The subprime crisis developed into euro crisis

Paul Vieira, Financial Post ·     Angel Gurria is never short of words, or emotion. The secretary-general of the Organization for Economic Co-operation and Development will talk about almost anything economic-related, and do it with a passion that’s to be expected from a native of Mexico. Mr. Gurria, a former finance and foreign affairs minister in Mexico, has been head of the Paris think-tank since 2006, and has tried to provide a voice of reason during the economic crisis. In its most recent outlook, the OECD said developed economies should begin the process of budget-cutting and get debt levels back to more reasonable levels. And in Montreal this past week for the International Economic Forum of the Americas, the multi-lingual Mr. Gurria warned economies have a tough dilemma ahead: They have to maintain fiscal policies that lead to job creation, while at the same time get their own fiscal houses in order. Mr. Gurria talked to the Financial Post’s Paul Vieira in Montreal. This is an edited version of the interview:

Q Is the euro crisis the beginning of new woes, or did the crisis that broke in 2008 really end?

A You are absolutely correct. The euro crisis is just a different phase of the crisis. And just like the first manifestation of the crisis, this deals with overleverage. First it was overleverage of the banks and the stabilization of the financial system, plus the drop in government revenues due to recession, plus the increase in automatic stabilizers, plus stimulus spending. All this produced these exorbitant deficits and this mind-boggling accumulation of debt, which we would have just laughed at a few years ago of ever happening. The euro crisis is the same problem of overleverage, but has moved from the private sector to the public sector. This is just unsustainable and has to be fixed.

Q Any surprise by the drubbing in the markets, due mostly to Europe? And any shock at how intense it has been in such a short time?

A I think at some point in time, governments took the first decision to do whatever it takes. No more failures of banks. That has consequences. The second decision was to say, “We will go out and stimulate.” That was a deliberate, co-ordinated, co-operative type of decision, and something which we are seeing the consequences of now.

The first decision was linked to stabilizing the financial system. The second decision was a little bit different because, objectively, everyone went into some kind of stimulus, with China doing 15% of GDP, and the United States did something like 6%. The difference was the degree of response that the economies had. And then there was the result of the economy. And that’s when revenue drops, and you have to spend automatically [on unemployment benefits]. That was not planned. It is the result of a general economic situation. Countries were having enough trouble just with that, on top of digging into their pockets and going into deliberate deficit spending. And now we see the consequences.

Q The US$1-trillion rescue package from European policymakers was meant to calm markets and support the euro, but that has yet to materialize. What happened?

A It is going to. It was only on [Monday] night that European policymakers got it together in term of finalizing the conditions. The proposal has been going through legislatures. Germany got its passed two weeks ago, but some of the other countries have been circling the wagons because their parliaments were reticent. But let’s assume everyone chips in, and they are in. Then that’s done. Once the money is in place and ready to be triggered, it is going to produce a lot more peace of mind than it has right now.

There were a lot of skeptical voices out there because they did not see the package gelling. What they don’t understand is the way Europe works, or how things happen. They happen slowly, there’s always a little bumpiness, but it happens. And there was enough resolve. This is sorting itself out.

Q What topic, or topics, is going to dominate the G20 leaders summit in Toronto?

A In 2008, the G20 was focused on stabilizing the financial system, and avoiding a cataclysmic disaster. In 2009, it was about growth. This meeting in Toronto is going to be about a more balanced, more nuanced, more complex formula for growth. The balance has to do with the situation where you need to put an emphasis on growth but also on fiscal consolidation, or deficit adjustment. That balance, and the need to be looking at both sides, will be much more apparent now.

There is also a need for countries not to withdraw the stimulus just yet. The monetary tightening is something that is going to happen by next year. Countries have to roll out all the stimulus packages –some of them are finished, but some of them are still happening. So don’t interrupt until you are through with them. Finish the plan. And don’t start cutting the budget just yet, maybe start in 2011. Leaders need to, at the very least, strongly signal how they are going to address the deficit and debt issues. How are they are going to bring down the deficit to a manageable level, but ensure a soft landing. Then the ultimate issue is, whether markets will be more or less tolerant and patient