The time of debate is over; there is no question that Europe is threatened by deflation. The European Central Bank has to start launching an aggressive economy-stimulating program, including the purchase of small and medium enterprise bonds, says one of the most well-known capital market economist in the world. According to Barry Eichengreen – Professor of the University of California, Berkeley and former Senior Policy Advisor of the IMF –, the global economy, the markets are primarily threatened by the “Russian story” in the long run.
The cold war atmosphere is not going to lighten because the opposition between America, Western Europe and Russia involves numerous uncertainties and unpredictable consequences that even affect the Chinese-Western relations. Investors are scared of that. Barry Eichenberg stresses the importance of American dollar as reserve currency even though it will certainly lose its exclusive role as a safe haven currency in the long run.
Zentai Péter: In the last years, you have constantly repeated that the monopoly of the dollar had ended after the cold war, after the collapse of the Iron Curtain. Now, it seems that a new cold war might begin. Are these geopolitical developments going to change your opinion?
Barry Eichengreen: The historic experience gives a clear guideline for all of us. If the world is hit by large economic-financial storms, the investors and the market players flee to the dollar haven. This is going to happen again as the worries of the investors will deepen sooner or later. Most likely, the dollar will gain strength.
That means you revise your strong view about the dethronement of the dollar?
I still think that the American dollar is finished in the sense of serving as an exclusive currency reserve in the world. I predict the end of this role. Nevertheless, the importance of the dollar is relatively increasing because the constant problems around the euro make it impossible for investors to consider it as a real alternative for the dollar. Although the yuan has significantly improved, it could not be equal to the task yet. Furthermore, China is now hit by problems that weaken the currency.
Today is the dollar’s but tomorrow is not its, more specifically, tomorrow is not just its.
Your short-term pessimism with the dollar is actually a long-term pessimism with America?
The actual fluctuations of the dollar against the euro, the yuan, or any other potential “opponent” are plain market movements – in effect, just what some shares perform on the stock market. In other words, whether 1 euro is worth 1 dollar or 1 dollar 40 cents does not reflect the strength or weakness of the United States at all.
What should be taken into account is the size and the liquidity of the capital markets of America, Asia – especially, China – , and Europe. These parameters should be compared to each other. The capital and financial market of the United States is larger in any sense than that of Europe and China right now, however, the gap is going to shrink. The time for the dethronement of the dollar has not come yet but it is approaching. The current worsening problems of Europe and China are maintaining the status quo and conserve the ruling role of the dollar.
When I talk to bankers and other intelligent people in a civil way, I have the feeling that they suspect that the United States is manipulating the exchange rate of the dollar. Recently, it has artificially weakened it because it was in the interest of the American economy.
There have been conspiracy theories about America for hundred years. You should ask your intelligent friends what they would do if they were the decision makers of the FED (Federal Banking System), whose official task – besides controlling inflation – is to help to reduce unemployment and stimulate the economy. Obviously, they would lower the interest rates. Therefore, the markets value the dollar lower. The FED has no intention to weaken to dollar.
You mentioned that the dollar is temporarily and relatively strengthened due to the problems around the euro. But we have gotten through with the crisis of the euro. So what is the problem?
We have not gotten through with it. The euro is hit by crisis of the European banks. Furthermore, it is hit by the crisis of debt and growth. There are three huge and, in fact, insoluble problems around euro. The real situation of European banks is still shrouded in mystery; the upcoming stress tests will only partly reveal the truth about it. The debt level of most of the European countries, governments is still bad; what’s more, it might even increase in the future. As for the growth prospects of the European states, that is clearly tragic.
My research has led me to believe that the forecast of a 1.1 percent average growth in the European Union is rather a daydream than a fact. In effect, the pan-European economy is permanently stagnating.
Compared to that, America is in an excellent shape…
I would rather say that 2014 is America’s year. It is going to be a good year from an American perspective. True, compared to the consequences of the insoluble problems of Europe and the slowdown of the Chinese economy, America is dealing with smaller issues right now. This overvalues its market and its currency; the dynamics of the actions of the FED is in accordance with the dynamics of the market. In Europe, it is absolutely not the case.
However, in the long term, the United States is going to get in trouble because there are no developments in its infrastructure, there are under-investments in the education and health care, and in general, there is lack of investment in many areas of key importance, which should ensure the future development of the country.
The current developments of the capital markets are affected by two big “stories”: the tapering by the American central bank and the assumed recurrence of the cold war. Which one do you think is more permanent and more important?
I do not think that tapering is that much of an importance. This is a predictable sequence of actions. Ten billion dollars of restriction per month? In effect, this is almost nothing, negligible compared to the size of the American economy, the American markets, and the global economy. The systematic start of the tapering program rather proved that the FED is led by reliable, predictable, and rightly recognized experts.
The relevance of the “cold war story” is not comparable to the tapering. This could severely affect the world economy, the markets. Some form of confrontation with Russia became inevitable, involving so many unknown, sudden, unpredictable factors that we cannot tell how the relationship between China and America – and in general, the West – develops. The world trade might slow down and be rearranged. The most important issues deriving from it are the changes in the world trade of the energy resources and its global financial consequences. Most probably, these uncertainties are going to lead serious market downturns.
Finally, what do you think about the debate among European economists, financial experts: is there already or is there going to be deflation? Or is inflation the big challenge?
Unlike the FED, the ECB (European Central Bank) has only been running after the events and the dynamics of the markets and real-world situations.
I find it absolutely possible that the economic growth falls into negative territory along the measured one percent average Eurozone inflation rate – especially, as a result of the Russian events. In other words, a deflation spiral seems to start. The ECB immediately needs to launch the European version of the American quantitative easing program, start purchasing bonds of small and medium enterprises, and flood the banks providing corporate loans with interest-free money in order to prevent that.
Therefore, I suggest they stop arguing about whether an inflation or deflation period is coming! The time of debate is over; we need to take action now.