Tag Archives: L. Randall Wray

It Takes Real Skill to Lose $2 Billion

By L. Randall Wray
Sometimes you come across a story that really warms the cockles of your heart. I am talking, of course, about the report on UBS’s star trader, Kweku M. Adoboli who lost $2 billion. He is only 31 years old. Now, what had you accomplished by the time you were 31? Mr. Adoboli had risen through the ranks to the point that he was entrusted with a trading account that let him accumulate a loss of $2 billion. Imagine this guy’s potential! Limitless opportunities await him on Wall Street—at least, once he gets out of prison. And he could open a “think tank” like Michael Milken, devoted to proving that his trades might possibly have made good if only the world had cooperated.

Look, it’s easy to make billions on Wall Street—any dopey trader can do that. You can always follow the example set by John Paulson. Approach Goldman Sachs and propose that the firm let you pick the worst possible toxic waste assets, bundle them into securities, and then Goldman sells them to its own clients. Upward of 98% of the bad assets prove to be, well, bad, and both you and Goldman make out like bandits, and the clients get screwed. Duping customers is the sure-fire investment bank way to make profits. You cannot help but funnel client’s money to traders’ bonuses. It is impossible to lose, and that is why Wall Street is doing just fine, thank you, while the global economy collapses all around us.

Mr. Adoboli presumably tired of the sure thing. According to reports, he was supposed to be working in exchange traded funds, matching buyers and sellers in a high volume, low risk market where risks are easily hedged. That is sort of like the investment bank equivalent of a Jimmy Stewart thrift. Obviously, no one wants to do that kind of business—earning spread money. And so investment banks have created an infinite number of schemes to dupe sellers and buyers, trading for their own account while betting against clients.

But that’s the sure thing. Mr. Adoboli instead—according to various reports—tried to take advantage of price differentials between traded index securities and underlying stocks, and avoided hedging risk.
It’s hard to lose money in investment banking, but if you are really, really clever you can find a way to do it.

I hope he gets his bonuses this year. Initiative deserves reward. After all, the big banks continued to pay stupendous bonuses when the financial crisis hit, rewarding traders and CEOs for record losses. The argument, of course, was that in a time of such distress, no bank could afford to lose such highly skilled help. Where would they find replacements able to dream up losing propositions?

Now, UBS will need to keep Mr. Adoboli on retainer or they’ll lose him to a competitor looking for a star with potential to lose big bucks. After a stint punching out license plates, he’ll rise to the top of some investment bank. I’ll put my money on him—as the next Bob Rubin, Lloyd Blankfein, Dick Fuld, John Thain, Hank Paulson or Joe Cassano, all richly rewarded for driving their institutions into the ground.
No one remembers the CEOs or traders who actually make money for their shareholders. Name one. That’s what I thought, you can’t. Because it’s child’s play. We remember the Nick Leesons, the guys with real vision and willingness to take risk, and ability to run up losses.

Even John Paulson got tired of the easy, sure thing. He’s now on a fantastic losing streak. He’s down 40% this year. Yes, I know he made $5 billion last year betting on gold. But gold is a fool’s bet. Look, when Dallas hedge fund manager J. Kyle Bass dupes the University of Texas into buying a billion dollars in gold bars, you know gold has become the sucker’s bet. Poor Paulson does not realize he is on the client side of a Vampire Blood Sucking Squid trade this time!

After all, investment banks only lose the money of clients and shareholders. Who cares? Wall Street is just a crap shoot, with other people’s money—heads Wall Street wins and tails everyone else loses. Why all the fuss?

Think about it this way. Let us say you go to Las Vegas to lose $2 billion (maybe you are the treasurer for a pension fund) and start feeding the slot machines as quickly as you can. The problem, of course, is that you are going to win occasionally—so you’ve got to get those coins back into the slots. Your goal is to lose, say, $1000 per day. Maybe you’ve got to put $1850 on average per day into the one-armed bandits to average a loss at that daily rate. It’s going to take you about 5500 years to lose $2 billion. That shows you the long odds that Mr. Adoboli was up against—he’s only 31 and he’s already lost his first $2 billion.

That folks, is skill.  

In related news you cannot miss three similarly heart-warming stories.
1. In a new book to come out this week by Ron Susskind (Confidence Men: Wall Street, Washington, and The Education of A President) we’ll see how Timmy Geithner saved the world from a rookie President Obama who ordered the Treasury to develop a plan to shut down the biggest banksters. Fortunately, Geithner thought better of that, so instead he worked with the Fed to provide a $29 trillion dollar rescue package to keep the banksters in business. If he had actually listened to his president, who knows whether Mr. Adoboli would have been able to lose those billions. 
2. Former Senator Bob Graham urged President Obama to reopen and investigation into the Bush Administration’s rescue of Saudis in the aftermath of 9-11. You see, most of the terrorists involved were Saudis and they almost certainly had help from rich and prominent Saudis living in the US. Fearing a backlash, investigation, and possible prosecution they asked President Bush to make a wee little exception to the grounding of all aircraft. Bush launched a fleet of jets to rescue them. All this had been exposed long ago by Michael Moore, but new information sheds lights on close connections between particular terrorists and rescued Saudis. Since the Bushes and the Bin Ladens are close family friends (even closer than the Bass brothers), all stops were pulled to sweep them out of the country. You’ve got to love the loyalty.
3. And speaking of loyalty, what do you do when your best bud dies? You take him bar-hopping of course. Especially if you live in Denver, where they not only serve drunks, but even corpses! When two guys found their buddy dead, they loaded him into the car and headed to the bar. The dead guy paid. After a couple of bars, his friends dropped him back at home to rest in peace, then they hit the ATM machines using his card. He won’t need the money in the sweet hereafter, after all. (The only Bush angle I could find is that brother Neil helped to bring down Silverado in Denver, with Uncle Sam footing the billion dollar loss. But we know those Bushes like to party and I’m sure they appreciate the spare-no-opportunity-to-party initiative taken.)

The Debt Pyramid and Clearing: Responses to MMP Blog #15

By L. Randall Wray

This week we examine the debt pyramid and clearing of IOUs in the state money of account. Thank you for your questions and comments, and apologies for being late with the response (believe it or not, I lost track of the days of the week—thought I had another 12 hours to get this done).

Q: (Douwe): Please explain the “degree of separation from the CB”.

GA: Thanks for the nice comment. See the pyramid below. Obviously this is a simplified picture of the hierarchy. Within government IOUs we include the Treasury and the Fed. Bank IOUs include demand deposits and other liabilities that banks promise to convert to government IOUs.

Nonbank IOUs are issued by firms and households; it is rather arbitrary where we put the dividing line between bank IOUs and IOUs of “other” financial institutions. Perhaps the most useful way is to distinguish between those types that have direct access to the central bank, and those that do not.

That also brings up the point made by RVAUCBNS: what happens if something goes wrong at the bottom of the pyramid (say, in the shadow banks)? Yes, and that is indeed what happened in the global financial crisis (GFC). Typically those lower in the pyramid issue IOUs that are convertible on some conditions to bank IOUs, that in turn are convertible to government (central bank reserve) IOUs. When something goes wrong, the nonbanks turn to banks for finance (lending against the nonbank’s IOUs); the banks in turn go to the CB. But when expectations turn ugly, the banks won’t lend so the nonbanks cannot make good on promises. That led to the liquidity crisis; the Fed eventually decided to lend to everyone, including the Real Housewives of Wall Street (as Matt Taibi demonstrated).

Additionally, the pyramid is useful for thinking about whose IOUs one can use to make payments on one’s own IOUs. You cannot repay your IOU with your own IOU (you’d still owe); only sovereign government can do that (as we discussed, if you present a five pound note to the Queen, she gives you another; she still owes, but so what—you’ll never get anything else out of her even if you go to court). You use someone else’s—what we call a second party or third party IOU (not first, which is yours; second would be using your creditor’s own IOU; third would be using the IOU of someone unrelated). Normally those lower in the pyramid use bank IOUs; banks in turn use government IOUs (CB reserves).

Jim wondered about power in the structure. Certainly! I’d love to be at the top of that pyramid! Even being at the bank level is a nice gig: government would stand behind your IOUs so they’d be as good as government’s. Gee, do you think your IOUs would then be widely accepted? Yes. When government handed a bank charter over to Government Sachs (oh, whoops, Goldman Sachs), suddenly its IOUs were as good as the Fed’s. Led to a huge multi-billion dollar subsidy. On the other hand, that comes with tighter regulations and supervision (at least, it is supposed to do so). Jim also wondered about the “flatness” of the pyramid—a good point. The pyramid is bigger at the bottom for a reason: more IOUs issued at the bottom than at the top. We can think of that as a more sophisticated financial system. And generally that is true—in developed economies government IOUs (including cash) are a smaller portion of the whole. Since the US Dollar is used all over the world to finance illegal activities, there are more of them sloshing about than you’d expect for a highly developed financial system. And now after QE, we’ve got a lot more bank reserves (at the top of the pyramid) than usual.

Q2: (Jeff) What about settlement of Eurodollars?

A: Same story. Ultimate clearing is at the Fed since these “leverage” US Dollars. (Note: there are also private settlement services—I am simplifying. Banks with off-setting claims on one another can use a private settlement system; they only need to go to the central bank for net clearing, as only the CB can create reserves.)

Q3: (Anon) The Fed mandates that primary dealers buy and sell treasuries.

A: Yes. This is part of the operating procedures to ensure the Treasury can get deposits as needed and move them to the Fed to cut checks or credit accounts as needed.

Q4: (Dave) Techie question about complications in Fed lender of last resort operations. Scott Fullwiler answered—and there is no way I can improve on Scott’s paper since he is the numero uno expert. Those who are really wonkie can go to his paper—it is far too complex for this primer.

Q5: (Glenn) Didn’t Chairman Bernanke admit he bailed out the banks with keystrokes? Where does the Fed borrow from and is there a limit? And wouldn’t it be better to spend the money to bail-out Main Street?

A: Yep. Fed “keystroked” trillions of reserves into existence, buying Treasuries and toxic waste MBSs. Calling this “borrowing” is misleading, which is why I do not use that term. Yes, the Fed is indebted, dollar for dollar, for every one of those keystrokes. Reserves are Fed IOUs. So you could call that “borrowing” and the banks with the reserves could be called “lenders” since they are the creditors. But this is nothing like you or me borrowing to buy a car. We are truly limited in how much we can borrow. The Fed has no limit to keystrokes (unless Ron Paul finally gets Congress to put a limit on the Fed—in other words, self-imposed limits are always possible).

The Fed and Treasury spent, lent, and guaranteed $29 trillion to rescue the banksters. Wouldn’t it be better to spend a fraction of that to rescue Main Street and the unemployed? I think so. Probably 99% of Americans would agree. Unfortunately we do not control the Fed and Treasury.

Q6: (Godefroy) What is inside bank assets? (RVAUCBNS) Aren’t there two kinds of money? Government and bank.

A: I think you mean what is on the asset side of a bank balance sheet. Reserves (electronic entries on the liability side of the CB), treasuries, private bonds and securities, loans, and a tiny bit of vault cash.

Two kinds of money: yes, two main categories. Inside money is the money-denominated IOUs of the nongovernment sector. What I called private money things. Outside money is the money-denominated IOUs of the government sector (cash plus reserves; we can also include treasuries since those are just reserves that pay higher interest). Note it is outside money that is at the top of the pyramid.

Thanks, again. Sorry for being a bit late and a bit brief.

Today’s Modern Money Primer

Follow Professor Wray as he examines bank clearing and the notion of a “pyramid” of liabilities with the government’s own IOUs at the top of that pyramid.

Today’s Modern Money Primer

This week’s primer deals with IOU’s denominated in the national money of account. So before you go out spending your hard earned dollars on burgers and beer, take a glance at how they actually function as IOU’s in our modern monetary system.

And of course, have a safe and relaxing Labor Day!

Today’s Modern Money Primer

The second part in Wray’s discussion on the origin of coins is now available. If you are new, check out the Modern Money Primer. You’ll find part one of this series, as well as the most thorough introduction to MMT, short of enrolling at UMKC as a grad student.

Today’s Modern Money Primer

Wray begins to dispel the view that coins used to be commodity money. Head over to the primer to read the latest in the MMP series: Commodity Money Coins? Metalism vs. Nominalism, Part 1

Pinch-Hitting For Peterson, Responses

By L. Randall Wray
It is perhaps a bit unseemly for the protagonist to be the first to answer Stephanie Kelton’s call for responses. However, I wanted to address two comments received to the series.
First, from GLH there was a question about the term “beltway progressive”. Fair enough. Comes from “inside the beltway” of Washington DC. Many “think tanks” (a misnomer as few think tanks actually do any thinking—most simply push an ideological agenda) locate within the beltway to have easy access to politicians, policy-makers, lobbyists, media, and funding. Most of these are center-right, or crazy right, but there are a few progressive think tanks slugging it out. I did not use the term in a derogatory manner, although I did criticize the “group think” on debts and deficits that emerges from within the beltway.
Locating within the beltway does provide many advantages. When media types are working on a story, they want to go where the action is—and that is usually Washington. The media loves to report on politics—as opposed to, say, economics—because everyone has an opinion and all opinions are seemingly more-or-less equal. It is easy to get a debate about the significance of the most insignificant political poll; it is easy to get some instant expert weighing in on what “the American people” want, and what any particular election “really means”. Occasionally they will cover economics, usually some proposed legislation that will benefit really rich people. Think tanks offer a veil of respectability that registered lobbyists cannot provide. It is hard for a policy-maker to directly affirm that he’s supporting a piece of legislation that benefits—let us say—some blood-sucking vampire squid because that firm’s lobbyists have promised campaign contributions. So it is much better to turn to a think tank that takes vampire squid money to produce “research” reports advocating policy that will benefit vampire squids. So that is the main role of beltway think tanks.
And that is, to me, what is so problematic about beltway progressives adopting the Pete Peterson approach to deficits, debt ratios, unfunded entitlements, and fiscal responsibility. As I have argued, that adoption is probably a “coincidence” in the sense that progressives in Washington are merely sucking the same air. It is “within the beltway” thinking. And within that beltway there is no longer any room for disagreement about “unsustainable” deficits and debt.
I know this from personal experience. It is much harder to influence policy from Kansas City or from upstate NY (the Levy Economics Institute). Yes, reporters occasionally decide: “hey maybe we should get an economist who is not connected to the beltway think tanks; maybe one of those farm country hillbillies in the Midwest. How about Kansas?” (UMKC, by the way, is in Missouri, and we are quite a distance from the Ozarks–but the confusion about Midwest geography probably helps us.) So we get our airtime. Occasionally I venture inside the beltway and meet with policymakers, politicians, heads of civil rights or labor groups, and so on. When I say that government solvency is not at issue, they look at me like I’ve just sprouted two horns. They call for the guards to escort me out. They warn me not to come back until I’ve got a letter signed by Joe Blow from XYZ progressive think-tank from within the beltway endorsing my proposal. I am not kidding, but I won’t name names. (Sometimes it is even worse—they’ll say: “Oh you are one of those economists that Paul Krugman attacked because you claim deficits never matter. Don’t come back.”) Therefore, not only is the endorsement by beltway progressives of the Peterson view limiting the range of debate within the beltway, it also closes off the beltway to any progressive alternative outside the beltway.
Second, for Craig Austin. Yes, I know we are terrible writers and promoters and don’t know a thing about PR. And yet, you are here, along with 2500+ readers every day to read what we write. A half dozen of us created the MMT that you now love dearly—those of us here at UMKC plus Warren Mosler, Bill Mitchell, and Scott Fullwiler. So we are not complete failures. We want you and others to take up the fight. If you are better at marketing, great, do it. If you want to self-promote your own blog, go for it.
But if you are here to get funding from us, you are delusional. There is no money.
Let me explain how things work at NEP. It was Stephanie Kelton’s brainchild; she bought a URL out of her pocket change, roped a couple of UMKC profs to donate time, got some of our associates to donate their time (Marshall, Scott), and started the blog. Frankly, I was skeptical. I barely even knew what a blog was (I knew Bill Mitchell had one but wasn’t quite sure if it was a disease or other affliction). She learned how to set up the blog, and then got some volunteer techie assistance from our grad students. There is no revenue; if there are expenses, Stephanie covers them out of pocket. And she and her techie grad students post every blog that is put up because the rest of us are too damned incompetent to learn how to do it. We can barely distinguish a URL from a URINAL.
So if you want money out of UMKC, here is what you need to do. Apply to our PhD program; get accepted; and if you are among the top applicants you might be awarded a stipend. For the princely sum of $10,000 per year, you attend lectures and study for 40+ hours a week. You also must work as a slave (whoops, we now call them GTAs—graduate teaching assistants) assigned to a prof for 20 hours per week, grading papers, leading discussions, holding office hours, and later teaching your own class. And then if we discover you know anything about computers, you get to donate your time at night to helping on the NEP.
So if you wonder why we do not have a PR firm, it is because we have not yet found one to work for free.

Pinch-Hitting for Peterson. Part 2: How Progressives Helped Stoke Deficit Hysteria; A Case Study

By L. Randall Wray

In Part 1 I argued that Beltway progressives aided and abetted deficit hawk Pete Peterson in his efforts to gut the last remaining vestiges of Roosevelt’s New Deal. By adopting Peterson’s views on government finances, they were unable to provide a progressive alternative to budget cuts. Since Republicans were willing to make a Custer’s Last Stand on the debt limit, and since President Obama was Wall Street’s designate to privatize healthcare and retirement, Democrats needed that progressive voice. But Beltway progressives had already caved, for reasons I discussed.

Indeed, it appears even worse than that. Yves Smith already blew the whistle on three progressive research groups (Roosevelt Institute, Economic Policy Institute, and the Center for American Progress) that produced reports with funding from Peterson. These reports adopted the deficit hysterian’s argument that the US budget is on an “unsustainable” course, and advocated a return to “fiscal responsibility”. Getting progressives to adopt neoliberal terminology was a real coup for the deficit hawks. With such hyped-up talk, there was no doubt that Obama would be able to put Social Security and Medicare on the chopping block.

I have recently discussed what I see to be problems with the Roosevelt Institute’s report over at FDL. This was also the main target of Yves. (Go here).

Let me say, however, that I think critics have been too hard on these three groups. I have argued that taking tainted money from Peterson can be justified if one uses the money to produce progressive research. I am sure all three groups believe that is precisely what they did—they thought they would get a progressive view into the debate, something that had been sadly lacking. In their budgeting exercises, they preserved what they saw to be progressive programs, they budgeted some new progressive programs, and they shifted tax burdens to higher income individuals and corporations. Surely, they believed, that is better than standing on the sidelines and letting Peterson choose which programs to cut? I get that. I sympathize with them.

But here’s the problem. They accepted—at least implicitly—the Peterson agenda. Deficits and debt ratios have to be reduced, if not immediately then eventually. In other words, they budgeted, but with Peterson’s Austerian constraints.

I do not know if Peterson demanded that they submit budget projections that showed debt and deficit reduction relative to the base case. But the RI proudly displays on the report’s homepage projections of very significant debt reduction relative to the “do nothing” baseline. (see here) In other words, they accepted the premise that debt and deficit ratios should be reduced. Once that is done, there is nothing to do but cut some programs and raise taxes.

Part 1 should have made clear, however, that progressives had already moved very close to the Peterson view before he put them on the payroll. For a variety of reasons they had already adopted a “deficit dove” position. The difference between a hawk and a dove is this: hawks want deficit reduction more-or-less immediately. Many of them hold the position that deficits are always bad because they always cause inflation and slow economic growth. The extreme hawk position is that even now, with official unemployment above 9%, government spending should be reduced. There is no plausible economic theory standing behind that position—it is ideological, or as Representative Ryan put it, it is a “moral” position. More “reasonable” hawks are willing to wait until a stronger recovery gets underway. Even Pete Peterson is on record favoring postponement of deficit-cutting until 2012 (see below).

By contrast, deficit doves believe that deficits are not only OK in a deep recession, they are even necessary. (Prominent deficit doves include Paul Krugman as well as many of the writers at New Deal 2.0 as well as individuals at the three institutions that accepted Peterson’s funds.) However, doves believe that “eventually” deficits need to be cut so that debt stops growing; they typically want to stabilize the debt-to-GDP ratio at some level. Some admit that the choice of a final resting place for the debt ratio is somewhat arbitrary—perhaps it should be 60%, or perhaps 100%. But doves are sure that 200% is worse than 100%, and that 100% is worse than 60%. Thus, “eventually” deficits must be cut—and that means hard choices.

A progressive dove can be identified by her preferred means of obtaining that final “sustainable” debt ratio. Tax increases on the rich and on corporations are good. Reductions in military spending and subsidies for corporate agriculture and oil companies are advocated. Raising taxes on the poor and cutting their benefits are rejected by progressive doves.

The problem is that most progressives accept the intergenerational warrior’s claim that “entitlements” (Roosevelt’s New Deal) will bankrupt the nation 25 to 50 years down the road. And those portions of the budget are already large and growing. Hence, as Peterson and his minions have argued for years, “TINA”—there is no alternative to hacking away at entitlements.

The more progressive doves advocate relatively small tweaks to Social Security (raising or eliminating the “cap” so that higher income folks contribute more payroll taxes; raising the retirement age; taxing benefits received by high income retirees; reducing the COLAs; and so on) or bigger tweaks to Medicare and Medicaid (greater emphasis on cost control—some go so far as to recommending the “public option”—or to slow health care cost growth more generally, using centralized bargaining over drug prices). The game played then becomes one of finding the least painful way to reduce longer-term budget deficits and growth of debt in order to move the government’s finances back toward “fiscal responsibility”.

That was a long excursion by way of introduction to what follows—an examination of EPI’s “progressive budget”. I want to make clear three points about EPI. First, EPI’s progressive credentials are not in question. It is without doubt the most important progressive voice in Washington. Second, EPI’s preferred budget was created before it accepted any Peterson money. I will actually refer to the budget it published in 2010, long before Peterson solicited EPI to produce a report. In all important respects, the earlier budget is the same as the budget EPI produced for Peterson. Thus, those critics who have argued that EPI “sold out” to get Peterson funds are wrong.

And, finally, I want to say that much of the budget is indeed “progressive”—it preserves progressive programs, it adds funding for new progressive programs, and it shifts taxes to higher income individuals and corporations. It obtains deficit and debt reduction mostly by increasing taxes. We could quibble over the allocation of funds or the budget priorities of EPI, but I have no problem agreeing that the priorities are consistent with a progressive agenda—albeit not necessarily one I would endorse. Further, EPI has been steadfast in its protection of Social Security. Unlike some other progressives, for example, EPI has rejected any attempt to cut benefits by raising retirement ages or fiddling with COLAs. So I want to make clear that when I criticize Beltway progressives for aiding Social Security’s enemies I am not including EPI, which has been a strong voice in support of Social Security.

Before closely examining EPI’s report let me quickly summarize my complaints about Beltway progressives:

  1. By adopting a deficit dove position, they legitimize the Peterson crowd’s focus on deficit ratios and debt ratios;
  2. By adopting the intergenerational warrior’s long-term budgeting methods, they legitimize the fear-mongering surrounding “unfunded entitlements”;
  3. This leads inexorably to weakening support for New Deal social programs by questioning their “affordability”; and
  4. More generally, it legitimizes the arguments of fiscal conservatives who want to reduce the role of government in the economy.

For the purposes of my analysis, I will compare an EPI report from 2010 (before EPI received funding from Peterson) with a Peterson-funded report from 2009, both of which provided “blueprints” for deficit and debt reduction. As one might expect, the dovish EPI report preserves and even enhances spending on progressive programs, while raising taxes on higher income individuals and corporations. The Peterson report is much more hysterical about a looming financial crisis if we do not do something immediately about unfunded entitlements. Further, the EPI budget would move toward deficit cutting much more slowly, and would stabilize the debt ratio at a higher level.

Still, as one reads the EPI report, one is struck by two things. First, both the goals of the research exercise as well as the major points made are remarkably similar to the earlier Peterson diatribe on the coming fiscal crisis: medium-term and longer-term deficits and debt ratios need to be reduced. I will next examine those similarities. Second, while EPI adopts a dovish position on budget deficits and debt, it offers no serious argument to justify that position. It simply takes as granted the belief that rising debts and deficits are bad, and the bigger they are the badder they are. I surmise that EPI simply presumes that everyone “knows” government deficits and debt are bad, so no explanation is required. Everyone, that is, within the Washington beltway. I suppose that because they all breathe the same hyperventilator’s air, it is just so obvious that Beltway progressives do not need to consider the assumption that the US is on an “unsustainable” course.

The EPI 2010 report provides the following summary of its “blueprint” for a progressive approach to budgeting that adopts a “sound fiscal path”:

1. Jobs first. Jobs and economic growth are essential to our capacity to reduce deficits, and there should be no across-the-board spending reductions until the economy fully recovers. In fact, efforts to spur job creation today will put us on a better economic path and create a solid revenue base. We believe there should be no consideration of overall spending reductions until unemployment has fallen to 6% and remained at or below that level for six months. 2. Stabilize debt. Over the long term, national debt as a share of the economy should be stabilized and eventually brought onto a downward trajectory. 3. Build on economy-boosting investments. We must build and maintain initiatives that directly support long-term job and economic growth. Failing to invest adequately in these efforts – or sacrificing them to short-term deficit reduction – would be a dereliction of sound public management. 4. Target revenue increases. Revenue increases should come primarily from those who have benefited most from the economic gains of the last few decades. 5. No cost shifting. Debt reduction must be weighed against other economic priorities. Policies that simply shift costs from the federal government to individuals and families may improve the government’s balance sheet but would worsen the condition of many Americans, leaving the overall economy no better off.…. We document the hard choices that need to be made and suggest specific policies that will yield lower deficits and a sustainable debt while preserving essential initiatives and investments. (p. V)

Note that of the 5 bullet points that summarize the blueprint, three address the supposed debt and deficit problems. Bullet 2 argues for stabilizing and then reducing the debt ratio; Bullet 4 argues for increasing tax revenues; and Bullet 1 postpones blood-letting through spending reductions until unemployment falls to 6%. It is also important to note, however, that EPI recognizes that it does no good to shift debt from government to households—so, for example, reducing Medicare costs by putting them on households only reduces government deficits and debt by increasing household deficits and debt.

Let us look at EPI’s projections, that compare the “do nothing” scenario against Obama’s proposals and the EPI proposals (labeled “OFS” for “our fiscal security”). This graph shows that EPI’s proposals will cut the deficit to GDP ratio by almost half over the medium term.

The next graph compares the medium term debt-to-GDP ratios under the three scenarios:

What is the source of the government’s financial problems? Rising healthcare costs and lack of adequate tax revenue. (“Any realistic solution to the long-term budget outlook must confront the real drivers of the growth of the national debt, namely the rapid rise in health care costs and the lack of adequate revenue.”, p. 2). It is important to note here that EPI wants to protect Social Security benefits—it does not advocate any cuts. So to close the “fiscal gap” it recommends higher payroll taxes by raising the “cap”. It tweaks “Obamacare” to reduce the rate of growth of health insurance costs. (Interested readers can go to the report. While I do not support either of these proposals, one could label them “progressive” given the narrow range of what passes for progressive discourse in America.) In summary, their proposal achieves deficit and debt reduction (relative to current policy):

Our suggested budget blueprint achieves lower deficits in the medium term and balances the primary federal budget (the year’s current revenue and spending, not counting interest payments on past debt) in less than a decade. This path recognizes the need to increase revenue while targeting certain areas for reductions in spending; in particular, our proposed path reallocates spending away from the Department of Defense by adopting common sense spending reductions. Finally, the blueprint protects core priorities such as Social Security and health care from economically counterproductive reductions in benefits. The net impact of the spending and revenue adjustments we put forth in this blueprint will produce the following short- and long-term results: • Substantial and sustained increased funding for job creation and investments, especially in the near term; • A budget path that significantly improves the 10-year budget window; • A transition from a primary deficit to a primary surplus in 2018, and sustainable debt levels by the end of the decade; • An improvement in the path for public debt in the long term (stabilizing debt as a share of the economy beyond 2025); • A solid footing for Social Security, Medicare, and Medicaid for the long term; • A modernized tax code that raises adequate revenue fairly and efficiently.

The following figure shows a significantly lower long-term debt trajectory as a result of EPI’s proposals.

Throughout the report, EPI refers to “fiscal security”, “fiscal responsibility”, a “sound fiscal path”, “sustainable debt”, and the current “unsustainability of the national budget”. None of these terms is ever adequately defined.

The report also discusses the “75 year fiscal gap”, that must be reduced to “stabilize the debt ratio at today’s level”, requiring tax increases or spending reductions amounting to 7-9% of GDP. It warns that the government is not raising sufficient revenue to cover its expenses and that we cannot face national challenges without adequate funding and a return to fiscal responsibility. I will return to these claims below.

It is interesting to compare the EPI Blueprint with the Peterson-Pew Commission’s report from 2009. The Peterson report is cited as a source for the EPI blueprint, and shares similar phrasing and analysis. Like the EPI Blueprint, the Peterson report advocates a return to “fiscal responsibility”, and the need to “return to a sustainable path”. And like the EPI, the Peterson group is committed to stabilizing the public debt over the medium term and then reducing the debt ratio over the long term. The Peterson report also attributes the fiscal problems to growing healthcare costs and insufficient growth of tax revenue, but it also adds as a cause an aging population. Hence, its attack on Social Security is direct, as one would expect from a group funded by Peterson. In summary, the Peterson report

“recommends that Congress and the White House follow a six-step plan: Step 1: Commit immediately to stabilize the debt at 60 percent of GDP by 2018; Step 2: Develop a specific and credible debt stabilization package in 2010; Step 3: Begin to phase in policy changes in 2012; Step 4: Review progress annually and implement an enforcement regime to stay on track; Step 5: Stabilize the debt by 2018; and Step 6: Continue to reduce the debt as a share of the economy over the longer term.”

The differences between the Peterson plan and the EPI blueprint are that EPI would move toward deficit and debt reduction more slowly, and its debt stabilization would be at higher levels (a ratio of about 80% for the medium term and 60% for the longer term, versus 60% and 40%, respectively, for the Peterson plan). According to the Peterson report, the consequences of not getting debt and deficits under control are: “An ever-growing debt would likely hurt the American standard of living by fueling inflation, forcing up interest rates, dampening wages, slowing economic growth and job creation, and shrinking the government’s ability to cut taxes, invest, or provide a safety net.”

I carefully searched the EPI report to find exactly what it is about growing debt and deficits that makes them “unsustainable” and “undesired”. There is no serious attempt made to justify the recommendation to “stabilize” and then reduce debt ratios. Indeed, in the 70-plus page document, the supposed negative impacts of growing debt ratios are discussed only briefly in three places. It boils down to this:

a) budget deficits and government debt might crowd-out private investment;
b) high deficit and debt ratios would hinder government’s ability to deal with future financial crises;
c) high debt ratios could trigger a fiscal crisis;
d) high debt service (ie paying interest on bonds) could crowd out other government spending;
e) high debt ratios could threaten confidence in government debt.

The Peterson report is much more hysterical about the possibility—nay, near certainty—of a fiscal crisis if debt ratios are not reduced. It also adds to the list above the possibility that deficits will spark inflation and devaluation of the dollar, and claims that deficits slow economic growth. But in general outline, the two analyses warn of similar dangers without providing any serious discussion of the mechanisms through which deficits and debts generate these outcomes.

Let me stick to the EPI fears. While we probably disagree about operational details, I suspect EPI agrees that government can make all payments as they come due in its own sovereign currency—that is a position to which even Ben Bernanke, Alan Greenspan, and Paul Krugman subscribe. But if that is so, I do not see how a “fiscal crisis” can be triggered. Let us say that market confidence in Treasuries is shaken. A sovereign government can offer to redeem all of them—that is, stand ready to pay off interest and principal by crediting bank accounts with US dollars. Yes, I know that the inflation hyperventilators are already screaming. But EPI did not list inflation as a possible result; it listed fiscal crisis. How can you have a fiscal crisis when you spend your own currency? EPI is silent on the matter.

The EPI report lists two types of crowding out. The first is the old and thoroughly discredited loanable funds idea: there is a fixed amount of loanable funds in markets and if government borrows, there is less available for private firms. Interest rates rise, investment falls, and growth suffers (one of the Peterson claims). There is also an ISLM version—but that is equally discredited (all modern macro has a horizontal LM curve) and too wonky for this blog. One must conclude that EPI’s macroeconomics is based on pre-Keynesian theory.

Actually, finance is not a scarce resource. (Anyone who thinks it is scarce had a Rip Van Winkle nap during the last two decades, when finance was more abundant than hot air within the Beltway.) Government deficits cannot financially crowd out investment. Yes, if we went beyond full employment of all resources, more government spending could crowd out private spending because there would be no real resources to devote to production of additional output. But it is pretty clear that EPI is not worried about real resources, since its Blueprint devotes Bullet 3 to ramping up public investment.

The second kind of crowding out listed is based on the belief that government faces a fixed budget so that if it spends more on interest it must cut spending (or raise taxes) elsewhere. This is also related to the view popularized by neoliberals Reinhart and Rogoff that low debt ratios are good because when a crisis hits there is fiscal policy space that can be used for bail-outs and stimulus packages. But that means EPI is using a circular argument: we must reduce the debt by cutting spending because the debt imposes a constraint on spending.

The reality is, as all those reading this blog know well, a sovereign government is never financially constrained in its own currency. Government spends by keystrokes. It can stroke keys to pay interest and as well stroke keys to undertake any progressive spending policies EPI proposes. And it still has “room” to stroke keys for bailouts. There is no affordability tradeoff. What matters is inflation—too much government spending drives the economy to the inflation barrier. And real resource use: a government that takes too many resources for its use (hopefully, to serve the public purpose) leaves too few for the private sector. But that requires full capacity use—otherwise at most you get bottlenecks.

Further, as all readers here know, the interest rate is a policy variable. The central bank chooses the overnight interest rate; the short maturity government bill rate tracks that closely since bills are close substitutes for bank reserves. Other rates are more complexly determined. Government bills and bonds are interest-earning alternatives to the rates paid on reserves by the central bank. Let us say that government decides it wants to spend less on interest on longer maturity bonds. Easy enough: stop issuing them. Facing a drought of longer maturity bonds, markets will bid up their prices and rates will fall. Government can stay in the short end of the market as long as it wants; indeed, it can stop issuing even bills and just pay 25 basis points on reserves (as it now does). Yes, this requires a change from current operating procedure. I won’t go through this now as NEP has provided ample analysis of operating procedures and the simple changes that would lead to an era of zero government debt (as conventionally measured, since reserves and currency are not counted).

Now, EPI might challenge me: what would my progressive 15 to 25 year government budget proposal look like? My response: I wouldn’t budget for 5 years, let alone 25. It is a silly exercise that only stokes the fires of Peterson’s hyperventilators.

The best argument against doing long-term budgeting exercises is here, a co-authored Policy Brief that was based on testimony we supplied to Congress. A quick summary is contained in my FDL piece (here). This blog is already too long to repeat the arguments. Budgeting by sovereign government does make sense, and one could even envision budgeting for particular long-lived projects for periods as long as 25 years. But it makes no sense to project total government spending, taxing, and deficits out to 15 or 25 years, let alone to infinity and beyond. And once we bring in recognition of the three sectors balances and the necessity they sum to zero, the futility of calculating budget deficits for year 2035 becomes obvious. You cannot even get a budget deficit unless the private sector wants to net save and the rest of the world wants to earn dollars by net exporting. To calculate the budget deficit in 2035 we would have to be able to project out the current account balance and the private sector balance. That is something EPI did not do—and so, the whole exercise is not only silly but seriously incoherent from the vantage point of the sectoral balances.

In conclusion: critics have wrongly implied that EPI (and perhaps RI and CAP) adopted Peterson’s hawkish approach because they were paid to do so. The similarity between the EPI and the Peterson position on sustainability of deficits and debts predates the funding. The EPI Blueprint does adopt a progressive approach to budgeting, so long as one agrees that progressives should adopt a dovish approach to budget deficits, and that it is progressive to draw up budgets for the far distant future. Personally, I reject both of those stances.

But, MMTers are in a distinct minority—we are deficit owls. As I have argued here, most progressives have lined up on the Peterson side because they adopt the deficit dove position. And that is why all progressive policies adopted since the Great Depression are now in danger.

Counterfactuals can never be proven. What if Beltway progressives had mounted a strong opposition against Peterson? What if they understood and endorsed MMT? Would Democrats have found the will to call the Republican’s bluff? Would Obama have stood up to the attacks on the New Deal? We will never know.

I conclude: progressives have unwittingly aided and abetted the deficit hawks because they do not have any strong alternative to the argument that deficit and debt trajectories are “unsustainable”.

Pinch-Hitting for Peterson. Part 1: How Progressives Helped Put Social Security on the Chopping Block

By L. Randall Wray

It’s official. Obama has decided to become a one term president. He caved in to the Republicans, agreeing to gut Social Security in order to get them to agree to raise the debt limit. This was never a real trade-off, as it made sense only within the Washington beltway. Obama has adopted the Jimmy Carter approach: promising pain and more pain, presenting a dreary (and false) message of no hope, just mindless human sacrifice to please the gods on Wall Street.

In the days of Carter, it was all about stagflation, running out of oil, and national malaise; today it is all about jobless “recovery” as far as the eye can see and unfunded infinite horizon entitlements for the undeserving. I do not know which is worse, but I am positive that voters will reject Obama’s perverted vision of our future, just as they rebelled against Carter’s. American voters are an optimistic lot and they know our best days are ahead of us. We do not face the futures envisioned then by Carter or today by Obama. Voters do have the audacity of hope, even though Obama does not and probably never did. I do not know who will be the next president, but Obama’s actions indicate he has decided he does not want the job. Voters are looking for the next Reagan who shares their optimism.

It was clear all along that this was the real agenda of the fake debate. It never had anything to do with debts and deficits and tens of trillions of dollars of unfunded “entitlements”. The goal all along has been to find a Democratic president willing to kill Social Security. Washington finally has one. Al Gore probably would have done it—but his “lockbox” proposal was too silly to sell with a straight face, so he never got the chance. Obama became the willing sacrificial lamb.

Wall Street wants blood for its vampire squids, and Obama is willing to deliver it by the truckload. To be clear, he is no martyr. Martyrs have to be unwilling, at least up to a point. It appears that President Obama wanted this outcome from day one.

But that is not the story I want to pursue here. What is interesting is how Social Security’s enemies enlisted progressives to fight their battle for them, lining them up to pinch-hit for Pete Peterson.

In the old days, the enemies were simply too obvious to be successful—using Cold War rhetoric and labeling the program a communist plot, they never gained traction.

As they became more sophisticated, they moved on to railing against future costs of taking care of babyboomers. They enlisted Alan Greenspan, who chaired a commission that unnecessarily jacked up payroll taxes to run surpluses to be “saved” for future use—something that was impossible for a sovereign government to do since Trust Fund assets were simply government IOUs (something later admitted by Greenspan). But the high taxes helped to build hostility to the program.

Then the enemies created the Concorde Coalition—that included some Democrat wolves in sheep clothing—to fan across the country beating the drums and scaring college students about rotten “money’s worth” calculations that showed they’d be much better off “investing” in stocks rather than paying high FICA taxes. The dot-com crash did not help that cause—which was always a hard sell because the Concorde Coalition’s members were so darned intellectually dishonest—people like Bob Rubin, Paul Tsongas, Charles Robb, Sam Nunn, Warren Rudman, and Bob Kerry. I debated them on college campuses and I can definitely attest to the greasy propaganda that they thought would capture the imagination of students. It did not. Bad haircuts, bad breath, leisure suits, and stupid arguments were all they had to offer. It was a big zip. Nada. Zero.

So, finally, hedge fund billionaire Pete Peterson helped push the notion of trillions of dollars of unfunded entitlements that would bankrupt our nation. Unfortunately, he was getting nowhere, even with the help of Reaganites like Pete du Pont, and Larry Kotlikoff.

Until Obama got elected, that is.

A peculiar alignment of the stars pushed the Peterson agenda forward. First of course there was the financial collapse, which brought on the worst recession since the Great Depression (a downturn that is not over and that still might morph into the first depression of this century). That crashed tax revenue and generated a huge budget deficit—fueling the fires of deficit hysterians.

Second, Obama’s campaign platform had featured deficit reduction as a major goal. Those of us with some audacity had hoped he was not serious about this. He was. And he brought into his administration a number of Clinton people, all of whom had sworn allegiance to Wall Street and the Clinton spin that deregulation of finance plus budget surpluses had created Goldilocks. In return for tens or hundreds of millions of dollars of rewards, they had agreed to act as Wall Street’s fifth column. For all practical purposes, Peterson was selected to head Obama’s deficit-cutting team.

Which leads to point 3: many Democrats had learned the wrong lesson from the Clinton boom. They convinced themselves (against all reason) that the Clinton budget surplus caused the boom. In reality, it killed the Goldilocks economy and brought on the Bush recession. But, no matter. Wall Street was very generous with its billions, and it had decided that the Obama wave was something it wanted to surf right into Washington. Whatever finance wanted, finance got. What finance wanted was tens of trillions of dollars of bailouts, Obamacare (more financialization of health insurance), and elimination of Social Security (financiers hate the competition).

Point 4. Finally, Beltway progressives decided to join the deficit hysteria bandwagon. The endgame was a foregone conclusion. With no opposition from the left, the Austerians would get whatever they wanted. And what they wanted was to eliminate Social Security, Medicare, and Medicaid.

But why would Washington’s progressive think tanks decide to join forces with hedge fund manager Pete Peterson to undermine the Rooseveltian New Deal? Here the plot thickens.

Some had actually joined up during the “W” years—using the rising budget deficits under Bush (actually due to the recession he inherited from Clinton) as an argument that he was mismanaging the budget with taxcuts for the rich. If only Bush would balance the budget, Goldilocks would rise from the dead. It was an embarrassing display of stupid politics, as progressives sold their souls to Peterson to beat down Bush as a big deficit spender.

Some Beltway progressives—including organized labor—had actually signed up even earlier, during the Gore campaign, manufacturing a fake financial crisis for Social Security in order to offer lock boxes as a better alternative than Bush’s plan to privatize the program. Joining the bandwagon by arguing that Social Security was unsustainable, they offered critical assistance to Peterson. And, of course, they lost the election. (Oh, I know, they continue to claim “but Gore really won”. Come on, if a candidate cannot beat a “W” by double digits, he does not deserve office.)

Still others signed on to the Peterson agenda after the financial crisis hit, in order to argue against payroll tax relief on the bizarre argument that Social Security already faces an uncertain financial future, hence, if we give payroll tax relief to workers now we won’t be able to afford the program in 2050. (We have dealt with that issue here at NEP and also over at New Deal 2.0.) They desperately wanted to hang the fortunes of Social Security on a supposed American love affair with payroll tax hikes.

Again, too stupid for school. No one likes the payroll tax. It is regressive. It taxes work. It makes American workers uncompetitive. And by tying Social Security benefits to payroll tax revenue, it ensures program accounting insolvency—as the Peterson crowd argues. Indeed, it is only because of the payroll tax that we can calculate bad “money’s worth” and project the exact date at which Social Security becomes insolvent. Eliminate the tax and it becomes impossible to calculate solvency or insolvency. But our progressives instead chose certain death for the program on the argument that the albatross of payroll taxes makes the program too popular to kill. (Hint: they were wrong. Evidence? Obama.)

And, finally, there was the debt limit. In the past, we got political posturing, but the limits were routinely raised. This time around, it was clear that Republicans had much more incentive to draw blood—they would require the Democrats give up some popular program before the limit would be raised, and this would cost them in the next election. Yet, success was far from certain as the Dems could have just called the bluff. But the stars were aligned, because by this time there were no longer any dissenting voices within the beltway on the need to cut deficits.

Progressives had a choice—they could take the high road, which meant isolation from the beltway and its funding spigots; or they could join the deficit cutting party and drink the Kool-Aid. That is, they could swing the progressive bat or pinch-hit for Peterson. They chose to pinch-hit.

So how did the remaining progressives get co-opted? Peterson had the brilliant idea of hiring Beltway progressive organizations to join his team. Why not pay progressives to come up with deficit and debt cutting plans? If you can’t defeat them, pay them off. It is like choosing from among the prisoners which ones get to do the whipping and hanging of the recalcitrants.

So progressives lined up at the Peterson Pig Trough. I’ll have more to say about Peterson’s funding of Beltway progressives in Part 2.

With no Beltway progressives left to fight Peterson’s deficit hysteria, Republicans knew they had a winning hand—so they demanded the so-called third rail: Social Security. Democrats in Congress had nowhere to turn for support. Progressives had abandoned the debate, and Obama had been hand-selected by Wall Street to offer up Social Security. Just as only a Republican President could go to China, only a Democrat could finally kill the last remaining remnants of the New Deal. President Clinton had destroyed all the financial regulations, eliminated welfare, and undercut consumer protection. Now it is up to Obama to eliminate Social Security and Medicare.

Obamacare will hand over the nation’s healthcare system to Wall Street, with elimination of Medicare removing the last remaining obstacle to complete financialization of medical care. Similarly, getting rid of Social Security will put Wall Street in complete control of our nation’s retirement system. Wall Street hates competition.

And so does Peterson. It is unfortunate that Beltway progressives voluntarily muzzled themselves, to eliminate any alternative to Peterson’s propaganda.

In Part 2, I will look at a specific case of self-muzzling by the premiere Beltway progressive research institute. Stay tuned.

Should European Nations Repudiate the Debt?

By L. Randall Wray

It is becoming increasingly clear that the global economy (at least in the West) is heading for a steep downturn. Almost all the US data coming out in recent days have been bad. The UK and Japan are in austerity mode, with predictable results. Worst of all is Euroland. It has imposed severe austerity—the modern day equivalent of Medieval blood-letting—on its periphery nations. These nations are loaded with debt. In the case of Ireland, which had been a model of a Neoliberal utopia, the government got into debt by taking over its banks’ debts. In an unfathomable act of charity, this was done only to save French and German banks—which held the unserviceable and unguaranteed Irish bank debt. In gratitude for Ireland’s equanimity, the EU imposed the equivalent of IMF sanctions on Ireland. The government is supposed to downsize and squeeze blood out of its population in order to reduce its debt load—which has thrown it into recession and reduced tax revenues. The worst thing you can do to a debtor is to force her to reduce her income. But that is exactly the Medieval medicine the EU prescribed for Ireland. The story with the other highly indebted euro nations is similar—if not in the causes of their particular debt disease, at least in the remedy prescribed.

There is now really no choice. The periphery nations must band together and go to the EU Parliament to present a unified voice. There are only three courses of action. The first is to abandon the euro, with each country adopting its own sovereign currency. For convenience, each could simply return to its pre-euro currency. All debts would be redenominated in its new (that is to say, old) currency. Each country would then adopt a package of stimulus policies to achieve growth with full employment. By returning to its own sovereign currency, no national government would have any problem servicing its debt. Each country could tell the ratings agencies to take a hike—if Moody’s et al are too stupid to recognize that a government operating with its own currency can always service its debt, each country could immediately pay off the debt in its own currency. All that really amounts to is crediting bank accounts with reserves and retiring the debt. As it reduces interest payments, that is actually a deflationary policy. However, any deflationary pressures can be offset by stimulative fiscal policy.

There is a downside to this policy. Holders of euro-denominated debt will be subject to redenomination in a new (old) currency. They will likely go to court in the EU to sue for recovery. This would lead to a long-drawn-out and nasty process that would at least buy time. I am not a lawyer and will not speculate on the likely results but I suspect that rulings will go against the “defaulters” and that sanctions will be imposed. Meanwhile, French and German banks will become insolvent, France and Germany will try to save them and will become exactly like Ireland—with huge and unserviceable government debts after they nationalize their private bank debt (ironically, in Germany’s case, its worst banks are already nationalized). Perhaps at that point they will join Ireland and the other formerly EMU nations in abandoning the euro. The last one out will need to shut off the lights. Say bye-bye to the euro. And hello to renewed hostility among European nations. We’ve been there before, with world war results.

The second approach is to stay on the euro but to default on euro-denominated debt. Now, in truth, there is nothing wrong with default by private sector debtors who are not insured by governments. Happens all the time. Debts owed to creditors are then pursued through bankruptcy courts. Ireland, however, decided to nationalize private debts of banksters. Unfortunately, sovereign default is not so simple. Yes, default by government on debt happens all the time, too. Remember Orange County? The problem is that creditors expect government to squeeze blood out of oranges (another Medieval technique) to pay off debt. In their otherwise awful book (This Time is Different), Carmen Reinhart and Kenneth Rogoff argue that when it comes to “sovereign” defaults, default is always in some sense voluntary. (It is noteworthy that they are unable to find a single case of a true sovereign default; that is to say, a default by a sovereign government on its own floating rate currency. So far as I can tell, every case of government default they identify has to do with a pegged exchange rate or currency board. But that is a topic for another day since the EMU countries essentially do have currency board arrangements.) Ireland could continue for some indeterminant period to let more blood out of its population. After all, the Irish are used to suffering. Perhaps with sufficient austerity, a modern equivalent to the potato famine could be reproduced. Young Irish are already emigrating in droves. Creditors could demand more Irish blood, until Ireland is completely depopulated. All that would be left would be the land—with foreclosure moving it to the portfolio of the French and German banks. No doubt they are drooling in anticipation. (Anyone who has ever been to Ireland can understand why.)

Defaulting whilst staying on the euro appears to me to include all the negative effects of leaving the euro but with none of the benefits. For example, Ireland and the other periphery nations would still be stuck with a vastly overvalued currency. At least if they abandoned the euro they could competitively devalue against German exporters. They will get sued in either case and rulings in EU courts will probably go against them. Perhaps it is best to leave the EMU and even the EU to protect their domestic economies if one is going to default.

The last option is to band together and to insist on EMU-wide reformation. Debts must be restructured and written-down. To be sure, default as well as leaving the EMU must be retained as a bargaining chip—but it should be “en mass”. And it should be made clear that the best option for both the indebted nations as well as the creditors is to come to mutually beneficial terms. European banks are, broadly, toast. Not only did they buy toxic US waste, but they also created plenty of their own. And they owe much of it to each other. Like the biggest US banks, they are “too big to fail”—which is to say that they are “systemically dangerous institutions” in Bill Black’s terminology. That means they must be “resolved”—downsized and closed, with assets and liabilities distributed to smaller institutions. Netting bad assets that banks owe to each other (within and across borders) would go a long way to downsizing exposures. (And banksters should be incarcerated. I suspect that the main reason that big banks are not closed is because governments know they will uncover massive go-to-jail fraud. It is not really that the banks are too big to fail but rather that they are too fraudulent to seize. If any honest examiner ever entered the doors of Goldman Sachs, for example, he could not leave with issuing thousands of subpoenas that would include the names of former, current and prospective future Treasury department officials.)

It is time to admit that the EMU was designed to fail. I have been arguing since the mid 1990s that the first serious financial crisis would bring it down. We are in that crisis. It is time to recognize that reality. The debts must be resolved and a new fiscal arrangement must be created. As I have argued many times, the EMU members are like US states, but without a Washington to help out in times of crisis. The chickens are here and they are roosting. We have come down to one viable choice—if the goal is to preserve European union. In addition to dealing with the debt, the EU must create a fiscal force similar in size to the US Treasury.