The global spread of the financial crisis

One thing to examine is the fact that Europe, or, rather, the Eurozone portion of Europe, effectively abandoned social democracy with the adoption of the Euro. Social democracies have traditionally inflated their currency during economic downturns via deficit spending and printing of money, but with the adoption of the Euro have lost those mechanisms for inflating their currency in the face of deflationary pressures such as are caused by a massive drop in consumption.

The ECB is basically the tail that wags the dog in Europe, and traditionally has been dominated by neoliberals whose one and only goal was to keep inflation in check, and to [bleep] with things like social justice or economic recovery. The ECB tells national governments what they are allowed to do in order to deal with economic problems, not vice-versa. Great Britain is looking downright prescient for staying out of the Eurozone now…

– Badtux the Banking Penguin

Isn’t the financial crisis an equally outstanding example of moral hazard on a world-wide scale. FDIC insurance meant that depositors didn’t need to watch the banks investments, implicit government backing of Fannie and Freddie meant that investors didn’t monitor the investments, the government bail-out of LTCM led to banking participants ignoring counterparty risk, the list goes on and on. We’ve been in a mixed economy and the managers both public and private of the mixed economy didn’t mind the store.

This issue is too complicated to really provide clear lessons. First, there’s the proximate cause of the crisis which was absurd banking regulation practices. But secondly, there’s the asset bubble which led to those bank’s exposure and that was primarily the US real estate bubble.

I think that social democracy has basically nothing to do with banking regulation. So whether countries were hit hard or not in the financial sector is determined by completely different metrics. Of course, once demand is falling globally, you can’t blame an economic system for suffering as a result. Only a very inefficient, totally isolated economy would avoid being hit.

I think the underlying cause of unstable asset inflation is more complicated, but the economic system of the United States is primarily at fault, in my opinion. The world economy became dependent on an expansion of consumption by American consumers. This was probably a rational model for the Chinese to follow to maximize their growth, but it did leave them vulnerable. The reasons why American consumption was able to grow so rapidly are surely quite complicated and could be debated endlessly. Simplifying greatly, I think the US economy was generating a lot of wealth, and the Chinese were also lending us plenty more. The difficulty was that this wealth was being concentrated in the wrong place. Real wages have been more or less stagnant in the US for 20 years and consumers were financing their spending through other means. Eventually this was going to be a problem. Ultimately, we have to arrive at a model where businesses are able to run efficiently, but are still forced to share the lion’s share of the profits with their employees. I read the crisis as emerging from the global economy finding creative, but unstable mechanisms for getting around this problem. I think we need to focus on addressing it head on instead. Social democracy can create pressure to increase worker wages, but it’s really just not an easy thing to get right.

So the defining characteristic of a social democracy is deficit spending during recessions. You learn some interesting things in blog comments.

Social democracies have traditionally inflated their currency during economic downturns via deficit spending and printing of money

This certainly isn’t true of Germany under the Bundesbank and it’s not really true of Trichet’s franc-fort era France either.

Did France have a recession in the franc-fort era?

First of all, let’s get rid of the idea that the housing bubble was primarily a U.S. or even anglosphere phenomenon driven by lax lending standards. Not only did the UK, Ireland, Spain, and Australia have much greater run-ups in house prices than the U.S., but France, Sweden, and the Netherlands were higher as well. In addition, Italy, Belgium, and New Zealand were within a few percentage points of the U.S.

http://www.finfacts.com/irelandbusinessnews/publish/printer_10002284.shtml

Given that the bubble inflated in all these places, despite differences in banking systems and regulations, seems prima facia evidence that the sub-prime lending shenanigans in the U.S. were a symptom of the mania (people cutting corners to get in on the deal) rather than the cause (or even much of a contributing factor — or else the price run-up in the U.S. would have been the highest rather than middle-of-the-pack).

And it seems to me that the interesting question that Quiggin does not address is what sort of system will adapt most quickly to the enormous structural changes and emerge from the downturn faster? I would bet on the more open, dynamic economies — and even more so in the post-recession period, because if most economies become less hospitable to entrepreneurship, that will create an golden opportunity for those fewer countries who are willing to use a lighter touch (e.g. regulation arbitrage).

@Slocum:
I have a related question. Newpaper accounts have said the home-price crisis did not reach the Indian subcontinent. I know middle-class Indians who say it had. Anyone know which is correct?

“The big losers here have been countries like the Baltic states, which relied heavily on capital inflows and have failed to build up the capacity to raise government revenue (it’s not so long ago, that the governments of these states were being lionized for their adoption of a flat tax system).”

John Quiggin,
In the current fiscal stimulus debate in the United States the Republicans are constantly harping about tax cuts as the most effective approach to combating a recession (it’s enough to make your head explode). So far, as usual, the American media has been woefully inadequate in pointing out that most of the countries who have adopted flat/low tax regimes such as the Baltic States, Georgia, Hong Kong, Hungary, Ireland, Singapore, and the Ukraine have been among those countries hardest hit by the emerging global crisis. Thanks for bringing the subject up. (Just for full disclosure, I’m not opposed to such tax regimes per se, but as a countercyclical or short run policy, adopting it would clearly be ineffective.)

Certainly, Ireland seems to be an echo of the US with many property developers holding big loans tottering, and a large unsold and unsaleable, half build stock of houses, offices and retail outlets. The banks are stuck with paper collateral on worthless (for a while anyway) land and buildings. Here, the Government is trying a bank bailout and is struggling to claw back the generous allowances they gave public sector workers when all that could be seen was blue skies. Talks of new taxes have not gone down well – but the country needs to save over E10 billion over the next three years or so.

The conventional wisdom is that if Ireland did not have a solid currency (the Euro) the country would be bankrupt, like Iceland. If the Irish pound still existed, it is not clear is a devaluation would have helped much – it might help competitiveness when the world economy starts to recovery, but that is couple of years out. As it is, Iceland may join to EU to give itself a liferaft and the Lisbon treaty will be a 2-to-1 win in Ireland when it comes up again in the Autumn, according to the latest polls.

This thread has been quite revelatory, thank you.

Sebastian @17,

I have heard … that most of the European banks have run into trouble with either local mortgage trouble, or non-mortgage but risky investments in Latin America. Is that the case in your view?

Here in Germany, as far as I can tell, the hardest-hit banks were done for mostly by investments in psychotic securities with, ultimately, psychotic US mortgages underlying them.

German mortgages are, you’ll be shocked to hear, rather stolid and stodgy. Nothing exotic or exciting (or toxic) here, though of course even the stodgiest mortgage starts to become exciting when the entire world economy is circling the drain.

Slocum, you seem to be missing the entire point of a social safety net: it’s to smooth out the fluctuations so that people don’t starve to death during the depressions.

There is more than one issue of interest. One is which countries will provide for their citizens best during the downturn. But another is which countries will make the necessary (and likely painful) structural adjustments most quickly and, as a result, emerge from the downturn most quickly. Which issue, BTW, is not unrelated to the first one; people subsisting on the dole who cannot find jobs tend not to be happy people–that is also a form of suffering.

Which is why I favor, in the U.S., an expansion of the safety net during the downturn (e.g. extended unemployment benefits and federal aid to states who are running out of money to pay those benefits) but oppose measures that would delay the necessary structural adjustments (e.g. attempts to prop up house values).

RB, that was funny.

I’ve read somewhere that if we were to use 1930s standards, we would have to add 5 to 10 percent to the current USA unemployment rate. Anybody here know if that is correct? (If it is, I think we’ve managed to get up to a 1931 level, which really doesn’t sound all that promising.)

Dave Weman,

what is there to question? I am familiar with, and regularly live in, both regions due to family and work. Sure, a country like Sweden is nice if you inherit a home from your grandparents. A cabin by the lake is nice, too, if your family is so endowed. If you want your own business then you better inherit that, as well, because the Nordic economies simply are not structured to foster start-up entrepreneurism. That’s to put it mildly.

In absence of these conditions, even if you are an educated person doing some type of professional work, you can expect to live a cramped life in a tiny flat somewhere with your family. It won’t be the worst life, perhaps, but just hope that you’ll have a job that you enjoy, because you won’t have many other choices in that respect. In fact, you can hope that you have a job at all before you turn 33.

In the case whereby you don’t get a job at all because the restrictive economy can’t accommodate you, you can spend your life sitting in your (really) tiny flat, in your long underwear perhaps, immersing yourself in spirits bought at the state-run liquor store, and looking out the window thinking about suicide. You won’t be going out much, because everything is severely overpriced as evidenced by the mostly empty restaurants around town. Generally, even those people with jobs splurge only one day on the weekend.

So alternatively, you might call-over your equally unemployed and borderline alcoholic colleague and discuss joining one of the many far right-wing street organizations. Those groups always seem to be hiring in the Nordics, and you’ll revel in solidarity ‘knowing’ that it’s The Foreigner who is responsible for diluting the payment you receive from the welfare office.

Of course, you won’t be totally off base, as foreigners also have a difficult time thriving in such an economy. You’ll notice that, as with right-wing extremism, most immigrant riots and other conflagrations invariably occur in the most highly developed social democratic welfare states of Europe: Sweden (search “Immigrants in Malmo” on youtube). Denmark, France, and most recently Greece (although, I don’t know about r/w extremism there)…

So why not in places like Germany?–plenty of immigrants in, e.g., Kreuzberg (a.k.a lil’ Anatolia). Some small riots perhaps, but nothing massive. Why no major riots? Because the immigrants there are too busy working in the service sector!–something that’s conspicuously missing in the high-tax Nordics and virtually all other social democratic welfare states. And sure, there’s right-wing extremism in Germany, too, albeit a proportionately smaller phenomenon than in the Nordics. In fact, German neo-nazis worship their better organized counterparts in the Nordics!

My point isn’t that the Nordic system is horrible. It is indeed good for some people. But it is far from the shangrila that we are tempted to envisage. The opportunity for self-actualization is quite meager unless you fit into a very narrow mold.

http://www.alli.fi/nuorisotutkimus/julkaisut/virtanen/contents.html

“1943 ………….. 1.8”

Being unemployed in 1943 would indicate very bad luck or very poor skills.

RobZ,
I’m still awake (just barely). Based on your response this is what you are actually looking for. These are the BLS alternative measures of labor underutilization. There is no equivalent for the Depression period in my opinion. However, It does show that our current labor market is much more slack than official numbers suggest:

http://www.bls.gov/news.release/empsit.t12.htm

Greece isn’t a highly developed social-democratic welfare state. Also, the French welfare system doesn’t compare at all well to that of Germany, Denmark or Sweden. But then, what good is there arguing with facts to someone who has convinced themselves Sweden is rather like Germany in 1932?

If you want your own business then you better inherit that, as well, because the Nordic economies simply are not structured to foster start-up entrepreneurism. That’s to put it mildly wrongly.

Typo fixed. You can’t chuck a prawn around in Stockholm or Helsinki without hitting a start-up entrepreneur, and Denmark is almost parodically the home of a million and one small furniture-exporting businesses. I mean, I am terribly sorry for LF, whose family and work seem to oblige him to live in some of the nastiest slums of Stockholm, but they really aren’t representative of the Nordic economies.

Stuart,
You’re right. I should have said “the headline number.”

The severity of the immediate financial crisis depended both on the magnitude of the impact and on the capacity of governments to respond. The big losers here have been countries like the Baltic states, which relied heavily on capital inflows and have failed to build up the capacity to raise government revenue (it’s not so long ago, that the governments of these states were being lionized for their adoption of a flat tax system). By contrast, most of the richest countries have been able to finance bailouts of various kinds.

It’s not clear, however, that financing bailouts will always leave you better off. Even if we accept the Keynesian model, we can imagine that a small country would like to simply free ride on the economic stimulus package of its much larger neighbors (assuming that various types of economic activity flow across borders). Some say that Ireland is pursuing a policy along these lines even now (though it’s questionable whether you could describe it as ‘small’…).

I’m under the impression, though, that the key factor here was not the mortgage market itself, but all the highly leveraged instruments that exaggerated its impact. If the mortgage market had been just as it was, but there had been no leveraged instruments, it would have been bad, but not a global catastrophe. OTOH, if the same sort of derivatives were used to bet that the stock market could not go down, even let’s say, over a 5 year span (I hope even Mr. Dow 36,000 would not be so foolish, but who knows), the impact if it had would have been similarly devastating. Not that we don’t need to fix the mortgage situation too, but if we focus exclusively there, we’ll just get hit from another quarter next time.

As far as the mortgages, the most basic problem seems to be the belief that housing prices would keep rising. Even the worst of the loans – the neg ams, the interest onlies – were manageable even for those who could not legitimately afford them so long as prices kept escalating such that they could sell or refi out before the payments escalated or the balloon came due. Now whose job is it to know that house prices do not only rise? At a minimum, the experts. If the experts are not going to realize and publicly state fairly obvious and important facts about the economy, what is their job? And how can we condemn people for taking mortgages they “couldn’t afford” when they actually could within the parameters of what they were being told was the macroeconomic situation going forward?

LF,

Your point seems to be that social democracy leads to high unemployment and generally poor economic performance. The support you have provided for your thesis combines the underwhelming with the outright bizarre (higher standard of living in East Europe than in the Nordic countries? Greece a social democracy?). You appear to support a neo-liberal economy agenda, which Jim Henley, in the post that originally initiated his thread, correctly identified as thoroughly refuted (have you seen the news coming out from the Baltic states lately?). I’d like to hear a straight up defense of neo-liberalism, in the light of current events, from your, rather than your BS about social democracy

Talk yourselves in circles all you want. The bottom line is, the credit destruction dwarfs, by an order of magnitude, any amount of stimulus the govt, can inject.