Greece, the Euro, the Drachma, and bad ideas...

On Tuesday, Martin Feldstein wrote an article for the Financial Times offering a solution to the Greek debt crisis: have Greece temporarily use the drachma instead of the euro. He suggests keeping bank deposits and obligations denominated in euros, while converting wages and prices to the new drachma, which will be fixed at 1.3 drachma = 1 euro. He suggests this will make Greece more competitive in the global market, as exports will be cheaper. This will stimulate the Greek economy and make paying off their debt easier and blah-blah-blah. Well, not only will this pose insurmountable logistical problems, even Krugman sees this; the macroeconomics supposedly working here is full of holes, something Krugman does not see: "In terms of the macroeconomics, this actually does make sense." Here is where Krugman is wrong:

Prices reflect the value of a good, determined by market forces. If you change the currency and reduce its value by 30%, prices negotiated after this date will take this into account. Thus, you have changed the nominal price of goods and services, but the real prices (were you to convert them back into any other currency) would remain exactly the same. Where this wouldn't apply is to contracts that have already been negotiated, as Feldstein suggests all payments would now be payable in the cheaper drachma. This means if you had negotiated a contract with set prices in euros, based on either your projected costs or cash flows, you would now receive a different amount (larger or smaller depending on which side of the transaction you fall).

What this will effectively accomplish is a transfer of wealth from employee to employer, from those who sold items on credit to those who purchased those items, and from those who prepaid for items to those who sold these items. It also acts to punish those who have entered long term contracts (and chosen the wrong side).

Also, keep in mind the bank balances and debt of the Greeks will not be changed, so while the (previously negotiated) wages of Greeks will fall by 30%, their mortgages and other debts will still be payable in euros.

Finally, and most worryingly, Feldstein is proposing that the Greek government should have the authority to arbitrarily renegotiate and enforce all contracts that are currently in place in the country. Further, the government should be allowed to exercise this authority because it has overspent and racked up an unsustainable level of debt. If that wasn't scary enough, Martin Feldstein is an adviser to President Obama (serving on the President's Economic Recovery Advisory Board).

http://www.nytimes.com/2009/08/03/opinion/03krugman.html?_r=1&emc=eta1

In this post taken from his NYT blog, Krugman takes aim at "Wall Street" for using super computers in the stock market and for speculation. Krugman claims that these are "destructive from a social point of view". This post will explain the fallacies in his reasoning.

Super computers:

Krugman points out that over the last several years large investment houses such as Goldman Sachs have been using supercomputers running complex algorithms to execute trades. Krugman claims that this is unfair to other traders who do not have access to these expensive machines. He claims that this acts as a "kind of tax" that "probably degrades the stock market's function" and therefore decreases "national wealth".

Here, Krugman either doesn't understand how the stock market functions or is intentionally misleading people for political reasons.

First of all, the firms using these expensive computers are market makers. They provide liquidity in the stocks they trade. This means that they are both buying and selling the stock to investors. This is an important function because it ensures that whenever someone wants to buy the stock, a trade will instantly take place with a very low gap between the bid and the ask. What these supercomputers do is give the firms an advantage over other market makers. They can act faster, filling orders quicker and at better prices. So yes, they are able to take profits away from other traders, but only because they are able to do a better job at providing shares at better prices to buyers and sellers. So while the traders competing against these supercomputers are worse off, it is because the investors who they would have been trading with are getting a better deal. This would be analogous to an economist complaining that Henry Ford was using his assembly lines to create cars cheaper and faster because he was acting as a "tax" on his competitors. Rather than acting as a "tax" on society, they are providing a service (better and faster trades) and are creating "national wealth".

Why Krugman is Wrong

The purpose of this blog is mostly to give myself practice at refuting liberal/keynesian economic policies proposed by "prominent" economists such as Paul Krugman. In this blog I will be breaking down posts found on Krugman's blog at the New York Times and showing the fallicies prevalent in his reasonings.

Criticisms, constructive or otherwise, are welcome in the comments.