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China and Greece Underpin Belgian Finance Minister’s new book, A Giant Reborn

The ongoing Greece-centered eurocrisis and the spectacular fall of share values on the Chinese stock markets are the two dominating issues in worldwide economic affairs during the summer of 2015. Both developments provide evidence in support of the main thesis of my new book A Giant Reborn: Why the US Will Dominate the 21st Century (Agate Publishing).

If you think we’ve seen major changes in our broader economic environment during the last three decades, prepare yourself for more of it—much more of it. I see signs all around us that the era of what I call “turbochange” is already upon us. Simply put, turbochange is the intense, rapid, large-scale change that will inevitably characterize the 21st century and shake up our society at large. There are three main drivers behind turbochange: knowledge and human capital, entrepreneurial drive, and globalization.

More and more, knowledge and human capital show signs of what economists call “increasing returns to scale,” which means the more you have of these two items, the faster ideas develop. Worldwide, there is an increasing number of people engaged in research. Modern modes of communication allow these thinkers to connect quickly, which increases productivity and invites entrepreneurial drive.

Entrepreneurial drive is necessary to turn knowledge into products and services that add to people’s welfare and wellbeing. Until the fall of the Berlin Wall in 1990, entrepreneurial activity was absent in large parts of the world, especially the Communist-dominated parts. Today, most of the world is engaged in entrepreneurial activities.

The cross-fertilization between fast-growing knowledge and human capital and feverish, worldwide entrepreneurial competition is bolstered by globalization. Most societies will have a hard time dealing with all this turbochange.  The societies that are able to adapt to this change will be in the best position to succeed economically. In this respect, the United States clearly has the upper hand over its main rivals, China and the European Union.

As many others noted already before me, the United States eats, breathes, and loves change. It’s deeply entrenched in the American DNA as a consequence of historical, institutional, and sociological characteristics. Dealing with (turbo)change is often messy, and the consequences are often unpleasant for many citizens, but Americans do not hesitate to look change straight in the eye and go for it.

This attitude contrasts sharply with the way China and Europe deals with change. The spectacular fall in the Chinese stock market is just one more sign of China’s relative inability to deal with change. Over the past several years, Chinese authorities have continuously applied increasing doses of monetary and budgetary stimulus to the economy.

By now, the economy is a huge bubble. The ruling Communist Party in China took the extravagant stimulus road because its leaders are frightened of the perception of substantially slowing economic growth, a prospect that has now become inevitable. The recent devaluation of the Chinese currency is another desperate attempt by the Chinese authorities to stimulate economic growth.

China’s leaders do not want to be confronted with the political and social consequences of slowing growth. This adds to China’s already existing problems with pollution, corruption, and inequality, among others. A worldwide turbochange-environment will deeply impact China’s already substantial internal problems. China lacks the historical, institutional, and sociological setting to deal constructively with turbochange.

Likewise, the member states of the European Union are deeply entrenched in their existing social and economic models. Change has proven to be a thorny issue; turbochange will prove to be worse. The ongoing Greek crisis greatly underpins this argument. The third rescue package for the Greek economy may be the only way out of the deep hole the country is in, but it will be very hard to implement.

The only way to deal conclusively with the Greek drama is to fundamentally strengthen the Eurozone’s institutional framework. One way or another, this means a loss of national sovereignty for the nineteen member states of Europe’s monetary union. This exercise continually proves to be a hard nut to crack, to put things mildly.

Not everything in the US runs perfectly, far from it. Issues such as political gridlock, crumbling infrastructure, overall debt, and inequality cast a long shadow over the country’s future. Nevertheless the proven ability of American society at large to deal positively and constructively with change will strengthen America’s relative position as the era of turbochange comes upon us.


Since October 2014, Johan Van Overtveldt has served as Belgium’s Minister of Finance



Johan Van Overtveldt--The French-German ECB Dispute

Since early November, Johan Van Overtveldt, author of the new book, The End of the Euro, has been blogging here about the eurozone crisis.

The discussions about how to solve the structural problems facing the European monetary union have repeatedly been overshadowed by electoral concerns in the member countries. The biggest upcoming electoral event in Europe is the French presidential election to be held in May. Nicolas Sarkozy is facing an uphill fight against his socialist challenger, François Hollande. Hollande is leading Sarkozy in the polls by a comfortable margin.

Hollande has made the euro the center of his campaign. In particular, he is questioning the role the European Central Bank (ECB) has played in the crisis so far. Hollande wants two things. First, he’s calling for a fundamental change in the status of the ECB. He wants its independence reduced, and he wants more political control over monetary policy. Second, Hollande cannot imagine a structural cure for the problems plaguing the eurozone without the ECB intervening on a much larger scale in the bond markets, and buying up massive amounts of the bonds issued by countries facing financing distress—Italy, Spain, Greece….

These ideas of Hollande’s are anathema to Germany. An independent central bank is an essential part of how the Germans approach finance and economics. Chancellor Angela Merkel and the Bundesbank, Germany’s central bank, have voiced strong opposition to larger bond interventions by the ECB. As documented fully in The End of the Euro, the role of central banks has historically been a constant source of friction between Paris and Berlin. At the moment, it is not clear whether Hollande is advocating these ECB-related ideas as campaign fodder or whether he is genuinely convinced of their merit. If the latter, he’s facing battles with the Germans he’s bound to lose should he defeat Sarkozy in May.


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Johan Van Overtveldt--The Euro-summit Disappointment

Since early November, Johan Van Overtveldt, author of the new book, The End of the Euro, has been blogging here about the eurozone crisis.

The European summit of December 8–9 was widely considered the last chance for the leaders of the eurozone to come up with clear answers to the crisis that has plagued Europe’s monetary union for more than two years now. The results were extremely disappointing.

There’s hardly anybody left who does not recognize that the euro needs a full-blown, truly empowered political union to give the currency the institutional framework that is so urgently needed. Since that kind of political union is absolutely impossible to bring about at this moment in time, the political leaders of the euro countries are trying to agree on lesser solutions, e.g. explicit and binding agreements regarding those policy issues that are crucial to stabilizing the monetary union in the long run.

Three policy issues stand out here: first, the evolution of budget deficits and government debt; second, regulation of the banking sector; and third, supervision of the international competitive position of each of the eurozone members. This last issue is too often overlooked. The loss of international competitiveness drives a country’s current account into the red, and makes that dependent on foreign capital, a situation that has proved to be highly unstable in recent years. Neither banking regulation nor competitiveness was really on the agenda of the summit. Budgetary rules were.

On December 8–9, 26 the EU countries (with the UK breaking ranks, a story of its own) agreed to write into their constitution a requirement for each country to balance its budget. If countries don’t follow the rules and reach budget deficits equal to 3 percent of GDP, automatic sanctions (that is, fines) will be imposed. However, a majority of the EU heads of state can decide to eliminate the sanctions again at a later date. It’s hard to conclude that the new rules are truly binding, and that a real transfer of sovereignty from the national to the European level has been agreed upon. Without such an agreement, the eurozone crisis will only continue, and continue to deepen.

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Johan Van Overtveldt--A Crucial Week

Since early November, Johan Van Overtveldt, author of the new book The End of the Euro, has been blogging here about the eurozone crisis.

This week is of the utmost importance to the euro’s future. European heads of state, led by German chancellor Angela Merkel and, to a lesser extent, French president Nicolas Sarkozy, are searching for a formula to restore confidence in the European monetary union and ensure the euro’s survival. At the upcoming European summit on December 8–9, they need to reach some convincing conclusions in order to prevent financial markets from launching a final assault on the euro.

As things stands now, it’s possible a deal will be hammered out that includes important steps toward forging a fuller political union, with more binding rules regarding fiscal deficits and fines for offenders. This deal should be enough for the European Central Bank (ECB) to step up its bond-market interventions aimed at guaranteeing the needed financing for troubled countries like Italy and Spain (while similar troubles loom for France and Belgium), and also to keep the cost of this financing at moderate levels. While these ECB interventions calm the markets, it is hoped, the politicians can work out their grand bargain on further political integration.

Whether this strategy can succeed depends almost entirely on the specific content and credibility of the deal to be negotiated in the coming days. The European leaders start with a huge handicap: the incompetence and negligence with which they tried to manage the crisis so far means that they will have to overcome a lot of a priori doubt. If the compromise is insufficiently firm on the transfer of powers to the European level, and on the automatic interventions affecting members that break the rules, the euro and the monetary union will soon be back under severe attack.

What is fundamentally at stake here is whether all members of the eurozone are prepared to give up substantial parts of their national sovereignty in economic, financial, and social issues. For several countries, such a decision remains hugely difficult. This is foremost the case in France, where next May will see new presidential elections. President Sarkozy’s major opponent will be the socialist Francois Hollande, who in recent weeks repeatedly claimed that he would not surrender one inch regarding French sovereignty. Opinion polls show this message to be resonating with French voters. That is an enormous problem for the feature of the euro.

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Johan Van Overtveldt--The Eurobond Challenge

Twice weekly through the month of November--though with a short break for the recent Thanksgiving holiday--Johan Van Overtveldt, author of The End of the Euro, will be blogging here about the euro crisis.

The European Commission is proposing to introduce eurobonds to help end the ongoing Eurozone crisis. These eurobonds would be backed by all the member countries of the Eurozone, even if the bonds are issued to cover the deficits of, say, Greece or Italy. Many leading European politicians and economists have already come out in favor of eurobonds. Regardless, they’re a bad idea.

Introducing eurobonds at this point in time would effectively repeat the single biggest mistake made when the monetary union and the euro were launched in their present form back in 1999. A monetary union without a fully empowered political union among its member countries will always be subject to severe strains and frequent periods of instability. Recent history provides us with abundant proof of this. Similar problems would occur if eurobonds were introduced before real political union exists among the Eurozone nations.

For those countries with weak to nonexistent reputations in the international financial markets, eurobonds would not only regain them access to those markets, but would also result in substantial interest rate decreases. Both history and political logic indicate that the governments of these countries would almost certainly then ease off on their efforts to bring their budget deficits under control and restructure their economies. Without real political union, the other countries would have no real power to oblige these economically weaker countries to make the hard choices necessary to strengthen their economies. Hence the very outspoken opposition to eurobonds coming from Germany, the Netherlands, and Finland.

In the case of Germany, this opposition to eurobonds is further backed up by a very explicit decision of the German Constitutional Court a few months ago, which stated that eurobonds without the existence of a real European political union would violate Germany’s constitution.

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Johan Van Overtveldt--The Chinese Analysis

Throughout November, Johan Van Overveldt, author of the new The End of the Euro, is blogging here twice weekly about the Eurozone crisis.

Major European banks are still struggling with weak balance sheets. The market is very unlikely to provide the extra capital needed to strengthen these balance sheets, since trust in the European banking system is faltering by the day. It won’t be Europe’s governments providing capital to their banks, either. Most eurozone member countries are struggling with their own mounting debt levels. Hence, some observers began discussing another idea few weeks ago: maybe the Chinese could provide capital both to the bleeding European banking system and Europe’s needy governments, either directly or through a recapitalization of the International Monetary Fund.

The Chinese authorities are sitting on international currency reserves worth more than $4 trillion, mostly in US dollars. Of course, it would be very naïve to think that Chinese capital would start flowing to Europe without strings attached. A recent statement by a top Chinese financial bureaucrat gives a sense of how the Chinese are thinking about such a scenario. Jin Liquin is chairman of China Investment Corporation, China’s top sovereign wealth fund, which supervises $410 billion in assets. Jin declared recently that “if you look at the troubles which have happened in European societies, this is purely because of accumulated troubles of the worn-out welfare state. The labour laws induce sloth and indolence rather than hard work.”

Basically Jin Liquin’s analysis is correct. A major overhaul of Europe’s welfare states and labor markets is necessary in order to reduce government debt and get the eurozone economies growing again. It’s just as essential for the Eurozone countries to agree on a real political union in order to save the euro in its present form. Achieving these two aims would require heroic if not outright impossible performances by Europe’s political leadership. Since Europe is unable to live up to the likely conditions China would impose in order to provide Europe with substantial amounts of capital, it’s very unlikely that Chinese capital will be available European countries and their banks.

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Johan Van Overtveldt--The Problem with Papademos

Throughout November, Johan Van Overtveldt, author of The End of the Euro, is blogging here twice weekly about the Eurozone crisis:

Technocrat and economist Lucas Papademos is Greece’s new prime minister. He will lead the national government until the elections of February 2012. The Papademos government is supposed to push through the tough austerity program imposed as part of the latest European rescue deal for Greece.  Papademos enjoys an impeccable reputation that, upon closer inspection, looks overblown.

Papademos eaned a PhD in economics  from MIT in 1978, joined the Bank of Greece in 1985, and became the bank's governor in 1994. Greece did not belong to the group of countries that first formed the European monetary union in 1999; Papademos was the key figure in Greece’s eventual approval for entry to the Eurozone in 2001. In recent months, Greek and European officials have confirmed that Greece’s admission to the Eurozone was approved on the basis of deliberately falsified data, especially with respect to the magnitude of Greece's budget deficits. In 2002, Papademos left the Bank of Greece and joined the executive committee of the European Central Bank (ECB) as its vice president. He left this position in May of last year.

Given Papademos’s close and daily involvement in Greece’s EMU approval process, one of two things must be true. Either he didn’t know about the forged data--which implies problems with oversight of the entry effort-- or he knew about and still approved the data--which implies problems with his “impeccable” credentials. I believe it unlikely that Papademos did not know about the forged data.

Considering this aspect of Papademos’s career leads one to consider Mario Draghi, the man who recently succeeded Jean-Claude Trichet as president of the ECB. Papademos and Draghi have known each other for a long time--Draghi too earned his PhD in economics at MIT, two years earlier than Papademos. Draghi was also vice chairman and managing director of Goldman Sachs International during the period 2002-2005. Goldman Sachs engineered the highly sophisticated financial strategies that many believe allowed Greece to obscure its falsified data for many years.

Draghi has always claimed that these strategies were set up and executed before his time at Goldman Sachs. I am not sure these claims are convincing. However, even if Draghi’s claim are true, then Goldman Sachs's contribution to the Greek charade dates from before 2002--which means it occurred on Papademos’s watch as governor of the Bank of Greece.



Johan Van Overtveldt--Beyond the Personalities

Throughout November, Johan Van Overtveldt, author of The End of the Euro, is blogging here twice weekly about the Eurozone crisis:

Johan Van Overtveldt

In Greece, the socialist government of George Papandreou is about to be replaced by a  national coalition. The new prime minister will be Lucas Papademos, vice president of the European Central Bank from 2002 to 2010. In Italy, it seems we might at last be seeing the final days of Silvio Berlusconi as prime minister. It would, however, be foolish to think that these leadership changes will make a big difference to the crisis affecting the Eurozone. Both countries will still be facing the same difficulties--huge budget deficits, rising debt levels, close to nonexistent growth prospects, and low international competitiveness. Their new leaders are each facing public opinion increasingly hostile toward the euro.

Moreover, the structural deficiencies afflicting the European monetary union (EMU) will remain exactly the same, the two worst of which are the lack of a true political union and insufficiently flexible labor markets. Beyond these challenges, at least three of the decisions made at the October 26 euro-summit further handicap the EMU:

  • the decision to impose a 50 percent haircut on private bond holders of Greek debt, while public bond holders do not have to bear such a haircut. This unequal treatment will not stimulate private bondholders to keep their European bonds.
  • the European stabilization fund (EFSF) will guarantee 20 percent of future bond issues of troubled countries, including Spain and Italy. This action not only creates a dual bond market, but also lacks credibility; defaults never occur for percentages like 20 percent, but rather for 50 percent or more.
  • European authorities are trying to avoid defining the Greek default as a “credit event” since this would trigger payouts on the credit default swaps (CDS) underwritten in large part by European banks whose balance sheets are already in shambles. Investors will rightly conclude that even a CDS-insurance on a European bond will not protect them from default. This makes European bonds even less appealing.    





Johan Van Overtveldt--The Greek Footnote

For the next month, Johan Van Overtveldt, author of the new Agate B2 title The End of the Euro: The Uneasy Future of the European Union, will be blogging here twice weekly about the ongoing travails of the European monetary union as it deals with the Greek debt crisis and the wider unease affecting many European economies.

On Friday, November 4, Greek prime minister George Papandreou survived a vote of confidence in the Greek parliament with the thinnest of margins. It remains uncertain what might happen next in Greece: a reshuffle within the present Socialist government of socialists; a grand national coalition; or even new elections. Whatever the political outcome, the Greek economy remains in shambles. The country requires strict austerity, which it will only be able to survive economically and socially if external demand can partially fill the gap. It remains inevitable that Greece will have to exit from the Eurozone to create devaluation-driven economic growth.

Johan Van Overtveldt

Although Greece occupies a central place in all present discussions regarding the Eurozone, the problems originating in this small nation are not much more than a footnote to the real story of the crisis. Greece is one of the smallest economies of the Eurozone. Two other small economies, Portugal and Ireland, are also in very deep trouble, Portugal in particular. After these small countries, much bigger ones--like Spain and Italy—are also in significant trouble. At present, the Eurozone crisis involves hundreds of billions euros. When the big countries start failing, it will involve thousands of billions of euros.

The fact is that the European Monetary Union does not function well because of basic flaws in its construction. Two of these stand out: the lack of true political union, and insufficiently flexible and mobile labor markets. Even if you get the Greek problem out of the way—and the Portuguese, Irish, Spanish, and Italian problems--these two basic flaws preventing a durable, efficient monetary union will remain. And the European political leadership has demonstrated convincingly over the past two years that it is unable or unwilling to repair these flaws.



Johan Van Overtveldt on the Euro crisis

For the next month, Johan Van Overtveldt, author of the new Agate B2 title The End of the Euro: The Uneasy Future of the European Union, will be blogging here twice weekly about the ongoing travails of the European monetary union as it deals with the Greek debt crisis and the wider unease affecting many European economies. Today's first post deals with the Greek prime minister's proposal for a national referendum on the Eurozone's proposed bailout terms for Greece.

 The Greek prime minister George Papandreou has proposed a referendum on the bailout package negotiated for his country during the Eurozone leaders’ summit on October 26 and 27. The agreed-upon bailout consists of two basic elements: First, private bondholders will have to accept a 50 percent haircut on their holdings of Greek bonds. Second, in return for more cash from the Eurozone’s stability fund (EFSF) and from the IMF, the Greek government must go further down the austerity road with new taxes and expenditure cuts.

The other European leaders showed great surprise at Papandreou’s referendum proposal. Well, they shouldn’t; Greece is simply desperate. As I argue in The End of the Euro, Greece finds itself in a totally hopeless situation. The latest data show Greece’s economy contracting at 8 percent on annual basis, unemployment rising above 20 percent, and a budget situation that’s out of control. The Greek budget deficit is estimated to be something like 10 percent of GDP; government debt stands at 160 percent of GDP and is rising rapidly. The desperate measures necessary to cut the Greek deficit will just worsen Greece’s depression in the short and medium term.

No country has ever escaped from a situation like the one facing Greece without a massive devaluation of its currency. This devaluation is necessary to restore the international competitiveness of the Greek corporate sector. Per definition, a Greek devaluation can only happen if Greece leaves the Eurozone and reintroduces a new drachma. George Papandreou is asking his people for a mandate to do just that. Can the European monetary union survive a Greek exit? Unlikely.

Johan Van Overtveldt is also the author of Bernanke's Test (Agate B2, 2009), and The Chicago School (Agate B2, 2007). He is the editor of the Belgian newsmagazines Trends and Knack.