Wall Street Journal Europe
August 31, 2011
by Irwin Stelzer
She came to Jackson Hole, Wyo., to speak truth to the confessedly powerless. And becauseChristine Lagarde, head of the International Monetary Fund, is not a central banker, but a politician, she could speak truth in the simple language that politicians understand.
Here we have Jean-Claude Trichet, head of the European Central Bank, on Saturday: "Smooth factor sustainability could rid us of the Harrod-Domar boom-bust cycle." Surely a rallying cry that will resonate in the corridors of power in Berlin, Washington, Brussels, Paris and wherever policy makers gather. Add to that Federal Reserve Chairman Ben Bernanke's confession of virtual impotence and his insistence that the next moves to prevent another recession are up to politicians, not the central bankers, who have almost run out of ammunition. This is a view in which Mr. Trichet implicitly concurs when he says that future growth will depend on the pace of technological progress, productivity, the removal of economic rigidities and all of the things repeatedly addressed at the serial meetings and by the serial pronouncements of European politicians, but beyond the purview of central bankers.
Since central bankers feel they can do little more than fiddle while the European and U.S. economies burn out, and often speak in a language that is inaccessible, it is worth attending to Ms. Largarde's (mostly) plain speaking. The IMF managing director said straight out what the central bankers could only hint at, that the "dangerous new phase" into which the world economy is entering is exacerbated by the fact that "policy makers do not have the conviction" to take the decisions necessary to meet the crisis. Most of all, they need to force the recapitalization of Europe's banks, using public funds if need be, a view vehemently rejected by Brussels. Ms. Lagarde was implying that the stress tests imposed on euro-zone banks only a short while ago were a nonsense—almost all banks passed muster, something she hailed as a sign of the sector's strength when she was France's finance minister. But new office, new perspective.
There is no question that the Greek banking system has proved to be the Achilles' heel of the euro zone: We can't yet tell whether this weekend's merger of the nation's second- and third-largest lenders will significantly strengthen the sector. With the economy likely to decline this year by 5% or more, rather than by the 3.8% Greece's finance minister predicted only last month, panicked depositors are withdrawing funds, moving them out of the country or into vaults and mattresses, or simply using the savings to make up for lost wages. All in all, some €50 billion ($72 billion) has been pulled out of Greek banks by households and businesses, a 20% drop from the September 2009 deposit peak.
But Greece shouldn't bear all of the blame for the 25% decline in European bank shares this year. Investors worry that German banks are exposed to shaky sovereign debt and French banks even more so, and that all of Europe's banks are having trouble raising funds. U.S. money-market funds are fleeing European exposures; banks are refusing to lend to one another, preferring to hoard cash by depositing it at Mr. Trichet's ECB; and what lending there is is for short periods, often shorter than a week. As the Economist puts it, in the markets on which the banks rely for funding, "the life is being squeezed out of Europe's banks."
This and the impending recession are avoidable, say the trio of Mr. Bernanke, Mr. Trichet and Ms. Lagarde, if only the politicians would act. In America, address the issue of "fiscal sustainability" without disregarding "the fragility of the current economic recovery" (Bernanke), and cut the deficit with both tax increases and spending cuts (Lagarde); in the euro zone vigorously implement structural reforms in the labor market and distribute wealth so as "to ensure some acceptable social balance" (Trichet); in Europe recapitalize the banks, and in China allow the currency to appreciate, boosting domestic demand and "rebalancing" world trade (Lagarde).
Which brings us back to the IMF managing director's charge that policy makers lack the conviction to make these policy decisions. It is fruitless to ask Europe's politicians to honor the broken promises of reform enshrined in EU treaties for two decades, or to ask President Barack Obama to restore civility to American political discourse by holding a tea party for his Republican opponents. They won't, at least until—or perhaps even if—bad morphs into worse.
The problem in Europe is that politicians think they can fool the markets. Spain is amending its constitution to include a deficit cap in its constitution—the first country to respond to lender-in-chief Angela Merkel's demand that all supplicant nations do so—but the amendment does not include any actual deficit cap. France has joined Ms. Merkel's call for balanced budgets, but has not balanced its own budget in 35 years, and is unlikely to do so soon as its economy is slowing, and will slow further when planned tax increases on capital gains, businesses, and the rich—who have published a Warren Buffet-style plea to have their taxes raised "reasonably"—are put into effect. Greece has promised to privatize large swathes of its economy, but has not so far sold off any significant assets. Italy has refused to undertake the structural reforms needed to end a decade of economic stagnation. Markets are appropriately skeptical, nay, cynical.
It would have been easier for Italy and other countries to make the needed changes in policy when rapid growth enabled Ms. Merkel to call on Germans' better natures and willingness to support them and the euro. With growth halted, any such generosity she might have been able to coax out of her electorate is a thing of the past. We might yet see a downsized euro zone.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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