Summary: A mark of successful people and nations is that they function well under stress. What’s the alternative? Magic! Here we look at some examples of the search for magical solutions seen in the US and Europe today.
History suggests that the quality of a nation’s decision-making under stress has a large effect on its success. Not just prosperity, but even survival. Europe during 1914 – 1945 provides powerful examples of every kind, from wise leaders (UK during WWII) to mad leaders (Germany during WWI). Surprisingly (to me), nations in Europe (and Japan) retained social cohesion to the end despite horrific conditions. Contrast that with the frequent forecasts today of social breakdown if Europe or America experience a purely economic downturn (no mega-deaths in battle, no firebombing of cities, no massive drop in food production).
But there is evidence that the decision-making process (the observation-orientation-decision-action loop; OODA) is decaying in many nations. Here is a brief note on this important subject. In brief, under stress people revert to magical thinking. Ignoring what we know to seek easy and fast solutions to what look like overwhelming problems (and what might in fact be overwhelming problems). These are alternatives to the difficult but more realistic alternatives to today’s problems and policies.
Also note how the range of solutions considered shows that the creditor “class” (and those they pay) dominates the discussion.
In the US there is broad (so far minority) support for adoption of a gold-backed currency (despite their theoretical flaws and horrific history), but often for remaining with the same fiscal and banking systems (probably impossible). Oddly similar is the enthusiasm for what is in effect the opposite prescription: modern monetary theory (MMT) so that we need not even worry about fiscal deficits. These theories have expert advocates; but their non-expert advocates tend to have wildly exaggerated (often delusional) beliefs about how these systems would work, their costs and benefits. Magical solutions.
These beliefs could have unpleasant effects. The breath and intensity of support for gold (seen in the enthusiasm for Ron Paul, despite his profound ignorance of basic economics) is underestimated by leaders in NYC and Washington. Things could get exciting if the current policy gridlock continues after the election AND the economy does not recover. Public support might rapidly increase for what are now considered fringe policies. Demagogues will quickly appear to turn this public support into votes and political power.
Economic policy in the EU rests on what should be an obvious misunderstanding of the causes of the crisis (eg, visible in their large factual errors about basic facts in most speeches) and the probability of their cure (ie, fiscal austerity) working. Fiscal austerity has been frequently used, there is a good understanding of its effects. It seldom works when done without devaluation and massive monetary stimulus (ie, low interest rates) — neither of which the PIIGS have today.
Hence the search of easy and fast solutions, an alternative to continued internal devaluation of GIIPS’ wages and fiscal austerity. Such as devaluation of the Euro to boost exports. Krugman gives the obvious rebuttal to the latter: “Let’s All Devalue Against Each Other” (New York Times, 22 May 2012):
Jeremy Siegel echoes a lot of what some of us have been saying for years about the infeasibility of internal devaluation, but then argues that the answer is devaluation of the euro as a whole. Um, against whom?
I mean, it’s not as if America or Japan are towers of economic strength, easily able to provide the demand Europe lacks. That leaves emerging markets. And while I and others have been pushing for years for an end to Chinese currency manipulation, China is at this point (a) not looking very strong itself (b) just not that big in the world economy — not yet. More generally, Europe as a whole, like America, remains a relatively closed economy. Its salvation must be mainly internal.
Now, if devaluation is a code word to mean raising the inflation target, fine.
The last time I got to hear the late James Tobin, he gave a talk in which he joked that as far as he could tell, all the world’s major currencies needed to devalue against each other. This is sort of one of those times — and what that actually tells you is that we need fiscal and monetary stimulus.
For more information
For good analysis of economic events in Europe see Krugman at the NY Times and Roubini Global Economics. Readers of these have understood in real time both what’s happening and the likely effects of current policy actions.
To learn about modern monetary theory (MMT):
- “Good alternative theory“, Steve Keen, Switzer, 29 September 2009. Scroll down to find a sub-article “The fundamental principles of modern monetary economics” by Bill Mitchell (Prof Economics, U of Newcastle)
- “Understanding The Modern Monetary System” by Cullen O. Roche (professional money manager), 5 August 2011 — clear, long and technical explanation
- “Deficits and the Printing Press (Somewhat Wonkish), Paul Krugman, New York Times, 25 March 2011
- “MMT, Again“, Paul Krugman, New York Times, 15 August 2011
This post originally appeared at Fabius Maximus and is posted with permission.