Avoid a monetary bloc, says economist

17:00, May 24 2013

Europe may feel extremely distant from New Zealand, but economist Oliver Hartwich believes the continent's ongoing debt crisis should be watched more closely than ever as an example of what not to do.

Addressing an audience of investors at the annual Russell Investments conference in Wellington, the executive director of the New Zealand Initiative think-tank said the primary lesson from the euro zone was do not enter monetary unions.

The NZ Initiative was formed out of the Business Roundtable and the NZ Institute.

"Europe remains the biggest risk to the world economy, and it is quite likely that we will see a new global financial crisis in the next few years," Hartwich said.

"Just this time [not only] with Lehman Brothers and Greece, but with France, Italy and Spain at the centre."

The merits of New Zealand and Australian economies uniting under a single currency have long been debated to the point where the New Zealand Productivity Commission was last year asked to explore the merits of the idea.


And while the commission deemed it unfeasible, the lower interest rates and foreign exchange costs offered by such a deal mean it could still appeal to certain segments of the economy.

New Zealand has an AA sovereign credit rating, one full notch lower than Australia. In the latest quarterly trade figures Australia became the second biggest consumer of NZ exports, after China.

But Hartwich said one only had to look at risks posed by the poor economic design of the European Union to see why a monetary bloc was a bad idea.

An example was the "Target 2" bank transfer system, which was set up to handle normalised money movements among banks in the member states.

However, as the crisis has worsened and private capital has dried up, core central banks are having to step in and fund trade imbalances among the heavily indebted member states.

These commitments have grown to the point where creditor countries are funding this gap at the expense of their own economies, but cannot afford to stop doing so for fear realising a massive loss should a debtor country default.

Germany's Bundesbank alone is on the hook for € 608 billion, outstripping the € 190b the country has committed to the European Stability Mechanism - an exposure that's getting the German constitutional court and central bank increasingly concerned. "What was once meant as a technical tool to facilitate bank transfers has become a doomsday machine," Hartwich said.

The cure to the crisis was for the European Central Bank to step in and guarantee the solvency of all governments and banks in the EU - but the sum required to do this was so big no one could borrow it, let alone afford it, he said.

Meanwhile, the debt levels continue to climb. Recent figures show member states needed to raise € 375b to fund their budget shortfalls, taking overall debt to € 8.6 trillion, equivalent to 91 per cent of eurozone GDP.

The bitter pill, said Hartwich, was that as long as Italy, Spain, Portugal and the like stayed in the EU, the less chance they would have of ever righting their economies through currency depreciation.

Hartwich said ultimately the lesson for New Zealand was to live within its means and fiercely defend the independence of its currency and central bank.

"There is little good coming out of the euro crisis. But if at least we can keep these lessons in mind, then we should be able to avoid a replay of the European crisis in New Zealand."