Why the Fed Buried Monetarism

Anatole Kaletsky

Janet Yellen

LONDON – The US Federal Reserve’s decision to delay an increase in interest rates should have come as no surprise to anyone who has been paying attention to Fed Chair Janet Yellen’s comments. The Fed’s decision merely confirmed that it is not indifferent to international financial stress, and that its risk-management approach remains strongly biased in favor of “lower for longer.” So why did the markets and media behave as if the Fed’s action (or, more precisely, inaction) was unexpected?
What really shocked the markets was not the Fed’s decision to maintain zero interest rates for a few more months, but the statement that accompanied it. The Fed revealed that it was entirely unconcerned about the risks of higher inflation and was eager to push unemployment below what most economists regard as its “natural” rate of around 5%.
It is this relationship – between inflation and unemployment – that lies at the heart of all controversies about monetary policy and central banking. And almost all modern economic models, including those used by the Fed, are based on the monetarist theory of interest rates pioneered by Milton Friedman in his 1967 presidential address to the American Economic Association.
Friedman’s theory asserted that inflation would automatically accelerate without limit once unemployment fell below a minimum safe level, which he described as the “natural” unemployment rate. In Friedman’s original work, the natural unemployment rate was a purely theoretical conjecture, founded on an assumption described as “rational expectations,” even though it ran counter to any normal definition of rational behavior.
The theory’s publication at a time of worldwide alarm about double-digit inflation offered central bankers exactly the pretext they needed for desperately unpopular actions. By dramatically increasing interest rates to fight inflation, policymakers broke the power of organized labor, while avoiding blame for the mass unemployment that monetary austerity was bound to produce.
A few years later, Friedman’s “natural” rate was replaced with the less value-laden and more erudite-sounding “non-accelerating inflation rate of unemployment” (NAIRU). But the basic idea was always the same. If monetary policy is used to try to push unemployment below some pre-determined level, inflation will accelerate without limit and destroy jobs. A monetary policy aiming for sub-NAIRU unemployment must therefore be avoided at all costs.
A more extreme version of the theory asserts that there is no lasting tradeoff between inflation and unemployment. All efforts to stimulate job creation or economic growth with easy money will merely boost price growth, offsetting any effect on unemployment. Monetary policy must therefore focus solely on hitting inflation targets, and central bankers should be exonerated of any blame for unemployment.
The monetarist theory that justified narrowing central banks’ responsibilities to inflation targeting had very little empirical backing when Friedman proposed it. Since then, it has been refuted both by political experience and statistical testing. Monetary policy, far from being dissipated in rising prices, as the theory predicted, turned out to have a much greater impact on unemployment than on inflation, especially in the past 20 years.
But, despite empirical refutation, the ideological attractiveness of monetarism, supported by the supposed authority of “rational” expectations, proved overwhelming. As a result, the purely inflation-oriented approach to monetary policy gained total dominance in both central banking and academic economics.
That brings us back to recent financial events. The inflation-targeting models used by the Fed (and other central banks and official institutions like the International Monetary Fund) all assume the existence of some pre-determined limit to non-inflationary unemployment. The Fed’s latest model estimates this NAIRU to be 4.9-5.2%.
And that is why so many economists and market participants were shocked by Yellen’s apparent complacency. With US unemployment now at 5.1%, standard monetary theory dictates that interest rates must be raised urgently. Otherwise, either a disastrous inflationary blowout will inevitably follow, or the body of economic theory that has dominated a generation of policy and academic thinking since Friedman’s paper on “rational” expectations and “natural” unemployment will turn out to be completely wrong.
What, then, should we conclude from the Fed’s decision not to raise interest rates? One possible conclusion is banal. Because the NAIRU is a purely theoretical construct, the Fed’s economists can simply change their estimates of this magic number. In fact, the Fed has already cut its NAIRU estimate three times in the past two years.
But there may be a deeper reason for the Fed’s forbearance. To judge by Yellen’s recent speeches, the Fed may no longer believe in any version of the “natural” unemployment rate.

Friedman’s assumptions of ever-accelerating inflation and irrationally “rational” expectations that lead to single-minded targeting of price stability remain embedded in official economic models like some Biblical creation myth. But the Fed, along with almost all other central banks, appears to have lost faith in that story.
Instead, central bankers now seem to be implicitly (and perhaps even unconsciously) returning to pre-monetarist views: tradeoffs between inflation and unemployment are real and can last for many years.
Monetary policy should gradually recalibrate the balance between these two economic indicators as the business cycle proceeds. When inflation is low, the top priority should be to reduce unemployment to the lowest possible level; and there is no compelling reason for monetary policy to restrain job creation or GDP growth until excessive inflation becomes an imminent danger.
This does not imply permanent near-zero US interest rates. The Fed will almost certainly start raising rates in December, but monetary tightening will be much slower than in previous economic cycles, and it will be motivated by concerns about financial stability, not inflation. As a result, fears – bordering on panic in some emerging markets – about the impact of Fed tightening on global economic conditions will probably prove unjustified.
The bad news is that the vast majority of market analysts, still clinging to the old monetarist framework, will accuse the Fed of “falling behind the curve” by letting US unemployment decline too far and failing to anticipate the threat of rising inflation. The Fed should simply ignore such atavistic protests, as it rightly did last week.

A scandal in the motor industry

Dirty secrets

Volkswagen’s falsification of pollution tests opens the door to a very different car industry

EMISSIONS of nitrogen oxides (NOx) and other nasties from cars’ and lorries’ exhausts cause large numbers of early deaths—perhaps 58,000 a year in America alone, one study suggests. So the scandal that has engulfed Volkswagen (VW) this week is no minor misdemeanour or victimless crime. The German carmaker has admitted that it installed software on 11m of its diesel cars worldwide, which allowed them to pass America’s stringent NOx-emissions tests.
But once the cars were out of the laboratory the software deactivated their emission controls, and they began to spew out fumes at up to 40 times the permitted level. The damage to VW itself is immense. But the events of this week will affect other carmakers, other countries and the future of diesel itself.  
Winterkorn is going

VW first. Its chief executive, Martin Winterkorn, has resigned, and the company is setting aside €6.5 billion ($7.3 billion) to cover the coming financial hit. But investors fear worse: in the first four trading days since the scandal broke on September 18th, VW’s shares fell by one-third, cutting its value by €26 billion. Once all the fines, compensation claims, lawsuits and recall costs have been added up, this debacle could be to the German carmaking giant what Deepwater Horizon was to BP.
At least BP’s oil-drilling disaster was an accident; this was deliberate. America’s Department of Justice is quite right to open a criminal investigation into the company. Other countries should follow South Korea and probe what VW has been up to on their patch. Though few Chinese motorists buy diesel cars, the scandal may prompt its government to tackle the firm for overstating fuel-economy figures for petrol engines.
Whether or not Mr Winterkorn bore any personal responsibility for the scandal, it was appropriate that he should lose his job over it. He is an engineer who is famous for his attention to detail; if he didn’t know about the deceptive software, he should have. Selling large numbers of “Clean Diesels” was central to VW’s scheme for cracking the American market, a weak spot, which in turn was a vital part of the plan to overtake Toyota of Japan as the world’s largest carmaker. The grand strategy that Mr Winterkorn had overseen now lies in ruins.
A change at the top, and a hefty fine, must not be the end of the matter. America’s prosecutors ought to honour their promise to go after the individuals responsible for corporate crimes, instead of just punishing companies’ shareholders by levying big fines. Most of the recent banking scandals have ended not in the courtroom, but in opaque settlements and large fines.
Earlier this month the Department of Justice announced a $900m settlement with GM, America’s largest carmaker, for failing to recall cars with an ignition-switch defect blamed for crashes which killed at least 124 people and injured 275. Prosecutors said (unnamed) managers at GM had knowingly ignored the potentially deadly effects of the fault, and put profit before safety. Yet they announced no charges.

That has to change—and the authorities know it. In a speech this month, America’s deputy attorney-general, Sally Yates, said that from now on, fining businesses would take second place to pursuing criminal and civil charges against individuals. An accused firm will no longer get credit for co-operating with investigations (as VW says it will) unless it gives the feds the names of every manager or employee involved in wrongdoing, and seeks to gather and submit evidence of their personal responsibility. VW is a test of this new approach. But to avoid suspicions of being tougher on foreign firms—as were raised in the BP Deepwater case and in recent banking settlements—the American authorities should also prosecute culpable GM managers.
Yet the biggest effects of the scandal will be felt across the Atlantic. VW’s skulduggery raises the question of whether other carmakers have been up to similar tricks, either to meet Europe’s laxer standards on NOx emissions or its comparable ones on fuel economy—and hence on emissions of carbon dioxide. BMW and Mercedes, VW’s two main German peers, rushed to insist that they had not. However, in Europe, emissions-testing is a farce. The carmakers commission their own tests, and regulators let them indulge in all sorts of shenanigans, such as removing wing mirrors during testing, and taping up the cracks around doors and windows, to reduce drag and thus make the cars burn less fuel. Regulators also tolerate software a bit like VW’s, that spots when a car is being tested and switches the engine into “economy” mode. This is why the fuel efficiency European motorists achieve on the road is around 40% short of carmakers’ promises.
At least America’s regulators, unlike Europe’s, sometimes stage their own tests to verify the manufacturers’ findings. But it is time this whole system was swept away and replaced, everywhere, with fully independent testing of cars in realistic driving conditions. Now, with outrage at VW’s behaviour at its height, is the moment to act. That would mean overcoming the objections of carmakers. But it also requires European regulators to change their attitudes to diesel, which accounts for half of cars sold on the continent. Diesel vehicles can be very economical on fuel (and thus emit relatively little carbon dioxide) but often at the cost of increased NOx emissions. That trade-off has been decided in diesel’s favour by Europe’s lousy testing regime and more lenient NOx-emissions standards.
See no diesel
Even if other makers of diesel vehicles have not resorted to the same level of deception as VW, the scandal could mean that these cars struggle to meet standards applied rigorously to both types of emission. Some fear that this may be the “death of diesel”. So be it. There is still scope to improve the venerable petrol engine; and to switch to cleaner cars that run on methane, hydrogen and electricity, or are hybrids. A multi-billion-dollar race is already under way between these various technologies, with makers often betting on several of them as the way to meet emissions targets. If VW’s behaviour hastens diesel’s death, it may lead at last, after so many false starts, to the beginning of the electric-car age.

Debt As Far As The Eye Can See

There is an alarming rise of public and private debt ratios in much of the world; this simply cannot continue like this.
The situation is greatly complicated by low growth and low inflation as we need high nominal GDP growth to stabilize debt ratios.
We look at the sustainability and alternatives to deal with the problem.
Part of what led to the financial crisis of 2008 was simply the steady accumulation of debt. At one time, the bottom 90% of households spend almost 10% more than their (stagnant) incomes, in order to keep on spending and/or buy a house.

Much of this borrowing binge was financed by mortgage debt, which was very easy to get as banks and other mortgage lenders repackaged loans into inscrutinizable tradable securities which could be offloaded from their balance sheets and shifted to unsuspecting investors.

A big part of why the 2008 financial crisis produced such a big economic crisis is that household balance sheets were ravished, with $9 trillion in assets wiped off, or nearly 40% of household wealth, because of the crash in house prices while the debt remained.

Part of the reason the recovery was a little tepid was because of households trying to repair at least part of that damage to their balance sheets, hence the term balance sheet recession.

Deleveraging occurred, that is, households started to save more and spend less, in order to pay down debt. The increased savings in a balance sheet recession also explains why interest rates are so low and why monetary policy has been relatively powerless. Rather than take up new debt, households prefer to pay-off old debt, no matter how low interest rates are.

And indeed they did, as you can see in the following table from a BIS study:

A closer look at the table above shows that there really are only a few minus signs, indicating that, by and large, deleveraging has been few and far between.

The private sectors (households and corporate) in the US, UK, Germany and Spain did manage to deleverage, as did the private sector in South Africa. But that's about it. What strikes is the continuous increase in leveraging up at the aggregate (private + public sectors) basically everywhere.

There has been overall deleveraging.

Public sector leveraging, that is, a rise in the public sector/GDP ratio, has gone on unabated (apart from Turkey, India, Indonesia and Switzerland). To a large part, this is a reflection of lower economic growth and inflation affecting tax receipts (more especially in the eurozone).

Part of it isn't so worrying as when private sectors are deleveraging, the slack this creates in the economy has to be absorbed in order to keep the economy afloat, lest it succumbs to a Fisherian debt-deflationary vortex. One should also realize that the public sector is way more creditworthy, so it substitutes high-rate private debt for much lower-rate public debt.

This is Krugman's "debt is good" argument. This isn't a blanket pro-public debt argument, but circumstantial under the present conditions (interest rates at the zero lower bound, lowflation, considerable slack in the economy):
  • Public debt can pay for good things like infrastructure, boosting production and the supply side at a time when interest rates are very low.
  • Provide safe assets the markets demand and so ward off a destructive scramble for cash.
  • Produce upward pressure on interest rates without slowing the economy.
What is certain is that deficit spending has considerable multiplier effects under these conditions, Summers and DeLong even argue that it could be self-financing, that is, reduce, rather than increase debt dynamics.

However, it's also clear that this accumulation of debt, whether private or public, simply can't go on forever. There are simply enormous risks attached to that:
  • Sudden stop in funding: acute financial crisis.
  • The slow debt-deflationary grind, with eurozone countries, especially Italy as a prime example and risk.
  • There will be no region left to absorb another shock, as emerging markets (especially China) did after the Lehman crisis.
  • There will be no policy instruments left to absorb another shock.
  • Problem will escalate when interest rates "normalize".
Let us discuss some of this in more detail.

Financial crisis

The most immediate and biggest risk is that the rising debt will lead to financial crisis. Here is Martin Wolf from the FT:
Ruchir Sharma of Morgan Stanley argues that the 30 most explosive credit booms all led to a slowdown, often a crisis. A rapid change in the ratio of credit to gross domestic product is more important than its level. That is partly because some societies are able to manage more debt than others; it is partly because a sudden burst in lending is likely to be associated with a sudden collapse in lending standards.
Indeed, this is what happened before the biggest financial crisis of them all:
In an update of work on debt and deleveraging, McKinsey notes that between 2000 and 2007, household debt rose as a proportion of income by one-third or more in the US, the UK, Spain, Ireland and Portugal. All of these countries subsequently experienced financial crises.
In this respect, the 70-point rise in the debt/GDP ratio of China is particularly worrisome, not only in and of itself, but also for other aspects as well:
  • China's economy is slowing down, which could lead the authorities to open the credit floodgates once more.
  • Capital is flowing out of China, which is a worrying sign in and of itself, but it also automatically tightens domestic monetary conditions (the result of the PBOC buying its own currency in order to support it), which could lead to strains and default of debtors. Luckily a full-blown banking crisis isn't very likely in China as these are state owned or backed.
In China and other emerging markets, debt has been accumulating as capital has entered, and now that it is leaving (to the tune of almost $1 trillion since July 2014), economies are worsening in a worrisome way.

Capital outflows sink their currencies, which increases the (largely private sector) debt value in domestic currency. It forces selling foreign currency reserves, tightening domestic monetary conditions, which slows their economies further.

Many of these economies are already in trouble as a result of reduced demand for commodities and the subsequent crash in commodity prices. Such are the problems in emerging countries that it even prompted the Fed to hold off interest rate rises, given that emerging markets are now half of the world economy and provided it with much of the economic growth post Lehman.

While foreign currency levels are generally considerably higher and governments have borrowed less in dollars, another emerging market crisis like the Asian crisis or the Russian crisis of the 1990s cannot be excluded.

We are especially concerned about China, not because we think that it will suddenly implode, but simply because its size and its nexus to commodities and financial flows makes it especially important for the health of the world economy.

If and when the Fed does decide to tighten monetary policy, the fallout in emerging markets could be considerable, given that they already suffer from capital outflows and sinking currencies. This could easily accelerate when US money is repatriated on higher rates and dollar appreciation expectations.

We're hardly alone in pointing out the problems here (per CNBC):
The U.S. Federal Reserve risks triggering "panic and turmoil" in emerging markets if it opts to raise rates at its September meeting and should hold fire until the global economy is on a surer footing, the World Bank's chief economist has warned.
The IMF has issued similar warnings, and the Fed has obliged.

The slow grind

There is another, less visible, but equally disturbing debt crisis, which is mainly the result of low growth and "lowflation." This pincer produces a ratcheting up in debt ratios through the "denominator" effect (where debt/GDP increases as a result of stagnant nominal GDP).

The prime example here is Italy, and this is a dangerous situation (as we explained in much greater detail here) because:
  • Italy's public debt ratio is already very high at 130%+ of GDP.
  • Italy isn't the master of its own currency; its debt is basically in a foreign one over which it has no control.
  • Italy has few instruments at its disposal to revert the situation; it's unable to reflate by monetary, fiscal, or currency means.
Many eurozone countries suffer from the same problem. While some growth has returned to the eurozone, inflation is still very low, so this isn't enough to stabilize, let alone make any kind of dent in the debt ratios.

The next slowdown

There isn't much room for countercyclical policies when economies which already experience high public debt levels and zero interest rates face another recession.

We were quite lucky that emerging economies (very much including China) buffered the economic impact of the 2008 financial crisis, being responsible for most of world output growth since. However, there doesn't seem to be a region left that could absorb or at least mitigate another economic shock.

Private debt

Many blame the debt explosion on public sector largesse. However, here is Martin Wolf of the FT again:
Start with the sources of vulnerability. In economies with liberalised financial sectors, the driver towards disaster is far more often private than public imprudence.
Now, many then blame the Fed for the low interest rates, but as we argued extensively (here), the rates that matter most (bond yields) have been low with or without the Fed, and the Fed has limited influence over these in any case.

If there was any doubt about this, then the introduction and end of massive QE programs demonstrated this point with force. Rates haven't collapsed as a result of asset buying and neither have they exploded when these were stopped.

This doesn't mean that public authorities and central banks can be entirely exonerated from the rising debt binge. While we firmly believe that interest rates should be set with respect to the state of the economy, authorities can do a lot to prevent debt bubbles from emerging:
  • Fiscal policy should be countercyclical, that is, during boom times debt should be repaid.
  • Central banks shouldn't hesitate to intervene with macroprudential policies where credit growth is excessive.
Of course, the latter depends on the ability to spot asset bubbles, which is always that much easier with the benefit of hindsight. Still, an unusual and prolonged rise in credit or asset prices should serve as an early warning sign.

How to deal with the debt?

Historically, high debt levels have either been written off, or the real burden of debt has been eroded by a steady dose of mild inflation and economic growth. The latter increases nominal GDP, which is probably the least painful way to reduce real debt burdens.

Write-offs might still happen in isolated cases (Greek public debt?), but it's the growth of nominal GDP that seems to be lacking. The problem here is that in order to get higher growth, most countries have relied on monetary policy. However, this hasn't been very successful. See for instance the massive actions taken by the Japanese central bank, the BoJ, which hasn't been able to break Japan free from deflation.

That might still happen, as the tax hike and the commodity crash have considerably complicated things for Japan, but it shows how difficult it is in the present circumstances to create nominal growth.

Inflation is also very low in the US and the eurozone, and one has to keep in mind that inflation doesn't actually have to be negative to produce the damaging debt dynamics and other problems (per the IMF). Considering the difficulties of creating even some inflation, there is an increasing chorus of economists that argue for something bolder, especially if the world plunges into another recession and/or deflationary bout.

The bold policy is "helicopter money," an old idea from Milton Friedman (borrowing from an older Chicago tradition) where central banks directly finance public expenditures or tax cuts (or both). It has the advantage over QE as it injects money directly into the veins of the economy, rather than depending on financial markets or the creation of new debt.

We also know it works; this is mainly how Japan got out of the depression in the 1930s. It is also more likely to create the growth and mild inflation as to stabilize, and even starting to dent the existing debt mountains. However, it's not without risk. It compromises central bank independence and inflation can get out of hand.

The latter isn't a serious risk as interest rates can be increased and/or the bond portfolios of central banks (product of earlier QE policies) can be sold off. The main risk is politicians getting used to free money, so the instrument should be firmly in hands of the central bankers, deciding on quantities.

And, of course, like any policy avenue, its effectiveness, advantages and disadvantages should be judged against real-world alternatives. The real world alternative is low growth, lowflation, and ever increasing debt levels.


Much of the world is drowning in debt. In the present economic environment of modest (and decelerating) growth and lowflation, this is likely to get worse, not better. The only alternatives seem to be debt write-offs and/or some form of direct monetary financing of spending. Bold, yes, but there isn't much of an alternative.

Germany’s Immigration Challenge

John Mauldin

This immigration crisis in Europe is a big deal, and it’s a bigger deal for Germany than for any other European country. Germany is directly in the firing line, both geographically and in terms of how many of the migrants want to settle there. Nearly 40% of migrants choose Germany as their preferred final destination, while the only other nation that is chosen by more than 10% of migrants is Hungary, at 18%.

Daniel Stelter is a very wired German economist and business thinker. He wrote to me a couple days ago, said he had read my remarks on Germany and the immigration crisis in last week’s Thoughts from the Frontline, and recommended to my attention a couple of articles he had just written on the issue. They are today’s Outside the Box.

In his note to me, Daniel says:

I doubt that it will work out as politicians hope. In theory we agree: well-educated people come to Germany to help us deal with the demographic crisis we face. The reality is that a big part of the immigrants will not be able to fulfill these hopes as they are illiterate, etc. We would have to invest heavily to make this happen, but politicians shy away from doing so. I have summarized what the scenarios are and what we would have to do to make it happen in this two-part comment for the Globalist, which you might want to have a look at. To be clear: Germany looks like ending up with more problems than less if we don’t change gears fast.

Please note that Stelter is not anti-immigration. His first piece below, “Germany’s Immigration Challenge,” enumerates the difficulties to be faced if Germany is to greatly increase immigration and lays bare a number of misconceptions about Germany’s ability to do so; but he doesn’t stop there. In the second piece, “Germany: A 10-Point Plan to Deal with the Immigration Challenge,” he thoroughly details what it would actually take for Germany to sustainably integrate the current wave of immigrants. This is a no-nonsense, no-holds-barred effort to confront the immigration crisis.

Whether or not you think Stelter’s scheme can be realized, this (or something much like it) is what it will take to get the job done, not just in Germany but throughout Europe. This is going to be a costly endeavor no matter what, and it is going to happen as services and retirement payments are cut due to strained budgets. Which is going to strai n nerves. This is the type of problem that has led to Marine Le Pen in France and others throughout Europe on the radical right and left beginning to show real strength in the polls. (Take a look at this piece on Le Pen from yesterday.)

Perhaps I am more fretful than I should be after my dinner with George Friedman, who loves Europe but doesn’t think the EU is the answer, nor that will it last in its current form.

I spent much of the day and will continue long into the evening in a planning session for the 2016 Strategic Investment Conference. It will be held in Dallas May 24-27, and I truly believe it will be my best conference ever. Part of the new emphasis is going to be on the ability of attendees to network with one another. There are cool new technologies that allow us to do that.

The biggest “problem” is trying to sort out who the speakers will be this year: we have an embarrassment of riches. Well, that problem plus the half-dozen other major priorities that are already demanding lots of attention. I actually remember a time in my life when I felt that I could read the sports page and watch TV while still dealing with business and raising seven kids, plus being involved in politics and church, etc.

The irony is that I have this fabulous media system throughout the house, and I am ashamed to say that it is rarely used, except when kids or friends come over to watch something. I know I’m not the only person with insufficient bandwidth, because I hear it from friends everywhere.

And the availability of great information is only going to increase. I am told that someday we’ll each have an information “butler” to help us handle the load, but that cool new personal AI app is going to have to wait for a lot more power in our computers and phones and monster upgrades in software.

I suppose it will come much like the speech-recognition technology that I’m using to write this letter. Given that I’m actually a relatively slow and clumsy typist, it has really increased my productivity.

But I can’t tell you how many versions of this software I bought over the last 12 years that were not ready for prime time. I suspect that the introduction of techno-butlers will go much the same way.

We’ll endure a lot of hype, spend our money, and be less than satisfied with the results. But by version 12.5, iButler will actually be a tool we can’t live without. If its development proceeds at the same pace as speech-recognition, then my personal butler might not show up ready for work until sometime in the late ’20s. On the other hand, the technological transformation is accelerating, so…

While we’re at it, I really do hope that Mike West over at Biotime can figure out how to make a new or at least a younger version of me, or at least the parts of me that I’m going need, by then.

You have a great week.

Your trying not to overload your inbox analyst,

John Mauldin, Editor
Outside the Box

Germany’s Immigration Challenge


We have to make an honest assessment of costs and benefits of
the migration crisis.

By Daniel Stelter
September 13, 2015

Germany is considered a rational, fact-driven country, not an emotionally driven one. And yet, based on the current immigration debate in Germany, even the advocates of more immigration have little more to offer than emotional arguments.

Given our nation’s history, Germans want to help wherever and however possible. Offering asylum to those in danger is deeply rooted in our society and even those who look for a better living are welcomed by a large segment of German society.

The advocates of more openness point to the benefits which an aging and shrinking population receives from more immigration and they see the potential costs as rather minimal, at least for a rich country like Germany.

That is a rather rose-tinted assumption because it underestimates the financial costs, overestimates the benefits from immigration and clearly overestimates the financial capacity of Germany.

Being overly optimistic helps neither the immigrants themselves nor the cause of promoting greater openness in German society.

Tremendous costs

Proponents of more immigration to Germany refer to the shrinking workforce and the significant unfunded liabilities for pensions and health care, estimated at least at about four times the country’s GDP.

The ultimate answer about how significant more immigration is in that context depends on what the net contribution of immigrants is to the German economy.

Aside from the fact that the answer is very contested, even well beyond the realm of politics in the field of academic literature, there is an additional problem. No one can tell for sure, as the qualification of immigrants, especially refugees, is not registered.

Supporters of immigration point to the high number of academics immigrating, such as Syrian doctors. Critics point to a high number of uneducated and illiterate people. Most probably, Germany is receiving a mix of both, very well educated and uneducated people.

Even making a very optimistic assumption – that 50% of the one million immigrants expected in 2015 are well educated, willing to be integrated and want to contribute to the German society, while the other 50% will remain largely dependent on public support – we can make a simple calculation.

If the 50% share of skilled immigrants before long were to earn 80,000 euros on a per capita basis – well above Germany’s average income of about 40,000 euros – and paid taxes of 40%, their annual contribution to society in form of taxes would be about 16 billion euros per year.

Availability of only high-skill jobs

At the same time, assuming a social welfare cost of about 25,000 euros per “non-productive” immigrant, those costs would total 12.5 billion euros annually. That would still leave a positive net contribution to German society and the nation’s economy

This underscores that it is obviously critical from an economic point of view to attract a high share of productive immigrants.

But this matters for more than just economic considerations. As an advanced industrial democracy, Germany offers plentiful immigration opportunities for skilled people.

However, unlike the past when large swaths of low-skilled people came to Germany, the supply of low-skilled jobs in the manufacturing sector is drying up quite rapidly, not least due to the increased automation of German industry.

What is available are jobs in the services economy which require language skills and an ability to do abstract reasoning. Germany ought to be quite focused on this issue – not because it is heartless but prudent.

The country has made plenty of mistakes on the immigration front in the past, which ought not to be repeated. Not embracing an active, skills-based approach to the management of immigration – à la Canada or Australia – was one such mistake.

Does it matter?

Of course, one could conclude that net costs of a few billion per year do not matter for a country as rich as Germany. This is true – but only from the current perspective.

If one shifts from static to dynamic analysis and realizes that immigration into Germany may very well continue at the current speed, the picture looks quite different.

  • Assuming a total pool of five million immigrants flowing in and a more likely mix of 30% skilled immigrants to 70% unskilled or low-skilled ones, the net costs would rise to 38 billion euros per year.
  • Over a time horizon of 30 years, this would easily lead to costs of more than one trillion Euros. That is close to the entire costs of German reunification between 1990 and 2010.

Not as rich as it claims

Let’s also understand that Germany is not as rich as it claims. Besides the unfunded liabilities for the aging society of more than 400% of GDP, the strategy to exit from nuclear energy is expected to cost German consumers and businesses about 1 trillion euros.

Even that might be manageable if the euro were structured in a sound manner. As things stand, rescuing the Euro will at least cost another trillion euros. Add in the backlog of investments in public infrastructure and another trillion euros is gone.

A plan for immigration

Obviously, Germany needs to spend its money intelligently. But we also need to change our behavior.

From both an economic point of view, as well as from a humanitarian point of view and from the vantage point of providing of solid integration perspective in German society, we have to make the best out of the wave of immigration coming to Europe and Germany.

Germany: A 10-Point Plan to Deal

With the Immigration Challenge

What does it take to make sure that the immigrants now arriving
are integrated in a sustainable manner?

By Daniel Stelter
September 14, 2015

Reduce bureaucracy

The process of accepting someone as a refugee in Germany takes too long. We need to define safe countries, like Albania, and send immigrants from these countries back directly.

With all sympathy for their interest in a better living, they are not threatened by war or discrimination. On the other hand, refugees from countries in (civil) war should be accepted fast.

Get to work

It is very important to get immigrants into work once they are in Germany. It is bad for both skills and motivation levels if people cannot work.

Learning the German language is of utmost importance and should be mandatory. Ideally from day one onwards, immigrants should have to start learning the language.

And as long as the immigrants don’t have a job, they should do community service. This advances their integration into society and would give a clear signal: Everyone coming to Germany has to contribute to the common good with his or her abilities.

Significant investments in

education and integration

We need to register skills in order to find the appropriate job or define the necessary next steps in education. Education will the biggest challenge.

German schools even today fail to integrate and educate the children (and grandchildren) of migrants who have been in the country in some cases for some decades.

The school performance of children from Turkey, the Arab world and Africa is significantly below the average. We need to invest significantly, as this will define which share of migrants will become productive members of our society and which share will depend on social welfare.

Defend our values

Not only skills and language are important. In addition, we need to emphasize our principles and values. This includes freedom of speech and religion, women’s rights, tolerance for minorities and non-violence.

We have to make clear that integration will only work this way and is expected from everyone. Simply arriving is not enough to stay.

Canada, while generally being very welcoming to immigration, every year sends back about 10,000 immigrants – not necessarily for lack of integration, but it is not a one-way Street.

Mandatory schooling

Participation in language school and courses on values and rules in Germany need to be mandatory for every new arrival. Just as Brazil does with its bolsa familia, the payment of social welfare should be linked to language and values training.

In doing so, we would convey the image of Germany as we should – a country willing to help, but also a country in which everyone has to make a contribution. Everyone who expects help and support needs to be willing to learn the language.

Recruit qualified immigrants

It is clear that a selection process as in Canada and Australia succeeds in attracting better-qualified migrants.

Besides refugees from war and people in their home countries, who need our support and where economic considerations should play no role, Germany should become more attractive for well-qualified migrants and be more active in advertising the opportunity to build a new life here.

As a consequence, we should actively open the way for legal immigration to Germany. As a result, the applicants could spend their savings on building a new life here, instead of spending it on smugglers.


Both sides, the migrants and the German population, need to accept immigration as a lifetime decision. It is not a temporary refuge.

Again, Canada proves the point: If it is seen as permanent, both sides, the migrant and the accepting country, work harder to make integration work.

That has been a particular shortcoming of Germany’s immigration policies in the past, especially regarding Turks.

Help in the poor countries

It would be cheaper and more effective to help the people in safe countries such as Albania, who aim for a better life, with direct financial and organizational support.
The EU should invest there and help to build democratic institutions and a working rule of law.

Fostering peace

The current wave of immigration is the result of conflicts which have lasted for decades already – and will likely last decades more.

This is amplified by a demographic development which leads to a high number of young people without a credible perspective of finding a job in their home country. This, in turn, increases the propensity not just for social strife, but even for (civil) war.

The West needs to reconsider its strategy fundamentally. The current U.S.-led approach of favoring military intervention over development aid only leads to even more destabilization.
Be all in

The humanitarian and financial costs of such a strategy are enormous. But if we don’t do this, we will have much higher costs to incur.

Whoever speaks of the benefits of immigration also needs to make sure that all the groundwork is laid so that the possible benefits are also realized. Making the necessary investments can by no means be taken for granted.

In conclusion, the current and future wave of immigration to Germany could be beneficial for our country – but only if we address the challenge with full force.

Unfortunately, it seems as if, just as in the eurozone crisis, that our various countries’ leaderships – Germany’s included – are failing at the task.

There is no denying that any solution involves shouldering huge costs for all citizens, natives and migrants. Those who hope that the wave will end soon should think again: Sub-Saharan Africa’s population is about to grow by 600 million over the next 20 years.

100 million or more of those mostly young people will look for a better life in the north. We had better learn now how to deal with it.

Op-Ed Contributor

Let Refugees Fly to Europe


OXFORD, England — There are no easy solutions to Europe’s refugee crisis. In a world of fragile states and increasing mobility people will continue to come, irrespective of whether they neatly fit the legal definition of a “refugee.” Europe needs a clear strategy on who it wants to protect, and where and how to assess people’s asylum claims.
The European Union’s agreement earlier this week centered on a quota system to relocate 120,000 Syrian, Iraqi and Eritrean refugees across member states — most likely from transit centers in Greece and Italy. The plan has several flaws: It was passed without political consensus, it has no mechanism to ensure that people remain in the countries assigned to take them, and it does not say how those denied asylum will be treated.
The biggest problem, though, is that the plan does nothing to stop people from embarking on perilous journeys to Europe. In order to claim asylum under this plan, refugees would still have to arrive in Europe through clandestine means. This has been the direct cause of tragedy and chaos, with people dying on Europe’s roads and drowning at sea. The greatest strain has been at key border areas from Hungary to the Greek islands.
The way to avoid this would be to provide an alternative, legal means for asylum seekers to travel to Europe through “humanitarian visas.” Small consular outposts could be created outside the European Union, in places like Bodrum in Turkey or Zuwara in Libya. As migratory routes change over time these posts could be relocated. At these transit points people could be quickly screened and those with a plausible asylum claim would be allowed access to Europe. They could then simply fly to Europe or take a scheduled ferry at their own expense.
At the moment, Syrians are paying over 1,000 euros for a short but dangerous crossing from the Turkish coast to Greek islands like Lesbos or Kos, some being rescued by the Greek coast guard. The cost in lives and in resources for the already-stretched Greek state is high. In contrast, a nonstop flight from Bodrum to Frankfurt costs 200 euros.
Humanitarian visas would also undercut the smuggling markets. Since the start of the crisis, Europe has declared a “war on smugglers,” even proposing to use military force against them. However, like the “war on drugs,” such policies are doomed if they only offer supply-side solutions but do nothing to remove the underlying demand of vulnerable people. Enabling refugees to access legal travel routes would immediately reduce the smuggling problem.

There are several ways this policy could be implemented. It could be adopted throughout the European Union, and connected to the Europe-wide quota system. The union could establish outposts at which plausible asylum seekers are identified, in some cases purely on the basis of nationality.
They could then quickly receive a travel document, perhaps linked to a “temporary protection status” in a designated member state. The right to remain could last until they are able to return home or regularize their immigration status in the new host country.
Even if an E.U. agreement could not be reached, there are other options. Visas could be offered unilaterally by countries that have agreed to accept refugees. Indeed, Brazil has already done this by announcing its willingness to provide humanitarian visas, so far taking over 2,000 Syrian refugees through the scheme, all of whom were recognized as refugees upon arrival. Germany and Sweden, which have pledged to take an even greater number, could do the same, and provide screening and visas at strategically located consular outposts.

The idea of refugee travel documents has an historical precedent: the Nansen Passports used by the League of Nations. Following World War I, the collapse of the Ottoman Empire and the consequences of the Russian Revolution made hundreds of thousands of people stateless and brought refugees to Europe’s borders.
In 1922 the first High Commissioner for Refugees of the League of Nations, Fridjtof Nansen, convened a conference in Geneva at which a group of countries agreed to recognize Nansen passports as legitimate refugee travel documents. Between 1922 and 1942, the scheme was recognized by over 50 countries and enabled 450,000 people, including Assyrian, Armenian and Turkish refugees, safe passage to Europe. In recognition of its work the Nansen International Refugee Office received the Nobel Peace Prize.
There are challenges to issuing refugee travel documents today, but they are surmountable. Governments will understandably worry that allowing legal entry is likely to lead to a “pull factor” and increase the demand to move to Europe. This risk can be addressed in several ways.

First, establishing consular points near Europe’s external border would cater mainly to people who are already almost in the European Union and about to risk a dangerous boat journey. Second, visas would only be given to likely refugees, to whom we already have an internationally recognized legal obligation. Third, while it is possible that more Syrian refugees would choose to seek admission to Europe rather than remain in neighboring countries, a slight increase in numbers is a worthwhile price to pay if it saves lives, cuts costs, alleviates pressure at Europe’s borders and drastically curtails the human-smuggling market.
Humanitarian visas would not be a panacea and they would not completely remove irregular immigration to Europe. However, even if they were only granted to Syrians, that would address the immediate challenge for more than 70 percent of the people arriving on the Greek islands.
Powerful images of people walking long distances across train lines and motorways have created a widespread sense of crisis in Europe. But much of this tragedy and chaos is avoidable. Simple policy decisions by countries that have agreed to accept large numbers of refugees could halt the mass exodus. In the age of the budget airline and modern consular screening capabilities, such perilous journeys are not necessary.

It’s Always 1979 Somewhere

Jared Dillian
Editor, The 10th Man

First, let’s get the gloating out of the way. I said that the Fed would not hike rates here and here. Nobody likes a chest pounder, so that’s the end of the discussion.

So now, what is the trade? Not only did the Fed not hike rates, but the directive was so dovish, it was far outside the range that any reasonable person thought was possible. Should be bullish, right?

Bullish on two-year notes.

For years, Jefferies Chief Market Strategist David Zervos recommended positions in “Spooz and twos” when faced with a Fed that had no interest in tightening monetary policy as the economy was recovering briskly. Now the Fed is on hold indefinitely.

Buy stocks? Maybe. Maybe just not in the US.
No Hike Until 2017

In my publication The Daily Dirtnap, I’ve been saying for a while now, for almost a year, that the Fed is on hold until 2017.

Of course, I can say that to my subscribers, but I have not (up until this point) said it publicly, because that’s a good way to get yourself labeled as some kind of crank. But after what just happened, this is starting to look less like a crank point of view, and I’m comfortable talking about it publicly.

Based on the FOMC meeting last week (and the subsequent market action), it is looking less likely that the Fed will hike interest rates this year. I would place the probability for a hike between 30 and 50%. Although, keep in mind, there is no press conference at the October meeting, and it’s very rare for the Fed to begin hiking rates in December.

Once you are in 2016, you are in an election year, and… this is the point people get a little touchy about, but the political implications are a lot larger than you may think.

The current Board of Governors are all Obama appointees (including two in the hopper) and presumably all Democrats. What if the Fed hikes in early 2016 and the economy goes into recession, with layoffs and everything that goes with it, right in the middle of a presidential campaign? It would surely hand the election to the Republicans.

The bar will be very high to hike rates in 2016.

People have told me that the Fed isn’t a bunch of political hacks and that I’m the one who’s a political hack, that they will do the right thing and raise rates in the face of widespread political opposition. I’m not so sure. There is a former administration official (Lael Brainard) on the Board of Governors. Undoubtedly, there is a line of communication with the executive branch.

I think if we have a President Bush/Fiorina/Carson/whoever in 2017, that we will get rate hikes out the wazoo (and a recession the size of Greenland on a Mercator projection).
Other Considerations

But the big story here isn’t politics, it’s emerging markets. It’s an open secret that the Fed didn’t hike because of “international considerations.” The IMF, on behalf of the emerging world, respectfully requested the Fed to refrain from hiking rates.

The Fed might not have listened to the IMF, but financial conditions were very scary precisely because of emerging markets, especially China. Brazil, too, is on the brink. A political crisis, debt downgrades, a bottomless stock market, high interest rates—a disaster.

If the Fed hiked rates, it would have poleaxed EM, perhaps fatally.

I think the Fed understood this.

But the Fed isn’t supposed to think about the rest of the world when setting monetary policy. The rest of the world can screw itself. You can’t take into account what’s going on halfway around the planet when you set monetary policy. Otherwise you would never hike rates! There’s always a crisis going on somewhere in the world.

And that’s what happened.

So this is worrisome for sure (unless you are long two-year notes).
Dark Days

I am barely old enough to remember this, but in 1980, Ronald Reagan was elected, and Paul Volcker was in the middle of ripping interest rates to the moon, which set off a hurricane-force recession. Off the top of my head, GDP was down 6%. Not the way you want to start off your term. But it was necessary, to get rid of inflation.

Now, in the middle of this, the stock market got to a point where valuations were at ridiculous extremes, with P/Es and dividend yields in the high single digits. It was the best time ever to buy stocks. But nobody wanted to buy stocks. That was the time of “The Death of Equities” Businessweek cover, the ultimate contrarian signal on the stock market.

The year was 1979. It was (almost) the best time ever to buy stocks. There may never be another time that good ever again, at least in this country.

But the funny thing about being a global investor is that it is always 1979 somewhere. There are once-in-a-lifetime opportunities, but they seem to happen about once every three months. You just have to look around.

EM is there.

  • It literally is 1979 in India. Narendra Modi is Ronald Reagan, a free-market reformer. And he has popular support.
  • If oil prices rebound, and they might, it will be great to be long Russia.
  • It is perhaps 1979 or 1980 in Brazil. There is so much revulsion toward the current Workers Party leadership, there is a free-market revolution brewing. If Dilma is impeached, it is the biggest buy signal ever.
  • What if China just had its crash of 1987? 1988 was a pretty good time to buy stocks.


Markets Love Liquidity
There is a school of thought that the market would have rallied on a rate hike.

No. That is dumb.

This line of reasoning is based on the idea that a rate hike would have removed uncertainty from the market.

Liquidity is always good. Lack of liquidity is always bad.

The stock market is throwing a temper tantrum because the Fed didn’t do enough.

Another round of quantitative easing is not out of the realm of possibility. It’s unlikely, but possible.

Then, it will be time for spooz and twos.