Cameron is right over EU restructuring, says German economist

Interview Hans-Werner Sinn, WalesOnline, 19.06.2013

Prof Hans Werner Sinn of the University of Munich said the eurozone crisis could last 10 years and crisis-hit countries such as Greece should be allowed to leave the euro until they restored their competitiveness

It is not fair that taxpayers rather than investors should bear the cost of bank bailouts in the eurozone, one of Germany’s leading economists told Business in Wales recently.

Prof Hans Werner Sinn of the University of Munich also said that the eurozone crisis could last 10 years and that crisis-hit countries such as Greece should be allowed to leave the euro temporarily until they restored their competitiveness.

Prof Sinn explained that in his view the crisis affecting the eurozone was not one of financial confidence but of competitiveness.

“The countries of southern Europe have become too expensive, and lost their competitiveness. Why? Because the euro brought them cheap credit, it reduced the interest rates and they were borrowing like hell,” he said.

“It was a credit bubble which turned out to be over-borrowing by governments in some countries and over-borrowing by private agents for buying real estate in other countries. 

“That bubble burst when the American crisis swept over. Then the European Central Bank (ECB) stepped in with the printing press to help fund them while the private capital which they had borrowed abroad had become too expensive.”

Prof Sinn said that this printing press approach had simply delayed the necessary adjustments. “It’s a painkiller not a medicine,” he said.

The one exception, he said, is Ireland, where the crisis struck two years before it affected other countries.

“There was no possibility for Ireland at that time to use the printing press because the ECB had not yet introduced the new rules which allowed that,” Prof Sinn said.

“So they had to help themselves with austerity. Wages and prices dropped, prices by 15% from 2006 till now. Ireland managed to improve its competitiveness significantly but they only did so because they didn’t get help.”

The professor’s visit came shortly after the Cyprus bailout, which has seen mass protests against initial plans to take a cut from all bank deposits.

His interpretation was that the Cyprus government had chosen to include even the small savers in an attempt “to mobilise the people” against the policy of imposing losses on depositors.

“Because the ruling class have the big deposits and have close relationships with other business interests, they were afraid of losing their deposits and they wanted to include the small guys to bring them to the streets, which they did,” he said.

Eventually the terms were changed so that only deposits greater than 100,000 euros were affected.

“I find that way too high, because it’s a lot of money,” Prof Sinn said.

“It’s twice the median wealth of a German household, so how can you ask ordinary people from other countries to foot the bill to protect people in Cyprus whose median wealth is a couple of times higher?

“But the 100,000 euro figure comes from the EU. Given this number I think it was right to have the haircuts and equity stops only beyond 100,000 euros.

“What was not right was that Cyprus received 10bn euros to bailout the ECB which had given 9bn euro Target credits to the Central Bank of Cyprus to pay out deposits of rich foreign investors, enabling them to escape from Cyprus in the timespan  between the Greek haircut in spring 2012 and the default of the Cypriot banking system.”

Prof Sinn rejected the suggestion that his approach would impose pain on ordinary people in southern Europe who were not responsible for the crisis.

“I’m sometimes put into the corner of an austerity hawk, which is not true,” he said.

“I do think those who want to stay in the eurozone have no alternative to austerity because that’s the only way to bring their prices down. It’s a painful process of real devaluation through which Germany went in its own euro crisis 10 years ago when it had the lowest rate of growth in Europe…”

He added: “I think it would be better for some countries whose competitiveness is way out of line to exit the euro and devalue, that’s the better choice for the people.

“It’s not done because as long as they stay in and things go on as they did for the last five years, the investors have a chance to take more money out of the country. When their claims on the country mature then they will get their money back.

“So the investors – banks, insurance companies from Germany, Britain and  other countries – they of course insist that everything continues the way it is because it allows them to unload their toxic assets onto the European taxpayers. This I think is neither fair nor wise because it makes the crisis permanent.”

The result, he says, is permanent stagnation and increasing mass unemployment in countries such as Greece and Spain, which he describes as a “catastrophe” and an outrage against their populations.

The crisis, he says, could last 10 years. “We had a period of 12 years of wonderful growth after the announcement of the euro at the Madrid summit in 1995, and how can you expect that the period (for) solving the mess is shorter?” he said.

“It’s not a business cycle problem, it’s a long-term structural problem, due to the change in relative prices in the Eurozone that deprived the southern countries of their competitiveness,” he added.

“Devaluation through austerity is hardly possible. You destroy the societies if you try to bring down the prices and wages through austerity, if you do it too much, so it’s very limited what you can do.

“The other solution would be to inflate the core, to make the periphery more competitive. But it’s not so easy to inflate the core. The ECB, when the rate of interest is already close to zero, doesn’t have the means to do it even if it wanted to, and secondly it would violate the Maastricht treaty, according to which the ECB has to guarantee price stability.

“Third, it would create a lot of opposition in Germany which certainly does not want to inflate.”

Prof Sinn pointed out that this summer it would be six years since the crisis began, and said it was time to look for more radical solutions, as no correcting realignment of prices has taken place.

“You can solve the financial crisis with new money but you can’t solve the competitiveness crisis in this way, and the competitiveness crisis is the true underlying cause of the financial crisis,” he said.

Asked which countries should leave the euro, Prof Sinn said it was up to the countries themselves to decide, but added: “According to a study by Goldman Sachs, quite a number of southern (European) countries are overvalued in terms of their prices, primarily Portugal, Spain, Greece, not so much Italy. Even France has an overvaluation problem, according to Goldman Sachs their prices would have to come down by about 20% against the average.”

Speaking the day after he gave the annual Julian Hodge lecture in Cardiff, Prof Sinn argued that it was possible to achieve this within the euro if one accepted a decade of slow growth which would lead to wage moderation and low inflation, and pointed to the German experience.

“Chancellor Gerhard Schroeder carried out his austerity reforms – which really were harsh and cost him his job – in 2003, now we’re 10 years ahead and Germany’s doing fine,” he said.

If a country such as Greece did decide to leave the euro, Prof Sinn denied they would have to go through a period of pain before being able to rejoin.

“The pain is now in the euro where they don’t have competitiveness,” he said.

“When they exit the pain will immediately be relieved, because the drachma will devalue and all of a sudden two things will happen. Capital will come into the country because it’s cheap and seems profitable.

“The Greeks who have parked at least 120bn euros in Switzerland will return, rich Greek people will buy real estate at home and renovate it and invest, and other international investors will come too.

“Secondly, existing Greek firms will be competitive again because their products are cheap, and tourism will flourish once more. Greek people would stop buying Dutch tomatoes and buy their own. This all gives immediate relief to the Greek people.”

The policy carried out in Cyprus was in line with the approach recommended by Prof Sinn and a group of German economists in a letter to the German Chancellor Angela Merkel last summer.

Prof Sinn and his colleagues were concerned that the governments of Europe were under-estimating the scale of the banking crisis.

“The debt of the banks is three times as large as the debt of the states, so this is too big to bail, that was our main argument,” he said.

“We recommended that a re-capitalisation of the troubled banks of southern Europe take place through haircuts and debt-equity swaps, and indeed now as Cyprus shows the strategy has changed. They’re changing their plan to make a pecking order saying who suffers first, with the depositors coming at the end and the depositors under 100,000 euro should be protected. That’s exactly what we wanted,” he said.

The same approach, he argues, should be taken with other countries.

“It has to be, because Cyprus in total has received about 140% of its GDP in terms of aid from the ECB and the community of states, how can you replicate that?” he said.

“Greece has received 160% of GDP, suppose we have to do that with Spain and Italy? We’re talking about 5,000bn euros of public credit given to these two countries by the other countries? Impossible.”

The conclusion is simple, that taxpayers across Europe cannot be expected to pay for the misfortunes of investors.

“It’s not tenable, it’s not just, it’s not possible with the quantities. You destabilise the states of Europe, you create a fire channel from the banking sector into the governments and the still functioning states of Europe, you destabilise the whole thing,” he said.

Perhaps mindful of German history, he added: “This sort of destabilisation of states is much more important than destabilising a few banks. I never understood how people could put a political state crisis on the same level as a banking crisis. The banking crisis is bad enough, but if the states come into trouble it’s really much worse.”

Prof Sinn was in Wales before the recent county council elections, which saw a surge in the UKIP vote and David Cameron’s subsequent decision to commit his party to a referendum on EU membership by 2017.

But he was supportive of Mr Cameron’s attempt to renegotiate the terms of Britain’s membership of the EU.

“I think we should take up Cameron’s proposals and convert them into a constructive discussion about reshaping Europe. He has a point when he says that too much bureaucracy is building up in Brussels, too much centralising of decisions that by the subsidiarity principle should be taken locally.

“So I’m glad that Mrs Merkel did not follow others who said that Britain is just cherry picking but wants to be engaged in a constructive debate. Speaking from the German perspective it is vital to keep Britain in as a counterweight against excessive centralisation and socialisation attempts within Europe,” he said.

What did he think would be the consequences of a British departure from the EU?

“It would be extremely dangerous for the European integration project. Europe is not only the eurozone, it consists of many countries which are not in the eurozone which share the cultural values and traditional trade links,” he said.

He added: “It’s a big mistake to carry forward the integration of Europe only via the euro, and here I see a major risk of this euro project.

“It’s not only creating a borderline between the continent and Britain, but also between Germany and Poland and the Czech Republic and Sweden. I think this is all very dangerous and one has to avoid that under all circumstances.”

Prof Sinn advised the European authorities to change the nature of the euro: “Give up the idea of this being an eternal relationship which no-one believes anymore and make it more open and flexible – something between a fixed exchange rate system  like the Bretton Woods system and a currency union like in the USA, where it works because it’s a state in its entirety while Europe consists of many separate states.”

He added: “If at some stage we, as I hope, create the United States of Europe, then the euro in the sense of being an undisputable permanent currency would make sense. But not at this stage of history.”