Executive Director, Research Department, China International Capital Corporation Limited (CICC)
Breaking the Wall of Global Debt. How Economics Can Reshape the Development Models of Europe, the US and China
Good afternoon. It is my great pleasure and honour to be here. You may wonder: global debt crisis happens now in the US and in Europe, so why not an American or European at the podium, but a Chinese? Well, I can guarantee you I will not preach anything. It is just my profession as a macroeconomist to do the most fundamental research. Given that this global debt issue is so complex, and this morning someone said that we need simple questions and simple solutions, I will try to use the next 30 minutes to break down this wall – not completely – by some of the core critical bricks of this wall to see what really the problem is, making the global debt issue so complex, so difficult to address.
First of all, let’s look at it. In almost two years of the past, the debt issue is only getting worse and worse. It started from Greece. Now, this Greece issue, by looking at the number, it is quite small. Its GDP is only 2.5% of the Eurozone GDP, and its debt level is not that high. However, Greece represented a group of high-debt countries in Europe and how Europeans are going to deal with it, particularly Italy and Spain. Their debt level is ten times higher than Greece. By looking at the Greece issue, we talk about debt sustainability, but debt sustainability has three components.
Whether the current European policy helps to deal with all these three? First of all, it is the debt level. Everybody probably, by this point, is fully aware that Greece’s debt problem and other countries’ – at least Portugal’s – is already a solvency issue, not a liquidity issue. So, for the debt to be sustainable, either you reduce the debt level; when the debt level cannot be reduced, you need a GDP to grow. So, in terms of GDP, the debt is getting smaller. The third component, which is very critical, is the interest rate. If you have a very high interest rate, the debt burden becomes even larger. So, if the interest rate is usually above 5% and is already dangerous, Greece now faces 100% in the two-year borrowing and about over 20% at the ten-year borrowing. So, obviously it is not sustainable. At the same time, accumulation of debt until debt crisis means over-excess of spending. So, correcting this mistake is fiscal austerity.
But when you try to bring the debt sustainability back, you need growth. Austerity means more tax, more spending; so, obviously, drags down your growth. The GDP, in Greece’s term, is contracting for many quarters now. So, the market knows very clearly that Greece’s issue is no longer liquidity support. But EU leaders, up to this point, are providing liquidity support. The market gets a very temporary break. The IMF disperses the next trench, but a few weeks after – jittery return. When you have a debt overhang, adding more debt is not going to solve the issue. So, at this moment, the patience of a market is really wearing thin. They want to see the next step beyond the liquidity. So, liquidity only buys time. In fact, that grieving time gives the politicians and economists time to work out a solution of how to fundamentally change the tide. How to resolve that?
For debt overhang you need a debt haircut, restructuring, write-down. Currently Europeans talked about this issue, but only in a very kind of unclear fashion. For instance, a haircut of 50%, but this 50% in the longer term, by 2020, brings down Greece’s GDP, debt to GDP to 120%. Will the market buy that story – by that time is it sustainable? Obviously not, it is still too high. Secondly, we need external support, or Europeans have to come up with a very large fund of EFSF. But, every country, at this point, is still reluctant to give money to help these high-debt countries. Is there a good reason? Of course, because Europeans – when you look at the Eurozone, there are two groups: one is the surplus country, and the other is the deficit country. So, the deficit country overspent for many, many years. Now, they suddenly want the surplus country, which maintains the competitiveness, to now use their taxpayer money to save the others. The first reaction, of course, is a rejection. It is difficult to bring political consensus to deal with that issue. So, that is the second problem. It is reasonable for the Europeans, but unreasonable to the markets. Why is that? Because, if you don’t come up with a rescue package to solve the debt overhang, the result will be default.
Now when default comes, who will be hit first? Defaulting country banks. You say, “let them go.” Is it that simple? It is not. In here, the current solution is beyond the IMF, and EU liquidity support is the ECB liquidity support. They already engaged in buying government bonds, or, in another way, they have been using very low quality, including Greek bonds, as collateral in exchange for cash. So, it is bad assets in exchange for good assets. So, ECB balance sheets are already deteriorating.
So, how can we come up with a better solution? A better solution is to deal with the debt overhang right on. But, that requires, currently many people are talking about, leveraging up the EFSF or getting help externally – outside the European region, including from China. Is that the right solution? We think, first of all, when external support is to come, they are looking for three things. One: whether this is an investment or is it a bailout? If you want external investors to bailout European countries, what is the interest there? If a country bilaterally bails out, it will be seen as an opportunist. Or, if Germany thinks of China to rescue Greece – let them off the hook – how can Europeans push Greece to do structural reform? So, bilateral support, or a bilateral kind of deal, is not the first best.
So, second, if it is as an investment, of course you look at the returns. At this moment, even European investors are very reluctant to invest in these bonds – can any outsiders so happily invest? Now talk about guarantee: why not invest? Because EFSF is going to provide a guarantee, but at this moment, this guarantee is 10% or 100% – it is entirely still unknown. So, the market is unsure of exactly which direction to go. For Europeans, the bailout will be a waste of money if these countries hide that in the countries their behaviours do not change. Ten years from now, suddenly now the debt is lower, so I can borrow more, spend more. Ten years from now, we will again face the same debt crisis, maybe even shorter than 10 years. So, this entire puzzle has to bring together to see what the third element is – beyond the liquidity.
Beyond the bailout is the roadmap. How European countries, Eurozone, will emerge out of this crisis to become stronger, or weaker. In order to become stronger, a long-term pillar, supporting a better Eurozone, will have to be in place. That is the time to go back in history to revisit at a time of the European Union and the Eurozone establishment: what has been really missing, coming up to this stage? I am very pleased at this long time, Chancellor Merkel mentioned something that I have heard for the first time, which is: “revisit: crisis bring us to the point of change.” So, it is not that the crisis is a bad thing; sometimes it can bring a good outcome.
What is the change that she mentioned? One is the Lisbon Treaty, which is crucial. Secondly, it is to give away some of the national interest, thinking about a country issue in Europe not as “just their issue” but a European issue. It is a domestic issue. Thirdly, not a smaller Europe but a bigger Europe – a larger Europe. So, I hope this is the message that will eventually translate into concrete measures, which is critical of the third stage – it is a long-term map.
So, what is it missing? Number one is the fiscal union; it is missing. You have a monetary policy so centralised in the European Central Bank. You lost your exchange rate flexibility completely, but you don’t have fiscal policy. You only have a master treaty. What is a master treaty? It is an agreement of gentlemen – for the good boys. What is the penalty of violating a master treaty? None. No wonder, when you look at the last two weeks at the Greek survey of the Greek citizens, 60% reject all these austerity measures. But, 70% want to stay in the Eurozone; they want the best of it, but without taking harsh change. Now, this morning, Professor Weber mentioned that change is tough; change is difficult. But, without this change, you give good money, write off the bad money, and end up repeating the same mistake as before. So, in order to really have the bailouts, not only the market, but also it is in the interest of the European Union to really have the pre-commitment, the political pre-commitment, social commitment, from these high indebt countries to do structural reform.
So, lastly, if the Greek issue resembles a major structural reform needed, and a bailout package should be linked to the long-term reform needs, on that basis I am pretty sure that international support will come. The private sector will crowd in. Using a very simple example, right at this moment, free cash sitting on the sideline in the money market fund is almost 3.5 trillion. Before the 2008 crisis, it was only 500 billion. So, basically, so many investors want to protect their capital by putting money in the money market. If you have a sure future of these countries, will people become less risk averse investing in these bonds? Yes, they will.
Now by looking at the reserves of the Asian countries, including China, in fact, the number is much smaller. Talking about China’s reserve, it is almost about 3.5 trillion; but they are already fully invested. It is an accumulation of money of the past 30 years, but every time they already invested in US bonds, UK bonds, Japanese bonds, including European bonds. So, for external support to come is only the marginal saving from their trade surpluses, and it has to come maybe through the IMF mechanism, in order to link with the European interest to forge concrete long-term reform measures for high indebted countries, so the same mistake will not repeat again. Thank you.