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Eurozone Crisis: How Austerity is Obscuring the Big Picture

Published: November 22, 2011 in Knowledge@Australian School of Business
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Germany and France should take the lead in considering the medium and longer-term vision of the Eurozone, while its more troubled economies struggle with austerity measures and short-term solutions, suggests Fariborz Moshirian, a professor of finance at the Australian School of Business. His comments follow the recent G20 meeting in Cannes where the world's financial leaders effectively set aside pressing global issues to focus on the ongoing European crisis. While the Eurozone has monetary union – with a single currency and a central bank – it faces the overarching challenge of fiscal policy union. In the short term, widespread support may be required to get foreign capital flowing in Europe and create economic growth, Moshirian tells Julian Lorkin of Knowledge@Australian School of Business.

An edited transcript of the interview follows.

Knowledge@Australian School of Business: Europe seems to be falling apart with amazing speed, can you sum up the current situation after a not-very-successful G20 meeting in Cannes?

Fariborz Moshirian: Expectations were quite high prior to the G20 summit but as the leaders arrived at the summit they realised that they were facing a crisis in Greece. Of course, there were no concrete outcomes from the agreements made in late October by Eurozone leaders with regard to recapitalisation of banks, as well as the haircut for Greece's debt. So when the G20 leaders got together and tried to talk about their first key objective, which was restoring global confidence in the context of economic growth, they did talk initially about sustainable balance and economic growth, but they also talked about dealing with G2 – that is the US versus China, where they've been dealing with imbalances with regard to trade, savings and debt. By the time the meeting concluded there was no further discussion about anything like strong, sustainable and balanced economic growth. They said that they are willing to assist Europe through the International Monetary Fund (IMF) but again that contribution of member countries to the IMF Special Fund is going to be voluntary. We didn't end up with anything specific as a way of dealing with the European crisis, because they left it to Europeans to deal with it. We still got the global financial stability and economic growth, but we didn't see anything concrete between China and the US or Europe/US versus Asia.

Knowledge@Australian School of Business: Talk of the European debt deal seemed to dominate, whereas previously the meeting had been set out to discuss world trade. The talks seemed to fall apart because the [Deutsche] Bundesbank, the central bank in Germany, seemed to veto one element of it. Are people just looking after their own now? Isn't there a sense that people need European unity?

Fariborz Moshirian: I think the problem is people are looking at the short term and medium term, and they can't see the greater benefits of a fully integrated Eurozone or European union due to the fact that fiscal policies are set at the national level. And the question in Germany is: "Why should we pay the debt generated by other countries?"

They need to tackle the issue of fiscal union – they have monetary union, one single currency, one central bank, but left fiscal policy to national countries. So there's a major problem when it comes to public finance and for that reason politically it's not easy for leaders to promote European interests when their electorates are not very pleased with the way in which they have to contribute to the debt of other member countries.

Knowledge@Australian School of Business: Certainly people aren't impressed with Greece, it's really at the eye of the storm that's gathering over the world economy and threatening to tear the Eurozone apart. Should we be sorry for Greece or angry for the way it is handling things?

Fariborz Moshirian: I think it could be both. I suspect the problem here is the bigger picture of whether they should maintain the integrity of the Eurozone and European Central Bank and also contain the contagion effects of what's happening in Greece. It's a one-off opportunity for Greece to restructure its economy and accept some of the austerity measures for bigger gains maybe in the long run. At the same time, the Eurozone leaders have to deal with the banking system. If they let Greece default then they have to rescue their banks, the Eurozone banks, at a larger scale than they agreed in late October. So there are a number of policies that Eurozone leaders have to consider when you look at the challenges Greece is facing.

Knowledge@Australian School of Business: One of them seems to be that Greece squandered away the benefits of being in the Eurozone. Can the International Monetary Fund ever get Greece to put its own house in order?

Fariborz Moshirian: One of the major challenges facing Greece during the so-called financial crisis is whether it should take the opportunity to integrate its economy into the 21st century, to become more efficient, more competitive, more flexible in its labour force and other aspects of its economy and absorb some of these austerity measures or whether it should leave the Eurozone. I'm told that 70% of people in Greece would like to be part of the Eurozone, that means they now have to fast-track their reform rather than just go backward to what they were prior to the Eurozone and they need to get their national currency, the drachma, devalued by 50% and increase the debt of all companies by 50% - at the moment everything is measured in euro on the balance sheet of companies, not the government. So Greece could create more problems for itself in the medium term if it leaves the Eurozone.

Knowledge@Australian School of Business: Let's cross the Mediterranean now to Italy. What's your reaction to the resignation of Silvio Berlusconi?

Fariborz Moshirian: The New York Stock Exchange welcomed this news and, if it means the austerity measures are going to go through the parliament and everyone agrees to those measures. It's good news - in that the European Central Bank has threatened Italy that it will not continue to buy Italian bonds unless they can see that the government is taking serious steps to reduce debt.

Politically it's a different issue over whether Berlusconi was a stable force and what effect his departure will have. Is it going to be a stable national unity government? How will the politics play in the next couple of weeks or months? It's really a matter of wait and see.

Knowledge@Australian School of Business: With interest rates running so high, is there a sense that Italy has to resolve its problems quickly?

Fariborz Moshirian: It will have no choice because it knows that the European Financial Stability Facility doesn't have funding to bail out the debt of Italy, which is around 2.5 trillion euros. The IMF is not ready and doesn't even have the capacity to do that, so the Italian government and Italian people have to do most of the heavy lifting as part of their debt reduction, (including managing the) efficiency of the economy, reform of pension funds, reform of the labour market ... so Italy is going through a major challenge at the present time. Whether it is going to accelerate the process depends on how much pressure the market exerts.

Knowledge@Australian School of Business: Certainly the markets have been on a rollercoaster ride in recent months. Are we heading for a northern winter of discontent where the markets are going to be so unhappy that there will be no resolution to this crisis or are you optimistic?

Fariborz Moshirian: I think the way the debt crisis in Europe has unfolded we can expect ongoing challenges. It's not going to be a one-off event that the leaders get together and agree to some specific measures and therefore the Eurozone is going to turn around its fortunes. Unfortunately, we should expect more volatile time ahead of us as countries within the Eurozone try to get their public finances in order and agree to some of the austerity measures. At the same time, Germany and France probably should look at the medium and longer-term vision of the Eurozone to see what other measures could go beyond austerity measures and create economic growth. Only focusing on austerity measures, they're not going to see economic growth and all indications are the Eurozone might be in recession in 2012. So either they need support from China or all of the BRIC (Brazil, Russia, India, China) and G20 member countries. [They must] get foreign capital flowing into Europe or it's going to be a more prolonged process of integration in the Eurozone.

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