Which nations will make wise decisions under stress? Who will screw-up and fail?

Summary:  A mark of successful people and nations is that they function well under stress.  What’s the alternative?  Magic!  Here we look at some examples of the search for magical solutions seen in the US and Europe today.

History suggests that the quality of a nation’s decision-making under stress has a large effect its success.  Not just prosperity, but even survival.  Europe during 1914 – 1945 provides powerful examples of every kind, from wise leaders (UK during WWII) to mad leaders (Germany during WWI).  Surprisingly (to me), nations in Europe (and Japan) retained social cohesion to the end despite horrific conditions.  Contrast that with the frequent forecasts today of social breakdown if the Europe or America experience a purely economic downturn (no mega-deaths in battle, no firebombing of cities, no massive drop in food production).

But there is evidence that the decision-making process (the observation-orientation-decision-action loop; OODA) is decaying in many nations.  Here is a brief note on this important subject.  In brief, under stress people revert to magical thinking.  Ignoring what we know to seek easy and fast solutions to what look like overwhelming problems (and what might in fact be overwhelming problems).  These are alternatives to the difficult but more realistic alternatives to today’s problems and policies.

Also note how the range of solutions consider shows that the creditor “class” (and those they pay) dominates the discussion.

America

In the US there is broad (if so far minority) support for adoption of a gold-backed currency (despite their theoretical flaws and horrific history), but often for remaining with the same fiscal and banking systems (probably impossible).   Oddly similar is the enthusiasm for what is in effect the opposite prescription: modern monetary theory (MMT) so that we need not even worry about fiscal deficits.  These theories have expert advocates; but their non-expert advocates tend to have wildly exaggerated (often delusional) beliefs about how these systems would work, their costs and benefits.  Magical solutions.

These beliefs could have unpleasant effects.  The breath and intensity of support for gold (seen in the enthusiasm for Ron Paul, despite his profound ignorance of basic economics) is underestimated by leaders in NYC and Washington. Things could get exciting if the current policy gridlock continues after the election AND the economy does not recover.  Public support might rapidly increase for what are now considered fringe policies. Demagogues will quickly appear to turn this public support into votes and political power.

Europe

Economic policy in the EU rests on what should be an obvious misunderstanding of the causes of the crisis (e.g., visible in their large factual errors about basic facts in most speeches) and the probability of their cure (i.e., fiscal austerity) working. Fiscal austerity has been frequently used, and there is a good understanding of its effects. It seldom works when done without devaluation and massive monetary stimulus (i.e., low interest rates) — neither of which the PIIGS have today.

Hence the search of easy and fast solutions, an alternative to continued internal devaluation of GIIPS’ wages and fiscal austerity.  Such as devaluation of the Euro to boost exports.  Krugman gives the obvious rebuttal to the latter: “Let’s All Devalue Against Each Other” (New York Times, 22 May 2012):

Jeremy Siegel echoes a lot of what some of us have been saying for years about the infeasibility of internal devaluation, but then argues that the answer is devaluation of the euro as a whole. Um, against whom?

I mean, it’s not as if America or Japan are towers of economic strength, easily able to provide the demand Europe lacks. That leaves emerging markets. And while I and others have been pushing for years for an end to Chinese currency manipulation, China is at this point (a) not looking very strong itself (b) just not that big in the world economy — not yet. More generally, Europe as a whole, like America, remains a relatively closed economy. Its salvation must be mainly internal.

Now, if devaluation is a code word to mean raising the inflation target, fine.

The last time I got to hear the late James Tobin, he gave a talk in which he joked that as far as he could tell, all the world’s major currencies needed to devalue against each other. This is sort of one of those times — and what that actually tells you is that we need fiscal and monetary stimulus.

For more information

For good analysis of economic events in Europe see see Krugman at the NY Times and Roubini Global Economics. Readers of these have understood in real time both what’s happening and the likely effects of current policy actions.

To learn about modern monetary theory (MMT):

  1. Good alternative theory“, Steve Keen, Switzer, 29 September 2009. Scroll down to find a sub-article “The fundamental principles of modern monetary economics” by Bill Mitchell (Prof Economics, U of Newcastle)
  2. Understanding The Modern Monetary System” by Cullen O. Roche (professional money manager), 5 August 2011 — clear, long and technical explanation
  3. Deficits and the Printing Press (Somewhat Wonkish), Paul Krugman, New York Times, 25 March 2011
  4. MMT, Again“, Paul Krugman, New York Times, 15 August 2011

Other posts about MMT:

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29 thoughts on “Which nations will make wise decisions under stress? Who will screw-up and fail?

  1. Concerning the above references, take the statements of Mr. Krugman with a large quantity of salt. He tries to compare apples to oranges in order to make his point. His point is valid (simply printing money to finance the government and not taking in sufficient taxes and issuing sufficient bonds will most definitely lead to inflation), however the MMT people have been saying this all along. Mosler and others are stating only that a government will not go bankrupt if it is a sovereign issuer of currency. They state quite clearly that INFLATION would be a major headache if the government did not “destroy” money by taxing it out of existence.

    Thus, MMT does not suggest that deficits do not count. Quite the contrary, deficits matter a great deal. MMT simply suggests that the deficits and debt do not, in and of themselves, impoverish a nation which has issued its debt in fiat currency. Mosler is very specific in stating that tax policy is a very important tool to be used to curb inflation (since, according to MMT, taxes destroy money by taking it out of the system). Thus, if in Krugman’s example, the economy were to begin taking off, the deficit would need (in no uncertain terms) to shrink or even go negative (i.e. surplus) in order to prevent the kind of out-of-control inflation Mr. Krugman warns about.

    1. Coutinho, I suggest you read the Krugman articles more carefully.

      “…bonds will most definitely lead to inflation”

      Krugman doesn’t say that because is will not “definitely” happen, unless taken to an insane degree. Japan is the obvious counterexample. That’s an important point. Misunderstanding this dynamic led to Ron Paul and other conservatives confidently forecasting high US inflation or hyperinflation in 2008, 2010, 2011, (and perhaps, I’ve lost interest) 2012.

      “however the MMT people have been saying this all along”
      Krugman explicit says that. You’re grossly overstating (or oversimplying) the debate. As with most scientific discussions, the debate concerns “how much” and “when” — not “if”. Magnitudes and timing.

      “are stating only that a government will not go bankrupt if it is a sovereign issuer of currency”
      That’s Econ 101, and not relevant to the debate about MMT.

      “MMT simply suggests that the deficits and debt do not, in and of themselves, impoverish a nation which has issued its debt in fiat currency”
      I don’t know what you mean by “impoverish”. The economics discussion is more complex, and concerns the practical effects of monetization on a large scale, especially in generating inflation and destabilizing the nation’s foreign exchange dynamics.

    2. I believe you misunderstood my intent. I was stating that if there were insufficient bonds issued (in addition to insufficient taxes raised) in a good economy that inflation would result. Thus, I was including the “insufficient bonds” with the “not taking in sufficient taxes” since Krugman was suggesting (almost certainly correctly) that bonds and taxes together will often curb the inflation genie (where not issuing bonds, according the PK, would have a worse effect on inflation).

  2. “Also note how the range of solutions consider shows that the creditor “class” (and those they pay) dominates the discussion.”

    With one difference that under commodity-based monetary system credit comes from savings while under present paper-based monetary system credit comes from printing press, controlled by enlightened bureaucrats of the state.

    “But we there is evidence that the decision-making process (the observation-orientation-decision-action loop; OODA) is decaying in many nations.”

    State goes on a market of “scientific” economic opinions to purchase a proper product for justification of its policies. Namely – total control of economical activity of society.
    And then comes a man who can provide theoretical justification for leading role of a central bank and he is picked of course by central bank (!!) for Nobel Prize and lauded by government.

    1. I’ve learned never to rise to the bait in these discussions, as it’s a waste of time.

      As for the first paragraph, I suggest that Alex check out a Econ 101 textbook from the library. I don’t know what he is attempting to say (it makes little sense), but I suspect some reading will clarify some of your confusion.

      The second makes even less sense, so I can give no reply.

  3. “The breath and intensity of support for gold (seen in the enthusiasm for Ron Paul, despite his profound ignorance of basic economics) is underestimated by leaders in NYC and Washington. ”

    I think you mean “Dr. Paul”?

    LOL, just kidding.

  4. Btw, FM, thanks for that video of “Paul vs. Paul” debate. The Nobel Prize winner was badly bruised by that gentle gynecologist.

    Krugman explained that he was so kind and didn’t debate Dr. Paul on inflation issue – that’s why he lost.

    1. This is an illustration of a common result when experts debate amateurs. I used to watch biologists debate creationists. No matter how bogus the creationists’ arguements, the believers in the audience always thought it was a one-side victory.

      Thinking that Ron Paul won that requires forgetting the basics of Economics 101, much of 20th century history, and the basics of history (ie, we know very little about many events in the ancient world, other than the broad outlines).

  5. Just watched the “Paul versus Paul” video. Classic. Reminds me of when Richard Dawkins tried to debate Glenn Beck. Krugman has the same baffled expression, like someone locked him inside an insane asylum and threw away the key.

    1. Paul Krugman “On the Uselessness of Debates“:

      A bit of meta on my “debate” with Ron Paul; I think it’s a perfect illustration of a point I’ve thought about a lot, the uselessness of face-to-face debates.

      Think about it: you approach what is, in the end, a somewhat technical subject in a format in which no data can be presented, in which there’s no opportunity to check facts (everything Paul said about growth after World War II was wrong, but who will ever call him on it?). So people react based on their prejudices. If Ron Paul got on TV and said “Gah gah goo goo debasement! theft!” — which is a rough summary of what he actually did say — his supporters would say that he won the debate hands down …

    2. Its an interesting contrast. Krugman responded with facts, Paul responded by raising his voice. He sounded senile, borderline dementia, rambling about “the politicians” and “theft”, people being put in jail for barter (huh???), etc.

    3. Great point! Paul gave his followers want they want. Morality tales, however fictional. Simple rules. Black and white dynamics.

      Plus, speaking as someone who has discussed economics at great length with conservatives, it’s too-often an almost hopeless task. They tend to have layers upon layers of false information and doctrine, which they believe with a religious-like intensity. Laffer curve, Reagan Revolution, supply side, lower taxes boosts GDP and revenue, big government bad, libertarian minimal government paradise, Europe as a backwards slump, Ayn Rand, gold, Hoover was a spend-thrift New Dealer, Keynes was wrong about everything, Keynes advocated big deficits always, regulations slow economic growth — on and on. Take one falsehood, wrestle it to the ground — they’ll come back with another. Repeat enough times and they’ll come back to you with the first falsehood.

    4. The USSR in Spain comes to mind. The initial revolution tore down the Catholic Church (which was obscenely rich) and ostracized the rich – very alarming behavior that the USSR quickly ended by funding and arming the Communist factions (which ironically were very Capitalist friendly), and restored the original social order. Seeing an actual workers’ government in power in Spain might have upset the prols, and Stalin couldn’t have that. Allowing the Fascists to win was actually in his mind a better alternative.

    1. That Byzantine Empire did not fight wars would have surprised all the folks they defeated and absorbed. Perhaps Ron Paul believes that they expanded like Los Angeles. He should read more. For example, about (from Wikipedia): Basil II, a Byzantine Emperor from the Macedonian dynasty who reigned from 976 – 1025.

      Basil oversaw the stabilization and expansion of the Byzantine Empire’s eastern frontier, and above all, the final and complete subjugation of Bulgaria, the Empire’s foremost European foe, after a prolonged struggle. For this he was nicknamed by later authors as “the Bulgar-slayer”, by which he is popularly known. At his death, the Empire stretched from Southern Italy to the Caucasus and from the Danube to the borders of Palestine …

    2. The Byzantines reliance on mercenaries, and later Western armies (the Crusaders) to fight their wars for them is also worth noting.

  6. For all these military members who support Ron Paul, I have an idea.

    If going back to the Roman Republic with a nice stable gold standard economy is such a good idea, we should implement that idea in the military first. From now on Paul supporters will not be paid with evil paper currency. No evil 20 year pensions (that contribute to the deficit) either.

    American soldiers will be treated like the Roman legionaries. Paid 20 grams of spice a week. Upon retirement each soldier will be given 50 acres of land in Afghanistan or Iraq.

    1. “In the US there is broad (if so far minority) support for adoption of a gold-backed currency (despite their theoretical flaws and horrific history), but often for remaining with the same fiscal and banking systems (probably impossible). ”

      The issue with the low interest rate policies, and people like father, who depend on fixed income investments, is that they do make life difficult. The support behind the gold-based currency has to do with a large population of older guys who do vote, who do donate to campaigns, and who are absolutely hurt by the Fed lending money at very low rates. I think right now the power of the banks is greater than the power of the old people, so cheap credit from the FED is the rule.

      “Things could get exciting if the current policy gridlock continues after the election AND the economy does not recover. Public support might rapidly increase for what are now considered fringe policies. Demagogues will quickly appear to turn this public support into votes and political power.”

      Somewhere, one of these days, a racist right-wing party is going to take power, renounce debts, and then turn their economy around. Once that happens, look out.

      It’s a failure of the political system that we can’t debate fringe ideas within the mainstream parties. If the economy does not recover, then something is wrong with the mainstream ideas. Roosevelt was fan of fringe ideas — he was trying all kinds of weird stuff to get the economy going again. I found this quote online “You sometimes find something pretty good in the lunatic fringe.” Those days, some of the ideas were good, some bad, but at least they gave the people a sense that he was trying. We need to open up the debate more, and talk about jubilee and gold and nationalization of banks, breaking up banks — all this stuff.

    2. (1) We have low interest rates on treasury securities to a large extent because there is demand for them — and little demand in the private sector for funds (aka loans).

      Your father is mistaken.

      Flows must equal: government plus businesses plus consumers (plus foreign in/out) must equal zero. Now businesses and consumers are deleveraging; the equilibrium rate of interest for full employment is negative. It’s the zero rate problem (this is just a simple sketch).

      The Fed could raise rates for your father — and wreck the economy. Would he be happier then?

      (2) Right-wing parties seldom renounce debts, as they are run by and for the creditor classes. That’s what left-wing parties do.

    3. “Right-wing parties seldom renounce debts, as they are run by and for the creditor classes. That’s what left-wing parties do.”

      It’s the mainstream politicians and media, both D and R who are stooges for the financial system. So, it’s only the fringe on both the extreme left and extreme right remain as an alternative. It’s not a move to the left — it’s a move out of the center to the extreme. This is why the mainstream has been gutted in Greece. I expect the trend to repeat.

    4. Any examples of right-wing parties hostile to creditors? There must be some, but none come to mind. Even Mr. National Socialist of Germany was capitalist-friendly once in office.

    5. “Even Mr. National Socialist of Germany was capitalist-friendly once in office.”

      One could argue that both and left parties are creditor friendly once in power… because holding onto power requires either removing the creditor class (Be it redistribution or more violent methods), or gaining their support. And gaining their support is usually a lot easier!

  7. I’ve read Canada is toying with the idea of a digital currency, eventually adapting a completely cashless monetary system: Canada Asks Developers to Create Digital Currency“, PC Magazine, 13 Aril 2012.

    Now doubt Ron Paul would be furious (If he knew about it, I don’t think he’s aware of anything that happens outside our borders) – everyone knows the only legitimate way to run an economy is everyone carry around bags of gold coins and barter!

    1. Given the march of technology, using pretty pieces of paper as money will inevitably become impractical. Future generations will consider paper as money in the same category as shells and salt.

  8. If you want to see evidence that gold is being remonetized, you should look at trading volume of gold through the LOndon Bullion Market Assocation.

    “The average daily volume of gold and silver cleared at the London Bullion Market Association (LBMA) in November 2008 was 18.3 million ounces (worth $13.9 billion) and 107.6 million ounces (worth $1.1 billion) respectively. This means that an amount equal to the annual gold mine production was cleared at the LBMA every 4.4 days, and to the annual silver production every 6.2 days.”
    http://en.wikipedia.org/wiki/London_bullion_market

    $13 billion dollar daily, means $4.6 trillion annually, back in 2008 when gold was $900 an ounce. Today the annual gold volume probably exceed $7 trillion dollars. Do goldbugs have the power to move 7 trillion dollars worth of gold annually? I dont think. It’s mostly central banks trading with each other.

    1. Statistics show the daily trading volume of physical gold has reached 30 billion dollars.

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