Jeremy Siegel, a professor of finance at the University of Pennsylvania’s Wharton School, echoes a lot of what some of us have been saying for years about the infeasibility of internal devaluation in a commentary article published in the Financial Times on May 22, but then he argues that the answer is devaluation of the euro as a whole.
Um, against whom?
I mean, it’s not as if the United States or Japan are towers of economic strength, easily able to provide the demand Europe lacks. That leaves emerging markets. And while I and others have been pushing for years for an end to Chinese currency manipulation, China is at this point (a) not looking very strong itself and (b) just not that big in the world economy — not yet.
More generally, Europe as a whole, like the United States, remains a relatively closed economy. Its salvation must be mainly internal. Now, if devaluation is a code word that means raising the inflation target, fine.
The last time I got to hear the late economist James Tobin, he gave a talk in which he joked that as far as he could tell, all the world’s major currencies needed to devalue against each other. This is sort of one of those times — and what that actually tells you is that we need fiscal and monetary stimulus.
Keynes and the Euro Crisis
I just saw, and now cannot find, a comparison between Germany’s position vis-a-vis the European periphery now and the United States’ position vis-a-vis European nations with war debts after World War I. Anyway, it’s a very close parallel. Read from John Maynard Keynes’s “Essays in Persuasion”: “Ultimately, and probably soon, there must be a readjustment of the balance of exports and imports. America must buy more and sell less. This is the only alternative to her making to Europe an annual present,” the economist wrote in 1921. “Either American prices must rise faster than European (which will be the case if the Federal Reserve Board allows the gold influx to produce its natural consequences), or, failing this, the same result must be brought about by a further depreciation of the European exchanges, until Europe, by inability to buy, has reduced her purchases to articles of necessity.”
Mr. Keynes then goes on to discuss the folly of American policy, which simultaneously demanded that the Europeans pay in full while denying them the ability to export enough to make those payments.
So here too we are repeating ancient mistakes. But why does nobody learn?
A CURRENCY SOLUTION
The Financial Times published a commentary article on May 22 by Jeremy Siegel, a professor of finance at the University of Pennsylvania’s Wharton School, that echoes the sentiments of some economists and European policy makers, who support more currency-market intervention in the euro zone, where unemployment has now reached 11 percent and the sovereign debt crisis continues.
Mr. Siegel commented that the European Central Bank should lower the value of the euro in order to save the common currency because “labor costs in the peripheral countries are too high and uncompetitive with the northern European countries, particularly Germany.
“Historically, overpriced labor markets have been cured, albeit painfully, by currency devaluation — an option which is not open to euro-based economies.”
Devaluation generally makes a nation’s exports less expensive and, thus, more competitive. However, since nations using the euro cannot devalue the shared currency on their own, some economists have suggested that troubled countries should instead restore competitiveness in their labor markets by lowering their wages and other costs, a process known as “internal devaluation.” But, Mr. Siegel pointed out in his article, historical evidence suggests that those goals “would be extremely difficult to achieve and apt to worsen their current downtrends.”
Yet some economists are also skeptical that devaluing the euro would result in an increase in sales of European exports to other countries since the economies of the United States and Japan are still struggling to recover and those of emerging nations are seeing slowdowns. For instance, data released on June 1 showed that China’s factory output fell by nearly three points in May.,
Britain’s Self-Fulfilling Prophecy
I wrote a few days ago about the widespread belief in Britain that there has somehow been a dramatic collapse in the economy’s potential. The Financial Times columnist Martin Wolf adds much more in a recent column, plus a link to a very important paper written by the economists Bill Martin and Robert Rowthorn — titled “Is the British Economy Supply Constrained II? A Renewed Critique of Productivity Pessimism” — that, by my reading, very effectively debunks that belief.
There’s a lot of technical detail, but as I see it the main point is that we see a sharp drop in measured British productivity that could be the result either of some mysterious structural shift or the much more ordinary notion that many firms have held on to “overhead” labor in the face of what they expect to be only a temporary fall in sales. And the data just don’t support any of the proposed explanations for the supposed structural shift.
Specifically, the popular line here is that it’s due to the loss of all those high-value jobs in finance, which sounds plausible until you do the arithmetic and find that the figures are way, way too small. This bears a strong family resemblance to stories about alleged structural unemployment in the United States that focus on the shift out of construction; again, this sounds good until you do the numbers and find that it’s tiny.
This matters, a lot. If Britain has not experienced a mysterious productivity collapse, it is suffering much more than acknowledged from a lack of effective demand — and also has a much smaller underlying budget problem than the government claims. The British may be poor-mouthing their economy — and in so doing creating a self-fulfilling prophecy, in which excessive pessimism about potential leads to policies that in fact impoverish the nation.
Do I know for sure that this is the truth? No. But it looks more plausible than the official line. And surely policy should take into account not just the so far purely hypothetical risk of a loss of confidence by the bond market, but also the very real chance that vast amounts of potential production, not to mention the future, are together being squandered through excessive pessimism.
The Trouble With Vanity
Martin Wolf nails it in a recent blog post at the Financial Times: Prime Minister David Cameron’s government made a terrible mistake by going all-in for austerity doctrine — and now cannot change course, because to do so would be to admit its mistake.
“It may be humiliating for the government to offer such a speech now,” Mr. Wolf wrote on May 28. “But there is no reason why the people of the U.K. should suffer for its mistake, indefinitely.”
But there is a reason, of course: the ambition and vanity of politicians.
PUZZLING PRODUCTIVITY
A number of indicators have led some economists to conclude recently that Britain’s economic troubles may be deepening. Activity within the nation’s manufacturing sector declined sharply in the first quarter, and on June 1 the British Chamber of Commerce announced that the economy was expected to grow by a mere 0.1 percent in this year, partly due to the effects of the ongoing euro zone debt crisis.
What some analysts find most troubling, however, is a drop in productivity — the output of workers per hour and of the economy as a whole. Britain’s Office for Budget Responsibility estimated in late 2011 that output per hour was more than 6 percent below pre-crisis trends. Data indicates that economic output as a whole is about 14 percent below trend levels.
In a paper released in May, the economists Bill Martin and Robert Rowthorn of the Center for Business Research at Cambridge University posited that the adjusted shortfall in Britain’s economic output might be as little as 9.5 percent, rather than 14 percent. Of that, the cyclical, or temporary, aspect could be as much as 6 percent.
However, noted Mr. Martin and Mr. Rowthorn, “policy makers and others believe the crisis inflicted major structural damage with the result that national output may only be 2ı percent or so below potential.”
According to the Financial Times columnist Martin Wolf, the implications of that figure are very important. “If most of the fiscal deficit is cyclical, what is needed is to increase demand,” he wrote in a column published on May 31.
“If most of the deficit is structural, what is needed are permanent increases in tax and reductions in spending,” he wrote.
