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Conference call with David Marsh, co-chairman of the Official Monetary and Financial Institutions Forum (OMFIF)
The Atlantic Council of the U.S.
September 14, 2011
11:00AM CT

Operator: Excuse me, everyone. We now have David Marsh, co-chairman of the Official Monetary and Financial Institutions forum, and Alexei Monsarrat, Director of Global Business and Economics at the Atlantic Council on the line. Please be aware that each of your lines is in a "listen only" mode. At the conclusion of the remarks, we will open the floor for questions. At that time, instructions will be given as to how you can proceed if you’d like to ask a question. I would now like to turn the conference over to Mr. Monsarrat who will be offering some introductory remarks and introducing Mr. Marsh. Mr. Monsarrat, you may begin.

Alexei Monsarrat: Thanks very much and thanks, everyone, for joining us today and thanks to David for being available on such short notice. We’ve pulled this call together because of everything that’s happening right now in the Eurozone and there are an awful lot of developments coming at us very quickly and I wanted to pull in one of our good friends and an extremely knowledgeable person on the workings of Europe and its central banking community and its overall finance community to help give us a little bit of perspective on what’s going on and where we might be headed. As I think most of you know, this has been a pretty tough week. Juergen Stark’s resignation from the ECB, the German court case that came out with mixed results for what it means for the future of Germany’s ability to partake in European financial stability mechanisms, rumored and then unrumored conference calls and announcements by Merkel and Sarkozy. Barroso’s assertion today that maybe they will do Eurobonds there and all with the background of the financial markets that are going up and down like a rollercoaster. So, we bring to you David Marsh, who’s coming off two days of conferences at the UFB Investment Bank and who is always on the phone with people in Europe. As most of you know, he has a long-time background as a reporter of the Financial Times and lawyers and a career in investment banking. He’s now with SCCO International and co-chairman of the OMFIF and has just updated his 2009 book on the Euro and, David, I would start with your piece in the Financial Times yesterday, and one of the points that you make there that I think would be an interesting thing for people to hear is: Is Europe heading into a fourth round of its monetary evolution? Why do you think so? And what is that going to look like as we go forward?

David Marsh: Yeah. Thanks. Good afternoon, ladies and gentlemen. Very good to be with you. We are getting into a spirit of a new historical dimension, I think, in terms of money, and what I was saying in the FT article also is that there have three great monetary upheavals, two brought about by war and one brought about by the fall of the Berlin Wall in German history since the 1920’s. The reform of the mark after the First World War and the replacement of the Reich’s mark by the D-mark in 1948 and then a much more benevolent episode, the Euro came in between 1999 and 2002; that’s when it replaced fully the old Deutsche mark with the setting up of economic and monetary union in Europe. And I have a mind that a fourth period is upon us, maybe not as cataclysmic as we’ve had in the periods after the two world wars, but still a very important time when the monetary order for Germany will change once again. I think the Euro will still be with us, but it will be a new Euro. It’ll be a Euro which is less ambitious, smaller, and will contain more convergent countries. It could easily be quite a stable and actually quite an expensive currency, if the right countries leave, and if the critical countries, above all, Germany, are there, then clearly the new Euro will be a lot higher valued than the present one. That’s one of the things that is slightly disturbing. But let me just go into the recent background, because you mentioned, Alexei, there’s been a whole series of news developments and there must be four different crises at the moment, but Mrs. Merkel, the German chancellor, is trying to deal with; that’s the crisis at the Bundesbank and at the ECB. Mr. Stark, who resigned on Friday; although, he’s going to stay on for a few weeks. He’s extremely well known and very diligent, tireless, honest, very loyal policymaker, who’s been on the ECB executive board now for five years as the sort of chief economist. The de facto number two to Mr. Trichet, who’s the president, and he’s resigned because he feels he can’t get his own way because the ECB has been buying up rather large quantities of weaker country state bonds, and that’s opposed by the Bundesbank and opposed by Stark. And it’s a dramatic step to resign over something like that, because Mr. Stark, who’s a very experienced person, he was the sherpa for Chancellor Kohl for instance in the 1990’s. He knows that that was going to have an enormous reaction on financial markets, but he did it. We don’t fully know the reasons, but he did it, because he’d come to the end of his mettle. He realized he could no longer argue effectively on the board, particularly with Mr. Trichet, the president, with whom he seems to have had a blazing row, according to some reports. Anyway, that’s crisis number one.
Crisis number two is in the German population, because the Germans don’t like the idea that they’re going to be called upon to pay the debts of the rest of Europe. And the Germans might look quite powerful and rich to the rest of the world, but they don’t feel all that powerful or rich because they feel that they have tightened their belts over the last 10 years to get their competitiveness in order and they have sacrificed living standards at a time when people in Ireland and Greece have had increases in public sector wages of 100 percent since they were in monetary union. The Germans have had stagnant living standards. There is an almighty revolt in the German public against Mrs. Merkel and it’s almost certain that she will not be reelected in a couple of years. It will be a different government when we have the next elections. She’s on to a highway to nothing, electorally.
The third big battle is really within Europe with the debtor countries; the Greeks, but not only the Greeks. Now, the Irish and the Portuguese, who have been asked to undergo very dramatic austerity programs to make up for all the loose living that they did in the early years of the Euro and they’re getting into classic debt deflation, like during the 1930’s. The more they cut spending, the more the economy goes down, the lower the tax base, the bigger the deficits, and the more austerity they’re being asked to pile on because they’re not managing to keep to the deficit target. So, this is a crisis of liquidity and solvency and it’s almost inevitable the Greeks will have to default, because they simply won’t be able to meet the targets for various IMF and European Union-imposed budgetary programs.
And the fourth crisis is on the wider capital markets. There has been a run out of the Euro over the last few weeks. The Euro has fallen by about 5 percent against the Dollar and that is because of the worries about the solvency of the banks in Europe, many of whom are exposed to the weakest countries in monetary union, and people think that the banks could just about survive without too much trouble a default by Greece or Portugal or even by Ireland, which are the three most exposed and most weak countries, but the facts couldn’t survive unscathed if two of the largest economies in Europe; that is, the Italians and the Spanish were to go down as well. And there have been fears that the Spanish and the Italians are being hit by the so-called contagion.
So there is big brushfire of different crises here in Europe, maybe just one last word about the famous Eurobonds. We heard today, as Alexei said, to be somewhat hapless Jose Manuel Barroso, the president of the European Commission, putting forward one more time that may be collective borrowing by Germans backing up everybody else’s debt under the so-called “Eurobond initiative” could be the way to escape this mess. In fact, there’s no way that Eurobonds will come in in the foreseeable future; no way whatsoever. The constitutional court ruling that we had, which, Alexei, you mentioned. That rules that out. Everything that goes forward henceforth, every debt package, has to be ruled by the German Parliament. That Eurobonds would no doubt require some kind of constitutional change. It is not impossible, but it would take a very long period of time for, not just Germany, but for other countries in Europe who are also fed up about paying for the debtors, to enact the necessary legislation. So, Eurobonds might come in time, but they will not come in time to solve this particular crisis. And the irony of all this is there will probably be a greater degree of coordination and a greater degree of fiscal union among certain countries in Europe, but that coordination and that fiscal union, all those nice sounding things, will only be amongst the countries which don’t actually need it, because they already reasonably convergent. There’s also convergence going on in Europe between the Germans and the traditional hard currency allies, the Benelux countries joined by Austria, joined by Finland, joined by some Scandinavian countries, like Denmark and Sweden, which are not actually at the moment in the Euro. There’s a lot of countries that could join together fiscally and monetarily, and this may well happen. But the countries in the South would actually need the fiscal union because they need the comfort of the creditor countries; they’re not going to be part of it. So, I think inevitably by some lot of messy mechanism, the likelihood of which we cannot fully predict, we are heading for a break-up of the Euro into North and South debtors or creditors and there is a disintegration, I believe, on the way. Exactly how that will happen and when that will happen, I cannot predict, but I think the time scale for this is getting shorter.

Alexei Monsarrat: Well, David, you’ve anticipated a little bit my first question, and I’d like to, we have a number of people on the line, and so I’d like to open it up for questions now. We’ll have the Operator just briefly explain how to do that and than I will lead off with the first question while we build up our calls here. So, Operator, if you can –

Operator: At this time, we’ll open the line for questions. If you would like to ask a question, please press the "star" key followed by the "one" key on your Touchtone phone now. Questions will be taken in the order in which they are received. Please be sure to introduce yourself when asking a question. If at any time you’d like to remove yourself from the questioning queue, please press "star two."

Alexei Monsarrat: Thanks very much and I do, before we head into this section of things, want to remind folks that we are on the record and so just bear that in mind when you’re speaking. So, David, as I mentioned, you’ve anticipated my first question a little bit which is, I’m just wondering what it looks like? What is this scenario under which you have this future vision that you’re setting out there, which is a different shaped Eurozone? And what is it going to take to get it to that point, because it strikes me that it must be pretty bad and so I’m just interested to hear a little more of your thinking on that.

David Marsh: Yes. Well, I think, as my starting point this dramatic departure of Mr. Stark on Friday, because I think this really does throw this whole thing into a very dark perspective. And we also have later on today Angela Merkel, the German chancellor, and Nicolas Sarkozy, the French president, and Mr. Papandreou, the Prime Minister of Greece, having a conference call to discuss the latest Greek debt situation. So, both of those actions contain the seeds of two potential crunch points.
Let’s take the Greek situation. The Greeks are actually piling on austerity at a tremendous pace. The economy has fallen by about 5 percent over the last year, so that is much, much worse than how the Greeks fared in 2009 when they actually did rather well during the year of the Great Recession. And they are, therefore, not meeting the deficit targets, because their economy is generating much less taxation revenue than in the past, almost like you drive yourself into the ground through this type of austerity. Because they’re not meeting the deficit targets and because they’re not getting the budgets under control as they had promised, there is a big worry that they will not get the next slice of funds under these bail-out programs, which have been agreed over the last 18 months by the European Union and the ECB and the International Monetary Fund. If they don’t get that money, then the civil servants are not paid, maybe all kinds of public services start to run down, and people start to say in Greece, "Well, is it actually worth the trouble of remaining in the Euro?" Before that, Greece would probably have to default on some of its contractual debt obligations, because there’s so much money that has to be repaid because of all the borrowing they did in previous years. So, a default could take place relatively soon, and then it would be a moot point whether they would leave the Euro or not. It is difficult to say what would happen in the case of a Greek default, because there may be this sort of contagion to those countries.
The other crunch point which could lead to some disintegrative step is this row that I’ve pointed out regarding the ECB. You’ve got the Bundesbank, which has just two representatives on a 23-person council. The head of the Bundesbank, a man called Jens Weidmann, and then the German representative on the ECB executive board, who at the moment is still Mr. Stark, so the Bundesbank in the form of its place then is voting against the purchases of government bonds by the ECB, particularly for Italy and Spain, which has started over the last four weeks. And the Germans are now in a position of being a structural minority on the European Central Bank decision-making council. This may work technically and may go on for several weeks, but it can’t work politically. You can’t have the country, which makes up nearly 30 percent of the GDP, of the monetary union area, and a country in whose name monetary union was forged, and the country which gave the Bundesbank’s constitution to the ECB. You cannot have them in a permanent position of being outvoted on the governing council. That just won’t work, politically. And, therefore, that is also a potential crunch point that could lead to some unpleasant effects taking place. Some people speculated that Germany itself, if the going got really bad, might leave the Euro area itself. That would be a really extreme position to take because the Germans don’t want to do anything by themselves, but it is not totally to be ruled out. The Germans, if things really got bad, might say, "Well, together we follow the other creditor countries; we will form a new currency." I don’t think that’s something that is going to happen right yet, but the way I see splits taking place is either the debtor countries leave one by one or the creditor countries. That is also a possibility. So, those are two particular areas where such a fateful event could crystallize.

Alexei Monsarrat: Okay. Thanks, David. We’ve got a number of questions queuing up now, so what I’d like to do is take a couple at a time. So, first we’re going to go to Ron Freeman, who is a member of the Troika dialogue, and also of the Atlantic Council’s Business and Economics Advisory Group. Ron?

Ron Freeman: Thanks, Alexei. Can you hear me?

Alexei Monsarrat: Yes.

David Marsh: Yes. Hello, Ron. Are you the Ron who was at the EBRD?

Ron Freeman: I confess my sins. Yes, I was.

David Marsh: Yes. Well, hello, Ron. Yeah, good to hear your voice.

Ron Freeman: And yours. Let me ask this. First of all, is it clear that if there is a default in legal bond terms, does that necessarily imply (a) devaluation or (b) exit from the Euro area?

David Marsh: No, it doesn’t. Because clearly there would be a change in the viability and asset spread of many banks around Europe if it suddenly Greece were to formally default on its debt. But a lot of these write-offs, as you know, they’ve already been somehow encapsulated in banks’ balance sheets, so they’ve already written down in many cases the value of their assets held in Greek banks, shall we say, or their holdings with Greek government bonds. So, no, the answer is that would not lead to devaluation or a departure in any automatic way.

Ron Freeman: So, if I may, Alexei, so even if we recognize that Greece, Ireland, Portugal are all insolvent, if we distinguish default from devaluation, let alone European area exit, there are a variety of banking devices, recapitalizations and the like, public and private, that could still keep the Eurozone together, notwithstanding these default risks looming on the horizon.

David Marsh: Yes, it will be a question of political will really, because so much as it has been put into saying, "Greece will not default," and now everybody thinks that they will. It could be that the politicians will say, "Well, this shows that the Greeks are just not capable of living up to their obligations." And don’t forget the default by itself would not curb the wretched state of Greek competitiveness. So, if you take the point that the austerity measures by themselves and default are not enough, because the Greek economy is so fundamentally uncompetitive because it’s been kept basically in a currency zone where the currency is far too high, therefore, you might say, "Well, you need as well as austerity as well as the rebalancing of the economy, which is taking place, and as well as the default, you need a good old-fashioned currency devaluation as well," which, of course, is what would be in the prescribed IMF package in a situation like this. So, it might be the next part of the policy package, and I think also, of course, as I said before, a default might have a knock-on effect on other countries as well it might harm, therefore, banking relationships throughout Europe. And in that febrile state of affairs, a currency break-up might become more possible. But you’re right; there are recapitalization packages. I think recapitalization would have to come from other countries, because it’s quite plain the Greek government itself doesn’t have the funds. We’ve seen two of the largest Greek banks just merge with a convertible loan from Qatar, so that’s a good sign, if you like petrodollar recycling. The Chinese, as you know, have been making all kinds of noises about wanting to “help” the Europeans, and so the Chinese would also be circling, I think, and ready to pick up any assets that were going, whether on the banking side or elsewhere. But obviously you’re right, Ron. There are all kinds of devices; a default need not necessarily lead to devaluation enough to break up. But it might do and that’s really the slightly alarming feature.

Ron Freeman: As long as eloquent speakers like yourself can continue to distinguish between Eurozone exit, devaluation, and default, it might help keep a debate on track.

David Marsh: Well, it’s nice to know that other people care, so thank you for your question.

Alexei Monsarrat: Okay. Let’s go to James Kitfield of the National Journal.

James Kitfield: Yes. I’m curious about if this scenario that you sketch out here happens, and it seems like a fairly alarming one to me, what the contagion is you think is across the pond to the United States? Not to be cold and calculating in this, but I’m curious for our readers at National Journal what you think the effect on the global economy as well as on U.S. banks.

David Marsh: Well, I think it’s a very good question. Sorry; do you want to take another one, Alexei?

Alexei Monsarrat: Sorry, David. If you don’t mind, I shall get Javier Guzman of Deutsche Bank.

David Marsh: Sure.

Tom Joyce: Yeah, this is actually Tom Joyce and Javier. Very interested in the question that was just asked. And related to that, maybe just taking a view on should we go down the path of unwind? How long will that take and where do you think the contagion will be most felt? I assume bond markets in the banking system, but obviously the gist of our question is the complexity of this unwind is probably almost impossible to overestimate.

David Marsh: Yes. Well, the two questions are in a way are linked. First on the U.S. economy, well, in the short term it would be bullish for America. Bond yields would fall farther in America. Having just been downgraded, bond yields fall to record lows and that would carry on, I reckon, because the safe haven, the premium of the Dollar, although many people might say it doesn’t really merit it, it would clearly rise. As I said before, the Euro over time could actually become a quite strong currency, but it certainly wouldn’t in the immediate aftermath of some sort of a default or even a break-up. I fancy that the so-called "exorbitant privilege” of the Americans, which has been so much a thorn in the side of the Europeans for 40 or 50 years would actually become more of a privilege and, therefore, the Americans would be able to finance their deficits, and the latest Obama plan being just one of the aspects, at a lower case than would otherwise be the case.
So, I’m not actually a believer in world cataclysmic scenarios, if we were to have a Euro break-up or disintegration. I don’t think it would be orderly, but I don’t think it would be the end of the world either, and I am for a cleansing, if you like, of the situation in Europe, which has been allowed to become very, very unbalanced and I see nothing wrong with fixed rate systems breaking up. They are governed and they can lead to turmoil, but it won’t lead to the end of the world, and the history is littered with cases where things which were deemed to be either impossible or extremely disastrous–they actually do happen and the world doesn’t end. I mean, take the ending of Britain’s adherence to the gold standard 80 years ago this month in 1931. Everybody said it couldn’t happen; everybody said it wouldn’t work, everybody said it would lead to great ruin, and it didn’t, even when Britain messed up the exchange rate mechanism of the European monetary system in 1992. I’m not trying to be too sanguine about this, but history has an effect of actually sometimes not being quite as bad as what people present.
Just in terms of the unwinding, the interesting thing is some of the unwinding has taken place already. As I mentioned for Greece and Portugal and Ireland, the banks have taken the hits. They’ve written down quite a lot of their assets, maybe not enough. They’ve also got the Greeks and the Irish and Portuguese don’t have anything like a big bond market like the Spanish and the Italians and quite a lot of the bonds that have been issued by those countries have now landed at the European Central Bank, because the banks have held those bonds or the insurance companies have held those bonds. They’re actually carted and sold them to the ECB at a loss and a crystallized loss already. The bigger question actually is that the sort of your question is what would happen if the unraveling were to extend to Spain and Italy, which have got colossal bond markets, very large borrowing. Italy, I think, the bond market is about $1.9 trillion, many, many times bigger than the other three countries by themselves, and unraveling that would really be a major case of an incendiary device landing in the middle of Europe. But I don’t think actually that Italy even that perilous of a state, because Italy does have relatively long maturity of debt. It’s typically something like seven years. So, Italy can actually live with the present interest rate of about 5 percent without too much harm being done. I don’t think there is a danger of an instant conflagration.
And maybe just to end the question, in terms of a firewall, the big question would be if Greece were to default, is there enough of a firewall between Greece and, let’s say, Portugal, and that’s a big question. If we could postpone Greece for another six months, it could be that Portugal would have improved sufficiently for a genuine firewall to have been built. The problem is it looks as though Greece is going to default in less than six months and, therefore, there is a danger the fire will leap over into Portugal because the Portuguese really haven’t made enough improvements to guarantee their continued sanctity if there were to be a Greek credit event. So, it’s all about timing and, unfortunately, the markets have a habit of getting ahead of the political game and that’s exactly what’s happening at the moment.

Alexei Monsarrat: Thanks. Now, I’ve got Stewart Macintosh with the Group of 30.

Stewart Macintosh: Hello, David. Thanks very much for your remarks.

David Marsh: Hi Stewart. Good to hear your voice.

Stewart MacIntosh: It follows on from what you just said. My concern is that you might not be able to stop, that that firewall will be insufficient and that the current sort of extremely panicked atmosphere, not just for Europe, but in the U.S., that if we allow default in Greece and then that also spins on to Portugal, that we may not be able to get ahead of it at that stage. And I also have a question. My question is related to your comments on the write-down of the debt the banks already have done. I mean, we hear over here that they’ve written down the debts or they’ve hedged it. My question is: Who have they hedged it with? And who sold those CDS’ and those other instruments? And the very audacity of that situation makes it for greater degree of panic. Do you not worry that if we saw a number of major banks in Europe teeter or collapse, then the situation may spiral out of control.

David Marsh: Shall I answer the question or is there another one?

Alexei Monsarrat: Yeah. Go ahead, David.

David Marsh: Yeah. Well, regarding the firewall, you’re absolutely right. And I think what is so worrying is not so much the question of will country X physically default on its debt? It’s simply that we’re getting into a Lehman Brothers-type syndrome here where the banks are becoming progressively afraid of just what you’re saying. So, it’s not the actual physical likelihood of a default; it’s the fact that people think that something at present is going to happen.
So, we’re having now very large spreads opening up in major bank markets. Banks are reluctant to part money with each other, even overnight. There’s a suspicion about banks. We’ve seen, we’ve just downgraded a couple of banks, French banks, the Credit Agricole and Societe Generale, and it is leading to a contraction of liquidity in the system. Of course, it is very harmful for the economy as well as being harmful for individual banks. Therefore, I do think that if European policies are sensible and, if there were to be a default, there would have to be some sort of a TARP-like system to put money into the banks which were deemed to be the most at risk. One of the problems, as you know, is that Europe has already spent a great deal of money, propping up the banking system. And there is not a great deal of firepower still available, but there’s some kind of public sector-backed recapitalization or guarantee exercise would have to be put into place without a doubt as part of any series of default measures, simply to guard against the idea on the markets that this would just spread like wildfire. And, of course, Europe is not in a very good state to do that, neither is there much financial firepower left after the extraordinary efforts they’ve done in the last three years, nor is there very much political capability to actually do things in a quick fashion, a difficult technical exercise putting across several different countries.
Regarding the CDS, I’m sure there are other people who know much more about it than I do, but there have been a lot of CDS written by American banks and, therefore, if there were to be what the experts say, "a credit event," if a bank or a sovereign were to be called into default in their outstanding loans, then there would be a lot of money paid out by American banks to European banks to insure them, to indemnify them, against part of the losses, because the loss of CDS’ have been written through transatlantic contracts. I think the figures, though, are not almighty and compared with the overall losses that would be going on in Europe as a result of write-downs, the figures are not huge; they’re on the order of $5 to $10 billion. That is not huge in today’s terms. But it does show that something done as insurance credit default swaps, while it may help one bank it may hinder another, so it’s not actually safeguarding the system.

Stewart MacIntosh: Thank you.

Alexei Monsarrat: Thanks, David. I know you have to run in just a couple minutes. But I wanted to squeeze in one last question, sort of at the end.

David Marsh: I have a bit more time actually, but it’s strictly up to you and to the listeners.

Alexei Monsarrat: Okay. Well, my question is, I think, I know the answer, unfortunately, but from over here the European process looks extremely disorganized and even unorganized, and as someone who’s pretty deeply involved in talking to folks over there, I just wonder if your perspective is any different from ours over here, if maybe there are things that are actually happening and discussions taking place that maybe are quieter but might somehow help mitigate what looks like an awfully messy process.

David Marsh: Well, I’m really sorry to disappoint you, but it’s probably a lot worse than you think. The political class in Europe has been criminally negligent in allowing this thing to happen, because the writing was on the wall five years ago and they were in far too complacent a state when the ECB celebrated its tenth birthday in June, 2008. So, only three years ago. There was a whole outpouring of celebration and bonfires were being lit and festive commemoration. And nobody actually saw the things going wrong and all these countries getting into completely overborrowed states. And I’m afraid to say since then the politicians have always been behind the curve, they’ve always been behind what is really needed. They haven’t understood the markets, they haven’t understood the way that markets react; sometimes act like spoiled children. They just got out of hand and you need a very strong teacher in the classroom, or maybe even water hoses to cool those children down. And they have always been doing things too little too late, and this is partly a reflection that Europe is not a country. It’s 17 nations joined together in a monetary union. And it’s the old cart before the horse syndrome; they should have actually had a political union before they put the monetary union in place. That’s the basic problem behind it all. It’s also partly because in many countries governments are under also pressure from electorates who don’t like the recession they’ve been living through, to not doing so many things which are unpopular or cost money. So, governments are under fire everywhere. You’ve got the third thing that government leaders we have now do not seem to be really capable of facing this challenge. I think it’s a bit unfair to criticize too much Sarkozy and Merkel because every country gets the leader it deserves more or less. Even Helmut Schmidt, when he was around a few years ago; he did ultimately fail. But I have to say the leadership we have either at the European level at the Commission or at the level of national governments doesn’t seem up to the task of facing up to the challenge that’s on their hands. The European Central Bank has been, generally speaking, the only game in town as far as crisis fighting, but now we see this really horrific split at the very top of the ECB. So, even the ECB cannot be counted on now to carry on in the firefighting role. So, really the fire is still blazing and the fireman outside are still more or less putting on their helmets and deciding what wall to put their ladders up against. So, I’m afraid to say, Alexei that your perception is not wrong and your perception is relatively optimistic compared with the reality of the abject state of the political process that we have here on the ground.

Alexei Monsarrat: Okay. Well, we’ve got, it looks like Tom Joyce with another question. So, Tom, why don’t you go ahead?

Tom Joyce: Just a quick question that’s extremely difficult to answer. Given how long the construct has taken to come together and the complexity with which you describe, should we have the unwind along the lines of what you’re suggesting–how many years would you envision this process taking?

David Marsh: Well, there’s obviously the unwinding of the banking market, which is a whole spaghetti. I mean, that could happen relatively quickly; it would be a mess. There would be lots of write-downs, there would be a need for recapitalization. Things would go through the wall. You’d have money coming in from China to take over some banks. You’d have more consolidation of the banking system and that could take between six months and a year. When the Czech-Slovak states broke apart in the early 1990’s, there was obviously a different state of affairs, but there’s nothing constitutional about that. There was nothing in the Czech-Slovak constitution that said, "You’re allowed to break up," and then they had two currencies which were originally at par with each other and that also broke up; that took three to six months. But the actual decision was taken in an afternoon. Now, clearly this is all much more complicated. It’s going to take a lot shorter time for it to disintegrate or for it to sufficiently change in the time scale, which was described, which has taken 50 years to put together. So, you might say that’s something of a shame. And it would certainly take another 50 years to put together anything quite so grandiose as economic and monetary union. But I reckon that the technical aspect of an unraveling, let’s say, into currencies of different denominations for the North and the South linked together by some sort of exchange rate stabilization scheme, that could take probably over a couple of years. The political shock and the political unrest and the political weakening of Europe’s sentiment and the weakening of Europe’s standing in the world would take a lot longer to overcome, because don’t forget this is the flagship project as Europe, this is the one big thing that it could claim to really have accomplished in the last 20 years, and it’s something of which many Europeans for many reasons are immensely proud and many, many fine imaginative intelligent hard-working men and women have put a lot of work into this in the last 20 or 30 years, so that’s a shame, but these things do happen. The cathedrals get built and sometimes they get knocked down in a bombing raid. So, I’m afraid to say this is probably we’re seeing not quite the knocking down of a cathedral in a bombing raid, but we’re seeing large chunks of the cathedral falling away and rebuilding those cathedrals and hiring the people to do it and having the energy and having the will and the vision to do that does take time.

Alexei Monsarrat: Okay. We’ve got Peter Chase from the U.S. Chamber of Commerce.

Peter Chase: Hi. Yeah, thank you very much. I’d like to go back to, I guess it was Ron Freeman’s question, about the distinguishing between the question of a Greek default and the unraveling of the Euro. And one of the problems with unraveling the Euro is that it’s actually technically not an easy thing to do and logistically not an easy thing to do, and would be horrendously expensive in terms of its immediate pain for the Greeks and probably for the remainder of the Eurozone. There’s a sense here, I’m based in Brussels, there’s a sense here that a lot of the steps have been taken to try to ring fence at which you mentioned the adjustment in Greece so that Portugal, certainly Ireland, I think Ireland is seen as having taken a lot of the steps necessary in order to buy some time to allow a more orderly working out of the Greek debt position, likely a default. The question that I have is this: U.S. firms, the U.S. economy has a lot of equities in this game, and is there a possibility that the United States Treasury could and would get involved in concert with the ECB to strengthen those walls if necessary to allow a differentiation between a Greek default and working out and contagion in other countries?

David Marsh: So, I think you’ve got to distinguish between in say technical central banking aid, banking is available to help dollar liquidity in Europe, namely the Treasury and the Fed, which directly would increase lines to European Central Bank and so on, to overcome liquidity shortages in the European banking market, just as they did in 2007/2008. I think it’s very different if you’re putting American taxpayer’s money at risk in shoring up differences which should be allowed to crumble. So, I think there’s no chance that the Americans would decide a TARP system for European banks; whereby, there’s actually being taxpayers money on the line. I even wonder whether Tim Geithner is in the mood to even be helpful in his rhetorical statements, because the statements we’ve seen from this Treasury over the last six months or so have not really been designed to win friends and comfort people in Europe. They’ve been rather hard medicine. I mean, I think it’s quite admirable really, so I don’t think there’s any need to tell Europeans that things are better than they are. I think it’s far likely that Europeans will get money from China than from the Americans, and that money does come with strings attached, as we saw today with Prime Minister Wen, who says, “We’d like to help you, Europeans, we think you’re really great people, but we’d really like you to recognize our status as a market economy, and for you to relax controls on technology transfers.” So, there is one way around, but I don’t think from my vantage point, I don’t think it’s going to come from America. I don’t even know whether Americans are even going to sound very sympathetic.

Alexei Monsarrat: Okay. And we’ll circle back. I think we’re probably getting pretty tight on time now, so we’ll circle back to Ron Freeman and then we’ll end the call.

David Marsh: Sure. Thank you.

Ron Freeman: Just as a last comment, I wonder whether you heard Christine Lagarde at Chatham House the other morning –

David Marsh: (overlapping) No, I didn’t; I wasn’t there. No, I’ve been in Luxembourg the last few days.

Ron Freeman: Well, she got herself into a peck of trouble by being perhaps a bit too blunt, even under Chatham House rules. But it does raise a question whether the EFSF could be a mini-IMF or a European IMF and given the status really of an international financial institution with the kind of, it does have a lot of balance sheet firepower, more than any of the Central Banks do, and it could be the beginning of something that would help along with distinguishing devaluation from the default to leaving the Euro area.

David Marsh: Well, yes, I don’t know what she said, so I can’t comment.

Ron Freeman: Well, she basically said that the European banks are grotesquely undercapitalized and, of course, under-provisioned in their exposure to the sovereigns. So, what is really required is a meta bank, which is the IMF is meant to be, and whether the EFSF is very close to becoming a European monetary fund.

David Marsh: No, it really isn’t, you see, Ron. And she may –

Ron Freeman: (overlapping) the status –

David Marsh: I mean, she is very much entitled to her opinion. And as you know, there’s a bit of row going on between the IMF and the ECB people. The ECB thinks that she’s being overdramatic in what she’s saying. The EFSF is a very long way from being a kind of mini-IMF. They’ve got ten people working for the EFSF.

Ron Freeman: I understand.

David Marsh: And it’s going to be increased to maybe 70 people. They’re a very long way from even having the technical capability of purchasing bonds from the weaker states on the secondary market. They haven’t been given the authorization for that, as far as I know. The things are decided by the government on the 21st of July has not been enacted. Over time, we might well have a kind of European monetary fund if it’s sound enough and convergent enough to speed the course over the next five years and those, by definition, will be countries which don’t actually need that help. So, we may have more things in Luxembourg with bells and whistles and all sorts of wonderful people running them, but they’re not actually going to be around in time to solve this crisis.

Ron Freeman: Well, you may be right, but I do hope you’re wrong.

David Marsh: Well, I’m sure there will be something and some fine person like you Ron will be running it. But let’s solve the next crisis, not this one.

Ron Freeman: All right. Thank you.

Alexei Monsarrat: We’ve got one more question, David, but I want to check on your time.

David Marsh: Sure. Let’s have one more quick question; that’ll be great.

Alexei Monsarrat: All right, David. Then Kris Bledowski from the Manufacturers Alliance is on the line.

Kris Bledowski: Hi. When we look back a couple of years back when the U.S. banking system was in trouble, these were wholesale intermediaries; these were investment banks. So, now when we are facing a possibility of a European banking crisis, these are universal banks with a lot of retail exposure, both the funding and the lending. It’s much, much closer to the real economy. Would that, in your view, impact the European business cycle far more than we had the case in the United States or you see more of a parallel?

David Marsh: Well, the parallel is actually more with the U.K. because, of course, we had Lloyds and Royal Bank of Scotland, big retail banks, getting into trouble about their commercial lending and, of course, it’s a misnomer to think it’s only an investment bank that can get into trouble. The commercial bankers lend money for real estate which then goes sour also gets us into trouble. So, an analogy would be with that, and we have had these examples of contagion here with the Deutsche Bank, the Universal Bank, or the Commerz Bank, which the government took over a stake in the Commerz Bank, which they still own, so I don’t actually think it’s going to be very radically different from what we saw three or four years ago where the government did intervene and they did put TARP-like systems into place and we’re going to have to see that this time around. I’m more optimistic this time. Short of an absolutely major conflagration involving Italy, which as I said, I don’t exactly expect, but you see the default of Greece has been 18 months coming. Mr. Ackermann, head of the Deutsche Bank, predicted on German television in about May last year that Greece couldn’t repay its debt, so he’s got his fiduciary duty to his shareholders, he’s been reducing his exposure to Greek debts as have all the other banks. So, any default that takes 18 months to put into place, as this one has, the banks by definition are serious people; they’ve already made some of their adjustments. The big issues, as we just said, would be whether the fire leaps over to Italy and Spain. I don’t think it would. And I think, therefore, we will be safe from a Lehman Brothers-type financial meltdown.

Alexei Monsarrat: Okay. Well, David, I really want to thank you for spending time with us. I know you’re busy and on the go and it’s been great to hear from someone with your historical background and your current knowledge of where everything is. So, it’s been great to hear you and I’ll look forward to seeing you when you’re in town next week.

David Marsh: That we’ll do indeed. Thank you very much. Thank you, everybody, for listening and good luck with all you’re doing in your lives as well as us Europeans in our lives. All the best.

Alexei Monsarrat: Thanks.

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