Do Republicans risk becoming a neo-Nazi party?

Is Donald Trump simply a maverick inoffensive contestant from a Jerry Springer reality show?

Many moderate Republicans sincerely hope so, and refuse the similarities between Trump and Hitler.

There are certainly some differences, and Trump is no match to Hitler in terms of racism, imperialism or intelligence. However, the similarities are too many, from an anti-capitalist and protectionist stance, to an exacerbated nationalism, both being compulsive liars, demagogues, militarists and paranoid self-centered personalities.

Yet what is more frightful in relation to a possible election of Trump, is that a number of economic and political conditions are comparable to those in the 1930-1933 Germany when Hitler rose to power. I shall deal here with the political parties only.

Just like Trump, for many years until 1928, Hitler was basically seen as a wild card. Still, Hitler’s Nazi party rose to power from a 2.6% share of the vote in May 1928 to reach 37.3% in July 1932, followed by a subsequent decline to 33.1% in November 1932.

This meteoric rise was the result of a combination of the misery caused by the economic crisis of 1929, the political instability created by the fall of the so-called center-right grand-coalition brought down by the People’s Party (DVP), the 6.3% rise of the Communist Party (KPD) to 17%, at the expense of the social democrats (SPD) which declined 9.5% to become the second party, the divide in the left and right-wing liberal parties (DDP and DVP), rising anti-Semitism and, crucially, the referendum held in Germany on December 1929 to introduce a 'Law against the Enslavement of the German People' which gave prominence to the Nazis.

Throughout this period, the German Centre Party (Catholic)’s share of the vote remained stable at around 12%. But, it headed the government and, together with the German National People's Party (DNVP), was one of the main “establishment” conservative parties. The successor of this party is now the CDU (Mrs. Merkel party) and it its ideology is close to the declining moderates still in the Republican Party.

So, the main political base for Hitler’s rise came from the other conservative parties – DNVP, DVP and DDP. Let me reproduce from Wikipedia some of its characteristics, so that we may compare them to the political factions in today’s Republican Party in America.

Classical liberalism of the kind espoused now by some Tea Party and Cato Institute activists, was also split in Germany between liberals on left (DDP) and right (DVP) wing parties.

The German Democratic Party (DDP) was founded by leaders of the former Progressive People's Party, left members of the National Liberal Party, and a new group calling themselves the Democrats. The party was attacked by some for being a party of Jews and professors. Among its well-known politicians were Hugo Preuß, the main author of the Weimar constitution, and the eminent sociologist Max Weber. Hjalmar Schacht, president of the Reichsbank and one of the founders of the party, left the party in 1926 and became a supporter of Adolf Hitler. This party today would resemble some of the Bernie Sanders supporters that refuse to vote Clinton or may even vote for Trump.

The German People's Party (DVP) was a national liberal party in Weimar Germany and a successor to the National Liberal Party of the German Empire. It was the right-wing liberal or conservative-liberal party, generally thought to represent the interests of the great German industrialists. Its platform stressed Christian family values, secular education, lower tariffs, opposition to welfare spending and agrarian subsides and hostility to "Marxism" (that is, the Communists, and also the Social Democrats). Today’s equivalent names in the Trump campaign include people like Ralph Reed and Paul Ryan on the religious/political side and Aleson, Deason, Ichan and Ross on the business side. Today’s Trump financiers are mostly involved in casinos and deal making, and not so much in the traditional military industrial complex.

The German National People's Party (DNVP) was a national conservative party in Germany during the time of the Weimar Republic. Before the rise of the Nazi Party (NSDAP) it was the major conservative and nationalist party in Weimar Germany. It was an alliance of nationalists, reactionary monarchists, völkisch, and anti-Semitic elements, and supported by the Pan-German League. After 1929 the DNVP co-operated with the Nazis, joining forces in the Harzburg Front of 1931, forming coalition governments in some states and finally supporting Hitler's appointment as Chancellor in January 1933. Initially, the DNVP had a number of ministers in Hitler's government but quickly lost influence and eventually dissolved itself in June 1933, giving way to the Nazis' single-party dictatorship. The current day Republican equivalent is found among the more conservative Republicans and some Tea Party activists.

These three parties had their role in paving Hitler’s rise to power, the same way that several Republican factions paved the way to Trump’s nomination as Republican candidate for President in 2016.

Should Trump be elected, can we expect the Republican factions to merge into a neo-Nazi party?

The risk is very real.

So, what can Bush and other moderate Republicans do to stop this nightmare scenario?

They have basically two defense lines. First, recommending a vote for Clinton to stop it happening. Second, should this fail, to stop the Congress and Senate from approving an “enabling act” of the type that gave Hitler the power to obliterate the other parties and become a dictator. Not even if Trump portrays himself simply as a Putin-like dictator, and not a radical like Hitler, should the moderate Republicans conciliate.

In conclusion, Republicans have an enormous moral and historical responsibility in stopping the devil before it rises again. The Great American Nation and World Peace depend on their wisdom and courage!

Wage devaluation: Why Brussels insists on this mistake

The Brussels consensus keeps insisting that to solve the external adjustment problems in the peripheral countries they need a major wage devaluation. They ignore both theory and experience showing that wage and currency devaluations are substantially different and that even the later has limited success in balance of payments adjustment. Moreover, they also ignore the macroeconomic debate and experience on money illusion concerning the differences between real and nominal wage declines.

They persist in their recommendation despite a failure of the current adjustment programmes to show the benefits of such policy. And, unfortunately, some of the countries are eager to accept them unquestionably. For instance, some supporters of the Irish Fine Gael – Labour coalition are calling for a €2 an hour cut (25%) in the minimum wage fixed since 2007 and which is paid to less than 5% of the labour force. Slovenia, has in place measures aimed at cutting the public sector wage bill. Likewise, in Portugal both the government and the main opposition party are disputing the next general election with a proposal to cut the taxes on wages (the so-called TSU).

Regardless of whether nominal wage costs are reduced through cuts in the minimum wage, public servants pay cuts or labour tax reductions, the relevant assessment is how wage cuts impact on take home pay and employer total labour costs, as well as in the government budget.

The following charts drawn from OECD data illustrate some of the misconceptions about nominal wages.



The chart above depicts the evolution of manufacturing hourly wages in Germany and the peripheral countries. It shows that, as expected, they have risen in all countries, except in Portugal.

Now, with rising wages, the so-called labour unit costs (the measure often used to assess competitiveness) will also rise unless productivity gains outpace such rise. The following chart shows that, except in Germany for the period before the 2008 crisis, none of the countries achieved the necessary rise in productivity.



The case of Portugal is especially noteworthy. Since it did not experience a rise in hourly wages, the rise in unit labour costs means that it had a serious decline in productivity. However, the link between hourly wages and unit labour costs does not work only through productivity. Two other factors – employment and nominal wages - also play an important role. Let me illustrate it through a numerical example for Germany and Portugal.

Imagine that the high wage sectors employ 30% and 40% in Portugal and Germany, respectively. Moreover, assume that wages and productivity are 50% higher in the high wage sectors and two times higher in Germany than in Portugal, so that both countries would have the same unit labour costs. What would happen under three different scenarios?

First, imagine that nothing changed in Portugal but in Germany wages continued to rise at 1% and 2% in the low and high wage sectors, respectively. In this case the unit labour costs would rise 1.5% in Germany but remained constant in Portugal.

Next consider the case where additionally 10% of the labour force in the Portuguese low wage sector migrates to Germany increasing the low wage labour market there by 3% without affecting the sector’s average wage and productivity. In this case unit labour costs would remain constant in Portugal and rise slightly less in Germany (1.49% against the 1.50% of the first scenario).

Finally, ponder the case where nominal wages and productivity are cut by 5% in the Portuguese high wage sector. In this case the result would be exactly the same as in scenario two. Only if productivity had not declined as much as wages would we have a reduction in unit labour costs. For instance, if productivity had declined by just half of the nominal wage cut the unit labour costs would be reduced by 1.05% continuing to assume that the labour force in the low wage sector had been reduced or just 0.99% if there was no change in its labour force.

This relationship between employment, wages and productivity depends on how much workers take home out of their salary and whether retained earnings are used to pay taxes or fund pensions. The following chart highlights once more the striking difference between Portugal and Germany in the aftermath of the 2008 crisis.



It can be observed that, on average, the Portuguese took home almost less than 10 percentage points while the Germans took home more than before (1 percentage point). Such a drastic reduction had a dramatic effect on nominal contracts (in particular mortgage loans) and on private consumption. If continued, this could degenerate in a vicious circle of reduced productivity, higher unemployment, higher public debt, higher taxes, lower take home pay and lower productivity, without achieving any significant reductions in relative unit labour costs.

Now, contrast this policy with a policy without nominal wage cuts. Using the numerical example given above and assuming that productivity declined by merely half a percentage, then the rise of unit labour costs would be barely noticeable (0.2%) and the negative impact on unemployment and fiscal consolidation would be much smaller.

In conclusion, the small gains in relative labour unit costs achieved through wage devaluation are too small to justify the large costs in terms of employment and fiscal consolidation.

The Reinhart-Rogoff controversy: some microeconomic evidence

The duel between pro-austerity and pro-stimulus advocates is now being fought on the relationship between economic growth and debt/GDP ratios, following the Reinhart and Rogoff finding that there was a "tipping point" around 90 per cent of debt-to-GDP ratio when the correlation between debt and economic growth would become negative.

Their finding was questioned by Herndon-Ash-Pollin who estimated that the strength of the negative relationship was actually much stronger at low ratios of debt-to-GDP. Recently Dube, using the same set of data, estimated that current period debt-to-GDP is a pretty poor predictor of future GDP growth at debt-to-GDP ratios of 30 or greater but it does a great job predicting past growth which he claims is a tell-tale sign of reverse causality. That is, recession leads to increased spending and greater government borrowing not the other way around. Krugman joined the debate on Dube´s side but cautioned about claiming any causal relationship, or, if it existed, it would be pretty slim.

The debate is not over and, most likely, macroeconomists will continue sabre-rattling with lags and correlation studies to discuss the direction of causality and the location of the “tipping point”. In my view, it is unlikely that they will arrive at any unequivocal conclusion at the macroeconomic level for three main reasons. First, if we assumed a closed economy with a single firm we would end up with an accounting identity between total assets and their financing that would prevent any causality conclusions. Second, since leverage amplifies both gains and losses, any relationship must be very sensitive to the business cycles. Finally, the microeconomics of debt financing is too complex to build a one-way macroeconomic theory.

Yet at the firm level it must be easier to find if there is such a tipping point. There are basically three ways in which we can use debt-financing – to finance consumption, failed investments (including gambling) and profitable investments. In the long run only the third use is sustainable, but in the short run the three types of spending have a positive multiplier effect on economic growth. Elsewhere, I have shown why at the corporate level debt financing has simultaneously contracting and expansionary effects on investment, with the positive generally offsetting the negative effect depending on lender’s mark-ups and borrowing limits.

The corporate level is the right place to find out if and where there is any tipping point in the spectrum of leverage, because if there is one it should be close to the maximum debt-capacity financiers impose on the basis of several debt coverage ratios. Moreover, we may extrapolate those results to the macro level under the following, not very extravagant, assumptions: a) the shares of labour and capital in total income are relatively stable; b) an ever increasing number of companies do not pay dividends so that the growth of equity is a good proxy for economic growth; and c) listed companies give a good representation of the entire business sector.

Since profitable companies should use leverage to increase the return to their shareholders, the correct way to verify if they benefit from increased leverage is to check if the elasticity of equity in relation to debt is greater than one or at least positive. Since at SADIF Investment Analytics we cover more than 20,000 stocks worldwide we quickly pulled the quarterly growth rates of equity and debt for the last four years which allow us to gauge the relationship between equity growth and debt-financing.

We used data from countries that in the popular imagination epitomise the three types of use for debt financing. Americans are often seen as reckless shopaholics pursuing consumption-led growth policies, Euromeds (Portuguese, Spaniards, Italians, Slovenes and Greeks) are generally perceived as castle-in-the-air investors in loss-making projects in transportation and alternative energies generously financed by the EU/EIB and Germans are traditionally depicted as successful thrifty mercantilists. The distribution of firms and the median equity elasticity in each quadrant of the equity and debt growth space is given below.

The median equity elasticities highlighted in the table seem to validate the popular view on the use of debt financing since the Germans have the highest value and the Euromeds the lowest. The only discordant note is that the percentage of firms with a positive elasticity is much higher in spendthrift America than in thrifty Germany which weakens any macroeconomic extrapolation.

To test the location of a possible tipping point I plotted the equity elasticity against the extra debt capacity measured as the spare level of debt capacity as a percentage of total outstanding debt, so that we can measure the leverage spectrum from left to right in the chart below for the USA.
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The expectation is that elasticities rise as firms deleverage or leverage towards their maximum debt capacity (0% extra-capacity). The maximum of the quadratic functions fitted are indeed close to zero (i. e. -1.7% in the US and 7.3% in Germany). However the function is meaningless for the Euromeds and the coefficient of determination is too low for the other two countries.

So, in conclusion, this microeconomic evidence suggests that it is not possible to settle the debate on the correlation between growth and debt without allowing for the business cycle and the microeconomic complexities of debt financing.

German fun vs. Spain´s pain

The debt markets are focusing on Spain again, and the debate between fiscal conservatives and stimulus proponents rages once more. Paul Krugman has just published another post showing that before the real estate bust Spain´s public debt was much lower than Germany´s. He compares net flows in 2010 and 2007 to state his case. This is not a reliable method to compare leverage levels. So here are the most recent balance sheet values as published by the OECD.

It is true that with an economic size of less than half the size of Germany (43%), Spain´s government debt was just one fifth of Germany´s public debt. However, the Spanish economy as whole had a net debt equivalent to almost 80% of GDP, while Germany was a net creditor, and between 2007 and 2010 increased its creditor position from 6% to 21% of GDP.

In what concerns the shares of public consumption in total GDP we can see from the following table that the share in Spain is only marginally higher than in Germany.

The fundamental difference between the two countries is that Spanish companies borrowed more than German firms while Spanish households saved very little when compared with those in Germany.

Moreover, some of the borrowing was financed by Germany and was mostly invested in loss-making real estate. Indeed, the robust public finances in pre-crisis Spain were the result of paper profits generated during the real estate bubble (in a fashion not much different from the Clinton surplus during the internet bubble).

So, the Spanish problem is a banking problem and should not be transformed into a long term fiscal problem, like in Ireland, which will compromise its future growth.

Mob Management Style in Communist State Capitalism

The success of dictatorial forms of state capitalism often depends on the adoption of a mob management style.

As is well known, the various Mafia families run both legitimate and criminal activities. Often, what is not realized is that successful mafia bosses learned that they could not run the two types of business in the same way. When taking over lawful businesses they leave in charge the previous managers or employ new professional mangers (often reputable citizens) but appoint a minder to remind such managers that they cannot step out of line. The minder may be a deputy, a security guard or even a driver but the manager cannot doubt that he is the eyes and ears of the boss. This way, the mafia boss avoids turning his criminal associates into lousy managers that would ruin his business while preserving their loyalty by giving them limited power and rewards.

Maverick dictators like Hitler used the same management approach. He used his rogue bunch of SS criminals to instill fear among top civil servants but left intact the efficient German army and government bureaucracy, including the famous financier Hjalmar Schacht as president of the Reichsbank.

In the early 1990s, I personally observed the same policy being pursued by Kazakhstan’s communist-era leader and for-life President, Nursultan Nazarbayev. Before independence, the Kazakhs were predominantly poor and uneducated and the Russians dominated the entire government administration. Instead of packing them back to Moscow, he maintained their positions and privileges if they accepted the tutelage of his handpicked ethnic Kazakhs.

More recently, after the Chinese took over Macau from Portugal I observed the same policy in action. While the Chinese swiftly erased many of the Portuguese symbols in the territory, they kept most of the Portuguese running its administration. They simply appointed a party member from mainland China to monitor them, often despite the resentment among local ethnic Chinese.

Although this mob style of management can be successful in the short run, as it was in the early days of Nazi Germany and as it is now in China, I do not believe that it will be sustainable.

Its failure will happen not because the Mafia’s boss family or the Party Nomenklatura are prone to end up fighting over power (although this often happens), but because of a fundamental flaw of the mob management style.

Lasting management success requires three distinct qualities – investment acumen, business savvy and leadership.

While the mob management style guarantees leadership and may substitute business shrewdness by corruption, robbery or outright threat it can never achieve investment wisdom. It cannot provide the vision and flexibility necessary to anticipate opportunities and allocate capital efficiently. On the contrary, it will inevitably overspend in low return projects aimed at rewarding political clienteles or at securing the bosses’ own glorification and security apparatus.

Therefore, despite its recent success, we believe that communist state capitalism in China is doomed to fail. Unless, of course, the Chinese reverse their ways and move towards market capitalism and democracy.

The German Surplus and the Euro Zone Demise

Here are some figures someone should have explained to Mrs. Merkel, before she coerced European leaders (with the exception of Mr. Cameron, the UK prime minister) into fiscal fundamentalism.

First, a look at German savings:

With a slow growing economy, Germans save every year €130 billion, or 6% of their income, that they have to lend abroad. With the exception of the government, all sectors of the economy are net savers. Even the government managed to run a balanced budget during the financial crisis of 2008.

The problem with this Teutonic frugality is that it puts a burden on its trading partners, in particular those in the Euro Zone. Germany is currently running a current account surplus of about €140 billion per year, of which more than half (€73 billion) with her Euro Zone partners (of which Italy, Spain, Greece and Portugal account for half):

Simple national accounting arithmetic tells us that the reverse picture of a surplus is a deficit. Therefore, a reduction in the external deficits in the southern European countries will have to be matched by a partial reduction of the German surplus.

Should Germany succeed in the policy of bringing its Government deficit to zero as well those of the other Euro countries, this would have to be matched either by an increased external surplus (with the US, UK and other countries) or by a reduction in German economic growth and savings. Lower growth with the same rate of saving by Germans will depress the exports of other Euro area deficit countries to Germany and will depress further their growth in a recessionary spiral.

In summary, the misunderstanding of economic interdependence between Euro Area member countries and Mrs. Merkel housewife economics risk ruining the rest of Europe.

Subsidy Madness: The New Energy Policy of Germany

Free money is everywhere and every time a sure way to waste money in the most ludicrous ways.

Often this is only pathetic without causing serious damage to the economy. For instance when Brussels pays you to keep your pony paddock or when you no longer need even to pretend to grow olives; you simply have to show that you have title to the land and that you are keeping it in good nick, olives or no olives.

French farmers used to be the champions when it came to exploit the madness of government subsidies, but they are now being surpassed by the German producers of the so-called renewable energy (mostly wind and solar power).

Some years ago Germany established by law a ‘feed-in tariff,’ which obligated private utilities to buy renewable electricity from private producers at prices up to seven times higher than the market price and make their ratepayers pay for it (other countries like Portugal followed with similar measures). Some years after the German government imposed a moratorium on building nuclear power plants (one of the cheapest producers of electricity, see the table below) and ordered the existing ones – which produced 25 percent of the country’s electricity – decommissioned by the year 2021. The annual cost of this madness costs German taxpayers more than 17 billion Euros, this is an amount equivalent to more than 10% of the entire European Union annual budget).

To understand why this is economic madness you just need to consider this example. Imagine that a firm has two power plants, one powered by wind and the other by oil. The first has fixed costs of 40 cents per Kwh and zero variable costs. The second has 10 cents in fixed costs and 5 cents in variable costs. In a free market firms would build a second fuel-powered plant and decommission the wind-powered plant. But this not so as long as the government pays them a subsidy or lets them charge a tariff high enough to make the wind-power profitable. Now the firm’s optimal mix in terms of the two technologies will depend on the vagaries of the government policy not on the economics of the most efficient technology.

Unfortunately the madness of this policy is not an exclusive of the rich Germans. The debt-laden Portuguese responded to the recent rise in imported energy prices by switching to a similar energy policy and they have even overtaken Germany. Portugal now gets 53% of its electricity from renewable sources. The bad news is that it costs them 3 or 4 times more than conventional sources (at their current high level). Not a rational move, is it?