David Folkerts-Landau has been Chief Economist and Head of Research at Deutsche Bank since 2012 and is heralded as “one of the richest bankers in Europe”. The German born economist studied at Harvard University and later Princeton University. The Worldly’s Economics Correspondent William Phillips had lunch with Mr Folkerts-Landau.
WP: Why would it be such a terrible thing for Greece to leave the Euro?
DF: It may not be, but we worry about it being a bad thing. When you have a currency union like the Eurozone, then you have institutions in place, like payments and clearing systems which precludes the possibility of leaving. So if central banks owe each other money, interest is paid on that but there are no risk spreads attached to the debt. However if one member leaves then you face the possibility of risk premiums being placed on the money they owe to one another.
The point being that if one member leaves – however small – then you no longer have a currency union; you simply have a fixed exchange regime. We know from the history of Europe before the euro that there were lots of currency crises, but that all disappeared with the introduction of an irrevocable joint payments and clearing system (the Euro).
So the fear is that if Greece leaves the Euro, people will start viewing the Eurozone as more of a fixed exchange rate regime, and when the next crisis hits, people will target, for example Portugal, by selling Portuguese debt.
WP: And your personal view?
DF: But I don’t buy into that. From my experience within the investing community, the view is that Greece may well be a liability because it creates so much uncertainty about the future of the system. And it occupies so much managerial time of senior statesmen that the costs and uncertainty arising from that are far greater than the uncertainty created by letting one member go.
But this issue cannot be proven right or wrong, it is a belief and a view born out of experience.
WP: So could one member leaving begin a knock on effect for the rest of the Euro?
DF: The Greek crisis has had very little impact on the spreads of sovereign debt, so what other countries like Spain and Portugal are paying on their debt has not changed much at all. Whereas two or three years ago there was a big problem for this spill over effect into the PIGS (Portugal, Ireland, Greece and Spain) economies.
This time around we have come very close to letting Greece go but we barely noticed it in a sense, because the European Central Bank (through its OMT programme) stands ready to support countries that are experiencing liquidity and debt crises.
You are confronted with the very basic task of analysing current developments to get a sense of where the world is going
WP: Do you prefer working in academia or researching for a company, such as your current role here at Deutsche Bank?
DF: Oh that’s an easy question to answer! To be a successful academic you are required to stay focussed on what can sometimes be a very small problem. Whereas economists in an institution like Deutsche Bank, you are confronted with the very basic task of analysing current developments to get a sense of where the world is going.
From interest rates, to exchange rates, to fiscal deficits, to growth, to productivity, to fiscal policy…it covers it all. For example if you speak to a professional fund manager about which asset class is the best to invest in, they can’t say sorry I only specialise in one, they have to have a view.
So I’ve always thought it’s harder to be in research for an institution like this than in a university. It’s more brutal. If you get a prediction of the euro-dollar rate wrong, then you will be punished for it, including in your pay. That’s not true in academics. If there is a problem with your data or a theory isn’t proved…people move on. But here you get brutally marked to market every day. And there are so many more questions than answers and you just need to use your gut and your experience to come up with answers that make sense.
WP: Could you give a brief example?
DF: I mean now, is the devaluation of the Renminbi a danger to the surrounding Asian countries? They have experienced significant devaluation themselves as a result. And their corporate sectors have very large exposure to foreign currencies, so could we see a rolling crisis there?
And that is the kind of question you have to be able to answer; you have to understand the country, the corporate capital structure, and the sensitivity to the exchange rate. On one hand debt is more expensive, but on the other hand it will generate more domestic demand. You have to think all of this through and it can be hard.
WP: In Konzept [a Deutsche Bank research magazine] you said “we are living in one of the most unusual economic and financial periods ever.” How temporary do you think this is?
DF: Some of it is hopefully temporary. It would be difficult to think of a world where near zero interest rates were the norm. But it is definitely possible. But you’d think eventually investment will start reacting to the low rates, as with all the macro mechanisms we are familiar with, when there is cheap money, the demand for that money will increase, and then somewhere along the way credit and money will become more expensive and interest rates will go up… It is possible it could persist for another five years or so, but the way we think about the world, macro interaction and people’s reactions, it is hard to believe it will stay this way.
Knowing how global finance works, that is just something that you can’t quite get your head around.
WP: You have worked in academia, for the IMF, and for a bank, what was the most exciting point in your career?
DF: October 2008. I was in New York for a meeting; everyone was congregating in New York at this time, and I woke up to the Bloomberg news…and for the first time in my life I was concerned that major money centre banks would fail. End of the world! Global payments systems collapsing! To have lived through that and to have seen my colleagues with net worth’s in the millions go to cash machines because they were worried they didn’t have enough cash…well those were seriously exciting times.
It did take a while, it wasn’t until a while after the collapse of Lehman Brothers that the panic started to set in. It was just unbelievable to think that a bank like Deutsche Bank, or Citibank or Goldman Sachs might not be able to open for business the next day. Knowing how global finance works, that is just something that you can’t quite get your head around. So that has probably been the single most unusual experience of my professional career.
Banks are still the most important financial institution in an economy.
WP: Can you expand on your work at the IMF?
DF: I thought my work at the IMF was very rewarding. Doesn’t pay as well as a bank obviously! But I spent 15 years there. You would have countries in danger of fiscal collapse and you’d go in with a team of really good people and you would look at the books and the policies and you’d tell them “if you do this we will give you the money for it.” And after a while you would see the country perform again in economic terms, and I found that to be very rewarding; I seriously enjoyed that.
In my last five years I ran a team that looked financial systems of countries with potential problems. So similarly we would go in and talk to the bankers and ministers and we were pretty good in forecasting that there was going to be a problem in Korea for instance in 1997. We said that the banks are far too exposed to foreign currency, the government didn’t have enough reserves to support the exchange rate if there was a crisis. And that is what happened, the currency was attacked, it devalued and the stock market collapsed. Banks ran into problems and couldn’t make the foreign payments and there was a massive debt crisis.
So for somebody with an interest in the political economy, the IMF is a fabulous place to work. Working for a bank is less thoughtful, a bit faster paced: you have to make decisions more quickly. And it is more financial, whereas the IMF takes the whole country into consideration.
WP: Do you see bank ever being as powerful as they were before the financial crisis?
DF: No, banks will not go back to what they were in 2006/2007. They are much more heavily regulated now. They are more restricted in what they can do, and I think that is the right thing to do. Banks are still the most important financial institution in an economy. In term of payments systems and risk management and solving corporate finance problems etc. But for their own account participation, due to the Volker rule it is almost negligible now. And that wasn’t the case before the crisis; banks were serious players in various markets.
It creates a problem because if there is a mis-pricing in the market, banks used to step in. But the question is who does that now? Have markets become less efficient? I don’t know, it is an interesting research question. Once you remove the liquidity banks give the market, does the shadow banking system taken the place of what banks used to do?