‘The eurozone is like the Hotel California – you can check in, but you can’t check out’ – interview with Professor Barry Eichengreen

The National Bank of Hungary (MNB) dedicated the 2020 Lámfalussy Lectures Conference to sustainable convergence in Europe and Asia. They invited among other distinguished guests Professor Barry Eichengreen to give his thoughts on the topic. On this occasion Danube Capital R&A met Professor Eichengreen to discuss currencies, the future of the eurozone and ECB.

D.C.: You have written many articles and books about international currencies and especially about the role of the US dollar. Some say that the dollar will gradually lose its dominance in international transactions. Where are we heading especially considering trade war? Which currency (if any) could threaten the leading role of dollar, could this be a digital currency?

B.E.: I published my views about the US dollar in 2011 in my book ‘Exorbitant Privilege’ about the international role of the dollar. I argued that the international dominance of the dollar in cross-border trade finance could not last forever. Other economies would continue to catch-up with the US, and over time the US would account for shrinking share of global trade and transactions and it could not support the dollar as the currency of the US and the world either.

A feasible alternative would be a multi-currency system, in which the dollar, the euro and the renminbi also played consequential international roles. But in the absence of a serious international incident, this transition will only take place gradually. I believe that this is still the right diagnosis and prediction: the only viable alternatives to the dollar remain the euro and the renminbi. For the foreseeable future digital currencies are not likely to go anywhere.

Many people were uncomfortable in 2011 about dollar dominance after the 2008-2009 global crisis. They are even more uncomfortable about dollar dominance today than they were ten years ago. There is now the danger of a renewed trade war, of the US weaponizing the dollar in order to deny access to dollar credit to foreign companies and governments, even using the dollar as part of the US foreign policy. All this provides incentives for companies and governments and accelerate the development of alternatives.

But for the euro to be a meaningful alternative, there must be a safe asset in the euro area, upon which to build a euro-denominated financial infrastructure. Specifically, there will have to be Eurobonds. For the renminbi to become the serious competitor to the dollar, China would have to dismantle most of its remaining capital controls and strengthen its domestic financial markets. This is a very laborious process that will take time.

Thus, we are still in the uncomfortable no man’s land where the dollar dominates international transactions. People understand more clearly than they did, say, 10 years ago that this situation cannot last forever, but at the moment the preconditions for moving away from dollar dominance are not yet in place.

D.C.: What would be needed to strengthen the position of the renminbi to become a more dominant international currency in the foreseeable future?

B.E: China had a financial bout of instability in 2015, when the stock market crashed and there were once problems of a capital flight for about a year. These problems developed because they were internationalizing the renminbi too quickly, before they have done the necessary domestic reforms.

Now I think they understand domestic reforms should come first and that renminbi internationalization occur afterwards. At the same time, they are currently developing some ideas that might make it possible to promote the international use of the renminbi before their capital controls are removed, specifically through the issuance of a digital renminbi that might be usable for limited range of cross border transactions with a limited number of other countries.

D.C.: The 2020 Lámfalussy Lectures Conference focuses partly on sustainable convergence in Europe and the eurozone. What do you expect referring to the future of the eurozone: progress towards a deeper integration, collapse of the monetary union or a third way?
B.E.: My view for a long time has been that eurozone membership is forever. It’s like the Hotel California, where (as the Eagles said) ‘you can check in, but you can’t check out.’ Greece discovered this when Syriza came to power a few years ago. In case of Italy we will again see talk about whether leaving the euro would solve the country’s problems. But governments that have talked about this in the past quickly realized that talking about quitting the euro would only make things worse – it could precipitate an adverse financial market reaction and even a panic – so they changed their minds. That’s the case of Syriza and Greece.

Brexit was different. Brexit was possible in part, because they were not in the eurozone, otherwise that would have caused a financial crisis and a run on the banks.
As there is no way out, it leaves one alternative, namely, to make the eurozone work. Making the eurozone work means completing a banking union, adding a eurozone-wide deposit insurance and positive risk weights for government bonds that would limit banks’ ability to hold their governments’ bonds in excess. It means completing the eurozone’s capital market union.

These steps will go a long way making the euro more attractive to Europeans, but also to banks, firms and governments in other parts of the world. To make the euro into a leading international currency, it will ultimately be necessary to create a Eurobond in the long term. But that’s for the long term. In the short run, the priority should be completing the banking union.

D.C.: Christine Lagarde announced the strategic review of ECB monetary policy in 2020, what would you like to see as part of the change?

B.E.: I think a symmetrical inflation target, a proper 2% inflation target would be better than the current asymmetrical one (ECB definition of price stability:’ Below, but close to, 2%’). I published an article last week suggesting the ECB should vote on consequential monetary policy decisions and that it should release votes to the public. This is a way of making the ECB more accountable.

Currently we have a strange situation where the president of the ECB announces decisions are made by consensus and then various board members make speeches saying, ‘I didn’t like that’. Better would be a systematic process where people explain why they voted with the majority, and or why they dissented from the consensus. Releasing votes and explaining them would enhance accountability and transparency.

D.C.: Clearly there is a need to find new ways of monetary policy in a low interest rate environment more than a decade after the 2008-2009 crisis. There has been a lot of talks regarding the Modern Monetary Theory (MMT). What are your views on the MMT?

B.E.: Nobody knows exactly what Modern Monetary Theory is. The assumptions made by its proponents are not very clear. If Modern Monetary Theory is the idea that sometimes, under some circumstances, central banks can finance government budget deficits without inflationary consequences, then I think there are certain limited conditions when this makes sense. When the economy is depressed, and unconventional monetary policy (quantitative easing) is appropriate, then indeed it may be possible for the central bank to buy government bonds without inflationary consequences. But these are limited circumstances – specifically, circumstances in which the economy is depressed and interest rates have fallen to zero.

More generally, the ECB needs to clarify, as part of its current strategic review, about what the central bank can and can’t do (e.g. it has limited ability to fight climate change, however damaging climate change may be, and it has limited ability implement other social policies, however much people may object to the current distribution of income.). These other problems are for other agencies of government, with the appropriate tools, to address. The danger is that people expect central banks and monetary policy to solve different problems. But in practice there are some limits to what monetary policy can accomplish.

D.C.: Danube Capital’s mission is to aid SME-s by translating and interpreting macroeconomic, sectoral and sociological processes into everyday business language. What would you suggest to SME leaders to focus on in the upcoming 12 months? Where do you see the challenges?

B.E.: The danger I worry about of more conflict between the US and the EU over trade and technology. In the case of French tax on digital transactions. The Trump Administration is unhappy that the US imports more vehicles from Europe than it exports to it. Now that the trade conflict between the US and China in on the back burner, my fear is that the new target could be Europe. So, SMEs in Europe that sell part of their output, part of their products to the US, they have to worry about this.

About Mr. Barry Eichengreen, George C. Pardee and Helen N. Pardee Professor of Economics and Political Science, University of California, Berkeley
Barry Eichengreen is the George C. Pardee and Helen N. Pardee Professor of Economics and Professor of Political Science at the University of California, Berkeley. He is a Research Associate of the National Bureau of Economic Research and Research Fellow of the Centre for Economic Policy Research. In 1997-98 he was Senior Policy Advisor at the International Monetary Fund. He is a fellow of the American Academy of Arts and Sciences.

About Danube Capital Research&Analytics
Danube Capital Research&Analytics was established in 2019 as a member of MKB Group. In addition to providing professional service to MKB Group, the company aims to develop a service portfolio that supports Hungarian businesses in their growth. Danube Capital’s purpose is to contribute to the emergence of a successful corporate sector by translating and interpreting macroeconomic, sectoral and sociological processes into everyday business language. We prepare macroeconomic, capital market and sector analysis, as well as market research to our customers.