Monday, June 18, 2012

Dodging A Bullet

The Greek election results are almost in:

Greece Steps Back From the Brink

Greece isn’t ready to call Europe’s bluff. If early indications from the polls are correct, the top vote-getter in Sunday’s parliamentary elections was the pro-euro New Democracy Party–not the leftist Syriza coalition, which campaigned on a platform of rejecting Europe’s conditions for bailout assistance.

That’s good news for the rest of Europe–and indeed the rest of the world, which would be harmed by a chaotic exit of Greece from the 17-nation euro currency zone.

New York University economist Nicholas Economides, who was in Greece for the elections, said in a telephone interview that “if things go the way it looks like now, the Europeans should breathe a sigh of relief.”

Bloomberg News reported that according to final exit polls, center-right New Democracy had narrowly edged out Syriza, with Pasok, the center-left party, which is also pro-euro, coming in third. It appeared New Democracy and Pasok would have enough seats to win an outright majority in parliament if they formed a coalition government.

I’m not going to go “hurrah!” just yet though. If Europe and Greece have dodged a bullet, there’s plenty more on the way. Fundamentally nothing has changed, except the buying of a little more time. The contradictions underlying European monetary union remain unresolved – wide productivity differentials, huge budget gaps, and a central bank unable and unwilling to rise to the occasion.

Even the bailout of Spanish banks last week, which was far more critical from the point of view of preserving the Eurozone, hasn’t restored market confidence – Spanish government bond yields have hit another all time high.

It’s going to be a hot, tense summer.


  1. It's true that the EMU has always been more of a political objective than an economic one. But this part of your post caught me a little of guard...

    "...wide productivity differentials, huge budget gaps, and a central bank unable and unwilling to rise to the occasion."

    Leave out the dysfunctional ECB not willing to be the lender of last resort (LOLR), and you wonder whether current monetary unions (e.g. United States or even, Malaysia ~ i.e. across its states) are optimal currency areas.

    Just goes to show you how important LOLR's are in an economy.

    The Economist's recent take on US state finances:

  2. Jason, by law the ECB is not allowed to act as lender of last resort to member governments, only for the financial system. Other more stable monetary unions have both that feature and the ability to conduct fiscal transfers between member states. Germany is attempting to lead the EU towards the latter, but I think for the Eurozone to survive, you really have to have both.

    1. Yup, was referring to Central Banks acting as LOLR for Governments.
      The "backdoor bailouts" of the Long Term Refinancing Operations to the banks doesn't seem to be as effective as straight up massive open market operations of QE.

      My point is though, even with disparate components of a monetary union, all you need is just a bit of fiscal solidarity and a central bank to do what's right when the time calls for it. (It seems that) we can have a divergence of growth and fiscal balances as long as authorities are willing and able to lend a hand to each other.

  3. Demolish the riba-based financial system and adopt the dinar, we'll see the light at the end of the tunnel earlier.

  4. No, doing that would take us straight into the abyss.

  5. we're already deep into it and going deeper. The west is already stuck at the bottom, and pulling us down with encouragements and false assurances from western-trained economists.. that there is no alternative to the "ponzi scheme" we've ignorantly embraced

  6. But having said that, I'd still think that you're the most sensible economist I've come I urge u to do yr part, dear hishamh.. and take that small but critical step towards the REAL solution

  7. Dinar isn't a solution if you cherish flexibility. Gold/commodity-backed currency would send us into deeper recession just because it is inflexible.

    Just imagine having no money circulating when you need them in recession-time. Everybody hoards the money. That what would happen gold-backed currency.

    If Europe were on gold-backed currency, there would be no Europe anymore.

  8. Hafiz, do u mean if Europe were on gold-backed currency, the current financial meltdown would have caused the whole European continent to sink into the ocean or the earth mantle? Or all the European people, their properties and productive assets to simply vaporize?

    That'll make an interesting plot for Steven Spielberg, I'll tell you.

    Oh c'mon..nothing of that sort will least not until hari kiamat.

    Both Japan and Germany were bombed to oblivion during the WW2, but look at them a decade or so later. In a conducive political environment, its the people that will get the nation back on it's feet. You know that.

    On the question, of dismantling riba-based financial system and the dinar - there has been innumerous discussions, debates, papers, books - so it'll be superflous and unworthy to have a lengthy debate on them here.

    The fact of the matter is that what we're witnessing now is the systemic collapse of the free-market or laissez faire capitalism.

    And if we do a reverse Jim Collins approach of identifying the cause of greatness (in this case - of evilness and malignance) we'd find the riba', unfettered capitalism and fiat money (in their present form) to be the top causes.

    I am not suggesting there shd be an abrupt dismantling of the current dysfunctional system.

    The fiqh of Islam political economy needs to be further developed. But the basic quranic tenets are clear and intact. The result of centuries of neglect has left the institution of ijtihad in need of revitalisation and refinement in contemporary context.

    Therein, there is a dearth of leaders,experts and practitioners.

    1. It's true that it's the people that brought the countries back up. But institutions matter. And Germany and Japan certainly didn't rely on gold currency to do what they did. They weren't on gold all this while and in fact, they abandoned the Bretton Woods system in the 1970s.

      And I'm more inclined to see Europe as a crisis of monetary union than a collapse of laissez faire capitalism. First, I'm unsure if Europe would consider itself as practicing laissez faire capitalism. (And here's a kicker: prior to this, people have been saying Europe is a better alternative than the US, which is supposedly the hallmark of laissez faire capitalism. The US is doing much better now while Europe is pretty much in double-dip recession). Second, the accusation of collapse of capitalism in one way or another has been leveled back in the 1880s Long Recession, 1930s Great Depression, 1970s oil crisis, 1980s S&L crisis, 1990s Asian crisis/dotcom bubble, 2000s housing bubble and now 2010s Europe. Yet, here we are close to 150 years later. So, I'm rolling my eyes here.

      And maybe Islam political economy needs to be further developed. But as it right now, it is inadequate to solve problems in the real world. Meanwhile, most of its supporters are advocating pre-1930s policies, which are inferior. Modern economics from mainstream to the heterodox schools have learned so much since the 1930s. The Islamic school hasn't and that is sad.

  9. With respect, a gold based currency standard is the worst possible remedial measure for Europe (btw, post-war reconstruction of Japan and Europe was primarily achieved with lots of American help and especially money, not to mention in the case of Japan, the Korean War).

    If anything I'm far more rabidly against commodity currency based systems then Hafiz is. It has been the root cause of far more economic and social evil than anything fiat money can do and a primary contributor to the economic decline of Islam and the Ottoman Empire.

  10. I am not equating gold-based currency with dinar coinage currency, nor advocating the merits of either.

    What is imperative is to cut off whichever currency system that a riba-based economy thrives upon or are accomplice of.

    BTW,the Quran does not instruct either the dinar system nor a commodity-based currency.

    The current riba-based system however loves fiat money and debt as otherwise they cannot squeeze more interests and profits beyond the amount of gold in the system.

    But back to Europe, if there was a contagion collapse of the financial institutions, it is the banks that will be hit most. So will other institutions, companies and individuals that live squarely off the staple and derivatives of the system.

    And yes, also the people (especially the middle-class) who keep their savings in the banks will also suffer and be impoverished as was with Argentina(1999.

    That's what generally happens in a crisis.No?

    But it's inevitable... and it is un-natural to try to circumvent it, not bite the bullet. (Haha..funny, why am I having to say the obvious)

    Okay, the Americans did help Europe and not act like they did in Iraq..but that notwithstanding, the Germans had the human resource, human capital, knowledge, technology and social structure that cannot be destroyed by the bombs - to rise again!

    That's why I mentioned earlier that the political environment need to be is not in Iraq.

    Similarly, the bombs of financial crises will hurt terribly.. but will not annihilate the people.

    The banks will conked out. So what's the big deal if they have to sacrifice some shylocks?

    Worse, as we saw in the Reagan era, he perpetuated the profligacy by "robbing others"...via inventing crises and promoting wars and hegemonies. A strategy Bush Jr. also adopted with his "war on terror", and robbing the Arabs and in particular Iraq.

    Prior to Reagan's presidency, Carter was urging Americans to do "soul searching" and to relook at thier excessiveness.

  11. Irrespective of whether you use a gold-backed currency or gold currency itself, an interest-based system or a profit based system, the essential problem remains that the supply of gold is independent of economic activity but not the other way around if make it the basis of the monetary system.

    That inherent dichotomy is what makes gold-based systems (or any commodity backed monetary system) inherently unstable, gaining monetary stability at the price of real economy volatility. You solve one problem by creating a far more welfare-damaging solution.

    Don't think this is a new idea. Monetarism in its original form under Friedman was nothing more than an attempt at creating an analogue of a gold-backed monetary system with fiat money. It didn't work, because all it created was wild swings in real economic activity.

    The Great Depression was turned from a stock market crash into a deep, multi-year recession with multiple bank failures because the Fed maintained dollar parity with gold and liquidationist ideas ("don't interfere") predominated. It took three painful years of continuous falling output and rising unemployment before they gave up. They tried going back to gold-backing again a few years after that, which resulted in another recession.

    Compared to the Great Depression, what we have gone through in the last 4 years is a picnic.

  12. Its obvious that current system allows for unfettered risk taking cos of greed n irresponsible mgmt i.e at govt as well as micro company level.Its not sustainable cos its founded on making bets..big ones create illusion of growth.There is no bedrock to keep it all real.

  13. Even at micro level...valuations is on earnings(which is pretty pliable n suggestive) and not on widgets or assets.This are the bubblers that creates cycles.The supply demand equation thrown out of whack cos of speculators..the hedge funds.nthe currency players.There is no firm foundation..just imsgery floats.Its enron n global crossing played by nations.Truly not sustainable

  14. I see danger...
    catastrophe lay before us and ahead
    where then lie the answer

  15. Wats the weapon a country hv against speculators?and wat weapons do leaders hv to win votes n remain in power? Interest rates..borrowings byond reasonable levels benchmarked against perceived growth? Commodoties n real outputs are subsiadary to currency fluctuations n hedging.With instant info..ripples turns to tsunamis if the purveyors of false prophecy decides.
    Who suffers?its the family of 4 in Greece living in a house lighted by candles cos electricity is cut off n mortgage deliquent.
    Speculation by riba is not n will never be sustainable if the bulk of the wealth is controlled by a few.Riba must be removed?

  16. Bankers using human shields and fear-mongering ..the people will suffer.

    We all know who the bail-out funds will end up with..the bankers - not the job-creating economy.

    Thus is the despicable unrepenting perangai of the western riba-eaters.

    The bullet wiil get them.

  17. The moral bankruptcy of the riba eaters is reflected in the economies and politics just south of Europe - in Egypt, Libya, Algeria, Palestine, Africa, etc

    Why care if the pro-euro conservative wins and forms the government in greece, when basic values and needs are trampled south of the Mediterranean.

    From human perspective, the whole of Europe should right now be more concerned if Egypt will be free to elect their own government and liberate themselves from the clutches of neoliberalism and politcal lackeyism.

    Where is yr humanity, europe?

  18. China kept inflation low cos their good so cheap...Feds kept interest rates accessable to many...funny money kept the system going.The rich made a huge killing.When it collapsed as sure it will the rich is bailed out but the poor left to regret believing the stories the rich told them ine greed is good.Wat allowed this unreal economy?Its the monetary system based on perception n not on real output.Analysts were earning usd20 mil to sell stories n create imaginery feel good for companies they advise.
    This concept of value hv to change.One bird is better than 2 in the bush.The system is too easy to corrupt.
    I don't hv solution..but I know we need to base on real stuff that u can touch n smell.U can't sustain the speculators n thise who made money without selling real stuff...only dreams.

  19. If all this is coming from the same person, you're getting incoherent.

    With reference to Europe, the lack of currency flexibility is precisely the problem, not the solution. The suffering of Greece and Portugal and Ireland and Spain and Italy and so on could have been avoided if those countries had opted not to join the straitjacket of a monetary union dictated to by a Germany determined to keep things "real".

    If you are just advocating profit-based banking, fair enough - my own "Western-educated" Mat Salleh professor in the UK proposed the same, before Islamic banking was even known in the West. There are some attractive features to risk-based financing (socialisation of not just losses but profits as well, deeper monitoring of lending), but not on the basis of backing currencies with gold or any other commodity.

    The human price you have to pay following that path is too steep - economic growth turns into a zero-sum game leading to booms then busts; higher income and wealth inequality because of gold's deflationary tendencies; colonialism, imperialism, merchantilism, war.

    Moreover, true profit-based banking is really hard to do because of the negative incentives on the liabilities side, something our Islamic banks know too well.

  20. Fair enuff...So if Greece hv the flexibility of printing more drachmas to get out of this mess..wat's the outcome for the ppl especially mid to low income?Assets still devalued n underwater?And cost of living will go up tremendously too?How did the situation get to this point..dunno wat but debt;both public n private seems to be the root cause.
    Will a better monetary system...better control of speculation or rather an economy not built on speculation n extreme the panacea?Or wat we hv got is the best?
    My father is no economist...but he does reminisce the 50s n 60s when a cup of coffee seems to cost the same for 2 decades.

  21. No, some of the abv comments are not mine. Though, I won't deny suffering from my own incoherency. But like many I do want to adhere to quranic riba is a a simple big a NO.

    Regardless of the present state and efficacy of the riba based system. It's got nothing to do with its apparent success or failure.

    The speculated human price of implementing a holistic profit-based being steep is pure conjecture.

    The human price of the present system is right in front of us. Untold suffering and enslavement of the 90% of humanity. Or is it 99%?

    Anon A

  22. Ah ok,

    @anon 6.35

    Greeks accumulated debt because in joining the Euro, they only had to pay interest rates consistent with the Euro area as a whole, and not what should have applied to their own country in isolation. In other words, borrowing costs were too cheap in the PIGS because ECB monetary policy was geared towards the major Euro economies (Germany and France) and not the southern periphery which were neither as competitive or productive.

    My preferred solution would be for Germany to leave the Eurozone, and not Greece or Spain or Portugal. It's Germany's super productivity levels that are out of line with the rest.

    A new Deutschemark would appreciate against the rump Euro, but to a far lesser extent than the devaluation necessary for Greece or Portugal to equalise their internal competitiveness relative to the rest.

    That's the minimum pain option; but unfortunately its unlikely to happen.

    @anon A

    No conjecture; the basic analytical framework rather ironically comes from Muslim Spain 700-800 years ago. The rest is historical evidence.

    If money is backed by something real, it follows that money will be treated as the financial representation of all real things (i.e. money=wealth). If production of real things outstrips its financial representation (i.e. economic growth), then the value of money must increase to compensate (deflation) and vice-versa (a recession eventually results in inflation).

    But deflation causes money hoarding and reduces profits, as wealth increases without having to do anything (historically a prime cause of higher income and wealth inequality) while real prices fall. Money hoarding in turn results in lower demand, and eventually lower output - but because real output only adjusts with a time lag, output overshoots to the downside, and you get a recession that turns into a depression. Eventually output adjusts, and you have inflation instead, as there is too much money relative to too few goods, and the whole thing goes in reverse - boom and bust.

    Bottom line is that output growth necessarily must fluctuate around the growth path of the stock of money. If money is backed by gold, then the growth of gold stocks determines long term growth potential - effectively a zero-sum game around that growth path. For any individual country to achieve economic development (economic growth in excess of the norm) requires a surplus approach to the balance of payments - merchantilism. If that's not possible, appropriation will do just as well - colonialism and imperialism.

    Long term growth estimates of global growth before the industrial revolution and the wide adoption of fiat money are around 2%-3% per annum. Coincidentally, growth of gold stocks during the same period...2%-3% p.a.

    Our problem now - the increase in gold stocks is sub-1.5% and falling, while aggregate global growth is averaging around 4.5%. Trying to create a gold (or for that matter silver) based monetary system means embedding deflation permanently into the system, increasing inequality and international competition for wealth. The numbers simply don't work.

    I'll say it again - the conditions we have now are a picnic compared to the damage inflexible monetary systems can do and have done.

  23. Isn't zakat a wealth tax thus making money n wealth hoarding a thankless endeavour with 2.5% bitten off per year.Doesn't this encourage circulation of money for useful pursuits whilst at same time limits wealth concentration?

  24. You're right in the sense that zakat will limit money demand - in that sense it will function similarly to inflation. But when debt deflation bites, that's not an effective deterrent.

    Consider the situation now - real borrowing rates for the US and German governments are negative in real terms. People are essentially paying the German and US governments to hold their money for them, because they don't trust their own governments or banks.

    Corporations involved in Europe are hoarding cash because of economic and political uncertainty, even when they are losing money on it. A few German MNCs (like Siemens) have even obtained banking licenses, so they can keep their cash right at the Bundesbank at 0% interest, even as European inflation stands at 2.4%.

    Also consider that if zakat acts similarly to inflation with relation to wealth, that hasn't stopped the increasing wealth concentration that we've seen over the last 30 years.

  25. Key feature of Muslim biz is that there must be a tangible product in every transaction...thats wat someone explained.Is a futures contract a tangible product?Is a hedge a tangible product?Are the toxic derivatives a tangible product?

    And zakat regime discourages idle assets.Thus if one does nothing with a piece of land or a ton of gold for 40 years the zakat is 100% of acquisition value.

    These two factors will create a sea change of mindset.And myb zero yield on excess funds is not too bad if my cup of coffee going to cost same in 2030.

  26. 1. In modern economies, more than half of economic activity involves services - non-tangible products. And no, it's not all finance.

    2. With respect to zakat, that's the same incentive provided by inflation.

    3. What's the point of having the same prices, if your income goes down?

  27. Zero yield on excess funds may discourage saving.

    An environment of no interest rate in fact may encourage instant gratification: spending now now now and less thought about tomorrow. This is especially so when there's inflation with the (nominal) interest rate is zero.

    Any system that does widely that will be in trouble soon enough.

    This suggests one thing: just because it's labelled Islamic doesn't mean it will work.

  28. "..the basic analytical framework rather ironically comes from Muslim Spain 700-800 years ago. The rest is historical evidence"

    Apprec it if u would quote some literatures/references on the above.

    Anon A

  29. For the monetary aspects, it should be in any standard macro textbook, variously called the equation of exchange or the quantity theory of money. It's often credited to Irving Fisher, but his was only the modern formulation.

    On the mechanics of depression Keynes of course wrote the seminal work. Also try Friedman and Schwartz' "Monetary History of the United States", or the any of the works of Barry Eichengreen, such as "Golden Fetters: The Gold Standard and the Great Depression, 1919-1939" (more recent treatment here). Most textbooks on monetary economics should also have an overview of the underlying theory.