Morningstar Advisor - February/March 2012 - (Page 51)

Ben Johnson: Let’s first discuss the causes of the crisis. George, can we start with you? George Magnus: Sure. This euro-system crisis is really, in essence, a good old-fashioned balance-of-payments crisis. It seems to be about budgetary discipline and fiscal issues, which obviously have plagued Europe since Greece first appeared on the scene a couple of years ago. But this is just a manifestation of the problem of an incomplete monetary union and coming to terms with the fact that imbalances between member states don’t disappear. And, of course, these imbalances have grown to rather large proportions; France and Italy actually have been chalking up external deficits, which are the largest they’ve been since the monetary union began. So, I think that’s really what the underlying cause of the crisis is. The misdiagnosis of the crisis is leading Europeans into adopting a flawed agenda with inappropriate policy tools. I don’t really see that they are even close to coming to terms with this as yet. Johnson: Edward, you’ve done a terrific amount of work examining historical sovereign defaults and trying to provide context for the issues facing Europe today. How is the current crisis similar to past crises and how is it different? Edward Chancellor: First, I’d like to say that I agree with George’s analysis that this is a balance-of-payments crisis. There are a number of ways of referring to the periphery of Europe, as sometimes they’re called, in a derogatory way, PIIGS. One other way of referring to them was as CADs, which stands for current account deficits. It was a term coined by Bernard Connolly, who is a longtime euro skeptic. Connolly elaborated that idea of the problem within the eurozone long before this crisis, even long before the global financial crisis. is that during the boom times, the periphery— which normally when we’re referring to the periphery, it’s probably a Latin American country like Brazil, Argentina, or Mexico— typically runs a current account deficit that’s offset with capital inflows or a capital account surplus. And then, during the bust, money flows from the periphery back to the core, and no one is funding the current account deficits. Countries that have fixed currencies typically then find themselves with a large amount of external debt, possibly in an uncompetitive position, and with capital outflows, and that is followed very typically by a default. One sees that pattern recurring from the first Latin American debt crisis of the 1820s, periodically through the 1870s, again in the 1930s, and again in the 1980s. So, these are sort of 50-year-plus cycles. What’s different today, as George pointed out, is that the periphery is actually part of the currency union with the core. In the past, if creditors in the City of London suddenly decided they didn’t want to lend to Argentina, it might bring down Barings Bank, but it wasn’t going to bring down the British economy. The trouble with the currency union is that if the core of Europe decides that it does not wish to fund the periphery, it creates an existential problem for the European currency union. That, in turn, creates a very severe problem for the French and German financial systems. So, in that sense, it has many of the hallmarks of a typical sovereign debt crisis— feckless low savings, overborrowing, peripheral countries. But the difference is that the seriousness of this crisis is, in my view, a lot greater. Johnson: So, we have a monetary union without any sort of fiscal policy coordination. Yet some of the remedies being put forth are trying to coordinate fiscal policy across the member states. Is this something that is even feasible, given the various interests involved and that the pain of creating any sort of common fiscal policy may not be shared? Magnus: It’s theoretically feasible. There are instances where we know that it’s practically feasible. In the case of monetary unions, there are examples such as the United States, the United Kingdom, greater Germany post-unification, and so on. So, these things can be done. But it requires a degree of political integration, which happened in these cases and in others, sometimes violently and sometimes over long historical periods. The problem that the Europeans have is that it’s a bit of a Catch-22. They’d almost have to have a political union in order to agree to a feasible fiscal union. And, of course, they can’t get a political union because there probably isn’t any basis for it. So, I wouldn’t say trying to establish some degree of fiscal coordination and integration is a wild goose chase. But I don’t think that what Europe is trying to do at the moment is going to be particularly effective, partly because the fiscal union and fiscal discipline implications— which the Germans, in particular, are stressing—may be something that you have to have by way of institutional arrangements to deal with future financial crises. But I don’t think it resolves or even addresses the current, as Edward said, existential crisis in the eurozone. In fact, it’s going to make it worse, because what they’re trying to do is to institutionalize what I call the “pro-cyclical austerity zone.” In other words, Europe is in a situation where European countries have similar problems to the U.S. and the U.K.—the credit system has malfunctioned, they’ve lost their growth drivers, and so on and so forth. But on top of those problems, the Europeans are now trying to institutionalize fiscal austerity and the kind of rigid observation of deficit and debt targets that will slip ever further into the future the more austerity the European countries are forced to, or voluntarily choose to, implement. So, in effect, what economic policy inadvertently is doing is turning Europe into kind of an economic zone, which is likely to be character- Now, one of the problems with a balance-ofpayments crisis—and this is why it’s quite similar to previous sovereign debt crises— MorningstarAdvisor.com 51 http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - February/March 2012

Morningstar Advisor - February/March 2012
Contents
Contributors
Letter From the Editor
Make a Difference Stories, Not Debates
How Concerned Are You About Europe?
Analytical and Independent
What to Ask When a Fund Manager Leaves
Past, Present, Future
Have Financials Gotten Cheap Enough?
Four Picks for the Present
Investment Briefs
Tactical Funds Miss Their Chance
Specialty Retail: Ad Hoc Opportunity
How Europe Is Making Its Crisis Worse
Impact on U.S. Economy Will Be Minimal
European Banks: Bargains or Value Traps?
Don’t Count the Euro Out Yet
Europe on the Brink
GoodHaven Realizes Its Vision
How Index Trading Increases Market Vulnerability
Nonlisted REITS: Handle With Care
Safety Picks for the Many Moods of Mr. Market
On the Prowl for Large- Blend Index-Beaters
Our Favorite Mutual Funds
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
The Math That Matters

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