It is the illusion of achieving the impossible—for a (small) fee. It is now the artifact of policymakers. As Europe goes down in flames, there is a vacuum of leadership on the global stage. In contrast to previous global crises, when the U.S. was at the forefront of action, Washington has been reduced to a spectator role—with President Obama only appearing for the photo shoots at the global summits. The former Senator from Illinois weaved a gilded fabric of hope for change, but only delivered more of the same. It is little wonder that people are taking to the street. Moreover, his impeccable Ivy-League pedigree was no substitute for the sweat and acumen of real world experience. Unfortunately, he is not the only one guilty of trafficking false hope. In the modern world of real-time media, politicians are only interested in the immediate effects of announcements, with no attention on the details. Shock and awe is the main objective of most policy measures. As former Treasury Secretary Larry Summers was fond of saying, ‘the important thing is to be caught trying to do something.’ In other words, there is no real desire to deliver actual results. This was clearly evident by the lack of detail on the various Greek bailouts, the recapitalization of the European banks and the creation of the EFSF. German Chancellor Angela Merkel and French President Nicolas Sarkozy are prime examples of ‘form over substance.’ The problem is that despair sets in when hope fades.
Unfortunately, despair is in the air as the market realizes that there is nothing behind the veneer. This is why the political body is finally getting religion, and trying to become serious. The French and Italians are introducing fiscal measures that were long overdue. A fresh batch of technocrats was chosen to replace the bungling group of politicians who led the periphery. Lucas Papademos, a former Vice-President of the European Central Bank, was chosen as the new Prime Minister for Greece. A graduate of MIT and a visiting professor at Harvard University, Papademos is expected to bring the wizardry needed to solve the country’s ills. The same occurred in Italy, where President Giorgio Napolitano paved the way for Mario Monti, the former head of the European Commission, to replace outgoing Prime Monster Silvio Berlusconi. Like Papademos, Monti has an impressive CV. He studied at Yale under James Tobin, and is President of Bocconi University in Milan. Both men are considered to be highly capable technocrats. However, it is unlikely that they will be able to do much. The situation draws many similarities with Argentina in 2001, when Domingo Cavallo was appointed Minister of the Economy as a desperate ploy to stabilize the economy. Like the European periphery, Argentina was suffering the debilitating effects of having employed a fixed exchange rate regime for a decade. The country had lost all external competitiveness and was trying to deflate its way back to normalcy. Endless reforms and adjustment packages, under the auspices of the IMF, World Bank and AIDB, were to no avail. In a final act of desperation, the country turned to the highly-regarded Harvard-educated economist to see if he could wield some form of technical alchemy that would solve its woes. Like Monti may end up doing, Cavallo asked for special powers to break through the logjam of Argentine politics and pass through the draconian legislation that could restore the economy to equilibrium. Wage and spending cuts were imposed, as well as capital controls, which erupted into social and political unrest. Rioters looted supermarkets, banks and tried to burn down the Congress and the Ministry of the Economy. Unfortunately, as is the case in peripheral Europe, Argentina was too far gone to realign its relative prices without enduring a gut wrenching adjustment. In the end, Cavallo was able to buy nine more months before the economy collapsed in default and maxi-devaluation. Perhaps, that is all the time the periphery has.
Therefore, the markets may rally on the hope that the new sorcerers of Europe will solve its ills, but the cold hard economic reality is such that an adjustment is impossible and people will soon despair. Economists should return to the basic tenets of the discipline. They should focus on the policies needed to maintain equilibrium and understanding the oscillations of the business cycle, instead of conjuring the false messages that are endemic to signaling theory. As the old saying goes, you can fool some of the people some of the time, but you cannot fool them all of the time.