments on Switzerland prove my point. I want countries to have excellent relations with the Eurozone. Indeed I don’t even have any problem with a fixed rate, like Denmark has. At least Denmark had the ability to easily devalue in an emergency. And whether Sweden has a long term commitment to join has zero bearing on what we are discussing. It’s outside right now, and doing relatively well. BTW, it is certainly less likely to join than 3 years ago. You also forgot Norway. The big efficiency gains to having a common currency are a complete myth, at least for Europe. Especially as we move toward electronic money. BTW, if the ECB was not totally incompetent, I might feel differently. But they have probably surpassed to BOJ to become the single most incompetent central bank in the entire developed world.

    Paul, I believe in the EMH, so I’m not particularly worried about Fed losses. I’m not suggesting they buy 2 trillion worth, BTW. I don’t think that is politically realistic. And I want the purchases to be at market prices. 10% of euro-debt should be enough.

    I have no opinion on Zervos’s motives, never met the guy.

  23. Gravatar of ssumner ssumner
    29. November 2011 at 06:29

    Paul, I’d also suggest they avoid Greek debt. I believe the other debts will be repaid if the central banks hold down rates. In that case the Fed might make a tidy profit.

  24. Gravatar of James Oswald James Oswald
    29. November 2011 at 12:54

    @Scott: Ah, but counterfeiting is just involuntary NGDP targetting by another name.

  25. Gravatar of Paul Andrews Paul Andrews
    29. November 2011 at 19:25

    Scott, “I have no opinion on Zervos’s motives, never met the guy.”

    So you don’t have opinions on motives of anyone you haven’t met?

  26. Gravatar of Paul Andrews Paul Andrews
    29. November 2011 at 19:31

    Scott,

    “Paul, I believe in the EMH, so I’m not particularly worried about Fed losses. … And I want the purchases to be at market prices … I’d also suggest they avoid Greek debt. I believe the other debts will be repaid if the central banks hold down rates. In that case the Fed might make a tidy profit.”

    The EMH doesn’t make claims about markets distorted by massive intervention – e.g. when central authorities are investing other people’s money without a pure profit motive, as you are recommending they do here, with a series of arbitrary rough guesses as to what might be good and what might not be good.

  27. Gravatar of ssumner ssumner
    30. November 2011 at 19:28

    James, Good point!

    Paul, Not based on a snippet in a long article.

    My point about the EMH is that I want to make sure plenty of private sector actors continue to buy debt at the same price as the Fed. I don’t want them to take over the market.

    People also said they’d lose money on Tarp loans–how’d that prediction turn out? Last year was far and away the most profitable in Fed history, despite all the “toxic assets” they bought. That’s the least of my fears. Any losses would be pocket change compared to the economic damage of another leg down in the endless recession.

  28. Gravatar of Paul Andrews Paul Andrews
    30. November 2011 at 20:23

    Scott,

    You don’t just have the snippet to go by. You have knowledge of who the person works for. You have knowledge of the types of assets owned by that organization. If you are on a genuine quest for understanding and to promulgate understanding, you would have more success if you were more careful about whose opinions you use to try to backstop your position. Instead you amplified his name-calling: “Sado-fiscalist” by putting it at the front of your headline. Companies like Jefferies, and Goldman (in a previous post) are hardly independent objective observers.

    Re: EMH – purchases by the Fed increase the prices, as do purchases by any entity. Therefore the intervention is distortionary and reduces the efficiency of the market, whether they take it over or purchase a single bond through a motive other than profit. Whether people said they’d lose money on Tarp is irrelevant, because the possibility exists that they will lose money in the future. The point is that the people making the choice to “invest” are not the people who stand to lose – i.e. the taxpayers. The “investment” is not being made with a profit motive in mind, and therefore the EMH does not apply.

  29. Gravatar of Scott Sumner Scott Sumner
    2. December 2011 at 05:55

    Paul, You argument on debt purchases could be used equally well against QE2.

    The title of the post was a joke.

  30. Gravatar of Paul Andrews Paul Andrews
    2. December 2011 at 21:31

    Scott,

    “Paul, You argument on debt purchases could be used equally well against QE2.”

    Yes I agree. I don’t see how that fact bolsters your position here.

    “The title of the post was a joke.”

    OK I didn’t realise that. The term seems to have been coined by someone who agrees with your position, so I assumed that you repeated it in your headline because you agreed with the characterisation that “Sado-fiscalist” implies regarding those who are careful with the use of taxpayer funds.

  31. Gravatar of ssumner ssumner
    3. December 2011 at 07:15

    Paul, i thought all the terms in the title were amusingly over the top. I’ve been very consistent in arguing that the optimal policy mix is eaiser money and tighter fiscal.

    Regarding central bank risk, I just meant there there is no extra concern here, as compare to QE2. I have many posts arguing that the risk associated with QE2 is greatly overrated.

  32. Gravatar of Paul Andrews Paul Andrews
    3. December 2011 at 16:17

    QE2, NGDP targeting, Euro “rescue” or any other excuse to purchase dubious assets or to lend against them is distortionary by design. This breaks the EMH, and cannot fail to reward those who have misallocated capital, be they private or public actors. Until this is recognized and the process stopped, the misallocation will only get worse.

  33. Gravatar of ssumner ssumner
    3. December 2011 at 20:59

    Paul, NGDP targeting is non-distortionary by design. If the Fed was doing NGDP targeting the monetary base would be about 1/3 it’s current level. Do you have a problem with that?

  34. Gravatar of Paul Andrews Paul Andrews
    4. December 2011 at 15:00

    Scott,
    How did you come up with 1/3?
    What would be the effect on the monetary base of returning to 2007 trend growth, as you have proposed?

  35. Gravatar of Scott Sumner Scott Sumner
    10. December 2011 at 09:12

    Paul, It would normally be almost entirely cash, or about $1 trillion. It’s now mostly excess reserves. With fast NGDP growth who in their right mind would want to hold lots of excess reserves?

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