I was at the Conference of Montreal on Monday (and watching the game tonight). The conference this year is sort of a post G-20 finance minister event sandwiched between last week-end G-20 meeting in Korea and the upcoming G-20 summit in Canada next month. The Conference of Montreal is often used as a venue for such officials to exchange views in a more discreet and informal fashion; away from the big media things are said that would not normally be said. It is also a way for officials to test their narrative and to practice their speeches. Present among the speakers were the Governors of the Bank of France and the Bank of Canada, the Secretary-General of the OECD, the Minister of Finance of Canada, the heads of the Asian Development Bank as well as a plethora of other “big” guests and VIPs.
The new buzz word in town is officially “Fiscal Consolidation”; a euphemism for cutting government expenses. It also is often combined with the expression “Growth Friendly Policies” to convey the message that the cuts will be surgical, not to upset the fragile recovery. Prepare yourself to hear these two expressions until you get sick during the next few months. The finance officials are now in need of a good story to convince the markets that they know what they are doing. And, as you might suspect, they talk a pretty good game. But the pitch still shows a few obvious cracks.
The first vulnerability of their story is a lack of consistency. A mere few weeks after promising to keep the spigot going, the Greek tragedy instilled the fear of God in these guys. Europeans were very worried that Greece would become another Lehman; another climactic event that could have totally spooked the markets. They acted swiftly but it did not quite work. The disease spread to the PIIGS, then to Hungary last week and suddenly panic really set in. You can read in the last communiqué from the G-20 finance ministers meeting “The recent events highlight the importance of sustainable public finances and the need for our countries to put in place credible, growth-friendly measures, to deliver fiscal sustainability, differentiated for and tailored to national circumstances. Those countries with serious fiscal challenges need to accelerate the pace of consolidation.” Thus, it is clear to me that they are reacting to events rather than taking the lead and control over this crisis.
The second problem is an increasing lack of credibility. The lack of consistency mentioned above is creating a credibility vacuum. If, one month after you strongly affirmed that you are firmly in favour of maintaining the stimulus, you change your mind for no other reasons than that the markets don’t like the turn of events in Greece, it becomes quite evident that whatever you say should be discounted as you may change your mind again quite soon.
The third issue is the lack of rational for the change in policy. These very well informed officials did not learn last month that Greece was in trouble and that eventually, sooner rather than later, Europe would have serious fiscal issues to deal with. They knew about this for a long time. And they also knew that the more they were going to spend in the short term, the bigger the issue of fiscal sustainability would be and the sooner it would matter. Unfortunately, the financial markets started to notice, or care about it, in May. But, if last month’s events had any impact on the real economy, it is that European growth could potentially, in the short run at least, be lower and more fragile than previously anticipated. Obviously, with more uncertainty and a higher risk premium, the private sector is going to have an even harder time to “take over” and growth targets are therefore going to be even more difficult to reach. This should have reinforced the expansionary fiscal bias, not tame it.
Fourth there is the lack of clarity in the statement. “Growth Friendly Policies” and “Fiscal Consolidation” are a big contradiction. You can say them in the same sentence if you want but it still does not make sense. Officials need to explain that the fiscal consolidation they are talking about is something that is going to reign in budget deficits only beyond the current crisis, once the recovery is firmly established. Only if you can commit to do this credibly will you improve the long term fiscal outlook.
Fifth, in spite of all the talk about international cooperation, there is a lack of consensus on the issue. The dissension comes mainly from the US which fiscal situation is not as critical as that of Europe. Tim Geithner wrote a letter to his finance minister colleagues urging them to maintain the stimulus. Today, Ben Bernanke also testified in front of the House Senate Committee. Although he warned of unsustainable deficits, he said “This very moment is not the time to radically reduce our spending or raise our taxes, because the economy is still in a recovery mode and needs that support.”
Sixth, there is a total lack of credible commitment to return to a balance budget down the road. It is a neglected issue because we are all short-term driven. Now that the market is bringing the long-term issue in the fore front and in the face of officials, they are forced to publicly acknowledge it. Yet, nothing concrete is being done about it and if history is any guide, it will not happen until it is too late.
Finally and most important, there is still a lack of understanding regarding the roots of this crisis and hence about what needs to be done to resolve it once and for all. I talked about this on Monday in part I of this series and will be back on this topic soon in the third and last installment early next week.
Go Hawks Go!