A Conversation with William R. Rhodes ’57 LHD’05 (Hon.)

This text has been adapted from a conversation between Mr. Rhodes and Noah Elbot ’14.

You've been lauded by many sources, including the Wall Street Journal and even Paul Volker, for being able to bridge the gap between the private and public sector. Can you tell us a bit about the challenges of each, and why that particular skill set is so important in this day and age?

I think the private sector is always important. In the Eurozone debt crisis, for example, a vital objective is getting countries back to growth. In order to achieve this, they need to be able to finance themselves – it is important that the countries in difficulty restore their access to the financial markets. This is important not just for the public sector, but very much for manufacturing and services industries. The private sector is needed as a driver of growth to assist countries to access the financial markets as well as to provide investment. Both of these private sector roles are important because often a country has access to the markets but it is not able to get sufficient private sector investment. Governments can't restore economic growth by themselves.

This has been one of the problems in Japan. One of the issues of the last decade and a half is that the Japanese private sector frankly wasn't really investing as it should have. Industries began hollowing out and moving offshore because Japanese investment just wasn't effective anymore. We'll have to see whether Abe-nomics [the economic policies advocated by Shinzo Abe, the current Prime Minister of Japan] will be effective or not. Their economy has been affected by Europe's problems as has the Chinese economy, and everyone elses. In the case of Japan, the fiscal and monetary expansion are not enough; they have to get into structural change and deregulation. All of those involved will be affected by the far-reaching structural change and deregulation that is needed, and it will then be up to the private sector to start investing again.

In your book Banker to the World you discuss the Chinese word for crisis, Weiji (危机), which is composed of the characters for danger and that for opportunity, can you speak more to the opportunity of the current debt crisis?

To answer your question one first has to start with a couple of basic questions in this context: "Who's learned what? And where?"

It's still not clear that the Europeans have learned the lessons that they need to and that result from the experiences that we all suffered through with the Latin American debt crisis, the Asian financial crisis, and Japan's stagnation. Nor have they learned from the positive experiences such as when Brazil turned around under then finance minister, subsequently president, Cardoso in 1994; when South Korea got out of its debt problem in 1998 under president Kim Dae-Jung, and when Turkey, under finance minister Kamal Dervis, got out of its crisis to secure substantial growth in the years after 2001.

So far it appears that Eurozone leaders have not learned the hard lessons of those crises that I mentioned, nor drawn from the positive experience of these and other countries.

I think in terms of crisis the Chinese are absolutely correct, and that's why Weiji is my favorite expression in Mandarin: every crisis presents an opportunity for us to take advantage of it. Cardoso, Kim Dae-Jung and Dervis all showed us this, for example, in their own countries.

Look at the United States and the leading industrial countries where in the immediate aftermath of the 2007-2009 Great Recession, everyone said this could be a real opportunity to strengthen the global financial system and improve regulation worldwide. And, of course, it's not clear that we've taken that opportunity. We still have countries in different areas implementing Basel III differently and regulation differently. The Group of 20 is supposed to make sure that you have an across-the-board implementation worldwide, so we don't get more regulatory arbitrage. The opportunity was there, but up to now they haven't used it.

For example, the strongest finance minister in all of Europe is Wolfgang Schäuble, the finance minister of Germany. I was with him in a small group in October 2012 at the IMF-World Bank meetings and he was asked, "What was the biggest mistake the policy makers made in the Eurozone since the crisis began?" And he answered very simply with one of the lessons learned from Latin America and Asia, which is, "Contagion." He admitted that he and his colleagues underestimated the risks of contagion. If you don't stop a crisis head on in one country it will flow into another, particularly if you're in a monetary union like the Eurozone.

The question is how to learn the lessons and then to do something about it. Obviously crisis avoidance is the best course, but if you do end up in a crisis then you need to lead to secure an effective outcome. The Eurozone's leaders, however, made two mistakes: A, they didn't want to admit they were in a crisis, and, B, they took their time in doing something about it. It has now turned from a debt problem into a major growth crisis, and we still have not seen the end of it.

I think in France there's a good chance that they'll have another few quarters of no growth, and they're the second largest economy in the Eurozone. We have seen recent difficulties in such countries as Cyprus, Ireland and Portugal. I am particularly concerned about the large countries that are in trouble: Spain, Italy, and France. Even the Netherlands, which has been a strong support for the whole area, has been suffering between stagnation and recession.

You've recently been calling for austerity to be phased out and for spending to resume. Do you think the austerity policies have been a mistake in Europe, or have merely run their course?

I would go back to the third leg of the stool, or as [Japanese Prime Minister] Abe likes to say the third arrow in the quiver, which is that the big mistake at the outset of the Eurozone was that they put together a monetary union, which was the European Central Bank (ECB), but no comprehensive and realistic fiscal union to match that.

What I like to do is compare it to the United States after the Revolution. You had thirteen separate colonies and fortunately George Washington appointed Alexander Hamilton as a head of the Treasury. Hamilton put together a fiscal and monetary union. Europe has not done that.

In the founding union, the US did the right thing, and we have to see if Europe is able to do the right thing after all this tumult. That's why I talk about the lost decade, because if you look from 2007, we're already in the sixth year, not the fourth year, because its not clear whether Europe ever got out of the Great Recession.

What happened in Europe was there was no fiscal restraint, and no effective enforcement of the Maastricht Treaty that set budget deficit limits. Member countries got the benefit of the union when they were able to gather debt at very low cost and where for a long time there was no market differentiation between economies.

This is why George Soros thinks the answer to all of this is the Euro-Bond. The problem is the Germans oppose that solution because then Germany would be bailing out all these economies that don't have their debt-to-GDP in line.

A friend of mine who used to work at the Central Bank of Germany and I have talked about Germany doing what the United States did for Europe after WWII with the Marshall Plan. The problem is, there's no stomach for that kind of action now in Germany. What the Germans are saying is that, "if we Germans can put in fiscal restraint, then you other countries in the Eurozone ought to be able to do it as well."

It is not that simple. Resolving the current problems calls for actions on a range of fronts at the same time. You have to have balance in life, you have to be able to walk and chew gum at the same time. You have got to take the necessary steps over time to bring the debt down, but at the same time you have got to be able to have pro-growth policies.

Every single country in the Eurozone has had a change of government since the crisis began four years ago except for Germany. The general public in most of the countries in the Eurozone have suffered from austerity programs and we see record high unemployment rates.

And against this background the question increasingly is, are we going to have a second and third wave of political change? You've got to be able to show the population of the countries that have had severe economic crises that if they swallow the tough reform medicines and austerity measures then they can return to growth and higher employment in time. That's what the Brady Plan – named after former US Treasury Secretary Nicholas Brady - did for Latin America at the end of the 1980s and into the 1990s: it gave hope to those countries and their populations that they could return to growth, and they did. If the government in power does not have the ability and the wherewithal to take a country from crisis back to growth over a period of time, then the citizens of the country will not support it. This is what political leadership is all about in situations like this and it is an absolutely essential element to restore growth – this is a key lesson from past sovereign debt crises.

If you really want to go into dire comparisons, that's exactly what happened to Europe in the late 1920s and 30s. I'm not saying we're at that stage, but you could have considerable political fallout if you can't get these countries back to growth in a reasonable period of time.

Is there one question that the media is not asking, that you think they should be?

What is the end game here?

Most of the media coverage has been on the shorter term, but these governments have to have a short-term plan with longer-term goals. In other words, you have to bring these countries back to sustained, non-inflationary growth, which demands policies that have longer-term dimensions. This is why, for example, a new fiscal pact in Europe is so important. In a sense it's like the United States, there were some urgent things like settling the "fiscal cliff" at the end of 2012, which you can say we did it well or poorly, but it got done. Sequestration is kicking in, but we're still left with the question of what are we going to do to cut U.S. budget deficit over time? We have seen the short-term measures, but there have to be longer-term solutions that address core issues of social security and other entitlement policies.

The press appears to focus on the central banks to take all the necessary growth-oriented actions, lower interest rates, put in monetary easing, and all that. But at the end of the day, one of the questions that should be asked is: how easy is it going to be to unwind or exit this tremendous amount of liquidity. The Fed has taken its balance sheet from under a trillion dollars to somewhere around 3.5 trillion dollars. At some point it will need to exit this, and if it is not done efficiently, then it could cause another bubble.

To me it's very frustrating when I see the lack of ability, particularly in the Eurozone, to understand the past, learn from it, and take the necessary measures to move forward on growth and resolution. To look at this as Weiji – crisis/opportunity – is to hope things will be done during the next year to turn this around.

History never repeats itself exactly, but there are lessons learned in all these historical events. The wise person digests that, looks at where the landscape is, and decides what pertains and what doesn't pertain as he or she moves forward.