Wolfgang Münchau (FT Jan 23, 2012) has a point when he says that the IMF should not agree to any more money for the Eurozone, unless the EZ drastically changes direction, including „a minimum degree of joint economic management to address some of the underlying issues, including the fragility of the banking sector, and policies to remove the interdependence of national banks and national governments“. Any additional money by the IMF, barring such conditionality, would be throwing good money after bad (my words, KB) and encourage the continuation of the insufficient and faulty policies both at national and international level.
Münchau also argues, rightly, that the Eurozone with its current account surplus has enough resources of its own to save itself and thus should not go begging to outsiders to help it solve the crisis.
This “begging of neighbors”, the IMF, Sovereign Wealth Funds, etc. is a telling sign of the lack of joint leadership and self-assurance by the Eurozoners. And this is, in addition to the financial crisis, at the root of the Eurozone’s inability to solve the crisis once and for all.
Just to explain: since the Greek crisis became the poster child of EU lack of governance, its debt ratio has increased from 106% of GDP to 150% today. If at the beginning of 2011 the German government had not diddled – hoping to keep the issue out of its Nordrhein-Westfalen election discussions – the costs of helping Greece would have been the 110 bn €, and probably less, which were then discussed and delayed. Now we have the endless discussion with private sector participation which has thrown the whole assessment of government bonds being AAA’d into turmoil, we are talking about another more than the 130 bn € package for Greece and have driven Greece and (all other EZ countries) into the throes of a prolonged recession, with increasing violence in the streets and orderly strikes, as the austerity packages are imposed simultaneously on the whole of Europe.
At the ECOFIN this week ministers are further pursuing their austerity (intergovernmental pact on budget balancing) cum crisis umbrella activities, fiddling at the edges of existing EU strategies.
However, it should be clear by now, that the strategies up to now have not worked: Governments have saved failing banks, thus transferring private-sector (bank) debt to the taxpayers, increasing government debt ratios by 30 percentage points and adding to the budget woes; the EZB has bought around 200 bn of government debt, mainly from Southern EZ countries, thus extending their balance sheet and making it far more risky; the EZB has funnelled 500 bn € of 3-year money at cheap interest rates into the EZ banking sector, which has stabilized long-term government bond yields, but has not increased lending by banks to the real economy, thus perpetuating a credit crunch; EZ banks nightly deposit more than 500 bn € at nearly no interest with the ECB, instead of lending to each other and the real sector; divisions about the way forward within the EZ are strong, not only between the Parliament, the Council and the Commission and the ECB, but also between the member states. As always, the default-consensus within the EU and EZ will be to stay within the system and only very carefully extend its limits, but certainly not engage in radical change- which might be needed.
- The biggest obstacle is the lack of political union which leads to a lack of a true fiscal union where joint responsibility is taken for budget, tax and rescue situations. Thus, no total package has been devised, part of which would need to be joint bond issues by all Eurozone countries.
- Another major obstacle is the fixation of the EU institutions on budget consolidation, instead of devising a strategy able to solve both the private and public sector debt situation and developing a futures strategy whose growth dividend can service the debt. Selective debt cancellation and well-timed consolidation packages need to be combined with joint growth investments.
- Another impediment is the stipulation for the ECB not to act as a “lender of last resort” in case of one or several countries’s problems. This does not necessarily mean, that the ECB has to fill every budget hole, but that it stands ready to support countries and banks with unlimited resources in case of need. This would have provided a “cheap” guarantee to Greece one and a half years ago, and might not need to have been triggered.
- It is additionally problematic, that the ECB attempts to combat the present credit crunch by flooding the banks with more and more cheap money – which then they deposit in turn overnight with the ECB instead of lending it.
- So far, there have not been any successful attempts to really shrink and outlaw the undesirable parts of banking activities; while banks are attempting to deleverage by not extending new credit and not buying government debt – both of which hurt the economies – they are still engaging in investment banking, in derivatives trading (partially with cheap ECB money) and currency and raw materials speculation – all activities which are socially detrimental. There also have not been any serious attempts by EU regulators to bring the unregulated “shadow banking” system under control. And: the continuing excessive bonuses paid not only to CEOs, but to traders, still show that no reversal in thinking has set in, but that business as usual prevails.
- Banks and governments are closely interlinked: governments own (via bailouts) large parts of the banking sector and banks hold large junks of government bonds. Thus, banking problems spill directly into sovereign problems and vice versa, banks are downgraded when their largest owners, sovereigns, are downgraded. Furthermore, banking regulation and rescue is still organized by nation state, but with the interlinkage of banks, this should be done jointly: joint supervision, joint regulation, joint rescue operations when necessary – would require a banking union with funds available on a European scale for potential rescue operations. Such funds could be provided by a Europe-wide financial transactions tax, or a VAT surcharge.
- A more radical approach would selectively extend debt relief to lower-income households and SME business. This could be funded by a wealth tax on land, or property or total wealth. This would enable demand to pick up and grow the economies via private consumption and investment. It is not clear why debt relief for defaulting governments (Paris Club) should not be extended to EU or EZ countries low-income segments. Again, such a solution would require joint EU/EZ activity, not country-by-country activity.
- The whole crisis has been caused by the debt bubbles (sub-prime housing crisis, construction booms, debt-fuelled consumption booms) stemming from the inability of the global financial system to effectively deal with large current account imbalances over long periods of time: the structural deficit of the US and many emerging countries and the large and increasing surpluses of the net exporters China, Germany, and others flooded the international system with cheap loans which led to consumption and construction booms. The inability/unwillingness of the surplus countries to consumer or invest more domestically, the undervaluation of their real exchange rates (e.g. China by nominal exchange rates, e.g. Germany by wage restraint below productivity increases) and the inability of exchange rate movements to even out these imbalances, caused large income differentials, both within and between countries. The excess packages (wages and bonuses) paid to bank and corporate executives and financial operators sucked effective demand from the global economy and led to a frantic search for ever higher returns for “investors”, aka savers.
- Coordinated programs to build up public pension systems, public health and education systems in emerging economies could put much of their savings to better use than buying US treasury bonds and thus destabilizing the global economy; poverty alleviation through job creating investments in industrialized countries could solve the paradox that the richest countries have higher and higher unemployment and poverty rates. Internationally coordinated investments in renewable energy production (especially solar), and national programs to insulate housing, etc. could provide millions of high-value jobs. A more equitable income distribution is not only a moral objective, but also a boost to productivity and a potent source of social cohesion.
Our EU and Eurozone leaders must urgently design a more radical re-thinking of how our economies work. EU Treaties are important, but must be changed if adherence to the letter of the law threatens the welfare of its citizens. Mistakes may have been made in devising the European Monetary Union; this deep crisis requires to right them and make EMU functional, so it can once more be a tool of human betterment and not a cause of crisis.