Interview with Prof. Dr. Teodoro Cocca: Euro on the brink

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Almost a year has gone by since our last interview in September 2011. The debt crisis, and especially the euro crisis, are still omnipresent. In the meantime the contagion has spread to Spain and Italy, who are in the throes of a public finance and banking crisis. Optimism in Europe appears to be waning and resignation is spreading. We hear warnings such as those issued recently by IMF boss Lagarde or the investor George Soros that the euro is in danger of collapsing in three months. How long do you give the euro and what would happen were it to collapse?

Prof. Dr. Cocca: The moment of truth is edging ever closer. The situation will become critical if Italy elects a new government and the markets lose trust in it. At present the Mario Monti government is still enjoying confidence, although this is fast disappearing. As regards the future of the euro, all roads lead to Rome. Whether the euro survives in its present form rests with Italy. Where possible the euro and the existing hopeless crisis management strategy will be held on to for so long that in the end everyone will be pleased if the euro collapses. The risks of existing rescue measures are increasing so rapidly that you have to ask yourself whether the collapse of the euro, which today could still be managed in an orderly fashion, might be a better option.

Spain still just fits under the rescue umbrella, but there is no solution for Italy. With long-term interest rates of more than 6 %, a debt level of over 120 % and a structural growth weakness, Italy cannot maintain its membership in the euro. Italy needs euro bonds; a permanent reduction in financing costs through a joint debt of the Eurozone countries.
You said at the interview in September 2011 that euro bonds are no solution. Do you think there is still a way of saving the euro without resorting to euro bonds? If so, what solution do you think is politically feasible given the enormous pressure by capital markets?

Prof. Dr. Cocca: Who would buy euro bonds? Nobody seems to be thinking about this. I think the longer the crisis drags on and the clearer it becomes that the current political class is not able to solve the problem, the more pointless euro bonds will be. Euro bonds would only make sense for a eurozone 2.0, where it would be ensured that budgetary discipline and competitiveness are guaranteed, but we are a long way from achieving that goal. It seems to me that the time window for reaching a political solution is slowly closing. The credibility of EU politics has hit rock bottom. Instead, the signs are that a solution is needed which will allow a twospeed Europe, in other words, withdrawal of the weak countries and reintroduction of the European Monetary System (EMS). This will be painful, but it appears to be the only credible solution.

We talked about euro bonds at the interview in September 2011. You pointed out that we already have a kind of mini transfer union. Between 1976 and 2008 one EU member, i.e. Germany, made more net contributions to the EU than all the other net payers put together. The transfer union will be strengthened by the introduction of the ESM (European Stability Mechanism). The current dispute between German economists clearly illustrates that in Germany political unrest about the rescue measures is growing. A current and representative survey indicated that 58 % of Germans (in 2010 it was only 39 %) want the return of the deutschmark. How long will Angela Merkel be able to withstand this political pressure, from her EU partners on the one hand and her electorate on the other, especially given that federal elections are due to take place in 2013?

Prof. Dr. Cocca: At the moment Angela Merkel appears to be firmly in the saddle, if you look at her popularity figures. The lack of discipline of the EU peripheral countries seriously calls into question the current crisis strategy. Germany will reach a point where, as the rescuer, it will itself be in great danger of becoming insolvent. It is actually already implicitly the case today that without Germany the eurozone would long since have collapsed. If the impression is reinforced that the peripheral countries are not really willing to change, the solidarity between the richer and the weaker states will rapidly disappear. The first signs of this erosion are already apparent. This solidarity is actually the only reason why the euro construct is still holding steady. However, it will not be able to continue for much longer unless a different crisis management strategy is pursued. As an Austrian taxpayer, I have personally lost patience with the situation and would no longer be prepared to support the peripheral countries with my taxpayer's money and would rather call for reform measures, especially in the case of huge government apparatuses (e.g. in Italy).

The problem is not just the size of the ESM, but rather its structure. Under this system, all the countries outside the rescue umbrella are liable for all the countries under it. If Spain also joins them, two things will happen simultaneously. The total guarantees will sky rocket. And there will be fewer countries who are accountable for these guarantees. Therefore, you can't solve the problem by simply making the rescue umbrella bigger. Don't you think the rescue umbrella is a flawed construction when at the end of the day perhaps only Germany, Holland, Luxembourg, Finland and Austria will be left to pay for all the others? On the other hand, it is suspected that Germany would lose its top rating as soon as the ESM is introduced and would then also have to pay more interest. What do you think?

Prof. Dr. Cocca: Yes, you're right. The basic problem is that the ESM and all the rescue measures so far have merely tried to buy time. The underlying problems were not adjusted to accommodate this. There are now signs that sooner or later it will no longer be possible to buy time. The situation could intensify further, in that the eurozone receives outside help; the US and China could soon be asked to step in as lenders. However, these lenders will demand more concrete measures.

Italy is not far away from the point at which it can no longer finance itself on the markets without outside help. As Italy is actually too big for the rescue umbrella, but interest rates are increasing more and more to an intolerably high level, political pressure in Italy to exit the euro will grow. Since Italy has a comparatively low level of new debt, in spite of the old debts, this makes the country relatively independent from the outside world. A brutal debt cut would put an end to the inner-Italian crisis overnight. Leaving aside the catastrophic consequences for the rest of Europe and the banking system, do you think this scenario would be conceivable?

Prof. Dr. Cocca: Italy's debt cut would have serious consequences for the global economy because Italy is one of the largest debtors. The repercussions would stretch from the US to Asia. As Mario Monti's government is showing, Italy would have the means to win back the trust of the markets on its own. Compared to his predecessor, Monti has already achieved quite a lot. However, the politicians in Italy are still ranting about the wicked speculators, instead of recognising that they are actually the problem. As long as they refuse to face reality there will be no solution for the country. A debt cut would not restore Italy's competitiveness. Devaluation via the reintroduction of the lira would at least artificially strengthen its competitiveness. A reform of the health system, public administration, educational institutions and the political architecture is unavoidable.

The net claims made by the German Bundesbank on Target 2 (Target 2: intra-European payment system between the central banks in the euro system) amounted to € +730 billion at the end of June 2012, more than double what they were a year ago. This clearly demonstrates that a massive capital flight from the European periphery is taking place in the direction of Germany, which is also intensifying the banking crisis in the peripheral countries. This means that the intra-European balance of payments crisis is becoming more and more risky for Germany and a collapse of the euro would be an expensive nightmare for Germany in this role as guarantor. What kind of solutions are available to stem this capital flight?

Prof. Dr. Cocca: All the protagonists must believe in the future of the euro again. As long as there are doubts, moving capital in the direction of Germany is a very rational thing to do. Who wouldn't do that? The good thing about this gigantic sum guaranteed by Germany is that Germany is sitting in the same boat as the peripheral countries and is therefore just as interested in retention of the euro and the constant refinancing of debt as the problem states. On the other hand, this also means that Germany is de facto already insolvent if one were to take into account the implicit guarantees that the country is giving or will give. The total debts of the eurozone are weighing on Germany's shoulders. This may be a good sign and shows what a mess the eurozone is in. By trying to save the whole unsustainable euro construct, it has now really been compromised.

At the interview in September 2011 you said that intensification of the euro crisis could only be prevented if stronger integration, i.e. a common fiscal and economic policy were to be operated. Recent developments in this direction were not very promising. In the European crisis as whole everything is now revolving around Germany. Now there are signs that Germany is falling back into recession. Do you think there is still enough time and political will to push through the fiscal union if Germany then has to put itself first?

Prof. Dr. Cocca: It will indeed be increasingly difficult to believe in further integration. Certainly there has hardly been any change up to now despite considerable efforts. When it comes down to the really crucial details, budgetary discipline and reforms will not play a part, and instead it will be about blithely financing debt with new debt. I fear that in the current situation Germany will not be in a position to just think about itself, as ultimately it is sitting in the same boat as the other countries. Should Germany decide to leave this boat, that would, of course, be the end of the EU project in its current form. Therefore, it is not a good idea to overstretch the patience of the contributing countries (Germany, Holland, Luxembourg, Finland and Austria). If you are constantly wanting fresh cash, you should be prepared to offer something in return. Recently, France and Italy, in particular, have given the impression of being very outspoken in their dealings with Germany and are mainly demanding money or a bailout, but they don't want to do anything for it. How can that work in the long term?

When defending the euro, it is often claimed that in this globalised world only the giants can survive. The reasoning is that we need the United States of Europe so that we could hold our own against China, India, the US and other heavyweights. If that had ever been the case, then we would still have dinosaurs, but no lizards. The lizard survived because globalisation means competition and for this it's not size that counts, but rather productivity, creativity and adaptability. Do you think Europe would still have a chance of being internationally competitive, even without a monetary union, especially given that regional, structural imbalances in Europe and the resultant competitive disadvantages can be compensated for by individual, regional monetary and economic policy (e.g. currency devaluation)?

Prof. Dr. Cocca: I think there is a need to differentiate between economic power and political power. Europe is a political project and has only pursued economic power as a secondary goal. This is also one of the reasons why the structure of the euro is unsuitable. Countries like Switzerland demonstrate very well that you can be very successful economically even if you are a lightweight politically. Naturally, it would be ideal to have both, but in Europe this has proved to be a failed venture, at least for the time being. I think Europe also urgently needs to clarify how it stands in terms of the relationship between politics and economics. On both sides there is very little understanding for one another, which is not a sustainable basis for the success of an economic region. Also, Europe's problems originated above all at the level of the individual countries and without the existence of the euro countries like Italy or Spain would long since have been insolvent. In this respect, interconnected constructs make a lot of sense. However, as is so often the case, the issues that matter are the actual implementation and incentives that exist in such a network.

Everyone has to actively contribute something and then the whole is worth more than the sum of its parts. Europe deserves better than what it is currently having to endure. Hopefully, Europe will rise up from the ashes to become stronger than before. As is always the case in such situations, this is hard to imagine in the midst of one's darkest hours.

Professor Dr. Teodoro Cocca, Vice Chairman of the Board of Directors of GGI

Professor Dr. Teodoro Cocca is Professor of Asset Management and member of the Research Institute for Banking and Finance at the Johannes Kepler University in Linz. He is also Adjunct Professor at the Swiss Finance Institute in Zurich. Prior to that, he worked at Citibank for several years, where he was involved in investment and private banking, conducted research at the Stern School of Business in New York and taught at the Swiss Banking Institute of the University of Zurich. As an adjunct lecturer for banking and finance at the University of Zurich, he is coveted speaker at academic conventions and international conferences and is adviser to a number of financial institutions. In October 2011, the banking expert was selected as Dean of Faculty of Social and Economic Sciences at the Johannes Kepler University. Professor Cocca was born in Switzerland and has Italian roots. He is the Chairman of the annual European Private Banking Summit, which takes place in Zurich. He is a member of the Board of Directors of VP Bank and an advisor to various finance companies in Switzerland and abroad.


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