Last night, here in Edinburgh, I attended a fascinating lecture by Willem Buiter, founding member of the Bank of England’s Monetary Policy Committee and author of the celebrated (in certain circles!) Maverecon blog on the Financial Times website. Sadly, the blog is discontinued as Professor Buiter is now the Chief Economist of Citigroup, the US banking and finance giant.
Despite this last fact, Prof Buiter is an interesting economist. Although coming from the mainstream tradition, he is an independent thinker and pragmatic analyst who isn’t afraid to follow his analysis to unexpected conclusions. In the course of his lecture and in conversation afterwards, it seems he isn’t too constrained by his current corporate role. I hope he will forgive me for reproducing his thoughts here as accurately as I can.
Professor Buiter was talking about the current state of government finances in Europe, particularly in the light of the unprecedented deficits and debt levels of many countries, particularly Greece and the UK. His view is that the UK and other governments should have spent less in the period of the ‘Great Moderation’ of the 1990s and early 2000s, when there was an unusually prolonged period of inflation-free growth. This is based less on the actual debt/GDP ratios that existed but on the fact that the tax revenues obtained during this period were clearly obtained on the back of unsustainable financial and property asset price rises. Who was to blame for this situation? Nearly everyone who was in a position to do anything about it, it appears: the bankers, including central bankers, governments and regulators. As far as the bankers are concerned he believes that not only were widespread conflicts of interest going on, such as that seen at Goldman Sachs, but actual widespread criminal behaviour.
Professor Buiter’s view of the debt crises centres on the ‘political capacity’ of governments to repay debt. He points out that the actual assets of any of currently heavily-indebted countries are more than enough to cover their public debts. The problem is not that they can’t pay but that they won’t pay. We can see this panning out in Greece as mass protests and strikes face the government as it tries to force through massive public expenditure cuts. The reluctance of the British political parties to spell out the details of planned expenditure cuts in their election campaigns is part of the same picture.
So as governments come up against the limits of this political capacity, what happens? Historically, defaults on sovereign debt are not uncommon, and have often been followed by fairly reasonable recovery of their value by debtors and prompt recovery of the defaulting countries’ economies. Today, however, the integrated nature of finance, particularly in Europe, has changed things. A sovereign default in Europe would have major consequences for banks, because of their large holdings of Eurozone bonds. This is clearly why there is pressure for a bailout of Greece, and why we see the downturn of European stock indexes in the face of a rising probability of Greek debt default. Given the serious consequences of an outright default, Prof Buiter predicts a negotiated restructuring of Greece’s debt.
For the UK, Professor Buiter sees a prolonged period of ‘fiscal pain’ rather than default, with greatly increased taxes and large cuts to public services. The focus of tax rises will be on those taxes easiest to collect and the focus of the cuts on the weakest in society. There will not be ‘just deserts’ in the visiting of this pain. The option of inflating away the debt burden, which may well be the US option, would be risky for the UK, because of the exposure of its huge financial sector to a fall in the value of sterling.
Growth in the European nations is going to be slow over the next ten years, and primarily driven by emerging markets. What growth as there is will result in relatively less revenue for governments, exacerbating the difficulty of stabilising debt levels.
The main thrust of reform that Professor Buiter advocates is aimed at shifting the risk of the activities of financial institutions to bank creditors and shareholders. There must be no more banks that are ‘too large to fail’ – although under current conditions many are now ‘too big to save’. In particular he would like to see a more-or-less automatic process by which the creditors of troubled financial institutions become equity holders. Another proposal he made was for ‘Islamic-type’ mortgages, where the lending institution holds a stake in the property until full payment is received from the householder. With the option for the relative shares in ownership to be flexible, this allows home-owners to avoid losing their property even in times of financial difficulty.
He insists that internationally homogeneous regulatory standards are required for financial institutions, although he doesn’t see much prospect for this at present. Along with this the Eurozone must develop central fiscal mechanisms to go with its centralised monetary control. If this were present he still thinks the UK would be better off in the long-run with the Euro. The base of sterling is too small not to make the UK economy vulnerable.
© Diarmid J G Weir 2010