Euro's Fiscal Policy Will Give Pause to Reserve-Currency Allocators
Ian Bremmer & Jon Levy
The Greek crisis is making clear a reality long ignored or glossed over: Eurozone fiscal policy is messy and opaque. This is not a short-term phenomenon, nor can any concerted action change this fact. Global central banks, sovereign wealth firms and other major entities are going to revise their currency-allocation strategies based on this new recognition. This process is just beginning, but it suggests a roadblock to the euro taking up a greater share of reserve-currency allocations.
At first glance, there is a strong case for the euro to emerge as an increasingly important part of the global reserve-currency mix. It is very liquid; is accepted in highly competitive, globalized economies; and has international convertibility. Eurozone monetary policy, hewing to a strict price stability mandate may be more predictable than in any other regime. European powers have few contentious political relationships in the world. In a non-polar, anti-hegemonic world, all of these factors can be seen by global reserve-currency allocators as attractive arguments for holding an increased share of euros relative to dollars.
Throughout the Greek crisis -- which is by no means over -- much attention has focused on a European solution, the idea that somehow
In all of the above currency regimes, fiscal policy was the product of domestic decision-making. This is not the case in the eurozone because there is no such thing as a single domestic policy.
In the eurozone, fiscal policy decisions are made by 16 different governments. They are supposed to be guided by benchmarks governing the levels of government debt and deficits -- with limits set at 60 percent and 3 percent of GDP, respectively. When governments breach these limits, the European commission can launch an "Excessive Deficit Procedure," intended to force countries to correct violations. This procedure can lead to legal, administrative and financial punishments.
However, there is ample evident that the threat of punishment has little dissuasive weight:
This policy structure means that to figure out what the eurozone's governments will tax and what they will spend is a complex, constantly evolving process.
The very notion of a reserve currency is conservative; it suggests a maximal interest in capital preservation, contingency planning and crisis management. A bias toward predictability and clarity naturally follows.
At any given time, exchange rates may reflect a set of assumptions about fiscal policy. However, it is the structural nature of eurozone fiscal policy, rather than any current trends, that present the most significant challenge to the idea of the euro as a reserve currency.
European policymakers cannot alter this reality. Trying to create consolidated eurozone fiscal policy is politically toxic -- particularly as it would be seen as a backdoor means to transfer wealth from countries with lower debt levels to those with higher levels.
Even if these political hurdles could be overcome, opacity and uncertainty would still prevail. In areas in which there is a great deal of centralized policy power -- such as trade policy -- national and other interest groups shape policy to a high degree. This creates a separate, but no less challenging, source of uncertainty. Thus, from a reserve allocation perspective, new fiscal policy mechanisms will do little to bring greater clarity. Just as with the Greek budget crisis, there is simply no European solution. The problem with the euro is a fundamentally European problem.
If there is to be any policy response to the Greek mess, it will probably be the establishment of a eurozone sovereign lender of last-resort facility -- a eurozone version of the IMF.
However, any new facility is unlikely to deal with yet another highly problematic issue in the EU: the lack of a formal mechanism to deal with a potential cross-border banking crisis that is too large to be managed by a single country. This is yet another potential surprise hiding in plain sight in the eurozone -- and yet another risk that will give any prudent central banker pause when thinking about ramping up relative euro exposure.
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Euro's Fiscal Policy Will Give Pause to Reserve-Currency Allocators | Ian Bremmer & Jon Levy
(c) 2010 Ian Bremmer & Jon Levy