ECONOMIC AFFAIRS: by Patrick J. ByrneNews Weekly
Could global tsunami bring down the Eurozone?
, June 11, 2011
The world’s banking regulatory authority has warned that more financial shocks are inevitable and that Australia may be at the centre of the next shock.
The world’s top banking regulator has told the Australian Financial Review (May 30, 2011) that it will be impossible to avoid a repeat of the financial failures that brought on the global financial crisis (GFC).
Stefan Walteris the general-secretary of the Basel Committee on Banking Supervision. The Switzerland-based Basel committee is responsible for setting, in particularly, the minimum capital standards for banks across the world.
He warned that, despite the relatively strong performance of local banks during the GFC, Australia’s banking system could well find itself at the centre of the next crisis.
The next financial shock in the ongoing GFC is most likely to come from Europe, as revealed in an extensive set of interviews with leading European economists conducted by Peter Day, from the BBC World Service’s Global Business report (May 29, 2011).
The GFC began with the onset of the American sub-prime mortgage crisis in 2007. That grew into an international banking crisis, which morphed into the largest rescue of banks by governments in history.
Austerity measures created a long recession and reduced tax revenues at the same time as the cost of bank bailouts and stimulus packages soared. This has resulted in a sovereign debt crisis for some European governments, at the same time as their banks remain weak, undercapitalised and vulnerable.
The governments of Greece and Portugal are so indebted that they risk defaulting, while the banks in Ireland and Spain carry debts so large that their governments may not be able to support them in the event of another financial shock.
Andrew Balls, head of a European investment team for one of the world’s biggest bond market companies, Pimco, told Global Business that the massive loans from Germany and the European Central Bank to the failing smaller members of the European Union are designed to “buy time”, particularly for Spain.
Spain’s economy is bigger than Greece, Ireland and Portugal put together, hence a default by Spain would send major shocks though the European financial markets and into the world markets.
Balls said that the aim is to allow Spain to “demonstrate its ability to make a fiscal adjustment, rein in spending. Secondly, reform their banking system. Thirdly, … you want European countries to encourage their banks to recapitalise against further losses.”
Then, in a few years time, when the next crisis hits, “the contamination may be less”.
The plan is modelled on how Argentina’s debt crisis was handled in the 1990s. Argentina was propped up for some years, then when it “eventually defaulted, no-one much cared”.
Hopefully, by 2013 when major restructuring is planned, “Spain and others will have made their adjustments,” according to Balls.
But will the European banks be strong enough to withstand the next financial shock wave?
Simon Johnsonis of the most outspoken U.S. commentators on the GFC. He’s at the Sloan School of Management at the Massachusetts Institute of Technology (MIT) and is former chief economist at the International Monetary Fund (IMF).
He told Global Business, “There is a myth, an idea that politicians put forward, not just in France but also in Germany [and the UK], that their banks are somehow well run, that their banks are somehow run better than other people’s banks.
“This is not true. They have been run in an absolutely disastrous manner. They now would face big losses if, for example, Greece had a debt restructuring.
“There isn’t enough capital or equity financing in the French banking system. And, in fact, they resisted strenuously all efforts on the part of the international community to raise capital in banks.”
Johnson said that some countries, France in particularly, have strongly resisted the new international banking rules, known as “Base III”. Introduced last year, they require banks to increase their capital reserves and to apply counter-cyclical dampeners to make them capable of withstanding future financial shocks.
Andrew Hilton, from the London-based Centre for the Study of Financial Innovation, told Global Business that much of the debt of the so-called PIIGS countries (Portugal, Italy, Ireland, Greece and Spain) is held as bonds by German and French banks, and by many pension funds.
Asked if these banks were fearful of a default by any of the PIIGS, Hilton said, “Not frightened enough! If I was a German banker or a French banker, I would be much more concerned than the bankers appear to be.
“The problem is that banking is too profitable at the present time.… You borrow from the government. You lend back to the government. The spread is about 300-basis points [3 per cent]; and you can go on the golf course by three o’clock.
“However, if the chickens come home to roost, … then the bank itself is in trouble and its solvency is really in question,” warned Hilton.
Sushil Wadhwaniis a former member of the Bank of England’s interest-rate-setting policy committee and now runs Wadhwani Asset Management in London.
Wadhwani described to Global Business how the crisis in Europe was unfolding like “a train crash in slow motion, where the people who can make a difference seem to be taking measures to postpone it, but by taking these measures they are making the train crash more likely not less likely”.
Roger Bootle, managing director of Capital Economics in London, told Global Business that European “politicians are just running like scared rabbits around a room. They don’t grasp how serious the problem is. You can’t solve this sort of thing by just having an agreement.”
The solution, he said, will probably require that “some countries will have to leave the Euro”.
Bootle suggested that the core economies of Europe — German and her close neighbours, Holland, Austria, Finland and possibly Belgium and France — should adopt their own new currency, abandon the Euro and leave it to the periphery countries.
In that way, the core economies would not continue to be shackled to the Euro and be dragged down by the weaker economies, whose problems cannot be solved without a major depreciation of the currency and more bailouts.
Equally, the weaker European economies would benefit from a Euro that would be allowed to depreciate, making their industries more competitive and allowing their economies to grow and pay off their huge government and bank debts.
Meanwhile, The Economist magazine, in a 16-page feature on Australia (May 28, 2011), describes the country as complacent, Greens-driven and seemingly oblivious to the fact that, for the first time in our history, the country is economically dependent on a country that is not a strategic ally, i.e., China.
“She’ll be right!”, we reassure ourselves, while the next shock from the ongoing GFC looms like a Japanese tsunami.
Patrick J. Byrne is vice-president of the National Civic Council.
“Continental drift”, Global Business report, BBC World Service, May 29, 2011.