At times of economic crisis, politicians like to blame investors, preferably foreign investors.
Harold Wilson, the British prime minister in the 1960s, pointed the finger at bankers in Zurich. Prime Minister Mahathir Mohamad of Malaysia accused George Soros of undermining his country’s financial stability in the late 1990s. And in parts of Europe today, it is increasingly common to blame hedge funds, “locust”-like investors, or even credit-default swaps for the euro-area crisis.
This is almost entirely a smokescreen. To be sure, politicians worked closely with global megabanks in building up public and private debt in recent decades. But the idea that investors are now responsible for Europe’s debt crisis ― or could somehow fix it if they stopped “speculating” ― reads like something from the Soviet Union in the 1920s.
Europe’s politicians are to blame. They are the ones who built an unsustainable gold-standard-type structure, in which currencies are fixed in relative values and it is costly (and frightening) to change those values. Many gold enthusiasts believe that such monetary arrangements lead to stability, which is completely at odds with the historical record.
The gold standard era was characterized by repeated boom- bust cycles. Low interest rates encouraged public- and private- sector borrowing and episodes of overborrowing were the norm, not the exception. Convertibility into gold was suspended at regular intervals, including every 15 years or so in the U.S.
Euro-area governments unfortunately cannot suspend convertibility. It is even harder to alter exchange rates today than it was under the gold standard, when everyone kept a domestic currency and only its price against gold was in question. The European Union could introduce a full fiscal union, as the U.S. did after the Constitutional Convention of 1787. But it’s hard to see it adopting the complete Alexander Hamilton solution. In 1789, as the first treasury secretary, he had the federal government take over much of the states’ debt.
Today, euro-area debt is significantly higher, relative to the size of Europe’s economies, than the U.S.’s was in 1790. Federal debt, post-Hamilton, was about 40 percent of gross domestic product. Average debt in the euro area is about 90 percent of GDP, with the most indebted above 100 percent; the details are in table 5 of the International Monetary Fund’s most recent Fiscal Monitor.
More important, Hamilton’s move was justified by the fact that most state-level debt had been incurred to fight the war of independence. Even so, Thomas Jefferson and James Madison, for a time, strenuously opposed the assumption of state debt by the federal government.
One of the biggest problems flowing from the euro area’s fixed currency is that wages and prices are too high in heavily indebted states, compared with Germany and a few others, leaving the higher-wage countries uncompetitive. Cutting wages in the troubled periphery would be difficult politically. Lower wages would also make it harder to pay mortgages, compounding the problems for banks and probably for public finances, too.
The solution involves a move straight out of the gold- standard playbook, with a modern twist. Since monetary union began, Germany has had substantial productivity gains and only moderate wage increases, making it highly competitive. Eurostat reports that German wages rose 2 percent a year from 2000 to 2009, while Spanish wages increased by 4.7 percent a year in the same period ― more than twice as fast. Because the currencies are the same, Germany’s competitiveness has made it tough for Spain and the other weaker states to sell their products in the euro area.
But the cavalry may show up in the unlikely form of German trade unions, which are seeking big wage increases this year. Recent demands by German workers range from 3 percent to 6 percent. As Bloomberg News reported, IG Metall, Europe’s biggest labor union with about 3.6 million workers, is demanding 6.5 percent more pay at a time when inflation is about 2 percent.
This isn’t crazy. German unemployment is at its lowest level in two decades. German exports have been doing well around the world. To some monetary purists, talk of higher wages suggests that the European Central Bank’s policy is too loose for current German conditions. But this is really taking an idealized version of the gold standard too far.
The point is to have relative wages and prices adjust ― higher for Germany and lower for its European trading partners. If German incomes rose, German consumers would have more disposable income with which to buy imported goods. And lower labor costs in other European countries would make their goods and services less costly, giving them a leg up against Germany’s export machine.
If the people in charge ― mostly Germans at this point ― insist that the adjustment must come entirely through a fall in the absolute level of wages and prices in countries with current-account deficits and large amounts of debt, then Europe is in for a difficult, and perhaps lost, decade.
But if part of the adjustment can come through higher German wages ― recognizing productivity gains and consistent with continued prosperity ― the path forward will be easier.
Don’t blame the investors. Don’t wait for the politicians to sort out the mess they created. Hope that, in an increasingly globalized world, German trade unions still have enough muscle to get significant wage increases.
By Simon Johnson
(Bloomberg)
Simon Johnson is a professor at the MIT Sloan School of Management as well as a senior fellow at the Peterson Institute for International Economics. ― Ed.
