Back in the era of unquestioned US hegemony, many Europeans (and I include myself) dreamed of the moment when our leaders would find it in their hearts publically to repudiate the heavy handed advice of a high ranking visiting American dignitary. This weekend, the dream came true. Only it turned out a terrible nightmare.
Tim Geithner was in Europe this weekend for the purpose of appealing to European leaders to put their money where their mouth is; to complement lofty declarations of a commitment to saving the euro with actual policies that might achieve the stated objective. Not for the first time since the Crisis erupted in 2008, the visiting US Treasury Secretary had his advice thrown back in his face by a European leadership that seems to have found unity in inanity.
Maria Fekter, Austria’s finance minister, had this to say afterwards: “I found it peculiar that even though the Americans have significantly worse fundamental data than the eurozone, that they tell us what we should do and when we make a suggestion … that they say no straight away.” What this sentence reveals is the deep ignorance in which our European leaders’ thinking is veiled. When they refer, for instance, to “fundamental data” which is worse in the US than in the EU, they are obviously referring to debt-to-GDP ratios. Which means that they, clearly, believe that Europe’s problem is a debt crisis. Which, of course, it is not.
Isn’t it a debt crisis? Of course not! Indeed, the Austrian Finance Minister is right to point out that, by US and Japanese standards, Europe’s aggregate debt is hardly a problem. But then again, how come Europe is immersed in a debt crisis? If Europe is afflicted by a debt crisis, it must surely be less severe than America’s or Japan’s. It is not. US and Japanese bonds are finding legions of willing buyers at record low interest rates (unlike the European bond markets which have almost seized up). Meanwhile the dollar and the yen are doing fine thank you while the euro is under pressure. Something in the Austrian minister’s logic does not add up…
That ‘something’ is, of course, that Europe’s debt troubles are a mere symptom of a problematic architecture of the euro which Europe, in its infinite wisdom, tried to resolve by creating a toxic bailout fund; the EFSF. One wrong to correct another, in simpler words. (See here for an earlier post which explains this point.)
In short, the reason why Tim Geithner has every right to offer the Europeans advice on how to handle their Crisis is because they are stubbornly refusing to grasp its nature. By insisting that Europe’s problem is one of too much debt and insufficient fiscal ‘discipline’, they are running the grave risk of allowing the euro to unravel, with horrid repercussions that will soon travel across the great oceans bringing down with it any chance the global economy currently has to avoid another Great Depression.
So, what did Geithner actually advise the Europeans to do? Three things:
First, to realise that nothing they do in the realm of sovereign debt (e.g. austerity) will work as long as Europe’s banking sector remains practically insolvent. To prevent a repetition of Japan’s fatal error of the 1990s (i.e. allowing the banks to remain in a zombie state through liquidity injections that do not address their underlying insolvency), the US Treasury Secretary urged his European counterparts to turn the European Financial Stability Fund (EFSF) into a Euro-TARP; a pan-European institution that would recapitalise the banks in exchange for equity that will be resold to the private sector immediately after the banks are returned to a modicum of heath. (NB. this idea was first canvassed in our Modest Proposal, see Policy 2, and only last month was also supported by Christine Lagarde, MD of the IMF, during her excellent Jackson Hole speech.)
Secondly, mindful of Germany’s reluctance to increase the EFSF’s funding power (from the current €440 billion, a large chunk of which has been assigned to the ‘bailouts’ of Portugal, Ireland and Greece), so that it can indeed recapitalise Europe’s ailing banks, Geithner tried to educate his European counterparts to the policy trick that he conjured up in 2008 while heading the New York Federal Reserve; a financial technique that would allow the EFSF considerably to expand its €440 billion-euro by means of leverage made possible by the ECB.
Thirdly, Geithner told the Europeans that which a 12 year old child would have known: With world aggregate demand stalling, and the EU’s own growth grinding to a halt, the debt and banking crisis cannot be overcome unless growth is somehow stimulated. He appealed to them to abandon their policy of free riding on the coattails America’s monetary easing and China’s fiscal stimulants. He begged them to do their bit to shore up aggregate demand in Europe in order to avert Europe’s own decline and, by extension, the globe’s next recession.
Well, we all know how the Europeans reacted: By a mix of denial, ignorant rejoinders and downright impudence. The Austrian Finance minister’s silly remarks are just the tip of an embarrassing hideous iceberg. Our European ministers indulged, once again, their steadfast denial that there is anything fundamentally the matter with Europe’s banks (repeating the unconvincing statements they issued following Christine Lagarde’s Jackson Hole speech). Additionally, they put again (in full Technicolor display) their dogged determination to maintain the pretense that the ECB can afford to (and must) stay out of the debt and banking loss management game. For example, Bundesbank President Jens Weidmann had this to say in response to Geithner’s proposal that the ECB helps the EFSF ratchet up its funding in order to have enough dough to re-capitalise the banks: “The EFSF’s sole purpose is the financing of states and that’s in order as long as it’s done via the capital market.” “If it’s done via the central bank it constitutes monetary state financing.” How terrible that would be! Seriously Mr Weidmann? Clearly, Mr Weidmann cannot grasp the simple fact that, at a time of an imploding currency union, the line dividing fiscal from monetary financing becomes blurred for a Central Bank whose remit is to be the currency’s guardian.
Tim Geithner, as I have argued in my Global Minotaur, is a US Treasury Secretary with a tainted past. Indeed, as a handmaiden of Wall Street, since his Clinton Administration days, he carries the sin of having released the banks from any constraints that might have prevented their predatory and fraudulent practices in the 1990s. More recently, Geithner played a crucial role in assisting the creation of (what I call) post-2008 Bankruptocracy.
Nonetheless, this does not mean that, on this occasion, his advice is to be ritually discarded. Tim Geithner is a skilled and experienced government man. The Crash of 2008, which caught him at the New York Federal Reserve, has taught him to recognise the signs of an impending financial disaster. His experience of dealing with such a disaster, especially a bankrupt banking sector that resists recapitalisation even when recapitalisation is sine qua non, led him to the conclusion that Europe must turn the EFSF into a European TARP and that, unless it does so, the world’s financial system is in serious peril at a time when government lacks the deep pockets it had in 2008 to come to their rescue.
For these reasons, Tim Geithner rushed to Europe this weekend with pretty good advice. Europe shunned him. I have no doubt we shall all pay for this.