The Long View 2003-04-03: Consider the Alternatives

Here is an interesting one on the Euro and Germany. John felt that Germany couldn't pursue a sane fiscal policy because of the Euro. Twelve years later, this turned out to be very true, but not precisely for the reasons John thought. He did get the overall dynamic right however, the big economies, like Germany, are tied down by monetary union, and the smaller ones, the PIIGS, are overstimulated and prone to meltdown. Well, we proved that one right. John also was correct that no one dared question the idea of making Germany and Greece in some sense economic equals, at least until everything blew up.

A prediction that did not go so well is that China's financial system would also have blown up by now. There has been a market crash over there recently, but the kind of thing Gordan Chang has been going on about for fifteen years keeps not happening. John once pointed out that things like the unusual financial growth China has been experiencing of late tend not to go on forever. To date, the Chinese have been giving it their best shot.

I do think John was right to fear another nasty influenza epidemic. SARS looked pretty bad for a while, but it fizzled in comparison the the Spanish flu. Another pandemic of that magnitude would do very bad things to a word with daily international flights. We have just been lucky.

Consider the Alternatives
Here's an interesting point that Kermit L. Schoenholtz, the chief economist of Salomon Smith Barney, made about the decline in foreign investment in the US:
"If people believe that the events we've seen in Iraq are not one-off events, it will affect their investments."
The New York Times piece in which this appears deals chiefly with the failure of the gradual decline in the value of the dollar to spur exports. Currency fluctuations are temporary, but we could have a long-term problem. It is likely that the Iraq campaign will not be the last of the 911 Wars (though it may be the largest: North Korea could turn out to be surprisingly brittle). Will people decline to invest their money in the US if the country is conducting a string of military campaigns?
* * *
Well, as the ancient comedian George Burns used to say when people asked if he minded getting old: "Not when I consider the alternatives." There is a good article in the Spring issue of The National Interest by Adam Posen: "Germany's Path to Economic Perdition," which covers not only the German economy, but also Japan's. Most important, there is a critique of the euro system.
We won't dwell on Japan's problems. Posen endorses the familiar assessment that it's an institutionally "blocked" society that can't summon the political will to pump the bad debt out of its submerged financial system. He says that Germany has not quite reached the same point, but it is in danger of a deflationary spiral. The reasons are different from Japan's. Germany's markets are freer, and the economy on the whole is more dynamic. The problem is that the euro system prevents Germany from adopting a sane fiscal policy. Today we are in the sort of period in which a country with control over its own currency would run large deficits and reduce taxes. Germany, however, is biting the bullet by keeping its deficits within the range prescribed by the European Central Bank in Frankfurt.
The charter, not just the policy, of the Bank requires a deflationary bias. This might not have been such a bad idea, if Europe had consisted of many small, roughly equal economic units. Unfortunately, it consists of highly unequal ones. The pattern seems to be that the smaller economies in the euro system are overstimulated (hence the Irish "Celtic Tiger," now gone a bit mangy), while the larger ones are depressed. No one has dared address the fact that this is an inherent feature of the system.
The French deal with the fiscal prescriptions of Frankfurt by ignoring them. When the Germans start to do that, there won't be much of a system left.
* * *
Then there's Asia. We have already noted the problems of the Japanese financial system. The Chinese a similar situation, but exacerbated by an order of magnitude by the remnants of a command economy. Still, the economy posts large nominal gains, so people who you think would know better continue to pour money into the country.
At any rate, they did so until recently. Now the SARS pandemic has come along, which is going to make people reluctant to travel to southern China, or indeed to receive people from that region as guests.
As any epidemiologist can tell you, SARS is not a big deal as pandemics go. (I knew an old man who had been a teenager at the time of the influenza epidemic that occurred toward the end of the First World War. There were seven people in his immediate family before the epidemic; just he and his father survived it.) The Chinese problem is that their investment-based economy is still more prospect than actual return. It is not quite a Ponzi scheme, but it is vulnerable to an interruption in capital investment. It is conceivable that SARS could occasion the bursting of the bubble that Gordon Chang writes about.
* * *
Contrary to some expectations, the United Nations did not turn into a pumpkin when the Iraq War began; neither did NATO turn into six white mice. However, even though the UN is going to survive, it will be hard to take it altogether seriously hereafter. Ideas are surfacing for a supplementary organization that could be trusted with serious security issues, but which would be more than the telephone numbers on the American president's speed-dial.
Anyone in immediate need of a proposal might take a look at Adam Garfinkle's Democratic Union. He actually proposed this in the early 1990s, but to small effect. It is time to work out the details, I think.

Why post old articles?

Who was John J. Reilly?

All of John's posts here

An archive of John's site