Worse than in 2008?
John Charalambakis on the economy, Greece, the EU, and the future of the Euro
One of my first assignments for the Austrian Economics Center was to cover, for our web site, economist John Charalambakis’s visit to Vienna. And honestly, I couldn’t have had a better start! Dr. Charalambakis struck me as an energetic speaker with a lot of things to say. He was knowledgeable, clear, deep and even funny — since he started his talk with a joke that mocked Eurocrats.
Nowadays it’s difficult to find people like Charalambakis. In the sense that he’s kind of a Renaissance man who combines very successful professional activity, he’s Managing Director of the BlackSummit Financial Group, with teaching economics at the University of Kentucky.
This year he’ll be joining, once again, the Free Market Road Show and as “warm up” I wanted to have his opinion on some of the hottest economic issues. It’s definitely worth paying attention to what he has to say.
Federico N. Fernández: Are central banks out of control? Can we survive in a world of fiat money?
John Charalambakis: The fiat system has inherent flaws and weaknesses that leave the global economy prone to bubbles, credit excesses and financial instability. It’s the name of the game. The excesses and turmoil such a system brings have been increasing in severity since the abandonment of the gold exchange standard in the early 1970s, which in turn allowed for the explosion of credit creation and the generation of instruments some of which could be considered weapons of mass deception. Let’s review some those events: the double oil crises of the 1970s, the currency misalignments of the 1980s, the Latin and South America debt crises of 1980s, the S&L crisis of the late 1980s, the Asian Financial Crisis of 1997, Long-Term Capital Management, the Tech Bubble, the global financial imbalances of the 1990s and the early 2000s, the recession of 2001 and of course the Financial Crisis in 2008 which was the worst financial downturn since the Great Depression.
With such severity and danger in financial markets the temptation to embark on extreme policies rises. Banks by nature are wired to respond to a bet gone badly by making an even bigger bet in the other direction to try and dig out of a hole. Central banks have doubled down on such behavior with their machinations of the past few years.
Living in such a world exposes us to greater risks and the “benefits” are uneven. Banks and financial institutions get a sort of seignorage out of the system. Meanwhile wages for median families and workers have been stagnant for thirty years in major developed economies. With free-flowing credit and higher cost of living and assets (real estate, education, etc.), the average families had to turn to credit to finance a basic life. But they are the ones least equipped to deal with the downturns that a credit-based economy poses.
So long as such a system is in place a 2008-moment is always in danger of recurring. Getting around this requires a rethinking of banking, monetary policy, and economics in general and may require us to reexamine the architecture and infrastructure of the global economy. My fear is that we are headed into a major crisis that could be much worse than the 2008 crisis.
FF: Why do you believe that the Euro is a dysfunctional currency?
JC: Any currency arrangement (whether a union between sovereign countries such as the European Union or one reflective of a single state such as the US Dollar) must have adequate institutional support from the state and monetary policy makers. No currency arrangement is perfect or without vulnerabilities but there are basic functionalities that must be met. The Euro fails in multiple ways from being an Optimal Currency Area (OCA).
First, the European Central Bank (ECB) lacks the mandate of being a lender of last resort. This is one of the most basic features of any central bank. Second, the absence of a common Treasury with a fiscal union mandate as well as the absence of a banking union does not allow for a true mutualization of debts and synergy between the various economies in Europe (it does not mean that I espouse such mutualization). Markets perceived a union when the underlying fabric was not there. As a result of these structural deficiencies and also due to policies pursued, risks could not be adequately assessed. This can easily be seen in the convergence of interest rates between various EU countries leading up to the crisis. In no way should Greece have been able to borrow at the same rates as Germany. Yet the infrastructure of the European Union allowed for this exact dynamic to play out.
Since the crisis erupted, there has been no cohesive vision in the Eurozone, which when combined with excessive bureaucratic bickering and over-regulation are bogging down the Euro into a dysfunctional currency that has nineteen heads. Perhaps no situation better represents the flaws in the EU system than the case of Cyprus where the institution of capital controls essentially admits that a Euro in one member state is not equal to a Euro in other states.
FF: Mario Draghi has recently launched QE to fight “deflation” or “lowflation”… Is this a real threat?
JC: The deflationary trend within the EU (due to the debt hangover and the inability for the EU to grow due to its regulatory framework) coincides with the contraction in the balance sheet of the ECB and virtually nonexistent credit growth in Europe (who would borrow when conditions are bleak?). The buildup of debt, credit, and junk “assets” that came crashing down with the Financial Crisis set in motion the process of Debt Deflation as articulated by Irving Fisher. The collapse in the value of these “assets” destroyed balance sheets. With the institutional dysfunction in the Eurozone and lack of reforms that could instigate growth, credit expansion has been muted.
Deflation, in general, is a worrisome phenomenon when it is prolonged and severe as it exemplifies weak demand and thus poor investment prospects. The debt overhang (which could be resolved with the inflationary mechanism) throughout the continent of Europe and the world is an impediment to solidified growth going forward but QE is not an adequate tool to address Europe’s troubles of institutional weakness, shallow capital markets, heavily burdened banks and rigid labor markets, among other problems. For a more detailed approach as to why the ECB’s QE expedition may not work, I would refer your readers to the pertinent commentary on BlackSummit’s website.
FF: Is the worst part of the international financial crisis over?
JC: It is too soon to tell whether the crisis is over. There are still way too many risks related to the excessive build up in credit, debt and extraordinary policies central banks around the world have taken. These are unprecedented policies at this scale. For someone to say they know how it will unfold is hubris. Risks abound from the Fed’s balance sheet, to EU sclerosis and indebted banks, China’s shadow banking risks, Japan’s debt load, etc. And those are some of the economic risks. They do not include political risks directly tied to these problems like the rise of fringe parties in Europe, the dissolution of the EU, a Greek or British exit, tension in Southeast Asia, let alone the emerging new cold war. When we take all those geoeconomic and geopolitical risks into account along with the fact that we have not addressed yet the causes of the 2008 crisis, I am inclined to believe that the worst is yet to come.
Having said that, allow me to state that I’m an optimist by nature and some of the innovations that are occurring in areas such as technology, medicine, energy, etc. are exciting. How we get to an era where we can focus on the positive developments going on around the world and whether a path to such a future is not interrupted by additional financial calamity is the question and remains to be seen.
FF: Has Brussels betrayed the dream of a free and united Europe?
JC: At its current juncture it is difficult to say that Europe and its leaders have any semblance of an idea of how to promote unity on the continent. Observing Europe it is quite clear that countries are promoting ideas and policies that serve their own national interests rather than thinking about what is best for the Continent as a whole. This goes both for the core and the periphery nations. Most certainly there is no leadership in the EU. A leaderless “union” is destined to fail. Germany wants nothing to do with any sort of internal stimulus that could help balance the region in a more appropriate manner. Germany and France are trying to protect their domestic banks while the burdened periphery has in large part resisted necessary reforms. Entrenched interests are digging in and as a result there is no EU-wide vision both the people and individual governments can aspire to.
None of this is necessarily irrational, but it is at odds with a sort of consolidation of the European dream set in motion decades ago. Efforts to unify the Continent are disjointed. Some parts of Brussels are trying to move towards greater unification, such as the permanent bailout fund but other parts, like leaving the onus of QE on national central banks, relay a lack of coherence.
With different institutions moving in different directions and at a different pace a truly united Europe cannot materialize. As a result tensions (politically, socially, economically, etc.) will tear at the core of Europe. Maybe the best the EU can do is to return to a free trade zone where goods, services, people, and all forms of capital move freely. Fiscal and monetary union — let alone a political one — may be a utopia for Europe.
FF: At the Free Market Road Show event in the US, you said that the European youth “has lost the ability to dream”. What do you mean?
JC: When youth unemployment in the EU is almost 25% and with some countries (such as Spain, Greece, Portugal, Croatia, Italy etc.) suffering from a youth unemployment rate of more than 45%, how could you dream?
When the youth face a society where meritocracy has been abandoned how could they dream?
When the young people are burdened with debt, dead-end jobs, secondary labor markets where earnings and benefits are depressed while opportunities for advancement non-existent, how could they dream?
When the youth face a myriad of sclerotic bureaucratic measures that serve those “connected” and their special interests, how could they dream?
When life is expensive and demanding and all they see from the Eurocrats are empty promises that perpetuate misery, how could they dream?
My fear is that Europe due to its structural deficiencies is facing a lethargic future where the status quo deprives its young people of their future.
FF: The leftist and anti-austerity party Syriza has won the elections in Greece. Why has Greece reached this point?
JC: The Greek people have long rejected not just the program of austerity but the way it was implemented. Mainly, austerity was imposed on the people outside the scope of any sort of democratic process. Moreover, Greece lost its sovereignty in the process. The bailout packages were used to bail out EU banks, not Greece. Very little of the bailout funds were used in Greece. This whole endeavor not only was humiliating, but also made no economic sense. In the middle of the crisis Greece even had a government organized and agreed to without any sort of election. Rather Prime Minister Lucas Papademos was put in power through the EU command-center! Meanwhile the brunt of the austerity measures fell to the country’s average citizens, destroying a good chunk of the middle class.
Thus, the story of Syriza’s rise is based on the natural political evolution of a country’s system that says “I had enough”. This asymmetry threatens the basic fabric among the country’s citizens and jeopardizes decades of progress, while threatens to unravel an economic and financial earthquake if Greece leaves the Eurozone.
FF: We see today a European continent strangled by centralization in Brussels and overregulation. However, isn’t that at the same time a great opportunity for liberalization? Can Europe’s creative energies be liberated?
JC: I certainly hope so. Europe is at a crossroad. It can choose liberalization and reform that can awake dormant capital and assets which in turn will create jobs, incomes, profits, and growth, and thus can turn page from its bleak future where entrepreneurial activity is depressed. For such a turn to take place, it requires comprehension of the causes that brought it where it is today, vision related to where it wants to go, abandonment of practices that resemble a death squad dedicated to slow execution of the subject, and most certainly to get the wrong politicians off its bus.