Business Times Singapore Investment Roundtable
Seeking exit from economic woes

William R. Thomson
Posted Jun 30, 2012

PANELLISTS

Charles Dallara: Managing director, Institute of International Finance

Richard Koo: Chief economist, Nomura Research Institute, Tokyo

Eisuke Sakakibara: Former vice-finance minister for international affairs of Japan

Kenneth Courtis: Former vice-chairman, Goldman Sachs (Asia), and co-founder of Themes Investment Management

Ernest Kepper: President, Asia Strategic Investment Associates, Japan

William Thomson: Chairman of Private Capital, Hong Kong, director of Finavestment, London

MODERATOR: Anthony Rowley: BT’s Tokyo correspondent

THE Greek election and the G-20 summit in Mexico have both come and gone, but still the global economy looks little closer to being saved. What more can be done? The Business Times convened a roundtable of international experts, chaired by BT’s Tokyo correspondent Anthony Rowley, to offer their prognosis.

Debate: We’re privileged to be joined today by Charles Dallara, managing director of the Institute of International Finance in Washington, as well as by Richard Koo, chief economist of Nomura Research Institute in Tokyo, and Professor Eisuke Sakakibara of Waseda University. We also have trusted “old faces” around the table. A warm welcome to everyone, and let’s get started.

Rowley: Europe, obviously, remains the centre of global concern. Charles, as a key figure in European and international debt negotiations, what do you think Europe must do to escape from its predicament?

Dallara: European leaders need to send clear signals that they are prepared to deal with the immediate pressures they face, in Greece and Spain particularly. More generally, they need to adapt their economic strategy away from short-term budgetary measures and towards greater emphasis on medium-term structural reforms. Strengthening the euro-area monetary union requires a far greater degree of fiscal integration which in turn demands greater fiscal risk sharing with some form of debt redemption fund or Eurobonds, conditional on centralised fiscal governance. I think Europe would be well advised to move promptly towards development of a unified banking regulatory authority: A unified deposit guarantee system and unified resolution mechanism. If Europe could agree upon the goal and the time line, that would do a lot to demonstrate intent and generate confidence. There also needs to be a willingness by major economies such as the United States, Japan, to take other actions. A coordinated cut in interest rates among some of the world’s central banks – not just the G-7 but also one or two emerging markets – might send a powerful signal to the market that the global slowdown is at risk of becoming once again a global recession.

Rowley: Richard, do you see a danger of the Eurozone crisis triggering another global recession?

Koo: The US, Europe and Japan all face balance-sheet recessions. If you look at the flow of funds, the private sectors of these countries are all paying down debt or increasing savings at near-zero interest rates. This is completely outside of neo-classical economics. After the bursting of the bubble in all of these countries, the private sector is stuck with balance sheets under water and they are basically minimising debt instead of maximising profits. When you are in that very rare situation, governments must borrow the excess savings in the private sector and put them back into the income stream.

Rowley: Professor Sakakibara, how do you rate the chances of another global recession?

Sakakibara: I think this year could turn out to be the worst year since World War II. I don’t think a depression will come but certainly it’s going to be a simultaneous recession. In a situation like this, markets will always become pro-cyclical and that is accelerating the crisis. The financial sector in Europe is very weak. So it’s not only a fiscal problem; it’s a complex problem of fiscal and financial systems and I’m afraid that some kind of major banking crisis may take place in Europe within a matter of six months or a year from now involving French or even German banks. In the US, too, they have balance-sheet problems.

Rowley: Kenneth, your view.

Courtis: No sooner have we witnessed the make-believe G-20 Los Cabos summit, with flailing gesticulations of helplessness, then we start a series of Eurozone meetings, which promise little more. The reality is as simple as it is brutal. The economies of the so-called developed world are carrying much more debt than they have cash flow to finance. When that happens, great chunks of debt crash with a thud and create in the process vast economic, social and political dislocation. That is broadly what has happened in Japan over the past two decades, and is happening today in America and Europe. As demand weakens, growth slows, cash flows shrink even more, and still more debt comes crashing down. Since the Bush Bubble popped in 2006, governments have intervened aggressively with monetary and fiscal policy, desperately trying to stop the process. At the core of this increasingly dangerous dynamic is a largely insolvent banking system. The banking crisis in effect created a fiscal crisis, because large amounts of their losses on misguided loans have been transferred to the public sector. As the banking crisis intensified, the credit system went into reverse, and that set off a recession-depression, which in turn led to a collapse of government revenues and an explosion of transfer payments.

The only way to break this economic and financial death spiral is to recapitalise aggressively the banking system, force them to cleanse their balance sheets of the bad loans, and to sell off the underlying assets at market clearing prices. Full stop.

Rowley: William, your take on the situation in Europe.

Thomson: We are in the midst of a period of immense uncertainty and things could unwind quickly and get truly ugly. The key problem is one of governance rather than economics. There is a lack of competent, honest, leadership in the Western world with vision and, in the case of the EU, a democratic mandate. The ways to resolve the crisis are reasonably well known but the present leadership lacks the trust of the governed to make the tough choices required: Eurobonds, a banking union, in effect “more Europe”. If this persists for a few more months, we could begin to look for the unravelling of the Eurozone and perhaps the EU itself as countries sink back into beggar-thy-neighbour nationalistic policies of which there are already nascent signs.

That prospect is so grim that I feel there will be a series of last-minute compromises and fixes allowing us to continue muddling through the way we have for the past four years until a real consensus can be developed to take radical action, perhaps after the existing political leadership has been replaced.

Rowley: A Greek exit from the euro seems to have been avoided for now. Charles, what do you think?

Dallara: A Greek exit from the euro is a potential catastrophe that can easily be avoided. I do not expect them to leave the euro but it’s clear to me after all the time that I’ve spent in Greece that any Greek government will need to reaffirm its commitment to reforms. At the same time I would hope that Europe would recognise that previous budget goals are no longer realistic. Provided there is a rational response on both sides, this is a manageable problem. A Greek exit from the euro would lead to dramatically lower economic growth and run the risk of precipitating a global recession. Spanish and Italian authorities are doing a fair job of dealing with their problems. But the reactions of the market to the problems of the eurozone cannot be solved by any one individual country.

Rowley: Kenneth, any comment?

Courtis: Europe is now trapped between by the heavy weight of history, and in the irresistible inevitability of financial mathematics. The only way for the countries of the eurozone even to hope to escape the irresistible inevitability of the financial mathematics now closing on them is to trade national sovereignty for fiscal and monetary federalism.

But that escape hatch is closing and still key countries such as France have not even begun the discussion about the transfer of sovereignty.

Rowley: Ernest, what do you see in store for Europe?

Kepper: The euro is not the real problem but the start of a race to the bottom. Politicians will go from one compromise and quick fix to the next with the crisis deepening until Greece and Spain exit. Greece will soon need another bailout. Its economy is contracting at a 5.5 per cent annual rate, unemployment has soared to 21.8 per cent.

In Greece, the problem is an insolvent government bringing down the banks. In Spain, the problem is now insolvent banks bringing down the government. Greece’s unfunded liabilities are now more than eight times the country’s GDP. Greece can’t even make payments on bailouts received last year. France, home of the world’s largest banks with mountains of toxic European debt, is hanging by a thread and may soon need its own bailout. Even Germany is starting to slide.

Rowley: William – “Grexit”, or not. What do you think?

Thomson: It is quite possible, even likely, that Greece will have to leave the euro in coming months, and that could trigger others leaving. The fear among some is of a domino effect but I do not believe that Greece leaving the euro would be Armageddon. It would probably mark the nadir for Greece and the beginnings of recovery as happened for Thailand in the Asian crisis, Argentina, Russia and recently Iceland. Europe is wealthy and can solve its problems; all it needs is the will.

Rowley: Let’s turn to the wider world. Should we spend our way out of trouble? Richard.

Koo: Governments should not try to take austerity measures through fiscal consolidation when the private sector in so many major Western countries is deleveraging. In a national economy, if someone is paying down debt you have to have someone who is borrowing and spending money at the other end. We have the private sector of all of these economies deleveraging massively in some cases so the government has to borrow and spend money or else the whole thing implodes.

Because so many Western countries are now in a deflationary spiral, people are rightfully scared and governments are doing the opposite of what they should be. Everyone is on deleveraging and austerity mode and so the so-called risk appetite in all of these areas is down to absolute minimum. Japan, more by default than by design, basically did keep spending. After the bubble, Japan managed to maintain its GDP above the bubble peak for the entire 22 years until today in both nominal and real terms.

Rowley: “Keep spending and keep lending.” But that isn’t happening is it?

Koo: I handled the American debt crisis at the New York Fed in 1982 and I had to handle the Japanese banking crisis in 1997 – I was the key person in both – and from my experience I can tell you that when all banks have the same problem at the same time, you go slowly. If all banks are trying to raise capital at the same time, who can provide it? The EBA is putting on limitations at the worst moment in history. So, the European banks are all forced to withdraw and that is adding to the problem we have of non-banking businesses not being able to take on risk assets.

With European banks withdrawing, Japanese banks should take over whatever assets they can but they are scared to.

Rowley: Let’s turn to the global economy. Sakakibara-san, this is not just a European problem is it?

Sakakibara: In the US, they have balance sheet problems. Their financial system collapsed in 2007/08 and it has not fully recovered from that. It’s like the Japanese economy in the 1990s. Japan went into the so-called “Lost Decade” after that. It’s quite possible the US will go into a Lost Decade too. You have to really look at the balance sheets as a whole. Despite the fact that Japan has a huge government debt, household financial assets are huge as well. So that Japan is, on balance, the biggest creditor country and that is not true of Europe.

Rowley: Kenneth?

Courtis: As demand weakens in the developed world, and as global credit system contracts, demand falls globally. Even the high-growth economies of Asia are now beginning to wobble, and in turn the commodity producing economies see demand plummet. The world economy is entering a renewed downturn. At the same time, debt across all sectors of the economy – households, banks, non-financial corporations, governments and external debt – is 400-500 per cent of GDP, for many of the core developed countries today, and the global credit system is seriously damaged. That is a very problematic combination.

For it means in the quarters ahead, as the world economy continues to slow, there will be less growth to support a still rising level of debt.

Rowley: Ernest, what do you think?

Kepper: An interesting side effect of the Greek elections was that the yuan soared to its highest level since early May. Why? Because savvy investors know that the Greek elections won’t change a thing for Europe; Attention should be on the dollar, which is not in much better shape. The US is the most indebted government, and it won’t be long before investors who are jumping from the euro to the dollar will wake up and get out of the greenback.

The yuan is poised for an explosive move upside against the US dollar. I expect European countries to take back their national currencies. And while the dollar might gain in value against the euro in the short-term, it’s up against the battle of its life against Asian currencies, in particular, the yuan. Beijing is taking very active steps to internationalise its currency. The US government is desperately trying to inflate away the country’s debts, which plays right into the hands of the Chinese and their desire to make the yuan the world’s next major currency. It appears that Washington and Beijing are cooperating to devalue the dollar so that the US can repay otherwise un-repayable debts with cheaper dollars.

Rowley: A closing word, Kenneth, on what all this means for investors.

Courtis: I am expecting more and more volatility in all markets – currencies, equities, debt and commodity markets. I fully expect the 2007-2008 crash lows of equity markets to be retested during the months ahead. This is no time for investors, for investors to experiment. It is in crisis of the type we have entered, that vast fortunes are lost... and made. In periods like these, the investor with cash will be rewarded. The investor who prepares to capitalise on the crisis will be even more rewarded.

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Jun 28, 2012
William R. Thomson
email: wrthomson@private-capital.com.hk

William Thomson is Chairman of Private Capital Ltd. in Hong Kong and an adviser to Axiom Funds and Finavestment Ltd. in London.

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