The future of economic governance in the EU - European Union Committee Contents

Examination of Witness (Question Numbers 49-81)

Mr Mark Cliffe


  Q49  The Chairman: Good morning, Mr Cliffe. My name is Lyndon Harrison. I am Chair of Sub-Committee A and we are most grateful to you this morning for coming in and helping us with our report on economic governance. Are you now able to hear me?

  Mark Cliffe: Yes, I can hear you clearly now, thank you.

  Q50  The Chairman: Thank you very much indeed. We will start the session in a moment and I will ask you whether you would like to make an opening statement, but, first, just a few housekeeping matters. There will be a record of this session; we will send the transcript to you. If there are errors or things you wish to add or adumbrate we would be most grateful if you could do that. I understand that there may be a pause on the line for some of the answers, so forgive us if we don't seem to be sharp off the mark, but we are very grateful indeed. Would you like to make an opening statement?

  Mark Cliffe: No, I'm fine. I've received an excellent set of questions so I'm happy to jump right in.

  Q51  The Chairman: Well then, let me ask you this one; what do you think of the likelihood that the eurozone might break up, either partly or completely; what are the factors that might cause this to happen; and how would it benefit a member state that was either being evicted or which chose to leave?

  Mark Cliffe: I think the issue of the probability of the eurozone breaking up is as much a political as an economic question because, ultimately, if a country is prepared to make the appropriate economic sacrifices it can remain within the monetary union. I think it's fairly clear in the light of the events of the last year or two that the probability, whatever it is, of breakup has risen significantly. I think the economic crisis has revealed a number of structural flaws within the monetary union—of course some people would say that those flaws should have been evident from the outset, but it is certainly clear that the markets now put a significantly higher probability on at least some exits from monetary union over the next few years. You can see this from the very wide bond spreads that we have within the eurozone at the moment. There have also been a number of surveys of businesses and market participants. For example, there was a survey in June that revealed that 50% of executives and bankers in this particular poll expected that there was a chance of at least one exit within the next three years. It was more likely than not. I think it is certainly the case that the markets are now much more concerned about the possibility of a breakup than they were a year or two ago. What are the conditions that would drive this breakup? Well, clearly it's anything that undermines the wisdom of common monetary policy and the political support to maintain it. The most obvious factor that would precipitate a breakup would be sustained weak economic growth, whereby some of the members judged it to their economic advantage to leave the monetary union in order to depreciate their currencies and potentially lower their interest rates to boost their economic activity. A second factor, obviously to some extent related to this, would be rising budget deficits which might lead to higher bond yields; this is market discipline kicking in, as we saw around the back end of last year with the emergence of problems in Greece. This puts considerable pressure on Governments to impose potentially politically intolerable fiscal austerity measures. That would be another trigger for a breakup or an exit from monetary union. But we can't exclude the possibility that some of the stronger members of the monetary union might wish to leave if they felt it to their advantage, if they were perhaps being forced to pursue excessively inflationary policies or if they were being asked to bail out the weaker members; one has in mind of course Germany in this context. A number of commentators have suggested that the Germans and perhaps a number of other core eurozone members might wish to leave. That's another possibility that can't be excluded. In terms of the benefits for a member state leaving, clearly this would be largely revolve around the issue of gaining renewed independence in terms of monetary policy—and fiscal policy, I hasten to add. There could indeed be an immediate benefit for weaker members of the union from a sharp depreciation in their currency. I think the longer-term benefits would really revolve around renewed independence in terms of policy making, but I hasten to add that the benefits would come along with considerable costs. I'm not sure whether you have seen the report that we published at ING in July which was called Quantifying the Unthinkable, where we made the point that regardless of the longer-term benefits of exit there would be severe transitional costs for any members leaving the monetary union. There would obviously be severe logistical and legal problems with such a step. There would be the risk of substantial capital flight and systemic distress in the financial system. I think there would be massive damage to consumer and business confidence and a need to tighten fiscal policy aggressively in order to restore confidence in the bond markets. These transitional costs, according to our estimates, would be huge. We are not dealing with some kind of abstract theoretical world about whether this is an optimal currency union or not; but rather the hard reality that the members are in it, there is no provision at the moment for exit and therefore there would be very substantial transitional costs from any kind of exit.

  The Chairman: That is very useful indeed. May we explore that further? I turn to Lord Hamilton.

  Q52  Lord Hamilton of Epsom: The question of managed default has been raised by the Germans, although it hasn't been adopted by the Commission. Can you just take me through how managed default would actually happen and work? I am unclear in my mind as to how this could be processed through. Presumably the Germans have given this some thought. Have you?

  Mark Cliffe: Yes. I think certainly there are a number of ways in which this would work. Essentially the idea is that the burden of default would not fall entirely on taxpayers. This has of course been the impetus behind the German push towards some kind of managed default process. In other words, the bond holders would have to share the pain. Obviously, the degree to which they take the pain is something for discussion and negotiation. The pain would perhaps involve a write-down in the principal on the bonds or alternatively some kind of reduction of the coupons or interest payments, or delay to the repayment of the principal on these bonds. Obviously, some kind of process would have to be put in place to decide exactly how big these losses are that are imposed on the bondholders. In the market vernacular, these are called "haircuts". The markets have a tendency to overreact, fearing the worst; and therefore the presumption would be that the haircuts perhaps would be less than current market pricing. The precise details of the burden-sharing, as it were, would obviously have to be worked out, and I think this is where a considerable amount of work will be going on right now in devising this managed default mechanism.

  Q53  Lord Hamilton of Epsom: Are you saying then that if the European banks took the full hit of the devaluation, for instance, of the Greek currency, that would create a banking crisis across Europe?

  Mark Cliffe: Well of course this is a related problem.[1] I think this is perhaps something about which there has been an awful recognition on the part of the core countries which are, of course, the principal holders of the debt of the weaker members on the eurozone's periphery. German banks and French banks are particularly exposed and so at one remove it, as it were, comes back to the state as a problem. As you well know, the financial crisis has forced European Governments to step in to support their banking systems, so sovereign default and bank default are obviously closely connected crises, as we've discovered.

  Q54  Lord Hamilton of Epsom: Is there a role for the European Central Bank to step in and purchase Greek Eurobonds in these circumstances?

  Mark Cliffe: Well it already has been, and I think this is part of the concern of the Germans and others that the ECB has already been purchasing the government debt, not just of Greece but of other affected members. Of course this has evoked considerable controversy in Germany; not least at the Bundesbank itself, because the ECB now is running a considerable credit risk on these holdings of eurozone government bonds.

  Q55  The Chairman: Do you think that a well managed default is compatible with remaining in the membership of the eurozone?

  Mark Cliffe: Yes, I think it is. Indeed, I think a well managed default is implicit in the insistence on sticking to the so-called no-bail-out clause within the Maastricht treaty. One has to remember that exit from monetary union does not in itself solve your fiscal solvency problem; in some ways it makes it worse, particularly if the leaving member—let's make a presumption here that it's one of the weaker members—does not redenominate its debt. For example, hypothetically, if Greece were to leave the monetary union and was obliged to honour its euro-denominated debt, its fiscal solvency problem would be greatly exacerbated. So the presumption that most people in the market have is that, if Greece were to leave the monetary union, it would redenominate its existing debt into new Greek Drachma, as it were. But of course that doesn't in itself solve the debt to GDP burden that it's currently facing.[2] Leaving the monetary union does give them the possibility of growing faster and growing in such a way as to generate more income to repay those debts. That's the logic. So in itself, exit from monetary union is not a solution to the fiscal solvency problems of the weaker members of the union.

  The Chairman: Thanks very much. Lord Trefgarne is interested in this topic.

  Q56  Lord Trefgarne: Thank you my Lord Chairman; good morning Mark Cliffe. If we put in place arrangements for orderly withdrawal of countries that find themselves in difficulties, does that not create the possibility that they would all rush for the exit if the situation got bad?

  Mark Cliffe: I think that's absolutely right, yes. I think the logic of this at the moment is there is no provision for any member to leave monetary union. This is meant to be a permanent monetary union. Of course, the idea that any member could leave would create a very damaging precedent; of course the markets would then start to speculate about other members of the union departing, which is why there is clearly a big incentive, in terms of the crisis resolution mechanisms, for there to be fallback provisions to support the existing members of the union. So if one county gets into difficulty then one has to assume that there's also money in a fund, for example, to support other members who might be close behind in terms of getting into difficulty.

  Q57  Lord Trefgarne: Thank you, but if a country is faced with difficulty, it can't leave, but if somebody is ready to bail them out one way or another—although that's not the words that they use—there is not much incentive for them to put their house in order, is there?

  Mark Cliffe: I think there is because I think what's envisaged here is that there would be pressure on the country to tighten its fiscal stance under the arrangements. There would also be some kind of bail-in provision whereby debt holders would suffer losses. So while it is true that a lot of the debt of these affected countries may be held outside the country concerned, there would certainly be problems for domestic bondholders in any bail-in provision that would be set in place in this kind of mechanism.

  Q58  Lord Trefgarne: Should we have let Greece default—I say we, it wasn't down to us; but should Greece have been allowed to default?

  Mark Cliffe: I think many Germans would probably agree with that assertion, but of course the problem is that the creditors are also on the hook.

  Q59  Lord Trefgarne: I am asking whether you agree or not, it's your opinion I'm looking for.

  Mark Cliffe: Sure. Personally I think it would have been very difficult to have managed this process,[3] given what we were talking about earlier on—that this would have set a very dangerous precedent and would have required a long preparation. If you remember how many years it took to prepare for monetary union, preparing for exit, if anything, would probably be just as complicated. Going back to the point I was making earlier, the transitional problems of exit cannot be disregarded in this process, regardless of the hypothetical benefits that there might be for Greece in the longer term. Just to say one thing on Greece itself; it faces a huge economic challenge in terms of being able to stay in the monetary union. It is obviously now facing a prospect of many, many years of fiscal austerity and severe adjustment in terms of wages and prices, which is very politically challenging.

  Q60  Lord Trefgarne: If the countries gathering around Greece last time had not been prepared to do what they did, she would have defaulted, presumably, and then just have been ejected from the mechanism.

  Mark Cliffe: Well, it wouldn't necessarily have been ejected from the monetary union.

  Lord Trefgarne: Well, that's what I mean.

  Mark Cliffe: I think we have to differentiate between default and exit from the union. One could argue that the principal problem is a fiscal one and that in the first instance, at least, a default would give relief on that problem. But of course in the longer term the issue isn't simply about fiscal discipline, it is also about Greece's ability to grow. If the Greek economy can't grow it's never going to be able to repay its debts.

  The Chairman: Let's pass on. Lord Haskins.

  Q61  Lord Haskins: Thank you; just on the issue of default, there are defaults and defaults. You are probably are aware that the Anglo-Irish bank, which is owned by the Irish Government now, is renegotiating the terms with certain of its bondholders. Is that a default and is it a default of the bank or is it a default of the Irish Government?

  Mark Cliffe: Sorry, I'm not quite with you here. Basically if they are renegotiating the terms of the bonds, that is to all intents and purposes a default. I mean, a restructuring is typically a more politically correct term for default.

  Q62  Lord Haskins: But two years ago the Irish Government assured the bondholders that their position was secure. The point I'm trying to make is there are defaults and defaults; this seems to be an acceptable default, but when does it become unacceptable?

  Mark Cliffe: Well I suppose it's a question of the circumstances of the time, because they probably made that pledge in good faith and they didn't anticipate that the situation would continue to evolve as it has, which has obviously not been very pleasant for the Irish state over the last couple of years. So that's presumably the logic behind this decision.

  Q63  Lord Moser: You know that we in this Committee are very much concerned with economic governance generally in the EU, so it's quite important for us to understand to what extent progress in that direction would help against a breakup or whether it is virtually irrelevant.

  Mark Cliffe: I think this is actually extremely important, because I go back to the point that I made, which is that the integrity of monetary union isn't just about fiscal discipline and fiscal responsibility; it's also about economic growth. Therefore, economic governance has to concern itself not just with fiscal balances, it has also to look at underlying real economic balances—and also financial stability, I should say. For example, if you think of Ireland and Spain, they were actually running budget surpluses in the run-up to the crisis. With the benefit of hindsight we can see that those surpluses were based on a bubble in the real estate market, which of course has burst. So had there been more attention paid to what was going on in the private sector—obviously in this case, specifically in the real estate markets—we might have stood a better chance of taking pre-emptive action to avoid the kind of imbalances that eventually emerged and created the problems.I also mention financial stability here, because, to go back to the point we touched on earlier, there is clearly a connection between the fiscal problems and the problems of the financial sector. So we need to be clear on the kind of risks that are being run within the financial system as well. That is something that needs to be monitored at the same time as part of this new system of economic governance and surveillance.

  Q64  Lord Haskins: Presumably all the European nations, whether they are in the eurozone or not, would like to avoid a walkout. I mean, presumably none of them are hoping for a walkout. If that is the case, roughly speaking, the question is whether Van Rompuy's taskforce goes far enough, or is strong enough, to help avoid the breakup, or whether it is a bit too weak.

  Mark Cliffe: I think this is a very good point. I think what we come to here really is a matter of political will. To go to your point, it's very clear that the political will to sustain monetary union is still very strong. Angela Merkel herself, and I will just read the quote to you from our report, said in May, "If the euro fails it is not only the currency that fails, then Europe fails. The idea of European unity fails". The problem with this is that it then becomes a question of: is there sufficient political will to countenance the kind of fiscal transfers and burden-sharing that would make it sustainable in the long run? Many Germans pointed out that monetary union should have been preceded by political union, not followed by it. Now we are discovering the truth of that observation because the Germans' patience for bailing out the weaker members of the monetary union is wearing extremely thin. I think there are some really hard discussions to come in coming up with a really durable system of economic governance for monetary union.

  Lord Haskins: Thank you very much, that's very helpful.

  Q65  Baroness Hooper: Mr Cliffe, you referred earlier to the part played by the crisis-resolution mechanism. In your opinion, should there be a permanent crisis-resolution mechanism and if so what form should it take?

  Mark Cliffe: Well, certainly from the point of view of the financial markets they would like to see this put in place. Of course the devil is in the detail, as we have been seeing over the last few days. In the midst of this debate the markets have now started to recognise that the so-called bail-in process, whereby the bondholders would have to take some of the pain from countries getting into difficulties, has led to a substantial sell-off in some of these markets. Nevertheless I think they would like to know what the rules of the game are, and then the markets could go ahead and start to price in what is likely to happen.I think it's also important in terms of setting in place the right sort of incentives for politicians and policy-makers. Of course, ultimately, this does beg the question of the political will actually to stick to the rules. I think that part of the problem that the markets have been wrestling with is that the original stability and growth pact was not actually fully enforced. Indeed the Germans themselves backed away from it when they themselves got into difficulty in the early part of the last decade. I think the markets really want to see something that is convincing, that is clear, and then we can perhaps get to a position where the risk premium that we see in the bond markets starts to subside and this itself provides an economic benefit for the countries in the eurozone, because clearly it's in nobody interests that we see consistently high long-term interest rates.

  Q66  Baroness Hooper: Thank you. So do the European Financial Stabilisation Mechanism and the European Financial Stability Facility go some way to meet the requirements?

  Mark Cliffe: I think they do. I think the problem is that the EFSF is due to lapse in 2013; hence the debate about what comes next. One of the important issues about this, apart from the precise details of how this actually works is, are these funds sufficient? The markets recognise that Greece, and indeed Portugal, are relatively small countries; while obviously they have substantial debts in relation to the size of their economies, in the broader scheme of things the markets could absorb the losses that might flow from some kind of restructuring of their debts. However if we were to look at a country like Spain, or, worse still, Italy, then that's a completely different question because the scale of their debts are far greater; in fact the Italian government bond market is the biggest in Europe, so therefore you can see the problem. We would need to see a fund in place which is of convincing size.

  Q67  The Chairman: So it would be a permanent crisis-resolution mechanism, Mr Cliffe, would it? Would it apply to the eurozone and, beyond, the rest of the EU, and would there be any role for the IMF or the ECB in developing that?

  Mark Cliffe: On the technical sense one we would certainly expect to see—the European Central Bank involved in the development of this. Indeed it is already involved; the boundaries between monetary and fiscal policy have become distinctly blurred during this crisis, of course. As for the IMF, I think this again is partly a question of politics and partly a question of credibility. I think for both reasons the Germans were very keen to have the IMF involved with the fund that was put in place back in May. Whether that is something that the members would want to have in future I somehow doubt. I think there's obviously a strong preference for a European solution, because where is the money ultimately going to come from? Ultimately, it has to come from eurozone taxpayers, I would say.Your question also raised the question of whether this would also involve non-eurozone members like the UK. I think that's again more of a political question—is this an act of good will on the part of UK and other non-members to be communitaire and really play their part in the interests of the broader stability of the European Union?

  Q68  Lord Jordan: Good afternoon. The competitive imbalance between Germany and Greece is substantial. It's not likely to change very much in the future; it can improve a bit but it's not likely to change. Can the eurozone survive a continuing competitive imbalance between member states?

  Mark Cliffe: Certainly life would be a lot easier if economic activity was growing rapidly. I go back to the point I made earlier which is that, of course, in the end, if you don't grow you can't repay your debts anyway. A small economy like Greece is obviously very much dependent on what's happening in the rest of the world, in its trading partners. If we have a buoyant global economy then these imbalances can be papered over. Of course, the flip side of that is that if we see a renewed recession then they are in deep trouble because of the competitiveness gap that currently prevails. That is why these economies are now being effectively threatened with years of austerity—not just fiscal austerity but pressures on the private sector to improve competitiveness which would involve potentially downward pressure on wages and efforts to improve productivity by whatever means. Of course the Germans will point to the restructuring that they have been through over the last decade, but the challenge for these economies is that they are potentially facing a very deflationary scenario because in order to regain competitiveness—unless you can find the means for a productivity miracle—you have to reduce your wage levels if your trade partners are running very low inflation rates. Deflation is a situation that is very difficult to manage economically, and indeed politically.

  Q69  Lord Jordan: Do the markets believe that some of the measures now being pursued by the European Community, such as the crisis-resolution mechanism and other mechanisms, will help countries to improve their general competitiveness?

  Mark Cliffe: I think if you look at what has been happening to bond spreads over recent weeks, the answer to that is no at this stage. At the moment the focus is really more on the fiscal aspects of the probem than the underlying real economic aspects of the problem. We've had endless debates across Europe for the last 10 to 20 years about improving economic performance, improving the structure of the European economy, and I think the markets are rather sceptical about the ability of European politicans to deliver on this. This is where there will have to be more work done in the longer term if monetary union is to be truly sustainable.

  Q70  Lord Woolmer of Leeds: Good morning Mr Cliffe. Could you tell us something about the current state of proposals on the matter of macroeconomic surveillance and, in relation to that, what are the essential variables that would have to be considered to determine whether or not an imbalance exists?

  Mark Cliffe: My impression is that this is still at a fairly early stage of discussion. One of the reasons for this, I think, is that there is probably a greater emphasis from some of the core countries on fiscal discipline than there is on improving economic performance. I think that in this regard there are a whole host of variables that would need to be monitored closely in terms of macroeconomic surveillance; this would include trade and capital flows; I think it would include divergences in price and cost competitiveness; I think it would include an examination of private sector indebtedness—going back to the remarks I made earlier about the likes of Spain and Ireland. I think there would also have to be monitoring—just in general, of what's going on in the housing markets, which of course have been the source of many of the difficulties through the course of the financial crisis. Related to that, of course, is monitoring of credit and monetary growth, and in turn the balance-sheet strength of the banks. I think all of those things would need to be watched very closely.

  Q71  Lord Woolmer of Leeds: Who would do that monitoring and, having monitored, who would decide what actions, if any, needed to be taken by which country, and how would that be enforced, given the complexity of the variables you have just mentioned?

  Mark Cliffe: Clearly it is not an easy exercise. In terms of the institutions that are qualified to do this, I would imagine that you would have to be looking at arms of the European Commission and also the European Central Bank, but one could also envisage that a separate body might be set up to do this, perhaps at somewhat arm's-length from the political arm of the European Union, maybe to give it greater credibility and room for making independent assessments.

  Q72  Lord Woolmer of Leeds: Would markets be impressed by monitoring bodies; wouldn't they want to know who would do what, what actions would follow, what enforcement mechanisms there would be over—again I say—a wide variety of economic variables: fiscal, monetary, trade, you've mentioned, and competitiveness? What body could possibly not only monitor but take actions and enforce them that would satisfy the markets?

  Mark Cliffe: Sure, I think you have to make a distinction between the surveillance aspects and the analytical aspects if you will, and the policy and political aspects of enforcing the necessary responses to any problems or imbalances that were identified during the course of the surveillance.

  Lord Woolmer of Leeds: Finally—

  Mark Cliffe: And you know that's obviously—

  Lord Woolmer of Leeds: Carry on. Sorry.

  Mark Cliffe: Sorry. I would say that this is something that the euro group will probably have to, in the end, take the lead on and that this would have to go to the highest levels of Government for agreement, because the markets obviously want to see a clear commitment from the politicians actually to act upon those problems rather than just monitor them.

  Q73  Lord Woolmer of Leeds: There has already been established, or is being established, a macro financial stability committee of Finance Ministers, the European Central Bank and so on. I assume that this extra surveillance could not be done by that body. This would have to be an additional body.

  Mark Cliffe: Not necessarily. I would have thought that would be one body that could take on this task. As I say, you come back to your very important point: how is this actually going to be enforced? That is something that the politicians would have to come up with some kind of clear answer to, frankly.

  Lord Woolmer of Leeds: Thank you.

  Q74  Lord Vallance of Tummel: Chairman, first, I need to declare an interest as a member of the International Advisory Board of Allianz SE, the insurance and financial services group. Perhaps, Mr Cliffe, that leads me into my first question, which is: a number of my German colleagues would argue strongly that there is no culpability in running a large account surplus; that is just a function of their competitiveness. Do you share that view or would you see large surpluses as equally undesirable as large deficits?

  Mark Cliffe: I think for the country concerned they are not equally undesirable. Clearly if you are in the advantageous position of being a substantial creditor, that gives you a lot of freedom for manoeuvre; you are not going to be at the whim of your creditors in the way that debtors are. I think the issue here which creates a problem for monetary union is that countries that are systematically running surpluses may therefore be creating problems for the debtor nations to the extent that they are not stimulating demand. If the surplus is a reflection of weak domestic demand then clearly that is a problem for the debtor nations, because who are these debtor nations going to be exporting to in the future? So this is the source of the tension and it is a sort of collective action problem because, of course, in the longer term, not everybody can export their way out of difficulty. Maybe we could make an argument for the European Union operating as a greater Germany—in other words becoming an export-led zone in the global economy—but I am not sure that this is going to be very well received by the international community, not least the US, which of course is at the moment on a campaign of global rebalancing; the focus of their ire at the moment is Asia in general and China in particular. But I think the Germans, who are very keen in this global context to point out that the eurozone is not running a substantial surplus, might find that their kind of economic model is not one that can be applied to the eurozone as a whole.

  Q75  Lord Vallance of Tummel: I think we accept—don't we?—that there should be some sort of penalty for running excessive deficits; I think that is more or less understood. But is there such a thing as an excessive surplus, and if so, should that be penalised?

  Mark Cliffe: This is indeed a very difficult issue, because Europe isn't actually on another planet and in principle there isn't a particular problem with the eurozone collectively running a surplus with the rest of the world. Obviously, within that the picture what we see is that Germany is the dominant player in Europe and it's obviously in absolute terms running far and away the biggest surplus in Europe. I think it is very difficult to identify the point at which a surplus would become excessive. This is where the matter of judgment comes in, which is rather unfortunate, because people are rather keen on having rules rather than discretion in this regard. Rules are being imposed on the debtors but not on the creditors and that's, I think, just an unfortunate fact of life.

  The Chairman: Thank you very much indeed. Lord Hamilton, before we move to our final set of questions from Lord Haskins.

  Q76  Lord Hamilton of Epsom: Can we just return to Lords Woolmer's point about monitoring and surveillance—which, I think we are all agreed, is pretty meaningless unless it is followed with enforcement. If enforcement was going to be introduced, could that be done within the existing treaties or would this mean a new treaty would have to be drawn up?

  Mark Cliffe: That's a good question. I think it would be very difficult to have a convincing enforcement mechanism without some kind of treaty change. Of course we have in the stability and growth pact, the idea of penalties, but they were not enforced. I think the markets will remain sceptical of these penalties and of sanctions really being enforced unless there is some more substantive change in the legal framework. I think that that would probably be the judgment of most market operators.

  Q77  Lord Hamilton of Epsom: But Mr Von Rompuy has ruled out any idea of a new treaty, so that means we are a bit stymied on that one, doesn't it?

  Mark Cliffe: Yes, it's indeed going to be extremely difficult. I think that the question here is to what extent the burden is going to be placed on the bondholders—in other words, the market players—as opposed to, as it were, the recalcitrant states. Because if we are going down a path where, effectively, the problems lead to a bail-in of the bondholders, you are likely to see continuing problems in terms of the level of interest payments that some of these states will have to pay, because, having had their fingers burnt during this crisis, the markets are not going to be in a very forgiving mood. Hence I think there is a need for some more substantive change to make this sustainable in the longer term. Of course, they could get lucky and we could have a burst of strong economic growth over the next two or three years but that's clearly not something you would want to rely on.

  Q78  Lord Haskins: We are all struggling with this idea of penalties and punishment for people who behave badly. The only thing that really concentrates national treasuries' minds is when they go out to borrow money in the bond market and find that their rates are going up very high. That certainly is the ultimate penalty that they have to suffer. Why, however, did the bond markets not see all this coming? In other words, had Greece, Ireland and Portugal been faced with paying more for their money than they were in the run-up to the crisis, would that not have changed the situation very dramatically? Why did the markets not spot this coming—perhaps nobody did—and could we find a way of making sure that the markets are more responsive in the future, because that is the real way to concentrate people's minds.

  Mark Cliffe: I agree, and I think that this is certainly the logic of the German position on bail-ins, which is to make it crystal clear to the markets that taxpayers will not be offering blank cheques in future. Of course, it's easy with the benefit of hindsight to say that the market should have realised that this was a problem, but I think there is another dimension to this which is that the markets were always rather sceptical of the political will to stick to the "no-bail-out" provisions in the Maastricht treaty. In other words, they thought they were going to be bailed out. That's always the source of the problem. This is an issue: when it comes to the crunch will Governments be prepared to let the pain be inflicted on the bondholders, bearing in mind that a lot of the bondholders are actually in the creditor nations of Europe? We go back to the point made earlier on, that the Germans and the French are overly exposed to the government debts of southern Europe.

  Q79  Lord Haskins: And do the markets still think that governments will bail out the bondholders or have they leant their lesson?

  Mark Cliffe: Well I think if you look at the current level of bond yields I think they've learnt the lesson.

  Q80  The Chairman: Two final questions if I may, Mr Cliffe. Does the creation of a permanent crisis-resolution mechanism constitute an important step towards the creation of a minimal fiscal Europe, and could you say a little bit more in relation to your last answer? Would a permanent mechanism result in moral hazard, or is moral hazard a figment of the imagination of economists?

  Mark Cliffe: To take this as a whole, I think this really begs a question of where the money is coming from for the stabilisation mechanism, because I think the central problem that German politicians have identified is that, at the moment, Germany is most exposed to picking up the bill if there are any difficulties in the monetary union. That is clearly a position that they find unacceptable and that the German people find unacceptable. Hence, if there is going to be some kind of crisis-resolution fund put in place, let's call it a European monetary fund, for want of a better term, who is going to put the money into the pot? Well, the idea is that the countries that are running high budget deficits or have high public debts should be putting in a disproportionate amount of the funding for such a fund. In other words, this is like an insurance fund and this, hopefully, will get round some of the moral hazard problems—as it were—that we currently face under the current regime.

  Q81  The Chairman: Mark Cliffe, the Committee is tremendously grateful to you for speaking to us this morning. As I mentioned earlier, if there is anything you wish to add to your evidence we would most grateful if you could write, and if you could examine the transcript of this meeting just to correct anything which is inaccurate. Again, we are most grateful to you Mark Cliffe, and thank you for speaking to us from Amsterdam. Thank you, dank u wel, tot ziens.

  Mark Cliffe: Well thank you very much. It was a great privilege and I'm sorry that I couldn't be there with you in person.

  The Chairman: Thank you very much indeed.

1   Note by witness : To clarify: "managed default" by a Eurozone member state in its government debt does not necessarily require (indeed, may be motivated by the desire to avoid) the devaluation that would follow exit from monetary union. However, such devaluation would impose currency losses on the foreign holders of the leaving member's government debt which would be akin to the effects of a default. Further it is possible to conceive of situations in which the devaluation of the currency and default would both occur, compounding the losses for foreign holders. Back

2   Note by witness: In the first instance the redenomination of existing debt would simply leave Greece where it started in terms of its public debt to GDP ratio, since both would be recalibrated in new Greek Drachma. Back

3   Note by witness: To clarify: this answer mistakenly addresses the question of a Greek exit from monetary union, not default per se. The answer to Q61 gives a fuller clarification of the distinction. Back

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