No, this is not about influenza, but about contagion of financial crises. Greek government debt has recently been downgraded, and this might be bad news for Ireland and others, according to Gregory O’Connor:

The Irish problem with Greece’s growing troubles is that financial crises tend to be contagious. One of the “signals” that could instigate a sudden stop in Ireland is a sudden stop somewhere else, particularly somewhere with regional or trade connections.  This is why bad news for Greece is bad news for Ireland.  If Greece hits a sudden stop, Ireland will wobble, and will be the next in line for a sudden stop in Europe.

This is something that we used to see in developing and emerging economies during the Asian crisis of 97 when Russia, Argentina and Brazil wobbled in its aftermath. It is unfamiliar and slightly irritating to see it happen in the European Union.

Gregory O’Connor has only this advise to give:

In my opinion anyone who truly cares about the Irish banking system and its role in the economy should be encouraging the government to sell off the Irish domestic banks, shorn of the liability guarantee, and with the worst of their excesses spun off into NAMA.  If this were done, the risk of an Irish sudden stop would fall close to zero, and our sovereign borrowing rates would also fall sharply.  A sudden stop is an ugly thing and we should do everything we can to prevent it.  If the banks were safely inside large foreign holding companies then these insolvent Irish banks, and the risk they engender for the whole Irish economy, would cease to weigh down Irish economic recovery.

This is about priorities, and saving the government is higher on the list than saving individual investors. Government provides vital functions like enforcing the law, providing education and health care, and they are accountable through democratic rules. The case for rescue is strong, especially since it was not the government that caused the crisis.

The Commission on the Measurement of Economic Performance and Social Progress, which is chaired by Joseph Stiglitz, Amartya Sen and Jean-Paul Fitoussi, makes an important point:

Recommendation 11: Sustainability assessment requires a well-identified dashboard of indicators. The distinctive feature of the components of this dashboard should be that they are interpretable as variations of some underlying “stocks”. A monetary index of sustainability has its place in such a dashboard but, under the current state of the art, it should remain essentially focused on economic aspects of sustainability.

Why is this relevant? Well, the discussion of growth versus green is mainly caused by misleading accounting. It really should be growth and green. The reason is that not accounting for external effects improves growth today while worsening it tomorrow. Thus the idea that going green will hurt growth is at least to an important part based on wrong measuring of growth. Also, growth for one nation causing decline of another is not a thing to aim at. So when growth of, say, India, today causes other countries, like Pacific Island or Bangladesh, to submerge in the future, this should not count towards growth in the sense of better quality of life. Probably India would have to take a lot of Bangladeshi refugees in case that the place gets even wetter. This will put strain on Indian infrastructure and lead to less well-being of Indians (apart from the suffering of the Bangladeshi people, of course).

There are two dimensions where accounting for external effects should be made more explicit: nations and time. So, economists have been thinking about external effects for a long time. It shouldn’t be that hard to come up with indicators that take into account these two dimensions. Actually, a lot of work has been done in this field, leading to the Human Development Index among other things. It’s time to put those things into the policy sphere. Why not start at Copenhagen?

As next year’s main event casts its shadow, here’s the game schedule for the playoffs. Voting is now open, but one serious contender is missing: global imbalances. I suppose that after some discussion on game theory with the commissioner of the AEA, Robert Hall, a wildcard might be available for the ambitious contender.

p.s.: Not funny? Well, check this out and come back later.

p.p.s.: The AEA’s 2010 calendar is probably the most serious gift there is.

This presentation by Richard Koo sheds some light on some main issues of today. It explains why interest rates on government debt will not rise and why the banks will not increase lending. In short: since firms are not investing because of the lack of demand (consumers are saving to repay debt instead of consuming) the government has to collect the savings that normally should go into private sector debt and then spend the money to prop up demand.

Banks won’t do it because they are probably bankrupt at this moment, using the money they earn to repay debt now. This means they are not interest in making profits in the future. Also, firms probably won’t like to borrow right now anyways. Which German car maker (apart from Opel) would like to invest now? It is expected that car sales in Germany will plunge by about one million units, after the €2.500 rebate last year.

UPDATE 07/12/2009: This is from today’s FT’s comments section:

HSBC estimates that 85 per cent of UK loans made in the past five years are in breach of lending agreements. But banks are ignoring such problems. Instead they are rolling over loans as these near maturity, in the hope that capital values and loan-to-value (LTV) ratios will rise once again to refinanceable levels.

This confirms the core issues of a balance-sheet recession: banks are bankrupt because borrowers are in default, but instead of admitting it they use monetary policy (ZIRP, quantitative easing) to hide the state of the economy. Borrowers can roll over their loans and pay back debt as long as their cash flow is positive. Investment will be suppressed as long as it takes to repay the debt to reach a sustainable level of indebtedness.

I have started a new category – just one graph. The idea is to connect just one graph to an event, a theory, a person in order to highlight something or focus on some particular issue. The graphs will be controversial, but hopefully good enough that they can trigger a discussion on why the graph matters and what exactly it shows. I started this category with a graph on 1937. Have fun!

Also, I have added the possibility to subscribe to my blog by e-mail. You’ll find the button on top of the right column. Here is more information on this feature from wordpress.com.

Willem Buiter has announced his move to Citi, where he will be chief economist. He will stop blogging as a consequence. Here is an extract from his farewell:

The joys of academic freedom and irresponsibility include the ability to participate in public debate using expressive, forceful language, strong metaphors, analogues and similes, to go over the top from time to time, to overstate the case and over-egg the pudding and not to worry about giving offense to the high and mighty.  Because of their sheltered existence, academics can be reckless with impunity in their excursions into the forum of public opinion.

Your voice will be missed, Willem, so let your actions speak. Good luck!

During the Great Depression protectionism ruled. Tariffs were enacted and while they did not cause the collapse of world trade seen above they blocked its revival, according to Barry Eichengreen.

The same might happen today, but instead of tariffs devaluations are the instrument of choice. Here is the FT:

Vietnam’s decision to devalue its currency by 5 per cent last week to protect itself from undervaluation of the Chinese renminbi, and the worried response from Thailand and other Asian countries, suggests the move towards global trade conflict may already be unstoppable. As one group of countries seeks to gain or maintain trade advantage by manipulating their currencies, the historical precedent suggests that countries that are not able to devalue will respond with trade protection, especially tariffs and other barriers, and global trade will suffer.

This is bad news for those hoping that an export-led recovery would take place. This is especially bad news for Germany.

The deficit scare had reached Germany last week. The “Spiegel” used to understand how our society works, but already 10 years or so back it lost track of the whole picture. This is last week’s title:

 

 

 

 

 

To the Spiegel’s credit, the last article titled “Die Billionen Bombe” was only from September 2006. The authors speculate that hedgefunds will pulling all markets down if they get into trouble, and that nobody would understand the risks. Good one.

Transunion has released numbers on the delinquency rate of credit card debt QTR3 2009. Ezra Becker comments:

For the first time in ten years, third quarter national delinquency rates showed a decrease from the previous quarter, indicating a departure from the usual seasonal patterns. This movement could have occurred for a number of reasons.

Well, let’s leave these reasons aside for the moment and focus on the main story. Consumers are cutting back their spending in order to repay their debt. Probably firms are doing the same thing: repairing their balance sheets, paying down debt. This, following the arguments developed by Richard Koo, is the answer to a famous question put by John Maynard Keynes in the General Theory (ch.22):

It may, of course, be the case — indeed it is likely to be — that the illusions of the boom cause particular types of capital-assets to be produced in such excessive abundance that some part of the output is, on any criterion, a waste of resources; — which sometimes happens, we may add, even when there is no boom. It leads, that is to say, to misdirected investment. But over and above this it is an essential characteristic of the boom that investments which will in fact yield, say, 2 per cent. in conditions of full employment are made in the expectation of a yield of, say, 6 per cent., and are valued accordingly. When the disillusion comes, this expectation is replaced by a contrary “error of pessimism”, with the result that the investments, which would in fact yield 2 per cent. in conditions of full employment, are expected to yield less than nothing; and the resulting collapse of new investment then leads to a state of unemployment in which the investments, which would have yielded 2 per cent. in conditions of full employment, in fact yield less than nothing. We reach a condition where there is a shortage of houses, but where nevertheless no one can afford to live in the houses that there are.

So the reason why there are no investments which would have yielded 2 per cent. in conditions of full employment is that instead debt is paid down that would have cost more than 2 per cent. in conditions of financial crisis – which is now. My avoiding the loss has bigger benefits than my getting the benefits. Think balance sheet – what do you prefer?

1. a higher value of assets, or
2. a lower value of debt

The International Society for Ecological Economics (ISEE) will hold its 11th biennial conference: ADVANCING SUSTAINABILITY IN A TIME OF CRISIS on 22 – 25 August 2010 at Oldenburg and Bremen, Germany. The extended deadline for abstract submission is 30th November 2009. More information here or here (pdf).

A colleague told me today that the event was to be held at Oldenburg, but with more than 1,000 attendants expected the infrastructure of the city would collapse – Oldenburg simply has no hotel rooms for 1,000 people…