What Can Save the Euro?

Joseph E. Stiglitz

2011-12-05



NEW YORK – Just when it seemed that things couldn’t get worse, it appears that they have. Even some of the ostensiblyresponsiblemembers of the eurozone are facing higher interest rates. Economists on both sides of the Atlantic are now discussing not just whether the euro will survive, but how to ensure that its demise causes the least turmoil possible.
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It is increasingly evident that Europe’s political leaders, for all their commitment to the euro’s survival, do not have a good grasp of what is required to make the single currency work. The prevailing view when the euro was established was that all that was required was fiscal disciplineno country’s fiscal deficit or public debt, relative to GDP, should be too large. But Ireland and Spain had budget surpluses and low debt before the crisis, which quickly turned into large deficits and high debt. So now European leaders say that it is the current-account deficits of the eurozone’s member countries that must be kept in check.
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In that case, it seems curious that, as the crisis continues, the safe haven for global investors is the United States, which has had an enormous current-account deficit for years. So, how will the European Union distinguish between “goodcurrent-account deficits – a government creates a favorable business climate, generating inflows of foreign direct investment – and “badcurrent-account deficits? Preventing bad current-account deficits would require far greater intervention in the private sector than the neoliberal and single-market doctrines that were fashionable at the euro’s founding would imply.

In Spain, for example, money flowed into the private sector from private banks. Should such irrational exuberance force the government, willy-nilly, to curtail public investment? Does this mean that government must decide which capital flows – say into real-estate investment, for example – are bad, and so must be taxed or otherwise curbed? To me, this makes sense, but such policies should be anathema to the EU’s free-market advocates.

The quest for a clear, simple answer recalls the discussions that have followed financial crises around the world. After each crisis, an explanation emerges, which the next crisis shows to be wrong, or at least inadequate. The 1980’s Latin American crisis was caused by excessive borrowing; but that could not explain Mexico’s 1994 crisis, so it was attributed to under-saving.
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Then came East Asia, which had high savings rates, so the new explanation was “governance.” But this, too, made little sense, given that the Scandinavian countries – which have the most transparent governance in the world – had suffered a crisis a few years earlier.


There is, interestingly, a common thread running through all of these cases, as well as the 2008 crisis: financial sectors behaved badly and failed to assess creditworthiness and manage risk as they were supposed to do.
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These problems will occur with or without the euro. But the euro has made it more difficult for governments to respond. And the problem is not just that the euro took away two key tools for adjustment – the interest rate and the exchange rate – and put nothing in their place, or that the European Central Bank’s mandate is to focus on inflation, whereas today’s challenges are unemployment, growth, and financial stability. Without a common fiscal authority, the single market opened the way to tax competition – a race to the bottom to attract investment and boost output that could be freely sold throughout the EU.


Moreover, free labor mobility means that individuals can choose whether to pay their parents’ debts: young Irish can simply escape repaying the foolish bank-bailout obligations assumed by their government by leaving the country. Of course, migration is supposed to be good, as it reallocates labor to where its return is highest. But this kind of migration actually undermines productivity.


Migration is, of course, part of the adjustment mechanism that makes America work as a single market with a single currency. Even more important is the federal government’s role in helping states that face, say, high unemployment, by allocating additional tax revenue to them – the so-calledtransfer union” so loathed by many Germans.


But the US is also willing to accept the depopulation of entire states that cannot compete. (Some point out that this means that America’s corporations can buy senators from such states at a lower price.) But are European countries with lagging productivity willing to accept depopulation?


Alternatively, are they willing to face the pain of “internal devaluation, a process that failed under the gold standard and is failing under the euro?


Even if those from Europe’s northern countries are right in claiming that the euro would work if effective discipline could be imposed on others (I think they are wrong), they are deluding themselves with a morality play. It is fine to blame their southern compatriots for fiscal profligacy, or, in the case of Spain and Ireland, for letting free markets have free reign, without seeing where that would lead. But that doesn’t address today’s problem: huge debts, whether a result of private or public miscalculations, must be managed within the euro framework.


Public-sector cutbacks today do not solve the problem of yesterday’s profligacy; they simply push economies into deeper recessions. Europe’s leaders know this. They know that growth is needed. But, rather than deal with today’s problems and find a formula for growth, they prefer to deliver homilies about what some previous government should have done. This may be satisfying for the sermonizer, but it won’t solve Europe’s problems – and it won’t save the euro.
 
Joseph E. Stiglitz is University Professor at Columbia University, a Nobel laureate in economics, and the author of Freefall: Free Markets and the Sinking of the Global Economy.
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Copyright: Project Syndicate, 2011.


Eurozone crisis: A light at the end of the tunnel?

Mohamed El-Erian

December 2, 2011


Everyone is on tenterhooks in the countdown to next week’s critical European summit. The outline of the grand solution being pursued is becoming clearer as a growing number of officials take to the air waves. What is emerging seems to be a pretty good approach, provided – and this is vitalEurope agrees on the details while avoiding some highly pernicious traps.
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To be clear, it is now the region’s moment of truth. To avoid a very costly and disorderly fragmentation, Europe may well be embarking on the road to embracing a smaller, stronger and less imperfect monetary union in the future. And it is down to just four carrying the heavy burden of responsibility of offering a credible hope for stabilising Europe’s crisis, namely German chancellor Angela Merkel, French president Nicolas Sarkozy, Mario Draghi, president of the European Central Bank, and Mario Monti, Italy’s prime minister.
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Over the next few days, these leaders need to unite on ways to enhance the institutional underpinnings of the union, to reduce the risks imposed by the banking sector, to delineate clearly between solvency and liquidity cases, and to stop the latter from tipping into insolvency.
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Should they fail, the probability of a disorderly collapse of the eurozone would increase materially. Accordingly, six key risks must be managed proactively.
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They need to agree quickly on the anchor for a stronger zone. As indicated in her powerful speech to the German parliament on Friday, Ms Merkel insists on a strong legal and institutional basis. Mr Sarkozy seems to favour something less rigid, while Mr Draghi speaks of “fiscal compacts”. There is absolutely no room for differences of views or interpretations.
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Second, as he puts the finishing touches on the economic programme scheduled to be announced on Monday, Mr Monti must combine fiscal adjustment with concrete steps to increase actual and potential growth in Italy. If he fails, he will lack the legitimacy needed for sustained implementation. And he must avoid a repeat of the flawed programmes that continue to predictably disappoint on virtually all fronts in countries such as Greece.


Third, armed with assurances of these two points, Mr Draghi should show no hesitation in taking the ECB all in” and, thus, provide a credible balance sheet bridge. Discussion of the ECB lending to the IMF in order for it to lend back to European countries is intriguing but potentially detrimental. There is no substitute to direct and forceful engagement by the ECB as part of a holistic and durable solution.
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Fourth, the banking system will need to play, or be made to play a more constructive role. Injections of exceptional liquidity from the official sector should be used to encourage in new private capital rather than finance its continuous exit. In some cases, this could happen endogenously; in others, it will require more forceful intervention by both national and regional authorities.
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Fifth, Ms Merkel will need to be brutally honest in its engagement with its European partners. To be part of a proper solution, other leaders must be credibly able and willing to commit. Germany needs to call out those that cannot, and also to proceed without them.
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Finally, communication must not be bungled yet again. Domestic and global audiences should be informed in a consistent and clear manner. This means conveying a clear vision along with accompanying steps. It is certainly not the time for the type of conflicting and competing remarks from European officials that have undermined virtually every recent attempt to halt this crisis.
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There is a lot of work to be done in the next few days, and quickly. Leaders will need to resist the natural tendency to cut corners and please each other with unsustainable compromises.
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If they again succumb to shortcuts and partial answers, history will mark this as an enormous failure to deliver on one of the last, if not the final, opportunity to save a union that is key to the region’s wellbeing, as well as that of the global economy.
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The writer is the chief executive and co-chief investment officer of Pimco


December 4, 2011 7:07 pm

US-China trade ties: A heated exchange

By Alan Beattie

Renewed economic weakness raises fears of an all-out trade war
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A bureau de change in Hong Kong
A bureau de change in Hong Kong. US lawmakers say China’s surplus reflects an undervalued renminbi
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Europe’s economic conflagration is generating more than just horrified fascination from the world’s policymakers. The weakness radiating from the eurozone has the potential to inflame existing tensions elsewhere. In the US, though the administration and Congress are casting an increasingly worried eye on the region, the continued irritation of China’s actions on currency and trade remains one of their main preoccupations.
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If the American economy stalls and unemployment remains high as the US heads into an election year, Capitol Hill’s patience is likely to wear thin, and fears of an all-out international trade war will rise.
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Several potential flashpoints remain. Although Beijing unpegged the renminbi from the dollar in June 2010, it has allowed only a small appreciation this year. And despite some reform of its “indigenous innovationpolicy, aimed at creating high value-added industries, China retains an array of domestic interventions including subsidies, procurement controls and the compulsory transfer of technology by foreign companies.
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Yet US officials argue they are making some progress with a nuanced and flexible approach, taking opportunities as they arise and trying to work with Chinese reformers rather than endlessly seeking confrontation.


“We are following a dual approachtrying to bring China into the international system and get it to take responsibility for being one of a small group of countries responsible for making the international system work well,” says one senior administration official. “And, at the same time, push them hard when they take actions that contravene the rules.”


Although the US administration has been trying to widen the front of its engagement with Beijing, it is still the currency that most exercises Capitol Hill. China’s current account surplus, which American lawmakers say largely reflects undervaluation of the renminbi, has fallen from more than 10 per cent relative to Chinese gross domestic product in 2007 to a likely level of about 4 per cent this year. Nonetheless, many on Capitol Hill claim that currency manipulation to support China’s exporters has maintained global imbalances.
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This year China is likely to permit appreciation of less than 5 per cent, which would still leave the renminbi substantially undervalued by most estimates, though such calculations are rejected by Beijing. The Peterson Institute for International Economics, a Washington-based think-tank, says the renminbi remains 24 per cent below fair value against the dollar. Easing inflationary pressures and signs of slowing growth have reduced the incentive for China to allow faster appreciation to cool the domestic economy.


The US has used a mixture of bilateral and plurilateral diplomacy to try to persuade Beijing that its interests lie in allowing appreciation; Washington has sought to corral a supporting posse among the Group of 20 leading economies.


Politicking in Washington has handed the administration a further, though potentially dangerous, negotiating tool: the threat of currency tariffs. In October, the Senate passed a bill that would compel the US to use calculations of currency undervaluations when assessing to what extent imports are deemed to be unfairly priced, for the purposes of imposing emergency so-called antidumping” and “countervailing dutytariffs. Almost all the plausible Republican candidates for the presidential nomination say they support the bill.


The White House appears to be trying to use the bill as a threat, saying it shares its aims while expressing vague concerns about its legality under World Trade Organisation rules. This nuanced position irritates the Republican leadership in the House of Representatives; it says the proposal threatens an out-and-out trade war, and is resisting Democrats’ pressure to bring similar legislation to a vote in the House.


Some experts agree that such threats can be counterproductive. Nick Lardy of the Peterson Institute says direct confrontation merely weakens the position of those in the Chinese system – such as the central bankarguing privately for greater currency flexibility. “Other departments and agencies can say to the [central bank]: you are just kowtowing to western interests,” he says.


He reckons the administration’s other tacticorganising a coalition of sympathetic countries – is probably more fruitful, playing on China’s unwillingness to appear isolated. Washington has many natural allies in the G20. Brazil, in particular, has also been exercised about the renminbi.


But events elsewhere in the global economy are conspiring to weaken the campaign. Rising risk aversion among investors has recently reversed capital flows into China and weakened the renminbi. And in Europe, some officials still hope that China will help a eurozone rescue effort and so have little incentive for confrontation.


Currency has always been a hard point to press. There are few laws governing global exchange rates. By contrast, the trade in goods and services – and the associated issues of procurement, foreign investment, intellectual property rights and domestic regulation – has a variety of avenues that can be explored without touching off a diplomatic explosion. True, the tapestry of trade law has large holes but the rules of the WTO, which China joined nearly 10 years ago, do have some constraining effect.


The US administration cites a string of actions it has taken. These include WTO litigation against China’s own use of antidumping and countervailing duty import taxes on US exports, and the initiation of a wide-ranging investigation by the administration of Beijing’s support for its renewable energy industry. In this case, China pre-emptively abolished a programme subsidising its wind power industry.


Once the potential for litigation is raised, to date there has been about a 50 per cent record of China taking an action to comply with its obligations before it actually goes through the dispute settlement process,” says Tim Reif, general counsel at the US trade representative’s office.


Washington has also initiated cases with an eye to establishing useful precedents. Recently, it brought an action against Chinese antidumping and countervailing duties on US chicken exports. Poultry may not be the most glamorous or the highest value-added of exports but, since the case has broader connotations, it could prove a useful one.


China has been using antidumping and countervailing duties as a retaliatory measure,” says Mr Reif. Part of the reason for bringing this action is to prevent their use as retaliation.”


Legal process is not without its problems. One is the limited coverage of WTO rules. China, for example, has placed much of its giant public procurement market off-limits to foreign companies. It also has yet to fulfil a promise to join the WTO’s government procurement agreement, a standalone pact separate from the body’s normal rules. Beijing has promised by the end of the year to make a fresh bid to join the agreement, but US businesses doubt its commitment.


Furthermore, the low-hanging fruit has already been harvested. The relatively easy cases have already been brought; bringing future actions is likely to be hardernot least because of the lack of information on Chinese subsidies and regulatory practices. Washington recently complained to the WTO that Beijing was failing to provide required information on its subsidies, but it has limited recourse in this area.


Business groups say American companies are also often reluctant to provide the US government with the information needed to bring cases, concerned about official retribution against their operations in China. The request for the renewables probe came from the US United Steelworkers’ Union rather than a business. In a recent antidumping and countervailing duty action brought against imports of Chinese solar cells by US renewable energy businesses, six of the seven complainants exercised their rights to keep their identities secret.


Washington is coming under pressure to adopt a more confrontational stance on this issue. Providing information to [the US trade representative] is a costly exercise both in terms of the resources involved and the potential for tit-for-tat retaliation,” says Bill Reinsch, who chairs the US-China Economic and Security Review Commission, which reports annually to Congress. He believes US administrations, which have traditionally brought cases only when they consider themselves very likely to win, should file more long-shot actions to keep up the pressure on Beijing. The US could, he says, bring nullification or impairmentactions, which argue broadly that China’s trading partners have not received the benefits they might have reasonably expected from its entry into the WTO.


America’s final tactic for dealing with China is to set up trade deals with groups of countries, and hope China will feel compelled to join. Recently the US agreed an outline pact in the Trans-Pacific Partnership, a grouping of nine countries – including Vietnam, which has extensive Chinese-style state intervention – with the aim of concluding a deal by the end of next year. Washington is also exploring the idea of creating more plurilateral agreements in the WTO on the lines of the government procurement agreement.


China needs to understand that they are welcome to join future developments, such as plurilateral agreements in the WTO, or the [TPP], says Dan Price of Rock Creek Global Advisors and a former senior White House international economics official. “But those will go ahead whether it decides to participate or not.” However, the countries involved in the TPP collectively account for only about 6 per cent of US trade, so China is unlikely to feel compelled to join or lose all its export markets to American companies any time soon.


No one ever said persuading the world’s largest goods exporter to change its strategy would be easy. The US administration says China will move when it accepts that international commerce is not a zero-sum game, and that its maturing economy will benefit from a wider set of trade rules. Bringing this about will take time but, with America’s negotiating leverage limited, it looks like the most realistic strategy.


“We have to be able to show China that it is in its own interest to take a particular action,” a US official says. “We need to find lines to push for that seize the moment.”
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BACKGROUND NEWS
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To Beijing’s unelected leaders, the political cycle of criticism emanating from Washington over China’s trade and currency policies has grown tiresome, writes Jamil Anderlini. US politicians’ fixation on the value of the renminbi is “not just a case of bad maths, but an example of a political tactic that is often used to distract citizens from domestic problems”, thundered an article in state media last month.
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Chinese policymakers uniformly reject claims that their currency is undervalued, and that it is responsible either for distortions and imbalances in global trade or for America’s economic problems. But behind the show of unity, different parts of the government hold a wide range of views on the issue that reflect internal political divisions.
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In public, all officials argue that the real exchange rate of the renminbi has risen 40 per cent (about 23 per cent in nominal terms) against the dollar since July 2005, even as the US jobless rate increased from 7 per cent to more than 9 per cent over the same period..They also point out that before the renminbi was put on a gradual appreciation track, from 2005, Washington estimated that the currency was undervalued by as much as 40 per cent, or roughly the amount it has appreciated in real terms already.
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But many in the government and the Communist party believe China must introduce a more flexible exchange rate mechanism, and that this would help to address international and domestic imbalances. The most prominent advocate is the central bank, led by Zhou Xiaochuan, its urbane governor.
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The central bank is charged with intervening in currency markets to keep the value of the renminbi within a narrow band, and also with managing the enormous foreign exchange reserves built up as a result. It must also manage liquidity in the bubble-prone domestic economy while trying to micromanage lending in the state-owned banking sector.
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For years, Mr Zhou and his colleagues have been quietly lobbying for reforms on currency and interest rates. But the central bank is not independent, and is relatively weak compared with many other branches of the government.
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Among the departments that oppose currency reform and appreciation, the ministry of commerce appears the most vehement. It is charged with overseeing the powerful export sector and lobbying for manufacturers that see themselves being squeezed from all directions – by rising costs, a shrinking labour pool and stricter labour and environmental standards as well as an appreciating renminbi.
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Copyright The Financial Times Limited 2011.

Note from the editor

ECB holds the key to next gold rally

By Jack Farchy in London


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Gold has been a conundrum in the last couple of months. For its most ardent fans, it has been a downright disappointment. Despite the rising sense of alarm in Europe, regular sell-offs in the bond markets and relentless headlines about the demise of the single currency, gold – supposedly a “safe haven” against such turmoil, has been mundanely rangebound in a $1,600-$1,800, or €1,200-€1,300, band.
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The next leg of the gold rally may not be far away, however. If Mario Draghi, president of the European Central Bank, follows through on a hint last week that the ECB may step up bond buying activities, he could trigger a new rush for physical gold among conservative Swiss and German investors.
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A look at the history of the eurozone debt crisis shows why. For all the fear that it has caused in the debt, equity and currency markets, the eurozone crisis has only seriously impinged on the gold market twice. The two instances have one thing in common: the ECB.
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The first time was in May 2010, when European leaders succumbed to the necessity of bailing out the eurozone’s peripheral countries. Gold, denominated in euros, rose 11.5 per cent in the month. It also hit new records in dollar terms.
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Of critical importance to the surge of gold buying was a policy U-turn by the ECB, which agreed to start buying eurozone bonds. German TV broadcast footage of Germany during the hyperinflation of the 1920s, and coin dealers in Germany and Switzerland were sold out for weeks.
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The second key moment in the eurozone crisisat least from the perspective of the gold market – came this August. Again the ECB was central. Following an escalation of the crisis the central bank announced it would start buying Italian and Spanish bonds for the first time.
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Again, gold’s reaction was electric. It jumped 8.7 per cent in euro terms, and 7.8 per cent in dollar terms, in the three days following the ECB announcement. Of course, the ECB and the eurozone crisis are not the only factors driving the gold market. But they have contributed to two of the most dramatic surges higher in recent years.
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For the thing that most terrifies German and Swiss investors holders of much of the wealth in Europe – is not a breakup of the single currency bloc per se, but uncontrollable inflation. As that footage of Weimar Germany demonstrates, the fear of hyperinflation runs deep.
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Indeed, a look at the gold price (especially in euro terms), German coin and bar demand, and the ECB’s bond buying activities shows a remarkably tight correlation. In the second quarter of 2010, the ECB expanded its “securities held for monetary policy purposes” by some €75bn.
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German coin and bar demand, according to the World Gold Council/GFMS, jumped by 167 per cent to 49.6 tonnes. And the euro gold price rose 23.2 per cent. The third quarter of 2011 witnessed the ECB’s most aggressive bond buying to date: an increase of about €85bn in “securities held for monetary policy purposes”. German coin and bar purchases leapt 162 per cent to 59.3 tonnes, and the euro-denominated gold price rallied 17.3 per cent.
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The lesson? Gold investors should pay little heed to “Merkozy” and Monti. The crucial player over the coming week is the other Mario sitting in Frankfurt.