Who makes war on whom?

Romain Wacziarg from UCLA was at UPF today, talking about his latest paper on war and relatedness. He is using the same data that he used in a paper on the diffusion of development (also with Enrico Spolaore, published in the QJE). Its based on genetic similarity analysis - an examination of the extent to which genetic code of humans shares genes that are not immediately useful for (reproductive) success. In their QJE paper, they argued that genetically similar populations are more likely to share the same level of riches. In their latest, they find that they also make more war on each other. Romain's interpretation is that cousins fight each other because they care about the same issues. The result is very intriguing, it survives controlling for distance, and it's robust to a lot of alternative specifications, such as excluding those with shared borders, etc., but I remain puzzled... do we want to think of Canada, NZ and Australia making a decision to fight Germany in World War I and II? Or is it that they are more or less compelled to fight, since Britain is fighting? In other words, what's the identifying variation (countries that are similar genetically, but not close) once you look at units of analysis that are not right next to each other?

Next stop, Portugal?

Simon Johnson and Peter Boone have some interesting things to say, thinking through the implications of the recent aid package to Greece (Baseline Scenario). They basically see the incentives firmly in favor of moral hazard throughout the Euro zone... nobody will want to tighten after the EU underwrote Greek profligacy (and after the spineless ECB decided to take Greek bonds as collateral no matter what their quality). Funny thing is, where is the rally in bond prices? After a brief pop, Greek bonds have been trading down again. Financial markets, as we all know, love a good bailout. Now that the EU has finally committed to rescuing the irresponsible, what is there to worry about?

Simon Johnson on Colbert Nation

A year ago, Simon Johnson, an MIT professor and former IMF chief economist was in Barcelona telling ITFD students how a seemingly small problem in US mortgages transformed into a gozilla-style financial crisis. He has now written a book (with James Kwak) called 13 bankers, which is a splendid if rather scary read. Bottom line - if we don't take the big banks apart, the US is in serious danger of becoming a banana republic run by the princes of Wall Street, and the next financial crisis will make this one look like a small hickup. Simon was recently on Colbert Nation explaining it all.

Beware of the people who cite you...

for the wrong reasons. Over at the Daily Telegraph, Ambrose Evans-Pritchard had lunch with Carmen Reinhart, who (together with Ken Rogoff) wrote a well-timed, erudite and enormously important book on financial crises: This Time Is Different. Evans-Pritchard cites my work with Mauricio Drelichman on the debts and defaults of Philip II. He argues that Greece is a bit like Habsburg Spain -- and that default is inevitable. I actually agree with the conclusion, but I cannot agree with his characterization of why bankers lent to Castilian Crown. Mauricio and I basically say -- the defaults were anticipated; bankers made money, on average; and a default was simply a bad outcome that everyone anticipated could happen. Much like in the case of insurance, the insurer sometimes has to pay out. In good times, they collected a lot of money upfront. It all evens out.

Somewhat oddly, Evans-Pritchard drags out the old chestnut how Philip II's defaults ruined his bankers, including the Fuggers. This is what Fernand Braudel famously claimed, but we find the exact opposite -- the same banking familes who lent to Charles V also lent to Philip, and the ones affected by the early bankrutpcies (in the 1550s) are still there in the 1590s, doing a healthy business, including the Fuggers. Even a default needn't be a calamity, if you play it right.

The implications for today? I think a Uruguayan solution (ie a healthy haircut for the bondholders) would make a lot of sense. It won't be fun for the investors, but we are creating a world of monstrous moral hazard if we bail out Greece and, in turn, the French and German banks who bet that the taxpayer will always help. Will this create another Lehman-style meltdown? I don't think so. Financing costs on sovereign debt are going to go up anyway, by a bit, in the next few years; many people are worried about the overall level of debt as it is. A Greek default won't change a thing. A lot of people received higher interest on their Greek bonds (unless they bought in the last 2 years); the higher return goes with higher risk, which should materialize in their portfolios roundabout now.

Painting the World Red...

On old maps, the British Empire was always shown red... well, I thought I would color the world according to where our applicants for next year (so far) come from. As you can see, there are still some white spots, but we already have students from 33 countries who have sent in their applications...

All Greek to me...

So there is a solution to what some people have called a "Greek Tragedy" after all. In true Euro-fashion, it's a bit of a fudge -- IMF involvement in the way the Germans wanted, but some Euro-bailout, too, with a role for the ECB and EU Commission. Loans are to be at market rates, or so one reads. I wonder what to make of all this. The origins of the Greek problem are clearly not a sudden speculative attack or disequlibrium in bond markets. If you lie, steal, and cheat long enough, you get caught. Try to lie about your FICA score (for Americans) or Schufa history (for Germans) for about 10 years, and NOT see a change in your interest rates after lenders catch up with what you have been doing. So a big package via the IMF that says "boooh" to some nasty speculators is not going to do the same trick that worked so well when Brazil was in trouble in the early 2000s.

Fiscal austerity will now be reinforced by the IMF. In an earlier post, I raised some questions if that is going to work -- it's a bit like root-canal work without anaesthesia. Everybody else is trying to spend more, in a bid to ward off depression. If budget cuts are too big, you get more recession. Today brought the news that Ireland's GDP fell even more in Q4 than in Q3, which puts it on a very different trajectory from everybody else. This tells you that very severe budget cuts can backfire, as Chancellor Brüning of the late Weimar Republic could also tell you. Given the size of the adjustment needed in Greece, I doubt that public finances can be cut back to health.

So, just before we all despair, four German economists writing in the FT come up with a real solution (indirectly). They remind us that the German constitutional court put a lot of emphasis on the no-bailout clause in the Stability Pact; its last ruling said that, if violated, Germany would have to leave the Euro. Should aid to Greece really go ahead, I expect someone to sue the German government. Sure, German lawyers and judges sometimes find ways of bending the law if it suits those in power (just try watching Roland Freisler in action, or reading "Der Führer schützt das Recht", a treatise by the brilliant Carl Schmitt on why Hitler's massacre of the Nazi Party's left wing was perfectly legal). Today's bunch will of course do nothing so outrageous (and I am not trying to say that declaring "too bad" and ignoring earlier EMU rulings would be comparable to Schmitts and Freisler's transgressions. I am just trying to point out that creative lawyers and judges can justify anything -- they did award Freisler's widow a bigger pension after she sued, because he would have had a brilliant career in West Germany had he not been killed by a bomb in 1945). So there is a non-zero chance, given its earlier rulings, that the Constitutional Court would actually oblige the government to either stop support to Greece, or get out of the Euro. If you take a deep breath for a minute, and dispassionately think about the consequences, this may be actually good solution for everyone (except, perhaps, the ECB bankers who would presumably have to move away from Frankfurt). The new Deutschmark would probably revalue by a lot. The soft-currency countries who now dominate EMU would get their beloved pesetas, francs, and escudos back, but with a common design on the pieces of paper. Policy could be as loose as Spain, Portugal, Greece, Italy, France, and Cyprus like; Germany could engage in its preferred policy of reducing unit labor costs, and running big current account surpluses. Every time they get too big, the Euro would devalue against the DM, the way the lira et al. used to. Everyone is happier. Probably, countries like Holland and Austria would shadow the new DM, as they did before EMU. Now, to be realistic ... if history teaches you something, it's that countries will stick to a silly monetary standard for way too long, especially if it's seen as the ultimately proof of adulthood in terms of currency. Just think of how long it took countries to abandon the gold standard in the 1930s... and as a beautiful paper by Sachs and Eichengreen showed many moons ago, you can explain most of the variation of when countries exited the Great Depression by when they abandoned gold.

Is Merkel Putting Her Money Where Her Mouth is?

I just gave an interview about the Greek debt situation to Swiss Radio. No idea when they will broadcast it, but one of the things I suggested is that, if Mrs Merkel (and Mr Sarkozy, et al) really think that Greek debt is suffering from a "speculative attack", they should use their own money to buy Greek bonds. This would serve as a public vote of confidence, and she should make money hand-over-fist if her reasoning is right. Greece's 2040 bond is still trading at only 77 cents on the dollar in Berlin, Frankfurt, Munich, Stuttgart. If one really believes that the decline from 100 in mid-2007 is simply "speculation", then a buy-and-hold investor should salivate at the 6.3% return promised. If Merkel and friends are right, that'll be risk-free, if you hold the bond till 2040. On top, you get the upside of the bond rising back to where it should be (if you believe it is worth more than 77) sometime before 2040. Why do I like this impractical idea? First, it shows that Greek's travails have nothing to do with speculation. Problems with incentives in financial markets are plentiful, but this particular episode has nothing to do with a bear attack. Second, once Mrs Merkel and friends own tons of Greek debt, they cannot possibly use taxpayer funds for a bailout...