fiscal policy

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Jobs and Production: Where’s The Improvement?

Yesterday we read that Bernanke gave a fairly upbeat assessment of the economy in his regular briefing of Congress. We also read that his information was derived, in part, from the local Federal Reserve banks, all but one of which – the laggard being St. Louis – reported improvement in activity and jobs within their respective areas. Finally just this morning the New York based Empire State activity index, which measures manufacturing in New York, showed a healthy jump from 22.9 to 31.9 last month, the biggest jump since 2004.

The markets have taken this and run with it: if we believe this narrative the outlook is much brighter than it has been for many months and the economy’s return to health is fully assured.

Hmmmm.

So why aren’t jobs and overall production showing signs of this improvement?

Conversely, what is it that Bernanke knows that is not publicly available?

I ask this because this morning’s two main reports, of new claims for unemployment assistance and that for industrial production, were both mediocre at best. A surface reading of them suggests a sideways trajectory not an improving one.

Let’s take a brief look at the reports:

New Claims For Unemployment Assistance

The surprise here was that claims rose again, by 24,000 this week up to a total of 484,000, This was in sharp contrast to the general market expectation which was for a drop to offset the prior week’s increase. Last week, if you recall, we were all scratching our heads wondering why claims had suddenly reversed their steady improvement and jumped up slightly. The Labor Department told us that the odd timing of Easter had muddied the data collection in some states and that there would be a correction soon. Once that correction had been made the downward trend would be visible again.

Obviously not this week.

While the ‘Odd Easter’ explanation for the increase could still be valid, we have to begin wondering at what point these excuses will no longer be needed to explain why the job market is stuck in neutral. Clearly the vast wave of job losses is behind us. The problem is that, for all the protestations about an improving economy, the business community is stubbornly clinging to a relatively down beat medium term outlook and thus doesn’t feel the need to hire.

This results in a very patchy tone within the recovery. Parts of the economy are doing reasonably well – health care for instance. Others are faring less well – construction being an obvious example. So far there is no dynamic sufficient to get all the economy’s different parts moving in unison.

I suspect this stuttering growth is what we will see for most of this year and well into next. This is why the jobs market is equally confusing to try to predict. And why it will remain stuck for a good while longer.

The issue is not the usual recovery process, we are certainly on the way to recovery, but is the long term adjustment we are going through as we rebuild the economy to rely less on consumption and more on savings and investment. This rebalancing inevitably reduces consumption and makes the prospects for business less clear than it used to be. In turn, this engenders hesitancy and thus a poor job market.

In this context we should expect to see the claims data improve slowly, but should not be surprised at episodes such as the past two weeks where the market stalls or even retreats somewhat.

Industrial Production

This same pattern of business hesitancy is clearly a factor in the industrial production data also released today. Output grew only 0.1% in March, down from February’s 0.3%, and much less than the 0.8% analysts had predicted. The slowdown was caused by two factors: a change in the weather reduced demand for electricity which shows up as a drop in production; and the general malaise within the economy evidently caused some retreat in factory output.

This latter point is important since it could also be evidence that the inventory re-stocking that was a major factor in GDP growth late last year and during the first quarter has now worked its way through the economy leaving us to rely on less cyclical sources of activity. Since those sources are heavily affected by business expectations the slow down between February and March may be an early indication that activity is not as strong as we thought.

So when we take an overall look at today’s data I am forced to conclude that, while the economy is growing, that growth is highly focused on certain areas, it is not systemic, and is therefore insufficient to justify claims of imminent breakthroughs.

Thus I find myself in a very different spot from Bernanke. He is portraying the economy as well on its way to health, and is even beginning to urge clear thinking in Congress – if that is possible – about ways to contain the Federal deficit. He is not advocating fiscal tightening just yet, but is evidently so encouraged about the economy’s prospects that he wants to shift the focus of discussion to the tough task of reducing the deficit.

In contrast I see the economy as growing, but still in need of support. This makes any discussion of fiscal restraint highly premature, and even dangerous if it is interpreted by the credit markets as a sign of concern at the Fed.As a result I represent a school of thought still advocating stimulus, especially for jobs, whereas Bernanke has now shifted closer to the fiscal hawks and sees the economy robust enough to withstand the dampening effects of tightening – not yet, but soon. To make that shift he must have seen plenty of improvement.

Given today’s jobs and production data I am led to ask: where is that improvement?

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Funny Math: Federal Debt Style

Politics can intrude all over the place. No more so than in the aftermath of the great health care fracas. The losing side seems hell bent on stirring up anger over the legislation and, equally, on totally misconstruing it. The simple fact is that the health care reform as it has been signed into law is a great boon to small businesses, the middle class, the elderly, and those who previously who were uncovered. The only people who come out worse off are the highly paid folks – those with over $250,000 in annual income – who will see a modest tax increase, and the insurance companies who will have to make more pay outs than they used to.

There is no question that, over time, most voters confusion and anger will subside, and that health care reform will be as accepted as Medicare and Social Security already are.

Meanwhile we live in a fantasy world of the opposition’s making. Apart from the ludicrous charges leveled against reform, things such as ‘death squads’ and so on, one criticism that seems to have resonance with the public is the impact it has on the Federal deficit, and, by extension, on the national debt.

Let’s not belabor the point: such criticism is flatly incorrect.

The passage of health care reform reduces the debt, and it reduces the deficit. Cumulatively over the next ten years this reduction is expected to be approximately $138 billion. In the context of our total debt this is not a vast amount, but at least it is moving in the right direction.

Yet the hysteria continues. Articles are pouring out of various right wing pens full of the doom and gloom about the fiscal irresponsibility of the Obama administration and its vast new burden on the poor American taxpayer. Typical of this rubbish is Robert Samuelson’s article in the Washington Post. Samuelson’s main point is that the new law adds about $900 to ‘an already bleak budget outlook’. But he never mentions why that budget outlook is so bleak. Perhaps it’s because he supported all the policies that made it so. Then again maybe he suffers from amnesia.

His thinking is a great illustration of the funny math the Republicans are reduced to in order to foist the debt problems we have on Obama.

Let’s think this through a little more objectively.

In the past decade we have witnessed a number of key policy implementations that have had a material impact on the long term fiscal outlook that Samuelson says is now so bleak.

Here are the high points:

  1. The Bush tax cuts. Impact: increase the deficit by about $1,825 billion.
  2. The Iraq war. Impact: increase the deficit by about $750 billion.
  3. Health Care reform. Impact: reduce the deficit by $138 billion.

Hmmm.

Fiscal rectitude is a subject that anyone who supported the first two of these initiatives should not make a big deal of.

Setting all of this within the current crisis makes it a little easier for faux deficit hawks to make their case. After all we have just plunged deeply into the red in order to bail ourselves out of what could have been a nightmare. Yet the hawks fail to see it that way. They decry spending of any kind. The purpose of the spending is irrelevant to them, they simply oppose it. The fact that spending is the only policy we have to fend off depression is something they deny. They are still mired in market worship, of the Ayn Rand kind, a deeply mystical place where the market weaves magically to overcome all and every problem – even those the market itself caused.

Market magic is now debunked rubbish, but it still has a hold on the kind of conservatives who are repelled by all government spending.

Meanwhile they resort to funny math to cover their real motivation. Their scare stories about the ‘bleak debt outlook’ are a subterfuge. If they were truly scared of debt they would have risen in revolt at the Bush tax cuts and would have demanded that the Iraq escapade be paid for by raising taxes or cutting spending elsewhere. Based upon the evidence we have at hand their opposition to government spending is not that it adds, potentially, to the debt. It is that sometimes the spending is socially beneficial. That they cannot abide. The notion that – gasp – someone is better off as a result of a government program is anathema to them. Keep up with such programs, and before you know it America looks like those funny European countries who look after their poor and wretched citizens.

Nothing should rile Samuelson more than the French President’s comment yesterday. He remarked that he failed to understand the health care debate and the opposition. His reaction to the new law was that he welcomed America to the club of countries who cared for their poor. At last.

So scared are the conservatives that people might end up liking the reform that they are forced to twist the numbers about and talk as if they actually cared about deficits. They clearly forget their hero Dick Cheney’s famous dictum: ‘deficits don’t matter’. And they neglect to comment on those devastating tax cuts. Instead they weep and gnash about the horrors Obama has unleashed and his fiscal irresponsibility.

Unfortunately, we are stuck with an uncritical media that trots out the same garbage. We still read of a ‘$940 billion health care cost’ in the New York Times. It’s as if we all look at our expenses and not at all at our income when we discuss how we are doing financially. The reform law has a $940 billion cost over the next ten years. That’s why the same law covers those costs by legislating new revenues. So well crafted is the law that it ends up showing a profit. It’s called being fiscally responsible.

Only funny math can make that into a reckless thing.

Only funny math can distort reality to make Obama into someone deserving of the kind of accusation Samuelson makes.

Then again through the lens of funny math people like Reagan and Bush can appear to have been conservative. The two most profligate presidents of all time.

Funny. As in hilarious.

That’s funny math for you.

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Jobs, Trade, and Debt: What’s New?

There was a modest flurry of reporting this morning that enables us to take the temperature of the economy. Unfortunately, once again, we are left with a ho-hum feel. This really is a long slow slog.

Jobs:

The weekly release of new claims for unemployment assistance showed a very modest – 6,000 – improvement and came in at 462,000. This was very slightly above expectations and so is something of a disappointment. Worse: the four week moving average rose 5,000 to 475,500 which tells us that any positive momentum in the job market we saw late last year has dissipated. This conclusion is backed up by the fact that claims are now running about 7% higher than they were in November. While some of this loss in momentum can be attributed to the oddities of the weather and spotty data collection, every week that goes buy without improvement undermines those factors as sufficient explanation for what’s going on.

A better explanation is simply that the economy is close to a stall, and needs another kick start. Frankly the jobs bill that just passed through Congress is an affront: it is way too small to have enough immediate impact, and relies far too much on tax incentives rather than direct job creation.

Lurking in the underbrush of the data is an ugly fact: long term unemployment is growing steadily and has now reached 4.56 million receiving regular assistance and a grand total of 11.36 million people receiving some form of unemployment aid. With Federal programs already stretched to 99 weeks it is hard to see what more can be done in terms of assistance. I think the obvious next step would be work programs in the manner seen during the Depression. So far, though, such ideas have not received much attention in Washington.

When we discuss unemployment aid it is very important to recall its stimulative value for the economy. Since unemployed workers are generally very hard up, they tend to spend any aid they receive. So channelling stimulus cash through the unemployment assistance route is an extremely effective way of getting aggregate demand to rise. It is demand we are attempting to reflate with the stimulus and we get a great ‘bang for the buck’ with unemployment aid.

I won’t comment again on the inhuman folly of the Republican position that aid acts to undermine a worker’s determination to seek work. I am sure there are examples of such idleness. I am equally sure that those instances are not representative of the general unemployment market. If they were we would not be witnessing the long lines ate job fairs, job workshops, and employment bureaus that we are. The Republican view is reminiscent of Victorian England before the emergence of the labor movement. The paternalistic moralizing that underlies such an attitude towards those unfortunate enough to have lost their job is staggeringly demeaning and massively insulting. Yet it still crops up. Personally I find it disgusting. From the point of view of economic policy it makes no sense either. Unfortunately, as I have said here many times, orthodox economic theory lends its support to the ‘unemployed as indolent’ perspective: according to the Chicago school of economics – Milton Friedman’s legacy – anyone who is unemployed has specifically chosen to be such. That theory assumes an unemployed worker values leisure so highly that they prefer to remain unemployed rather than find work at a lower wage. Hence there can be no ‘involuntary’ unemployment. The persistence of this specious thinking is one reason it is hard to purge right wing politics of its frequent bouts of paternalism, which is unfortunate when, as now, we need a united front with which to confront the terrible social effects of a crisis.

Trade:

File this in the category of ‘not good news’. Our trade balance shrank 6.6% in January to $37.29 billion. This is not good news for the simple reason that it probably indicates that worldwide economic activity slowed somewhat. The last thing we need is a global retrenchment. It is also unfortunate since the previous two months had seen large increases in the deficit which had all the feel of a strong economy: not only were we exporting more, but we were importing more as well which is usually a sign of increasing demand and industrial activity. A sudden stall such as that in January is something we need to watch carefully. A repeat in February would be unwelcome.

While I am on the subject of trade I should mention the administration’s export initiative. Politicians always love export stimulating programs because they draw a straight line between a surge in exports and a healthy outlook for jobs. Allow me to pour cold water on that notion.

It takes a little thought to see why a surge in exports and thus a surge in jobs is not a healthy thing. There are two essential reasons.

First: any increase in our exports implies an increase in someone else’s imports. All we do in this case is to create jobs here at the cost of jobs there. The lost income abroad will eventually feed its way through as lost demand and eventually a loss in demand for our goods. To maintain our trade advantage in the face of this lost demand we would have to cut prices and engage in a trade war. The end result would be an erosion of activity and the potential loss of those jobs we created at the start.

Second: a surge in export related jobs would put pressure on our labor market. Right now that seems like a good idea – we have tons of slack to be taken up. But as that slack is removed and as the domestic economy improves the added export related jobs will exert inflationary pressure on wages and will cause the Fed to have to raise interest rates. This would cut off domestic growth at a lower point than normal, meaning that fewer domestic jobs were created during the business cycle. In other words the extra jobs in export industries come at the expense of fewer jobs in domestic industries. Over the course of the entire business cycle the number of jobs created will be the same, they will simply be allocated somewhat differently.

This is basic economics.

The only way to create extra employment over a business cycle is to increase total – ‘aggregate’ – demand. That way more stuff will be bought from all industries whether they are export, import or domestic only.

So stimulating exports, while it appeals to voters, politicians, and to business leaders in exporting companies, has no long term value. There are no extra jobs created and the effort simply masks losses elsewhere.

This is why stimulus should focus on reflating demand rather than on targeting specific industries.

Beyond stimulus, an industrial policy that helps expand the economy in a general sense has value, but that is not what the administration’s export initiative appears to be about. Obama should get back to finding ways to develop new industries and leave exports alone.

Debt:

One of the great features of this crisis, especially in the recovery stage is the massive de-leveraging going on. Households and businesses are shedding debt at unprecedented rates. Debt still continued to climb in the fourth quarter – at a 1.6% annual rate – but that represents a significant withdrawal from credit. Don’t forget the economy grew at over 5.5% during the same period.

According to the government businesses cut debt at rates never before seen, and the fourth quarter increase was the smallest on record – going back to 1952. The outstanding debts of non-financial companies fell at an annual rate of 3.2% in the fourth quarter, bringing the drop for the year as a whole to 1.8%.

Meanwhile households cut their debt levels by an annualized 1.2% in the fourth quarter, bringing the annual decline in that sector to 1.7%, the first annual drop ever.

At first sight these figures seem welcome: one of the chief concerns of the past few years has been the indebtedness within the economy. So de-leveraging appears to be a sign of a more healthy balance being established within the economy.

Not so fast. Think about this a little: every dollar spent on debt elimination is one less dollar spent on investment or consumption. All this debt reduction is putting a massive constraint on demand. No wonder the economic recovery is so slow. As in all things there needs to be a better balance between debt reduction and spending. Right now the economy has veered far to heavily towards thrift and too far away from expenditure.

But there is an offset. One that has been much debated recently: government debt.

One reason why the surge in the Federal deficit has been of little concern is that it is filling the debt void opened up by the huge private sector retrenchment. That’s why total debt is still rising even in the face of the private sector cutback. Without that surge in public debt aggregate demand would have imploded completely and we would most likely be in a deep depression.

Conversely, those who argue that the surge in public debt is somehow ‘crowding out’ private debt – making it difficult for businesses to raise debt and thus invest for the future – is clearly wrong. There is no private demand for debt to be crowded out. All the data suggests otherwise: the private sector has gone into a deep freeze and is trying to shrink itself at an unprecedented rate. The crowding out argument might have some validity during a normal business cycle, but this is far from such a cycle. We are witnessing an historically large retrenchment, which requires an equally historically large response.

One reason why the economic recovery is so meager is that policy makers completely misread the unique character and size of the crisis. Especially the impact that the banking implosion would have on the real economy.

It is vital that we all grasp the true nature of our current problems and understand that we are dealing with crisis whose size and scope is beyond any other than the Great Depression itself.

So, yes, debt retrenchment is great in the medium and long run. But short term it is acting as a massive brake on GDP growth. Only continued government debt creation can fill the gap and keep us afloat. Hopefully there will come a time soon that we can switch back to private sector borrowing and reduce the Federal debt. Right now any discussion on the subject is being rendered moot by the private sector’s actions.

So what do we make of today’s data on jobs, trade, and debt?

The economy is still a mess. The issues are still complicated and not easily tractable to simple policy shifts like the export initiative. Nor is debt reduction necessarily a good thing

This year continues to look very difficult. Even though we have made progress, it is both tenuous and far to reliant on government support. We are still waiting for private business and households to stop reducing. Only then will we see an easier path emerge. And until then risks abound.

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The Deficit Debate Continues

Martin Wolf in today’s Financial Times absolutely nails the essentials of the current debate breaking out over our national debt and the federal deficit. I completely endorse his point of view.

I can understand people who are not involved in economic policy discussions making the mistake that we ought to deal with our deficit as a matter of urgency – it seems intuitive that nation’s should balance their books in the way that private citizens have to. But I am shocked at the irresponsibility of some who participate in the discussion and advocate fiscal tightening without thinking through the consequences.

And it isn’t as if we have no empirical support for the debate: presumably 1937 means nothing to the minds of the fiscal hawks who are now clamoring for tightening.

This is odd, since the hawks are being led by Niall Ferguson who is an internationally known historian. I could not disagree with his reading of the history more. My explanation for Ferguson’s mistake is that he is in the thrall of Milton Friedman’s famous interpretation of the Great Depression which placed the blame for the disaster on the Federal Reserve Board and its poorly timed tightening of monetary policy. Such was the influence that Friedman had that even as recently as the mid 2000’s, at an appreciation dinner, Bernanke told him that the Fed was sorry for its mistakes and would not repeat them.

This is important because Friedman’s analysis opened the door to subsequent attacks on Keynesian style deficit spending. The logical conclusion of the Friedman thesis was that the Depression was a monetary policy induced error and that fiscal policy as advocated by Keynes was irrelevant, and may indeed be harmful.

Friedman should not be blamed entirely for the current malaise in the economic policy debate since it was his followers who pressed the logic to its limits and have now developed the view that fiscal policy can never be effective – Nobel Prize winner Robert Lucas’ so-called ‘rational expectations’ theory tells us that consumers and firms immediately change their behavior when the government runs a deficit to take into account the future taxes needed to pay down the debt created by that deficit. The effect of this changed behavior is to induce extra savings which offset exactly the stimulus effect intended by the deficit. Thus fiscal policy is useless.

This is what appears to be Ferguson’s position. So he can assert that the damage done by accumulating debts and the chances of impending financial market chaos necessitate fiscal tightening, and that we should put the entire burden of economic management on monetary policy. He takes advantage of the Greek crisis and tries to characterize it as a portent of our future if we don’t tighten the budget up.

This is just nonsense.

There is no comparison between the US and Greece that makes any sense whatever. Ferguson is simply using Greece as an opportunity to trot out the fiscal hawk position he has been advocating since the crisis began. It made no sense then and it makes less sense now. It is tiresome to have to keep trumpeting the efficacy of fiscal stimulus. It is even more tiresome, but important, to have to keep rebutting people like Ferguson who advocate poor economics.

Let me recapitulate the major point that Wolf makes: the private sector has shifted from net debt accumulation to net savings. From negative 2.1% to positive 6.7%. That implies an equally dramatic shift in consumption, which collapsed by the 8.8% difference between those two numbers. That creates a huge gap in the economy we need to fill temporarily. Hence fiscal stimulus.

This does not imply we should not concern ourselves with the medium term: the deficit looms large as our most significant medium term problem, but as Wolf successfully argues it is not a short term problem at all. Put another way, the medium term cost of running a deficit is much less than the near term cost of not kick-starting the economy.

That means we keep the peddle pressed down firmly on stimulus and ignore people like Ferguson. He should stick to history and stay away from economics.

A more sophisticated argument against a policy of general stimulus is given by Bradford Cornell a professor of financial economics at Cal Tech. His point is that since a stimulus is inevitably a generalized policy – it lacks precision – and the problem is one of what he calls ‘misalignment’ which requires a precise response, we should abandon stimulus and focus instead on microeconomic solutions such as improving the allocative ability of the financial sector. Although it might appear to be very different Cornell’s approach is informed by the same neo-classical economics that Ferguson is advocating.

The notion that tinkering with removing micro level blockages in order to ensure the allocation of resources within a economy is most ‘efficient’ is straight from the Friedman/Lucas playbook. It assumes that macro level discussions of things such as ‘aggregate demand’ are irrelevant – Cornell comes right out and dismisses the very concept of aggregate concepts. This leads him to object to anything remotely Keynesian since Keynes’ entire approach is based upon aggregate analysis.

I find Cornell’s analysis less objectionable only to the extent that his idea that we should be able to wind up banks more easily, and thus ensure banking efficiency in the long run, an acceptable addition to any new re-regulation of the industry. It is not, however, a substitute for macro level stimulus.

Now is not the time for tinkering in the Cornell model. We need more stimulus.

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Kick The Greeks Out?

A small majority of German voters apparently now want to kick the Greeks out of the Euro. That won’t happen, of course, due to the enormous consequences of exposing the Greek economy and its new non-Euro currency to the fury of the world markets. Going solo right now would be a one way ticket to oblivion.

I have not yet commented at all about the big mess that has surfaced in Europe, but since it seems to get top billing in the financial media it’s worth taking a look at. In particular we need to compare the crises in various Euro countries with the very similar crises in various US states.

In many ways the problems faced by California, Florida, and New Jersey – to name the obvious suspects – are very similar to the crisis that is currently engulfing Greece, Portugal and Ireland. Notice I leave Spain off of this list, an omission I will explain in a moment. Each of these countries or states has run profligate and reckless budgets in the recent past, the consequences of which are now coming due. The easiest example to lampoon is Greece, where the government has run massive deficits, the tax system is so corrupt that revenues are never collected, and the nation is knee deep in over-paid and under-worked civil servants. There is nothing positive to say about the way in which the Greeks ran their economy over the last decade or so. They are due for a nasty and brutal adjustment.

In some ways the Greek problems are a classic example of what we call ‘the tragedy of the commons’. This is a circumstance where a group of individuals – such as a nation – make decisions that collectively impose a cost on society, of which they are a member. In many ways this is the diametric opposite to Adam Smith’s fabled ‘invisible hand’ where individual greed produces a collectively superior and beneficial result.

The example in Greece is non-payment of taxes. The Greeks, like the Italians, are culturally so averse to payment of taxes that it is normal for them to keep two sets of books: one for cash and one for all other payments. Naturally cash payments go unreported for tax purposes. The size of this cash, market is so large a piece of the entire economy that it significantly alters the tax rates necessary to levy on the taxable part in order to raise sufficient revenues to pay for the Greek equivalent of Social Security and so on. It gets worse: because tax rates are so high, many people evade paying them, which just makes the revenue shortfall worse.

None of this would matter were it not for the fact that the people who are avoiding and evading taxes still want to receive their state pensions. That plunges the state into debt. A fiscal crisis soon follows, and unemployment rises rapidly. In other words the culture of cheating simply boomerangs and damages those who cheat as well as those who don’t.

That’s a simple case of a ‘tregedy of the commons’.

The comparison between the Euro and the US states like California breaks down at a macro-economic level. The two situations provide valuable lessons in economics.

Let’s go back and look at Spain.

The Spanish economy was run in exemplary fashion. It had very conservative fiscal policies and tight management all around. The Spanish, however, are cursed with glorious weather, so in the real estate boom times of the last decade cash flooded into Spain from other European countries, in particular Germany. So far the analogy with Florida is fairly good, but the analogy with California and New Jersey has already broken down due to their profligate budgeting and fiddling of expenses. The Spanish experience gets unique after the bursting of the real estate bubble. Prices had been driven up by that flood of incoming cash, so after the bubble broke Spain found itself hopelessly uncompetitive. Its labor market was overpriced, and it was left as an outlier in terms of prices, and productivity.

The big divergence between the Euro and US state experience is now exposed: whereas the failed US states still benefitted from massive inflows of Federal cash in the form of Social Security, Medicare, and other program payments, Spain is self contained at the fiscal policy level. That means it receives no fiscal aid from some source outside itself, there are no ongoing payments to provide stimulus. Worse: Euro monetary policy is centralized. This means that Spain’s interest rate and currency exchange rates are outside its control. The combination of having no control over its currency and yet no sources of fiscal aid, reduces Spanish options to virtually nil. The entire burden of getting their local economy going falls on the Spanish budget. Consequently they have to institute extremely harsh measures to stop the rot. Spanish unemployment has shot up to near 20%, they are experiencing severe deflation, and there is no real prospect of a near term recovery. Had Spain not ben part of the Euro it could simply have devalued its currency and allowed a much softer adjustment to take place. Instead is is stuck in a rigidly and externally imposed currency regime.

Contrast that with Florida. There the process of adjustment is much easier: its local real estate and labor markets are linked more freely with the general US economy. Stimulus cash flows in easily and monetary policy is a non-issue. Florida, although it suffered a bigger bubble will adjust more quickly because other parts of the US are sending cash in via the Federal budget – Florida doesn’t have to slash its own budget as much as a result.

This is the big lesson to take away from the Euro crisis. The euro experiment was half baked. Monetary policy was unified, but each country kept its own fiscal policy. That has now been shown to be a foolish mistake. There are two solutions: ditch the Euro or unify national budgets into one Pan-Euro fiscal policy.

I have already mentioned that I don’t think the Euro will be ditched. The economic consequences for laggards like Greece, Portugal and Ireland would be devastating. The political consequences would be equally incalculable. So I expect the Euro area to fudge and muddle its way through the crisis. The cost will be massive in terms of slow economic growth and high unemployment, but both will probably be better than the alternative. Oddly though I see the long run being very different: eventually this crisis will provide impetus to tighter fiscal union. The Euro experiment has gone too far down the road to turn back, so logically it must plunge on forwards. I doubt there will be any greater union in the next few years, but such a union is now almost inevitable.

So it is very dangerous to compare the crisis in the Euro region with the crises unfolding at the state level here. Decrepit US states like California and Florida can survive because they they are not independent and are subsumed into Federal monetary and fiscal policies. They are bailed out through the backdoor rather than through the front door.

Poor Spain has to suffer despite having done everything correctly because it has no control over monetary and currency policies. That throws the burden onto its local fiscal policy which has to be draconian because it is the only lever available locally.

As for Greece: they deserve what they get. Fortunately they are so small in terms of the entire Euro economy that their failure should not prove too disruptive. I expect them to suffer through regular crises and wild swings from growth to collapse until they establish a more modern economic infrastructure to support the level of expenditure they seem to demand of their government.

You have to pay taxes if you want the government to give you a pension and health care.

Hmmm. What an interesting concept!

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