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Europe’s potion is now its poison with China inheriting the benefits.

February 17th, 2012 · Gregory Clark · 16 Comments

Today’s lecture is on the sorry state of that dismal science called economics. Hands up, economists who foresaw the Lehman collapse in the United States. OK, I see a few hands out there. Now hands up, those who also foresaw the eurozone crisis? Not so many, it seems.

Hands up, those who realized from the start that combining nations with very different cultures into a eurozone economy was bound to fail? Almost none.

Finally, hands up, those who realized that the fashionable call for austerity policies would drive the European Union economies even further into disaster? I see a few — Paul Krugman who writes for the New York Times; Joseph Stiglitz, a Nobel Prize winner; one, possibly, two writers for Britain’s Financial Times, which, with its ideological supply-sider bias, has often got it wrong in the past, over Japan especially.

The politicians, of course, have an even worse record. What do those of the Greek, Italian, Portuguese and Spanish variety have to say for themselves now that it is clear they were living in fantasy land?

“PIGS” was their well-deserved acronym, and one cartoon showed Madame Merkel of Germany trying to drive this sad collection of four-footed animals to fiscal salvation. In fact, she too got it wrong, and almost certainly is driving them to the abattoir with her Teutonic calls for fiscal rectitude and her refusals to allow the European Central Bank to come to a full-scale rescue.

As in Japan, few of the European policymakers seem to realize that while austerity policies may cut government spending, they cut tax revenues even more, leading to a net increase, not decrease, in official debt. As the crude saying puts it, they cannot walk and chew gum at the same time. They cannot get their minds around the need for two different policies simultaneously: Cut spending in nonproductive areas and expand spending in areas with strong stimulus effects.

How can so many of the best of our brightest get it so wrong? With the Europeans, there is no need even to ask. For years, their idea of a policy initiative was a good meal at a five-star restaurant. Their EU delegates who could find their way perfectly around the menus of the top Brussels restaurants could not even read national accounts well enough to discover that, for years, Greece was hiding 9 percent fiscal deficits.

None seem to realize what the U.S. finally realizes: In a financial crisis, the loss of confidence is contagious and you must move quickly and strongly to expand spending. Debt problems can look after themselves later, when tax revenues begin to improve.

International economists are no better. My introduction to trade economics years back was the Heckscher-Ohlin theory of the 1930s that “proved” the virtues of free trade. The only problem was that it was based on the outdated principle of fixed or even diminishing returns to scale.

In today’s world, almost every industry shows increasing returns — the more you produce the cheaper is the cost of each item. This means that under free trade, determined manufacturers can easily dominate production of almost any item if they seek ruthlessly to protect domestic markets and expand exports.

The free traders then say not to worry, that freely fluctuating exchange rates will keep things on track. But they do not move freely; adjustments are very jerky and harmful. And for very understandable reasons the currencies of developing nations will tend chronically to be undervalued anyway, giving them an even larger trade advantage since they usually also have lower labor costs.

Even here we were told not to worry, thanks to the racist doctrine that said the developed economies of the West would always be able to keep ahead thanks to their superior skills and work ethic. In that case go tell your average British worker that he need not fear the 3-to-1 wage and exchange rate advantage enjoyed by his Chinese counterparts since his bosses are three times smarter and he himself works three times harder. And don’t forget also to tell him it is pure bad luck that his factory is being closed down and exported to China.

Free trade economics are a relic of the days when imperialist powers could use them successfully to prevent the industrialization of weak nations. Now ironically they are being used by the former weak nations to de-industrialize the former imperialist nations.

The only way to prevent this reverse de-industrialization from getting out of hand is either a large upward readjustment of exchange rates in the now unduly favored developing nations, or else heavy tariffs on imports from those nations, China especially.

And don’t bore me with outdated anti-protectionist shibboleths. They, too, were inherited from the ’30s.

By the way, if you want China to lend you the money to save your economy from the mess created by your economic commentators, let’s put an end to the 1989 Tiananmen Square myths created by your political commentators and still being used to justify a Western anti-China embargo. Beggars usually do not usually insult and accuse would-be providers for crimes they did not commit.

(For the facts on past economic mistakes I recommend Krugman and Stiglitz, available on the Internet. For the Tiananmen facts simply go to the reports by the U.S. Beijing Embassy at the time, also available on the Internet.)

This article by Gregory Clark (website) first appeared in the Japan Times and has been republished on this site with the author’s kind permission. Gregory Clark is vice-president of Akita International University and a former member of the Bank of Japan, Expert Consultative Committee.

16 responses so far ↓

  • 1 Stillgotshoeson // Feb 17, 2012 at 1:53 pm

    Those over indebted nations should do what any over indebted person should do. Declare bankruptcy, implement the austerity measures and start anew.. If it means they are removed from the Euro, so be it.. This too would be for the better. The inequality between the economic strengths of those Euro nations means the system is unworkable anyway and doomed to failure, if not now, certainly in the future.

    A nation can not spend more than it earns for too long, no different to an individual.

  • 2 Greg Atkinson // Feb 17, 2012 at 5:19 pm

    It’s certainly a mess in the Eurozone. It amazes me how people who were supposed to be managing the economy could allow governments to take on so much debt. How did they ever imagine they were going to pay it all back. Was their plan to win big at the races? 🙂

  • 3 Trading Coach // Feb 20, 2012 at 12:25 pm

    Yeah, we have all played the wizards at one point or another, giving our two cents for every economic issue there is but never really showing how to do it.

  • 4 Greg Atkinson // Feb 20, 2012 at 1:23 pm

    By the way comments regarding the article can be submitted directly to the author (Gregory Clark) via his website:

    He was written quite a few articles related to economics and outlined his views on how various global economic issues should be managed.

  • 5 Lachlan // Feb 20, 2012 at 3:57 pm

    “Was their plan to win big at the races?”
    Ha ha Greg, not even that I’d guess, probably no plan at all.

    Krugman’s ideas just can kick anyhow and they serve the political will of the day.

  • 6 Lachlan // Feb 20, 2012 at 4:03 pm

    For anyone keen to answer here is a question…. What do you believe about interest rate risk in Australia for Joe Average’s in the near term to next few years… and why?

    Sorry if this is in a wrong thread Greg. If you move it I will track it down later on. Cheers

  • 7 Greg Atkinson // Feb 20, 2012 at 8:32 pm

    Lachlan we are sort of between a rock and hard place in regards to interest rates now I feel. If the RBA drops them down too far then households are likely to take on more debt which I don’t think is a good idea at the moment. If the RBA holds them where they are then home prices will remain weak or even fall further, consumer confidence will suffer & exporters will continue to do it tough because of the high AUD.

    As for what rates will do over the next few years…honestly I don’t have a clue 🙂

  • 8 Lachlan // Feb 20, 2012 at 9:00 pm

    “honestly I don’t have a clue”

    Crumbs Greg, I was afraid you’d say that. Lets face it, the authorities everywhere make up the rules as we go along… making everything very hard to predict. Or they probably always did but now everyone is focused and can see it.

    Thanks though Greg, I’ll check back in a few days.

  • 9 Greg Atkinson // Feb 21, 2012 at 9:34 am

    Lachlan if the Chinese economy continues to slow (and I think it will) then it is going to get very interesting to say the least.

    The Baltic Dry Index already tells us that the demand for shipping is in a trough & most (if not all) the major shipping lines don’t hold out much hope for 2012.

    The EU is a bigger economy than the US and it’s also China biggest trade partner. Clearly the strife in the EU will have (and is having an impact on China) and don’t just think about exports, think also about Foreign Direct Investment (FDI). I don’t suspect many European companies have the money to build too many more mega factories in China these days.

    So we have to ask ourselves this question: Where is the money going to come to keep funding Australian home loans (since much of this money comes from overseas) and at what cost will the banks be able to get it at?

  • 10 Stillgotshoeson // Feb 21, 2012 at 5:51 pm

    Lachlan // Feb 20, 2012 at 4:03 pm

    For anyone keen to answer here is a question…. What do you believe about interest rate risk in Australia for Joe Average’s in the near term to next few years… and why?

    Greg Atkinson // Feb 20, 2012 at 8:32 pm

    Lachlan we are sort of between a rock and hard place in regards to interest rates now I feel

    A couple of years ago I commented on a discussion The Barefoot Investor had going. I said then that we could well find ourselves in the position that the RBA will be lowering rates and the banks will be raising them due to the financial situation in Europe and the effects all the money printing will have on inflation in the coming years.

    I used the same term of being caught between a rock and a hard place, lowering of central bank rates occurs when the economy is in the shits, not to help out over extended mortgage holders and over capitalized retailers, (far too many shopping malls for the size population)

    RBA rates or mortgage rates?

    I think the RBA will be moving into a reduction faze for interest rates in the shorter term, these will lessen the impact of banks moving rates upwards as the financial situation in Europe continues to get worse. I don’t believe the damage has been truly factored in yet.

    We will see more money printing from the Norther Hemisphere, fairly soon I would expect too..

    Personally I think the RBA rate is almost as low as it can go to actually make any difference to the masses. (100 basis points more ) Bank rates will never fall below the current (RBA) rate anyway so the effect is essentially zero rates now. We may see HONEYMOON rates circa 4.95% for mortgages but that is about the absolute low point.

    Medium to longer term (3 years +) we will see RBA rate rising to combat rising inflation as hyper inflationary effects start to flow through from the Northern Hemisphere.

    First sign of rising interest rates in the Northern Hemisphere will also curtail our dollars magnificent rise to date.

    Will we see Keens 0% rate and 10% unemployment? I do not know, I do feel however that we are about to go closer to those numbers than we currently are.

    Shoes… Sydney

  • 11 Lachlan // Feb 24, 2012 at 7:00 am

    Thanks fellas, much appreciated.
    I am considering borrowing for my business which has come to life since the drought broke. I guess I can lock in a rate if I am concerned.

    My shares have had a nice run of late particularly AWE,GMR and NCM.
    I think New Hope should run through 6 dollars and then have a break out soon. Despite all this I have a good number of beaten down small caps which are keeping my 13 share portfolio just below the water line for now. TLS is annoying Greg 😉

  • 12 Stillgotshoeson // Feb 24, 2012 at 7:43 am

    SBM, NCM, PRU and EAU have had a good run…. 😉

  • 13 Plornt // Feb 24, 2012 at 2:46 pm

    Wow great stuff Still and Lachlan. Just checked out the performance of some of those stocks. I like your API pick Still; has an instrinsic value of 1.10$. I prefer PBP though in that space which has an intrinstic value of 2.60$.

    Your beaten down stocks will turn soon Lachlan. You have done well to hold your nerve during the crash we had.
    How much has your portfolios moved up from the lows?

    Anyone see Warren’s call on gold? I don’t agree with him personally, but he makes some good points. Then again he did sell silver at what price ;). I am a great fan of his nevertheless !

    This drivel should not be taken as financial advice. Seek to obtain professional
    advice before proceeding with any financial decision.

  • 14 Ned S // Feb 26, 2012 at 9:39 pm

    “go tell your average British worker that he need not fear the 3-to-1 wage and exchange rate advantage enjoyed by his Chinese counterparts since his bosses are three times smarter and he himself works three times harder. And don’t forget also to tell him it is pure bad luck that his factory is being closed down and exported to China”

    And while you’re at it, ask him to have a think about the fact that someone who can live on USD 4K pa can outcompete someone who needs USD 30K pa and what changes he’s going to make to his expectations plus what changes he’s going to ask his politicians to make to his economy and society so he can also live on USD 4K pa.

    Protectionism … Perhaps? But it sounds iffy to me if one has to import their oil and natural gas and coal and iron ore from elsewhere – As I suspect the Brits would?

  • 15 Greg Atkinson // Feb 27, 2012 at 9:25 am

    Ned I suspect things will get even more ‘uncomfortable’ as further free trade agreements are signed. I wonder how many industries in Australia for example will be able to handle more competition from cheaper imported goods?

  • 16 Biker // Jun 27, 2013 at 3:31 pm

    How interesting to read back through the ideas, comments and punts offered in this 16-month-old thread… .

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