Monday, November 28, 2011

Euro Debt Crisis: The Confidence Fairy Tale and Devaluation Delusion

The Confidence Fairy (Fear and Greed) Fable

Suggestions have been made that Euro crisis has been an issue of confidence or “animal spirits” as alleged by the mainstream analysts.

This represents half-truth.

The idea that people are driven by sheer optimism or pessimism dumbs down the people’s ability to look after their self-interest. Of course those peddling such rubbish assume that they are above the rest of mankind.

Yet in a bizarre way of thinking, they use assorted and complex economic analysis when at the end of the day, everything for them, essentially boils down to random optimism or pessimism.

The assumption that psychological factors as purely driving the marketplace ignores the truism of the collective individual’s ability to calculate on the elemental tradeoffs of cost relative to benefits or of risk relative to rewards.

People don’t buy financial securities because they wake up in the morning feeling ‘optimistic’ or sell when they feel ‘pessimistic’. People buy or sell because they see, rightly or wrongly, beneficial aspects from the execution of such actions. Whether psychic or monetary, the assumed rewards are subjectively determined by the person taking action.

The supposed confidence fairy of fear and greed are essentially driven by an underlying event stimulus or incentive and not by mere impulse.

For instance, a market crash doesn’t happen because of fear itself. Instead a crash happens when people discover that the issues they own have not been priced accordingly or has substantially been worth below the most recent value as a result of some chain of causes.

Like those stampeding out of a theater (effect) because of a sudden discovery of fire (cause), the simultaneous act by many to exit ownership of financial securities fuels impulses or emotions to go along with the crowd (bandwagon effect). Thus fear signifies a symptom of an underlying cause rather than a cause in itself.

Yet fear and greed are prominent symptoms of bubble cycles.

During market euphoria usually at the acme of a bubble cycle, people pile up on ascendant prices because of the thought of the perpetuity of such price trends.

Of course, this can be only made possible by the loosening of extensions of credit (circulation credit) where the credit-collateral feedback loop mechanism gets rolling—where rising collateral values prompts for more lending, and more lending increases collateral values.

Thus, circulation credit (which are consequences of artificially suppressed interest rates and from policy directives, e.g. credit subsidies, bailouts) fuels bubble cycles which impels contortions in people’s economic calculations and subsequently results to the emotive price chasing phenomenon—Greed.

The opposite phenomenon holds true during bubble busts. The credit-collateral feedback loop mechanism goes into a reverse operation—falling collateral values prompts for margin calls and the calling in of bank loans both of which decreases collateral values. The simultaneous acts of exodus essentially signify—Fear.

In truth the confidence fairy has nothing been more than a pretext for more government intervention.

As the great Murray Rothbard once wrote[1]

Keynesian doctrine is, despite its algebraic and geometric jargon, breathtakingly simple at its core: recessions are caused by underspending in the economy, inflation is caused by overspending. Of the two major categories of spending, consumption is passive and determined, almost robotically, by income; hopes for the proper amount of spending, therefore, rest on investment, but private investors, while active and decidedly non-robotic, are erratic and volatile, unreliably dependent on fluctuations in what Keynes called their "animal spirits."

Fortunately for all of us, there is another group in the economy that is just as active and decisive as investors, but who are also--if guided by Keynesian economists--scientific and rational, able to act in the interests of all: Big Daddy government. When investors and consumers underspend, government can and should step in and increase social spending via deficits, thereby lifting the economy out of recession. When private animal spirits get too wild, government is supposed to step in and reduce private spending by what the Keynesians revealingly call "sopping up excess purchasing power" (that's ours).

The Euro crisis has hardly been founded from the issue of greed and fear, but of boom bust cycles.

Following massive imbalances acquired from the antecedent boom, market prices have been prevented from clearing or from seeking to adjust to the required levels that would allow resources to be transferred from unproductive to productive use. The discoordination and coordination mechanism of the marketplace have been impeded.

Yet the constant interventions that has sustained the current artificial price levels have led to mass distortions and market participants astray. So once the effect of interventions subsides or once markets discover the artificiality of such price levels, volatility ensues. Emotional transactions follow.

Hence, the distributive outcomes from a significantly politicized marketplace suggest of massive price distortions from repeated government interventions. This has been mistakenly construed or touted as fear. Those saying so have been misreading effects as the cause.

Political Insanity and the Devaluation Elixir

The mainstream has also been suggesting that the gold standard effect from the Eurozone Union, which prohibits internal devaluation of member states, has been a cause to this crisis. For me this represents as unalloyed hogwash[2].

While I agree that the EU needs to be dissolved because of the latent intention to politically centralize Euro economies such as the supposed need to fiscally integrate the EU, I oppose the idea of nationalizing currency for the sole purpose of inflationism via devaluation.

I will not elaborate on the evils of inflationism[3], but rather point out how ridiculous the assertion of supposedly allowing Greece, for instance, to devalue to become ‘competitive’.

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Based on the average hourly labour costs in the business economy in 2009[4], Greece has been one of the cheapest among the peripheral EU states. Italy, Spain and Portugal are just within the range of Greece.

The cheaper labor costs (on the right) belong to those of emerging Europe.

And labor costs signify as part of labor market efficiency[5]

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The crisis affected PIIGS also belong to the least competitive rankings[6] in terms of labor efficiency.

In other words, cheap labor did not translate to export greatness.

Thus, devaluation will hardly impact the competitiveness of the labor market because this does not treat the disease.

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The disease which plagues the PIIGS are highlighted by the unfriendly business enviroment[7] caused by too much regulations and bureaucratic hurdles.

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And importantly, by the intractable government expenditures[8] mostly from the welfare state as measured by the Fiscal Imbalances (FI)[9].

At the end of the day, those who yearn for a Zimbabwe solution to the Euro don’t have the intention of resolving the crisis but to promote the same ills that has blighted them.

No wonder Albert Einstein called—doing the same thing and expecting different results—insanity.


[1] Rothbard Murray N. Keynesianism Redux, Chapter 12, Making Economic Sense

[2] See Quote of the Day: A Very Expensive Education in Basic Economics, November 10, 2011

[3] See Vatican Banker Endorses ECB’s Inflationism November 24, 2011

[4] Euro Commission Wages and labour costs, Eurostat

[5] Financial-lib.com Labor efficiency variance: the number of hours actually worked minus the standard hours allowed for the production achieved multiplied by the standard rate to establish a value for efficiency (favorable) or inefficiency(unfavorable) of the work force

[6] Infectiousgreed.com Reforming Labor Markets, November 14, 2011

[7] Danske Research Euro Area Macro Handbook, November 2011

[8] Gokhale Jagadeesh Measuring the Unfunded Obligations of European Countries January 2009

[9] The fiscal imbalance (FI) measures the size of the total imbalance built into current fiscal policies, including future changes already scheduled by law. It is a country’s unfounded liability, looking indefinitely into the future. It is the difference between the present cost of continuing current government spending programs, including entitlement promises, present public debt, net of expected tax revenues. It is the amount of additional resources the government must have on hand today, invested and earning interest, in order to continue policies forever. Alternatively, it equals the additional net revenue or cost savings required from future policy adjustments to close the budeget gap embedded in current fiscal policies.

The FI is similar to outstanding public debt in one important way: It grows larger over time because of accruing interest costs. In addition fiscal policies that imply a positive FI are unsustainable: Because the ratio of FI to the present value of future GDP also grows larger over time, the implied annual service payments would eventually become larger than annual GDP

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