Mundell: World Is In Depression

Ambrose Evans-Pritchard The Telegraph August 25, 2011

Thursday 25 August 2011 | Blog Feed | All feeds

By Ambrose Evans-Pritchard Economics Last updated: August 25th, 2011

Comment on this Comment on this article

Robert Mundell says: 'The world is in a depression in America, Europe and Japan'.

After all these years, I have finally been able to sit down for an hour with Robert Mundell, the great theorist of currency unions and the godfather of the euro.

“We’re in very serious danger. The world is in a depression in the Big Three of America, Europe and Japan, a mini-depression that we have not seen since the 1930s,” he said, speaking at the Lindau conference, where half the world’s Nobel economist are gathered on one tiny island with cobbled streets looking across Lake Constance to the Alps.

Few economists inspire such devotion and fury as Professor Mundell.

He is a hero to America’s free-market Right for sponsoring the Reagan tax cut agenda, and has not relented on that front. “Any country with public debt over 40pc of GDP needs its head examined,” he said.

His prescription for America’s ill today is to slash corporation tax to 20pc (from an effective rate of 52pc, he says), and kill the entitlement behemoth. By the way, he blames the Fed for triggering the Lehman crisis by keeping money too tight in mid to late 2008. There is very little inflation risk now from QE because M1 money velocity has collapsed “by half” and is likely to stay there.

But equally he is a villain to the eurosceptic Right on this side of the Pond, having made it a life mission to sponsor the Europe’s fixed exchange experiment. Some say he has bent the theory of “Optimum Currency Areas” (OCA) to justify combining the vastly different economies of Europe in monetary union "“ whatever this implies for freedom and democratic legitimacy.

If you read his own pioneering work on OCAs – “A Theory of Optimum Currency Areas” in the American Economic Review of 1961- it is hard to see how the eurozone can possibly qualify. He argued then that even Canada and the US might have benefited from a break-up into East and West dollars to reflect regional economies.

Does one see hints of doubt now, as EMU disaster unfolds? Not really.

“We’re in the midst of a very big crisis because nothing has been done yet to convince the markets that there has been a fundamental change. To save Europe there has to be a move in the direction of shared government.”

He admits that will not be easy. Alexander Hamilton managed to create a US debt pool in 1792 (against fierce resistance), arguing that the debts of 13 states were modest and had mostly been accrued debts during the Revolutionary War. This was therefore a shared interest. Greek pensions are not. “You can’t do that in Europe,” he said.

“There is a tremendous problem in five or six countries of the eurozone. But the solution is not the end of the euro, because that creates more problems than it solves. There would be a tremendous run on the banking system, and countries that left would still have to deal with all their debts.”

Prof Mundell said it would help if the ECB ripped up its price stability mandate and took pro-active steps to force down the euro, and then peg it at $1.30 to the US dollar. This would also bring the euro down pari passu against the Chinese yuan, creating a three-way managed global system "“ or the DEI as he calls it.

“The euro is too strong. A weaker euro is the best news you could have for governments (in trouble).”

“The ECB should follow an easier policy. Of course they have a strict rule to safeguard against inflation but that is not correct. I have never believed that central banks should have rigid inflation targeting. That is not a good thing to stabilize. There is nothing in economic theory to back this.”

He added it is folly to tighten monetary policy into a “deflationary” oil spike, (as the ECB did in 2008 and has just done again). “That is exactly the wrong thing to do”.

Mundell says US and euroland should manage the Atlantic exchange rate in the mutual interest, setting outer bands of 5 cents on each side of the $1.30 target. If the euro reaches $1.35, the ECB intervenes to buy dollars: if it drops to $1.25, the Fed buys euros. Both sides have gravity on their side since they can print unlimited sums to defeat the market.

Interesting idea (he has discussed it with US Treasury Secretary Tim Geithner, who listened closely) if you like managed exchange rates. I don’t.

I certainly agree that a weaker euro would help to lift the EMU periphery off the reefs, but it comes very late in the day and ignores the core problem that currencies are massively misaligned within EMU. The gap in unit labour cost competitiveness between North and South has grown to 30pc. Prof Mundell seems to have no answer to this other than grinding deflation in the Club Med bloc and Ireland.

As his Nobel colleague Joe Stiglitz said at the same Lindau gathering, democracies won’t stand for this kind of “medieval leech cure”.

Prof Mundell is however unrelenting: “The euro hasn’t done anything bad. The problem is lack of fiscal discipline. Countries like Greece, Portugal, and Ireland have been on a spending spree on entitlements,” he said.

Uhhm! So there is nothing structurally wrong with combining Greece, Spain, Ireland, Germany and Holland in a monetary union? Nothing wrong in inflicting negative real interest rates for years on the fast-growing catch-up economies of Club Med and Ireland? Nothing wrong in mixing up vastly differing productivity growth rates?

Professor, if you strip out Greece, the euro crisis is not caused by lack of fiscal discipline in any meaningful sense. That is a Wagnerian myth, much promoted by Chancellor Angela Merkel.

Spain and Ireland never violated the Maastricht limits on deficits. Both ran a big budget surplus during the boom when monetary policy was kept loose to help nurse Germany through a mini-slump. Italy is running a primary budget surplus. Ireland came close to eliminating its public debt altogether.

The real problem is that EMU stoked a private sector credit bubble. That proved the killer.

As the ECB’s Jean-Claude Trichet constantly reminds us, the public debt to GDP ratios in Europe are lower than in the US, UK, or Japan. So why then is monetary union suffering an existential crisis? Why is the ECB having to intervene to stop Italy and Spain spiralling into default?

The Euroland whole is visibly less than the sum of the national parts. That surely invalidates the claim that euroland is an optimal currency area. It is a “Pessimal Currency Area”.

Joe Stiglitz says events are now charging ahead regardless of political pieties. Argentina’s 8pc growth rate after ditching the dollar peg in 2001 offers a tempting way out for countries running out of popular and democratic consent for Berlin-imposed austerity, if Germany does not get there first by pulling out. “There is life after default, and life after leaving a fixed exchange rate system,” said Stiglitz.

You might equally add that the break-up of the Gold Standard was the necessary pre-condition for recovery in the early 1930s, since it broke a self-reinforcing spiral that compelled contracting economies to contract further.

By the way, do visit Lindau. It is one the most enchanting spots on earth, a timeless Bavarian gem from the Wittelsbach era. Yet with roots in the late Middle Ages when Lake Constance was the intellectual heart of Europe.

There are hardly any cars.

Wunderbar.

Tags: currency areas, emu, euro, Europe. currency union, eurozone, godfather of the euro, Professor Robert Mundell, qe, quantitative easing

Recent Posts

Search the blogs Search for: --> Our Finance Blogs Economics Business Your Business Energy Retail and consumer Your Money Broadcasting and media Finance bloggers Ambrose Evans-PritchardAndrew LilicoIan CowieJames HallJeremy WarnerNeil MidgleyPhili AldrickRichard BlackdenRowena Mason Finance Tags Bank of England banks budget Capital Gains Tax Chancellor china coalition government david cameron debt euro financial crisis financial services authority George Osborne Germany Gordon Brown government greece Hargreaves Lansdown HMRC HM Revenue & Customs homebuyers house prices income tax inflation Interest rates investors Mervyn King mortgage mortgages pension pensioners pensions property quantitative easing recession retirement RPI savers shares stock market tax treasury ON THE FINANCE BLOG Professor Mundell, euro, and 'pessimal currency areas' HMRC's Swiss deal: why new technology means old fashioned tax evasion is dead Good news about hard-pressed homebuyers and house prices – from the bailiffs Expat pensioner exodus: would the last person to leave Britain please switch off the lights? Angela Merkel is right – eurobonds are indeed the wrong answer to Europe's debt crisis Archives Select Month August 2011 July 2011 June 2011 May 2011 April 2011 March 2011 February 2011 January 2011 December 2010 November 2010 October 2010 September 2010 August 2010 July 2010 June 2010 May 2010 April 2010 March 2010 February 2010 January 2010 December 2009 November 2009 October 2009 September 2009 August 2009 July 2009 June 2009 May 2009 April 2009 March 2009 February 2009 January 2009 December 2008 November 2008 October 2008 September 2008 August 2008 July 2008 June 2008 May 2008 April 2008 March 2008 February 2008 January 2008 December 2007 November 2007 October 2007 September 2007 August 2007 July 2007 June 2007 May 2007 April 2007 February 2007 January 2007 August 2006 Finance Topics Energy Retail Financial Crisis Recession Interest rates Budget Gordon Brown George Osborne

News Politics World News Obituaries Travel Health Jobs Sport Football Cricket Fantasy Football Culture Motoring Dating Finance Personal Finance Economics Markets Fashion Property Crossword Comment Blogs My Telegraph Letters Technology Gardening Telegraph Journalists Contact Us Privacy Policy Advertising A to Z Tickets Announcements Reader Prints Follow Us Apps Epaper Expat Promotions Subscriber Syndication

Terms and Conditions

Today's News

Mundell: World Is In Depression

Related Articles