_ Hans-Werner Sinn, Dr. Sc., president, ifo Institute for Economic Research (1999-2016), member, advisory council, Federal Ministry for Economic Affairs and Energy (Germany); professor emeritus, Ludwig-Maximilian-University. Translation into English by Yuri Kofner. Munich, 24 July 2020.*
Professor Sinn, almost all participants and observers were satisfied with the result of the recent EU summit and the agreement on a reconstruction fund. You also?
Yes, yes. Countries particularly affected by the epidemic, such as Italy, deserve the solidarity of others. And finally, the participants in the EU summit unanimously opted for the reconstruction fund. This is good, because when it comes to such transfers, nobody should be overruled. But I would have liked it even better if each country could have decided for itself how much it would like to donate to non-performing EU countries like Italy.
Are you becoming mild-aged? In your book, you complain that corona aid is the vehicle for entering a transfer union in which the countries of the north are liable for the debts of the Mediterranean states.
I find the help itself sensible and correct. I am rather bothered by various accompanying aspects that were not necessary, such as raising common debts and financing these debts through the printing press of the European Central Bank (ECB). A debt union inevitably leads participants to go into more debt than usual because they rely on the community to bear these debts.
But isn’t there a meaningful idea behind the collective debts? Thanks to joint liability, all EU countries can borrow at very low interest rates to finance investments that lead to higher growth. With the additional wealth generated, the debt can then be repaid easily.
Please, you know yourself that this is just a pious wish. The growth story is a nice story to be presented to the public, but nothing more. Regional aid from the EU can somewhat reduce the differences in living standards. But relevant studies have shown that this does not improve the quality of the location. In any case, the transfers mean that wages in the recipient countries are kept at a higher level than what the manufacturing companies can handle.
How should the corona-related debt be settled?
In no case through the printing press of the ECB. The monetary base, i.e. the central bank money supply, has increased dramatically since the financial crisis. We are currently in a liquidity trap with zero interest rates. The money is hoarded and not spent or lent out. That is the reason why the euro crisis has not led to inflation in the past ten years and will not for the time being. But that may change one day.
In what way?
When the epidemic is over and optimism spreads again, a global economic upswing can occur, causing prices to rise. The oil price can also rise again and set a wage-price spiral in motion. Whatever the reason for a price increase: if it comes, the ECB will find it difficult to put the reins on again. At the end of this year we will have a monetary base of more than five trillion euros. Four of them are superfluous because at the time of the Lehman crisis, when the economy was no smaller than today, just under a trillion was enough. How do you want to collect them again? In fact, this will not happen because either you get the banks in trouble because their air bookings of government bonds burst, or the states get financial problems.
Not only the ECB, but also the American Fed and the Japanese central bank print money in a comparable way. Inflation has not occurred in any of the economic areas.
Again, monetary policy is not inflationary in the liquidity trap. That only comes outside the liquidity trap.
In your opinion, are all countries in which the central banks pursue a principle similar to that in the euro zone, the USA and Japan, in the liquidity trap?
But until the Corona shock, the United States experienced the greatest upswing in decades – yet there was no questionable inflation there.
The US was in the process of getting out of the liquidity trap. The inflation rate rose again in the months before the corona crisis. That is why the Fed recently tried to reduce the money supply. With Corona, however, the USA slid back into the liquidity trap.
The liquidity trap usually involves hoarding money. How does it fit that the stock market prices in the USA are approaching new record levels again?
This is also a result of the liquidity flood. In the liquidity trap, interest rates and dividend yields are low and prices are high.
Was there anything in the economic consequences of the corona crisis that surprised you as an economist?
Yes, we can currently see a new type of crisis. A distinction is usually made between supply and demand shocks. The corona crisis is neither one nor the other.
We are dealing with a transaction ban that has never existed before. The essence of this crisis is that the state rightly followed the advice of epidemiologists and banished people from shops and restaurants. It also closed the borders. People wanted to consume and companies wanted to supply the stores, but the contact bans did not bring supply and demand together. It made no sense to take stimulating measures and initiate an economic stimulus program. Now the lockdown has ended and the economy starts up all by itself. But in Germany, unfortunately, a whatever-it-takes mentality has arisen, in which every politician tries to push through his favorite project in the Corona slipstream.
In contrast, you see the rescue packages for companies in your book as surprisingly positive.
It is right to save companies that have functioning business models and are only in trouble because of the epidemic.
And do you trust the state to make this distinction?
No, the state cannot and must therefore accept that it also saves companies that do not deserve it. In the meantime, the state of good has done too much. The large amount of money causes many companies and companies to rest instead of fighting for the customers. Joseph Schumpeter’s “cleaning crisis” does not take place.
Do you think that help for companies is delaying a structural change that would actually be necessary in Germany?
That too. But it is difficult to find the golden middle ground between “we save everyone” and “we save nobody”.
The road to a European transfer union
_ Hans-Werner Sinn, Dr. Sc., president, ifo Institute for Economic Research (1999-2016), member, advisory council, Federal Ministry for Economic Affairs and Energy (Germany); professor emeritus, Ludwig-Maximilian-University. Munich, 2 April 2020.*
Can European policymakers continue to rely on northern European countries to foot the bill for the rest of the euro zone? The former head of the Ifo Institute warns of northern baby boomers retiring and coffers running dry.
Ten years after the Great Recession plumbed economic depths unseen since the Great Depression, it is necessary to step back from quotidian politics to get a glimpse of the bigger picture. Europeans need to ask themselves where they have been, and where they are headed next on their journey.
Twenty years ago, in 1998, exchange rates among many countries in the European Union became irrevocably fixed in preparation for the introduction of the euro. Suddenly, near-bankrupt southern European countries no longer had to pay huge interest premiums of around 5-20 percentage points relative to Germany. So, awash in cheap loans, southern Europe experienced a debt-financed economic boom that pushed wages and prices sky-high. Eventually, that boom became a bubble.
Then, a decade ago, the bubble that had simultaneously been developing in the US subprime-mortgage market burst, leading to the global financial crisis and, subsequently, the breaking of the bubble in southern Europe. In their hour of need, crisis-ridden southern European countries ran up huge overdrafts with the European payment system, replacing the private loans no longer available to them.
Moreover, in an attempt to contain these overdrafts, northern European countries granted their southern neighbors massive fiscal bailouts. But these funds proved insufficient, prompting the European Central Bank to step in with unlimited guarantees for southern Europe’s creditors, all at the expense of euro-zone taxpayers.
Naturally, the ECB’s guarantees encouraged creditors to extend the crisis-afflicted countries still more credit, rescuing the investments of earlier creditors. The protected creditors hailed from all over the world, including northern Europe. French banks had by far the biggest exposure to distressed southern European countries, and thus benefited the most from the bailout.
But the creditors had to bleed too. They received hardly any interest on their assets, and their interest losses on loans to southern Europe piled up to several hundred billion euros.
The ECB’s bailout initiatives peaked with the introduction of quantitative easing (QE), whereby the Eurosystem’s central banks purchased €2.3 trillion ($2.8 trillion) in freshly printed euro securities – including government bonds worth €1.8 trillion – between 2015 and 2017.
In reality, the QE program was a huge debt-restructuring operation. Its primary beneficiaries were southern European countries, which had sold a disproportionately large share of their government bonds to foreign investors to finance their huge current-account deficits in the decade leading up to the global financial crisis.
The QE program worked implicitly through three-way deals. Southern European countries were able to retrieve their securitized government bonds because global investors substituted those bonds for assets in Germany, as well as, to some extent, the Netherlands and a few other euro-zone countries. The sellers of these assets, in turn, received euros, and hence claims against their national central banks. And the central banks themselves received so-called Target compensation claims against southern European central banks, guaranteed by the Eurosystem.
By the end of 2017, the Target overdrafts owed to the Bundesbank alone totaled €907 billion. And yet the Bundesbank’s Target claims are essentially worthless, because they can never be called due and are issued at an interest rate determined by the debtors, which hold the majority on the ECB governing council. For the time being, they have set the interest rate to zero.
Under the Bretton Woods system, which until the early 1970s pegged currencies to the price of gold, Germany would have received 19,000 tons of gold (based on prices at the end of 2017) for these claims. That is almost five times what it effectively had accumulated under that system (4,000 tons). The Bundesbank’s €907 billion in Target claims represents almost half of the net foreign wealth that the Federal Republic of Germany has accumulated to date through its export surpluses.
For those who will look back in 2028, the decade starting in 2018 will be remembered as one in which European politicians began to waive and abate the Target claims through north-to-south fiscal transfers. Such transfers will be pushed through with measures that French President Emmanuel Macron has already called for in order to strengthen his country’s southern hinterland, and which Germany’s new provisional grand coalition has already endorsed (with minor modifications). In Mr. Macron’s proposed scheme, each euro transferred from a northern to a southern European country would reduce the Target claims and liabilities by one euro.
The decade ahead will be a particularly opportune time to create a transfer union, owing to the looming demographic crisis that is threatening most European countries, with the exception of France. After the baby boomers retire, government coffers will run out between 2028 and 2038. That means anybody looking to tap the resources of northern European taxpayers will need to do so soon, before it is too late. Dépêchez-vous, Monsieur le President!
*Translated and republished without prior written consent. For educational purposes only.