Foto: Jakub Stadler

While many pundits are starting to use the past tense in talking about the economic crisis, Kohout says that 2010 is likely to have a few surprises. He remains skeptical about the euro in the long run, and says it is no cure-all for potential problems. Another popular idea, regulating bank bonuses, won’t accomplish much as these had little to do with the crisis. The overabundance of credit, which breeds too much bad credit, was the core of the problem.

Q: Will the world get a lesson from the crisis? Stricter control and regulation of financial markets is often discussed. 

A: Back in the ’30s America and the rest of the world learned a lesson, and supervision of banks and stock markets was established. The model was chosen rather well because half a century elapsed since then without any financial crises in the West. The next one came in the ’80s; it was a saving bank crisis in the U.S. In Europe it was Scandinavia, where a rather important financial crisis hit in the beginning of the ’90s. But these were crisis limited. … The model of regulation in banking and on financial markets established in the ’30s was not bad in principle. Canada may serve as a proof, because unlike in the U.S., the Canadian system has not changed much and the impact of the financial crisis there was much less serious than in the U.S.

Q: Why do you think the Canadian model of preventing crisis is so good?

A: In financial matters Canada was more conservative than the U.S. Canadians never ventured in subprime mortgages and there was certain restraint concerning derivates. And, most important, they never removed the rule saying what minimum share of a bank’s own capital is to go with any loan. Banks in America were overcredited. The principle of Canadian banking can be summarized in a few words: more conservative approach, fewer experiments, less hazard.

Q: Czech banks, remembering the ’90s, were careful, so the financial crisis did not hit us that much.  

A: The financial crisis did not touch the Czech Republic at all because no banks, insurance companies or pension funds were forced to ask a state or a bank for help, unlike in the end of the ’90s when the situation was quite different.

Q: Can the recession in the Czech Republic have a negative impact on banks because some businesses go bankrupt and are unable to pay, although their loans were by no means risky under normal circumstances?  

A: The fact that Czech banks avoided the first round does not mean that the financial crisis will leave them quite intact. Now we are in a second round, characterized by slow economic growth. During this year the European economy is probably going to recover somewhat, but it will not be 5 or 6 percent growth; perhaps only 1 or 2 percent. It is not difficult to predict that the share of bad loans will grow but it will probably not surpass any critical level.

Q: Do you believe in stricter financial market regulation?

A: I believe in precisely defined regulation, strict but not despotic. The worse is a situation when a regulator has strong, but not clearly defined powers, which means that its officials can do whatever they want. Also it is necessary to repair a ‘yawning gap’ between some overregulated areas and some derivates, which have not been regulated at all.  Some contracts that are not banking products … do not come under the supervision of securities commissions. They are not commodities either, so they are not looked after by commodity market regulators. It will be necessary to have new authorities—or the old ones equipped with new powers—to supervise such instruments.

Q: Are bonuses paid to bankers to be regulated too?

A: I do not think so. The basic reason the crisis erupted, was the same as with the financial crises in the 1930s or in 1973. The reason is that there was too much money in circulation, that central banks released too much virtual money. When a bank has more money, it lends more money, and the more loans there are, the more loans go bad. It is simple; in the economy there is a limited number of good projects that deserve credit. But when there is too much money available, credits are given even to projects that should not be given credit.  Such a credit expansion goes on until a too high percent of bad loans appears, and then there is a banking crisis. It is virtually the same, no matter how much money bankers get in bonuses.   

Q: In the past, Czech businessmen, mainly exporters, called for the euro to be established as soon as possible. Did having the Czech crown help or harm our economy?

A: Exporters always see that the euro removes volatility and the currency risk. But it is no redemption. Currency risk cannot be removed. When you suppress it administratively and the domestic currency gets aligned to a foreign one, as they did in Baltic States, then the currency risk is seemingly removed, but in fact it is only shifted elsewhere—creating risk of a swelling bubble.  And it is much worse than the currency volatility risk.

Q: In your book you said that even national currency is no panacea.

A: Iceland had a national currency and they came out badly. It is important to have an adequate monetary policy. If it means to have the euro or not, well, that is individual. Nevertheless, there are some countries that should never accept the euro for their currency. But they did, and the consequences were devastating. Ireland is a textbook case of a large credit bubble deflated. Italy pays for its inability to devaluate, so as to become more competitive. And Greece is an example of a country that should never be allowed into the eurozone. They got there through an unfortunate political error, and now they have severe problems. In the case of Slovakia, only time will tell. 

Q: Does it mean that it was better for us to not have the euro during the crisis?

A: Certainly, that saved us from the financial crisis, from contamination of our bank by those toxic assets, we were saved from an even larger bubble of credits than that one we had. The Czech crown worked as a breaking mechanism, although many people did not like it in the beginning.

Q: When do you suppose it would be useful for the Czech Republic to accept the euro?

A: First it should be established, that the euro is a viable project—which is by no means certain. The euro was set up and 10 years after Europe was hit by the largest crisis since the end of the war. The crisis was not caused by the American mortgage crisis. If it was the only reason, its consequences would have been solved a long time ago. The origin of the crisis was here, in Europe and it hit mainly countries that should not enter the eurozone, like Ireland.

Q: Can such a deep crisis be prevented in the future?

A: After the war more than 40 years elapsed in the West without any real crisis. Perhaps we should look back to the past, at what they did well in the ’50s in the West, and learn a lesson. Of course, we would not like to repeat some mistakes, like customs barriers, some special exchange rates or inconvertible currencies. We should get back to more conservative regulation of banks and we should try to curb the overgrown welfare state because it cannot lead to any good.  

Q: Some economists say that the recession is nearly over. Do you agree?

A: Everywhere you can read that the recession is passé. The weekly The Economist used the term ‘great stabilization.’ A lot of ‘buts’ remain. What about Greece and other problematic countries in Europe, like Slovenia and Austria? And another question: What about China? Is it able to curb its gigantic loan growth? This year may have many surprises in stock for us.  

Q: Will our large budget deficit influence our credibility in the eyes of foreign investors? 

A: Obviously it may have its impact. Last year the credibility of the Czech Republic sustained a heavy blow when the government fell during the Czech presidency in the European Union, which was something unseen and unheard of. If we keep cutting the branches we sit on, soon we may fall down.

Q: Speaking of the government, as a former member of the National Economic Council (NERV), how do you assess how the Chamber of Deputies dealt with the council’s suggestions and the Finance Ministry’s economic package?

A: NERV’s main task was not to look for brilliant solutions, because there weren’t any, but to find arguments for dismissing the precarious and crazy proposals pushed on the government from all sides. There were  many bizarre proposals, but they were similar in one respect: demanding money from public budgets. NERV’s main contribution was not in what it helped to push through, but in what it helped to prevent.

Q: Some of proposals you dismissed are now in the Chamber of Deputies, for example the 13th annual old age pension payment.

A: As an old song says, no one can ever take anything as definite. Of course, anything may appear, even after the elections, that is bound to come off badly, whoever the winner is. … But NERV managed to postpone such proposals by at least a year or two. 

Q: What proposal was the most important to block?

A: There was a proposal to increase salaries of all state employees. The argument was that it will lead to increase of demand and subsequently to GDP growth.

Q: How do you comment on the left finally succeeding in pushing through a higher budget than was proposed by the Ministry of Finance?

A: We are following the footsteps of Greece, and Greece follows Argentina. This cannot end well. In a better case, a drastic reform will have to come; in a worse case, an even more drastic reform will ensue after the state falls into a partial insolvency. Such things did happen before and they may happen again, maybe even this year.

Q: Will a drastic reform have to be undertaken by the new government elected in May?

A: It is impossible to predict. …  People often talk about a legendary 60 percent for the ratio of public debt to GDP, one of criteria embedded in the Stability and Growth Pact. But the pact is badly built. It is largely understood that to have a lower debt then 60 percent is OK, but it is not so. It may happen that one day markets stop buying Czech obligations, and all at once we can become insolvent. 

Q: What symptoms show that a country is sliding toward bankruptcy?

A: The symptoms were already visible here in 2006 and ’07, when no one had any idea about the coming crisis. These years marked a turning point because then there was still a chance to rearrange public finances in a sensible way. But the politicians dismissed the possibility, preferring to buy votes instead, and since then it has been sliding down. I want to point out, that in the years 2005–07 and partially even in 2008 we had a rapid economic growth and we should have surplus budgets too. But we didn’t—and there is no excuse for this.

Q: Is the situation in the Czech Republic different from Latvia and Hungary?

A: We are lucky to have a good currency and a central bank with a sensible monetary policy. That was lacking in Hungary as well as in the Baltic States.

Q: Do we still have a chance to prevent bankruptcy, or is it too late?

A: Purely from the economic point of view we have a chance, of course, but as political aspects are concerned, I do not dare to predict anything because, fortunately, I am not a politician or political scientist.

Q: Harvard economists say the only way out of the crisis is decreasing mandatory expenses, not increasing taxes. But if the left wins elections, they will probably opt for increasing taxes. Where do you think that could lead us?

A: They can make us one of the countries with a highly progressive income tax, like Greece, with a debt surpassing 100 percent of GDP.

Q: But the Social Democrats (ČSSD) point out that Scandinavian countries have high taxes and their economies are rather stable. Couldn’t they serve as a model?

A: First, I would like to ask those supporting the Swedish model, how many Swedes live in their house. The Swedish model is not reproducible in Czech society. …  It is quite specific and based on the mentality of the people, and absolutely not transferable.

Q: Why?

A: That is because the Swedes have been raised for centuries in a culture where everyone understands that bribe, theft, or preying on the state is bad. They have never learned the proverb ‘those who do not steal, harm their own families.’ The difference is so fundamental, that the model is absolutely inapplicable here. Just look at the situation here concerning public tenders. Should anything like this happen in Sweden, there would be a revolution. …

Q: How can we avoid problems like those in Hungary, Latvia and Greece?

A: Since last year everyone has been talking about the financial crisis. But that is only a secondary problem. It is something like having a house built on sand. Its foundation is weak, so it is bound to tumble down in the future. And when even a feeble tremor comes, it falls down somewhat earlier. The problem is not the earthquake, because if the house is well founded, it can stand the tremor. Our contemporary economy is built on an infinitely overextended welfare state, so it is naturally unstable and it has to tumble down. 

Q: Do you mean only the Czech Republic?

A: I mean Europe as a whole because the European welfare state is no traditional model at all, as the public has been repeatedly falsely assured. When you look in history, you can see it was born relatively recently, sometime in the second half of the ’70s. Before then European countries now well-known for their welfare models—for instance, Sweden, but mainly France, Germany, Belgium, Italy and Spain—were very frugal and modest, if we look at them from our contemporary point of view.  For example, Greece, now balancing on the verge of bankruptcy, had a state debt of less than 20 percent of GDP, in France it was some 30 percent and in Germany slightly above 20 percent.   

The horrifying model of the welfare state as we now know it, with skyrocketing debt has been forming only since the second half of the ’70s. Only 10 years ago no one could imagine that Germany could ever get into such bad shape, with debt climbing up to 70 percent of GDP. Today it is taken for a common reality.

Q: What impact will this cause in the future?

A: When a country bound to the euro, like Latvia or Greece, goes bankrupt because of public expenses going adrift, Germany will have to pay the bill at last. And what will happen, when some 10 or 20 years later Germany’s turn comes? Who will save her? There will be nobody disposing with the needed financial strength.

Therefore, the welfare state in its present form, with spending at about a half of GDP, is untenable in a long term. Basically, it is an economic experiment that cannot last longer than one human generation. 

Q: Can the fall of this welfare model be influenced by unfavorable demographic development?

A: The demographic development has been caused by this swelling welfare system, mainly the pension system because states create incentives for families to abstain from having children. Single people are burdened with taxes so they do not have enough money to start families. Housing expenses in many European cities are so high that you cannot afford to pay for anything else. Real estate prices are so high because, among other things, there is ever more money in circulation, which is related to the welfare state. And when people start a family, they often settle for only one child. The policy indirectly pushes people to have only one child.

Q: Is there a way out?

A: I think Europe could be saved by coming back to the legendary German social-market economy from the ’50s, adjusted to present conditions. Then the rate of GDP redistribution didn’t surpass 30 percent and people retired at 65, while the average lifespan was something over 60. It means that we would have to push retirement to 70 or perhaps even older. But no politician will be eager to do this.