SPIEGEL ONLINE
12/22/2010 01:07 PM
Top Economists Debate the Crisis
'Clinging to the Euro Will Only Prolong the Agony'
SPIEGEL: Mr. Bofinger, Mr. Homburg, can the euro be saved?
Stefan Homburg: In 1995, the great thinker and European policy expert Ralf Dahrendorf predicted that the euro would divide rather than unite the continent. At the moment, we are experiencing the beginning of this process. Political tensions are growing in Europe, and the Germans are being viewed as taskmasters. For these reasons, it would be better to bring down the curtain on the euro and return to the deutsche mark.
Peter Bofinger: That would be irresponsible. The euro has been a model of success. It is essential that we preserve it. The only problem is that the steps taken so far haven't sufficed. What we need now is a bold step toward more economic integration.
SPIEGEL: What do you have in mind?
Bofinger: We should seize upon the proposal of Luxembourg Prime Minister Jean-Claude Juncker and introduce common bonds for the euro zone. Such euro bonds would significantly reduce the interest costs for problem countries, such as Greece, Ireland and Portugal. These countries would then have an easier time putting their government finances in order with austerity measures.
Homburg: I doubt that. Euro bonds violate the Maastricht Treaty, which stipulates that no country can be held liable for another country in the euro zone. The euro bonds would even elevate liability to the level of a principle and force Germany to vouch for the debts of other countries whose fiscal behavior we cannot control. Our population would not tolerate the tax increases and reductions in transfer payments that this would necessitate.
Bofinger: Yes, they would. We would just have to explain to them that this is the only way to preserve the euro. This will not succeed with the current bailout funds. They are not sufficient for anything more than Greece, Ireland and Portugal, and possibly Spain. But they would not be enough if a country like Italy joined the fold.
Homburg: Are you seriously suggesting that Germany should leap in to help if Italy stops servicing its debts?
Bofinger: Absolutely. If Italy falls, so do billions upon billions that German banks and insurance companies hold in the form of Italian bonds. The consequence would be a massive financial crash -- a risk that no government can take. That's why we have no choice; we have to stabilize the system.
Homburg: Pardon me, but that's nothing but scaremongering. Throughout history, there have been hundreds of government bankruptcies. Look at Argentina and Russia, for example. But in none of these cases did the entire financial system collapse. Of course, the financial industry likes being able to collect hefty risk premiums without risk. But, it can't be right for Germany's taxpayers to prop up the banking sector under the guise of saving countries or the euro.
Bofinger: I completely agree with you. If it were somehow possible to isolate the effects of a bank's failure, it would be better for us to simply allow all the banks that speculated recklessly to go under. The only problem is that, unfortunately, we can't isolate the effects. Today's banks are too big and too interconnected for that. Besides, they have no equity reserves for government bonds. The financial crisis has taught us that the markets have a tendency toward uncontrollable chain reactions.
SPIEGEL: Are you saying that the euro crisis could develop into a new Lehman case?
Bofinger: The Lehman bankruptcy would look like a drop in the ocean compared to what we would see if a country in the euro zone were to go bankrupt.
Homburg: I see things completely differently. The cause of the euro crisis is not to be found in the irrationality of the financial markets. Rather, it lies in the fact that certain countries lived beyond their means. A Greek train driver earns a monthly net salary of €5,000 ($6,600), and Spanish air traffic controllers make up to €300,000 a year. Do you really want to ask German workers, who haven't seen wage increases in a long time, to pay for incomes like that with even higher taxes?
Bofinger: Now, hold on a minute. In Spain and Ireland, it was the private sector, not the government, that lived beyond its means. In 2007, the Irish government had a balanced budget, and the Spanish government even had a surplus. The financial sector, on the other hand, issued loans that made no sense at all for years. The damage is considerable, but it could be contained if Europe would introduce euro bonds. After all, a euro bond is not a transfer union.
Homburg: What else could it be? Economists have made reliable calculations showing that the interest rate on a euro bond would be about a percentage point higher than the rate on a German government bond. Each year, this would cost the (German) government about €20 billion more, which would be the equivalent of a 2 percent hike in the value-added tax.
Bofinger: I would contest the assertion that the interest rate on a euro bond would be higher than that on a German government bond. Indeed, the current problem is precisely that risks associated with the euro countries are evaluated separately. If, on the other hand, they had a united presence on the financial market, the risk of a bankruptcy would be low, and the risk premiums would disappear. US Treasury bonds would be the most important competitors. Since total new borrowing for the euro zone is substantially lower than that of the United States, the euro bond would be an attractive instrument at the international level. And that's particularly the case since the market for euro bonds would be much bigger than the market for German government bonds.
Homburg: Euro bonds would not be as safe as German government bonds. And since they would stimulate even heavier borrowing, they would have to yield higher rates. In the wake of the current bailout measures, the German government has already burdened taxpayers with risks worth €200 billion. Likewise, over the last year, risk premiums for German government bonds have doubled. There simply isn't any more room for maneuver.
Bofinger: If you stir together eggs, water and flour, you don't get 50 percent flour, 25 percent water and 25 percent eggs. Rather, you get dough for egg noodles. You create something new -- and the same would apply to the euro bond.
Stefan Homburg: In 1995, the great thinker and European policy expert Ralf Dahrendorf predicted that the euro would divide rather than unite the continent. At the moment, we are experiencing the beginning of this process. Political tensions are growing in Europe, and the Germans are being viewed as taskmasters. For these reasons, it would be better to bring down the curtain on the euro and return to the deutsche mark.
Peter Bofinger: That would be irresponsible. The euro has been a model of success. It is essential that we preserve it. The only problem is that the steps taken so far haven't sufficed. What we need now is a bold step toward more economic integration.
SPIEGEL: What do you have in mind?
Bofinger: We should seize upon the proposal of Luxembourg Prime Minister Jean-Claude Juncker and introduce common bonds for the euro zone. Such euro bonds would significantly reduce the interest costs for problem countries, such as Greece, Ireland and Portugal. These countries would then have an easier time putting their government finances in order with austerity measures.
Homburg: I doubt that. Euro bonds violate the Maastricht Treaty, which stipulates that no country can be held liable for another country in the euro zone. The euro bonds would even elevate liability to the level of a principle and force Germany to vouch for the debts of other countries whose fiscal behavior we cannot control. Our population would not tolerate the tax increases and reductions in transfer payments that this would necessitate.
Bofinger: Yes, they would. We would just have to explain to them that this is the only way to preserve the euro. This will not succeed with the current bailout funds. They are not sufficient for anything more than Greece, Ireland and Portugal, and possibly Spain. But they would not be enough if a country like Italy joined the fold.
Homburg: Are you seriously suggesting that Germany should leap in to help if Italy stops servicing its debts?
Bofinger: Absolutely. If Italy falls, so do billions upon billions that German banks and insurance companies hold in the form of Italian bonds. The consequence would be a massive financial crash -- a risk that no government can take. That's why we have no choice; we have to stabilize the system.
Homburg: Pardon me, but that's nothing but scaremongering. Throughout history, there have been hundreds of government bankruptcies. Look at Argentina and Russia, for example. But in none of these cases did the entire financial system collapse. Of course, the financial industry likes being able to collect hefty risk premiums without risk. But, it can't be right for Germany's taxpayers to prop up the banking sector under the guise of saving countries or the euro.
Bofinger: I completely agree with you. If it were somehow possible to isolate the effects of a bank's failure, it would be better for us to simply allow all the banks that speculated recklessly to go under. The only problem is that, unfortunately, we can't isolate the effects. Today's banks are too big and too interconnected for that. Besides, they have no equity reserves for government bonds. The financial crisis has taught us that the markets have a tendency toward uncontrollable chain reactions.
SPIEGEL: Are you saying that the euro crisis could develop into a new Lehman case?
Bofinger: The Lehman bankruptcy would look like a drop in the ocean compared to what we would see if a country in the euro zone were to go bankrupt.
Homburg: I see things completely differently. The cause of the euro crisis is not to be found in the irrationality of the financial markets. Rather, it lies in the fact that certain countries lived beyond their means. A Greek train driver earns a monthly net salary of €5,000 ($6,600), and Spanish air traffic controllers make up to €300,000 a year. Do you really want to ask German workers, who haven't seen wage increases in a long time, to pay for incomes like that with even higher taxes?
Bofinger: Now, hold on a minute. In Spain and Ireland, it was the private sector, not the government, that lived beyond its means. In 2007, the Irish government had a balanced budget, and the Spanish government even had a surplus. The financial sector, on the other hand, issued loans that made no sense at all for years. The damage is considerable, but it could be contained if Europe would introduce euro bonds. After all, a euro bond is not a transfer union.
Homburg: What else could it be? Economists have made reliable calculations showing that the interest rate on a euro bond would be about a percentage point higher than the rate on a German government bond. Each year, this would cost the (German) government about €20 billion more, which would be the equivalent of a 2 percent hike in the value-added tax.
Bofinger: I would contest the assertion that the interest rate on a euro bond would be higher than that on a German government bond. Indeed, the current problem is precisely that risks associated with the euro countries are evaluated separately. If, on the other hand, they had a united presence on the financial market, the risk of a bankruptcy would be low, and the risk premiums would disappear. US Treasury bonds would be the most important competitors. Since total new borrowing for the euro zone is substantially lower than that of the United States, the euro bond would be an attractive instrument at the international level. And that's particularly the case since the market for euro bonds would be much bigger than the market for German government bonds.
Homburg: Euro bonds would not be as safe as German government bonds. And since they would stimulate even heavier borrowing, they would have to yield higher rates. In the wake of the current bailout measures, the German government has already burdened taxpayers with risks worth €200 billion. Likewise, over the last year, risk premiums for German government bonds have doubled. There simply isn't any more room for maneuver.
Bofinger: If you stir together eggs, water and flour, you don't get 50 percent flour, 25 percent water and 25 percent eggs. Rather, you get dough for egg noodles. You create something new -- and the same would apply to the euro bond.
Homburg: You're living in a dream world. Euro bonds create a system in which countries assume joint liability -- and at Germany's expense. The European Central Bank (ECB) has already asked (euro-zone) member states for a capital infusion because, since the crisis began, it has bought up close to €75 billion in troubled government bonds. And who is paying the lion's share? Germany. For the time being, the shell game being played by politicians and the ECB is still working. But things will get worse when Greece and others can no longer service their debts. Then we'll have to guarantee amounts that no one could even imagine today. And, in Germany, it would necessitate massive cuts.
Bofinger: Things won't reach that point if the proposal is correctly implemented. After all, it doesn't just call for new bonds; it also calls for more power for the European Commission in Brussels. Under the proposal, in the future, it would be up to the European Commission to ensure that all member states are pursuing sound fiscal policies. It's very simple: Whoever violates the criteria of the Stability Pact will not be allowed to issue any more euro bonds.SPIEGEL: Let's assume that the system is introduced in the form that Mr. Bofinger suggests. Would that be the solution, Mr. Homburg?Homburg: No. The Stability Pact hasn't worked, and it never will. The German government has massively failed in all its efforts to bolster the Stability Pact.Bofinger: It's a question of negotiating skill. I'm convinced that, if the German government were willing to allow the introduction of euro bonds, it could impose conditions on the other countries. In effect, it would be saying: "We'll give the euro another chance, but only if our partners commit themselves to stricter fiscal discipline."Homburg: Clinging to the euro will only draw out the agony. I argue in favor of making a painful break -- that is, putting an end to this monetary experiment. It would calm thing down in Europe and, on balance, the continent would be better off.'We'll Wake Up One Morning to Hear We Have a New Currency'SPIEGEL: In other words, you are proposing that Germany should withdraw from the euro zone. The only question is whether we can handle the economic consequences.Homburg: Technically speaking, getting out of the euro is just as easy as getting into it was a few years back. But there will hardly be any forewarning about such a withdrawal. Instead, we'll just wake up one morning to hear on the radio that we have a new currency.Bofinger: The way you want to help the Germans get their beloved deutsche mark back overnight sounds downright idyllic. But, the fact is, it would not be dreamy at all; it would be a nightmare. If the Germans withdraw from the euro, the value of their assets in other EU countries would suddenly decline. This could lead some institutions to the brink of collapse, particularly banks and insurance companies. What's more, we would see a flight of capital into the new deutsche mark that would eclipse anything we have experienced so far.Homburg: Hold on a minute. What you call capital flight -- that is, the regrouping of Greek or Irish government bonds into German or French government bonds -- has been going on for a long time. These are normal movements within the capital markets.Bofinger: But the return of the deutsche mark would add momentum to the process. Our currency would suddenly appreciate by 30 or 40 percent. It would be a fatal blow to German exporters because prices for their products would rise by the same amount in key foreign markets. We experienced a similar situation in the mid-1990s, when the deutsche mark appreciated considerably against the British pound, the lira and the franc. It took the German economy more than a decade to recover from that blow.Homburg: The difficulties in the mid-1990s had their roots in the effects of reunification and not in the exchange rate. It's true that the deutsche mark would appreciate somewhat, but not by nearly as much as you suggest. On the other hand, our consumers would benefit from the corresponding increase in purchasing power. This is precisely what you were proposing for years. Scaring people is unfair because a transfer union -- which would only collapse in the end -- is far more dangerous, economically and politically, than a return to the deutsche mark.Bofinger: Only at first glance. If we abandon the euro, we will soon be funding other regions of the world instead of our partner countries.SPIEGEL: You'll have to explain that to us.Bofinger: Just look at how much money other countries spend to keep their exchange rates relatively stable against the dollar and other currencies. The Japanese have bought foreign government bonds worth $1 trillion. And Chinese banks have bonds worth $2.6 trillion in their vaults. This is several times as much as the Germans have so far spent to keep Europe together. Is it really better to buy US bonds instead of Spanish ones?Homburg: Objection. Were things really that bad for us 10 years ago, when the deutsche mark still existed? All of these nightmare scenarios you're painting here are really unfounded. Objectively speaking, over the last decade, an enormous amount of capital has flowed out of Germany and into other European countries. This current would be reversed if there were a return to the deutsche mark, and more money would be invested in Germany again.SPIEGEL: Mr. Bofinger, your colleague is saying that Germany is practically doing the concept of a unified Europe a favor by withdrawing from the euro. Do you agree?Bofinger: Not at all. If Germany were to leave the euro, it would set Europe back by decades. Once again, the continent would be viewed as an amalgamation of small countries rather than a strong economic zone that can pit itself economically against the United States and the emerging Asian economies.SPIEGEL: So far, German Chancellor Angela Merkel has taken a conservative approach toward the euro crisis. Though she wants to preserve the euro, she still opposes euro bonds. How would you rate her management of the crisis so far?Bofinger: The German government has been far too cautious and far too focused on the details. In all of its efforts, it has consistently hoped that things wouldn't really get so bad. But, in the long run, the individual actions that have been taken so far will not suffice.Homburg: I agree with you completely. The German government has allowed itself to be driven by events and has consistently said no at first, only to relent in the end. It was like that in the case of Greece, with the so-called "euro rescue fund," as well as in the more recent case of Ireland. This aimless muddling has only succeeded in further unsettling the financial markets.SPIEGEL: That sounds rather grim. Was the monetary union a mistake from the very beginning?Bofinger: No. The monetary union makes sense, both economically and politically. And we have benefited from the common currency. Without the euro, Germany would have come to resemble Japan, suffering from weak growth and always teetering on the edge of deflation. Like Japan, in order to re-establish competitiveness, we would have had to respond to every devaluation of the dollar with wage freezes. Thanks to the euro, we avoided that. And that's why it's worth doing everything we can to preserve it.Homburg: Every economist will agree that unified currencies offer theoretical benefits, such as enlarging markets and reducing costs. But, in practical terms, the euro experiment has failed. I think the European Union is a good thing, and I don't want to jeopardize it by desperately clinging to a failed currency experiment. But that's exactly what politicians are doing.SPIEGEL: Mr. Bofinger, Mr. Homburg, how much longer do you give the euro?Homburg: Less than 10 years.Bofinger: If it makes it through the next two years, it stands a good chance of survival.SPIEGEL: Mr. Bofinger, Mr. Homburg, thank you for this interview.Interview conducted by Christian Reiermann and Michael Sauga
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