Estonian President Slams Paul Krugman

When apologists for the state don’t have developments going their way, they intuitively employ verbal sleight of hand as defense mechanism.

Given that Estonia has recently been recognized as the pro-austerity model of success, which I recently posted here, Keynesian high priest Paul Krugman quickly wrote to downplay on such progress. Mr. Krugman's comments drew a vitriolic rebuke from the Estonian president.

From the Huffington Post (hat tip Cato’s Dan Mitchell)

The president of Estonia chewed out Paul Krugman on Wednesday, using Twitter to call the Nobel Prize-winning economist "smug, overbearing & patronizing," in response to a short post on Estonia's economic recovery.

Krugman's 67-word entry, entitled "Estonian Rhapsody," questioned the merits of using Estonia as a "poster child for austerity defenders." He included a chart that, in his words, showed "significant but still incomplete recovery" after a deep economic slump.

President Toomas Hendrik Ilves responded to Krugman in a series of outraged tweets, taking offense to Krugman's tone and writing that Krugman didn't know what he was talking about.

"We're just dumb & silly East Europeans. Unenlightened. Someday we too will understand," he tweeted. "Guess a Nobel in trade means you can pontificate on fiscal matters & declare my country a "wasteland". Must be a Princeton vs Columbia thing."

Estonia, which in 2011 became the latest country to join the eurozone, has been heralded by some as an austerity success story. That year, it clocked a faster economic growth pace than any other country in the European Union, at 7.6 percent. Estonia is also the only EU member with a budget surplus, and had the lowest public debt in 2011 -- 6 percent of GDP. Fitch affirmed its A+ credit rating last week.

Politics becomes a religion when people resort to lies and misrepresentation to desperately defend ideas that has been proven to be based on faith and wishful thinking than from reality.

Estonia Booms Amidst the Euro crisis

From CNBC.com

Sixteen months after it joined the struggling currency bloc, Estonia is booming. The economy grew 7.6 percent last year, five times the euro-zone average.

Estonia is the only euro-zone country with a budget surplus. National debt is just 6 percent of GDP, compared to 81 percent in virtuous Germany, or 165 percent in Greece.

Shoppers throng Nordic design shops and cool new restaurants in Tallinn, the medieval capital, and cutting-edge tech firms complain they can’t find people to fill their job vacancies.

It all seems a long way from the gloom elsewhere in Europe.

Estonia’s achievement is all the more remarkable when you consider that it was one of the countries hardest hit by the global financial crisis. In 2008-2009, its economy shrank by 18 percent. That’s a bigger contraction than Greece has suffered over the past five years.

How did they bounce back? “I can answer in one word: austerity. Austerity, austerity, austerity,” says Peeter Koppel, investment strategist at the SEB Bank.

Let me be clear, the issue here isn’t about the euro, rather the issue here is about how Estonia managed to deal with the crisis even as part of the euro bloc. Estonia began to use euro in January 2011

And as pointed above and as blogged earlier, Estonia resorted to the common sense approach of letting the markets clear and work and passed with flying colors.

Indeed, Estonia’s budget has shown a slight surplus (from tradingeconomics.com)

Estonia ranks 16th as the economically freest country in the world and 7th among 43 nations in the Eurozone

Writes the Heritage Foundation

Estonia upholds all four pillars of economic freedom relatively well, with the rule of law strongly enforced by an independent and efficient judicial system. However, respect for the principle of limited government has eroded as government spending has risen as a share of GDP. Public finance management could be enhanced through clearer coordination between central and local governments as well as better targeting of social benefits. The debt burden remains quite low and has not undermined long-term economic competitiveness.

Flexibility and openness have equipped Estonia’s small economy with an impressive capacity to adjust to external shocks. Sound economic policies grounded in a strong commitment to economic freedom have ensured high levels of investment and entrepreneurial activity. The overall investment code is conducive to dynamic growth, and the financial sector remains competitive.

Estonia and Sweden's case should become the paragon for dealing with a crisis. Unfortunately, Eurozone politicians has stubbornly been fighting to retain their privileges from an unsustainable parasitical relationship. Worse, the regional political trends suggests that policies might run in the direction opposite to what is required. On that condition the crisis is likely to worsen before it gets better (when markets forces the hand of politicians).

Global Stock Markets Update: Peripheral Markets Take Center Stage

Going into the last quarter of the year, Bespoke Invest has a great snapshot of what has been happening in global stock markets.

From Bespoke Invest, (bold highlights mine)

The average year to date change for all 82 countries is 5.39%, while the median change is 2.23%. The S&P 500's year to date change of -1.24% is obviously below both of these. The US currently ranks 53rd out of 82 in terms of 2010 performance. At the top of the list is Sri Lanka with a 2010 gain of 73.69%. Bangladesh ranks second at 49.37%, followed by Estonia (41.94%), Ukraine (40.86%), and Latvia (40.26%).

India has been the best performing BRIC country so far this year with a gain of 4.33%. Russia ranks second at 1.42%, Brazil ranks third at -2.43%, and China is down the most at -18.97%. Canada is currently the top G7 country with a gain of 3.26%. Germany and Britain are the other two G7 countries that are up year to date, while Japan is the G7 country that is down the most year to date (-13.58%). Overall, Bermuda has seen the biggest losses this year with a decline of 38.25%. Greece is the second worst at -24.56%.

Additional comments:

1. Global stock markets are MOSTLY higher from a year-to-date basis, be it in terms of average or median changes or in nominal distribution (53 up against 29 down). This hardly evinces of the ballyhooed “double dip”.

2. The best performance has been at the periphery (as previously discussed), particularly in emerging South Asia, the Baltic States (Estonia have been a favourite since she has adapted a laissez faire leaning approach in dealing with the most recent bubble bust) and ASEAN.

This appears to be manifestations of the “leash effect” from policy divergences.

3. The BRICS has underperformed, but that’s because of last year’s outperformance. This excludes China, whose markets have repeatedly been under pressure from government intervention. I expect the BRICs to likewise pick-up, perhaps at the end of the year or in 2011 (perhaps including China).

4. Major East Asian economies have likewise underperformed. But this appears to reflect on the actions of major OECD economies.

Overall, what we seem to be seeing has been a spillover dynamic from the prodigious liquidity generated from coordinated global monetary policies into the peripheral markets. It’s the impact of inflation on asset prices on a relative scale. In addition, this also reflect signs of the allure of inflation’s “sweet spot” phase, especially for the peripheral markets.

As a caveat, while stock markets do resemble some signs of “decoupling”, such divergences can be deceiving.

Decoupling can only be established once the US goes into a recession while peripheral markets and their respective economies ignore this.

Yet, I doubt this will occur.

Three More Reasons Why The Euro Rally Should Continue

``Inflation is not the result of a curse or a tragic fate but of a frivolous or perhaps even criminal policy.” -Ludwig Wilhelm Erhard

Lady Luck seems to smile at us, given that our forecasts of last week appear to have been serendipitously realized. The Euro surged by 2.4% over the week and risk assets turned materially positive, exactly as we spelled out[1].

But of course, we hardly ever talk about ONE week, we allude to near to medium term which may cover the outcome for the rest of the year. Perhaps the Euro may recover to the 1.30 to 1.32 level by the yearend?

There are three more reasons why the Euro should persist to rally and why risk asset markets are likely to gain momentum.

First of all, emerging markets continue to lead the way in terms of economic growth[2], whereby EM economies may do some heavy weightlifting to buttress developed economies.

And the cyclical broad based EM led global economic recovery, as a result of the expansive monetary policies and from globalization friendly policies, will likely expand global trade.

By cyclical recovery we allude to the bubble cycle.

Yet considering what mainstream calls as ‘global imbalances’, seen in many ways as ‘savings glut’, ‘dearth of investments’ or ‘Bretton Woods II’, instead we see this in terms of the Triffin Dilemma, where an international reserve currency, particularly the US dollar, would need to run large deficits in order to finance this burgeoning global trade from the cyclical recovery.

The Triffin Dilemma, according to Wikipedia[3], ``was first identified by Belgian-American economist Robert Triffin in the 1960s, who pointed out that the country issuing the global reserve currency must be willing to run large trade deficits in order to supply the world with enough of its currency, to fulfill world demand for foreign exchange reserves.”

``The use of a national currency as global reserve currency leads to a tension between national monetary policy and global monetary policy. This is reflected in fundamental imbalances in the balance of payments, specifically the current account: to maintain all desired goals, dollars must both overall flow out of the United States, but dollars must at the same time flow in to the United States. Currency inflows and outflows of equal magnitudes cannot both happen at once.”

This is one explanation mainstream can’t accept because it puts into the light or magnifies the inherent flaws of the current monetary standard, which the theory projects as unsustainable. Of course, homemade or national policies exacerbate such conditions.

But the point is, mainstream sees that the de facto currency reserve standard as an entitlement that must never be compromised, hence espouse theories even where water, in its natural state, can move upstream.

For instance, some see monetary policies will be engineered to promote exports.

Figure 7 BCA Research: Bearish On US Dollar

According to BCA Research[4], ``The U.S. also needs strong exports and an improving trade balance to add to GDP growth. Last week’s news on the U.S. trade front was not encouraging, with the deficit widening again in April. Furthermore, cyclical and structural factors are pointing to even wider trade and current account deficits ahead. In turn, with the unemployment rate still near 10%, U.S. policymakers are also unlikely to tolerate significant strength in the dollar and the consequent drag on growth.”

This outlook sees the application of monetary policies as a ‘one way street’ or where the policy actions of the other pair (or the other nation which is represented by the opposite currency) may not offset those of the US. This is pretty much one sided because monetary policies are not only relatively dynamic but also has relative impacts from perpetually evolving policy actions.

Secondly, the implication is that export growth can only be achieved by devaluation. Hence the kernel of this mercantilist leaning view is that every nation will try to out-export each other by competitive devaluation, or the race to devalue via inflationism which presumptively leads to prosperity.

Yet this outlook could lead to fatal results, as Ludwig von Mises warned[5], (bold emphasis added)

``they depend on the condition that only one country devalues while the other countries abstain from devaluing their own currencies. If the other countries devalue in the same proportion, no changes in foreign trade appear. If they devalue to a greater extent, all these transitory blessings, whatever they may be, favor them exclusively. A general acceptance of the principles of the flexible standard must therefore result in a race between the nations to outbid one another. At the end of this competition is the complete destruction of all nations' monetary systems.”

In other words, nations don’t trade people do. Yet people don’t trade to generate economic growth, people trade to have a need fulfilled and or to obtain profits. Nations only account for the cumulative actions of individuals. Hence inflationism isn’t an optimum way to meet such goals.

Besides, merchandise trade (exports and imports) for the US is only about one-fourth of the economy, such that the call to devalue in order to support the export industry, which is only 12% of the economy at the expense of the 88%, would seem absurd. Moreover, US unemployment from the 2008 crisis has been less related to the export industry as most of the job losses has emanated from the bubble areas (e.g. mortgage, construction etc...).

For me, the Triffin Dilemma has played the biggest role in shaping the underlying trend of the US dollar. And a global recovery translates to a weaker US dollar.

Next, the credit risks seem tilted towards US states than from the Eurozone economies (see figure 8)

Figure 8: The Economist: American states' finances are worse than those of some euro zone countries

According to the Economist[6], (bold emphasis mine)

``RECENT comparisons made between some American states' finances and those of Greece are exaggerated. But credit-default-swap (CDS) spreads, which measure investors’ expectations of default, are wider for some American states than for some of the euro zone’s other peripheral economies. On June 17th the cost of insuring Illinois’ bonds against default hit a record high, rising above that of California, America’s largest municipal borrower. Both considered riskier than Portugal’s debt. New York and Michigan are higher than Ireland’s. Like euro-zone members, American states may not declare bankruptcy and cannot be sued by creditors. And like many European governments, legislators are reluctant to impose the pain necessary to close budget deficits.”

As we pointed out last week, the downtrodden state of the Euro has emanated mostly from overly depressed sentiment. This has constrained demand for the Euro and has been more than the problem of relative structural issues, which seem to lean against the US. Thus, when finical sentiment shifts, structural issues will come into play.

Importantly as the Economist explains, fiscal discipline may not be stringently observed by both the affected parties in the Eurozone and in the US states. That’s because this may not be politically palatable for politicians. This serves as euphemism more inflationism.

Lastly, if the Euro is soon destined towards disintegration, as alleged by some, then she is probably looking towards the inclusion of more nations to join her death leap.

That’s because the Eurozone has enlisted Estonia as her newest member. Estonia will be the 17th country to carry the Euro by January 1, 2011.

Earlier we dealt with Estonia’s free market leaning approach even towards dealing with the recent crisis[7]. And perhaps such accomplishment has been recognized by the Euro bureaucracy.

According to the New York Times[8], ``Meeting in Brussels, Europe’s 27 governments hailed the “sound economic and financial policies” that had been achieved by Estonia in recent years. They said Estonia would shift from the kroon to the euro on Jan. 1, 2011.”

And unlike Greece who fudged their data to foist herself into the EU membership, Estonia seems more qualified.

Or perhaps could it be that Euro officials have been desperately looking for an agitprop to buttress their position? This from the same New York Times articles[9],

“The door to euro membership is not closed because we are going through a sovereign debt crisis,” said Amadeu Altafaj, a spokesman for Olli Rehn, Europe’s commissioner for economic and monetary affairs. “Estonia’s admission is a sign to other countries that our aim is to continue enlarging economic and monetary union through the euro.”

“Continue enlarging economic and monetary union through the euro” even when the Euro is in the death throes? Hmmm.

In my view, these three factors, specifically, growing global trade which should expand US trade deficits and amplify the effects of the Triffin dilemma, the credit risks slanted towards US states more than the EU and Estonia’s as the Euro’s newest member should all add up to boost the Euro vis-a-vis the US dollar.

Of course, a better bet in place of the Euro should be Asian currencies, including the Philippine Peso.

---

[1] See Buy The Peso And The Phisix On Prospects Of A Euro Rally

[2] See Another Reason Not To Bet On A 2010 'Double Dip Recession’

[3] Wikipedia.org, Triffin Dilemma

[4] BCA Research Currencies: Still Broad U.S. Dollar Bears

[5] Mises, Ludwig von The Objectives of Currency Devaluation, Human Action, Chapter 31 Section 4

[6] The Economist, Risky business, June 18, 2010

[7] See Estonia’s Free Market Model And The US 1920-1921 Depression

[8] New York Times, What Crisis? The Euro Zone Adds Estonia, June 17, 2010

[9] Ibid

Estonia’s Free Market Model And The US 1920-1921 Depression

First of all I’d like to thank Mr. Kristjan Lepik for his patronage and on adding his priceless thoughts on Estonia.

Mr. Lepik writes,

``Estonia has taken a rather different crisis-management approach than Western world (US, Western Europe et al) – no government stimulus, very low government debt (only around 10% of GDP) and no bailouts. Therefore the steep GDP drop in 2009 (around -15%), if US would have no stimulus or bailouts, the GDP would be surely negative as well.

``I think that Estonia has taken the quick and painful way, whereas a lot of countries have gone the route which may be more painful in the end – big budget deficits must be paid back at some point (probably higher taxes globally).

``I was really negative about Estonia’s outlook in 2006 (as you all know, that is not a popular thing to do), the economy overheated badly. But the normalizing process has been very effective after that, gross wages have dropped around -20%, asset prices around -60%. That surely is not a pleasant process but it is helping to restore Estonia’s competitive advantage.

``The recovery will probably not be not that quick in Estonia, the normalizing process is still ongoing and unemployment has reached 15%. But looking at the macro picture, Estonia looks pretty good (should I use the term “sane” here?) compared to most of the World.”

It may be true that the normalization in Estonia could take awhile as resolving high degree of overindebtedness could pose as significant drag to economic growth as shown by the charts below by the IMF.

From the IMF

Nevertheless, I’d be more optimistic than the IMF or of the mainstream, since they would naturally be more cynical or skeptical of the Estonia's unorthodox or unconventional approach, in a world where government intervention is seen essential or as a standard.

Although I usually refrain (and equally disdain) from making comparisons with past models, my guess is that a free market resolution would have more meaningful relevance than from an interventionist approach.

What truly distorts or impedes a market from delivering its inherent process of clearing the previously established malinvestments are further interventions. And since a free market approach would have less distortions, they are likely to elicit more “similarities” or parallelism.

And on that note, the US depression of 1920-1921 experience should pertinent.

Economist Bryan Caplan in a paper on the US 1920-1921 depression wrote of how events unfolded then,(bold emphasis mine)

``In one crucial respect, the depression of 1920-21 was actually more severe than the Great Depression itself: there was a rapid decline in the price level of between forty and fifty percent within the course of a single year. As Friedman and Schwartz (1963) explain, “From their peak in May [1920], wholesale prices declined moderately for a couple of months, and then collapsed. By June 1921, they had fallen to 56 per cent of their level in May 1920. More than three-quarters of the decline took place in the six months from August 1920 to February 1921. This is, by all odds, the sharpest price decline covered by our money series, either before or since that date and perhaps also in the whole history of the United States.” (1963, pp.232-233.) The wholesale price index during the Great Depression took about three years to fall by the same amount.

``Employment and output were however not as severely affected as in the Great Depression. Of course precise unemployment data are not available for this period, but one representative estimate (Lebergott, 1957) puts civilian unemployment at 2.3% in 1919, 11.9% in 1921, and back to 3.2% in 1923. Output figures tell a similar story: one aggregate index (Mills, 1932) indexes production at 125.3 in 1919, 99.7 in 1921, and rebounding to 145.3 in 1923. As these stylized facts indicate, the second unusual feature of the depression of 1920-21 was the rapid recovery in employment and output, in sync with a swift adjustment of the real wage to its new equilibrium position. …”

Some charts from EH.net

In other words, a market based adjustment that had been swift and drastic translated to equally a rapid and dramatic recovery in 1920-1921.

And why this should come about?

Austrian economist Robert Murphy provides as a possible answer,

``After the depression the United States proceeded to enjoy the “Roaring Twenties,” arguably the most prosperous decade in the country’s history. Some of this prosperity was illusory—itself the result of subsequent Fed inflation—but nonetheless the 1920–1921 depression “purged the rottenness out of the system” and provided a solid framework for sustainable growth."

When rottenness is purged out of the system, then the recovery is likely to be relatively more robust and sustainable since the economy should reflect on market dynamics than from artificial foundations.

We end with a quote from President Warren Harding’s inaugural speech in 1921 which dealt with the crisis, (all bold highlights mine)

``We must face the grim necessity, with full knowledge that the task is to be solved, and we must proceed with a full realization that no statute enacted by man can repeal the inexorable laws of nature. Our most dangerous tendency is to expect too much of government, and at the same time do for it too little. We contemplate the immediate task of putting our public household in order. We need a rigid and yet sane economy, combined with fiscal justice, and it must be attended by individual prudence and thrift, which are so essential to this trying hour and reassuring for the future.…

``The economic mechanism is intricate and its parts interdependent, and has suffered the shocks and jars incident to abnormal demands, credit inflations, and price upheavals. The normal balances have been impaired, the channels of distribution have been clogged, the relations of labor and management have been strained. We must seek the readjustment with care and courage.… All the penalties will not be light, nor evenly distributed. There is no way of making them so. There is no instant step from disorder to order. We must face a condition of grim reality, charge off our losses and start afresh. It is the oldest lesson of civilization. I would like government to do all it can to mitigate; then, in understanding, in mutuality of interest, in concern for the common good, our tasks will be solved. No altered system will work a miracle. Any wild experiment will only add to the confusion. Our best assurance lies in efficient administration of our proven system.”

We hope that the success of Estonia's model will lead the world the way.

Estonia: A Resurgent Baltic Tiger In Defiance of Mainstream Antidote?

Andreas Hoffmann writing in Thinkmarkets sees Estonia as a returning Baltic Tiger.

Here is Professor Andreas Hoffmann (all bold highlights mine)

``the Estonian government reacted in a way to the current crisis that should bring tears of joy into the eyes of any free market economist: First, they did everything to hinder a devaluation of the Estonian kroon, as a relatively stable exchange rate to the euro is a prerequisite for euro introduction. Secondly, they did not overspend. Instead they cut wages heavily with the fall in per capita GDP – even in the public sector. And third, unlike most economies, Estonia did not sacrifice economic freedom for crisis management. Instead, officials wait for the crisis to heal the market. At the same time lower spending is assumed to bring inflation down. The crisis is seen as a chance to (readjust and) fulfill the Maastricht inflation criterion, which was impossible during the boom period.

``Thus, as Estonia allowed for an adjustment process, malinvestment from the previous boom should be dismantled soon. This should bring about lucrative future investment possibilities in an economy with solid macroeconomic fundamentals, a high degree of economic freedom and prospects to enter the euro zone. At the moment interest rates are much higher there than in the euro area and a credible fixed exchange rate assures against depreciation. These facts should attract new investors. Therefore it is likely that we soon see the return of at least one Baltic tiger."

What makes the Estonian account very interesting is that she appears to have taken an unorthodox (or outlier) approach in dealing with the recent crisis- market based adjustments that had been swift, drastic and painful. But instead of encountering a prolonged recession or even a depression, it now seems that Estonia have been revealing signs of an equally rapid and dramatic recovery.

This seems to contravene anew the conventional notion that markets, when left to their own devices ("officials wait for the crisis to heal the market") to deal with the recessions or a crisis, would cause a depression.

Even the IMF look equally impressed: ``Following recent budget measures and assuming continued fiscal consolidation efforts, Estonia could meet all Maastricht criteria, while the policy record to date provides assurances for continued stability-oriented policies. This is remarkable, as it is being achieved against the background of severe dislocations due to the crisis. Joining the euro zone would remove residual currency and liquidity risks, adding stability to the Estonian economy."

Here are some charts from the IMF...

Real Effective Exchange Rates

Real Wages and Monetary Aggregates

Real GDP and Inflation

Estonia's OMX Talinn Index (from Bloomberg) [up 36% year to date]

I'll leave it to this blog's Estonian readers to contribute to this outlook.