Tuesday, December 28, 2010

Comment on BBC News:
Europe's Eastern periphery

BBC News - Europe's Eastern periphery

A false choice is offered in the example of Hungary. The author states that it cannot strengthen the currency because that would kill exports and also that it could not devalue the currency because that would kill domestic banks. The conclusion is that they have to borrow from the IMF to paper over the deficits and attempt to stimulate their economy. That is a logical fallacy. It is the same argument that produced the failed Stimulus policy in the US.

They can allow their currency to devalue and banks to fail without the consequences being worse than the increased long term debt under the IMF (or for Ireland or the PIIGS the EU loan) approach. Banks like other businesses can go bankrupt. The pain will be suffered by their owners, if they are private as they should be, and their managers. Failing to allow bankruptcy and reorganization or reallocation of capital is what distorts an economy and results in long term suffering.

The US is facing long term costs from banks that were bailed out and are failing a second time. GM and Chrysler should have gone through normal bankruptcy procedures to allow capital to be properly and lawfully reallocated. In the US politically connected financiers and unions were rewarded at the expense of those entitled to protection under the law. In Europe similar politically determined costs are being imposed. Reasonable care to avoid bankruptcy is needed. It should never be a first resort. Neither should devaluation be done without good reason. Stability and respect for contracts are the cornerstone of a free capital market system.

No comments: