Economist: Market instability is ‘appropriate for indebted countries’


Hans-Werner Sinn, one of Germany’s most influential economists, attacked excessive use of European funds to aid struggling eurozone countries, arguing in an interview with EURACTIV France that it dissuades them from pursuing necessary reforms and reductions in prices and wages.

Sinn questioned in particular the European Central Bank’s (ECB) massive lending to eurozone banks over the past months, to the tune of €1 trillion in low-interest, three-year loans, to calm financial markets.

“Yes, of course, and the markets have calmed themselves. But should we calm the markets? I am not of that opinion. A certain excitement of the markets is appropriate with regard to over-indebted countries,” he said.

Sinn argued that the interest payments that governments in struggling economies pay should remain relatively high, so as to encourage reforms and budget cuts, saying “when the spreads increased the Italians elected [appointed in exceptional circumstances] another government. When the spreads decreased, the unions shot the labour reforms initiated by [Prime Minister] Mario Monti.”

Bond spreads – the difference between what the governments of Germany and other eurozone countries must pay on the financial markets for new loans – have begun to increase again, prompting fears that Spain will require an EU bailout.

No eurobonds

Sinn rejected the idea of eurobonds – shared EU debt which proponents say would increase stability by being able to be sold at low rates on the financial markets – for the same reason.

“Eurobonds lead to a socialisation of responsibility and incite states to indebt themselves more,” he said.

“Even the Americans do not have similar tools. Each state emits its own bonds. And if it cannot repay this debt, it simply defaults. The fear of spreads [high interest repayments] forces states to be prudent when they borrow.”

Sinn was optimistic on the prospects of countries facing high debt refinancing costs, pointing out that they had to pay higher interest rates in the 1980s and early 1990s. “These countries will not collapse under the weight of interest rates. We are simply used to low rates,” he said.

“And even if this refinancing becomes more expensive, which I do not deny, we should not lose from sight the primary objective which is to put in place the necessary structural reforms, which would lead to a real devaluation through a reduction in prices.”

ECB should not finance governments

Sinn was firm in his rejection of any new role for the ECB, saying that it had already gone beyond its legal mandate and should not finance governments. “The ECB must not replace the financial market, except in cases of extreme emergency,” he said.

Last week, French President Nicolas Sarkozy called for a debate on the role of the ECB in stimulating growth. The opposition Socialist party, whose presidential candidate François Hollande receive the most votes in the first-round of elections on Sunday (22 April), has long advocated a reform of the ECB.

The ECB’s mandate, as defined since the Maastricht Treaty, is to maintain price stability and keep inflation low, making growth and job-creation secondary objectives.

Sinn noted there could be a role in granting short-term aid to countries like Spain. “I would not exclude granting aid to guarantee liquidity for a year, maximum two. But more is not possible,” he said.

He also dismissed talk of the ECB acting as a ‘lender of last resort’ for European governments if they are unable to finance themselves privately, saying: “The argument of the lender of last resort implies that the taxpayers of one country finance the banks of another. How can we seriously imagine this?”

Sinn said this was impossible until there was a fully-fledged “European nation-state”.

EU money 'ruined countries' competitiveness'

Sinn argued that easy EU money had led to high wages and prices in peripheral European countries, not in line with their actual productivity. “Financial gifts ruin a country’s competitiveness. These transfers of money prevent prices from dropping, increase imports and affect the competitiveness of exports,” he said.

“The Greek Minister [for Citizen Protection Michalis] Chrysodois very rightly said, in an interview published by the Frankfurter Allgemeine Zeitung, that Greece’s export industry had been destroyed by European aid.”

The solution backed by Germany and the European Commission is deflation, a generalised reduction in wages and prices, until peripheral countries are again competitive. There has been only very limited progress in achieving this however.

Reacting to news that Spain would renege on its planned budget cuts and might require an EU bailout, he said “If Spain does not implement this austerity programme, the necessary deflation will not take place. Goldman Sachs has calculated that the country must devalue by 20% to become competitive again.”

The economist added that this would not be a rapid process, saying “Germany, for example, took 13 years to regain its competitiveness through deflation. Spain has devalued by 1% since the beginning of the crisis, which is almost nothing.”

Spain is currently suffering from unemployment of more than 22%, and some half of its young people are jobless.

Greece suffering in the euro

Sinn argued that the euro is bad for Greece because, unable to pursue devaluation, it will be impossible for the country to reduce wages and prices sufficiently to become competitive. “To achieve this, they would need to become 30% cheaper, according to calculations by Goldman Sachs and the Ifo institute,” he said.

He added that a Greek default would not be catastrophic, saying “The financial industry is exaggerating the situation in order to find time to resell Greek government bonds.

If the country were to leave the zone, nothing would collapse … everyone is already prepared for this possibility.”

Hans-Werner Sinn is one of Germany’s most influential economists, often-noted for his frankness. He is a professor at the University of Munich and is president of the Ifo economic research institute.

The eurozone’s economic crisis has continued to rumble on with unemployment reaching a record 10.8% in February.

There continue to be key differences between member states on the reforms at EU level to resolve the crisis, with the two remaining French presidential candidates urging ideas anathema to Berlin.

Socialist François Hollande has pledged to revise of the fiscal discipline treaty to include provisions for growth and incumbent Nicolas Sarkozy has called for a debate on the European Central Bank’s role in promoting growth.

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