Spanish prelate sides with Elliott's Paul Singer to tell Paul Krugman that response to financial crisis destroying society

As reported by the Telegraph's Ambrose Evans-Pritchard, the Spanish prelate has weighed in on the side of Elliott's Paul Singer against Paul Krugman and called for a change in the policies adopted to deal with the bank solvency led financial crisis so that society does not collapse.

Professor Krugman wrote a post in his NY Times blog in which he defended the policies run by Ben Bernanke, the Fed and other central banks as

just what the textbook says you should be doing.

As regular readers know, the economic textbooks are wrong.

This fact is not surprising because leading up to our current financial crisis the models used by economists did not include the banking sector.

This fact is not surprising because even though the global central bankers claim to have read Walter Bagehot's Lombard Street, in which he "invented" the modern central bank, their response to the financial crisis has broken a number of the rules he laid out.  For example,

• Central banks are suppose to lend freely at high rates of interest against good collateral; or
• Central banks are suppose to keep interest rates at or above 2% as rates below 2% bring about a change in the behavior of savers.

Regular readers know that there is one response that works every time when dealing with a bank solvency led financial crisis.  That response is to adopt the Swedish Model and require the banks to recognize upfront their losses on the excess debt in the financial system.

The Swedish Model protects society as the banks absorbing the losses spares the real economy from diverting capital needed for reinvestment, growth and the social contract to debt service on the excess debt.

Regular readers know that under the FDR Framework, banks are designed to absorb these losses and continue to support the real economy.  Banks can do this because of the combination of deposit insurance and access to central bank funding.

Unfortunately, the Swedish Model has not yet been adopted to deal with our current financial crisis.  Instead, policymakers and central bankers have adopted the Japanese Model for handling a bank solvency led financial crisis.

Under the Japanese Model, bank book capital levels and banker bonuses are protected at all costs and the burden of servicing the excess debt in the financial system is placed on the real economy.

The results have been predictable (I know, I predicted them).  The global economy is in a Japan-style economic slump and the social contract is being rewritten to the benefit of the rich at the expense of the poor.

As the Spanish prelate said,

"We have to change direction, otherwise this is going to bring down whole political systems," said Braulio Rodriguez, the Archbishop of Toledo. 

"It is very dangerous. Unemployment has reached tremendous levels and austerity cuts don't seem to be producing results," he told The Telegraph.

Austerity will never produce a positive result when facing a bank solvency led financial crisis.  I have been making this point since the beginning of the crisis.

"There is deep unease across the whole society, and it is not just in Spain. We have to give people some hope or this is going to foment conflict and mutual hatred." 

Europe's Catholic bishops have been careful not to stray into the political debate or criticise EU economic strategy but the Archbishop said the current course is untenable.

There are two reasons that the current course is untenable.

First, it is not fixing the underlying problems.

Second, it is causing untold damage to society.

"The Vatican has always been an enthusiast for Europe, but a Europe of solidarity where we help each other, not a Europe of coal and steel. Whether this is possible depends on Germany and Chancellor Angela Merkel," he said. 

Unemployment in Spain has reached 6.2m, or 27pc, despite a growing diaspora of young Spaniards seeking work in Britain, Germany, Brazil, or the Gulf, and an exodus of immigrants returning home. Spain's population fell by 0.7pc last year. 

The jobless rate in the Toledo region of Castilla-La Mancha is 31pc. The rate for youth has jumped to 64pc from 14pc at the peak of the credit bubble. 

Spain has largely avoided the sort of street clashes seen in Greece. People have coped with stoicism, drawing on the deep strengths of Spanish family support. Yet the authority of the state is eroding. A new Metroscopia poll shows that 87pc of voters have lost confidence in premier Mariano Rajoy.

Confidence in the state should erode because it is being run for the benefit of the bankers and not for the benefit of its citizens.

El Mundo fears a slow-fermenting 'crisis of the regime', with almost every institution -- including the monarchy -- in disrepute. It likens the mood to "pre-revolutionary" France in the late 1780s. 

The Archbishop, speaking in the austere episcopal palace of Spain's ancient capital, said the current crisis is doing far more damage than the recession in the mid-1990s when unemployment briefly spiked above 24pc. On that occasion peseta devaluations let Spain regain competitiveness and recover gradually despite austerity cuts. 

This time the country seems trapped in slump. The long-term jobless rate is much higher. 

Unemployment benefits taper off after six months, and stop after two years. There are almost two million households where no family member has a job. 

Europe's Catholic bishops know first-hand from their Cor Unum charitable network just how desperate it has become. "We can try to mitigate the effects by giving basic help to people left totally unprotected, but we can't create jobs," said the Archbishop. 

"We are seeing families who used to middle class needing help. This is totally new. As a matter of honour, they won't come to us until they have exhausted everything,"

As we approach the sixth anniversary of the beginning of our current financial crisis, it is time to acknowledge that the response to the financial crisis has been a failure.  If it were a success, policies like zero interest rates and quantitative easing would no longer be pursued.

The time has come to adopt the Swedish Model.  

History shows that within a year of adopting the Swedish Model the bank solvency led financial crisis is over and growth has returned to the real economy.