Krugman’s Suggestion to Increase Inflation in Europe is Unwise

Krugman’s Suggestion to Increase Inflation in Europe is Unwise
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Krugman's Suggestion to Increase Inflation in Europe is Unwise


In regards to the Kenneth Rogoff and Paul Krugman debate about Europe. Krugman mentioned more inflation as a solution to help solve the crisis, below are some reasons why it is not such a good idea.

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1) There is rising wages in Germany. So relatively there is an internal adjustment – but that is in itself far from sufficient – it is just the normal German improvement in competitiveness. But Yes, it gives the PIIGS a market.

2) There has to be a redistribution of wealth from the pensioners (and other non-productive) – you could do that with a raging inflation; but a) it takes to long b) it works badly like a scythe chopping good as well as bad debt.

3) Inflation works as a de facto acceleration of service on principal as the lender will want to be compensated not only for interest, but also the inflationary loss on principal. That simply isn’t possible: At the moment home owners can’t even pay interest – let alone pay off principal.

4) Losses on bricks will have to be taken.

5) The way to take these losses is to clean out the banks – that will take care of a small part of the losses (a VERY small part).

6) Convert the housing debt into public debt, as it happens now and then you reclaim the losses through losses in the state owned banks. The state can then collect taxes to pay for the losses: This means losses can be “fixed” to be predominantly paid by non-working people.

7) As the tax burden is shifted towards the tax-evaded fortunes and excessive saving – then the general tax-burden on work can be lowered.

8) At the moment income-tax is rolled over on consumption (with an inflation of 2½% on consumer prices) and 0% wage rises the wage cut in real terms is about 2½% annually. Some may argue that it is to slow – and I couldn’t agree more.

9) First of all raw material prices could collapse at any moment and remove any inflation – handsomely. Secondly the wage deterioration is to slow to avoid unemployment.

To speed up things the state banks will foreclose on home owners and then rent them their (former) own home at a price they can pay. (Yup their debt remains – but to the public only to be ultimately written off when they die).

Now there is a balance between cost of living (reduced rent) and reduced wages. The existing rental dwellings will have to lower their rents, as there is a massive excess of real estate in Europe – some countries more than others (Spain is especially atrocious with 1½ dwellings per household).

The other problem is a distorted balance of employment: Far too many daycare workers and schoolteachers (with toe-curling productivity) slightly too few caring for the elderly. Slightly too many health workers (doctors, nurses, paramedics – people only shoot each other in the streets to a very limited extend in Europe) and the elderly are in much better repair these days.

The situation is far from hopeless, but every possibility but cutting into pension funds will have to fail first – the right solution is always the last resort.

Italy’s running deficit is not too bad; but the debt load is crippling. Spain has chosen all possible ways to commit economic suicide – simultaneously.

The other factor to take into consideration – long term – is the return of jobs when China (and India) collapses. Partly the work will be done with a better infrastructure and new investments – and partly with a more productive work force – so these jobs are not coming back on the same scale as they disappeared; but some will.

There will be cheaper raw materials when the Chinese syndrome of melting rubble and stacking it in cities with no inhabitants goes out of style – scrap is the new natural resource.

But the here and now to-do-list is to get the banks under control (taken over), pry open their books and take losses.

To increase inflation will only increase collapses, as inflation is an accelerated service on debt – no more. In 2009 when the flexible interest rate on real estate rose from 2-3% to 6% a quarter of the nations home owner would foreclose and be thrown into the street – which was clearly unrealistic. On top of that there debt would not be covered at all by their property’s sales value.

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