As everybody knows, the current crisis has remote causes and closer ones. The crisis in Europe is
linked to the level of debt. And this I will turn to later.
1. But let’s start with the structural problem.
1.1. We are living through a dramatic change in the global economy.
Not globalization, which is a fact and a ‘given’, a part of the way we live, but the ending of a very
special time, the closing of a singular period.
For centuries, I could say for millennia, economic power was strongly correlated with the size of the
labour force. Of course innovation and technology could temporarily change the balance of power,
but after a short period of time those new technologies were available to others and equilibrium was
• However these last two centuries have been an historical exception to this rule. For the first time in
the history of mankind some countries, not very populous as a proportion of the total, succeeded in
keeping for themselves the new technology they had invented or adapted, and they used it to dominate
the world. The global history of the 19th and the 20th centuries is a story of western dominance based
on proprietary technologies. This was equally the case for industrial as well as for military
• This period, this singularity, is coming to an end. We are back to the long term trend. Technologies
cannot be kept secret anymore. Education, voluntary technology transfers, the movement of people,
and also industrial espionage (including the use of the Internet) have helped to spread information.
Of course this process does not take place overnight. It takes time to get back to normalcy, it may take
decades to complete the change. But the move cannot be stopped. We are contemplating the end of
an era of technological exceptionalism.
1.2. Does this mean the beginning of the end of the period of dominance by advanced economies ?
• Does it mean that big countries, like China or India, will unstoppably become the Superpowers of
the coming decades ? Maybe, but technology alone is not enough to accomplish this changeover. The
whole of society must be able to take advantage of the process of innovation. The diffusion of
innovation throughout an economy relies on there being a more inclusive society where creativity can
flourish. It is not likely that the old state-driven technology policies will be appropriate to this
challenge. The American success story relies on technology plus entrepreneurship which in turn
requires unbridled creativity.
So that is what is at stake today. For two centuries we have experienced an incredibly odd situation
where some countries (including Germany, France, the UK and, of course, the USA) have been able
to play an outsize role despite the fact that they were small in population and geographic size (true
even in some respects of the USA).
• How long will it take to get back to normalcy ? I don’t know. But it will happen. And who is then
going to take the lead ? Probably the countries with large populations as has always been the case,
providing they are able to catch up on the technological side (and personally I have little doubt about
this) and can develop a model of society inclusive and free enough to boost creativity. This is the real
challenge. Both tasks are dual and equal keys to competitiveness.
It is competitiveness which is really the issue in the global economy, as long as the linkages between
the different parts of the global economy are working well.
These linkages have a name - the International Monetary System (IMS).
2. This brings me to my second major point. Is the IMS working properly ? And if not, what
needs to be done to improve it ?
Those who would challenge my assertion that the IMS may not be working properly point to the
following arguments. They say that, after all :
• the current IMS has enabled remarkable progress in the global economy, plus financial integration :
- fostering strong global growth in living standards ; and
- recently surviving a global financial crisis of historic proportions.
• but I say that this system has also exhibited symptoms of instability, as seen by :
- frequent crises, persistent current account imbalances and exchange rate
misalignments ; and also
- volatile capital flows and volatile currencies.
These symptoms of instability have been – increasingly - the source of tensions which if left
unaddressed will threaten the progress of globalization. We must address the root causes of these
instabilities. And what are they ? I see four : the absence of effective global adjustment mechanisms,
the volatility of capital flows, limited access to global liquidity, and the poor supply of ‘safe’ global
2.1. How can we promote more effective global adjustment ?
Cooperation is an obvious answer. It worked during the 2008 crisis but the momentum behind that is
now gone, despite the effort made by the IMF and the G20.
IMF surveillance should be a key instrument in promoting effective global adjustment. But in practice
this has not always been the case. Why ? The design of the IMS is not the sole culprit but it is limiting
in one important way, namely that (except for exchange rate policy) countries have no obligation to
run their policies in ways consistent with systemic stability. This hardly seems sensible in our
interdependent world. Hence, not only should countries’ multilateral obligations be strengthened but
also their accountability for failing to uphold them.
These are legitimate issues to raise at both global and regional levels, especially at EU level.
2.2. Can we make cross-border capital flows safer ?
This issue is often presented as one for Emerging Market economies to worry about. That is true for
sure, but in reality it is one that policy makers in all countries should worry about. The bulk of crossborder
capital flows actually takes place among advanced economies, and recent years have shown
that advanced economies are not immune to those asset bubbles and busts associated with large and
volatile capital flows. This suggests that the healthy functioning of the IMS depends crucially on
orderly cross-border capital flows. But there is no system at all here : flows are driven by policies
(monetary, prudential and capital account) which have until now been pursued with the focus on the
goal of domestic stability.
Hence it is worth asking whether globally agreed “rules of the road” might be useful ? Inflows are not
the only issue, outflows should also be borne in mind. That is why there is an urgent need for both
source and recipient countries to cooperate (bearing in mind that most countries are both source and
What do I mean by “cooperate” ? We need mechanisms for coordinating macro policies in times of
stress, just as we did in 2009. Why not consider mechanisms to bring together originators and
recipients of capital flows ? This is precisely the sort of international cooperation which the IMF’s
founders had in mind.
2.3. How can we enhance global liquidity ?
This is the question of the so-called ‘global financial safety net’ that the IMF together with the Korean
Government raised during the G20 meeting in Seoul in November 2010.
Since the 2008 crisis we have come a long way in enhancing the provision of liquidity in times of
extreme volatility. The central banks have done their job and the IMF’s resources have increased
But the size of global output, trade and capital flows now dwarf the Fund’s resources. These must be
increased dramatically. In the absence of IMF resources correctly scaled to the challenge, many
countries are justifiably not convinced that the global financial safety net is strong enough. So the
costly accumulation of reserves continues.
What else can be done ?
- one important avenue to explore is the strengthening of partnerships, of Regional Financial
Arrangements like the EU or the Chang Mai Initiative (CMI) ; and
- another is to improve the predictability of systemic liquidity provision more generally, instead of
leaving this task exclusively to the central banks, which always face the contradiction between their
domestic and global targets.
2.4. How can reserve asset diversification be promoted ?
The demand for safe global asset classes has been growing much faster than potential supply. This
reflects the fact that global monetary and financial assets are less diversified in currency terms than is
There could be scope for enhancing the stability of the system by encouraging greater international
use of currencies other than the four currencies currently in the SDR (Special Drawing Rights) basket.
A multi-polar system would by no means be a problem. There may also be other changes worth
considering for the SDR including :
- increasing the global stock of SDRs to help meet demand for precautionary reserves ;
- using SDRs to price global trade & denominate financial assets ;
- issuing SDR-denominated bonds by sovereigns and international financial institutions ; and
- even, the “crazy idea”, as I call it, of issuing bonds in SDRs in the public markets. The idea is for the
IMF to issue its own bonds denominated in SDRs to increase its own resources, de facto creating a
new market in SDRs.
On this road, we will encounter a large number of technical hurdles. But the main obstacle remains
that it requires a major leap in international policy coordination.
Let me wrap up this section. The IMS we have is not broken, but it has serious holes in it. Left
unaddressed, they leave the whole system vulnerable.
3. Turning now to my last point, the epicenter of the current crisis : Eurozone Debt.
3.1. This crisis is of course a debt crisis. But it is even more a growth, banking sector, and, for some
countries, a competitiveness crisis. The high level of public debt would be a problem by itself even
though, for many European countries, the debt ratio remains in the same range as in the USA. But the
particular European structural weakness comes from the fact that during the good years growth
revenues were spent, rather than being used to reduce the debt. Hence the question is whether or not
the European core countries will be able to reduce their level of debt using resources coming from
future growth ? And moreover whether there will be growth at all ? The prospects are not good, to say
3.2. On top of the debt problem sits the ‘austerity policy-setting problem’ - that the austerity policies
which seem to be the current European mantra will serve to make the debt ratio worse not better. Add
in a financial sector which has still not been fixed, is further endangered by the holding of large
amounts of public debt of questionable value, and which in conforming with the ratio-based approach
of the new Basel III capital requirements is, in practice, reducing the value of the denominator
(lending less) rather than enlarging the numerator (recapitalizing), and you have the perfect storm.
The storm which now besets the Eurozone economies.
3.3. Against this background, the posture of European political leaders has, first, been denial of the
problem. The IMF was initially not welcome as the Europeans believed they were able to fix the
problem alone. They seemed to have moved a long way since May 2009 when it appeared that the
IMF was not only useful but essential. But the IMF was at that point treated by them as a junior
partner, and when the Fund argued that the maturity of Greek loans should be longer and the interest
rates lower, in order to avoid killing growth, its point of view did not prevail. Each and every
European leader focused on the debt level and no one wanted to pay enough attention to the
competitiveness problem – the real key to growth. As is so often the case, the long term solvability
problem was hidden behind the short term liquidity problem. Attention was focused on the politically
“easiest” issue at the expense of the fundamental.
The political leaders were in denial. They are still in denial.
Because of policy mistakes made by Greek governments (and this is also true for other countries
beyond Greece, like Portugal) billions of euros have been lost. But the responsibility for this loss
cannot be attributed to these countries alone. Eurozone surveillance is also called into question by
what has happened, as is in some respects IMF surveillance. Hence, it is simply fair to share the cost
between all the members of the zone. It is the right thing to do. But not only is it fair, it is also
realistic. For it is quite unrealistic to think that the other choice is in any way workable. The loss is
too big to be repaid by the Greeks alone. Alternatively, because Greece’s GDP is only about 2% of
Eurozone GDP the costs could be shared among the members, if not without pain. But the basic idea,
the default setting chosen, was not this. It was not to consider the Eurozone as a zone of solidarity as
any monetary union should be. It was rather to ask the Greeks to pay for their sins, and hence to pay
yields exceeding the cost of the loans made by the European partners.
Why ? Because nobody wanted to acknowledge the loss even if the results of the denial could be, and
have been, to increase this loss.
European countries are now swinging from one plan to another, from one last ditch summit to the
next, still not accepting or acknowledging their losses, nor making it possible for growth to restart,
and as a consequence failing to restore confidence in the future.
3.4. The last episode in Brussels on December 9th was just one more example, bleeding away day by
day the remains of any confidence investors and potential lenders may have in politicians to solve the
• For the short term, the Brussels plan does not solve the liquidity problem.
The role of the ECB is still the one defined in the Treaty. It is fair to say that the ECB has played well
until now, but the ECB remains the only central bank that is not a lender of last resort. Hence the risk
is a risk of default not a risk of monetization.
The opposite may happen of course. It is possible that faced with an imminent crisis in Eurozone bank
and government debt refinancing, the ECB may decide simply to “print money” through nonconventional
measures and act as a quasi Federal Reserve. If the Eurozone really is at the edge of the
cliff nothing will be wrong with this. But of course this policy will have other important drawbacks
and moreover will not solve any of the structural problems. The cliff moves away but does not
In trying to avoid this, a firewall (EFSF + ESM + IMF) close to one trillion euros (without leveraging)
has been announced but :
- the 500 billion euros from the ESM will not exist before at least six months time, which is far
too late ;
- the 200 billion euros which are supposed to come from the IMF are in limbo as long as the
Bundesbank argues that it cannot go along without US involvement, which is not going to
happen ; and
- a possible complement could come from Asian countries which are ready to help because they
understand that decreasing trade and deleveraging by European banks are damaging their own
economies. But the counterpart will probably be in the area of quotas and voice at the IMF
Board, and here we face another kind of European denial.
• As far as the long term is concerned, it does not look any better.
What the Eurozone needs is real fiscal union. It is not news that the euro is sitting still in the middle of
the river. A monetary union without a central budget just does not make sense. This question was
extensively discussed in 1998 at the launching of the euro, but without successful resolution. During
the really rather calm first half of the last decade the raft survived comfortably enough on a placid sea,
but with the recent gale it appears clearly that the raft is not strong enough to avoid sinking.
Hence what the Eurozone needs is both a unified bond market and a fiscal union with strong central
institutions, not a “super-stability pact”. But what has been set up in Brussels today is indeed only a
super-stability pact, as Jens Weidmann, the President of the Bundesbank, recently made clear. This
may be good news for German domestic politics, but it is bad news for the European population.
Even the super-stability pact is lame. The so-called Golden Rule is confusing because it has already
attracted different interpretations and definitions, and because it is unclear how the sanctions would
work in any case. Let me put a straight question. “Just what will happen, do you think, if a ‘punished’
country refuses to pay ?” And if it pays this will obviously be pro-cyclical. Don’t get me wrong. I am
not saying that rules are useless but what makes the German rule credible for Germany is that the man
on the street there thinks it is a good rule, not the rule itself. Now I am afraid that the same rule
transposed to other Eurozone countries will not have the same legitimacy and respect among the men
and women on the streets in cities and countries west, south and east of Frankfurt.
4. So where do we stand ?
None of the main problems has been addressed : no central budget, no institutional centre, no lender of
last resort, no expansion of monetary policy (which would help solve the competitiveness problem if
inflation were comparatively lower in the debtor and problem countries), not to talk about the lack of
labour force mobility.
The only good news is that Eurobonds have not been banished. This is helpful even if they are only
one tool among others and not the essential political step forward which is required.
This inability to solve the Greek and other similar cases reveals essential European political
weaknesses. I do not buy the argument that if the Greek case were solved then the problem would go
to Italy, not least because of the fact that the Italian economy can live with current borrowing rates for
a rather long time thanks to the long maturity of its debt. I believe that if for once the Eurozone shows
that it has correctly understood the problem, that the markets would follow. But not before. Lenders
will not return in the absence of that act of political recognition.
Day after day the choice becomes clearer.
We Europeans can try to stay put in the middle of the river, attempting to roll forward an ever
increasing snowball of debt and inevitably bringing on ourselves a long period of low growth with its
accompaniment of social unrest. Or we can try, as many are beginning to suggest, to go back to the
original river bank and accept the dismantling first of the Eurozone, and afterwards as I believe of the
Union. In this case our future is decline and submission to our powerful cousins from overseas. Or we
can decide to make the crossing to the far bank and this is the right thing to do. It means going further
in building the European Union, it means understanding that although we may belong to the French,
the German or, dare I say it, to the British tribe, that from the perspective of a globalised world, and
indeed from Beijing where you and I are today, we are seen as Europeans. Then the challenge will not
be technical, it will be democratic.