Practical analysis for investment professionals
20 May 2015

Martin Wolf on the Eurozone, the ECB, and General Investment Woes

Martin Wolf is the chief economics commentator at the Financial Times and is widely regarded as one of the foremost economics writers in the world. His books include Why Globalization Works and Fixing Global Finance. Last year, Wolf published The Shifts and the Shocks: What We’ve Learned — and Have Still to Learn — from the Financial Crisis, in which he analyzes the causes of the 2007–2008 financial crisis and its aftermath through a detailed examination of the connections between macroeconomic developments and the behavior of the financial sector. He also proposes several measures to reduce the risk of an even worse crisis in the future.

Given important recent events in some of the major subject areas addressed in his book, it seemed an ideal time to speak with Wolf about his views on the current outlook.

Gustavo Teruel, CFA: Let’s start with the eurozone, which you describe in your book as a bad marriage. . . Looking at the quotes of bond markets, it seems that they don’t think Greece leaving the euro is such a big dealAt the beginning of the negotiations between the new Greek government and the rest of the eurozone partners, Yanis Varoufakis, the Greek finance minister, proposed a debt restructuring through a growth-linked bond (among other things), which has some similarities to one of the measures you propose to solve the debt overhang — namely to make debt contracts more equity-like.

Martin Wolf: Yes, that is absolutely correct. I approved of this proposal and supported it in my column. Unfortunately, the powers that be in the eurozone are far too unimaginative to take up this sensible suggestion. But it is a very good one. It is extremely important, as a general proposition, to promote better risk-sharing contracts. This is one good example.

What is your opinion of the way Varoufakis has led the negotiations with the “Troika” [the European Central Bank (ECB), the International Money Fund (IMF), and the European Commission]? Why do you think he’s been sidelined as the leading negotiator with the European Union?

It is too early to be sure, but it does not look as though things are going well for him or for Greece. Yet this raises many questions, of which tactics are only one. There would not have been any good outcome in the longer run if, instead, Greece had signed up to whatever its partners demanded and then continued to ignore the conditions. It is true that the Greek government has taken many actions that have damaged both its own economy and the trust of its partners. At the same time, the demands of its partners are unreasonable in many respects. I want to see an agreement that would be good for Greece and help it thrive inside the eurozone. I think that such an agreement should be based on the principle of substantial post-dated and conditional debt relief in return for economically relevant reforms. I have no idea whether this is possible. But I have always thought it would take time. It is important to avoid a breakdown in the discussions before then. Whether that will be avoided is now unclear. And whether somebody else can do a better job than Varoufakis is also unclear.

As for Europe as a whole, how sustainable is the idea of turning the eurozone into a bigger Germany?

It is still, it seems to me, the way the eurozone is going. That is to say, the eurozone relies heavily on external demand. The better alternative would be internal rebalancing of demand. I remain very skeptical about the likelihood of such a development.

It seems that the worrying inflation data of last summer (on the verge of deflation) made the ECB react with new non-conventional measures. How effective do you think these measures will be?

I think they were all that the ECB could do, and so it had to do them. Since the eurozone is now showing a weak recovery, it is possible that these measures will indeed prevent a slide into outright deflation. But it is far too soon to be sure. In some ways, unfortunately, the eurozone looks a bit like the Japan of 20 years ago.

At least in the banking union it seems that important progress was made during 2014 to break the link between banks and sovereigns within the eurozone, with some caveats as to the lack of agreement for a fiscal backstop and a joint deposit guarantee scheme. Is this a hopeful sign?

Yes, this is a hopeful sign, though how far it can achieve a unification of monetary conditions across the eurozone remains highly unclear. But, at the least, it is an important step in the right direction.

Speaking of banks, in your book you state that the majority of the reforms since 2008 have not changed the nature of the business and that higher capital requirements are needed. Do you think that the Financial Stability Board (FSB) consultative document for minimum amounts of Total Loss Absorbency Capacity (TLAC) of Global Systemically Important Banks (G-SIBs) is a step in the right direction or still not enough?

Yes, over time capital requirements have been raised substantially, though I remain very concerned over the reliance on risk-weighting, and I still regard the capital requirements as being substantially too low. But the movement has by now gone further than I had expected.

Another theme in your book is 100-percent reserve banking as a way to give back to states the monopoly of money creation. You advocate for testing this policy in a small economy. The government of Iceland is exploring the issue. Do you think that Iceland is big enough to see if it works or did you have another country in mind?

Iceland would be a good test case. It is small, but it is quite sophisticated. It will be very interesting to see what happens.

You link the low-interest-rate environment not only to the savings glut, but also to the scarcity of investment and the tendency of big corporations to accumulate cash. Has this tendency changed in the last 12 months?

It is unclear whether this condition has changed fundamentally. One has to distinguish cyclical from structural conditions. A cyclical recovery is now under way across the developed economies. This is a very good thing and should raise investment and improve growth in the medium term. However, I am not persuaded that the fundamental weaknesses created by a lack of strong incentives to invest have disappeared. On the contrary, I think these weaknesses are still very much with us.

And the final question: When I finished reading your book, the feeling that lingered with me was that the world economy is doomed. Are you a little more optimistic about the global economy now than when you sent your book to press?

No, I do not consider it doomed. There remain strong positive forces from the spread of prosperity across the world. But there are also important sources of fragility in our financial and political systems. Should we suffer another large financial crisis in the not-too-distant future, the outcome might be very damaging, not just economically, but also politically. So I regard my book as a warning. We must learn and we must reform before it is too late.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

About the Author(s)
Gustavo Teruel, CFA

Gustavo Teruel is a partner at Exxacon, a Spanish-Chilean company that manages investments in real assets for institutions and high net worth individuals since 1998. Apart from earning the CFA Charter, Mr. Teruel completed a M.Sc. in Civil Engineering at the University of Granada and an MBA at IE Business School.

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