A Balance of Payments Problem (BOPP)

Financial Big Lies by Krugman

Barry Ritholtz has a fine piece in the WaPo taking off from Michael Bloomberg’s recent venture into the rewriting of history. And I think Ritholtz’s Big Lie framework is just perfect.

After all, the way to understand the “Barney Frank did it” school of thought about the crisis is that it’s an attempt to turn a huge defeat for conservative ideas into a win. The reality of the financial crisis was that deregulation — which was part of a broader rightward shift in policies that played a large role in creating rapid growth in income inequality — led to an economic catastrophe of the kind that just didn’t happen during the 50 years or so when we had effective bank regulation.

So the right’s answer is to claim not just that the government did it, but that it caused the crisis by its attempts to reduce inequality! It’s kind of a masterstroke, in an evil way.

And I think it’s important to recognize the motives here. By all means let’s debunk the claims on substantive grounds, which Mike Konczal does very well. But they’ll just keep spouting these claims, and make up new ones, so you need to understand the fundamental bad faith that is driving the whole debate.

I agree but Ritholz writes:

Fed Chair Alan Greenspan dropped rates to 1 percent — levels not seen for half a century — and kept them there for an unprecedentedly long period. This caused a spiral in anything priced in dollars (i.e., oil, gold) or credit (i.e., housing) or liquidity driven (i.e., stocks).

There was also Bernanke's Global Savings Glut. Is there a problem with a system where low interest rates used to counter deflationary pressures cause bubbles? What if those low interest rates were used to invest in productive enterprises?

Somewhat related, Krugman blogs about a Gavyn Davies piece:

Gavyn Davies has a very good piece today offering another way to think about the euromess. I say “another way to think” advisedly — his analysis of the basics is, as far as I can tell, identical to mine, but he offers a different angle of approach that may be better than the route the rest of us have been taking. Here’s Davies:

It is normal to discuss the sovereign debt problem by focusing on the sustainability of public debt in the peripheral economies. But it can be more informative to view it as a balance of payments problem. Taken together, the four most troubled nations (Italy, Spain, Portugal and Greece) have a combined current account deficit of $183 billion. Most of this deficit is accounted for by the public sector deficits of these countries, since their private sectors are now roughly in financial balance. Offsetting these deficits, Germany has a current account surplus of $182 billion, or about 5 per cent of its GDP.

The euro problem can then be defined a finding a way (1) to finance these imbalances in the short run (2) end the imbalances over the medium run.

It’s also worth noting that we’re not talking about imbalances that have been going on forever.The internal imbalances of Europe are a recent development, coinciding with and almost surely caused in large part by the creation of the euro itself (GIPS is Greece, Italy, Portugal, Spain):

So how are these imbalances to be closed? European leaders have been completely unwilling to confront that question. Yesterday’s big Times piece offers a portrait of leaders — Trichet in particular — engaged in furious denial. It wasn’t just the insistence on Trichet’s part that no default could ever happen. The European Central Bank also went all in for the doctrine of expansionary austerity, aka belief in the confidence fairy.

And what Davies’s post drives home is that implicitly at least European leaders went in for the doctrine of immaculate transfer — in effect, they wanted to believe that the huge payments imbalances could be ended without major changes in relative prices.

So what’s happening instead is forced austerity in the deficit countries, not matched by expansionary policies elsewhere, in a low aggregate inflation environment — the ECB actually raised rates! — that makes adjustment almost impossible. The result is a eurozone headed for recession, and one in which a breakup of the euro itself is looking ever more possible.

Awesome.