Opinion

Anatole Kaletsky

Don’t panic about the fiscal cliff

Anatole Kaletsky
Sep 27, 2012 15:38 UTC

Who’s afraid of the fiscal cliff? Even as protests in Spain and Greece revive jitters in the euro zone, global businesses and investors have discovered a new political horror, this time in the U.S. The fear now in world markets is not so much about November’s election, but about the automatic tax hikes and public spending cuts that Ben Bernanke has dubbed the “fiscal cliff.” These fiscal changes, which come into force on Dec. 31 unless Congress passes new legislation, will tighten fiscal policy by some 4 percent of GDP, comparable to the austerity programs in Spain, Italy and Britain.

Given what fiscal austerity has done to Europe, the worries are understandable, but everyone should calm down. A drastic fiscal tightening is almost inconceivable after the election, because politics, economics and markets interact in Europe and America in opposite ways.

Let’s start with economic policy. The warnings from the Federal Reserve to U.S. politicians as the fiscal deadline approaches are all against allowing the legislated tax increases and spending cuts to take effect. Thus the Fed is giving politicians advice that is opposite that of the European Central Bank and the Bank of England.

Moreover, the Fed is now putting its money where its mouth is. By warning the U.S. government not to tighten fiscal policy, and simultaneously promising to buy bonds and to keep short-term interest rates at zero until the economy returns to full employment, the Fed is effectively offering to finance whatever deficit the U.S. government chooses to run at almost no cost.

In terms of economic philosophy, the Fed is now a clearly Keynesian institution. Bernanke sees unacceptable levels of unemployment and attributes them to an excess of saving over investment by the private sector. He therefore wants the government to keep borrowing until the private sector returns to normal levels of investment and spending – and promises to finance this borrowing with printed money. This policy is anathema in Europe, especially in Germany – so much so that EU treaties explicitly make “monetary financing of government” illegal.

Central banks make an historic turn

Anatole Kaletsky
Sep 19, 2012 19:33 UTC

When the economic history of the 21st century is written, September 2012 is likely to be recorded as a defining moment, almost as important as September 2008. This month’s historic events – Ben Bernanke’s promise to buy bonds without limit until the U.S. returns to something approaching full employment, Angela Merkel’s support for the European Central Bank bond purchase plans and the Bank of Japan’s decision to accelerate greatly its easing program – may not seem earth-shattering in the same way as the near-collapse of every major bank in the U. S. and Europe. Yet the upheavals now happening in central banking represent a tectonic shift that could transform the economic landscape as dramatically as the financial earthquake four years ago.

To see why, we must go back in history 40 years, to the early 1970s. Maintaining full employment was at that time regarded as the main objective of all economic policy, and this had been the case for roughly 40 years, since the Great Depression. But by the early 1970s, voters had enjoyed decades of more or less full employment and were starting to focus on inflation rather than depression as the main threat to their prosperity. Economists and politicians were responding to this shift. Milton Friedman led a monetarist “counterrevolution” against the Keynesian obsession with unemployment, designing new economic models to challenge the Keynesian view that market economies were naturally prone to long-term stagnation. By restoring the pre-Keynesian assumption that market economies were automatically self-stabilizing, the monetarist models produced two powerful policy prescriptions directly opposed to the Keynesian views.

First, the monetarists insisted that price stability, rather than full employment, was the only legitimate target for monetary policy and government macroeconomic management more generally. Second, they argued that central bankers should not accept any direct responsibility for unemployment, since sustainable job creation depended solely on private enterprise – full employment would be achieved automatically if inflation were conquered and market forces were allowed to operate freely, with the minimum of government interference or union constraints. A few years later, Margaret Thatcher and Ronald Reagan turned Friedman’s intellectual revolution into practical politics. On top of its economic impact, monetarism had huge ideological effects by absolving government macroeconomic management of any direct responsibility for jobs and instead attributing unemployment to regulations, unions, welfare policies and other market distortions.

Why the current europhoria will likely fade

Anatole Kaletsky
Sep 13, 2012 15:05 UTC

Does the German Constitutional Court ruling in favor of a European bailout fund, closely followed by the big win for pro-euro and pro-austerity parties in the Dutch general election, mark the beginning of the end of the euro crisis? Or were these events just a brief diversion on the road toward a euro breakup that began with the Greek government accounting scandals in 2009? Most likely, the answer is neither. This week’s political and legal developments have given European leaders just enough leeway to avoid an immediate collapse of the single currency, but not nearly enough to end the euro crisis.

In this respect, the German Constitutional Court has acted exactly in accord with the powerful speech delivered in Berlin this week by George Soros and published in the New York Review of Books. This accuses German policy of condemning Europe, albeit inadvertently and with the best of intentions, to “a prolonged depression and a permanent division into debtor and creditor countries so dismal that it cannot be tolerated.” Germany does this by always offering “the minimum necessary [support] to hold the euro together,” while blocking “every opportunity to resolve the crisis” once and for all.

From what he calls this tragic record of missed chances, Soros draws a conclusion similar to the one presented in my columns three months ago. Germany can continue as the economic leader of Europe only if it accepts the responsibilities of a “benign hegemon,” much as the U.S. did when it forgave Germany’s debts and launched the Marshall Plan after World War Two. If, on the other hand, Germany continues to identify debt with guilt (the German language, significantly, uses the same the word, schuld, for both concepts), it will continue blocking any resolution of the euro crisis that might involve the sharing of government debts across Europe. If, on top of this opposition to mutualizing debts, Germany retains its taboo against any monetary financing of government deficit, as practiced in the U.S. by the Federal Reserve, then Europe will be condemned to long-term depression and quite possibly a revival of national hatreds. In that case, it would be better for all concerned if Germany left the euro.

We’re coming into financial hurricane season

Anatole Kaletsky
Sep 5, 2012 19:57 UTC

The North Atlantic hurricane season runs from mid-August to October, with a strong peak in storm activity around the middle of September. A less familiar but even more destructive pattern of disturbances is the financial hurricane season, which coincides with the meteorological one almost to the day.

Most of the great financial crises of modern history have occurred in the two months from mid-August: the Wall Street crashes of Oct. 22, 1907, Oct. 24, 1929, and Oct. 19, 1987; Britain’s abandonment of the gold standard on Sept. 19, 1931; the postwar sterling devaluation on Sept. 19, 1949; the collapse of the Bretton Woods global monetary system on Aug. 15, 1971; the Mexican default that triggered the Third World debt crisis on Aug. 20, 1982; the breakup of the European exchange-rate mechanism on Sept. 16, 1992; the Russian default on Aug. 17, 1998, the bankruptcy of Lehman Brothers on Sept. 15. 2008 – and this list could go on.

The coincidence between financial and meteorological hurricanes may not be entirely fortuitous. The global economy, like the world’s atmosphere, is a finely balanced complex system. In such systems, small perturbations can accumulate to trigger big effects. And just as the meteorological tipping points tend to occur when autumn air circulation starts to disrupt the humid air accumulated in the summer doldrums, something similar seems to happen to financial markets when trading becalmed by the summer holidays returns to normal. The result can be sudden and violent reaction to events accumulated over the summer that markets had seemed to ignore. The world economy does not, of course, experience hurricanes with the same regularity as the Caribbean. But when big events happen over the summer, financial disturbances become quite probable in the fall. This is probably the reason why September has historically been the worst month of the year for stock market performance. In fact, September is the only month in which Wall Street prices have, on average, declined since the 1920s.

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