Morningstar Advisor - February/March 2012 - (Page 53)

at current interest rates—that without growth, the debt trap that Greece has fallen into is likely to become more widespread and could easily happen to Italy. Italy will have a recession, quite a deep recession, in 2012, which means that all of the best-laid plans of [prime minister Mario] Monti’s government to meet demanding deficit targets will continue to retreat into the future. So, competitiveness is part of the whole imbalances problem. It can be seen both from an export and a unit labor cost point of view, but also from a wider perspective, which is the ability of the country to grow. We’re not trying to excuse debtor countries from having to do public sector reform and fiscal restraint over the medium term. But we’d like them to be able to find ways of regaining growth that would enhance competitiveness without having to rely solely on an internal devaluation, which is the extraordinary reduction in wages, costs, and prices that countries have to endure. Chancellor: At GMO, we’ve created an index, comprising a number of competitiveness and corruption indices—the Corruption Perceptions Index, the Index of Economic Freedom, the Ease of Doing Business Index, the Global Competitiveness Report, the Economic Freedom of the World Report. We then looked at the eurozone countries and found, to no one’s surprise, that Greece scored the worst. Italy, I’m afraid, came in second place with Spain and Portugal also registering negative scores. By the way, Ireland, which is often considered a so-called PIIGS country, actually gets a perfectly respectable score, more or less on par with the U.K. And, funnily, its score is even higher than Germany’s. George will know that Britain in the 19th century had a debt burden—much larger than even Japan today. But because it was a relatively peaceful time, because the government didn’t have many welfare obligations, and because the laissez-faire economics, for better or for worse, allowed the economy to keep on growing, Britain was able to reduce its government debt/GDP ratio from 1820 to 1914 from around 250% of GDP down to about 40% of GDP. They did it solely by growing the denominator. They didn’t actually pay back any debt; they rolled it over—the debt was perpetual. They did it by the economy growing. So, it is very important that Italy grows. One hopes that Mr. Monti will make Italy an easier place to do business, and Italy’s economic potential will be released. Whether Monti has time to actually implement those reforms—whose fruits would take several years to grow—is another matter. Johnson: What are some of the precursors to sustainable growth in the periphery? What has to happen for these countries to instill confidence in their markets so they can make structural reforms and grow their economies? Magnus: It’s going to be really difficult for the debtor countries of sovereign Europe to set themselves onto a growth path. I don’t think they’re going to be successful in the absence of some kind of symmetry in the behavior of creditor countries as well. There is a basic inconsistency in the German position. Not that the Germans have actually said this, but in effect, what they’re saying is, “We need everybody to become more disciplined like us.” They haven’t said, “Everybody needs to be a surplus country,” which of course is nonsense, but effectively, that’s kind of the thinking behind the current policy stance. arrangement will only endure if their increased savings can be offset by somebody else’s reduced savings. Even though there is a strong case for more labor-market flexibility, public-sector reform, restructuring of public expenditure, and so on, I just don’t think these things can actually help them return to economic growth in the absence of adjustments by creditor countries, of which Germany is the largest, and a more proactive position by the European Central Bank, which can provide the kind of bridge financing via quantitative easing that’s necessary for structural economic changes and adjustments to work. But at the moment, very little of this is on the agenda. So, when you ask for precursors, a de minimis precursor is that debtor countries should be trying to do their adjustments over a reasonable period of time and not trying to rush it through in the next two years, whilst making employment the litmus test of pretty much everything they do in terms of structural reform from a macroeconomic perspective. And as I said, that on its own is unlikely to lead them to success. It requires the creditors, mainly Germany, to imagine that they have some self-interest in structural reforms, too, even though it may not have seemed like that to the German government and to German voters. It will make them less of an export, surplus-centric country, less mercantilist. I realize that I’m whistling in the dark by saying that, but that’s the underlying reality of it. Chancellor: One of the ways I started to think of what is the central problem of the single currency is in terms of a so-called trilemma, when you have three different objectives and it’s impossible to achieve all of them simultaneously. The famous trilemma in economics was identified by Robert Mundell and Marcus Fleming, who observed that a country couldn’t have a fixed exchange rate and an open capital account while keeping inflation under control. But when people start worrying that Italy cannot grow and that, therefore, the debt can never be paid back, it poses a problem, because Italy is—or at least was, until its bonds started falling—the third-largest government-bond market in the world. The thought of the third-largest government-bond market in the world not functioning properly is a very, very serious problem. If countries—Italy, Spain, Greece, Ireland, Portugal, even France—have to set a course to save more—i.e., in the process of deleveraging public and private sector debt—then obviously within the monetary union the integrity of that The Germans have a slightly different trilemma. They have three different desires. First, they MorningstarAdvisor.com 53 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

Morningstar Advisor - February/March 2012