Nostradamus and the Euro

L. Randall Wray

Let’s end the debate about who was first to predict the Euro disaster: Nostradamus.

When I was in high school we discovered Nostradamus while goofing around in the library. Man, that guy was prescient!  The book included commentary that showed he had foreseen Hueys dropping Napalm on villages in South Vietnam (an issue of the day). After leaving the library I found the book in my bag—and it became a running prank that Nostradamus would show up in lockers and cars, or on desks and occasionally even in mailboxes. I’m not sure where the book ended up—not with me, as I’d be checking it for his predictions on the Euro crisis. But I’m sure it is there in gory detail.

Some years later I was the TA in a college psych class. The prof and I formulated a little experiment on the lab rat students. He told them we were studying handwriting analysis and were becoming quite adept at uncovering the psyche as channeled through pen and ink. We had each student submit a writing sample, and at the next class handed each a personalized psychological assessment. He then told students to rate their assessment on a scale from 0 to 5—with 5 being a perfect fit. He asked how many rated zero? None. And so on up to a 4—he got a few hands. Then: 5? Almost everyone.

He asked if anyone would volunteer to read her assessment—one did, and of course all the others realized they got the same one. The trick was to write an assessment that superficially appeared to be quite specific but actually hit all the general psychological characteristics—mostly good, but some bad– that people (at least, 19 year old college humans) would like to attribute to themselves.

Nostradamus was a master at this.

In recent days a number of candidates have been put forward for the top prize of first predicting the demise of the EMU. The WSJ gave credit to a group of MMTers and Levy Institute scholars; PIMCO’s Paul McCulley also tipped his hat.

This rankled a lot of feathers of MMT critics who thought WE were making the claim. By now you’ve seen the attacks. In truth, we’ve only claimed we got it right—not that we were first. Nor did we claim to be the only ones to get it right. Nostradamus was first, and he got it right, too. So did others.

Many foresaw the problems of a one-size-fits-all central bank policy. The argument was that forcing all members to operate with the same overnight rate would mean excessively tight policy in slow-growing states and loose policy in those facing inflation. Surely there is truth in this. In the US we set up a system of districts so that in principle, each Federal Reserve Bank could set its own discount rate. However, we later dropped that as policy was centralized in Washington. For better or worse, we’ve managed such an arrangement with a single interest rate target for the whole nation. Much like the EMU. Yet, we aren’t facing the prospect of kicking—say—the St. Louis Fed’s entire district out of the dollar union. Unlike the EMU—which is very likely to kick the Greek district out.

Others correctly pointed to—shall we say—different political proclivities amongst the member nations. Some were used to more transparency and democracy. Others preferred the smoky, backroom deals. Some worked with Goldman Sachs to hide debt. Others adopted Teutonic fiscal rectitude (not really but that is the myth). Some were home to profligate consumers; others kept wages and consumption in check. These critics were right, too. Still, we’ve got political differences at least as great across the US states. The differences go way beyond red versus blue. The majority of voters in almost half the US states believe they can mandate through legislation that science return us to the eighth century when the earth was still flat and less than 10,000 years old, evolution wasn’t invented, global warming was a good thing, and birth control wasn’t practiced. Back when women were women and men were club-toting beasts. There’s simply no similar comparative disconnect in Europe, where everyone lives at least in the late 20th century. A Norwegian can enjoy a nice three week vacation anywhere in, say, Greece or Portugal; but you simply could not imagine a cultured New Yorker spending two enjoyable hours in most towns in rural America.

(Before I get the hate mail, I’m about as uncultured as any American, and I cannot find two hours of enjoyment in NYC, either. So the feeling is mutual. A friend from Manhattan spent a weekend in my tiny upstate NY village and managed to personally offend most of the inhabitants in just 24 hours; there’s still a poster on the village hall offering a reward to anyone who lynches him. And that’s just 90 miles from NYC. I cannot imagine what would happen if he spent a Wild Weekend in Wichita.)

There is also the related Optimal Currency Area argument. The Euro area was not optimal. Go figure! All those cultural differences. Lack of sufficient labor mobility. Prodigal southern sons versus anal-retentive Germanic daughters. And of course that was right, too. Yet all of these differences exist across US states—my goodness, if you want to see cultures collide check out what happens when Texans and New Yorkers cross paths in the Colorado Rockies whilst on vacation.  (There’s a fair chance most Americans would let Texas leave the dollar union, but we know it ain’t going to happen.) So, yes, locked-up chastity belts would help resolve a lot of the cultural differences across Europe, but that is probably only a small part of the problem.

You’ve all known marriages that were doomed to fail. And much like Nostradamus you probably put your finger on many of the general problems that would lead to the failure, and were quick to say “I told you so” at the divorce. In truth, you probably, still, do not know much about the specifics. And, I’ll bet that most of the problems you identified exist in most marriages that survive ‘til death-do-us-part, too. Truth is, marriage is hard, and so is nationhood.

Both are even harder when fiscal constraints bind.

So now we’ve got all manner of prognosticators claiming “Me Too, Me Too, I also saw it coming”. Some are even able to trot out a quote or two warning about unified monetary policy and political and cultural differences that would cause problems down the road. And, yes, the Euro skeptics—all of them—deserve credit. Congratulations.

None of them were first—Nostradamus gets that claim, hands down—but they joined a relatively small group of economists who “got it right”. Almost all economists got it wrong, as wrong as they got the Global Financial Crisis. They were cheerleaders for Bernanke’s Great Moderation and also for the Euro project. No prizes for them. That is where the critical energies ought to be directed. Not at MMTers.

Indeed, those cheerleaders for orthodoxy helped to bring on both crises by their wrongness. What they singled out as the best thing about the Euro, fiscal discipline, turned out to be precisely what they got most wrong. Not only did the EU’s Maastricht Criteria NOT discipline EMU members, but the actual fiscal constraints—not the Criteria–are what made the crisis inevitable.

As I’ve explained, the Maastricht Criteria on paper were far too loose as they allowed budget deficits so large that debts were run up to impossibly high levels—for nonsovereign states. Markets would eventually recognize the problem, raise interest rate spreads, and then nations would be caught in vicious death spirals. In truth, the Criteria made no difference since deficits are mostly nondiscretionary. So tighter legislated restraints would not have changed anything. And most countries violated them most of the time, anyway.

The actual deficit limit that would bind would be the market’s willingness to pretend that these are sovereign nations, more like Uncle Sam than Mississippi. In truth, any budget deficit at all should have rang warning bells. There was always solvency risk of every member—including Germany—unless the ECB was willing to violate at least the spirit if not the letter of the Treaty that prohibited it from standing behind government debt issued by each member.

At the same time, the fiscal arrangements meant that individual members could not deal with their own financial crises—crises that were ensured (in at least some member states) by the combination of the realities of sectoral balances: either the domestic private sector or the national government (or both!) would be likely to run unsustainable deficits to maintain aggregate demand at a level consistent with economic growth. That would eventually cause trouble for financial institutions. No member government could offer credible deposit insurance or amass sufficient funds for a bank rescue. So no individual nation could quell a financial crisis that would inevitably engulf the whole region’s financial system.

MMTers have not claimed they were the only ones to predict these dynamics. They do not claim they were the first to predict calamity. But MMTers explained in quite precise detail what was wrong with the set-up from the beginning and how the crisis would unfold. I have not seen any explicit case made yet for similar projections by others, although it is certainly possible that such a case can be made.

The fiscal constraints story is there in the Chartalist writings of Charles Goodhart from 1996 and the Soft Currency writings of Warren Mosler from the same period. The potential for financial crisis was clearly and early explained by Warren Mosler. The potential for current account and sectoral balance problems was laid out by Jan Kregel. Stephanie Bell warned of exploding interest rate spreads once markets realized they were no longer in Kansas, Dorothy—rather they had entered a grand and fundamentally flawed experiment that involved separating nations from their currencies.

These were not the vague predictions of Nostradamus. All of these things we warned about came to pass, in a manner that was very close to our prognostications.

Some now say that they could have just as easily foreseen the Euro crisis using the analysis of “Old Keynesians”. Fine. I wish they had done so. If more had been on board since the mid 1990s, the whole dangerous experiment might have been cut short. Our claim is that MMT is certainly a sufficient framework to generate a coherent explanation of what would go wrong with the Euro project. We do not claim it is a necessary framework—the jury is still out on that.

So here’s the deal. Forget about being first as Nostradamus beat all of us to it. But he did not and cannot explain in detail what was wrong with the Euro set-up. His gig is all about generalities that look good in retrospect. Many others also saw problems with the Euro, and like the sight-impaired humans and the elephant, they got something right in their critique. A few got the specifics right. And it is the specific understanding that is now necessary to move forward with EMU reform.

MMT shows a way forward. To be sure, others might reach the same recommendations using alternative methodology. The sight-impaired can grope the elephant and they might eventually recognize they’ve got the tail not the trunk or some other appendage. But it makes sense to use the vision that we’ve got rather than blindly groping about.

Final Point. Tom Palley has written yet another comment on MMT, in which he backtracks on his original accusations. That’s nice. He still adopts a hostile tone, mostly in his title—MMT is accused of holding mostly old ideas plus some new “unsubstantiated” ones. We are glad that Tom (and some other critics) finally recognize that MMT proudly stands on the shoulders of giants. We never claimed to have created MMT out of whole cloth. Our argument has always been that anyone who treasures the works of our “forefathers and foremothers”—people like Marx, Veblen, Keynes, Commons, Robinson, Minsky, Lerner, Godley, Moore, and Davidson—will immediately recognize their work in MMT. We are synthesizers, in the main. What we added—largely thanks to the insights of Warren Mosler—is a detailed examination of the coordination between the Treasury and the Central Bank, all those operational factors that negate not only the “deposit multiplier” but also the legislated and self-imposed constraints that make it appear that a sovereign currency issuer faces market-imposed constraints. It does not.

Tom makes two other claims. First, I have supposedly misled readers in his position on unemployment. Well, you can google for yourself and find his position in videos in which he argues against the ELR/JG on the argument that “If you start to create ELR jobs you will pay them…they will start to want things like TV and meals…that money will chase after those goods…cause more inflation…folks will want more electricity…those who already have jobs will oppose it…I call it an economic problem.” His words, not mine. It is a common criticism of ELR: Unemployed people cannot afford things like “meals”, “television” and “electricity”, but if we gave them jobs they’d try to buy those, sparking inflation. It is the economic trade-off we have to make. That argument is wrong on many levels, and is morally repugnant, in my view. If he’s changed his position, I’m glad.

The other argument he makes  is that blogs are not the right venue to debate such issues. I fully agree. He implies MMT and JG/ELR supporters have not dealt with these issues in depth in more academic venues. That is just plain wrong. There are hundreds of published articles and lots of books, too. Tom can even read them if he wants. It is one thing to be ignorant; it is quite another to argue from ignorance.