The Wall Street Journal Offers Spain Some Advice

The ECB shouldn't be acting as a crutch for ineffective national governments... Spain's crisis is Madrid's, not Frankfurt's, to resolve...Spain's political class is still goading Europe's central bank to do more. Without more labor-market reform and reductions in its swollen government, Spain will soon be back to Brussels with the begging bowl.
--WSJ editorial, July 24, 2012

The WSJ has been consistent in its support for hard money for over a century. As readers know, I am a soft money man right down to my toes. I wouldn’t blame the Journal for being consistently on the wrong side of history if they were just a voice in the wilderness. Unfortunately, a whole lot of important Republicans (and regional Fed presidents) believe that the Journal knows something about monetary policy, and parrot its quack nostrums and remedies as gospel. (These people worship Milton Friedman but have never read him.)

In my opinion, most of the world’s problems have been caused by hard money men and their camp-followers. Certainly every depression in world history has been caused by hard money. By hard money I mean deflationary policies caused by either inadequate money growth or, worse, a contraction in the money supply. Two classic (and self-inflicted) examples are: the deflation pursued by the US after the Greenback Era to resume gold convertibility at the prewar ratio; and the deflation pursued by the UK after the Great War to resume gold convertibility at the prewar rate. Both countries got the depressions their hard money men had desired.

Another of the world’s great self-inflicted depressions is happening right now, in the eurozone. In order for the southern members to stay on the euro, they are being forced to deflate just as much as if they were on the gold standard. Brussels’ tough-love prescription for them is to keep cutting spending until their expenses are as low as their ever-falling revenues. As their revenues decline, the more they have to cut. If revenue goes to zero, they will have to cut everything--but DO NOT PUSH THAT DEFAULT BUTTON! We’ll be sure to lend you just enough so that you don’t do that. Your people can starve in the streets, but don’t default. That would be disruptive and “bad for Europe” (cross yourself after saying that).

None of this would be happening if Europe had a responsible American-style central bank with a mandate to avoid depressions. If your mandate is to maximize employment, and some regions are experiencing up to 25% unemployment, you might be undershooting your employment target. And if your mandate is growth with moderate inflation, and your economy is in reverse and there is no inflation, you might want to touch the accelerator just a bit, rather than saying “I’m doing everything I can”.

No government in the world, no matter how "responsible" its policies, can engineer prosperity with an incompetent central bank. Right now all of the developed world’s major central banks are at best negligent. Their nonfeasance ranges from the catastrophic (BoJ, ECB), to the dangerous (UK), to the inadequate (US). And they are all pursuing hard money policies with low inflation and low growth. And they are all “doing everything that they can”.

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So, in the opinion of the hard-money boys at the WSJ editorial board, Spain’s current depression is caused by inadequate “labor-market reform” and a “swollen government”. Labor market reform won’t have any impact on Spain's debt-ratio arithmetic, and Spain’s government spending is declining at an annual rate of 5%. Not only isn’t its budget swollen, but cutting it further won’t make the slightest difference. Spain is running out of money, but not out of useless advice from Paul Gigot.

Spain is at a crossroads: it must either fix its central bank or get a new one.

Spain has a big deficit, billions of maturing debt into the horizon, no market access and an indifferent central bank. That is not sustainable, because she is running out of money (what economists call a "hard constraint"). Another handout by the Troika will be very costly, will add to Spain's debt, will annoy the German public, and won’t solve anything. Spain’s money needs to come from a printing press. If the ECB stepped up and did its job, the crisis would be over and the Dow would go up by 3000 points. Otherwise, Spain will have to follow Greece with all that that implies for the world as we know it.

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