For­give them their debts’ is not the an­swer

The Pak Banker - - OPINION - Mervyn King

WHAT is the re­la­tion­ship be­tween money and na­tions? The main build­ing of the In­ter­na­tional Mon­e­tary Fund in Wash­ing­ton DC is shaped roughly as an el­lipse. As you walk around the cor­ri­dor on the top floor, on one side are sym­bols of each of the mem­ber na­tions. On the op­po­site side are dis­play cab­i­nets of the ban­knotes used by those coun­tries. There is a re­mark­able, al­most un­canny, one-to-one re­la­tion­ship be­tween na­tions and their cur­ren­cies. Money and na­tions go hand in hand. Euro­pean Mon­e­tary Union (EMU) is the most am­bi­tious pro­ject un­der­taken in mon­e­tary his­tory. EMU has not proved to be an easy mar­riage, with the en­ter­prise try­ing to nav­i­gate a safe pas­sage be­tween the Scylla of political ideals and the Charyb­dis of eco­nomic arith­metic.

Euro­pean Mon­e­tary Union (EMU) is the most am­bi­tious pro­ject un­der­taken in mon­e­tary his­tory. How long this mar­riage will last is some­thing known only to the part­ners them­selves; out­siders can­not eas­ily judge the state of the re­la­tion­ship. The ba­sic prob­lem with a mon­e­tary union among dif­fer­ing na­tion states is strik­ingly sim­ple. Start­ing with dif­fer­ences in ex­pected in­fla­tion rates - the re­sult of a long his­tory of dif­fer­ences in ac­tual in­fla­tion - a sin­gle in­ter­est rate leads in­ex­orably to di­ver­gences in com­pet­i­tive­ness.

Some coun­tries en­tered Euro­pean Mon­e­tary Union with a higher rate of wage and cost in­fla­tion than oth­ers. The real in­ter­est rate (the com­mon nom­i­nal rate of in­ter­est less the ex­pected rate of in­fla­tion) was there­fore lower in th­ese coun­tries than in oth­ers with lower in­fla­tion. That lower real rate stim­u­lated de­mand and pushed up wage and price in­fla­tion fur­ther. In­stead of be­ing able to use dif­fer­ing in­ter­est rates to bring in­fla­tion to the same level, some coun­tries found their diver- gences were ex­ac­er­bated by the sin­gle rate.

The re­sult­ing loss of com­pet­i­tive­ness among the south­ern mem­bers of the union against Ger­many is large, even al­low­ing for some over­val­u­a­tion of the Deutschmark when it was sub­sumed into the euro. It in­creased full-em­ploy­ment trade deficits (the ex­cess of im­ports over ex­ports when a coun­try is op­er­at­ing at full em­ploy­ment) in coun­tries where com­pet­i­tive­ness was be­ing lost, and in­creased trade sur­pluses in those where it was be­ing gained. Those sur­pluses and deficits are at the heart of the prob­lem to­day. Trade deficits have to be fi­nanced by bor­row­ing from abroad, and trade sur­pluses are in­vested over­seas.

Coun­tries such as Ger­many have be­come large cred­i­tors, with a trade sur­plus in 2015 ap­proach­ing 8pc of GDP, while coun­tries in the south­ern pe­riph­ery are sub­stan­tial debtors. Ex­tract one: Lord Mervyn King: why throw­ing money at fi­nan­cial panic will lead us into a new cri­sis The sit­u­a­tion in Greece en­cap­su­lates the prob­lems of ex­ter­nal in­debt­ed­ness in a mon­e­tary union. GDP in Greece has col­lapsed by more than in the US dur­ing the Great De­pres­sion. De­spite an enor­mous fis­cal con­trac­tion bring­ing the bud­get deficit down from around 12pc of GDP in 2010 to below 3pc in 2014, the ra­tio of govern­ment debt to GDP has con­tin­ued to rise, and is now al­most 200pc.

All of this debt is de­nom­i­nated in a cur­rency that is likely to rise in value rel­a­tive to Greek in­comes. When debt was re­struc­tured in 2012, pri­vate- sec­tor cred­i­tors were bailed out. Most Greek debt is now owed to pub­lic- sec­tor in­sti­tu­tions such as the Euro­pean Cen­tral Bank, other mem­ber coun­tries of the euro area, and the IMF. Fis­cal aus­ter­ity has proved self­de­feat­ing be­cause the ex­change rate could not fall to stim­u­late trade. In their 1980s debt cri­sis, Latin Amer­i­can coun­tries found a route to eco­nomic growth only when they were able to move out from un­der the shadow of an ex­tra­or­di­nary bur­den of debt owed to for­eign­ers.

It is ev­i­dent, as it has been for a very long while, that the only way for­ward for Greece is to de­fault on (or be for­given) a sub­stan­tial pro­por­tion of its debt bur­den and to de­value its cur­rency so that ex­ports and the sub­sti­tu­tion of do­mes­tic prod­ucts for im­ports can com­pen­sate for the de­press­ing ef­fects of the fis­cal con­trac­tion im­posed to date

The in­evitabil­ity of re­struc­tur­ing Greek debt means that tax­pay­ers in Ger­many and else­where will have to ab­sorb sub­stan­tial losses. It was more than a lit­tle de­press­ing to see the coun­tries of the euro area hag­gling over how much to lend to Greece so that it would be able to pay them back some of the ear­lier loans. Such a cir­cu­lar flow of pay­ments made lit­tle dif­fer­ence to the health, or lack of it, of the Greek econ­omy. It is par­tic­u­larly un­for­tu­nate that Ger­many seemed to have for­got­ten its own his­tory. At the end of the First World War, the Treaty of Ver­sailles im­posed repa­ra­tions on the de­feated na­tions - pri­mar­ily Ger­many, but also Aus­tria, Hun­gary, Bul­garia and Turkey.

Newspapers in English

Newspapers from Pakistan

© PressReader. All rights reserved.