June 21, 2012
By J.D. Foster, Ph.D.
Larry Summers, the former Clinton treasury secretary and more recently a top economic adviser to President Obama, has demonstrated two exceptional abilities. The first is an insightful review of conditions in the European crisis and why political solutions are so hard to come by. The second is he managed to get the same column into two of the world’s leading newspapers simultaneously. It was printed in the Financial Times (“Listen to the private sector and plan for the worst”) and the Washington Post on the same day. To quote Darth Vader: “impressive.”
However, the greater story is that after discussing conditions and issues, Summers observes darkly, “Not all problems can be solved.” And then to underscore that critical observation, he concludes with a wispy triplet of minimalist proposals, none of which bear any resemblance to the empty bailout proposals announced at the G20 summit. The real conclusion from Dr. Summers, the proverbial bottom line, is that Europe is about out of options for avoiding the wretched harvest planted a decade ago with an ill-conceived monetary union. Not all problems will be solved? Very few, if any, problems will be solved by Europe’s leaders to their or the market’s satisfaction for they have no solutions.
Summers’s penultimate sentence containing his recommendations reads, “Now is the time for radical cuts in the rates charged by official creditors to European sovereigns; for a willingness to subordinate official debts; and for expansionary monetary policies in Europe that prevent deflation and encourage the growth that can create jobs and reduce debts.”
For those who don’t speak European international financese, I’ll translate. “Radical cuts in the rates charged by official creditors to European sovereigns” simply means the International Monetary Fund (IMF) and the various collective bailout tools Europe has thrown together ought to slash the interest rates charged to Ireland, Greece, Portugal, Spain, and possibly soon Italy for their bailouts. Cutting interest rates would moderate budgetary pressures in these countries. The colloquial expression might be the world needs to “cut them a little slack.”
The whole point of charging higher rates is to discourage borrowing and encourage rapid repayment made possible by the structural reforms mandated by the troika of the IMF, the European Union, and the European Central Bank (ECB). However, if Europe is to try salvaging its grand currency union, then the recommendation makes some sense at the margin. It’s not a game changer by any stretch, but cutting interest rates and the debt-service expenses can’t hurt. And if the Germans and the relatively creditworthy of Europe want a backdoor transfer system to the struggling periphery, that’s their business. On the other hand, it’s not clear why the rest of the world through the IMF would cut bailout interest rates, nor why it should, effectively transferring income to relatively rich countries. It is quite clear the United States should oppose any such effort.
Calling for the official creditors to European sovereigns to “subordinate official debts,” number two in the Summers triplet, is another matter entirely. When the IMF makes a loan as part of a bailout/restructuring agreement, that loan becomes the most senior of all, meaning that nobody else gets paid off until the IMF gets paid off. If the IMF is involved, then it and the borrowers must abide by the usual conventions.
Summers knows this, so his recommendation must apply, again, to the bailout tools of Europe. The translation, then, is that Summers believes the Germans and other European creditworthies should go to the back of the line behind private creditors. An interesting proposal: With default lingering in the air it suggests creditor nations should just forgive the debt, treat it as a transfer, a grant, a gift, to the struggling, hardworking Greeks and Italians. Put that way, one wonders if this proposal were adopted whether the German government would ever again participate in another bailout (read: banking union; Eurobonds; sinking fund; or other) or if the Germany people would ever again tolerate putting their own savings up as second-class creditors. I think not, so this really is a doomsday proposal.
Third, Summers calls for a more accommodative monetary policy by the ECB. In this, he is not alone, but this too would be a most desperate act. Not because the ECB has been demonstrably too loose already. But because those calling for a more accommodative ECB to resist deflation and spur growth ignore the facts before us in Europe and the United States and Japan for the past twenty-plus years — an accommodative monetary policy in this environment may barely deflect deflation and has even less effect on growth.
The Summers piece argues forcefully for strong actions in the face of dire threats. And then concludes with three itty-bitty proposals. As he concludes, “Only if the [European monetary and economic] system is preserved can its future be debated.” True indeed, but if even Larry Summers unconstrained by politics cannot concoct proposals to preserve the system, then there’s really not much point in debating its future.
First appeared on NationalReview.com.
J.D. Foster, Ph.D.
Norman B. Ture Senior Fellow in the Economics of Fiscal Policy
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