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Business News/ Opinion / The euro crisis returns
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The euro crisis returns

The only weapon that the generation that was born after the War knows to wield is easy money

Photo: Bloomberg Premium
Photo: Bloomberg

Earlier this month, the European Central Bank (ECB) announced symbolic cuts to the already-low interest rates that prevailed in the euro zone. The rates are indistinguishable from zero per cent. Banks have to pay an interest rate of 0.2% to the ECB if they kept the money with it. Then, there is the targeted long-term refinance operations (LTRO) which has already been announced. The purely monetary approach to the global economic problems continues. The belief in the omnipotence of monetary policy is breathtaking. That the policy is unprecedented, unusually prolonged and globally pervasive and hence has uncertain and unpredictable consequences does not seem to bother either investors or policymakers.

Regardless of whether the latest round of monetary policy measures work in the euro zone, the euro has weakened against most currencies. That is a necessary condition but it is a woefully inadequate condition. In the first two to three years after the 2008 crisis, the pound sterling weakened considerably against all currencies. That did not help the UK to grow its exports. Other than financial services and housing bubbles, the UK has nothing much to export. Low interest rates and targeted lending did not lead to a manufacturing revival in the country. It helped revive the housing bubble in London. It is worth remembering that the UK regained competitiveness in manufacturing in the 19th century through painful deflationary adjustment.

The recent weakness of the euro only confirms Reserve Bank of India governor Raghuram Rajan’s hypothesis that quantitative easing is nothing but quantitative external easing. First, it was the turn of the pound sterling and the US dollar, then it was the turn of the Japanese yen and now it is the turn of the euro to weaken. World’s leading central banks seem to believe this relay race of devaluation will restore economic growth without degenerating into a beggar-thy-neighbour approach.

Some others advocate a different form of restructuring. One of them is Yanis Varoufakis. His book, The Global Minotaur, is a brilliant exposition of the political reasoning behind American economic policies, domestic and global, since the end of World War II. He wrote a detailed blogpost recently explaining the failure of Germany to play the same role that the US played in the immediate aftermath of the War.

The US recycled its trade surplus into the war-ravaged economies of Germany and Japan. It boosted their productive capacity and transformed them into economic powers. The US achieved more than one goal in the process. His complaint is that Germany has not been willing to play the same role as the US did, recycling its trade surplus into investments in southern European countries such as Greece, Portugal, Spain and Italy. He provides a political economy explanation for that failure.

More important than the explanation is the question of whether German action would have met with the same response as the American action had from Germany and Japan. The answer has to be a big no. There are two big clues as to why Germany has been right to hold back on playing a similar role as the US did.

First, after the formation of the euro one in 1999, long-term borrowing costs in southern European countries declined substantially. That was already a huge windfall for them and they owed it, in large measure, to Germany. Without financial markets according them the same standing as Germany, their interest rates would not have declined that much. Financial markets believed that the euro one would soon reflect German productivity and price stability, as it bound the laggard nations and Germany together with a common monetary policy. That did not happen. Low interest rates did not turn them into industrial powerhouses. Instead, they set off construction and property booms in these countries and their real exchange rates appreciated due to low and declining productivity, compounding the problem of competitiveness. Given this hard evidence, it is hard to find fault with Germany for not emulating American behaviour in the euro zone either before or after the European crisis broke out in 2010.

There is a second reason that vindicates German caution. Forget about southern Europe. Even the US did not follow the example of Germany and Japan when the roles reversed since the seventies. The US recycled its trade surplus in the first two decades after the War. Then, it turned into a perpetual trade deficit nation attracting capital from trade-surplus countries—Germany and Japan first, East Asia next and then from China. That capital boosted the US’ Wall Street and did little to arrest the decline of manufacturing in the US. Therefore, the evidence is that Germany and Japan, after the War, were the exceptions and not the rule. The rule is that, guaranteed the recycling of their trade surplus by exporting nations, receiving countries settle down into a complacent and comfortable existence of low productivity, financial and real estate booms.

The only weapon that the generation that was born after the War knows to wield is easy money.

Their policies are a reflection of the fact that they had not encountered sustained hardship and hence do not know how to cope with it except to wish it away. That is what it is doing with quantitative easing policies. Hence, the euro will continue to weaken and, maybe, an even worse fate awaits it.

V. Anantha Nageswaran is co-founder of Aavishkaar Venture Fund and Takshashila Institution.

Comments are welcome at baretalk@livemint.com. To read V. Anantha Nageswaran’s previous columns, go to www.livemint.com/baretalk

Follow Mint Opinion on Twitter at https://twitter.com/Mint_Opinion

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Published: 15 Sep 2014, 05:50 PM IST
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