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Monthly Archives: July 2013

Some of the press regarding Croatia’s accession to the European Union has been cautiously optimistic, but the general tone is downright gloomy. Almost all reports express concern over Croatia getting caught up in the debt crisis, and one report in the Guardian reveals that “some economists” think that Croatia will ask for a bail-out almost immediately. However many of the worries expressed over Croatia’s accession to the EU are the product of flawed reasoning: there is no reason to believe that either party will be harmed, and there is every reason to believe that EU membership will be a force for good in Croatia and throughout the Balkans.

Fears of crisis contagion, both from Croatia to the EU and vice versa, are unfounded. It is true that both parties are experiencing difficult economic moments, to say the least, but this development will not harm them. Some images in the news of a commemorative coin in Croatia’s currency, the kuna, gave me a scare: for a while I was under the impression that Croatia would be adopting the Euro. If this were the case, then there would certainly be cause for concern. Poor countries in the eurozone are hurt the worst by crises due to their lack of control over monetary policy. A struggling Greece cannot let its currency fall to make its exports more competitive, nor can it cut interest rates to encourage economic activity. The Euro and interest rates are kept up due to (kind of) flourishing economies in other regions. However, since Croatia is keeping its currency, lack of control over monetary policy is not a concern.

Furthermore, I cannot imagine how EU membership would somehow cause Croatia to get caught in the debt crisis. The sovereign debt crisis was (is) a product of a complex chain of events, but the reason that countries have had trouble emerging from crisis is due again to a lack of control over their own currencies. In countries where excessive debt was a concern, rates rose to unsustainable levels since investors saw an increased risk of default because countries could not print currency to service debts in a worst-case scenario. But since Draghi famously vowed to do “whatever it takes” to save the Euro, markets have calmed down for the most part. Of course, Romania had trouble selling its own bonds in Romanian lei, which led to a bail-out in 2009, but this had more to do with the country’s flat-lining credit rating and ongoing political instability. Either way, if Croatia is going to have a problem issuing debt, its EU membership will not worsen the situation. Conflating the debt issuance woes of southern Europe with those of nations with sovereign currencies is lazy and harmful.

There are concerns that Croatia will need a bail-out as soon as it accedes. These “concerns” are voiced in a mildly accusatory manner that makes it seem as if the nation has been negotiating for EU entry for a decade just so it can have access to rescue funds. And that’s a load of hooey! Croatia’s president acknowledges that his country is struggling, with unemployment above 20%, but if the reforms required of it by the EC are indeed designed to make countries more stable and less vulnerable to collapse (ahem), then there should be no issue. Furthermore, the image of a ruined Croatia waiting until it gets into the EU to ask for funds makes no sense, since the majority of rescue funds provided by members are reserved for eurozone countries. When Romania was bailed out in 2009, the IMF was its creditor, helped by the World Bank with a little more thrown in by the EU’s development bank. How sneaky of Croatia, to lie in waiting for ten years just to receive a bail-out that it could have received anyway. Grow up, guys!

The one threat I cannot speak to is that pesky banking crisis that seems fond of taking down even the most innocuous of nations (see: Cyprus). This report gives some clues, but in general I’m going to conclude that Croatia is not a tax haven for rich Russians. Please someone let me know if I am wrong. In general, though, Croatia’s finances are quite solid, with a debt-to-GDP ratio far below the EU average.

There are also those who question whether the EU is already too large. While the eurozone’s troubles can be ascribed to too large a monetary union, the EU will not suffer from expansion. It seems that, again, a conflation of the eurozone’s challenges with those of the EU has occurred. There are a paltry 5 million people in Croatia. It is part of Europe. The EU should expand until all European countries have joined, or it should rename itself.

And now for the good: membership in the EU will provide Croatia, and eventually all of the Balkans, with a wonderful sense of belonging to Europe, both politically and geographically. It will provide further trade and economic opportunities (though the government should help local producers remain competitive, at least at first). And, most importantly, it holds countries to human rights standards that they would never adhere to without the immediate threat of being turfed out. It is especially important to have this stabilizing force in the Balkans, where regional divides and memory of war are still very present. While I’m not the biggest fan of the monetary union, I think the EU is a fantastic way for nations to integrate politically and economically, and an experiment in multinational governance that will hopefully serve as a template for a world government someday.

So to all the naysayers: stop raining on Croatia’s parade!

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The fallout from Fed Chairman Ben Bernanke’s suggestion that the Fed would begin tapering of its QE3 program in September of this year was swift and vociferous. Yields on almost all Treasury notes continue to rise, and the Fed is now embarking on what many see as a remedial PR campaign to undo the damage caused by Bernanke’s comments. The general consensus among economists and investors is that Bernanke has made a terrible mistake that will substantially slow down US, and therefore global, prospects for recovery.

Paul Krugman attributes this change in attitude of the Fed to two possible factors: a fear of bubbles, and worries about inflation, which have been voiced loudly and often by many concerned conservatives. I wholeheartedly disagree. While human kind as a whole has a long history of fudging macro policy, I still find it hard to believe that the Fed would honestly see inflation as a real threat at this point. Even with all the money being pumped into the economy, it’s looking like a bit of a struggle just to keep inflation above 1%–it was 1.1% in April and shows no sign of rising to dangerous levels. And as Krugman has argued, a rate of 4 or 5% wouldn’t be the worst thing in the world, as it would inflate away some of the US’ debt, and would perhaps incite firms to let go of some of that hoarded cash we’ve been hearing so much about. Harm to savers would be minimal, as current personal savings rates are abysmal. (Yes, the St. Louis Fed really outdid itself with this page. All flash and no substance, guys!) And as for the bubble threat, there doesn’t seem to be any on the horizon. One of the classic signs of a bubble is a thriving economy–albeit, an artificial sort of thriving driven by an asset that is about to crash spectacularly–but there is no thriving of which to speak. I am of the mind that the Fed knows all this perfectly well.

So if bubbles and inflation are not a concern, then why would the Fed want to begin tapering QE? Quite simply, because it’s not helping those that it intended to help. The one bubble that there has been some concern about lately is a stock bubble–the words “record high” are tossed around with astonishing frequency these days, enraging the struggling masses who wonder when they will see the benefit of all that prosperity. The answer is probably never, and the Fed probably sees this. What seems to be happening is that firms are getting hold of all that cheap money and, instead of reinvesting it to create jobs and improve efficiency, opt to instead use it to inflate their share prices by way of share buybacks and dividend increases. This is good for investors, but bad for people who need jobs. Exacerbating this pooling of money at the top is the fact that investment income is taxed so lightly, the result being that shareholders, usually those with the most disposable income, benefit disproportionately. This chart pretty much says it all:

While one could tell a story about how lower tax rates have given investors increased incentive to seek out profits, as this blogger has, that is not my primary concern here. What I am seeing is a very little portion of society benefiting from the Fed’s QE program, perhaps in part due to low tax rates on capital gains that raise the stakes, giving added incentives for companies to placate investors in hard times while ignoring long-term growth. Indeed, share repurchasing is at a record high, according to the Financial Times. So, seen in this light, why would the Fed want to continue a policy that is not having its intended effect? Will doing it more help matters? I personally don’t think so–the flaw lies in the structure of our financial system, not in the attitudes of business owners and CEOs.

A report on cash-hoarding by the St. Louis Fed gives a number of reasons for companies’ reluctance to reinvest, and acknowledges that many firms prefer to keep earnings overseas to avoid repatriation fees. The report cites tax uncertainty in the US as the primary reason that firms are holding cash, as well as the looming threat of tightened monetary policy, which may make it more difficult for firms to get cash quick if needed. It observes that the ratio of cash to net assets has more than doubled in the past 20 years, and that it is mostly smaller firms that are holding cash.

This very clearly signals a need for legislators in the US to make more cash available to smaller firms, because they are best-positioned to return the US to its former status as innovator and land of opportunity. Of course, I don’t think the Fed’s stats tell the whole story–many larger firms such as Wal-Mart seem intent on increasing share prices, regardless of the long-term effects this may have.

So, the solution is two-fold: make more cash available to smaller firms, and discourage large firms from engaging in stock market tomfoolery which they will certainly regret later, anyhow. Another sound policy might involve a clearer and more predictable system of taxation that encourages corporations to bring profits to the US. The Fed itself has acknowledged that companies are holding money abroad to evade taxes: why is this acceptable?

Getting back to Bernanke’s actions in the past week: the reaction has been very extreme, but perhaps it was long-overdue. Interest rates on US Treasury notes were at all-time lows to begin with, and the US is still a long way from ever having to default. If Bernanke’s statements incite large firms to begin planning for a time when easy money will no longer be available, by, say, reinvesting instead of engaging in share repurchasing, then perhaps they will have had their intended effect. Interest rates will still be low, so small firms should not feel that they cannot take calculated risks as well.

Though Bernanke’s recent tactics seem wrong-headed to some, a closer look at just who was benefited by QE shows that perhaps there is some method behind the madness. The subsequent contradictions by other Fed officials only serve to highlight internal divisions and show the Fed’s weakness to corporate interests. With the enactment of the policies I have suggested above, however, I see no reason why the end of QE should be the death knell of the US economy.