Saturday, April 14, 2012

Defusing the ticking time bomb in the EU Economy

A few days ago, the Financial Times carried an op-ed by Gideon Rachman on
"the ticking time bomb that no one can defuse." I sent him an email (first item below)
on what the real time bomb is -- not the banks, not the euro, but the risk of a new Great Depression. In other words, jobs and aggregate demand. And I argued that
we CAN defuse it... if we use our brains a bit more effectively and really focus on the problem.

A few days after that, there was another op-ed by Soros which actually did seem
to be aware of the real time bomb... TO SOME DEGREE. A good start, but we need a lot more. So my comments on that, somewhat technical come next. And then a few thoughts
about a friend's discussion with Larry Summers..


---------- Forwarded message ----------
From: Paul Werbos
Date: Fri, Apr 6, 2012 at 2:56 PM
Subject: any way to defuse the time bomb about to blow up in your face

Dear Mr. Rachman:

Thank you very much for your stimulating op-ed on the ticking time
bomb in the economy of Europe.

What scares me most here is that the biggest time bomb is not about
the euro or about the banks
(important as they are) but about aggregate demand. My worry is that
aggregate demand will keep slipping in Europe,
with or without the euro, and that a combination of decay in Europe
and naive policies coming into the US
might bring us to something a bit like reliving the thirties.. if
indeed we would actually through a repetition of
that level of stress. The recent suicide in Greece, and the problems
in Italy and Spain and even France,
should be deeply worrisome to anyone open to reality.

Is there any way to defuse that ticking time bomb? Perhaps that is the
number one question many of us should be thinking very very hard and
very creatively about.

A few months ago, I thought about this question in very concrete
terms. If we need more aggregate demand in southern Europe,
but the Germans worry they would lose if they sent more money to the
government of Greece ("down the toilet"), what is the resolution of
the impasse? Concretely -- if Greeks (and Italians and Spaniards) need
more jobs, what can German money buy from them that
gives jobs but is a worthwhile investment for Germany? It seemed
obvious electricity. More precisely,
Germans are preparing to pay 20 cents per kwh for huge volumes of
offshore wind, when the lowest cost versions of solar thermal solar
power (dish Stirling) would offer electricity at only 13 cents per
kwh, in a far more reliable and useful time frame. Why not an
immediate pan-European investment (some kind of private-public
partnership) to inject huge amounts of money into building such solar
farms in areas of reliable sun in Greece, Italy and Spain? A great way
to reduce the risk of depression and create jobs, while
making a real profit, reducing dependence on Russian natural gas, and
doing something good for the environment, all at the same time. A real
Pareto optimum.

But -- I am reminded that this would require someone actually honest
and competent enough to lead the investment.
I remember the old saying: "If you think you have invented the perfect
form of government, imagine how it would be implemented if all the
positions were staffed by chimpanzees." Elevated titles and such
certainly do not guarantee competence in this kind of venture,
especially when vested interests are involved. And after all, why
don't the European banks do this all unilaterally anyway,
if there were not a problem of sheer technical competence here?

So here is a second possibility, perhaps a bit more realistic.

You know that the US has some of the same underlying problem as the EU
(except for the personal skills of President Obama,
which are far from infinite but are also notably a help here). You
know that government debt levels are also similar in China, if
provincial governments are included.

So why not a kind of aim for a strange kind of new ultra-G-$ meeting
(US, EU (Merkel?), China (Xi), Brazil) aimed
at some kind of monetary cease-fire, so we can all have low interests
rates to pay off debt?

And why not include in that agreement a big new infusion through IMF
to the World Bank, to a major effort NOT limited
to developing nations, to a kind of competitive financing (with even
competing funds in the Bank) to
develop minimum cost renewable energy, alternate liquid fuels and the
like, to the market?

The skills of the World Bank are not unlimited, any more than those of
the ECB (or of the folks who made the Solyndra loan in the US), but if
funds were restricted to certain class of investment, we wouldn't have
quite the same liquidity trap
which limits the aggregate demand benefit from today's monetary
easings. As I think of this, I see some analogies to funding issues of
NSF (where I work), of ARPA-E, and of mainline DOE and DARPA. Neither
they nor the European banks are infallible, but a '
proper structuring of risk, uncertainty, commitment to fund, and
diversity of channels ought to be able to do as well as
anything else humanity can do. And it would be a lot better than
falling into total paralysis and depression.
A competition with a focus, a commitment to act, and some diversity
should really do quite well.

Anyway, that's the best I can think of right now to try to defuse the
bomb. If we don't find someone to do SOMETHING,
it's your face and mine (along with a few million others) which may
get blown off, regardless of whatever else we do.

Of course, if you can think of any way at all to increase the
probability of defusing the time bomb, I would want to help.

Best of luck,


Dr. Paul J. Werbos
Not representing official views of NSF, IEEE,, etc.


Soros' op-ed certainly describes other important aspects of this situation.
In a way, I's day my letter is like one eye, and his is like another;
one must see through two eyes to get
a correct three-dimensional picture.

There are certain technical details I left out of the letter to
Rachman. (I am usually leaving
out some technical details, because there are always so many of them.)

For example, when I wrote to Rachman, I was influenced by a message I
heard clearly a few days before from GE's
director of strategic policy, where he talked about the way funds have
dried up recently for many new energy projects.
"Appetite for risk" were the words he used. And Soros makes related
points. Part of our "liquidity crisis" is
actually a matter of fear. In a way, the threat of depression is
caused by a kind of prisoner's dilemma effect,
which strengthens a reflexive phenomenon. Of course, Soros is quite
familiar with the basic idea
and importance of reflexive phenomena, but this case is very special
in ways which go beyond
some of the examples he has seen before. I think of it in part as a
simple matter of the existence of multiple solutions
in the rational expectations model, where the choice of solution is
based on psychology. Actions to change the psychology,
for example by deciding we WILL invest X dollars in certain areas, can
make a crucial difference.
I also think of it as matter of how one organizes and allocates risk,
a topic which today's dynamic stochastic general equilibrium theory
does not yet do full justice to, because of the lack of consensus
about risk expectations. (NOT that we would
want to enforce such consensus!!)


A friend asked Summers: Do you know anyone is awake about
the risk of depression -- job loss and aggregate demand -- in the EU,
and about ways that energy investment could reduce the risk?

Summers was CERTAINLY aware of that risk in the US. But he said -- energy
is too small to make a difference.


Added April 16: this morning, the Financial Times has an op-ed by Wolfgang Munchau which also clearly states that the real concern even among investors is about
the level of the overall economy (aggregate demand) much more than about the narrower issues of euro and bank solvency. I would be tempted to quote a sentence or two... but I think that FT prefers that people go to their web page for their material.

Even the best economics at "300,000 feet" often loses touch with reality.
If electricity is about 10 cents per kwh, OECD data show 20,000 terawatt hours per year... $2 trillion per year. And yearly US oil imports have been bouncing around another half trillion per year, with lots of risk of going much higher.
Those kinds of numbers really are enough to matter, especially if we start building up
new capital which generates flows at that kind of level.

Best of luck,


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