An Interview with Louis Pauly

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July 29, 2011

Was the current European crisis caused by a "lack of stability culture" or by the flawed architecture of the single currency system?

Louis Pauly: Both. There is great lip service to former, especially in Germany, but even they let its banks operate with too much leverage, too little capital.  It’s not a new story.

Based on your answer to (1), are the weak members of the EU community to blame? Or do the stronger members deserve blame as well?

LP: Both.

Missing is a certain fiscal burden-sharing mechanism. But in its absence, the core members do what is necessary in an ad hoc fashion when they are under severe pressure. It is not pretty, but it is politically acceptable.  A full-blown equalization payment system like the one Canada has – a fiscal federation – is still distant. But they are developing the functional equivalent. In the end, whatever that may mean in historical terms, Greece may not be a full partner in it.

See the JCMS article on my personal website for more on this.

Will the euro survive the crisis?

LP: Yes.

Would the break-up of the "one-currency-fits-all-model" represent a "Lehman moment," triggering another slump? On a related point, how tied up are U.K. banks in the crisis?

LP: Maybe, but not likely after all this notice.  Lehman was a surprise. It unleashed uncertainty.   The erosion of EMU is a long process of shifting and managing risks, and private investors have had plenty of time to diversify their portfolios.

U.K. banks are certainly tied up.  London is Europe’s financial centre.

How far are France and Germany willing to go to save the euro? What is their breaking point? Is it possible that Germany will, as Niall Ferguson alleged, kill Europe?

LP: They have no breaking point; they will do whatever is necessary.  They will save an EMU, even if it is smaller than today’s.  Saving EMU, saving Greece, Portugal, Ireland – this is the same thing as saving their own banks.  Will they save their own banks?  Absolutely, most certainly - my best guess, since I have no crystal ball.

Ferguson is paid to exaggerate and get people thinking (and fuming), so take his word with a grain of salt.