WILL THE EURO SURVIVE? - Carnegie Endowment for...

WILL THE EURO SURVIVE?

MONDAY, OCTOBER 17, 2011 WASHINGTON, D.C.

WELCOME/MODERATOR:

Uri Dadush, Senior Associate and Director, Economics Program,

Carnegie Endowment for International Peace

SPEAKERS: Jacob Kirkegaard,

Research Fellow, Peterson Institute for International Economics

Desmond Lachman,

Resident Fellow, American Enterprise Institute

Liliana Rojas-Suarez,

Senior Fellow, Center for Global Development

Antonio de Lecea,

Principal Advisor to the Head of Delegation, European Commission in Washington, D.C.

Transcript by Federal News Service Washington, D.C.

Transcript Not Checked Against Delivery

URI DADUSH: Yes. Good afternoon, everybody. Thank you very much for joining us at the Carnegie Endowment today. This is probably the umpteenth – I can’t remember – the fourth or so event we’ve had on the euro crisis since the beginning of last year. And I expect to say that the titles of our events have become more and more alarmist as we’ve gotten on. And, you know, so the title this time is “Will the Euro Survive.” I think our initial title was something like, “The Euro Crisis: What Does it Mean?” or something like that. (Laughter.) And so I’m hoping that there’s not going to be a linear extrapolation of titles – that at some point that this thing stops getting worse. [00:01:22] DESMOND LACHMAN: Well, at some point you’ll drop the euro. (Laughter.) MR. DADUSH: Which sets the tone for the discussion. Let me – MR. LACHMAN: You’re right. MR. DADUSH: – introduce our expert panel today, just very briefly because you do have their vita. So to my left, Antonio De Lecea is the minister for economic and financial affairs and principal adviser to the head of the delegation of the European Commission in Washington, D.C. ANTONIO DE LECEA: It’s European Union. MR. DADUSH: Sorry? (Cross talk.) [00:02:03] MR. DADUSH: Of the European Union, I’m sorry – of the European Union. And that is also symptomatic because you will hear from Antonio the European Union view. And then next to me is Jacob Kirkegaard, who is a research fellow at the Peterson Institute for International Economics. And then to my right is Liliana Rojas-Suarez, who is a senior fellow at the Center from Global Development with expertise on Latin America and on financial services. And she was previously managing director at Deutsche Bank. And to the far right, geographically only, is – (laughter) – is Desmond Lachman, who is known to you, I’m sure. He’s a senior – is a resident fellow at the American Enterprise Institute and teaches at Georgetown University. And he has been a regular fixture at my euro events over the last year and a half. So we’re going to have a conversation and the panelists kindly agreed to that, which makes it a little more difficult on them, but I think – I think is better for the audience rather than have PowerPoints and prepared remarks. So I’m going to start with one question that I’m going to ask all the panelists to address. And the first question is: Will the euro survive in its current form? What is your subjective probability? And let me start with Desmond, to the right.


[00:03:57] MR. LACHMAN: Well, if you mean by that, are countries going to drop out of the euro? Then I’d say that it’s almost certain that countries will drop out of the euro. You know, that we’ve got a situation in Greece where it looks like Greece can’t avoid a hard default if you look at the numbers. Greece’s debt to GDP, according to the IMF projections, is going to peak at 172 percent. The IMF has been notoriously inaccurate – overly optimistic in its projections, you know, so it’s more likely that it’ll go towards 190, 200. So you know that the market has got it right when they’re pricing Greek bonds at something like 40 cents on the dollar – meaning that the market thinks that Greece is going to have a – something like a 60 percent haircut, you know, minimally. It’s more likely to be something like 70 cents. You’ve then got to think through if a country does have a haircut of that sort, and if its banks are holding a huge number of the bonds, it means that the Greek banking system is going to be in deep trouble. (They’re going to ?) re-introduce capital controls, so it’s not a very far step from there for Greece to be leaving the Euro. I think that it really goes to the heart of the problem in Europe – is that what we’ve got is we’ve got countries in a system where they don’t have their own currency but they’ve run up huge imbalances, both in their public finances and in the external side. And I think that what we’re seeing is you can’t correct those imbalances without winding down the debt and without getting out of the currency unit without having the deepest of recessions. And a country like Greece doesn’t really have the social appetite to do it. So I would say that Greece leaves. When Greece leaves you’ll get real contagion to Portugal and Ireland, you know, that those countries will leave in short order. So, you know, if you’re talking about – if you’re just giving me a year or two I would say that – I would be prepared to give you odds on that event occurring. [00:06:07] MR. DADUSH: Good. I mean, bad. Thank you. (Laughter.) Now, Desmond – MR. LACHMAN: I don’t know. I don’t think that is bad from Greece’s point of view. It’s bad from Germany and France’s point of view. But what the IMF is offering Greece is they’re offering Greece not only a Great Depression but they’re also giving them no prospect of getting out of that for the next decade if they stick within the system. So, you know, what – this is not going to be too good for the Germany and French banks and might not be good for Italy and Spain. But I would say that it would be good for Greece and Portugal to be taking the route that Argentina did in 2001 where, you know, with all the stories as the sky would fall if they got out of the convertibility plan – they had a very nice decade, thank you very much. MR. DADUSH: OK. Thank you, Desmond. So briefly, apologies, but I have 13 questions, so the – Liliana, will the euro survive in its current form, subjective probability? LILIANA ROJAS-SUAREZ: Yes. I think I agree a lot with what Desmond said for practically the same reasons, and I want to add one more. And it’s that in the situation like we have right now, a permanent solution needs a transfer from creditors to debtors. We are get more into this with your next questions, but – so you’re going to get a limit on the patience to which – and the limit to which that transfer from creditor to debtors can be extended.


[00:07:42] When that patience – I’m calling patience to a very complex issue – gets – when you get to the limits of that patience, then I believe that support for Greek – for Greece is going to vanish. I really don’t think that it’s a question as to whether Greece and the European Union wants Greece to continue within the euro zone. What I believe is that it’s a matter of fact that Greece will not be able to continue in the euro zone, that it will default and that – I agree with Desmond – that it – I don’t see whether it’s good for Greece, really, it’s just that sometimes there’s things in life that we don’t choose. They have to happen. And I think that’s an event that we must realize. My subjective probability of having Greece with that – leaving the euro zone is about 90 percent right now. If you add Portugal to that, it’s 70 percent. MR. DADUSH: Thank you very much, Liliana. Jacob. JACOB KIRKEGAARD: Well, starting with my subjective probability that the euro will continue with at least as many members that it has now – 100 percent, because I regard it – we need to make a very fundamental distinction between whether a country defaults – or deeply restructures or whatever we call whatever Greece is going to do – and leave the euro zone. These two things are fundamentally different. I believe that Greek debt will be privately held – that will be written down by as much as perhaps 50 percent as soon as next week – but that on the other hand, Greece will under no circumstances leave the euro zone. And I very much disagree with what Desmond says that what the EU and the IMF is offering Greece is a great recession – that’s absolutely not the case. They are offering to continue to fund Greece at essentially German interest rates for the foreseeable future, as well as ongoing fiscal transfers through the EU budget, you know, if need be in perpetuity, because the real contagion – and here I agree with Desmond – is the real contagion for the euro zone only emerges if a country actually leaves. [00:10:01] That’s what can create a kind of uncontrolled contagion scenario where markets will fundamentally lose confidence in the entire construction. And that’s not something that Germany, France or any of the other countries can survive. So, yes, Greece will default, but it will absolutely stay in the euro zone. And finally, the idea that Greece has any economic benefit outside the euro zone, I regard as a – as a – as essentially misguided. Greece had an export ratio to GDP in 2010 of 8 percent. This isn’t a country that can export its way to prosperity even if it gets a 50 percent real devaluation. It just doesn’t – it doesn’t export anything that the world really wants. The only thing it really exports is shipping services, which are denominated in U.S. dollars around the world. So the domestic currency of Greece is relatively irrelevant for the competitive of that – and then it’s tourism. Now, tourism clearly, if the domestic price level in Greece fell by, say, 50 percent vis-à-vis the other Mediterranean countries, would have an effect. But tourism is also very, very susceptible to social disturbances. You’re just not going to fly into Greece if there’s tear gas flying through Athens. And I think if you were to leave the euro that’s quite clearly what would happen. So it’s not in their own interest, and the idea that there is some sort of pot of gold at the end of the devaluation rainbow is a myth. MR. DADUSH: Thank you very much, Jacob. And Antonio, I think I know what you are going to say. What is the likelihood –


MR. DE LECEA: Not necessarily. MR. DADUSH: All right. What is the – what is the likelihood that the euro will remain in its current form? What is your subjective probability? MR. DE LECEA: At least 100 percent. (Laughter.) Since you asked for subjectivity. (Laughter.) On the same grounds as Jacob said, I mean, it’s not in the interest – neither of Greek – Greece and Portugal. I mean, the problems are not being in the euro or being outside the euro – the euro is not a panacea for – it’s not a substitute for good policies. Therefore, I mean, they have – they will have to run the good policies, I mean, inside the euro or outside the euro. And inside the euro they have the assistance of the European Union, plus the IMF – not only financial assistance, but assistance to re-haul – to overhaul the country, to overhaul the economy and the economic structure so that they can – they can grow – they can go back to grow and they can be on a sustainable path. [00:12:38] MR. DADUSH: Thank you very much. OK, I’m going to group my questions – the remainder of my questions in three. First I’m going to ask a short question about causes – what is causing this problem? What are the fundamental causes? But I want to spend most of the time on short-term solutions – short-term solutions first – and then long-term solutions. So the short-term fix, financing support, et cetera, et cetera, and then long-term fix, institutional change, so on and so forth. That’s the structure: causes, short term, long term. So let me – let me pick a couple of our panelists on the causes issues. So my question is, what’s the problem anyway? Is it fundamentally a competitiveness issue that the peripheral countries are confronting ,or is it a fiscal issue or is it a banking issue? And maybe – I don’t know if you have other causes – (inaudible). And let me – let me start with Jacob and then ask Desmond also to address this question. MR. KIRKEGAARD: No, but I think – I think, you know, it’s – we need to just – doing – this isn’t just one crisis. I mean, if you look at a case like Greece, it’s quite clearly a fiscal and a competitiveness issue. If you look at Ireland, well, it’s quite clearly a banking system crisis. If you look at Portugal, it’s probably more like Greece. If you look at Spain and Italy, it’s predominantly a competitiveness issue. So it’s a little bit of all of the above, and then combined with, what I think is pretty obvious, that Europe is underinstitutionalized. [00:14:27] The euro, as it was described – or as it was created in the mid-1980s – did not and has not had the institutional structure to withstand a serious crisis. So, you know, it’s all of the above plus, you know, under – or you know, wrong design, if you like. MR. DADUSH: Good. And Desmond? MR. LACHMAN: Yeah, no, I agree with Jacob that, you know, I think it’s a mistake to look for a single cause of the crisis or a single symptom of dysfunctionality. You know, that you’ve really got imbalances the size of which, in my career at the IMF, I’ve never seen, you know, in a serious country anything of the sort – that when you’re looking at government, you know, when they’re supposed to be running at 3 percent of GDP budget deficit and they run at 15 percent of GDP budget deficit, the debt level is supposed to be at 60; it turns out that it’s at 170.


If you look at the balance of payments side, I’d say that countries like Spain have got huge balance of payments problems, running very big external current count deficits still at this stage, and got an external debt that is over 100 percent of GDP. So there are huge imbalances. So I wouldn’t want to look at it simply. I think that the more interesting question is, how did we get to this pass? You know, what went wrong? You know, what was the breakdown? Why was more strict criteria not applied? Why did the markets not discipline these countries? You know, and I think that there’s a huge amount of government failure, a huge amount of market failure. And we’re in an unholy mess. [00:16:06] But there is just one point, if you’d allow me – just to say that the IMF is not offering Greece a Great Depression, well, you’re not really looking at the facts. Greece’s economy has fallen over the last two years by 14 percent. Its unemployment – I should say by 12 percent. Its unemployment is over 15 percent. And what the IMF is coming in to tell Greece to do is: Why don’t you have another round of real fiscal austerity? In this – these kind of circumstances you’re really just going to drive that economy totally into the ground with these sort of policies, and I’m afraid that the same is true with Portugal. Just one other point, if I may, is the damage to the system is not from a country leaving the euro – I think that that is a second-order question. The damage that Greece will do and where you’ll get the contagion will be when Greece defaults in a major way. And then when that causes a banking problem, that is what’s going to cause contagion. That is what the ECB has been emphasizing that they’re scared of. That’s why they don’t want Greece to default at all. But if you have a hard default, whether the country stays in the euro, whether it doesn’t stay in the euro, is secondary. The damage is done by the default. That really impacts the banks in the core. [00:17:27] MR. DADUSH: OK, good. So we’ve learned today a new word: underinstitutionalization, and a new disease. So, you know, if one of your children or your friends looks to you to be underinstitutionalized, please call the Peterson Institute right away. (Laughter.) Take him on an emergency visit. I love – I love underinstitutionalization. All right, the – let me now move to short-term fix – short-term fix. So the first question on the short-term fix is that now the big debate is around the EFSF – the – what is it – the Financial Stability – MS. ROJAS-SUAREZ: European. MR. DADUSH: European Financial Stability Facility, right? MS. ROJAS-SUAREZ: Uh-huh. (Affirmative.) MR. DADUSH: This is the financial backstop Europe created back in May, 2010, and then has decided to strengthen in July, 2011, in order to prevent contagion from spreading further. What changes should be made to the EFSF to make it more efficient? And I’m going to ask Antonio and Liliana to address that question. Antonio? [00:18:50]


MR. DE LECEA: Well, the changes that have been already agreed are to increase the capacity. And that was already agreed and ratified. It will also be able to intervene on a precautionary basis. It will also be able to intervene to buy government bonds. So – and it will be able to intervene to support banking systems when in – when in need and when there is a financial stability risk for the euro area. So these in themselves are what, you put it – it takes to kind of to provide this backstop for – and to avoid contagion. The – as you know, there is now the discussion on – by how much and how will it be leveraged so – (inaudible) – to have the adequate capacity to deal with more important – both banking and sovereign problems. But these are the changes that are already in the pipeline and that – of which the modalities are being discussed. MR. DADUSH: Thank you. Liliana, do you want to elaborate? MS. ROJAS-SUAREZ: Absolutely. I have big issues with the EFSF. I think that a mechanism that uses resources from the same debtor countries to finance those that are in debt is weakening the stronger countries. Let me explain. If I am Italy or if I’m in France, and I’m using part of my resources through the EFSF, which is (just ?) vague, all right, to help Greece and help Portugal, the markets know that me, Italy and France, are increasing my liabilities, right? And if they default, my contingent liabilities are even greater. [00:20:54] So it’s even worse when people talk about leveraging the EFSF, which means that, OK, I use – first, let me back up for a second. The EFSF does not have right now 440 billion (euros). They have already committed more than 200 billion (euros), so – it’s much less money, first of all. Second, if you were to leverage that, that even implies creating kind of a toxic asset. It’s equivalent of a toxic asset, which now, we say highly-leveraged toxic asset. The markets perceive that, and therefore, the credibility of the new instrument gets destroyed, OK? Why? And what – and you asked for a short-term solution. And I hope also you ask me about the bank – (inaudible) – MR. DADUSH: I will. I will. Don’t worry. Don’t worry. MS. ROJAS-SUAREZ: OK. But I want to finish with the EFSF – something else. This is not the same as when the United States TARP was put in place. At that time, you need to recall something: Nobody was doubting about the debt sustainability of the United States. That was not an issue on the table. Perhaps as a long term, but that was not an issue. So the government was able to make that transfer to the banks. But that’s not the case in Europe where sovereign debt problems and banking problems are completely interweened (ph), OK? [00:22:23] So there is – no, the only solution for me that can actually bring help – support to the European problem right now is fresh external money. You cannot help yourself when you’re sick. You need a doctor from outside, OK? So if, as Desmond said, many countries in the world, including the United States, are going to suffer contagion from this, we need fresh commitments from the U.S., the U.K., Japan and the IMF mobilizing these resources, and Germany, of course, which still holds some credibility – I say “some” because it has – it – decreasing by the day. But the


bottom line of what I just said is, I don’t believe that the eurozone problem can be solved with only eurozone money. MR. DADUSH: And I am going to come back to that later. And let me ask now about the other short-term fix everybody’s talking about, which is the European Central Bank increasing its purchases of government bonds or, for that matter, increasing its lendings – liquidity support to the banking system. So my question is, what is the appropriate course of action for the ECB? And will it take it? And here I’m going to ask Desmond and Jacob, perhaps, to address this question. [00:24:02] MR. LACHMAN: I think that the ECB is very uncomfortable doing these purchases. What we’ve seen over time is they enter into this market very reluctantly. They enter in extremis. I think that’s – I would perhaps disagree a bit with what Liliana said in that I don’t think that there’s an alternative but to leverage up the EFSF if you don’t want contagion to Spain and Italy. If you don’t have a real firewall for Spain and Italy, it’s going to be game over for the euro. So the ECB would prefer to see this done by governments through instruments like the EFSF rather than the ECB compromise its functions as a central bank. What you’re doing is you’re compromising the independence of the central bank; you’re making its monetary policy a lot more difficult. This is not something that the central bank should be involved in on a permanent basis. Having said that, the Europeans – the policymakers are likely to fall short, so they’re likely to leave the ECB once again in a position where the ECB is given this terrible choice between standing on the principle of its independence and good monetary policy and letting the whole structure fail. So I think that – you know, when the ECB is pushed, the ECB will come in at the last minute and prop them up the way in which they (have ?) been doing before. But I don’t think that that is the way to go. You know, I think that if you wanted to try to save the system, you really do have to come up with a firewall of something like at least 2 trillion euro; otherwise, you’re really going to get real contagion like we saw in July and August on Spain and Italy. And if Spain and Italy were to fail, you know, that would be a total disaster. [00:25:59] So, you know, if I were sitting in (Berlin ?) – the problem is that politically, it’s very difficult to do this, you know, because 90 percent of your – at least, should I say, 70 percent of the electorate in Germany don’t want to do this. And as far as the ECB goes, it’s very difficult for the ECB to pursue a line when not only does Axel Weber not want to it and Jurgen Stark, both of them leaving the ECB, but the president of the Bundesbank doesn’t want to do it, Otmar Issing doesn’t want to it, the whole German establishment – monetary establishment – doesn’t want to do it. So they’re going to be very reluctant to get into supporting Spain and Italy, which means that they’re going to be too late, too little, that this thing is going to just fester. MR. DADUSH: Thank you, Desmond. Jacob? [00:26:48]


MR. KIRKEGAARD: No, I find myself in surprising agreement with Desmond, and – But I think it’s important to distinguish between what will be the optimal position for the – the policy action for the ECB to take to finish the crisis – end the crisis as soon as possible, and what is optimal for achieving what the ECB actually wants, because if the ECB wanted to end the crisis, what they would essentially be able to do is, they could break very blatantly Article 123 in the treaty and just say, look, we stand fully behind all Italian debt. They could do that. They might be sued under the European court, but probably nothing would come from that. So the ECB has the ability to end the crisis if they want to do it. But I would contend that they’re actually not interested in that, because if you look at the ECB, you have to think of it, it’s not a normal central bank. It’s a – it’s a central bank that is so independent that it’s essentially unaccountable to anybody. You know, they send letters to policymakers, not like in the U.S. where, obviously, the Federal Reserve receives letters about what they should do from Congressional leaders. It goes the other way around. [00:28:04] So what – if you look at what the ECB has been doing throughout this crisis, it has essentially, I would argue, proven to be a conditional lender of last resort, which is what happened, obviously, in May, 2010, when they first initiated the security markets program, and it’s what happened again in August this year when they agreed to expand the security markets program to include nonprogram countries – and first and foremost, of course, Spain and Italy. And if we look at what is going to happen going forward next week, if this is your strategy – the ECB strategy is essentially to put maximum leverage on governments to do what the ECB wants them to do, which is to put in place binding constraints on the – on the Stability and Growth Pact, put together a longer-term fiscal – you know, what the ECB – or (that ?) Trichet calls a European finance minister – and then implement a lot of structural reforms. So what they are going to do is, they’re going to – unfortunately, if you want to end the crisis – they’re going to refuse to leverage up the EFSF; that’s very clear. What they want instead is this EFSF bond insurance program for new primary issuances of debt so that the EFSF insures 10, 15, 20, 30 percent of these primary issues, because what does that amount to? It essentially amounts to governments, the euro area governments, self-insuring their own primary issuances, which is the functional equivalent of actually strengthening the enforcement of the Stability and Growth Pact. [00:29:44] What the ECB is going to offer to that deal is, they’re going to not say it out loudly, but they’re going to leave the securities market program intact, which means that in the – you know, at the end of days, the ECB will still ride to the rescue of Italian and Spanish bonds if a true crisis comes. So as I said, there is a distinction between ending the crisis and achieving the outcome that the ECB would like. MR. DADUSH: OK. At some point I will encourage our panel to come back to this – to Jacob’s assertion that the ECB could end the crisis today if it wanted. I will ask him to come back to that. I think it’s a very important and controversial point. But let me just continue with my line for the time being, which is to ask Liliana, what action must be taken to shore up the banks in Europe?


[00:30:44] MS. ROJAS-SUAREZ: OK. One of your questions was, do we have a fiscal crisis, a (competitive ?) crisis, a banking crisis or whatever? When I heard your questions, my first reaction is, who cares? Once it gets to the banks, you focus on the banks. Why? Because behind the banks are the world payment system, right? I mean, basically, you cannot do any kind of transactions if they are not done through the banks. So once you hit the banks, then you have a banking crisis. People are talking about the formation of a banking crisis; that’s nonsense, right? We’re in the middle of a banking crisis right now. So people can say, well, but I don’t see huge runs out of the banks. I’ve never seen a banking crisis that starts on the liability side. They always start on the assets side. And the asset sides are – have a lot of problems. Some of them made by their own countries, including in Spain, with the lending to real estate, but all – most of them, because of the large holdings of government securities, which are in trouble these days. Now, when you get to that point, then you move to banking crisis resolution. Banking crisis resolution is very hard and requires lot of political will. And the first step – there are two steps that needs to be taken; the question is, how did you do it? And we have examples in the world on how to do it right. The two things that needs to be done is, the banks need to be recapitalized, and there have to be huge debt haircuts. OK, now let me explain. You – to have the banks recapitalized yourself is again an illusion, because that’s like going – telling the banks, go to the private market and borrow. No, the private markets don’t want to lend the money. So that means some form of government intervention, right? People say, that’s going to be nationalization. Yes, temporary. But that’s the only way to go. First you have to capital – recapitalize. [00:32:47] Why do you first have to recapitalize? Because first, you need the banks to be strong to then hit them. How do you hit them? Through the debt haircuts. The debt haircuts means, basically, that what they have or what they think they had of assets is worth much less, right? Why are you doing that? Because you are now transferring what I just first said that is absolutely needed, and it’s a transfer from creditors to debtors. That has to take place for every solution of the banking crisis. In the United States, one mistake was done. We still have – are not totally out of the banking crisis. And the reason is that you still have a problem with the mortgage markets. And Fannie and Freddy has not been resolved yet. So there has not been enough transfer from creditors to debtors, and that’s why we still have problems in the United States, and those are constraining the growth of the economy. OK. We need to think, in the case of – in Europe, exactly in the same way. We need to solve the banking crisis, which implies a transfer from creditors to debtors; private holdings of banks are going to suffer big losses; and recapitalization has to come from national money because private money is not available right now. I told you that there is lot of stories about how to do this. I just want to tell the story from Brazil. MR. DADUSH: Short, please. MS. ROJAS-SUAREZ: Huh?


MR. DADUSH: Short. MS. ROJAS-SUAREZ: Very short. (Laughter.) [00:34:24] The problem was different. But Brazil had to devalue in – 1999? Yeah. It had to devalue, OK? There was no way out. I’m not talking devaluation – (inaudible). The problem was that if it was going to devalue, because of the composition of assets in the banks, a banking crisis was to emerge. Arminio Fraga was the president of Central Bank of Brazil at the time. He did something – he first issue a large amount of dollar-denominated assets and place it in the banks – basically shield the banks, then devalue. And Brazil has passed, in ’99, as one story in which there was a currency crisis, but not a banking crisis. It was because the president of central bank took the right action to protect the banks. OK, we need to think in that direction to solve the problems of the banking system in Europe now. MR. DADUSH: OK. Thank you very much. My last question – and then I’m going to come back to monetary policy – on the – under the short-term heading, the short-term fix – is related to Spain and Italy. Everybody knows that an important part of the solution is adjustment in the periphery countries. And Spain and Italy are huge countries, much, much bigger, again, then Portugal, Ireland and Spain – Portugal, Ireland and Greece. So I want to ask anybody in the panel who wants to take it on: Are Spain and Italy, in your view, doing what is necessary to adjust? Go ahead. [00:36:16] MR. KIRKEGAARD: No, I mean, I think it’s pretty blatantly obvious that Italy is not, because Italy has a structural growth problem more than anything. They don’t actually need a lot more austerity. But the Berlusconi government has clearly put in – you know, has not moved down that – in that direction in the many – the many years he’s been in power, so I think it’s fair to say that Berlusconi needs to go before anything sensible can come from Italy. In the case of Spain, I think it’s fair to say that you had a fair amount of reforms taking place since May last year. The Zapatero government has done – has begun to liberalize the labor market, has – and I think has probably done as much as a socialist government can be expected to do. And then, finally, they’ve also moved to put in place a constitutional debt limit similar to one in Germany. And, you know, then Zapatero decided to – he cut public-sector wages, which is political suicide for any socialist government. And, you know, he basically called an early election which he knew he was going to lose. So he fell on his political sword, leaving the way for the PP to emerge and continue the consolidation, the reform effort. So I’d say in Spain, you’ve done most, but Italy is clearly lagging behind. [00:37:49]


MR. DADUSH: Good. Thank you. MR. LACHMAN: I would take the other side of that analysis, you know, that I would think that Italy is OK in a relatively good state of the world, that they got very high debt level, but Italy’s been running a primary surplus, so if Italy were to have growth and it were to have a favorable external environment, I wouldn’t be that concerned about Italy. The reason – part of the reason for my concern about Italy is that what we’re now doing is we’re seeing, partly for the reasons Laviana is mentioning, that you’ve already got real strains in the banks, you’ve got a real credit crunch that’s developing, and you’ve got – already got clear signs that France and Germany have basically run out of steam; it’s only a question of time before France and Germany go into recession. So that’s the reason that I’d really worry about Italy, is that it’s something external. [00:38:44] Spain is a lot more complicated. Spain had the mother of all housing booms that they financed from abroad, so Spain is stuck with house prices that still haven’t adjusted. Spain’s house prices have probably got to fall another 30 percent, and they’re expected to take fiscal adjustment, fiscal austerity for a number of years in that kind of environment. I just don’t see how Spain is going to grow. And likewise, Spain’s just got a huge external debt problem. I don’t see how you get out of that by just crunching the economy because if you try to crunch the economy, what that’s going to do is, it’s going to then exacerbate your public finance problems. So if you’ve got a public finance problem, a housing sector problem and a huge external problem, not to be able to write down your debt and not to be able to devalue the currency, you’re really in serious trouble. MR. DADUSH: OK. Good. Let me ask – you wanted to comment this? MR. DE LECEA: Yes, just for a second. Just to underline that the case of Italy and Spain is much different from the one of the other countries – in the case of Italy and Spain, it’s not a problem of solvency; it’s a problem of liquidity. And the measure that are being taken are so – are such that – I mean, they try to reassure the markets that the – that the government has the capacity to rein in the economy. And secondly, especially in Spain, they are also overhauling the structure – the structure of the economy so as to promote that growth that is desperately needed for the – for the next few years. So this is – I mean, I think that putting them together is an error. [00:40:32] MR. DADUSH: OK. Thank you. Let me come back to Jacob’s point. Is it true – and ask the other panelists, anybody who wants to kick in – is it true that the European Central Bank could stop this crisis tomorrow by issuing a blanket guarantee that it will purchase the government bonds of the countries in trouble? Anybody want to take that? MS. ROJAS-SUAREZ: Yeah. MR. DADUSH: Liliana.


MS. ROJAS-SUAREZ: No, I don’t agree. I don’t think that the ECB is like the Fed. If you look at current data right now – and the only thing I hate about not using PowerPoint, I have such a bad memory that I don’t remember any number – (chuckles) – so, but what you would see is that the holdings of euros – of foreign – (inaudible) – reserves in the world – is declining. I think that a blank check without proper corrections or fundamentals will not solve the problems in Europe because in contrast to the Fed, which is by definition – only because there’s nothing better – the safest asset in the world these days – all this is man-made, and so, you know – but right now it is perceived as the safest asset in the world. And there’s a run towards there. A huge blanket guarantee at the end will imply a run out of the euro. This is not – when you have a – and I have to go back, again, to the banks. When you have a banking problem, then the increase in liquidity, buying back of assets, that does not solve the problem. You need real capital otherwise banks are not going to lend. You give more liquidity to banks, banks will save – the same way they have been doing in the U.S. for a very long time. [00:42:24] So the resolution of this problem will start with the banks and end with the banks. The European Central Bank has a very important role to play. It’s a provider of liquidity. So where liquidity is needed, it helps. But it would be a big mistake to think that the actions of the ECB are similar to the actions – that can do the same actions that the Fed – that the U.S. Fed can do. MR. DADUSH: Thank you. Desmond? MR. LACHMAN: Yeah. No, I – disagree. I’d say hypothetically there is a very easy solution to this problem – you know, that you can push this problem many years – is if the Germans were one way or another prepared to write a blank check to these countries, you wouldn’t have a problem. You know, you would just finance it. You could keep the bond levels at that (side ?). And Germany initially would be capable of doing it because Germany’s public finances are very much better than those, for instance, of the United States. I realize I’m setting the bar low. But Germany does not have an 8 percent of GDP primary budget deficit like the United States does. It not – does not have as high a level of budget – of public debt. So they can do it either directly through writing a check through the ESFS or ECB, whichever mechanism they like. If they were to finance it that way, you wouldn’t have a problem. [00:43:44] The Germans, of course – the citizens understand that if you go that route what you’d be having to do is you’d be having to write a check year in, year out – (inaudible) – eventually it will sink you. You know, so the discussion is for – it’s not better just to cut loose, recapitalize our banks, and then we’ve got some kind of resolution to this problem. But theoretically you can do this. MR. DADUSH: Sorry, I didn’t quite understand. Are you agreeing with Jacob or not? He said that the ECB can, today, stop the crisis. MR. LACHMAN: Absolutely – theoretically the ECB can do it. But I – what I’m saying as well is that you’ve got to be looking at it – ECB in a political context. The ECB, like the Fed, can expand its balance sheet until the cows come home. They can – you want 2 trillion (dollars)? You need it. You want 3 trillion (dollars)? You know, you just use the printing press to do that. You can do it.


[00:44:48] The ECB is not going to do that because its major shareholder, the Germans, that is not their view as to the way in which a central bank is to be run. So, you know, one’s raising a very theoretical question. Practically, the Germans have got a constitutional court that would have problems with debasing the currency or not doing independents. You’ve got the Bundesbank that is going – it’s apoplectic about what’s going on – (chuckles) – right now, Uri. If you went that direction, the Germans would really have trouble staying within this union. MR. DADUSH: OK, anybody else? Antonio? Yeah. MR. DE LECEA: Yes, one point relating to your second question. To the extent that this crisis is fiscal structure, banks and institutions, I mean, one single measure or one single institution cannot solve it. So – yes. MR. DADUSH: OK. So you – (inaudible). I want to come back to Jacob. You had – MR. KIRKEGAARD: No, I mean, I just want to emphasize what Desmond also said. I mean, when I said that the ECB could end the crisis – (snaps finger) – like that if it wanted to, you know, I’m not talking about that the ECB can make Greece competitive overnight. Of course it cannot. You know, but what it could do, in my opinion, by issuing, for instance, a blanket guarantee to the Italian – to Italian debt, it could mean – it could basically make Italy trade much more like the U.K. than it does today. Because if you look at it, why is – why is the U.K., given its fundamentals, et cetera, et cetera, raising 10-year debt at, what 2, 2 ½ percent of the markets and Italy is about 5 or 6 percent? Well, I would contend that it has a lot to do with the way the markets perceive the role of the central bank backing the pound and the euro respectively. That the ECB could, if it wanted to, you know, change. But I agree with Desmond completely that for political reasons they obviously won’t do it. [00:46:43] MR. DADUSH: OK. All right. Good. What I am – I am getting from this discussion on the ECB, which I think is tremendously important, is – what I’m getting from Desmond and Jacob together is that in the end, this boils down to the same thing as saying the Germans and the other core countries have to expand he EFSF, have to issue euro bonds or whatever it is that the solution is because in the end, the ECB will have to be backed, so to speak, by the whole of the euro zone. And this backing, so to speak, can take the form either of, you know, financing the European Central Bank’s deficit or taking an inflation tax, you know, basically in the form of higher prices. One way or another, the European taxpayer pays. And therefore, it becomes a political decision. And the political decision so far has been, no, we are not going to – we’re not going to accept that kind of burden. OK. So that does the short-term questions. Now I’m going to ask one question about the long term and then I want to – I want to open it up. The – all the things we’ve talked about, you know, are about how do we stop this thing over the next year or two. How do we – how do we guide the countries in difficulty over? But this is a very different question than what should this European monetary union look like in order for it to be a sustainable thing not over the next two years but over the next 50 years – a hundred years?


What is the shape of this thing? What is needed in order to make sure we don’t get into this problem again in a big way – assuming we can get over the current crisis. And some people – Desmond, obviously, believes we can’t get over the current crisis anyway. But let’s assume that you can for a second. What would – how would you design it now? What would you – what would you do differently? [00:49:16] I want to stress this question because so much of the action has been oriented towards the short term. And clearly not enough attention is being given to: What does this thing look like in the longer term? And until, I think, markets have a sense that this thing is sustainable in the longer term, they’re going to be very nervous about the short term. MR. LACHMAN: No, I think it’s exactly the reverse. MR. DADUSH: Yeah, all right. Go ahead, yeah. MR. LACHMAN: That markets don’t – have got real concerns about the short term, as to whether you’re going to get towards the longer term – you know, they – you know, they just find it fanciful when you’re talking about what are you going to do in 2013 or 2014 – how are you going to design this all. You know, you’ve got a fire. You know, that this thing is – it’s the real conflagration that the market thinks that you haven’t got ahead of this crisis one bit, you know, from the beginning – May 2010 – each time the policy makers have fallen short of getting ahead of the markets. And you know, the markets have still got the question, is this really going to – (inaudible)? [00:50:24] But, you know, if – I would just say – to answer your question on the long run, I think that what you really have to do is go back to basics about the optimum currency theory of the monetary union, that for a monetary union to work you’ve got to have conditions satisfied for that. You’ve got to have the wave (ph) flexibility, you’ve got to have the labor mobility, you’ve got to have the fiscal federal union, you’ve got to have countries that are similar in kind that will actually be playing by the rules. You know, so my answer to your question is that for the euro to survive in the long term, what you’ve really got to do is you’ve got to strip out the countries in Southern Europe. You know, you’ve got to have a core – a reduced – you know, go back to your original euro – the strong countries that can abide by this that have got similarities. You know, then you’ve got a currency – you know, that’s – I wouldn’t be surprised if that’s where we’re going to be in five, 10 years’ time – that’s probably too long – two or three years’ time – is, you know, we’ll have a strong euro with the countries in the north, you know, and that’ll be a very serious country – that could really be a proper reserve currency. MR. DADUSH: Anybody else on this question of the long term? What is – what is needed? Antonio? MR. DE LECEA: Yes. Let me come back to – also to your first question of whether the euro will survive. I mean, the – it’s not a question of surviving. But, I mean, the euro will take the opportunity to come – to come strengthen from the crisis. And how? By completing the institutionalized setting. You call it underinstitutionalized. Well, it is – may be it – it may be a teething problem. But – so it is clear that the – we needed some more – some more cohesion, some more integration, to avoid countries going the wrong way and disregarding – having effects on the others and disregarding the sustainability of their policies.


[00:52:30] So this, to some extent, is now in place. Only two weeks ago a series of measures were approved in order to restrain the possibility of this – of this – (inaudible). So that’s one part. Probably is not enough. But going back to theory – I mean, to the optimum currency theory, I mean, misses a crucial point, which is the political aspect. And I’m sorry, but this is what binds people together. And you cannot disregard that. I mean, the countries of the – you call the periphery will not leave the euro. So you can – I mean, you need to take that into account if you look at – if you look beyond. I mean, countries – the public opinion in the countries may be – may be upset about the euro – the euro area or the euro authorities, but they are much more upset about their own – their own national authorities. So – and the latest euro barometer – the poll of European public opinion – shows clearly that the people believe that it is within the EU that they may solve better their problems. So – and – but, indeed, I mean, for that – for that to work you need some more constraining instruments and institutions. And this is what has partly been done and is probably more in the making. MR. DADUSH: Go on, Jacob. And please tell me also if in order for the euro to be viable in the long term we need to have a fiscal union. MR. KIRKEGAARD: Yeah. No, I mean, I think that, you know, we could all debate for a long time what does a fiscal union mean. But, I mean, at least for me, what it means is that you need to give the center, or Brussels, or whatever you want to call it, the ability to overrule national government budgets – you know, essentially veto them. And I would probably disagree somewhat with Antonio that the current six-pack is not nearly enough for that. You basically need to have what’s now called the European semester with the – with the veto power, meaning before it becomes national, you know, budgets. That would clearly require a new treaty. I think that kind of treaty will have to, in my opinion, to be approved by national referendas in all countries, not just in some of them, to have the proper electoral anchoring. If you read the German constitutional court it’ll probably – this type of fiscal union would also require a change in the German constitution, requiring a referendum. Clearly, I think, you will need to have common, centralized banking regulation and essentially a European FDIC version. Because of the size of the banking system it makes no sense to have it sort of essentially continue to be backstopped by national governments. That’s simply too much; it’ll be too unstable. And the risk for capture of national regulators is too big. [00:55:36] So if that’s – I think that’s the two main parts of it. And then, of course, you need to have, you know, all the things that national governments, in terms of structural reforms, need to do anyway. That’s another given, which you clearly will have to address. MR. DADUSH: Yes, Liliana? Yeah, quickly.


MS. ROJAS-SUAREZ: Just one small thing. I think that regardless of what we dream the euro zone could be if we could redesign it again, the way this crisis evolved is what is actually going to determine whether there will be the same kind of a structure, the same kind of countries or whether they will backtrack completely from initial intentions. I agree very heavily with what you said about the political differences between countries and willingness. Remember that when these things happen, we will have a new government in Spain. We don’t know what’s – you know, what’s going to happen. I mean, Merkel will be out of the – of the game too. So, you know, the whole political spectrum will be completely different and so dreaming about what the new – the new stable, long-term euro zone will be, it’s fun, but I couldn’t tell too much. MR. DADUSH: OK. Very good. So I’d like to open it up. I do have some more questions – I have many more questions. But I will hold off and open it up for you – for the audience to ask. Yes, sir? [00:57:11] Q: Microphone? MR. DADUSH: Yeah, microphone, please – gentleman here. Can you please introduce yourself? Q: OK. My name is Stanley Kobrick (ph). One thing that hasn’t been discussed yet is population movements. And I am reading about, hearing about younger people leaving, not seeing any opportunities. And if that’s the case, that would affect any scenarios for economic growth. If the talented young people leave, then where will the growth come from? How will the transfer payments for social security and health care be paid? MR. DADUSH: Yeah, Jacob, you want to take that? MR. KIRKEGAARD: Well, I think two things there. One, actually – one thing to keep in mind is actually that the legal immigration in-flows into the EU-15 have actually, in the last decade, been about twice the level of the United States. So this idea that on – in the aggregate that everybody is leaving the EU is actually not empirically founded. Secondly, I think it’s an important aspect to note that the reason that many, you know, young, educated people in Spain, Italy and the periphery are leaving is, in fact, that you have these archaic insider/outsider labor market structures that grossly favors – essentially the baby-boomer generation, because these are the people that have very well-protected jobs from which they are essentially un-fireable. [00:58:52] But it’s the young people that are denied these contracts because they’re very expensive contracts. And so obviously employers are very reluctant to hire new staff on them. So therefore, young people are essentially condemned to remain outsiders and be on very short-term, part-time contract at much lower wages. But this is – so this is essentially a structural reform issue which simply, in my opinion, shows that the labor market reforms, particularly in the southern part of the euro zone, has not gone near far enough. MR. DADUSH: Yes, the lady at the back? Is – oh, sorry, the gentleman. Sorry about that, yeah.


Q: My name is Orlando Sophski (ph). And on the point of the leveraging of the ESFS, I think I would agree very much with what Liliana said. And frankly, there’s something I don’t understand, because I don’t see how you can guarantee your own debt. If we are going to guarantee the debts of France, Italy and so on, who is left to do the guaranteeing? Secondly, it seems to me that there was some fairly definite and definitive statements by the German minister of finance to the Bundestag and the ruling of the constitutional court as to how that could be possible, and I’d like to know the panel’s view on whether the leveraging of the FSF (sic) could be done after what was said in Germany last month. [01:00:16] And finally, it seems to me that this would also require the approval of national parliaments, and we already saw one country with a political crisis last week for a much smaller increase in the capacity to – (inaudible) – EFSF. So there are also important political issues behind the leveraging of the EFSF that should also be taken into account. MR. DADUSH: Good. Anybody want to pick that up? Go ahead, Desmond. MR. LACHMAN: Yeah, it’s – just take the point of view of how – just answer the question, how is Mrs. Merkel going to be able to do a U-turn given what she assured the Bundestag to get the July 21 measures approved? That wasn’t just her; it was the minister of finance, that there were statements from the constitutional court – the head of the constitutional court that the Germans – politicians mustn’t try to pull the wool over the eyes of the taxpayer by using these kind of mechanisms. I think that, you know, when conditions change and when you’ve got a big crisis, you know, your position is going to change as well. So I think that basically the way in which this will work is Mrs. Merkel will make a U-turn out of necessity, but what she’s going to do is she is going to offer the Bundestag in return that they can have a say over how the EFSF’s money is going to be used. What that does is it reduces the ability of the EFS (sic) to be a real bazooka. You know, that’s really what you wondering is, you’re wondering – like, what the Swiss central bank is doing right now is the Swiss central bank is saying that the exchange rate of the Swiss franc to the euro is 1.20, and we’ve got a printing press, and we’ll use that printing press as – to print as many Swiss francs as it’s going to take to keep the rate at 1.20, then that is a credible bazooka. [01:02:09] If – even if you manage to leverage up the EFSF to 2 trillion euro, but you say each time we’re going to dribble out a little bit of money, we’ve got to get the Bundesbank to agree on the conditions we’re going to impose on Italy and Spain, that is not really going to convince markets that you’ve got something already there. And, you know, at this – I should really just say that I agree with Liliana, you know, just in terms of the EFSF, what they – what they’ve done is glacially they’ve managed to increase to the effective size of 440 billion (euro), but what they’ve done is they’ve already committed something like a 120 billion (euro) to Portugal, Ireland and Greece. What they’ve done is they’re saying that they’re going to use it to infuse capital; so they don’t have more than around about 200, 250 billion (euro) to leverage up, you know, and it’s fanciful to think that you’re going to be able to leverage this up 10 to 1. So I’m not holding my breath for an effective bazooka.


MR. DADUSH: OK, so at some point I want to come back and ask the question, who in the audience is has 2 trillion euros to provide? (Laughter.) And how do we – where do we find the 2 trillion euros? I will come back to this; it is a serious question. MS. : (Inaudible.) MR. DADUSH: Yes, Sundween (ph). Please state your affiliation. [01:03:28] Q: Yeah, I’m Sundween Rastella (ph) with Bloomberg. I’d like to go back to what Liliana said earlier about the need for Japan, the U.K., you name it, to help in the European debt crisis. We’ve had quite stirring statements at the G-20 last weekend that, you know, the European(s) have to do their homework; Japanese, U.S., India – IMF doesn’t need more resources. So I’m curious to see where you see that going: Is it just a lot of posturing on the part of countries waiting for Europe and waiting for the EU summit, or are we really stuck and where do you see that going? MS. ROJAS-SUAREZ: Yes, as I just said, I really think that the solution is a global solution as opposed to just coming from the countries in Europe. And before just getting exactly into your question, the reason why I was disagreeing with the ECB being the – a final solution to the crisis is, just following this Desmond’s own argument, the markets know that at the end of the game are the German taxpayers, and do the German taxpayer will have all the money that is needed to be writing the check year after year? The answer is no. So they bring up the present value and said, uh-uh – (negative) – not even Germany will be able to do it. That’s why bring it to the present and say, no, the ECB alone cannot do it. OK. How do you – starting from that perspective – [01:04:53] MR. DADUSH: OK. MS. ROJAS-SUAREZ: – then I need fresh money. Every crisis in the past has been solved with fresh money, meaning money that is not from the same people that are in the game. And I – when you look at the statistics about the amount of government – eurozone government debt held by the U.S. and other countries, it’s large. So the global system has a stake in this crisis. That’s why I think that you need the participation of other large economy (sic). Japan plays a role too, and Japan has a lot of – actually Japan has a huge amount of debt, but very little of that debt is held externally. So we see quite a good situation from that – from their perspective. And the IMF, you need to call the (native ?) institution, right? The IMF is the coordinating institution; at this moment in time, there is no other coordinating institution. It’s not that I think that the IMF is – I mean, Desmond and I have worked many years there – it’s not that we think that, you know, that’s God’s-made institution. It’s just the institution that we have at hand. [01:06:03]


Yes, you are right: People are waiting because the Europeans themselves are claiming that this is their own problem and it’s going to be solved within Europe, right? I mean, there’s not even requesting; I mean, extend the lines of credit from the IMF so that there could be help to the euro – to the euro crisis, but to – from my perspective, debt crisis need the outsiders and – (inaudible) – MR. DADUSH: OK, I want to ask a question and interrupt the flow. All right, so – MS. : (Inaudible.) MR. DADUSH: – IMF comes – IMF gets – has the 2 trillion euros. Actually it doesn’t. MS. ROJAS-SUAREZ: No, it doesn’t. MR. DADUSH: But if Japan, German(y) – everybody – China, U.S., et cetera – is willing to give the money, maybe – I don’t know if we need 2 trillion euros. I got up to $2 trillion in my own calculations, but look, what – MR. LACHMAN: Well – (inaudible) – (concede ?) the same. MR. DADUSH: Yeah, well – MS. ROJAS-SUAREZ: (All right ?). (Laughter.) MR. DADUSH: He has an answer for everything. So the – (laughter) – MR. LACHMAN: Well – MR. DADUSH: – 2 trillion something – something. (Laughter.) And so the IMF has – now I want to ask the panel: So, I am China, I am Japan, et cetera. Am I just going to give the Europeans $2 trillion, just like that? If I give you $2 trillion to solve your crisis – [01:07:33] MR. : (Inaudible.) MR. DADUSH: – Antonio, if I give you $2 trillion, I want to do something different than what I’ve done with Greece, Portugal and Ireland, where I basically put conditions on Greece, Portugal and Ireland. If I give you $2 trillion – MR. : (Inaudible.) MR. DADUSH: – if I want to give – if I give you $2 trillion, I’m going to put conditions on Germany. I’m going to put conditions on France. I’m going to put conditions on the European Commission and the European Central Bank, and I’m going to say to them, this is the way you have to solve this problem because it is a German problem, it is not only an Italian, Spanish, et cetera problem. So my question for the panel, is that fair, number one? And number two, if it is fair, can the IMF do this – MR. : No.


MR. DADUSH: – or is the IMF not equipped to set those kinds of conditions? [01:08:28] MR. LACHMAN: Well, I – MR. DADUSH: Desmond, go ahead. (Laughter.) MR. LACHMAN: – I would just start by saying that I’m not sure that the IMF has covered itself in glory over the past 18 months. You know, so to think that they’re going to have a solution going forward, you know, that they should have recognized, you know, that this thing doesn’t have a solution without a serious write-down of the debt and probably without some of the countries leaving the euro – you know, so I don’t have that much confidence in them. But the issue as to other people stepping up to the plate with big amounts of money, you know, you’re talking about burden sharing; why is it that they should be left holding the bag? Geithner knows full well that the chances of the United States making an additional appropriation for the IMF, with the present Congress, are close to zero. You know, so you can’t go that route, and I think, as a taxpayer in the United States, I think that for them to keep kicking the can forward with my dollars, I would be voting against it. You know, that all you’re doing is you’re kicking the can forward, and I’m going to get left holding the bag, which I don’t want to do. [01:09:41] MR. DADUSH: Anybody else in this? Jacob? MR. KIRKEGAARD: Yeah, I mean, a couple of – I mean, first of all, I agree completely with Desmond. I mean, there’s no chance that Geithner or the administration is going to get Congress along with that. But, on the broader point, I would – I would think from the perspective of Europeans, yeah, I mean, if the rest of the world’s (sic) want to come in with a pot of money, I’m sure they would take it in some shape, but I don’t think it’s credible. And I would also contend that, you know, I’m not – I don’t think it’s necessary. I mean, the euro area is (essentially ?) an external surplus, has a sizeable net external investment position positive and has a primary balance that’s relatively close to zero, at least compared to the other industrialized countries. So the idea that what Europe – or the euro area needs to do is to figure out how it wants to distribute, you know, its finances. If it wants to continue to finance Greece in perpetuity and can find a way to make that sustainable, that’s what it should do. I mean, this is the institutional problem in euro, it’s one of redistribution. It’s a – I don’t actually think that it’s one of actually lack of actual resources and, I mean, I think the idea that, you know, BRIC countries and other large industrialized countries should come to Europe with a pot of money – I just don’t think that that would fly in any of the domestic constituencies in any of these countries. MR. DADUSH: Liliana? MS. ROJAS-SUAREZ: Yeah – no, I – that’s why I had the IMF in there. I am really thinking not so much in countries coming unilateral. I – what I’m thinking – MR. KIRKEGAARD: No, but I mean –


MS. ROJAS-SUAREZ: – what I’m thinking is on the expansion of resources that the IMF has. In other words, remember the bazooka? The – I don’t think the Europeans have it. That’s basically my bottom line. So I – if I need a bigger bazooka, it’s precisely so that I don’t use it, right? But it has to be very big. And yes, I’m totally aware of the Congress in – the situation in Congress in the United States; I’m well aware of that too, but we’re looking for solutions right now. We’re also well aware that the ECB doesn’t want to – (chuckles) – to do what you are proposing to – that needs to be done. So we’re aware of that constraints, but in this panel, what is – (inaudible) – MR. KIRKEGAARD: But I think it – but I think it’s – the bazooka is only really required if you want to the end the crisis. [01:11:56] MS. ROJAS-SUAREZ: Yeah, I want to end the crisis. MR. KIRKEGAARD: The only institution that has 2 trillion euros is the ECB. Nobody else – everything else is fanciful. MR. DADUSH: Antonio, do you want to – please. MR. DE LECEA: Yes, I mean – sometimes I feel that the EU is considered as a small country. I mean, it’s almost one-third of the world economy. So there is wealth enough, I mean, to cope with our own problems. I mean, all the rest is based on assumptions, assumptions that this countries (sic) is not going to do this, that that country is not going to do that, that the – this institution is not going to do this. I mean, we have seen that institutions in countries have been pragmatics since the beginning of the crisis. So all the – (inaudible) – the assumptions that the – that the – that Greece will need transfers, I mean, forever, are again based on the assumption that Greece will not change its – I mean, its economic structure, that things will go on as they are, and they are not. I mean, there is the consensus, there is the understanding that there were problems, and these problems must be solved. I mean, much of the reason why the solution is not (there ?), it may be next Sunday, is because it’s complicated both technically and politically. But the will has been – has been made clear, that the leaders have made clear that they will be up to the job and now they are working out how to – how to play it. So I think that’s the answer. [01:13:31] MR. DADUSH: The gentleman in the back. Q: It’s always seemed to me that – (off mic) – MR. DADUSH: Please introduce yourself and affiliation. Q: Glenn Miller, from MTB Investment Advisors. (Off mic.) It always seemed to me that Brady bond plan of the 1980s was maybe a successful precedent for what’s going on now for resolving this – (inaudible, background noise) – that many of you could comment on that – sort of similar


to the bond insurance plan to a certain extent, but it seems to me that there’s some possibilities there for using something like that as a resolution. [01:14:06] MS. ROJAS-SUAREZ: The Brady bond? MR. DADUSH: Brady bonds – anybody want to comment on the Brady bonds? MS. ROJAS-SUAREZ: Yes, just a small comment. Actually, Europe was very involved in the – in the Brady bond – Brady bond plans, so they’re very well aware of that. Again, what was the solution there? The creditors agreed to take a hit, right? That’s very important. And the creditors were separate from the debtors, right? I mean, OK – again, it was solved because you had an external amount of – number of creditors who’s agreed to – one, to take a hit and, two, were not related to the debtors. That’s why my proposal solution is, do you want to solve the European problems? You need to go out of Europe. MR. DADUSH: Anybody else? Yes, sir. Q: My name is Andreas Kern; I’m from Georgetown University. I agree with Jacob that the ECB easily has 2 trillion euros, actually, because as long as they’ve got paper and ink, they might print this money. However, I believe, it politically makes a huge difference whether these 2 trillions (euros) are used to recapitalize European banks rather than directly bailing out basically countries. Don’t you think that Europe is playing – or like European policymakers within the European Council are just playing on time to force the ECB to bail out, once again, the banking system in Europe in order to end, basically, the crisis, which would be politically less costly, would not violate so many European, basically, treaties and so on and so forth, and basically would resolve the problem in the short run? Secondly, given the excellent position of the European – of the eurozone countries, which is positive right now, I don’t believe that basically the international investors would flee the eurozone because what would happen if, for instance, Germany calls in all its outstanding debt to the United States of America and also its foreign direct investment positions, for instance, in China to mobilize its funds? Because then we would – at the end – at the very end of today learn that basically international financial markets make us all very vulnerable to these short-run decision-making processes. [01:16:20] And my question is whether it makes a difference whether I bail out countries directly although – or whether I just basically take the bazooka and give it into the hands of someone else – of people like Joseph Ackerman and so on and so forth? Thank you. (Laughter.) MR. DADUSH: Well, that really makes us feel good. (Laughter.) Go ahead, Desmond. MR. LACHMAN: Just let me clarify something – is that the IMF has made estimates that the amount of money that you need to recapitalize the European banks is around about 200 billion euro, you know, that some people


think a bit less, some people might think a bit more, but in that ballpark. The 2 trillion euro is in order to prevent people from selling off – MS. : Right. [01:17:07] MR. LACHMAN: – the bonds in Spain and Italy, that Italy alone has something like 1.9 trillion euros of bonds as a stock and what they’re having to do is they’re having to roll over something like 250 billion (euros) a year. So you’re wanting to have a big firewall so when the Greek default occurs and it, again, is hitting Portugal, Ireland, when it comes to Spain and Italy, you know that there’s money there, more of liquidity provision rather than transferring. So I don’t think they’re wanting to confuse the 2 trillion euro being used to bail out the banks; you just need something like 200 billion euro, and the idea there is that that 200 billion (euro) would either come from the banks themselves placing securities in the market to recapitalize themselves – of course the banks don’t want to do it because it would dilute their equity a lot – or you get the national governments to come in and bail them out and, as a last resort, you might turn to the EFSF, but you’re only talking about 200 billion (euro), which is different from the 2 trillion (euro). Q: I just referred to the number which was said earlier, that was earlier – (off mic) – MR. LACHMAN: Yeah, but the 2 trillion (euro) is for a firewall; it’s not for recapitalizing the banks. MR. DADUSH: There was a hand at the back there. I’m just keen to make sure we don’t – Q: Robert Kent (ph) from University of Glasgow. So we hear stories about, in Greece, people protesting about, you know, having to work for a couple extra years until they’re 65, and no one pays income tax and things like that. And it sort of gets to the productivity question that we were talking about, and so if there is eventual fiscal union, can that address the productivity problem, which seems to be a long-term, underlying issue beneath all of this? MR. DADUSH: Yeah, you want to take that? Yeah. [01:18:59] MR. KIRKEGAARD: Well, I mean, there’s no doubt that the fiscal union itself can obviously not, you know, because it – because the competitiveness of productivity, even imbalances question, is a long-term one and if fiscally – the fiscal union cannot do it, but on the other hand, various conditionality for receiving such fiscal transfers might be able to do it. I mean, this is essentially – well, you know, that’s what the IMF program is there for. And I think if you look at – if you look at the actual IMF program and you assume it is, in the end, reluctantly and over the dead bodies of a couple of Greek governments, being totally implemented, I mean, it will have an effect. You know, I don’t think that anybody can look at that and say that’s not the case, but it won’t be the fiscal union that does it; it would be the implied conditionality in it. MR. DADUSH: The gentleman here. Just – yes. [01:19:55]


Q: My name’s Tom Caruso (ph); I’m with Morgan Stanley. And if we have to look – MR. DADUSH: It’s OK. Q: – for someone outside of the European Union – and obviously it’s not going to be the United States – can you – I know you brought up China. China can be the bazooka, and there is a phenomenal amount of business being done between China and Europe. Could you mention that? And the other is, on a longer-term plan, what other countries would want to be in the – in the euro? What countries would you be looking to bring in the euro to make the European Union stronger? [01:20:28] MR. DADUSH: OK, two questions. Yeah, Jacob and then Liliana. MS. ROJAS-SUAREZ: I can – I can answer the China part. MR. DADUSH: OK. So Jacob first. MR. KIRKEGAARD: I’ll take the first one. I mean, if you look at the political commitment by current European leaders, the only – pretty much everybody except the U.K. and the Czech Republic has signed up for the Euro-Plus Pact. So I think you can safely expect that in the longer term, everybody, with the exception of the U.K., is going to join the euro area because as the euro area institutionalize deeper, the political costs of the small, open economies that are currently, you know, in the EU but not in the euro area is going to rise exponentially. The only country that has the political and economic size to remain outside is the U.K. MR. DADUSH: And China. MS. ROJAS-SUAREZ: Yeah, on the – on the China thing, no, I really think that this is mostly an issue of developed countries. I think that China have some resources but it’s not politically feasible to expect that China is going to be providing with (those ?) resources. And related to that, what do the eurozone need is really just euros. Well, you need to remember something. Just recently – can’t remember when exactly, but there was this facility to provide liquidity in dollars until the end of the year – because at the end of the day, what the world (tends ?) to need when there is a huge liquidity squeeze is just dollars. [01:21:57] MR. DADUSH: The gentleman at the back, and then I’m coming to you. Yes? Q: Yes, thank you. Rob Colorina, AIAC Investment. Sort of following up on Liliana’s comment early about creditors and debtors, are you all seeing a reception towards a mezzanine debt instrument or conversion in some of these restructurings for debt, for equity swaps?


MS. ROJAS-SUAREZ: That’s of a second order solution. Yes, there (is ?) room for all kind of instruments that would alleviate that. But the truth of the matter is, doesn’t matter how you construct it. The bottom line is that you have to have a haircut. Could it be through those kind of instruments, through change in interest rates, through increasing maturity, through – name it – it doesn’t matter. The availability of resources that debtor have has to increase, and the amount of transfer from the creditor has to be there, not for the short term but on a permanent basis. [01:23:02] Q: What about counterparty – (off mic)? MS. ROJAS-SUAREZ: Again, the guarantee is as good as the issuer, right? I mean, the word guarantee will drive me crazy because a guarantee – (chuckles) – you first look, when somebody extends – receives – if I make a – (inaudible) – a loan, the first thing that I look is at the quality of the debtor, number one. Second, I look at the guarantee, right? If the guarantee is related to the debtor, the guarantee, really, is worth very little to me. So – MR. DADUSH: Gentleman here at the front. Q: Yeah. Sure. Josh Townsend with Philip Morris International. Just picking up on what Liliana was saying about this now having moved and evolved into a banking crisis and political fixes that the ECB can do, in light of Dexia over the past couple of weeks and the misjudgment and ultimate failure of them to judge the liquidity, the capitalization of Dexia, is it possible – are we going to see in the future the ECB trying again to do another round of stress tests? And have they already lost their credibility now on the world stage in order to try and shore up more confidence in that way? Thank you. MS. ROJAS-SUAREZ: The ECB – I don’t think the ECB has lost its credibility at all. By the way, my suggestions is because I want to preserve the credibility of the ECB. To me, the ECB will lose credibility if it expands too large – I mean, is so much that people – markets are going to price that in and say, well, no really, I mean, what you are issuing is a very devalued currency in real terms, and therefore, you don’t have the credibility. [01:24:44] I think that on a case-by-case basis, there is a lot of room for ECB interventions, for providing liquidity when it’s needed, from – sometimes, from even buying – you know, expanding more its balance sheet with purchase of certain kind of assets, like in the Dexia situation. But what I want is to preserve the overall credibility of the ECB, which I don’t think is lost. MR. KIRKEGAARD: If (you ?) look at it – they have already committed to unlimited liquidity for 12 months, including expanding the covered bond program, which is essentially something – a way for banks to raise capital. Going beyond that, it’s clearly in the hands of governments. MR. DADUSH: OK. I want to make a comment to ask a question of the panel. So the U.S. Congress, under no circumstances, will even consider the possibility of supporting a European bailout in the event of the crisis spreading to Italy and Spain. And anyway, Europe is rich and can afford to pay for it.


Two problems with this thesis, and then my question. The first problem is, if Europe is so rich, then why isn’t it solving the crisis already? I mean, in other words, what I’m saying is, maybe Europe is not as rich as people think, or maybe the politics is such that Europeans like to project themselves as a unified block when – you know, whatever the discussion requires, but then in practice, they don’t act that way; they are a bunch of, still, sovereign nations going in different directions, which is one of the reasons that the ECB, politically, cannot do what the Federal Reserve can do as Liliana – as Liliana said. So that’s one observation. [01:26:52] And then the second observation is, it is: So Italy cannot repay its debt. Spain cannot, you know, refinance its debt. So now we’re talking about economies that are, you know, in the trillions of euros. And it is highly likely, on current trends and evidence, that the Germans are going to find it very, very difficult to pay all that money for all the reasons we have discussed. And then what’s the United States going to do? So the United States is going to just stand back and just let these countries go under? Do we realize that the debt of Spain and Italy is a much, much bigger problem than the subprime problem ever was? Is this going to be a global banking crisis of Lehman-type proportions or even bigger, perhaps, because there’s no backup, and because it affects the European banks that are much more important than the Americans banks by the structure of the system? Are we really going to allow this to happen? Or are we going to go back, as we did in the TARP program, a couple of times to the Congress, until the Congress said, hey, hey, all right, all right, we can do this? So my question to the panel is, is it serious? Are we really – if it came to that, are we really going to let Italy and Spain go? Desmond. MR. LACHMAN: Yeah, I think that there’s just a minor issue like a 2012 presidential and congressional election that gets in the way, you know, that is – and going to get in the way of the United States going in riding in to the rescue of Italy and Spain. You know, I think I agree with the premise of your question, you know, which is, basically, the United States is hugely exposed to a Lehman-style event in Europe; that our banks have got a trillion dollars of exposure there; our money market funds had until recently over a trillion dollars invested in European banks; we’ve written a whole bunch of derivative contracts. So if Europe really does fail, that is not going to be a European event; that’s going to be a global event that’s really going to impact the United States, you know, (but ?) you would think that this would be in the United States’ interest. [01:29:41] But I think, in the same way as Europe is tied up in political knots, the United States will be the same, and this will play out. There’s no way that the United States Congress, you know, that has got real budget problems of its own to deal with, is then going to have an appropriation for some countries in Europe who have been lecturing us on the waywardness of our ways, you know, how their model is better than ours. You know, there’s a lot of feeling in the United States, you know, Europe’s had it coming to them for a long time; let them stew – you know, that people aren’t going to really see that we’re in the same boat. So, you know, I think, politically, it’ll play out that the United States will do very little to lift a finger.


And that’s what Geithner is doing right now, is Geithner knows that there’s no appetite for providing money from the United States, so what he can do is he can offer them the benefit of his experience with the housing market, resolving the United States banking crisis, which the Europeans – you can imagine how graciously they’re receiving him and telling him what to do with his advice. (Laughter.) [01:30:58] MR. DADUSH: Antonio, do you want to comment? MR. DE LECEA: Yes. Let me – let me go for your first question, (I mean ?), whether we are (a ?) union or we are a conglomerate of countries – and we are both. I mean, the uniqueness of the European model is that we have common policies, common institutions, but at the same time, we are 27 sovereign states. And it has proved to be extremely successful in many respects, but we will not hide that in some others, there was the need for – I mean, (farther ?) for a review of the mix of European and national sovereignty. And this is what has been happening – has been happening since one year and a half. It’s already happening this week in the run-up to the European Council this Sunday. So indeed, it – I mean, coming back to the initial premise, it was – there was an institutional incompleteness. And this is what’s being fixed now, so that, I mean, we will be able to get the benefits, and still go farther. It – I mean, what will come out of it will need not be the same as this country; it will be a kind – an integration that need not resemble the fiscal federalism in this country. But it will be more integrated, and in this respect, we will be able to reconcile once more 27 nations, 27 sovereign states, with institutions that they have – that we have created to cope with the common problems. MR. DADUSH: Jacob. [01:32:43] MR. KIRKEGAARD: Well, on the first question – I mean, the problem is that you’ve got, what, 85 percent of the European population that primarily identify as citizens of their own nation-state – they’re Belgians, they’re Germans, they’re French, they’re Spanish, they’re Greek and whatever. What that means is that if you – you cannot legitimately shift towards a transfer union. It simply will not politically fly. And you don’t have the option that – and therefore, you don’t have the option that, you know, the United States adopted after the war of independence to deal with its contagion issue in the sovereign debt market, which was, of course, to consolidate – you know, Hamilton’s great idea to consolidate it all into one federal debt. That option, for political reasons, does not exist in Europe. So in that sense, you are – you know, you’re somewhere in between. And – but I think, having said that, it’s quite clear that the crisis, as Antonio said, pushes you in the direction of allowing more and more fiscal federalism. On the second point about whether or not policymakers in Europe or the U.S. Congress would allow the global economy to go to hell in a hand basket, no they won’t, because, I mean – but I don’t think that it’ll actually get to the point of asking the U.S. Congress in several sort of “TARP two” votes; it’ll be the ECB that cracks in this regard. I mean, if we’re thinking about Spain and Italy failing, what does that mean? It means that they won’t be able to place – to place debt in the primary markets. Well, there are ways around that. You know, you could have them be


bought by national domestic banks in these countries, and then under emergency liquidity assistance, actually re-po them with, you know, domestic central banks – I mean, the point being that there are ways in which you can deal with this, and in my opinion, will deal with this in an emergency. You cannot, for political reasons, say out loud that this is what you’re going to do because it would be, as I said earlier, in breach of Article 123 of the European treaty. But you do have the ultimate backstop, and that is why the security markets program is going to remain dormant as part of the tools that you have in the cupboard, that you can draw out in a crisis. [01:35:15] MR. DADUSH: Liliana. MS. ROJAS-SUAREZ: Yes. You started your comment, Uri, saying that Europe is rich; why doesn’t it deal with its own crisis? Argentina was also very rich and still is very rich – very rich country. Wealth is not what determines a crisis resolution. It’s liquidity that hits you. The need to roll over maturing existing debt is what kills you. People always think, I guess having liquidity problem, I don’t have the solvency problem – I’m sorry, but the land of Argentina could not be sold in a second. And neither – (inaudible) – Spain, by the way, with the privatization program that they have started. So you can have lot of wealth, but it’s not tradable right now when you need the resources. So that’s why I think that that’s not the issue. You can be very wealthy and still fall into collapse. On the U.S. reaction: Well, I have very bad news from my perspective. I think that the U.S. crisis would not have developed to the extent – whether its politicians would have reacted much faster. I mean, many, many, many economists knew what was forming in the – in the subprime market, but politician let it go, let it go and grow and grow, until it collapsed, and then reacted, right? OK. With the status right now and the elections coming in the U.S. and whatever, I think that the U.S. could let the world sink. Of course, they will react later on, but I think – yes, I think that there is a possible scenario where we will have a huge economic crunch worldwide with much more deleveraging and with much higher credit squeeze than the one we’re facing now. MR. DADUSH: Thank you very much. Just by way of a quick – very quick synthesis, it is remarkable, given the brilliance of our panel, that they should disagree so much after so much reflection. They do agree – they do agree – our brilliant panel does agree – and everybody agrees – that the euro is underinstitutionalized. (Laughter.) [01:37:35] MR. : (Inaudible.) MS. ROJAS-SUAREZ: That’s true. MR. DADUSH: (Inaudible) – is – you must watch and go back to Peterson Institute anytime you see an underinstitutionalized person walking around. So that’s number one. They do agree; we need those reforms – (inaudible). Beyond that, these guys think a hundred percent probability the euro will survive. MR. : At least.


MR. DADUSH: At least. (Laughter.) These guys on my right think that there is a very low probability that the euro will survive in the – in the short term. There is also a deep division of views about if the crisis gets worse. And there is a fair probability that the crisis gets worse, according to our panel, I think, with perhaps one exception. If the crisis gets worse, there’s a deep division between, on the one hand, people who say, on my left, that Europe will be able to handle it on its own, and people on my right who, on the other hand, say, either they can’t handle it at all, this thing will collapse, or that they can only handle it if they get external help. OK? [01:38:58] That’s my synthesis, and that’s why I think we’re going to have another euro event – (laughter) – in a few months’ time. MR. : (Indefinite ?) title. MR. DADUSH: (Laughs.) I hope the title doesn’t get much worse than this one. Thank you very much. (Applause.) (END) [01:39:16]

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