Like last year, I had the opportunity this year to participate in a Q&A session with former President Bill Clinton, along with a handful of journalists and bloggers, on the sidelines of the 2011 Clinton Global Initiative Annual Meeting in New York. In my previous post, I included links to some posts from others who attended the Q&A. The focus of this post is on President Clinton's comments on the Eurozone crisis and what we should be doing in the future to address these types of problems.
The discussion was prompted by a question from Edward Harrison at Credit Writedowns around the potential impact of the financial crises in Europe on the world economy. President Clinton's response in excerpted below - I've not provided the complete transcript but only the most pertinent portions from his comments, with any bold text being my emphasis and italics representing President Clinton's emphasis. There are sections where my audio recording was unclear and I've included question marks in those portions:
A lot of European banks in successful countries have bought the sovereign debt of Greece and other European countries and a lot of American investors have invested not so much in Greece but in those banks […..] The fundamental problem the Europeans have in my opinion […] in following the plight of Greece as compared to, name an American state in economic trouble [Ed suggests California and President Clinton hints California due to the size of its economy is perhaps not the best comparison but runs with this example…] both California and Greece have accumulated obligations that they couldn’t finance in the current economy [...President Clinton then mentions austerity in Greece and California…] but what happens, because California is a state in a united economy, yes [California Governor Jerry Brown] has to have a balanced budget […but] because it’s a state, when CA cuts back, there’s still Federal unemployment flowing, there’s still Federal food stamps flowing […mentions the shocking depth of the recession…] so, if you have a genuine national economy, you have Federal cash flows which offset the austerity that is being imposed on the states….
…So, what happened when the Europeans decided to go for the Euro for financial integration for political [???], it worked on the way up, and its trouble on the way down. And when I was President, we had two examples in Latin America where Argentina tied the value of its currency to the dollar, and Ecuador believe it or not, flat out adopted the dollar. One of the reasons Ecuador joined with Venezuela and Bolivia in electing more populist leadership if you will, is that, when they rode the dollar up it was pretty, but it was really ugly riding down. So they had to get rid of it. And Argentina got rid of it, and was able to default and restructure, and they got one of the strongest economies in Latin America now, but if you are a little country in a big currency union without offsetting cash flows, you get all the benefits going up, but when the escalator starts going down, you’re just three seats to the wind. How in the world can the Greeks ever get ahead of this? They’ve already imposed enormous austerity. They’ve already cut back…and why is it not helping? Because there is no demand [???] in other words, they get all the macroeconomics that exists now and there is no offsetting stimulus. Same reason I’ll be surprised if some of the austerity measures for the Europeans work right now, so that’s the drill. So, number one, what you should want is, for the Europeans to develop either a system more like the American states, so that if you zap it to a Greece, there’s something you can do for the Greeks, coz most average Greeks are not responsible for the fact that Greece still had too many inefficient state owned [???] You should want either that or you should want some more orderly procedure for a Greece or someone else on the bottom end of the Euro to opt out or to take themselves out for a period of years without causing a run on the Euro or otherwise causing a stock panic.
My take on President Clinton's comments:
- At face value, he appeared more skeptical of Greece's austerity plan and its benefits than Secretary of State Hillary Clinton was, not unlike his comments earlier regarding the ill-timed austerity measures in the U.K.
- He identified the crushing problems faced by countries that benefit enormously from capital inflow bonanzas (sometimes tied to currency decisions) but whose economies and budgets could crumble as the money starts flowing out in a time of distress, especially when they do not have a sovereign currency or do peg their currencies to or adopt major reserve currencies (like the Euro or US Dollar)
- He emphasized the need for such countries that are fiscally constrained by the lack of their own sovereign currency to be supported externally, very much like states within the U.S. that get Federal stimulus support when they have to retrench fiscally
- He seemed willing to suggest that the Euro experiment should be restructured to even allow countries like Greece to temporarily "opt out" during such tumultuous times to avoid a collapse of financial integration altogether, in the absence of offsetting fiscal stimulus to protect them during the aftermath of "sudden stops"
His observations were a refreshing departure from the remarkable combination of ideological rigidity and incompetence that has been the hallmark of key players at the European Central Bank (ECB). For more on the topic of Greece and the Eurozone, see this post by Ed Harrison at Credit Writedowns - "On Greek Haircuts".
Kash Mansori at Street Light, in a follow-up to his analysis of what caused the Eurozone crisis - that I discussed here - provides his view on policy implications. Key excerpts are below although you should read his entire post with the chart included [colored text is my emphasis]. It's interesting that some of his ideas are similar to the comments from President Clinton:
1. Being judgmental is not helpful.
One of the objections raised by some who oppose support from the EZ core to the periphery is that such a bailout of the periphery countries may just encourage future irresponsible behavior. The periphery behaved badly, according to that argument, must pay the price, and clean up its own mess.
But if the very structure of the common currency area contained the essential ingredients for this crisis, and if the easy answer (namely, that the crisis is due to the irresponsible behavior of the periphery countries) is not the right answer, then such an argument no longer works. Since the crisis was largely the result of forces outside the control of the EZ periphery countries, it’s not appropriate to try to punish those countries through the bitter medicine of insufficient assistance. In other words, this crisis should not be turned into a morality story.
2. Austerity is not helpful.
Severe fiscal austerity by the periphery EZ countries has been the condition attached to assistance from the core EZ. But that austerity requirement brings with it several problems.
First, it is largely counterproductive with respect to reducing annual deficits; a simple textbook example illustrates how fiscal contraction during a recession will typically fail to meet deficit reduction goals, because the austerity itself makes the recession worse. That’s exactly why Greece keeps missing its deficit reduction goals: not because they aren’t trying hard enough, but because it’s inherently unrealistic and unreasonable to try to balance a budget through austerity during a recession.
Second, austerity is completely counterproductive with respect to reducing debt burdens. As the economy shrinks thanks to austerity, the debt burden skyrockets relative to the country's income. Just look at the debt, GDP, and debt-to-GDP ratios for Greece to see how that works. It's no wonder that it has recently become crystal clear that Greece will never have enough income to repay this level of debt. (Note: data from Eurostat; 2011 figures are forecast.)
But finally, and most importantly in the context of this analysis, austerity shifts most of the burden of dealing with the crisis onto the EZ periphery countries. And that means that citizens of the core EZ countries like Germany, France, and Benelux are essentially getting a free ride.
All of the members of the EZ have enjoyed the benefits of the common currency; that's apparent simply from the fact that they have worked so hard to construct and maintain it (recent evidence notwithstanding). Many of those benefits are political, but some are baldly financial as well: the large capital flows from the EZ core to the periphery during the years 1999-2007 are evidence that investors in the core EZ countries enjoyed and took full advantage of the high returns they could get on new investment opportunities in the periphery. Furthermore, the capital outflows from the core meant that the core EZ countries had to run current account surpluses; they have been able to enjoy significantly stronger exports for the past 10 years thanks to the euro.
But there is a fundamental asymmetry that goes along with international capital flows: the country on the receiving end risks a serious financial crisis when that flow stops, while the country that is the source of the capital bears no similar risk. In other words, the periphery of the EZ bore the bulk of the systemic risks inherent to the common currency area, while the benefits were shared by both the core and the periphery...
3. Shared responsibility is very helpful.
The opposite of trying to solve the crisis through austerity – which places the burden of escaping from the crisis on the periphery countries themselves – is for the core EZ countries to substantially share the cost of getting out of this mess...
After the Crisis
Suppose that at some point the EZ emerges from this crisis. And let’s be as hopeful as possible, and further suppose that the EZ emerges more-or-less intact, i.e. with most or all of its member countries still exclusively using the euro. What then?
1. Impose policies to reduce capital flows.
2. Make explicit institutional changes to explicitly support the EZ periphery countries ahead of time.
3. Restrict the eurozone to the core.
If the core EZ countries are simply not willing to accept the burden of substantially footing the bill to clean up the mess left by a capital markets crisis, then the only real remaining solution will be to make sure that all of the countries using the euro are similar enough that there won’t be any large-scale capital flows from one to another. If there are no significant and systematic capital flows within the EZ, then the likelihood of crisis goes away. The remaining eurozone would probably be half of its current size; but it would be stable....
I tend to agree with much of what Mansori and President Clinton have to say on this matter. Obviously, restricting abnormal inflows is going to be challenging, but ideas like a well thought-out financial transactions tax should be explored in addition to creating a framework for more effectively managing the aftermath of capital inflows - namely, changes that should be made to the financial regulatory structure to minimize or avoid asset bubbles and reckless financial behavior by the "too big to fail" financial companies across the developed world.