The asymmetry of adjustment in the European Monetary Union

For 70 years we have had the problem of how to distribute the weight of adjustment among countries with surplus and those with deficit… we can’t wait another 70 to deal with it. John Williamson.

By Luis Martí, in Madrid | Comments on Michael Pettis’ proposal | Skidelsky, J.M. Keynes’ biographer, tells us that it was the Minister of Labor Ernest Bevin who opposed the final objections of Keynes’ proposal for post war international order. Bevin feared that ultimately it could become another attempt to resurrect the gold standard as he recalled the unfortunate deflationary consequences caused by its restoration in 1925; and he knew, or intuited, that his country, whose economy was weak and with hundreds of thousands of demobilized soldiers, would have to subject itself to a painful readjustment in employment rates to be able to face the US competitive power that would emerge virtually unscathed from the conflict.

Keynes, far from lacking persuasive abilities, managed to convince him of the merits of what would be the British proposal for the negotiations with the US and Bevin confessed that “he was much more satisfied”. We suppose that besides the technical aspects, Keynes was able to transmit to the minister the fact that he trusted that to a certain extent the distribution of the weight would somehow be shared with the creditor countries so that the countries with significant debt balances could mitigate the social and economic costs of the adjustment. This was a critical point for the United Kingdom, which was reflected –although in ever so diffused terms– in the successive drafts drawn up by Keynes.

As it is known, the administration of the major creditor country at the time, the US, rejected the British proposal and it was the White Plan that served as the basis for the creation of the International Monetary Fund. The Fund would provide funding for unilateral balance of payment adjustment programs, at times grueling, and in its global analysis, it would not go beyond, nor was it allowed to, mere exhortations to the major creditors so that they contribute to balancing the burden of adjustment of the debtors. The only trace of Keynes’ concern included in the statutes of the Fund was the scarce currency clause, a way to correct the dominant position of the creditor with restrictive measures on the part of debtors, provided that the Fund had made a timely statement of “shortage” of a given currency (meaning, the US dollar). The clause has never been applied.

North American columnists, and now –if I correctly interpret his article– professor Pettis, place Germany in the role that Keynes attributed to the US (creditor country) and the peripherals as the debtors. The harshness of the latter’s restrictive policies would be mitigated if the main creditor executed simultaneously expansive expenditure policies. There is no doubt that the problems of our monetary zone would be considerably alleviated, even more so if – when facing the markets – this symmetric behaviour became accepted as a permanent commitment.

The symmetric treatment of the imbalances seems to be, nevertheless, very difficult to put into practice. The available case analyses shed little light on the matter. At the time, when it operated satisfactorily, the gold standard did not soften the adjustments due to the expansive policy of the countries recipient of the metal (David Hume’s simple flow model) but rather its disposition toward the bilateral financing of the central banks of the debtor countries so that they could maintain the monetary offer and avoid the deflationary effect of the exit of the gold. In our time, the seventy years that professor Williamson laments, one trusted that the creditors would agree at least to correct certain clear underestimations in the fixed exchange rate. We recorded, for example, occasional reevaluations of the German mark from 1961 onward, often negotiated as a counterweight to the devaluation of other European countries, and at times as an anti-inflationary action of the Bundesbank. These were never included in a comprehensive reorientation program of economic policy in Germany and few had any significance in the period prior to the floating of the mark in September 1969.

Germany did not accept that the manipulation of its exchange rate become an obligation in order to support the periodic adjustment measures demanded above all by France’s fiscal indiscipline and, of course, it vetoed, along with other European countries, the Volcker proposal to reform the international monetary system when the US, objector to the symmetrical treatment when it was the world’s creditor in 1944, argued in its favor when it became a debtor at the beginning of the 70’s. Years later the subject reemerges: the US with a bit more acrimony than diplomacy pressures insistently China to self-limit its ability to sovereignly manage the RMB exchange rate. Bergsten and others have made several proposals in this direction. As professor Williamson says, the symmetrical behaviour of creditors and debtors is still an open problem.

The appeal to creditors so that they accept to share the weight can occur, as is obvious, in two radically different scenarios. A confrontation scenario, (more or less covert) as in the case of the US and China, which highlights the relative importance that key economic instruments reach when the conflict appears within an extremely complex frame of political relations that will be, in the end, the one that is useful to help find some sort of negotiated solution or the one that continues to obstruct possible ones.

The cooperative scenarios, as recalled above, do not appear to be more easily possible: we are referring to desirable cooperation , hardly ever achievable. It is difficult to find a creditor, regardless of how connected to the country in crisis, that has lent itself to compensating the deflation, unemployment, the drop in consumption and investment of the latter, with expansive measures of its own, equally powerful but opposite. In a monetary union, this is the only possible road toward cooperation. The European Commission is now trying to seek fortune and in its recent regulation of the macro imbalances –part of the so called ‘six-pack’, the legislative package approved last October– it includes two timid references to symmetrical behaviour that lack regulatory hold. The absence of cooperation is, without a doubt, a serious irritant but it is convenient to refrain us from disqualifying it.

If the creditor country is growing at an acceptable rate, without unemployment problems, nor lacking idle resources, its authorities will not want to expose the country to the inflationary consequences of a provoked overheating; and, the countries in crisis would not be interested in an economic policy shift in the creditor country that would lead it, in no time, to cool down its economy by having to adopt the same contractionary measures. To encourage a relative change in the consumption/savings ratio in order to stimulate consumption –and the assumed import from the debtor country– it is easier to formulate in an economic model than attempting to influence an advanced society. The propensity toward consumption is rooted in the social behaviour and a government cannot reconfigure it at its will at any given time. A convenient public investment plan would make sense as a Keynesian recipe if the creditor country had idle resources. The government would resort, in any case, to this measure but its favourable impact on other countries would derive from an (expected) greater growth than from the program itself.

In short, it is not possible to ignore the enormous difficulties that the German government would have to face, if it hypothetically were willing to endorse such an initiative as the one brought to light by professor Pettis. But, his suggestion that Spain take on an activist role in the euro zone as a core unifier of the weak economies that still need major structural reforms to function smoothly in the monetary union does seem to be wise.

About the Author

The Corner
The Corner has a team of on-the-ground reporters in capital cities ranging from New York to Beijing. Their stories are edited by the teams at the Spanish magazine Consejeros (for members of companies’ boards of directors) and at the stock market news site Consenso Del Mercado (market consensus). They have worked in economics and communication for over 25 years.

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