By CHRIS GRAEME [email protected]
The European Union must act decisively at a political and economic level to avert a 1930s Depression, said an economist last week.
All EU member states needed to “mutualise sovereign debt through joint liability” as well as embracing austerity measures, even if that risked inflation, said SIBS board President Vítor Bento.
The European Central Bank and its governors had a key role to play in being seen as either the “saviours” of the Euro or those who “let it sink”.
They would remain on the pages of history whatever decision they ultimately took. But politicians also had a responsibility.
Controlling inflation as an “economic ill” was important, but it was also important to have independent central banks, because free from electoral pressure and short-term decisions they could take the long-term and sustainable view. Independence did not mean, however, the same as being politically irresponsible.
The great difficulty in managing society and our lives is never choosing between good and evil. Those kinds of choices are normally easy. The problem today was “having to choose between two evils and if the wrong evil was chosen that could lead to disaster”.
Germany, for good or bad, was today faced with a difficult choice and needed to choose the lesser evil or face European ruin and a Depression with consequences that would be difficult to foresee.
“If the risk we have to live with means inflation, then we know how to live with inflation, therefore it was preferable to live with an evil that could be controlled than something we can’t control,” he said.
That also meant providing liquidity for the banks. If all banks just recapitalised as prescribed, and stopped lending in all countries, an undesirable situation would be created – a credit crunch.
Decisions taken at a microeconomic level didn’t always make sense at a macro-economic level.
In other words, the panic engulfing Europe’s banks was alarming. As their access to wholesale funding dried up, the interbank market became stressed, as banks refused to lend to each other, forcing banks to squeeze lending to firms.
Independent of the decision that politicians might take, there were undeniable social realities. Frequently unwanted consequences dominated desirable ones.
Either there was a “mutualisation of debt” or there would be “general default with an uncontrollable bank crisis”.
“We have a debt crisis which is without precedence, which is difficult to measure in its extent and predict all of its consequences,” he admitted.
But one of the things spooking the markets most was the unsustainability of the European social model and the restructuring of that social model was something that European governments didn’t want to face.
“Fifty years ago there were nine working persons for every one retired person, now there are two for every retired person. For this reason, because of its debt, any country, except perhaps Germany, could become insolvent,” Vítor Bento warned.
This was also because their ability to manage debt depended on two things: the interest rate and growth. When the growth rate is greater than the interest rate there wasn’t a problem. When the interest rate is higher than the growth rate, there was a problem. Markets put up the interest rates when social costs were high and growth rates were low as the risk of default increased.
The vicious cycle had to be broken and this could only be done at a monetary level. So why was the position of insustainability worse in the Euro zone? Because it fuelled various illusions; one of them being that belonging to the Euro zone meant you didn’t have to worry about your own currency. That was false.
Today debts in Europe were held in foreign currencies and countries were losing control of the sustainability of their debt.
This problem could only be solved by the “mutual liability for the debts” or face a general default and all its consequences.
But the most important problem were the periphery economies which had lost competitiveness and had a long inflationary and monetary devaluation history behind them.
The whole point of the Euro was to create a strong currency which was disciplined, but the easy credit over the past 10 years meant that countries didn’t make those necessary adjustments. Boom and high demand led to increased salaries that didn’t keep pace with productivity, placing inflationary pressures on transactional goods, leading to loss in productivity, excess of internal demand and an excess of external debt.
The answer is to regain competitiveness and that could only be done by two methods: long-term productivity, and a tough, short-term inflationary measure. Either we have a recessionary period in the next few years which will emulate the crisis in the 1930s (the worst evil) or face inflation in the economy.