Robert Mundell says: 'The world is in a depression in America, Europe and Japan'. After all these years, I have finally been able to sit down for an hour with Robert Mundell, the great theorist of currency unions and the godfather of the euro.
“We’re in very serious danger. The world is in a depression in the Big Three of America, Europe and Japan, a mini-depression that we have not seen since the 1930s,” he said, speaking at the Lindau conference, where half the world’s Nobel economist are gathered on one tiny island with cobbled streets looking across Lake Constance to the Alps.
Few economists inspire such devotion and fury as Professor Mundell.
He is a hero to America’s free-market Right for sponsoring the Reagan tax cut agenda, and has not relented on that front. “Any country with public debt over 40pc of GDP needs its head examined,” he said.
His prescription for America’s ill today is to slash corporation tax to 20pc (from an effective rate of 52pc, he says), and kill the entitlement behemoth. By the way, he blames the Fed for triggering the Lehman crisis by keeping money too tight in mid to late 2008. There is very little inflation risk now from QE because M1 money velocity has collapsed “by half” and is likely to stay there.
But equally he is a villain to the eurosceptic Right on this side of the Pond, having made it a life mission to sponsor the Europe’s fixed exchange experiment. Some say he has bent the theory of “Optimum Currency Areas” (OCA) to justify combining the vastly different economies of Europe in monetary union – whatever this implies for freedom and democratic legitimacy.
If you read his own pioneering work on OCAs – “A Theory of Optimum Currency Areas” in the American Economic Review of 1961- it is hard to see how the eurozone can possibly qualify. He argued then that even Canada and the US might have benefited from a break-up into East and West dollars to reflect regional economies.
Does one see hints of doubt now, as EMU disaster unfolds? Not really.
“We’re in the midst of a very big crisis because nothing has been done yet to convince the markets that there has been a fundamental change. To save Europe there has to be a move in the direction of shared government.”
He admits that will not be easy. Alexander Hamilton managed to create a US debt pool in 1792 (against fierce resistance), arguing that the debts of 13 states were modest and had mostly been accrued debts during the Revolutionary War. This was therefore a shared interest. Greek pensions are not. “You can’t do that in Europe,” he said.
“There is a tremendous problem in five or six countries of the eurozone. But the solution is not the end of the euro, because that creates more problems than it solves. There would be a tremendous run on the banking system, and countries that left would still have to deal with all their debts.”
Prof Mundell said it would help if the ECB ripped up its price stability mandate and took pro-active steps to force down the euro, and then peg it at $1.30 to the US dollar. This would also bring the euro down pari passu against the Chinese yuan, creating a three-way managed global system – or the DEI as he calls it.
“The euro is too strong. A weaker euro is the best news you could have for governments (in trouble).”
“The ECB should follow an easier policy. Of course they have a strict rule to safeguard against inflation but that is not correct. I have never believed that central banks should have rigid inflation targeting. That is not a good thing to stabilize. There is nothing in economic theory to back this.”
He added it is folly to tighten monetary policy into a “deflationary” oil spike, (as the ECB did in 2008 and has just done again). “That is exactly the wrong thing to do”.
Mundell says US and euroland should manage the Atlantic exchange rate in the mutual interest, setting outer bands of 5 cents on each side of the $1.30 target. If the euro reaches $1.35, the ECB intervenes to buy dollars: if it drops to $1.25, the Fed buys euros. Both sides have gravity on their side since they can print unlimited sums to defeat the market.
Interesting idea (he has discussed it with US Treasury Secretary Tim Geithner, who listened closely) if you like managed exchange rates. I don’t.
I certainly agree that a weaker euro would help to lift the EMU periphery off the reefs, but it comes very late in the day and ignores the core problem that currencies are massively misaligned within EMU. The gap in unit labour cost competitiveness between North and South has grown to 30pc. Prof Mundell seems to have no answer to this other than grinding deflation in the Club Med bloc and Ireland.
As his Nobel colleague Joe Stiglitz said at the same Lindau gathering, democracies won’t stand for this kind of “medieval leech cure”.
Prof Mundell is however unrelenting: “The euro hasn’t done anything bad. The problem is lack of fiscal discipline. Countries like Greece, Portugal, and Ireland have been on a spending spree on entitlements,” he said.
Uhhm! So there is nothing structurally wrong with combining Greece, Spain, Ireland, Germany and Holland in a monetary union? Nothing wrong in inflicting negative real interest rates for years on the fast-growing catch-up economies of Club Med and Ireland? Nothing wrong in mixing up vastly differing productivity growth rates?
Professor, if you strip out Greece, the euro crisis is not caused by lack of fiscal discipline in any meaningful sense. That is a Wagnerian myth, much promoted by Chancellor Angela Merkel.
Spain and Ireland never violated the Maastricht limits on deficits. Both ran a big budget surplus during the boom when monetary policy was kept loose to help nurse Germany through a mini-slump. Italy is running a primary budget surplus. Ireland came close to eliminating its public debt altogether.
The real problem is that EMU stoked a private sector credit bubble. That proved the killer.
As the ECB’s Jean-Claude Trichet constantly reminds us, the public debt to GDP ratios in Europe are lower than in the US, UK, or Japan. So why then is monetary union suffering an existential crisis? Why is the ECB having to intervene to stop Italy and Spain spiralling into default?
The Euroland whole is visibly less than the sum of the national parts. That surely invalidates the claim that euroland is an optimal currency area. It is a “Pessimal Currency Area”.
Joe Stiglitz says events are now charging ahead regardless of political pieties. Argentina’s 8pc growth rate after ditching the dollar peg in 2001 offers a tempting way out for countries running out of popular and democratic consent for Berlin-imposed austerity, if Germany does not get there first by pulling out. “There is life after default, and life after leaving a fixed exchange rate system,” said Stiglitz.
You might equally add that the break-up of the Gold Standard was the necessary pre-condition for recovery in the early 1930s, since it broke a self-reinforcing spiral that compelled contracting economies to contract further.
By the way, do visit Lindau. It is one the most enchanting spots on earth, a timeless Bavarian gem from the Wittelsbach era. Yet with roots in the late Middle Ages when Lake Constance was the intellectual heart of Europe.
There are hardly any cars.
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