A panel of experts moderated by WSJ columnist Mary Anastasia O’Grady discussed lessons that are supposed to have been learned during the course of the euro crisis so far at the Cato Institute’s 30th Annual Monetary Conference.
O’Grady noted that having 138 fiat currencies is not compatible with a global-trading system and that the purpose of the euro was to facilitate trade on the continent, but now there are problems.
George Tavlas, director of the Bank of Greece, recalled that the entry of Greece into the eurozone was supposed to mark the transformation of the country from earlier bouts of inflation, anemic growth, large fiscal and trade imbalances and a series of exchange rate crises. The expectation was that the euro would help produce “a low-inflation, low-interest-rate environment conducive to economic growth.”
Precisely that happened for a while, and the spread versus leading currencies fell from 600 basis points to only 30-60 basis points. However, the growth was due to expansion of the government sector, and the share of gross domestic product (GDP) taken by government spending rose to 54 percent under a conservative government, largely financed by foreign debt. The current account deficit grew from 11 percent to 18 percent.
Spreads rose to 4,000 basis points early this year. Real GDP has fallen, and unemployment has risen to 25 percent. Tavlas’ thesis is that this could not have happened under the gold standard that prevailed from 1880 to 1913, because the economy would have made the necessary adjustments to avoid major runs on any of the leading currencies.
In contrast, the notion that Greek sovereigns represented a safe investment was based on the expectation of a bailout. However, Tavlas does not advocate going back to the gold standard, because it is associated with slower growth even though fiscal and currency crises were contained. In the future, according to Tavlas, serious fiscal discipline will have to be applied in order for the imbalance to be corrected.
Jurgen Stark, former chief economist at the European Central Bank (ECB), said markets have calmed down, but there are different views between the International Monetary Fund and the ECB about what should happen next. While Stark noted that the calm is due to several factors — including the European Stability Mechanism having come into effect in October, to do “whatever it takes” to rescue the euro — he does not believe this is a sustainable plan without the necessary structural adjustments based on rules and principles, including the no-bailout clause. Moreover, the ECB is not supposed to step in to purchase any government bonds in the primary market, but it is allowed to do so in the secondary market.
The experience raises questions as to the choice of states that compose the Eurozone, the application of the rules and principles of the Maastricht Treaty and the management of the crisis. Too many countries were allowed to adopt the euro while engaging in creative accounting practices, surveillance was inadequate and most of the states didn’t fully consider the implications of the monetary union for their fiscal and trade policies. Now the strategy calls for structural reforms particularly in Spain and Italy, recapitalization of the banking system and reforming the institutional framework of the zone. He insists that actions of the ECB must not be dependent upon those of third parties.
Wolfgang Munchau, associate editor of the Financial Times, proclaimed that the practice of rolling over debt and not recognizing losses that has prevailed for three years must not continue, and he predicted that the crisis will “roar again” sometime next year. The fault, he said, lies with inconsistency among the three founding principles of no default, no bailout and no exit, and “the financial markets certainly did not take the no-bailout policy seriously.”
He quipped that there can’t be a default, at least until after the German elections next October, because they don’t want to recognize a loss and politicians don’t understand this conflict. Munchau’s choice would be to make the accommodation by relaxing the no-default and no-bailout principles and holding fast to the no-exit rule.
As stated by the previous speaker, the second issue is the economic adjustments, but he would advocate “going easy on austerity.” He also predicted delays in the implementation of the banking union, the lack of which he called “the worst birth defect of the EU.” However, he said it is needed in order to separate the risk of the banks from the state, provide more effective resolution systems, remove incentive for runs, transfer funds from surplus to deficit countries through a fiscal union and get out of the Outright Monetary Transactions program, all to enable the ECB to regain its independence. His advice to Asia regarding creation a monetary union is, don’t.
Pedro Schwartz Giron, an economics professor at San Pablo University, also recounted the history of the euro, and he railed against the flouting of established policies, labeling as “rubbish” the claim that the ECB is not intervening in markets to support the member state finances and economies. He added that the euro was intended to administer a “quasi-gold standard” independent of governments, and the inflation hatch would be closed by following a 2 percent inflation limit. He credited Estonia with taking sharp measures, including a 40 percent decline in GDP, in order to join Europe, because this would be an improvement over the experience with the Soviet Union.
However, other countries are resisting taking such measures. Schwartz criticized the governments of the European Union for being slow to reform their public sectors, but he pointed to evidence of some change. He compared the recipe for a monetary union with the regime of the Federal Reserve, the dollar and a centralized state, which he called entirely different, because adjustments can be postponed for extended periods, with debt growing to 100 percent of GDP.
Schwartz, citing the Reinhart & Rogoff book “This Time Is Different: Eight Centuries of Financial Folly,” concluded that monetary policy must focus on the long term, because it cannot be adjusted to short-term conditions, therefore, he expects the euro to be saved at the expense of the European Union.
It would be interesting to explore how the actions of U.S. authorities related to the observations regarding the determination of political actors to postpone the recognition of losses. This question could be considered in light of the remarks by Tom Hoenig, vice chairman of the FDIC, on another panel at this event on the need to impose stricter capital and regulatory standards on the largest banks.
Robert Feinberg served on the staff of the House Banking Committee for the 10 years that encompassed the savings-and-loan debacle and the beginning of its migration to the banking sector. Subsequently, he has consulted on issues related to the crisis for law firms, accounting firms, securities firms and trade associations.
Feinberg holds a BS.E. from the Wharton School and a J.D. from the Law School of the University of Pennsylvania. He has drafted dissenting views on landmark banking legislation, contributed to a financial blog and written hundreds of reports for clients to document the course of the financial crisis as it has unfolded over the past three decades.
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