The issue: ‘We all carry this debt together’

Text: Geert Maarse / Photography: ANP

The billion-euro aid package for Greece put European relationships on edge. Who would be next? Was the euro a bad idea after all? Overreactions, suggests Casper de Vries, Professor of Monetary Economy. ‘The current crisis clearly highlights the rules of the game within the euro zone.’

What went wrong with Greece? “There was an international banking crisis. Governments over the past two years took over a portion of the banking debts. This is necessary, because they are essential institutions in an economy. If just one key bank fails among all the others, everything collapses. However, this left governments stuck with that debt. And some countries are less able to carry these debts than others. Furthermore, it became apparent that in the past Greece did not accurately report on a range of information. The shortage turned out to be much greater than originally thought. At that point all investors walked away.”

Sometimes it would appear that Europe’s problems, including the issue with Greece, are independent of those in the US. But in fact is it all simply the same credit crisis? “We are all part of the same world economy. The current debt crisis is a logical consequence of the too liberal monetary policy pursued by the FED and the collapse of the American housing market. European banks too purchased the conveniently packaged junk mortgages on a major scale.”

Did the EU member states react properly to the problem this created? “When there is a storm, there will be mistakes; this is something any skipper will affirm. However, grosso modo governments did what they had to do: provide credit. In the thirties, they did exactly the opposite, with disastrous consequences. At that time the erroneous response from governments caused a major stock market crash to grow into a depression. We currently managed to prevent this in the first instance. The fact is, however, that the size of the problem assumed unnecessary proportions because the ministers of Finance did not intervene sooner.”

Greece was granted a conditional loan in the amount of € 110 billion from euro countries and the International Monetary Fund. Critics are saying that this has only bought time.
“Certainly, there was a question of buying time. However, if the banks had no longer been willing to lend to each other and the public, the economic damage would have been that much greater. A crisis of confidence was prevented. The entire banking system is based on trust. It is impossible for everyone to withdraw their savings at the same time; no single bank ever has that much money. They all operate on the basis of a leverage principle, but you trust that they invest the money properly. As soon as that trust disappears, things go wrong.”

Do governments understand how financial markets operate? Angela Merkel who on her very own imposed a prohibition on ‘naked short-selling’ (speculating on price losses on the stock market – ed.) had to endure a lot of criticism. “That prohibition is totally useless. I assume that she availed herself of expert advice, but it would appear that she has little understanding of financial markets. Furthermore, I believe that we are very much indebted to these types of speculators. At least they have made it very clear that the squandering in Greece has got to stop.”

Is there cause for concern about the euro? Its value in relation to the dollar is continuously dropping. “There is a lot of fuss about nothing. When the euro was first introduced it was valued at $1.18. It then dropped to $0.80 and it later increased to $1.60. At the present time it is once again around $1.20. Any calculations based on parity of purchasing power shows that this is approximately the right exchange rate. Sarkozy for years has been saying that the euro is too high. Now that it is lower, it’s still not right. Politicians are simply posturing. It is good for our exports. And it will creep up again by itself.”

There are economists who are suggesting that the euro was a bad idea. Are they off the mark? “André Szász, former Deputy Director of the De Nederlandsche Bank, always maintained that the introduction of the euro first and foremost was a political process. Primarily to really have and keep Germany as part of Europe. People in the Netherlands never really wanted to accept this. A great deal has been accomplished with the European Union. The problems that we are currently experiencing are caused by countries that are only now discovering the rules of the game. All southern countries have profited from the too low interest rates, and have mostly consumed that money instead of investing it. Of course there is a possibility that the euro zone will burst apart. Throughout history there has not been a single monetary union that ultimately remained standing. But it is still far too early to be talking about such things. We are much better off to think about ways in which we can create a stronger and more stable political union in the areas of finance, agriculture and defence. And, I would plead for a genuine European banking sector.”

Have we come through the worst of it? “Just as happened with Greece, it is certainly possible for a large company to default at some point. We are not out of the woods that easily, because all of us together have a huge debt to repay. This is true for America, Britain and for Europe.”

The first cautious notes of optimism are coming from the US. Is that not strange, given their gigantic budget shortfall? “The American shortfall is higher than the European average. There too, the debt could rise to such levels that other parties, including China, are no longer prepared to assume it. The debt has to be repaid. And that is always at the expense of consumption and the stimulation of the economy.”

According to financial journalist Willem Middelkoop, there is a belief in the western world that we are entitled to our wealth. The Greek population went into the streets en masse when they were told that they had to give up something. Have we become addicted to growth? “Since the industrial revolution we have been experiencing real growth figures of two, three percent per year. That represents a doubling of wealth in thirty years. Of course that creates unrest when there are cutbacks. But the government's debt is a debt that we all carry together. Wages will have to go down somewhat and capital costs will have to be adjusted. Those are the rules of the game in a monetary union. However, we are resilient enough to be able to absorb a few jolts. Innovation is by far not yet at an end, and growth will therefore resume over time.”

Does that also apply to the US? There are people who firmly assert that one of these days things will blow up over there again. “When Clinton took office as president, he also inherited a huge government debt from the Reagan and Bush senior eras. And he managed to eliminate it in eight years. People tend to overreact somewhat. Dire pronouncements are being made about countries such as Spain, Portugal and Italy as well. And while there are definitely problems there too, they are of a very different order that those in Greece.”

You seem optimistic. Do you consider it a high probability that the right measures are being taken? “France is hard at work and the British are in the process of restructuring. If there are significant budget cutbacks, I think things will turn out for the better. A smart government cuts back on consumption, not on investments. In other words, cut back on wages and payments, not on education and infrastructure. Unfortunately many people, and this includes the political establishment in the Netherlands, fail to realise that in the long run we would be much better off if we gave up a little now and allow for the existence of income differences. Shaving and redistribution may perhaps appear to be fairer, but ultimately it will not get you as far.”

Do you consider this crisis to be a wake up call for governments? “In part. Mistakes were made. However, the current problems are nevertheless primarily due to the socialisation of bank debts. And the blame for this rests squarely on the shoulders of the private sector.”

And we, the taxpayers, are left to bear the costs. “Unfortunately, yes. You can wish to have heaven on earth, but that is not realistic. The only thing we can do is to learn from this and to reform the financial sector in such a way that it is difficult for this to happen again. But there will always be another financial crisis. The course of events is impossible to foresee. We will have to learn how to live with this to some degree. There is no such thing as a perfect system.”

Thursday, June 10th 2010 (week 23).


The issue is a section in Erasmus Magazine, the opinion and information magazine of Erasmus University Rotterdam, in which an EUR-academic responds to a current-social issue.


Prof Casper de Vries (The Hague, 1955) is Professor of Monetary Economy at the Erasmus School of Economics and Professor of Risk Management at the University of Amsterdam, Duisenberg School of Finance. He obtained his doctorate in 1983 in the US at Purdue University, and specialises in the area of monetary economy, international finance and game theory. He was also associated with Texas A&M University, the Catholic University of Leuven and others.