The supposed economic “recovery” is faltering. The sugar high of freshly printed money from the world’s central banks is beginning to wear off.
In RealClearMarkets, I address how misguided central bank policy led to Europe’s recession and I explain how to restore growth. Click on the previous link for the entire quantitative analysis.
Europe’s problem is the same as the U.S.’s - insolvency. The past 17 years have seen the greatest expansion of global credit in the history of the world. But this didn’t happen because the world economy became more prosperous. While the world was sleeping, central bankers around the globe have been printing money to fuel the booms of the past two decades. The inevitable result will be an even greater bust than the current one.
…manipulating the interest rate through monetary policy has immense distortionary consequences. The interest rate is the price of borrowing money. The amount of savings in an economy determines that price. But when central bankers set an interest rate, they decouple the interest rate from savings and replace it with politics.
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The solution is to (pardon the cliché) stop the presses! Instead of being bailed out, malinvestment must be liquidated before Europe and the rest of world can hope to end the stagnation that almost two decades of excessive monetary expansion caused.
For a similar quantitative analysis of central bank policy and the U.S. recession, see my previous OpenMarket post on the matter.
Italian Prime Minister Mario Monti is full of optimism these days. He has claimed to achieve “historic” reform in Italy’s la
bor market and to beat the “financial aspect” of the ongoing economic crisis. This is nothing more than political hubris.
Despite all the grandstanding and high rhetoric, the Italian labor market still remains broken and the resurgence in Italian bond yields over the past several weeks signal another impending beating from markets.
As I explain in the City A.M., Monti’s recent labor reforms do not free entrepreneurs from the regulatory straightjacket that has been suffocating them since the 1970’s.
The government and party leaders came to a fragile agreement with Italy’s largest unions. Businesses would be allowed to lay off workers for “economic reasons,” meaning financial distress, while paying up to an exorbitant 24 months of severance. But firms still would not be allowed to fire employees for incompetence.
The centerpiece of Italy’s rigid labour market, and the main issue of contention, is Article 18 of the Worker’s Statute. Under it, “poor performance” is not grounds for employee dismissal. Only “concrete and wanton negligence” justifies that. If a labour court finds a business guilty of firing an incompetent employee, the firm must rehire the worker and compensate for lost pay. If an entrepreneur has fewer than 15 employees, he faces a choice between rehiring or paying up to 14 months of severance. Article 18 protects 87 per cent of private sector workers, according to numbers from Datagiovani – a statistical agency that studies Italian youth.
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Entrepreneurs are afraid to grow. Within the EU, Italy boasts the highest proportion of employment in both micro-firms – businesses with fewer than 10 employees – and micro and small firms combined. It also faces the lowest proportion of employment in medium-sized enterprises.
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John Stuart Mill once wrote, “There is the greatest difference between presuming an opinion to be true, because, with every opportunity for contesting it, it has not been refuted, and assuming its truth for the purpose of not permitting its refutation.” Sticking to the latter, American public schools are not heeding his wise words.
Next month, the consortium of groups that set national science curriculum standards will release new instruction on teaching climate change, according to The Wall Street Journal. It won’t be balanced. And parents won’t have much choice.
While both parents and teachers alike have voiced their preference to have both sides of the climate change debate taught in schools, institutions like the National Research Council (NRC) – that are tasked with constructing the new curriculum – disagree. Martin Storksdieck, a director at the NRC, thinks that teaching both sides to this controversial topic would mislead students.
Despite cries that man-made global warming is “settled science,” there is considerable room for doubt. Look no further than the over 31,000 scientists who oppose the purported IPCC “consensus” or the deliberate attempts of the most prominent climate alarmists — shown in the leaked Climategate emails – to cover up the fact that there has been no net global warming for over a decade.
But climate alarmists at the NRC and its fellow curriculum-setting institutions don’t want balance. That might mislead students, of course.
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American Europhiles love to make comparisons between the entire United States and the rich Nordic countries in order to advocate America’s “Europeanization.” But comparing these two is deceiving. I explain why below in a letter I wrote to The New York Times.
To the Editor:
In “Why is Europe a Dirty Word?” (Jan. 14), Mr. Kristof claims that US emulation of Europe is not such a bad idea, holding up Norway’s higher GDP per capita as an example why.
But Norway’s wealth stems from its enormous natural resources in the North Sea—not its “superior” economic system. I suppose Mr. Kristof would also idolize Qatar—the richest country in the world per capita. Never mind its complete dependence on oil and gas reserves.
It is also not fair to compare a small homogenous country like Norway—a pocket of wealth in Europe—to the entire economically and demographically diverse United States. When compared to similar areas in America, like Connecticut, Norway’s GDP per capita pales in comparison.
The US and Norway are not like-for-like comparisons.
MATTHEW MELCHIORRE
Washington, Jan. 17, 2011
The writer is an Adjunct Analyst at the Competitive Enterprise Institute.
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Here’s a letter I sent to the Wall Street Journal:
In “Fed Will Detail Rate Plans, Easing Market Guesswork” (Jan. 4), Mr. Hilsenrath and Ms. Di Leo claim that the Fed, by letting markets know in advance of its plans to keep short term interest rates low through 2013 and early 2014, could induce recovery. Removing market uncertainty about short-term rates will drop long-term rates, thereby “spurring investment and spending.”
They neglect to mention that long-term rates have already been at historical lows since 2008, yet we remain in an economic rut.
Artificially low interest rates are actively harmful. They reduce the only true source of credit and the only true driver of productive long-term investment—savings. They distort business’ decision-making and redirect precious capital away from where it is needed most.
Recovery will remain elusive until the central bank realizes that its policies disrupt the means to the end it seeks.
Matthew Melchiorre
Competitive Enterprise Institute
Washington
Given the Fed’s continued actions to keep interest rates low and its reported plans to keep them that way beyond 2014, now seems a good time to revisit the deleterious effects that monetary expansion has on the economy.
The data makes all too apparent the relevance of the Austrian Business Cycle in explaining the results of years of easy money.
Loose central bank policy fuels artificial credit expansion—economists like Bernanke would say this is the point of his policies, but he ignores the problems that cheap money creates. Fed-induced cheap credit fuels an artificial boom—that is to say, consumers and producers have access to liquidity that they otherwise wouldn’t had the central bank not intervened. However, artificially low interest rates distort both consumption and investment from their efficient market allocation.
As interest rates plummet, firms shift production from present to future as long-term investment becomes less expensive to finance. But consumers haven’t changed their consumption-saving patterns—meaning that they still consume and save at the same levels as before the Fed altered interest rates. Consumers still prefer to consume today while firms plan as if they instead demand to consume tomorrow. Monetary expansion effectively decouples investment from consumer time preferences of consumption. And the interest rate thereby ceases to serve its equilibrating function between the two.
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Here’s a letter I sent to The Wall Street Journal:
In “Central Banks Take Coordinated Action” (Nov. 30), Mr. Sparshott and Mr. Hilsenrath rightly point out that the Fed’s slashing of dollar swap interest rates by 50 basis points “doesn’t address the fundamental problems related to European government debt that now plague the financial system.”
By offering yet another wooden plank to the drowning Euro, Bernanke merely prolongs its inevitable destruction. Bad debt must be liquidated, not preserved. Protracted global recession ought to make that lesson clear.
European governments must be allowed to default so they can undergo the painful but necessary process of reining in bloated public sectors and deregulating rigid markets. Helicopter Ben showering greenbacks over Paris and Rome provides the opposite incentive. He only assures that the Eurozone’s fall will be even harder.
Matthew Melchiorre
Adjunct Analyst
Competitive Enterprise Institute
Washington
Don’t let his short stature and friendly grandpa beard fool you. Federal Reserve Chairman Ben Bernanke has the power to control the money in your wallet and raise your taxes on all but a whim. And since the financial crisis, he’s been exercising these powers with extreme prejudice.
Bernanke makes it rain every day at the Fed.
Yesterday, the chairman slashed the Fed interest rate on dollar swaps by 50 basis points so that the European Central Bank could throw one last life preserver at the drowning Euro. But flooding the Eurozone with Dollars won’t change the fact that profligate southern European governments have been racking up unsustainable levels of debt for years by enjoying artificially low interest rates gained from the common currency.
Europe does not have a liquidity problem. It has a solvency problem. Bad debt must be liquidated before recovery can begin, but Bernanke’s latest move does the opposite. By adding to Eurozone indebtedness, he thereby disincentivizes the painful but necessary reform to rein in entitlements and deregulate markets.
Helicopter Ben’s Euro stimulus is only the latest in a long history of playing the man behind the economy’s curtain. America found out this week that the Fed made a whopping $7.77 trillion in secret loans to financial institutions like Bank of America and CitiGroup as of March 2009. That’s more than half of US GDP in that year and qualifies as the biggest bailout in U.S. history.
The fact that many of the loan recipients were simultaneously reaping the benefits from the Treasury’s Troubled Asset Relief Program (TARP) belies Bernanke’s claim that only “sound institutions” received Fed loans. The entire rancor in public and in Congress over $700 billion in TARP bailout funding now seems trivial compared to Bernanke’s hush-hush behemoth boondoggle.
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Entitlement reform. Those words alone make politicians’ ears bleed. Or in the case of Italy, it makes their fists literally fly at one another. I explain in Fox Forum why the collapse of Italy’s government at the hands of unsustainable indebtedness should have been a teaching moment for the now-failed Super Committee.
Stateside, Social Security and Medicare are the two most expensive and fastest growing entitlement programs. Reforming them faces a level of resistance almost on par with in Italy. Generous retirement and health care benefits are so entrenched in Italian society that two deputies got in a fist fight on the parliament floor over pension reform a few weeks ago. America cannot afford to go down that path.
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After years of watching their premier put off necessary changes while entertaining himself with “bunga bunga” parties and embarrassing political gaucheries, it’s no surprise that Italians took to the streets to celebrate his government’s demise.
With congressional approval at a dismal 12 percent, Washington lawmakers ought to get serious about deficit reduction lest they too find themselves in the unemployment line.
Read the whole article here.
Here’s a letter I sent to the New York Times.
To the Editor:
Mr. Krugman is correct in pointing out (Bombs, Bridges and Jobs; Oct. 31, 2011) the obvious hypocrisy of Republicans who decry cuts in “job-creating” defense spending while yet maintain that stimulus spending is waste.
However, it is unfortunate that Mr. Krugman falls into the same Keynesian trap as his rightward colleagues. He asserts, “Military spending does create jobs.” How true. But what use is a job if it doesn’t create a good or service that a consumer wants to buy?
Government-induced war production is not stimulative. Rather, it crowds-out private production. History bears that out.
Private investment, the keystone of economic growth, didn’t recover until after World War II had ended. Keynesians warned that cutting post-war military spending by 65 percent would result in a double-dip depression. Instead what followed was a period of historic prosperity.
MATTHEW MELCHIORRE
Adjunct Analyst, Competitive Enterprise Institute
Washington, Oct. 31, 2011
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