Recovery Needs More Than Just Low Rates

There is a legendary quote from the movie Top Gun when the commanding officer berates one of his ace pilots with the line: "Son, your ego is writing checks your body can't cash."

European Union flags in front of European Commission headquarter in Brussels, Belgium.
Rachele Rossi | Flickr | Getty Images
European Union flags in front of European Commission headquarter in Brussels, Belgium.

I like to think of this expression as a catch-all for not only when we promise something that we know we can’t deliver, but also when we promise to provide a solution that isn’t in our power to deliver. Hence I remembered it with an audible grin after European Central Bank(ECB) President Mario Draghi said that the ECB would do “whatever it takes” to save the euro , and again after the bond buying program of last week. I wonder if the ECB, not down to ego naturally but other expediencies, is writing checks that the taxpayer can’t cash?

Lets make no mistake, what this latest news from the ECB does is buy time. That is all. Time for the EU political leadership to arrange a fiscal unionto match the current euro monetary union, and the acceptance by all that what this means is large fiscal transfers from north to south for some time to come. Otherwise the euro remains long-term unviable and some sort of break-up is inevitable.

But there is another issue that governments would do well to remember, and that is that we still require economic growth. We require jobs to be created and growth to resume. That isn’t actually going to be helped in itself by the ECB’s action.

Providing a “lender of last resort” for euro zone sovereigns enables them to carry on rolling over maturing debt at an interest rate that is affordable, and so removes market disquiet on this front. But reduced market nervousness is only a start. The fact that a sovereign’s borrowing costs are lowered is not sufficient condition for economic recovery. And there is the rub: we have the stability provided by the good ship ECB, but the southern euro zone is still in a policy straitjacket that means they are condemned never to grow. In Greece,the problem is self-evident, and there we can expect contracting GDPfor the foreseeable future. In Spain, it’s the overhang from the housing crash, and the parlous state of the banks. And in Italy, Portugal and Ireland? A host of issues that need to be addressed and in the case of the last two may well result in requests for further government bailouts.

And that may end up being the ultimate solution. There is no point providing “restructuring” of sovereign debt if all it results in is prolonging the pain, as is happening in Greeceat the moment. Devaluation is not open to these economies, so we require a moratorium—or outright write-off—on debts allied with cuts in wage levels to boost competitiveness and harder working to boost productivity. Otherwise it’s a never-ending vicious downward spiral.

Even with debt write-off the medicine will be difficult to swallow, involving a smaller public sector, lower wages, less bureaucracy and red tape (something the SME sector in every European country could do with) and more reforms of labor markets to incentivize job creation. But with the current debt millstone around the economy’s neck, growth is virtually impossible.

Of course we wouldn’t be here if we didn’t have the euro. If Greece was still in drachma-land, it could default on its debt with about as much brouhaha as Argentina causedwhen it reneged on its debt in 2001. Too late for that now though, we’re all in it together….

The author is Professor Moorad Choudhry, Treasurer, Corporate Banking Division, Royal Bank of Scotland. The views expressed in this article are an expression of the author’s personal views only and do not necessarily reflect the views or policies of The Royal Bank of Scotland Group plc, its subsidiaries or affiliated companies, or its Board of Directors. RBS does not guarantee the accuracy of the data included in this article and accepts no responsibility for any consequence of their use. This article does not constitute an offer or a solicitation of an offer with respect to any particular investment.