'We’re experiencing crisis of advanced economies' - ex-head of ECB

SS:Only six years on after the crisis, would you say Europe is out of the worst?

JCT: I would say that the probability of a materialization of tail risk, meaning the change of the dimension of the euro area with countries or country, leaving the Euro area, that risk is considered to be alleviated, because of 4 reasons, as far as I see it: First, all countries which were under stress have adjusted and the result of the adjustment is very visible in the eyes of the external observers and markets. Second, governance has been improved quite considerably, with reinforcing of the stability and growth backed with the creation of a new pillar for surveillance of the competitiveness indicators, with Fiscal Compact and so forth and the banking union – that is the second reason. The third reason is that politically it’s been decided by all countries concerned that they wanted to maintain the integrity of the euro area, and it’s been confirmed both in Greece, in Germany, and all other countries. And the fourth reason is that the Central Bank, I believe it is very credible, has said in the past that it could intervene to maintain a correct transmission of monetary policy in cases where countries were behaving properly and embarking on a proper series of reforms. That makes full reasons why we could see very big improvement in the solidity of the euro area.

SS: If I may, because you were the head of one of the most powerful organizations in Europe at the time - you must have your opinion on that. Even now, you are a man of a great stature. Everyone asks you for advice. Do you think it’s normal that even if it started in the US, and was triggered in the US, is it normal that no one has been held accountable?

JCT: I think you cannot say that, I mean you had a number of fines here and there, all of the advanced economies that have been decided upon, you had a very large number of CEOs having to leave and quit. Those who engage in criminal activity have been pursued – Madoff is a case in point - but you have a large number of others, so you cannot say that. I have to say that what has to be done is to pursue those who have engaged in criminal activity, but the problem is much generalized. They had an enormous responsibility because they were not having a risk culture which was correct, but practically all the economists we have were more or less accompanying this very abnormal risk culture. And also, I have to confess, the financial world, but on the side of the authorities – the authorities in general, governments, supervisory authorities were so confident, until the start of the sub-prime and even after the start of the sub-prime, that they thought that it was impossible that the full financial system could collapse. It was something which was unthinkable. We were plain wrong, if I may, the international community. But, you see, if you’re targeting only one scapegoat that would be responsible for everything – let’s say you take the commercial banks – then what about the non-banks? What about the highly leveraged institutions, aren’t they also responsible? What about the hedge funds, for instance, what about all the special vehicles – so, you see, it’s more generalized.

SS:So you don’t believe banks are the main reason? That bad banking systems triggered the whole thing?

JCT: Banks are part of the whole – and everything involved has the responsibility, including the way you do computing, the accounting rules. Of course, also, the rating agencies – banks and non-banks. And the naïve belief that we were in a world where there was automatic self-correction of the markets themselves; the theory of efficiency of markets was also part of this whole situation. Again, I trust really that what has happened is absolutely unacceptable, the fragility of the financial system appeared to be absolutely dramatic, and if we want to never see that happen again, we have to correct the whole. If you target one scapegoat, then the other one is not correct, and you do not get what you want, which is a much more solid financial world.

SS:About your quote – “Trust in bank governance has eroded and it needs urgent repair, which means more effective supervision.” Supervision from whom?

JCT: Supervision from supervisory authorities. And in a large number of countries, they are close to the central banks now. Before, the theory was much more like “let’s have supervision out of the central bank sphere,” and one of the provisional lessons of the crisis was that this is not necessarily a good thing, because central banks are very close to the liquidity problem. They are close to a number of very important issues that are important when you have to exert supervision in an efficient and effective manner. So, I would say that I was addressing of course all authorities, because there is no consensus still at the global level. All authorities, whether they are fully independent in their own responsibilities, or whether they are central banks or close to central banks, which seems to be, again, an emerging consensus now.

SS:We’ve seen a lot of government bailouts of banks lately. Is that a part of banking supervision, you think?

JCT: Bailouts are a totally different thing, because then you are involving taxpayer money and so you are involving decisions taken by public authorities, by executive branches, and by parliament – if, again, public money is at stake. So, supervision exists precisely to exert appropriate control in real time on a permanent basis to avoid having at a certain moment a presence of institution which is collapsing and perhaps calls for taxpayer’s money. I say “perhaps” because one of the goals that we have now at a global level is that we believe that there should not be an institution that would be so big or so interconnected that it could not fail. We have to have in mind that any institution should be able to fail, if there is bad behaviour, and, very unfortunately, an absence of correct supervision – then those banks should not be destroying the system as Lehman Brothers did, and they should not necessarily impose a burden on a taxpayer.

SS:You recently also praised the Spanish economic model – you said that Spain has become more competitive than France due to its policy of low wages. So do you think lowering wages and salaries is the only way for European governments to get themselves out of crisis?

JCT: I did not say “lowering wages,” I said “lowering unique labor costs,” so the combination of nominal wages and productivity progresses. It is true that when you have a big trade deficit and a big current account deficit it means that you are not sufficiently competitive so you cannot convince your own consumers and the consumers of the rest of the Europe and the rest of the world – because we are in the open world – that your products and services are worth purchasing in terms of quality and price. It was clear that at a time, Spain was very much uncompetitive with unique labor cost too high, and the adjustment of this economy has driven the competitiveness of the country in the right direction. And what I see in terms of exports and in terms of dynamics of exports demonstrates what I can see also in the figures – namely the costs have diminished quite a lot and are now competitive.

SS:I was reading a recent article on the internet this morning, where you said that there is a lack of democracy in Europe. What exactly did you mean, and are the driving economic engines like France and Germany to blame?

JCT: No, my understanding of the present situation in Europe and euro area - and I’m concentrating on governance in the euro area in particular because we have reinforced the stability and growth pact. We have Fiscal Compact, the new treaty that is dealing precisely with these fiscal problems; we have the EU semester again, which is a way to look ex-ante to the budget of the various countries in the euro area in particular. All this is something which is very important and goes in the direction of de facto political union, because when you are dealing with the budget or with macro-policies in general, you really are at the heart of democracy: the parliament has to vote for the budget, so we are really at the heart of what created our democracies, which is the national assembly, the house of commons, the Duma, and so forth. There we have a de facto political union, but which is, in my opinion, at the level of Europe as a whole, but, more particularly, because it is really the problem in the euro area – you have no democratic legitimacy, and that is the reason why it seems to me in certain cases, not in all cases, it would be good to have more involvement in the EU parliament.I call that activating Federation by exception – in exceptional cases, perhaps, we should have more involvement.

SS:When I speak to people, they say that France isn’t at place right now either, and if things continue the way they are now, it could find itself in place of Greece in future. Do you think President Hollande’s policies are stimulating or stagnating EU growth?

JCT: I think France has three problems which are now very clear, they were clear since quite a long period of time – first, there is a problem of public spending as a proportion of GDP. The public spending is too high, it is around 57 percent of GDP, and France, along with Denmark, are two countries in the EU that are at the highest level of public spending as a proportion of GDP. That is no good for long-term growth and competitiveness. France has a second problem, which is the overall markets, including the labor market, are not flexible enough. When you are in a world which is changing very rapidly, if you adapt rapidly, you can save jobs and create new jobs, which is the ultimate target. So there is a problem there, to pursue the structure reforms, and then you have a third problem, which is an issue of pure unique labor cost competitiveness. There, of course, this country is not at all in the situation of Greece or the countries that are under stress, but it is an issue. To oversimplify, I would say that France is today in the situation of Germany at the beginning of the euro. So, there is a real issue of regaining competitiveness, which Germany did over time, year after year, in regaining, year after year, 1.5, 1.2 percent of competitiveness each year in terms of unique labor cost, the combination of productivity progress, labor productivity, and nominal revenue.

SS: But also Germany has products to export that France doesn’t.

JCT: No, no, don’t believe that. At the beginning of the euro area, France had a current account surplus, in 1999, and Germany had a current account deficit, so there is nothing in the chromosome, in the DNA, which is fixed by definition, neither in Russia, nor in France, nor in Germany. What you need is to create conditions for appropriate behavior of your economy. I have to say that France knows that it is possible, because in the 80s and 90s in France we pursued a policy of competitive disinflation, which is precisely improving competitiveness through unique labor cost being moderate year after year after year. And if we could make the euro, do the euro, it was because we had this long-term strategy. So, you see, the 80s and 90s was our proper-headed behavior in the setting up of the euro. Germany was in a bad situation, France in a good situation, and the situation reversed, because Germany was very consistent in pursuing competitiveness. And I believe it is what my country should do now.

SS: After all these years, and all the problems that the European Union has experienced, do you still believe it was a good idea to bring all those different countries under the EU umbrella?

JCT: Of course. I profoundly believe that. You can look at this present situation through two different angles. You can look at it from a negative angle, then, of course, you see, as I said, that the epicenter of the crisis crossed the Atlantic and came from the US to the euro area, Europe in general, the euro area in particular, and that of course creates a lot of problems and you have to adjust in a number of countries – and that is absolutely obvious. And when you are in the epicenter of the crisis, you have a lot of hard things to do: that’s your responsibility, not only for you, but also for the rest of the world, because we are all inter-dependent. Now, you can look at it from a different, more positive angle, and you could say: “First, it was the worst crisis of the advanced economies since World War II.” So, since two thirds of a century, we had the worst crisis. And the euro as a currency showed resilience, which was totally impossible to foresee. The external observers, whether in Asia, perhaps in Moscow, perhaps in New York, would have said: “That’s impossible, this currency is a new currency, and you are by construction in the worst crisis ever – that currency cannot behave properly!” And you know that it behaved properly. That is something which is a fact, the currency has been resilient. The euro area has been resilient. There was no departure of any country, so in the worst crisis of the advanced economies since two-thirds of the century, you had the resilience of the euro area; not only resilience, but do you know that we were 15 countries when Lehman Brothers collapsed, and next January we will be 18, so the entered the euro area: Slovakia, Estonia, and Latvia. And do you even know that we have created since the setting up of the euro a little bit more net jobs than even the United States of America, so you should not be entirely negative.

SS:But the question is, because you keep speaking about the crisis that came from across the ocean: The crisis there is not over, and America is going through a very deep fiscal crisis. Is the euro area going to continue to be resilient? Because they keep printing money and raising their debt ceiling – how’s that going to affect the euro and the eurozone?

JCT: We have to be absolutely clear – in my own understanding, we are experiencing the crisis of the advanced economies. You had the crisis of Latin America, you had crisis of the Asian countries, you had crisis of the Soviet Union, and you had crisis in many places of the earth. But for the first time since World War II, we had a crisis which was specific to the advanced economies. Exactly line with 1929, there was also a crisis of the industrialized economies of the time. In that crisis we are all in a situation which is difficult and calls for a very active improvement. The Europeans themselves, they have two challenges. One is the challenges of Japan, challenges of the UK, challenges of the US – they are of course very large, advanced economies on one hand. On the other hand, on top of that, they are ambitious enough to create a single market with a single currency which had never been tried in the world. So, all the governance of the single market with a single currency in the worst crisis since World War II is also part of the challenge of Europe in general and the euro area in particular. That makes two challenges, when the other advanced economies have only one. And that is the reason why it is extremely important that we improve the governance of the euro area.

SS:But, in simple words, just tell me: If the dollar crashes – you cannot exclude that possibility – will the euro still stay strong?

JCT: No, no, I totally exclude that the dollar could crash, personally, because I don’t think it would be justified by the fundamentals. From time to time, the US is posturing in a strange way, threatening the US itself and the rest of the world by default, but I don’t believe for one second that this is credible, and I would say that, again, the euro has proved as a currency its resilience, which is remarkable and was not expected from external observers. I was myself very convinced of course that we had a currency which was backed by good fundamentals and still is backed, of course, by good fundamentals. But it was not the perception, including this very simple reasoning – you are at the epicenter of the crisis, how your currency can be so solid and credible. But the paradox is that we are at the epicenter of the crisis – but it’s a part of euro area. The euro area as a whole has good fundamentals and the currency represents the euro area as a whole.

SS:But the fact that the euro has been rising relative to the US dollar, and everyone was like “yeah, the euro is doing great” – is this really good news for the eurozone?

JCT: Again, not necessarily. One has to choose – either you say, “the euro will disappear, the euro will evaporate, the euro is in a great danger, and they do that to save the euro.” Or, you choose the other way, which consists of saying, “the euro is too credible, the euro is too strong, the euro is too high,” and so forth. The fact is that we are living in a world where both are untrue. We are of course in a world of floating currencies, it’s certainly normal that the euro appears as being credible, but it is not welcome, of course, that it would skyrocket, that’s absolutely obvious. But again, we depend on the overall decisions of all the investors and savers the world over.

SS:Jean Claude Trichet, the former head of the European Central Bank, thank you very much for this interview.