Well some times I agree with Wolfgang Munchau, and sometimes I don’t. This is one of the occasions when I do, especially the following passage which can be found in his Financial Times op-ed this morning:
“Some degree of competitive adjustment is probably needed but the huge scale of the shock that is unfolding in Spain will almost certainly require a macroeconomic response that Spain cannot deliver on its own……….So what actions would be needed? In the very short run, a transfer mechanism to provide help for countries in severe distress. Of course, any transfers would have to come with IMF-style conditions attached.”
Basically this is broadly in line with what I was suggesting in my RGE Europe EconMonitor piece – What Is The Risk Of A Serious Melt-Down In The Spanish Economy? – last Friday. Essentially the ECB has now gone about as far as it can, and the EU Commission in some yet to be determined way needs to play the role of the US Treasury (we lack the appropriate architecture at this point, but still), and inject cash – rather a lot of it. This is an EU problem and not simply a Spanish one since the source of the bubble lies very clearly in earlier monetary policy over at the ECB (or in deficiencies in the way in which the “one size fits all policy has been administered, see in particular “How to prick local housing bubbles in a monetary union: regulation and countercyclical taxes” by Alan Ahearne , Juan Delgado and Jakob von WeizsÃ¤cker – also on RGE last Friday).
It appears the Spanish cabinet is now divided between one group – lead by Industry Minister Miguel Sebastian – who favours intervention to rescue ailing builders – and another – lead by Economy Minister Pedro Solbes – who do not favour intervention.
My view is that a substantial, but as of yet indeterminate quantity of money (possibly in the region of 300 – 500 billion euros) needs to be injected urgently into the Spanish banking system, either directly (by buying cedulas hipotecarias outright) or indirectly by buying up and closing down builders as part of a “restructuring programme”, and this needs to be done by the EU equivalent of the US Treasury (whatever we decide that that actually is) and not by the ECB. Thus I am neither with Sebastian (who would, I suspect like to save the builders) or with Solbes. Of course, as Munchau indicates, any such intervention would need to come with all manner of conditions attached (a restructuring of the whole Spanish mortgage situation, to put the banks back on a sound footing, being just one of these), and this would mean that the Spanish government would to some considerable extent lose control of its own internal affairs. But this possibility was already implicit in the creation of the eurozone in the first place, so I suppose you could say that one day or another this situation had to arise. And now it has. So let’s get on with things and take some decisions.
You can find the relevant part of Munchau’s editorial below the fold.
But what about intra-eurozone divergences? I was struck the other day by a statistic from the ECB that shows Spain losing competitiveness relative to Germany, even now. We knew this happened during the years of high economic growth in Spain and low growth in Germany. But the trend continued even when the relative positions of the two countries were reversing. One explanation is that Spanish wages are directly linked to inflation, while German real wages are still declining.
Worse, Spainâ€™s slippage comes amid the prospect of a serious downturn in its economy. Last weekâ€™s collapse of Martinsa-Fadesa, a large property developer, has been a reminder, if any were needed, of the massive scale of the Spanish property crash. Serious financial and economic distress is almost inevitable. Do not be fooled by the fact that Spanish banks had virtually no exposure to US subprime mortgages. Being exposed to Spanish mortgages is probably worse.
Spain is in a more delicate position than the US or the UK because, as a member of a monetary union, the country has fewer macroeconomic adjustment tools at its disposal. The dollar and the pound have devalued in real effective terms, while Spain has one of the hardest currencies in the world. Spanish interest rates have gone up while US rates have gone down.
The good news is that Spain has some room for manoeuvre in fiscal policy, given its low debt-to-GDP ratio. But the whole structural and legal setup of the eurozone requires that, in any adjustment, most of the heavy lifting is done via the real economy. Spain is thus in danger of entering a decade of misery, with falling real wages.
The problem is that even if Spain were to try to pull itself up through competitive adjustment, it is not at all clear that this would work. I am not even sure whether it works all that well for Germany in the long run, but that is another story. Some degree of competitive adjustment is probably needed but the huge scale of the shock that is unfolding in Spain will almost certainly require a macroeconomic response that Spain cannot deliver on its own.
Yet the eurozoneâ€™s system of economic governance is not designed to produce this type of response. There are no cyclical transfer schemes, only structural funds. No common rules exist on bank bail-outs. Small-minded national banking regulators even refuse to countenance the very obvious necessity of a central banking regulator for cross-border banks. The eurozone does not even have single representation at the International Monetary Fund. The economic shocks to be experienced by Spain, and by Ireland, will seriously test the eurozoneâ€™s see-no-evil-hear-no-evil approach to economic governance.
I have long thought that the only way the current set-up will be changed is not through debate about future eventualities but as a result of being plunged into crisis. Eurozone finance ministers â€“ the so-called eurogroup â€“ are a complacent bunch. They never do anything until it is absolutely necessary. But they will act eventually. I am relatively optimistic that they will always be able to ward off the worst-case scenario, one that still excites some commentators: the threat of a eurozone break-up.
So what actions would be needed? In the very short run, a transfer mechanism to provide help for countries in severe distress. Of course, any transfers would have to come with IMF-style conditions attached. As a price for an increase in intra-eurozone solidarity, the other member states would almost certainly demand that the beneficiaries end the silly policies that got them into the mess in the first place. Spain, for example, should end the automatic link between inflation and wages. It should also end the monopoly of the one-month euro interbank offered rate mortgage, which has had a hugely pro-cyclical effect on mortgage lending and the housing market.
The one institution that cannot help Spain is the ECB. Its role is to run an optimal policy for the eurozone as a whole. Dealing with this hugely asymmetric shock is primarily a matter for politicians, not central bankers. Anybody who claims to be serious about economic policy co-ordination, such as President Nicolas Sarkozy of France or the European parliamentâ€™s economic and monetary affairs committee, should therefore stop bashing the ECB for a few months and focus attention on the storm that is building up on the eurozoneâ€™s western front.