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University of Michigan economics professor William J. Adams will deliver the closing keynote session at the 2012 Morningstar Investment Conference in Chicago on June 22. Entitled "How Fragile Is the Euro?" his presentation will address the historical events precipitating the creation of the euro and the competing political interests that planted the seeds for the ongoing European economic crisis.
His extensive background on European economics includes acting as a consultant for the White House and the Federal Trade Commission, and a background in academia and European policy gives him a unique perspective on the current investing environment and horizon. Morningstar sat down with Adams in advance of the conference to explore the issues that will inform his keynote.
Morningstar: How intertwined are the economic troubles in the United States and Europe?
William Adams: [English economist] Alfred Marshall was so dominant in the Victorian era that people all over the world would go to Cambridge with riddles and puzzles in economics and present them to him. The story is that Marshall would listen patiently to the puzzle, and when the person was finished, he would say, "Annie, get the scissors and show him how it works." Supply and demand. The lesson is that they are two sides of the same coin--interdependent. A lot of causes go into a crisis.
Morningstar: What are some of the causes of the crisis with the euro?
Adams: Even if there had been no financial crisis, Europe created a financial union without a fiscal union. Here's why: European financial institutions were investing in US financial institutions one way or another; when the bubble bursts, it affects real estate markets over there, the same way it did in the US. The problems Greece had were caused by major budget deficits. But that wasn't the problem in Ireland or Spain; both of those were private-sector problems--real estate bubbles. It'd be hard to blame that on government excess. Yet, even when they were developing the eurozone, the statesmen understood that over the long term you can't have effective macroeconomic policy without having both a monetary union and a fiscal union.
Morningstar: Why didn't they create it at the time?
Adams: Too much too soon, but now there's a window for it. The [Chicago mayor] Rahm Emanuel principle: "Never let a good crisis go to waste." This is an opportunity for a good reform agenda, a chance for their "ever closer union." The idea there is that you begin with a very modest, very pragmatic project. When you show results, you use that as a vehicle moving forward to expand the scope of integration--show them that they're functioning better, and that they can function better yet.
Morningstar: The concept of a eurozone goes back decades before it was actually created. What was the impetus behind finally forming it?
Adams: It didn't happen back then because the two major countries, France and Germany, didn't want one for very different reasons. The decisive moment came when the Berlin Wall fell and the Iron Curtain was lifted. At that point, Germany wanted to reunify but needed the endorsement of the rest of Europe, which was concerned for obvious reasons.
The Germans were mainly afraid that this monetary union could be a vehicle for excessive inflation. In the 1920s, the Germans suffered hyperinflation, and that wiped out the savings of middle-class Germans. Many people argue that's what created fragility in the German political system. So ever since World War II, Germany has taken the position that, above all, the role of monetary policy is to limit the role of inflation. If monetary policy would no longer be under unilateral German control, and instead under the control of a group that had different priorities and ideas and didn't have the kind of experience with hyperinflation that Germany had, it might create a situation Germany wasn't happy about. So Germany insisted that the union contain safeguards--that it be written into the charter that the only goal be to limit inflation.
But Germany wanted reunification, and France wanted the Stability and Growth Pact. Quid pro quo. And then you form a monetary union that ties one hand behind national authority's back. Would people today have adopted the Stability and Growth Pact had they known? That I can't say. It's not clear France would have supported German reunification without it. The difficulties today come from the fact that these countries had very different perspectives on what this monetary union should be.
Morningstar: What kind of reform do you expect to see in the short run?
Adams: It's going to be difficult for Europe to reform radically, in the short term, the structure of the euro. All decision-makers, public and private, are very myopic; the CEO of a Fortune 500 company doesn't care nearly as much about the long-term health of his company as he does about short-term profits, and the same is true of politicians focused on their next campaign. What this means is that the perspective of many European politicians and statesmen is that a lot of the reforms, that people knew deep down they needed, they just haven't done.
Morningstar: Are statesmen who are tasked with creating reform behaving like business-people?
Adams: The question I often ask is this: Where does the boundary lie between a business school and an economic department? For me, it's very simple: When you listen to most economists, what they're thinking about is equilibrium, balance. In a business world, nobody is interested in equilibrium because, by definition, there's no money to be made. Business is all about how to profit from disequilibrium.
Morningstar: What do you foresee happening with the eurozone?
Adams: It won't break up because it's not in anyone's interest to break it up. It's definitely not in Germany's interest, and that country is the key player right now. It will have to take a slightly different form than it has now. It's become apparent that it isn't enough to be politically and economically stable.
