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25 October 2011, Gateway House

Nicolas Krul: “There will be no derailment of the [painful] adjustment process in Europe…”

Gateway House’s Hari Seshasayee interviewed Nicolas Krul. A stout defender of European unity, Krul discussed the origins of the crisis, the lessons learned, possible solutions and the opportunities for the emerging world.

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It seems like austerity measures and bailout packages are being negotiated almost every day in the Eurozone countries. Surmounting debt has challenged the economic and political unity of the region. In the inter-connected web of financial markets, the U.S. and European crises are spilling over, infecting the rest of the world.

American economists are virtually writing off the Europe’s ability to withstand the crisis. Will the Eurozone countries be able to stabilize their economies and emerge from this crisis relatively intact?

Is this current crisis an extension of the 2008 financial crisis or is there a deeper structural problem? What is the difference between the origins of the 2008 crisis and this one?

The financial crisis of 2008 was an American speculative crisis. This European one, in fact, has much deeper origins. It is a direct result of the 1971 dollar crisis and 1973 oil crisis.

In the 70’s, countries in northern Europe, such as Germany, Netherlands and the Nordic  nations, immediately adjusted to the relative price structures after the dollar and the oil crises: they re-organized labour markets, reformed their public sector and followed a cautious monetary policy. Thus, relative to the private sector, the public sector sank severely.

France and other Mediterranean countries, caught in the core of this crisis, however, didn’t undertake such measures. As a result, the public sector became the shock absorber of the financial crises.

But the European crisis is not only a debt-crisis of the profligate countries. Greece is an apt example. Its fraudulent entry into the Eurozone has contributed directly to its present state. While Italy and Spain may seem debt-ridden, the truth is that the financial markets of those countries exaggerate largely. But France, with its 35-hour work week and its exorbitant social security system, is in deeper trouble and, in a few years, is bound to come to the forefront of the instability surrounding the Eurozone.

Some global economists are ready to write the obituary of European unity. Are they justified?

There is a lot of misconception about what is truly happening in Europe. In part, this is due to the fact that the European unification process, and especially the monetary unification process, has no precedent. There is no model to follow. Therefore, everything Europe does is a question of trial and error, and when that involves 27 countries, the problem is amplified. And this is true even in India – the press distorts what really happens.

There is also a total underestimation of the adjustments that are happening in Europe. Everyone is focusing on Greece, because they started to adjust late. They’ve now raised taxes, fired excess public workers, and their banks have increased capital. But this is a long-term process, and the results will only show later on. In my opinion, Greece will default around 50% of its debt, but it will be an orderly exit. But nothing dire will happen to Spain, Portugal, Ireland or Italy. That is simply a rumour spread by the adversaries of Europe’s monetary unification, largely through the Anglo-Saxon press.

Is the crisis really as widespread as it’s made out to be then?

Europe is a very rich continent, but since the taxes are so prohibitive, most of it is unseen. Take the Forbes Billionaires List for instance. There are around 20 Europeans on this year’s list, but I presume the real number is closer to 80 – because their money is completely hidden. We have a culture of tax evasion, which has largely benefitted the world’s tax haven, Switzerland. But now, other countries like Singapore and Dubai are taking over.

There will be no derailment of the adjustment process, but it will not be a straightforward path. It will be painful and long, and I doubt we will come out of the crisis before 2015. However the signs of change are already here: the relative price structure is changing rapidly in Europe, housing and equity are going down, the price of labour and the cost of capital is also decreasing, and there is substantial public sector reform. They are not only raising taxes, but reducing expenditure too. It is essentially the financial sector that is adjusting in a formidable way, and it’s impressive to see how capital and liquidity has been raised.

There has also been talk of the BRICS nations participating in the bailout process. Is that at all relevant?

The answer to the latter half of the question is no. It is not at all relevant.

In this adjustment process, is there a legitimate opportunity for emerging economies?

Definitely, this crisis is an extraordinary opportunity for the emerging economies. There is a whole rebalancing of the economy that is going on. The opportunities that came to the emerging economies earlier have always been rather controlled by the West. But now, the West is no longer able to control it. Globalization, for instance, is now a two-way process.

The West is heavily indebted, while there is hardly any debt in the emerging world. More than anything, this crisis provides the financial sector with an incredible opportunity. My view is that regulation is not very effective. You can raise capital requirements, liquidity ratios, set leverage ratios and so on. But in reality, there is always a way around.

The only effective control is the market. Thus, the market must be substantially informed. The demand for information, coupled with the technology revolution in the supply for information, together with the central banks, will provoke the upsurge of information. It is the only real way to reach the correct pricing. It always has been, but people have forgotten that.

Nicolas Krul is co-founder of the International Center for Monetary and Banking Studies.

Hari Seshasayee is a Researcher at Gateway House.

This interview was exclusively conducted for Gateway House: Indian Council on Global Relations. You can read more exclusive content here.

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