The View of the Eurozone Crisis From ChinaApr 16th, 2012 | By Tianyi Zhang
Andong Li is a deputy director of the Central Budget Office under the Budget Department at the Treasury of the People’s Republic of China. He oversees revenues and expenditures for the central government. He is a prolific author and his papers are published in core journals in China. His interest field lies mainly in budgeting, government and economic policies. His latest paper Analysis of Section Budget Reform of Central Department is published in Journal of Central University of Finance and Economics. The following interview was translated from Mandarin by Tianyi Zhang.
In the opinion of you and your colleagues, what is the major cause of the current European Debts crisis?
That’s a good question. Generally speaking, government failure, over-borrowed debts, and system deficiency in the Eurozone are all triggers for the current European debts crisis. The prolonged over-borrowing in both public and private sector also contributed dramatically to this ongoing crisis.
In the Euro zone, the 5 so-called PIIGS countries—Portugal, Ireland, Italy, Greece and Spain—have been most affected by the debt crisis. Could you elaborate more on these specific cases?
Let’s start with the Greek example. From 2001, when it entered the euro zone, to 2008, right before the crisis, the annual fiscal deficits in Greece increased from below 3 percent to 5 percent, while the whole euro zone was at 2 percent. And in 2009, Greece’s total debt took 115 percent of GDP.
Similarly, after joining the European region, countries such as Greece and Portugal raised their salary, social welfare, and social security levels to keep up with Germany and France. However, the expenditure increasingly exceeded the total domestic output. Due to the “stickiness” of salary and social welfare levels, it becomes difficult to lower the provision levels, which in turn worsens the debts situation in the future.
For Spain and Ireland, the formation of debts differs. These two countries were influenced by the contagion of the subprime mortgage crisis, and their banks suffered substantial debt write-offs coinciding with the recent decline in the real-estate industry. This led to a solvency crisis.
Italy is relatively better off than the other 4 PIIGS countries, but the interest rate for its 10-year government bonds is nearing 6 percent. Common knowledge suggests that 6 percent interest rates are a “warning line,” after which a country will be vulnerable to sovereign debts crises. Besides Italy, all the remaining PIIGS are dramatically above this safety threshold, and things will turn particularly bad once they are unable to issue new bonds to support the previous ones.
What strategic steps can these countries take to overcome the crisis, and were there any particularly bad decisions made? Are there any restrictions from the Eurozone system?
Unfortunately, the five governments I’ve mentioned failed to react properly, quickly and shrewdly during the crisis, and this exacerbated the situation. There are several common mistakes the governments made. The first involved a shortsighted view, along with singular pursuit of short-term benefit. They tried to please and fool the majority of the population during election seasons and during national opinion polls. That is how the Greek government concealed their large deficits prior to 2009.
Second, some countries deliberately avoided the supervision of the European Commission and European Central Bank. Germany and France set a precedent for this, and other countries mimicked their behavior.
Third, some interventions were not appropriate. For example, some of the policies implemented in Ireland and Spain worsened the asset bubbles distorting the economic system by expending large amounts of spending on economic rescue packages.
So, this crisis also revealed some faults of the euro zone system. In joining, Euro zone members had to abandon their own currency, give up their exchange rate independence, resign from their own monetary policies, and conform to the consequences of a large-scale economic union. In short, economic autonomy was the cost of access and integration into European markets. During the years when the economies prospered, this kind of converge boosted international trade within the area and largely reduced trade costs.
However, once the states found themselves in the center of an economic crisis, they were not able to apply monetary policy in order to lower the exchange rates, which would have allowed them to stimulates exports and mitigate the crisis. They were left with the sole option of budget retrenchment and tax increases through fiscal policy, which only worsened the recession. Thus, the system itself reduced the ability for individual entities to withstand economic recessions.
So what is the main influence of the European debts crisis? In particular, as a senior officer in Treasury Department of P R China, could you please talk about the influences the crisis has had on China?
Believe it or not, China is more vulnerable than the U.S. For both Britain and the U.S., their real economy is less influenced due to trade. Even though Europe is the second largest export market for the U.S., the actual amount of export is only 7 percent of the total output, and contributes just 1 percent to U.S. GDP. It’s obvious that American economy depends only slightly on European demand. That said, the European sovereign debts held by the U.S. may be the real danger, given the ambiguity of the market status quo. One European bond payments cease, a chain reaction is expected into the foreseeable future.
By contrast, things are different on the other side of the world. Japan and China would be highly affected by the recession in Europe, since the reduction in European demand will impair exports a much higher degree. The European Union is the biggest buyer of goods from China, and Chinese growth is heavily reliant on exports. If the recession spins is out of control, it will definitely influence the real economy of China.
And what about industries? Which do you think is the most vulnerable industry in China, given the Euro crisis?
I think the bank system will bear the brunt of this impact. In the European sovereign debts crisis, the burst of bonds bubbles in Ireland and Spain began in banks and continued to governments via bank saving interventions. In fact, the close relationship between banks and the government made it a fatal strike. When the government debts are restructured, they are written-off accordingly. Thus, any related banks holding those bonds were hurt. Unfortunately, it is common for banks to hold government bonds in Europe, such as the National Bank of Greece—a Greece national debt holder to the tune of 18 billion Euros.
Besides banks, an important and interesting agency in the financial market are rating companies, which are the independent third parties in transactions. Literally, they can’t forecast the crisis and forced to follow the crowd. Rating agencies upgrade securities and countries in booming economies and downgrade them in downward-sloping ones. As a point of fact, rating analysts do not have exclusive access to confidential market information, nor do they have better analysis models for pricing. So these days they are criticized by the pessimistic influence on market during a recession that they seem to do nothing but strike at people’s confidence. But overall, they are important agencies in financial market and great influencers of popular opinion at large.
Will things turn for the better in the future?
The most efficient path for recovery is to seek help within the European Union, because if they don’t lend a hand today, they will be in debt tomorrow themselves. In this rescue procedure, the European Central Bank, the European Commission and the International Monetary Fund all proposed viable solutions. In fact, Greece, Ireland and Portugal have already applied for bailouts. And this approach’s high probability of success is based on favorable outcomes in 2010 for Ireland. Also Germany, the relatively strongest economy in the European Union, should lend a hand too.
At the same time, the convergence of currency is more like a one-way road, it’s hard to quit without being badly hurt. Thus, collective action is the best way out, since no one is immune from the crisis. Germany is gradually recovering from recession today and has the best means to help her next-door neighbors.
But these are all the approaches in the short run. In the long run, the main characters in the recession should rely on themselves. It is high time for actors to change over-drafting consumption habits as well as their investment patterns. After all, others are not the ones responsible for paying their bills. If they don’t enact conservative fiscal policies and work to make ends meet, similar crises will be just around the corner.
That said, the whole picture is still optimistic and I personally believe things will be better if proper policy implemented. During the whole of the crisis, there were several mistakes made by the European Central Bank (ECB). The first was to increase interest rates from 4 percent to 4.25 percent in 2008, right after the subprime mortgage crisis in the U.S. This action shook the fragile economy of European countries, the financial markets, and the real estate industry. Due to the inconvenience of being unable to tailor policy for specific areas, the policy implemented by the ECB is always rigid and outdated when it comes to stemming inflation-related problems. So if ECB adjusts the policy slightly, things will be better.
Secondly, the ECB holds substantial national debts of its members: 47, 19, and 21 billion Euros respectively for Greece, Ireland and Portugal. Without precautionary policies, the default of the individual countries would largely hurt EC. But we should be confident to that, as said by Jose Manuel Barroso, president of the European Commission, “leaving the euro currency would be a tragedy, and it will continue to be one of the most stable currencies in the world.”
Feature photo: cc/Andres Rueda