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System reset
System reset
Dollar domination and growth of external debt put at threat the recovery of global economic that has just started.
Current crisis has revealed inadequacy of the market’s invisible hand. That is why the countries should keep a watchful eye on rehabilitation of the global economy. Pierre DeFraigne, Executive Director of the Madariaga, the College of Europe Foundation, an official of the highest public bodies of European Economic Community/European Union (1970-2005) told the Ekspert how the post-crisis capitalism should look like.
— Can we consider this economic crisis unique? Or did similar cataclysms happen before?
— It has a unique aspect: it is the first global crisis. Moreover, it is a system’s crisis that is hard to overcome. As to the rest of aspects, the disease developed very typically — first, the cyclic crisis in the real economy came to the fore, then real estate and financial markets faced problems.
The crisis was driven by the very structure of the international financial system – by dollar domination. We let the USA, the richest country in the world, control the global currency and pursue the monetary policies on the basis of their internal interests only. It increased household debts and inflated bubbles at the real estate and financial assets markets. The US got enormous external debts, which is quite unusual for the richest country. Respectively, China and Japan became the creditors.
In the long run, the interest rate fell to a minimum extent, and this changed perception of a risk. Both households and financial institutions slid deeper into the debt pit. Debt of the financial sector in the USA and Western Europe soared unprecedented. The situation aggravated because of financial innovations that acted as a catalyst of the crisis.
The cleanup alone in the financial sector will not ensure a well-balanced economic growth. It is the international financial system and the largest economies – Western Europe, the USA and China – than should be reformed.
— However, the US dollar share in reserves of the central banks is getting lower (about 60% now). Can’t it be a proof that the American currency gradually loses its popularity?
— The “market hand” must not be allowed to determine the global reserve structure. Careful investors certainly diversify their assets with the main focus on the European currency. Yet the currency is a thing demanded in the entire world, a sort of a public good worldwide. Therefore, the role of currencies must be determined by institutions. I believe, only the International Monetary Fund can organize the transition from the dollar to the basket of currencies. No country must become a supplier of the world currency.
— Will the Chinese Yuan become an international reserve currency?
— That’s an option for China that in fact is being doubtful about stability of the dollar system, and right it is. However, if the Chinese wish Yuan to be the world currency, they will have to make it convertible and accept when it gets stronger. There is no simple recipe with a win-win effect.
— Should the biggest economies reach an agreement to reform the global financial system?
— They’ve agreed so far that a national currency can not be international. They also realize that a multi-currency system is not stable. Therefore, the currency basket is the last option.
— Like special drawing rights (SDR)?
— Yes, they could be a solution but the basket structure should be slightly changed including an increase of the basket with that same Yuan.
A doubtful growth
— Many largest economies are recovering from the recession. Is this something temporary or a beginning of a long-term revival?
— No one knows. No realistic economist will dare to predict the future developments. True, we see recovery in some countries. The question is why: the market reasons or actions of the governments. We know the answer – actions of the government. Huge budget spending however increases the national debt. So, the growth resulting from stimulation packages will continue as long as the debt-to-GDP ratio is reasonable. Every nation has its own ratio. Some countries can afford to spend more, whereas others can not. For example, Greece, Italy and Belgium have too much debt already (exceeds GDP by 100%); others eg the UK are not far behind. It is time for the US to start thinking about recovery strategies, too.
So, we see signs of recovery but they come not from the market and it gives reasons for concerns. We can not rule out a W- or even L-type of recession. Someone has even made a theory of a square-root-recession, when an economy falls, than grows and then stagnates again.
— What should the recovery strategies look like?
— The problem has two aspects. First, you need to repay debts, which will take ten and, in some cases, even twenty years. The ideal way would be to reduce the debt-to-GDP ratio through an economic growth without salary cuts and/or tax increases.
Second, the leading economists must change the focus to green economy, to get off the hydrocarbon hook. This is a structural choice, which is event more important than the recession, to some extent. If the pressure on the energy market is not reduced, the growth in the emerging economies will conflict with the interests of the developed countries. We must change our consumer and production habits. Eventually this will deliver more benefits in terms of strategic stability in the world.
— It is the governments’ job. What should the central banks do?
— This depends on how big inflation risks are for a country or a region. The risk is not high today in the EU, whose currency is getting stronger. In turn, the weak dollar speeds up inflation in the USA, especially as the oil prices go up. Therefore, there is no a common answer about the future of interest rates.
— Some economies, eg China, show growing bubbles in the assets market. Does it bear any dangers?
— There are in fact the prerequisites for the bubbles to come up. The Chinese government understands the problem though and, I think, they can cope with it. A crisis in China is obviously the last thing we need today. The People’s Republic drives the global growth. It is not a very big economy in absolute terms (roughly equals France), yet it contributes much more.
The need for new capitalism
— How can the downturn change the nature of capitalism?
— The first practical aspect is the level of national debt. If a nation cannot ensure an economic growth without running into debt, it means this society has problems. It cannot make a choice and wants to eat the pie and keep it untouched at the same time. This means a lack of maturity. The problem with inequality in the western countries, which has been outrageous over the past 30 years, needs to be addressed, too. If a person makes during a year as much as another individual can make over 500 years, it means something is wrong here. The market should find a solution by establishing a new corporate governance system. The main problem is a tie between finance and corporate governance. The financial revolution resulted in a dictatorship of shareholders with short-term vision. Managers also stay on their side, too (not on the side of employees, government and the society). The world needs the capitalism capable of reducing inequality otherwise the countries will have to improve the situation through taxes and social transfers, which is inefficient.
China has another, Socialist type of market capitalism with major problems being an environmentally unfriendly economic system and no social security system. The best thing China can do for the global economic growth is to increase consumption of its citizens by giving them a system of healthcare, pensions and cheap education.
— The governments pursuing bankers and their bonuses, is it a witch hunt?
— We need to recognize that the share of financial sector in the gross added value is too high. The main point in favor of this situation that financial innovations lead to technical innovations is untrue. They hardly give anything for growth yet much for instability and even more for inequality. The financial section in the West should be reduced and lower bonuses must contribute to it. Sorry for talking so much about the West but this is the western crisis.
— More serious methods have to be there too though …
— Classic and investment banks should be separated again with the state deposit guarantee provided only to the first group. If people wish to risk their money, all right, go ahead - at any rate there won’t be a problem “too big to go bankrupt”. Competition should be tougher in banking. This sector is too concentrated now, it is an oligopoly. I wish it could ensure at least stability, but consumers pay eventually more and then taxpayers come to rescue the banks gone bankrupts.
— So, you support the initiations of Great Britain to split big banks, don’t you?
— It is not that simple. We come across competition between financial centers during restructuring of the financial system. The world has three levels of this competition. The Asian centers, firstly Singapore and Hong Kong as well as Tokyo, wish to get their share in this business. Paris, Frankfurt and London compete in Europe. At last, there are heavyweights – London and New York. A care for security requires setting limits, yet the industry may be less effective then. Ideally, some minimum international standards are needed. If this is impossible, Europe needs its own system of finance regulation and supervision system. As a result, London can lose in competition to New York. However, the advantages in terms of stability invite to consider this option.
— Why do we need international standards?
— Let’s say they are not that needed here as in trade. Common rules should be in place in trade, otherwise the risk of protectionism appears. The quality of regulation in the financial system is more important than the free floating of capital. It means that regulation comes first. If a country wishes to work with, say, Europe, it must accept its standards. This will result in free floating of capital but after compliance with certain conditions. Some people believe this will lead the financial activity away from Europe (let it be, it’s not that important). Others say the capital outflow will increase in Europe. That’s an absolutely bad joke as Europe is the largest source of savings in the world.
— Will the state capitalism be more popular? The China shows it can be successful.
— Everything depends on the quality of the government. For example, the main weakness of Ukraine is its government and the market cannot offset its drawbacks. This is especially important in case with the economies in transition.
— Well, other countries have governments with a stronger record. Can a state capitalism exist in, for example, the USA?
— Yes, the U.S. started to nationalize banks. Yet, some said Goldman Sachs bank was privatized by the government. This is not a joke. The influence of the financial lobby in the U.S. was too high. The process has gone backwards now. Please get me right: I support the state regulation but this is a hard business. Governments may make mistakes.
Dmitry Goryunov
Ekonomicheskiye Izvestia
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