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Dani Rodrik, Professor of Government at Harvard and an expert on economic development, wargames the Euro crisis: The End of the World as We Know It.
It is too long to excerpt, but it is worth reading. Some of the elements of the scenario are more likely than others, but the overall scenarios does underscore the potential seriousness of governments making short term decisions without considering the long term implications.
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The prospects indeed are grim.
Greece will default. This now and for several months has been a mathematical certainty. The only remaining issue is whether it’ll be an “orderly” default or a disorderly contagian of epic proportions. Greece also will exit the Euro and return to the Drachma. At least one and perhaps more of the other PIIGS nations will follow suit. Not tomorrow. Perhaps not next year. But within the near-term event horizon.
There will be large-scale devaluations of the Euro (for its remaining members) and for Europe’s legacy currencies (for those among PIIGS that jettison themselves or become jettisoned).
Europe as far as the eyes can see will be saddled with high borrowing costs, slow growth and weak employment. This negatively will affect the U.S., given that Europe is a major trading partner of ours.
As capital dries up and as the world’s poor are hit by higher inflation rates on the most basic items (food and fuel) there will be a lot of company for misery. Moreso than today.
Fiscal and economic policies have real world consequences.
@john personna: This is almost certainly true. I also do not see the US withdrawing from the WTO.
Fiscal and economic policies have real world consequences.
And yet “Yields on US 10-Year Treasurys Plumb a New Bottom” (1.622%)
(I set that in contrast because the right loves to tell a “we are Greece” story. Not hardly.)
(I set that in contrast because the right loves to tell a “we are Greece” story. Not hardly.)
Indeed–and worth repeating.
There will be large-scale devaluations of the Euro
I’m not sure about this. Getting rid of the poor performers could make the Euro more valuable on the basis of the remaining countries.
I think our low bond yields are due to the fact that we’re currently the tallest midget. We shouldn’t panic, but it shouldn’t be taken as a sign that everything is great either.
I marked this as related, in the other thread, for that reason.
I agree with the basic idea that “kick the can” and “crush the can” are both bad, and that some middle path change is necessary.
Agreed. We are the tallest midget. So indeed, don’t panic. Don’t run ’round saying “woohoo, free money!!!” either, but no one – not even Krugman – is saying that.
@Steven Taylor,
I find Rodrik’s scenario plausible until he discusses possible ramifications for the U.S. Europe’s problems pose no threat to availability of credit here because our banking system doesn’t depend on foreign reserves for the ability to clear payments, and since 2010 we’ve seen our GDP growth diverge further and further from Europe’s, a decoupling if you will. In short they provide us with nothing we can’t do without, nor do we sell all that much to them relative to GDP. I agree with him that should China double down on draining net financial assets from the U.S. they’ll get more than they bargained for.
@Stormy Dragon,
In Europe the bond market is king. Here it’s the Fed’s whipping boy. Yields will not rise until the Federal Reserve decides to raise the Federal Funds Rate, and with the current state of our economy that’s a long way off.
I hope Ben Wolf is right and that we are largely insulated from a European crisis. I know Krugman feels our exports to Europe are too small for their loss to be a crisis. However, I fear Rodrick may prove to be right about Europe and I’m far from comfortable about the effect on us.
If something like Rodrik’s second depression scenario comes to pass, it won’t be because of resource depletion. Even accounting for the tsunami, it won’t be the result of natural disaster. It won’t be because of the US deficit, or the (very small going in) Spanish deficit, or even the Greek deficit, which is too small to matter on a global scale. Unlike the Great Depression, it won’t be because we don’t have economic theory to explain what to do. If we collapse into a second depression, it will be because collectively, we are too stupid to govern ourselves.
I think that Dr. Rodrik probably understands European economics and politics better than he does U. S. economics and politics. I seriously doubt that we will withdraw from the WTO come what may (we’d be more likely to ignore it). I also doubt that we’re as vulnerable to a European downturn as China as or as the Europeans are to a U. S. downturn for that matter. Just look at the proportions of GDP dependent on bilateral trade.
However, I also think that Brad DeLong is right: we should have been taking steps to insulate ourselves from the fallout of a eurozone collapse eighteen months ago. We may be facing another round of bank bailouts.
In my quick look at Dr. Rodrik’s scenario I didn’t see that mentioned. Some big U. S. banks still have European exposure.
@Dave Schuler: I’m not sure there’s really anything the Fed can do. Buying up eurozone bonds held by U.S. banks, without collateral, could be considered a violation of the Fed’s charter because it would be knowingly taking losses. In effect it would be printing money which is forbidden. If the banks need another bailout then their only hope may be Congress, which is to say no hope at all. I can’t imagine TARP II ever being authorized.
@gVOR08:
I know Krugman feels our exports to Europe are too small for their loss to be a crisis.
It would be ironic if we end up being shielded from a European economic meltdown by the lopsided balance of trade everyone has been predicting would lead us to financial ruin for decades.
