The Washington Post reports today that Barack Obama has received donations from 30 billionaires while Mitt Romney has received donations from 42 billionaires. Ho hum. But there's this fascinating little tidbit halfway through the story:

Romney has attracted the support of Redskins owner Dan Snyder and other billionaires, including California real estate developer Donald Bren, who is worth $12 billion, and developer and publisher Sam Zell, who is worth $5 billion.

As a lifelong reader of the Los Angeles Times, I'd say that the support of Sam Zell ought to be reason enough to disqualify anyone from the presidency. I suppose there's a good chance that he's not actually much more of an asshole than hundreds of other billionaires, but he sure went out of his way to make it more obvious than usual. He's just lucky that LA also has Frank McCourt around, which means there's at least one zillionaire here that we all hate even more.

A few days ago Tyler Cowen kicked off a discussion of whether or not Germany (and the core European countries in general) have acted more virtuously than Greece (and the periphery countries in general) during the decade since the euro was introduced. It was unclear how much he was simply presenting a debating case vs. how much he actually believed his own arguments, and in that spirit I want to present a different case. This one is about how Europe got where it is today and who deserves a bigger share of the blame for its current mess. I'm not suggesting this is the only way to look at things, or even necessarily the best way, but I do think it's an instructive way. So here it is in seven easy steps.

1. The introduction of the euro made cross-border capital flows far more frictionless. As a result, money began flowing from the sluggish economies of the core countries (mostly Germany, but also France, Benelux, and others) to the more capital-starved economies of the periphery. You can tell two basic stories about why this happened:

a) A "push" story: Investors chasing higher yields actively pushed money into the more vibrant economies of the periphery.

b) A "pull" story: Profligate national governments, addicted to living beyond their means, pulled money into the periphery via heavy borrowing, which crowded out private borrowing.

Most likely, both of these were part of what happened and both reinforced each other. But generally speaking, if the pull story were true you'd expect to see increases in nominal interest rates in the periphery. As the table above shows, that's not what happened, which means the push story is more likely to be the primary explanation. The primal sin here is that for years supposedly sophisticated investors in the core shoveled money into the periphery with abandon, ignoring the obvious risks of doing so.

2. Normally, capital flows would eventually be moderated by changes in exchange rates, but this was impossible for the periphery since they no longer had their own currencies. The result was persistent hot money flows into a fixed exchange rate area and steadily higher inflation in the periphery compared to the core. This state of affairs is widely known to be unsustainable and eventually disastrous, but it was something Germany happily ignored since it provided German savers with a place to invest their money and provided the periphery with enough cheap capital to act as a thriving market for German exports.

3. High inflation in the periphery would normally be moderated by tighter monetary policy. Again, though, this was impossible for the periphery because they didn't control their own monetary policy. The chart on the right shows actual ECB monetary policy during the aughts (red line): it was kept loose in order to keep Germany's sluggish economy growing, but this meant that monetary policy was way too loose for the periphery. The overheated economies of the periphery thus overheated even more. This was largely the fault of the core, which controlled monetary policy, not the periphery. It was Germany that needed loose monetary policy, not Greece.

4. Capital inflows produce a capital account surplus, and the flip side of a capital account surplus is a current account deficit. This is an accounting identity, not a matter of morality or recklessness. And current account deficits always produce either matching government debt (i.e., budget deficits) or matching private debt (i.e., low private savings). This is also an accounting identity, not a matter of morality or recklessness.

So all the current account deficit countries inevitably got one or the other or both. In the event, Ireland and Spain got a property bubble; Greece and Portugal ran up sizeable budget deficits. We know from painful experience that capital flows like this are unsustainable in the long run, but they can go on for quite a while until something happens to scare everyone into calling a halt and producing a sudden crisis. The 2008 financial crisis was "something."

5. There's another side to this too: banks intermediate current account deficits. This is inevitable, hydraulic. A banking system in a current account deficit country always features a high loan-to-deposit ratio, which means that banks in the periphery became dependent on skittish wholesale funding instead of more durable retail deposits. As with capital inflows, when investors suddenly decide to stop the music, wholesale funding dries up and the banking system goes into cardiac arrest.

6. This creates a vicious cycle: The financial crisis produced a recession that cratered both periphery country finances and the periphery's banking system. Budget deficits in the periphery blew out, debt levels became unsustainable, and at the same time investors began a run on their banking systems. As Hyun Song Shin puts it, "The European crisis carries the hallmarks of a classic 'twin crisis' that combines a banking crisis with an asset market decline that amplifies banking distress…In the European crisis of 2011, the twin crisis combines a banking crisis with a sovereign debt crisis, where the mark-to-market amplification of financial distress interacts to worsen the banking crisis."

In other words, as sovereign debt woes got worse, bank woes got worse too. And as bank woes got worse, sovereign debt woes got worse.

7. The damage wasn't limited to the periphery. All those capital inflows came from the core, and when the music stopped and the periphery was left in shambles, banks that had loaned out all the money were suddenly in trouble too. As an example, the chart on the right shows bank exposure to debt from Spain. German and French banks alone have over $300 billion in exposure to Spanish debt, so if Spain goes kablooey, so do they. And that brings us to the present day.


If you've read this far, let me make it clear that nothing here is meant to absolve the periphery countries from their part in this. Ireland fed the fire of its property bubble irresponsibly, Greece lied about its finances, and throughout southern Europe there was a persistent refusal to reform their labor practices, improve productivity, and live within their means. The core countries have every right to hold the periphery accountable for this.

At the same time, this is fundamentally a story of economics, not morality, and it's only in Step 1 above that the periphery countries bear even a share of the blame for what happened. The rest was either caused by deliberate core policies or else the inevitable result of those policies. Whether Germany likes to hear it or not, it's simply a fact that both sides allowed—even encouraged—capital flows to remain imbalanced for far too long. The periphery enjoyed access to cheap money and the core liked having a thriving market for its exports. The core and the periphery both rode this wave up, and now they're both going to have to ride it down.

It's also an unfortunate fact that no one handles hot money flows well, something that's doubly true in a fixed exchange rate area. Germany was no better at identifying this and doing something about it than Greece was, and they're no happier about giving up their export-driven economy than Greece is about giving up its import-driven economy.

What does all this mean going forward? I guess I'd say a few things:

  • Germany is justified in demanding reforms from the periphery as the price of a bailout. Partly this is just because creditors generally have that right. But it's also for practical reasons. Even if you feel that reckless lenders are morally equivalent to reckless borrowers, it's still the case that if Germany simply bails out the periphery without anything changing, they're essentially committing themselves to subsidizing the periphery forever. That's not something any country will (or should) feel obliged to do.
  • At the same time, forced austerity for its own sake is foolish. Demanding reforms that promote long-term growth is fine. Demanding austerity that will make periphery economies even worse off in the short term is counterproductive for everyone, including Germany.
  • It's probably also wrongheaded to focus so heavily on budget deficits, no matter how virtuous it seems to insist on balanced budgets. That's not what caused the eurozone's problems: Spain and Ireland ran budget surpluses during the aughts and only went into deficit after the financial crisis cratered their economies. Europe's fundamental problem wasn't budget deficits, it was capital flows within the eurozone—or, put a different way, the problem was persistent current account imbalances in a fixed exchange rate area. It was the countries with current account deficits that consistently ran into trouble, and any reforms worth doing need to address that directly. That requires changes from both the core and periphery. After all, every country can't run a budget surplus at the same time, just as capital can't flow into every country at once.
  • A non-eurozone country that ended up in the trouble the European periphery is in would most likely declare bankruptcy: They'd "restructure" their debt, meaning that banks and others who held their bonds would lose all or some of their money. The EU's leaders, however, appear to consider this unacceptable for a member of the eurozone. Unfortunately, as Felix Salmon says today, this is probably a mistake. Even if you feel that reckless borrowers are more blameworthy than reckless lenders when a crisis hits, surely lenders should retain some incentive to make sure their loans are properly vetted. A promise from the EU to always keep sovereign bondholders whole sends a message to banks that reckless lending carries no penalty at all. That's a recipe for a repeat of 2008.

As a side note, it's worth pointing out that Italy is sort of a special case here. (That's why I didn't include them in the charts above.) Their economy has been in the doldrums for over a decade, and that's something they need to address. At the same time, they were a middle-of-the-pack country on a wide variety of economic measures all through the aughts: they ran only modest current account deficits and modest budget deficits; their inflation rate was only a bit higher than Germany's; and their debt-to-GDP ratio actually declined. Their problem isn't so much that their fundamental economic position is disastrous, it's that (a) their economic position was weak and the recession made it weaker, and (b) they're much larger than any of the other periphery countries. They're ground zero of the crisis right now simply because investors have lost confidence in them, but they don't really belong in the same basket as the four other periphery countries.

I've wondered for a long time why the finance industry has gotten so immensely profitable in an era of computerization, globalization, and intense competition. After all, those are things that you'd expect to reduce sector-wide profits, not increase them. The answer remains a bit mysterious, so I'm glad to see an actual economist asking something similar: namely, has the cost of financial intermediation gone up or down in recent decades? Here is NYU finance professor Thomas Philippon:

The cost of intermediation in the US is between 1.3% and 2.3% over 130 years. However, the finance cost index has been trending upward, especially since the 1970s. This is counter-intuitive. If anything, the technological development of the past 40 years — in IT in particular — should have disproportionately increased efficiency in the finance industry. How is it possible for today's finance industry not to be significantly more efficient than the finance industry of John Pierpont Morgan?

If Philippon is correct, the financial industry charges more for its basic task of matching borrowers and lenders than it used to:

What happened? Why did we get the bloated finance industry of today instead of the lean and efficient Wal-Mart?....One simple answer is that technological improvements in finance have mostly been used to increase secondary market activities, i.e., trading.

....The finance industry of 1900 was just as able as the finance industry of 2000 to produce bonds and stocks, and it was certainly doing it more cheaply. But the recent levels of trading activities are at least three times larger than at any time in previous history....I conclude that the most important questions in finance today are:

1. A positive question: Why do people (fund mangers, households, etc.) trade so much?
2. A normative question: Has increased trading led to either better prices or better risk sharing?

I would like to believe that the answer to (ii) is yes, but I am still waiting for the evidence. If the answer turns out to be no, then we would have to conclude that the finance industry's share of GDP is about 2 percentage points higher than it needs to be and this would represent an annual misallocation of resources of about $280 billion for the US alone.

Hmmm. I'm pretty sure that nearly all of the recent increase in trading volume is due to automated trading, and in particular to high-frequency trading. This is almost certainly a socially useless activity, but does it account for $280 billion in resource misallocation? Maybe. That's a big number, but not so big that it seems obviously ridiculous. What's more, if this number is correct, you should probably figure that resource misallocation in fixed-income trading is at least two or three times as big. The total could be a trillion dollars or more. That's a helluva lot of waste.

Paul Waldman summarizes a Washington Post piece today that I didn't link to when it first came out. But I should have:

Everyone knows that campaigns get more expensive every cycle; that is, we knew it until this year. As The Washington Post detailed last week, this has been the cheapest primary campaign in over a decade. Four years ago, the Republican candidates spent a total of $132 million through the September before voting began; this year they spent a mere $53 million. That combined total is less than one candidate, Mitt Romney, spent during that period four years ago. This year he spent a mere $18 million through September, compared with the nearly $54 million he spent through September 2007. Political observers swooned over Rick Perry's dramatic fundraising during the 12 minutes or so he spent at the front of the pack. But even if Perry sank $100 million into Iowa, it wouldn't help him now. Meanwhile, Newt Gingrich became the front-runner without his campaign having two nickels to rub together. That isn't to say the ads won't fill the airwaves in Iowa and New Hampshire soon enough, but to this point things have been awfully quiet.

I've been mulling this over ever since I first saw it, but I'm no closer to figuring out what's going on. In theory, this should be a big money year for Republicans since President Obama looks genuinely vulnerable and the conservative base is practically in a frenzy of anti-Obama venom. But it hasn't been so far. I can think of a few reasons why this might be:

  • Despite the happy talk, GOP donors don't actually believe that Obama is that vulnerable. They don't want to waste their money on a lost cause, so they're reluctant to open their pocketbooks.
  • The media landscape has changed more than we think, especially for conservatives. Over the past few years, they've discovered that they can run very effective campaigns by using free media (Fox News, talk radio, etc.) rather than paid ad buys on mainstream media. This is especially true in primary campaigns, where their sole audience is the conservative base.
  • Big money donors don't have much of a dog in the race this year. This is because either (a) they like all the candidates and don't have a strong preference for any of them, (b) they dislike all the candidates and don't want to be associated with any of them, or (c) they just don't think it matters much because they're all pretty much saying the same things.
  • These days, all the right-wing money is going into super PACs, which seem like a more effective force for promoting conservative goals than individual campaigns do.

All of these are partly true, but I'm not sure I believe that even taken together they add up to the real answer. It's especially perplexing because Obama, who has problems with his liberal base that most of the GOP candidates don't, is nonetheless having no trouble raising enormous sums of money. So it's not because donors in general are sick of politics or because the recession has depleted everyone's bank accounts. But what is it?

Alphaville's Cardiff Garcia calls this the most important chart in the world, and maybe it is. (Though there are lots of competitors for that title these days.) It shows the precipitous drop in the stock of safe, AAA-rated assets from its 2007 peak of about $20 trillion to roughly $12 trillion this year. In one sense, you could say this is a good thing: at least we're no longer pretending that risky assets aren't, in fact, risky assets. Unfortunately, the availability of safe assets is pretty important to the smooth functioning of modern finance because they're necessary as collateral in the repo market:

When you hear concerns that the ECB has lost some control over monetary policy because of a liquidity-starved credit channel — or indeed when you hear Draghi himself say that he’s cognizant of the “scarcity of eligible collateral” — this is why.

....A somewhat obvious and related point here, but the loss of “safe” status for so much debt contributes to the deleveraging burden of European banks and their American subsidiaries; by definition it means higher risk weightings for these assets.

Declining asset quality is surely also one reason that European banks had trouble funding themselves in US repo markets, and the resulting stress in the currency basis swap markets as banks sought dollars elsewhere led to last week’s intervention.

This is bad for Europe, of course, and as we discussed a couple of weeks ago, there's reason to think that deleveraging among European banks could have a pretty serious impact on American credit markets too. We may or may not like much of what the shadow banking system does, but there's no question that it plays a key role in sustaining bank lending, and the repo market is its backbone.

In other words, just another thing to worry about. I wouldn't want this morning's semi-optimistic post about Europe to get you too excited or anything.

A couple of weeks ago Mitt Romney ran an ad in which Barack Obama was heard telling an audience, "If we keep talking about the economy, we’re going to lose." The obvious implication was that Obama was desperate to avoid talking about his own dismal handling of the economy. But that was untrue. It was actually a clip from the 2008 campaign in which Obama said "Senator McCain's campaign actually said, and I quote, 'If we keep talking about the economy, we’re going to lose.' "

Today, Thomas Edsall gets the following defense of this lie from a "top operative" in the Romney campaign:

First of all, ads are propaganda by definition. We are in the persuasion business, the propaganda business....Ads are agitprop....Ads are about hyperbole, they are about editing. It’s ludicrous for them to say that an ad is taking something out of context....All ads do that. They are manipulative pieces of persuasive art.

I wonder if this guy actually believes what he's saying? He didn't have to talk to Edsall in the first place if he didn't want to, so I assume he does. He's genuinely aggrieved that anyone holds this against Team Romney.

Edsall's conclusion is that this spot is "the latest step in the transgression by political operatives of formerly agreed-upon ethical boundaries. What was once considered sleazy becomes the norm." The rest of his column is a history of such transgressions, and it's interesting reading. But this sort of thing strikes me as different from the changes in campaign financing and lobbying that he devotes his piece to, and it would have been even more interesting to read a column about the history of changing norms in how baldly you can lie on the campaign trail.

(My guess is that a real history of this would be U-shaped. Flat-out lies were quite common throughout the entire history of the nation but started to decline after World War II in favor of more subtle distortions. Then, over the last few decades, they've risen again as candidates began to learn that they could manipulate — or ignore — the mainstream media in ever more brazen ways without penalty.)

In any case, it would be nice to think that this episode has wakened the media a bit from its nonjudgmental stupor. It's true that campaigns engage in artful distortion and simplifications all the time. So do bloggers. I don't pretend to be writing austerely evenhanded and neutral posts here, and I'm certainly guilty of cherry picking my topics and my evidence on occasion. At the same time, I'm well aware of some boundaries here. It's one thing to present evidence in a way that helps me make my point, but it's quite another thing to flatly lie about what the evidence says or to flatly ignore evidence that I know perfectly well undermines my point entirely. Likewise, I might highlight a damaging quote from someone I dislike, but there's a bright line there: the quote has to be accurate and it has to be offered in its proper context. If it's still damaging, great! That's legitimate blog fodder. If it's not, then it's not.

The same is surely true of political campaigns, even if the stakes are massively higher than the integrity of someone's blog. If Romney and his people genuinely don't get that, or if they get it but they don't care, they shouldn't be allowed to pretend that this is just part of some normal evolution of political norms. It's not.

It has — understandably — taken quite a bit of time to persuade the German public that it should bail out the periphery of Europe, but apparently German chancellor Angela Merkel thinks the time is finally right to propose changes to EU treaties that would trade fiscal consolidation (i.e., binding budget controls on every country) in return for more fiscal support (i.e., more money to rescue troubled countries). Here's the deal in a nutshell:

Under growing pressure from nervous financial markets, the leaders of France and Germany reached a compromise agreement Monday to seek mandatory limits on budget deficits among debt-laden European governments.

The limits--a “golden rule” of 3 percent of Gross Domestic Product--would be enforced by leaders of the European Community, according to explanations provided by President Nicolas Sarkozy of France and German Chancellor Angela Merkel at a joint news conference here.

Governments whose debts exceeded three percent of their GDP would be cited by the European Court of Justice, after which a super-majority of 85 percent of European governments would have to agree to impose some sort of sanction against the offending country.

I have mixed feelings about this. On the one hand, a more reliable backstop mechanism is important to stop runs on weak countries (and their banks), and it's hardly reasonable for the eurozone's core countries to agree to fund this without some say over the budgets of the countries they're guaranteeing. As it happens, this deal doesn't actually appear to be an awful lot more binding than the current rules, but still, it's probably a good first step if this is what it takes to get nervous Germans on board.

On the other hand, budget deficits have never been at the core of the eurozone's problems. Capital flows have. This deal doesn't appear to do much about that, so it's not clear to me that it's really a long-term solution.

Still, a medium-term solution will do the job for now, and perhaps the longer term will find its own solutions in the future. This is at least moderately promising progress, assuming that the necessary treaty changes can be approved in a fairly short time. It's the first time in a while that I've felt anything but gloom over Europe.

So are Republicans going to agree to extend the middle-class payroll tax cut that expires at the end of the year? The LA Times reports:

House Speaker John A. Boehner (R-Ohio) met behind closed doors with rank-and-file lawmakers Friday morning, but opposition to continuing the payroll tax break still runs high among conservatives in the House, showing the difficulty Boehner will face in drawing backing for the measure.

...."I'm just not sold on this payroll tax extension, this unemployment extension" said Rep. Allen West, a freshman Republican from Florida. Like many foes of the payroll tax break, he said he opposes the way it reduces the revenue stream to Social Security — even if those funds are replenished with spending cuts elsewhere in the budget.

I hope no one is really surprised about this. The modern Republican Party is interested in two things: tax cuts for the rich and spending cuts for the poor. This doesn't fit into either category.

Of course, there is one other thing they're interested in: anything that Barack Obama opposes. That's why Boehner has proposed a sweetener to the payroll tax cut bill: legislation that would advance the Keystone XL pipeline, which Obama recently postponed. Apparently, though, even the prospect of giving Obama the finger over the pipeline isn't enough to overcome Republican opposition to something that's neither a tax cut for the rich nor a spending cut for the poor. The rank and file still aren't biting.

Note to the middle class: the GOP is just not that into you. Maybe it's time to call off the relationship?

National Review's Katrina Trinko attended one of Newt Gingrich's town hall meetings for local tea partiers today:

One thing that struck me was his earnestness in pushing bipartisanship, not a typical theme at Tea Party events....He spoke about having to attract Democratic votes to stay in Congress during his early years as House member in Georgia, and referred to working to get Democratic votes in the '80s to pass Reagan’s initiatives. "I grew up in politics learning a lot about how you build bipartisan coalitions," Gingrich observed.

…"There are a thousand small things that create bipartisanship even if you disagree about big things," Gingrich said. "And it's really important to remember that, all the little human things that a good leader can do to get the city of Washington to work again. Tragically, none of them are being done by the current team."

I read that with my mouth agape. If there's a single person in the country more responsible than Newt for the poisonous state of partisan politics in America today, I don't know who it is. Remember these gems down through the years?

1978, speaking to a group of College Republicans: "I think that one of the great problems we have in the Republican Party is that we don't encourage you to be nasty."

1989, speaking about the Democratic leadership in Congress: "These people are sick…They are so consumed by their own power, by a Mussolini-like ego, that their willingness to run over normal human beings and to destroy honest institutions is unending."

2011, speaking about the current Democratic president: "Obama is the most serious radical threat to traditional America ever to occupy the White House."

There's no cherry picking here. These are all workaday themes for the GOP's self-proclaimed philosopher king, one of the nastiest, most malignant pieces of work ever to grace American politics. Newt Gingrich extolling the virtues of bipartisanship is like Hannibal Lecter promoting the value of good nutrition.

From Prime Minister Jean-Claude Juncker of Luxembourg, explaining why it's so hard to fix the euromess:

We all know what to do, but we don’t know how to get reelected once we have done it.

That's from Jared Bernstein. More at the link.

UPDATE: This quote is actually from 2005 and has nothing to do with the current crisis. I'm not sure why Jared made it sound like Juncker said it last week, but in any case, I suppose it never hurts to recycle a good quote.