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Rebuilding Together: The Renewal of Transatlantic Leadership in the Global Economy

Rebuilding Together: The Renewal of Transatlantic Leadership in the Global Economy

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This Brussels Forum paper is the winner of the Young Writers' competition.
This Brussels Forum paper is the winner of the Young Writers' competition.

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Published by: German Marshall Fund of the United States on Mar 21, 2012
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Summary:
The global recession
has raised difcult questionsabout the primacy of market-based democracies andtheir ability to lead the globaleconomy. The transatlanticpartnership must undertake anaggressive, coordinated effortto reafrm its leadership of theworld economic order on twomain fronts. First, the dramaticcollapse of the nancial sectordemonstrates the need forstrategic regulatory reform.Policymakers must addresskey weaknesses in regulatoryagencies, banking structure,ratings agencies, and therole of lenders of last resort.Second, monetary policy needsto return to the forefront of the transatlantic conversation.The United States and theEuropean Union should act nowto preserve and enhance theadvantages of having the world’smost powerful currencies. Thereforms resulting from this far-sighted, cooperative effort wouldhelp each side of the Atlanticescape their own unique crises,as they solve their shared crisistogether.
Rebuilding Together: The Renewal of Transatlantic Leadershipin the Global Economy 
by John Schellhase and Thomas Gietzen
1744 R Street NWWashington, DC 20009T 1 202 683 2650F 1 202 265 1662E ino@gmus.org
March 2012
Paper Series
Introduction
Each o the transatlantic partnersis mired in a unique state o crisis.In Europe, the euro remains acurrency without a country in anasymmetric system. Necessary stepstoward political reorm and deeperintegration conict with nationalinterests. In the United States, anunprecedented budget decit weighsdown an economy that is slow torecover, and political brinkmanshipand rigidity preclude innovativeproblem-solving. Tese immediate,separate problems take place againstthe backdrop o a larger, sharedcrisis. Te global recession hasraised dicult questions about theprimacy o market-based democ-racies and their ability to lead theglobal economy.Te transatlantic partnership mustundertake an aggressive, coordi-nated eort to rearm its leadershipo the world economic order ontwo main ronts. First, the dramaticcollapse o the nancial sectordemonstrates the need or strategicregulatory reorm. Policymakersmust address key weaknesses inregulatory agencies, banking struc-ture, ratings agencies, and the roleo lenders o last resort. Second,monetary policy needs to returnto the oreront o the transatlanticconversation. Te United States andthe European Union should act nowto preserve and enhance the advan-tages o having the world’s mostpowerul currencies. Te reormsresulting rom this ar-sighted,cooperative eort would help eachside o the Atlantic escape their ownunique crises, as they solve theirshared crisis together.
Strategic Regulatory Reform
Policymakers must pursue coordi-nated nancial regulatory reormsto minimize the possibility o another global collapse. Te polit-ical economies o the United Statesand European nations demonstrateimportant dierences in how they  view the purpose o economicbehavior and the role o the state.Nonetheless, the transnationalnature o modern nance, as shownrecently by the contagion o baddebt, demands more than mereconsultation between governments.Te United States and EU must each— independently, but cooperatively — reorm their regulatory regimes.Tis process would create a moreunied, transatlantic economicspace. In particular, both sides o theAtlantic must consolidate regulatory agencies, demarcate commercialand investment banking, address
 
2
aws in the ratings agencies, and establish clear standardsor access to lenders o last resort.Consolidating regulatory agencies will help both theUnited States and EU anticipate and prevent uture crises.Te bewildering mesh o agencies currently charged withoversight ailed to orestall the global crash. In 2009, theOrganisation or Economic Co-operation and Devel-opment (OECD) recommended that the United Statespursue “[s]implication o regulatory structures” and thatthe EU should adopt a “single bank regulator” to, in bothcases, strengthen regulation through streamlining it.
1
 As both the United States and EU independently reducethe number o agencies involved, they will clariy roles,concentrate authority, and reduce myopia in avor o amore system-wide perspective. Tese steps will be thegroundwork or urther coordination. A more stream-lined regulatory regime on each side o the Atlantic willenable governments to oversee bank behavior more eec-tively and will oer rms a more ecient transatlanticmarketplace.Regulatory reorm should also involve returning toa more traditional understanding o what a bank is.Commercial banks and investment banks should beseparated and should have dierent regulatory standards.Tis division actually simplies the tasks o regulatorsby quarantining dramatically dierent risk pools. TeUnited States had such regulation under the Glass-Steagall Act rom 1933 until its repeal in 1999. Sincethe crisis, various maniestations o this concept havere-emerged, including the Volcker Rule in the Dodd-Frank Act in the United States and the Vickers proposalin the United Kingdom. Tese promising reorms, i seento completion, oer one way to manage the size o bankswithout taking draconian, and uneasible, measures tobreak them apart. Ensuring these provisions are enorcedand expanding them throughout the EU ought to beurgent priorities.
1
See “The Financial Crisis: Reform and Exit Strategies,” ps. 29-32,
OECD
(2009).
Te ratings agency system also requires serious reorms.Over the last century, both in the United States andEurope, agencies such as Moody’s and Standard andPoor’s have acquired a semi-governmental mantle thatleads to “perverse outcomes or the nancial marketsand global public policy,” worsening pro-cyclical markettendencies and weakening accountability.
2
o correct thisproblem, policymakers have two choices: either to disen-tangle the ratings agencies rom ocial policy; or, giventhe complexity o the rst option, to open the currentsystem to new rms to promote greater competition.More competition would need to be combined with sti legal consequences or ratings malpractice so that rmswould not run to the agency oering the highest ratingbased on the lowest standard. Instead o being bestowedwith ocial privilege regardless o outcomes, ratingagencies would have to earn their reputations based onthe accuracy o their predictions in a competitive market-place.
3
 Finally, the transatlantic partnership should coordinatethe conditions it will require that rms meet in orderto receive taxpayer bailouts rom lenders o last resort.Te unprecedented rescue packages doled out to scoreso banks on both sides o the Atlantic have created anenvironment o extreme moral hazard. Naturally, rmsare likely to expect similar taxpayer assistance in thenext crisis. Te Federal Reserve, the Bank o England,national banks throughout the European continent, and,as it evolves urther into this role, the European CentralBank need to dene clear, strict procedures or whathappens when a near-insolvent bank wants to accesstheir liquidity. First, rms should be required to make“living wills” that have clearly-dened and credible plansor how to maintain capital and liquidity adequacy inthe event o distress.”
4
Second, governments should beclear in advance about what decision-making authority they will assume upon bailing out a rm. For example,will rms exchange corporate governance control oraccess to taxpayer unding? One consequence, though,should be nonnegotiable. Governments should have theability to take toxic assets o o a rms balance sheetand deal with them as quickly and protably as possible.In Europe, ocials should consider similar prerequisitestandards or access to European capital during national
2
Matthew R. King and Timothy J. Sinclair, “Private Actors and Public Policy: A Re-quiem for the New Basel Capital Accord,”
International Political Science Review 
. Vol24, No. 3 (2003).
3
See Nouriel Roubini and Stephen Minh,
Crisis Economics
, p. 197. Penguin Press(May 2011).
4
David T. Llewellyn, “The Global Banking Crisis and the Post-crisis Banking and Regu-latory Scenario,” p. 89,
Research Papers in Corporate Finance
(June 2010).
The bewildering mesh of agencies currently charged withoversight failed to forestall theglobal crash.
 
3
Transatlantic coordination of standards for access to lendersof last resort will reduce moralhazard, regulatory arbitrage, andthe likelihood of the uneven,ad hoc responses that havecharacterized the aftermath of the current crisis.
debt crises. For banks, transatlantic coordination o standards or access to lenders o last resort will reducemoral hazard, regulatory arbitrage, and the likelihood o the uneven, ad hoc responses that have characterized theafermath o the current crisis.Tese strategic responses diminish both the likelihood o uture nancial catastrophes and their potential allout.While the United States and Europe should pursue suchreorms or their own separate benet, coordinatingthis strategic, ar-sighted response can only strengthenthe results. As Daniel W. Drezner has written, “Regu-latory coordination reduces the transaction costs o cross-border exchange, leading to an increase in staticeciency, which increases economic benets or allparticipating states.”
5
While multinational rms may resist strong, coordinated standards, Drezner agues thatsuch standards benet rms in the long-term by clari-ying regulatory restrictions, creating a level playing eldacross borders, and illuminating “the political processby which transnational regulatory standards can bechanged.” A coordinated, transatlantic nancial regula-tory policy built on the lessons o the global crisis is anessential step toward restoring healthy, growing econo-mies on both sides o the Atlantic.
Currency Exchange in the 21st Century
Facing new currency competition rom China and others,the United States and the European Union must makemonetary relations a priority. Historically, monetary management has been a key eature o the transatlanticpartnership. Te ollowing represent only a partial listo transatlantic monetary agreements over the last hal century: the Bonn Summit in 1978, the Plaza Commu-niqué among the G5 nance ministers and centralbankers in 1985, the Louvre meeting o the G7 in 1987,the rst Basel Capital Accords o 1988, and even the enig-matic meeting o Presidents Nixon and Pompidou in theAzores in 1971. For the last 20 years, however, monetary relations have been dramatically underrepresented, espe-cially compared with trade relations.
 
Tis approach made sense during the “GreatModeration,”
6
when, starting in the mid-1980s, lowoverall economic volatility allowed central banks to ocusalmost exclusively on ination targeting. Te economicgrowth ollowing the collapse o the Soviet Union also
5
See Drezner,
 All Politics are Global
, pp. 43-45. Princeton University Press (2007).
6
Though often attributed to Ben Bernanke, this phrase rst appeared in James H.Stock and Mark W. Watson, “Has the Business Cycle Changed and Why?,”
NBER Work-ing Papers
, #9127, National Bureau of Economic Research. (2002).
contributed to complacency among central bankers andpolicymakers. Since the advent o the euro in 1999, theFederal Reserve and ECB have shown a “benign neglect”or their mutual exchange rate. In the wake o the nan-cial crisis, however, the dollar-to-euro exchange rate hasbecome highly volatile. In a world o vigorous cross-border trade, the costs o this volatility, i ongoing, couldexceed the costs o managing the exchange rate moreactively. It is time or monetary management to return tothe transatlantic agenda.Te extensive literature o ideas or a more active rela-tionship between the Federal Reserve and the ECB datesback to the introduction o the euro. In 1999, PeterBonger argued or an active exchange rate manage-ment in which the ECB deends the upper band andthe Federal Reserve deends the lower band at a certaindollar-per-euro value via interventions on the oreignexchange market.
7
 All oreign exchange market interventions impact themonetary base. Tereore, central banks will sometimesinevitably have to carry out ination- or deation-spur-ring strategies to deend exchange rate bands. Bonger’sstrategy, however, could be accomplished using sterilizedinterventions — that is, interventions that counteract rstround orex-market interventions. When threatened by ination, which calls or the deense o the upper band,the central bank could issue bonds domestically to mopup the excessive money supply. Exchange market inter-
7
See Bonger, “Options for the Exchange Rate Management of the ECB EconomicAffairs Series,”
ECON 115 EN, European Parliament Working Papers
(1999).

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