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If we use one phrase to generalize the world’s real economy in 2011, the most appropriate one might be the sovereign debt crisis. As this crisis is going on, some European countries still have an extremely high debt-to-GDP ratio, which has hit 159% in Greece, 120% in Italy and exceeded 100% in Portugal, Ireland and Spain. Even in some better-off countries like Germany, this ratio still hits more than 80%. Comparatively, the ratio for the U.S. is about 100% and for Japan it reaches as high as 250%.
The huge debt has caused heavy burden to the world economy. Will it be a serious problem and how worse will it become? Qian Mu, a Chinese historian, has given a very interesting remark. He said that if we find issues in our real lives, we shall search for the answer from history. Generally speaking, the sovereign debt crisis might impact the investors’ confidence, shake the whole financial market and slow down the world economic recovery. The economy might even slide into recession and trigger a chain of social and political conflicts.
However, a study of history shows that the sovereign debt crisis actually has existed for a long time, rather than a recent phenomenon. In the year 1845, the debt-to-GDP ratio of Britain hit 250%. In French history, its debt-toGDP ratio exceeded 100%. The ratio also reached 115% in the U.S. after the Second World War. Since the era of Roman Empire, debt crisis has happened in countries like Greece. This is also why the French president Sarkozy said it was a mistake to invite Greece to join the Euro zone, because Greece is almost the byword for debt crisis. During the 210 years stretching from 1800 to 2009, there have been more than 250 sovereignty crisis (the government default) in both developing and developed countries, including Greece, Germany, France, covering almost all countries in the world. There was even one debt crisis in the period of Republic of China, when the government could not repay the debt it had issued.
How many approaches are there to solve the debt crisis? Neil Ferguson, Harvard professor of financial history, summarizes five approaches: the fist is to levy taxes on the wealthy or the holder of government issued bonds; the second is to legitimize the reduction of interest on debt, the third is to defer the debt payment, the fourth is inflation, and the final one is to increase the economic growth rate.
Different countries have different solutions to this debt crisis. The U.S. levies taxes on the wealthy group, which pacifies the anger against income inequality of developed countries. Also, it raised the government income to avoid the chance of social upheaval, like the social movement “Occupy Wall Street”.
Greece has curtailed its public spending by reducing 3.2 billion budget plan, which accounts for 1.5% of Greece’s GDP. Also, it cut down its number of public servants by 15 thousand, considering the large scale of the public servant sector. In the past the Greek government offered public positions even to dock workers to win more votes. It was easy to let these jobs in the government system, but difficult to drive them away. Also, the average salary in the private sector also goes down by 22%, which might ignite huge social conflicts.
Another solution is keeping low interest rate. Take the U.S. for example, during the recent meeting on interest rate, the Fed decided to keep its federal funds rate between 0 and 0.25, while its European counterpart stays at 1%, a historical low of European central bank. Such a low interest rate has many advantages. On the one hand, it might stimulate the economic growth and the negative interest rates in Europe and the U.S. could achieve such an outcome. On the other hand, it could relieve the burden of high national debt, because the short-term low interest rate has connection with the long-term interest rate. Finally, the low interest rate could raise the price, and if the price is up, all difficulties will be easily settled.
Then what is the most under-cover approach to solve the debt crisis? The answer will be inflation, which is also the most frequently used. After the First World War, Germany was forced to pay huge debt and to clear the debts, it took advantage of its 1.2 trillion inflation rate. Roger, former chief economist of International Monetary Fund and famous economist of the U.S., once pointed out that in the future five years the U.S. inflation rate shall be kept between 4% and 6%. If the 6% inflation rate maintains for five years, the U.S. debt-to-GDP ratio will reduce by 20% without any other measures to adopt.
What is the biggest problem for Europe? The commercial banks shall buy those high-credit financial products, but they think that the national bonds or sovereign bonds contain no risks. Therefore they bought too much of the national bonds, making their countries unable to repay the debt. The commercial banks were downgraded as default risks emerge and this will trigger the disorder of the whole financial system. The downgrading of commercial banks has happened in France and Italy, because they hold the bond assets of problem countries. Therefore, this debt crisis has a very unique feature, which is that the commercial banks hold large amount of sovereignty debts. How to solve such a problem? Mr. Phillips gave his solution, which is to cut the connections between sovereignty debts and commercial bank assets and their capital adequacy rate. Until now only Greece has experienced debt restructuring. In my opinion, the debt crisis in Europe and the U.S. would not become serious, because in the U.S. the Fed is the capital lender and has the ability to issue capital, and the European bank would follow the measures taken by the U.S. Fed, which leaves it various chances.
The general view on the cause of European debt crisis is the conflict between a unitary currency and divergent financial systems in different countries. But could we doubt the predictive ability of the founding designers of euro? They must have known that the various financial systems of European countries and the irresponsible development of some will lead to serious problems. But it was not time for them to raise such an issue, because after forfeiting the currency sovereignty, many European countries were not willing to give up their finance sovereignty and this would have been politically impossible. It would have to rely on a serious crisis to let these countries accept a unitary and binding finance system. So from such a perspective, this debt crisis is a long-awaited one. These countries have to forfeit their finance sovereignty by allowing their finance budget to be discussed in the European Union after passing domestic parliament; otherwise they could not gain the financial assistance to help them go through such a crisis.
Are there any risks? Of course there are. If the risks are not properly managed, the whole Euro zone will suffer great losses. Now a trend has emerged that Europe is unifying its finance system, which has also been accepted by most countries. Only Britain in the 27 EU member countries has a negative point of view, and the new member country Czech has also accepted such a trend. If the conditions in Greece are becoming worse, then it might be forced out of the union. So generally speaking the European Union is undergoing a unification of finance system. We should also attach great importance to the role played by Germany during the debt crisis. Germany will become the main driving force of the integration of finance system, which might exert profound influence on the global geopolitical landscape. The U.S. will be the last country willing to see the emergence of Germany-led Europe. Also, many small countries in Europe have their own considerations. Leaders in Luxemburg once commented that it would be impossible to imagine the collapse of Euro zone, because if it happens, the small countries like Luxemburg will have no power status on the world stage. The widely known G20 actually include 19 countries and European Union. Therefore, small countries could make their voices heard by playing their strength in the European Union and if the Euro zone disappears, the existence of European Union will be immediately put under threat. For these small countries this is really hard to imagine.
As conclusion, I would like to share some of my opinions on such a debt crisis. First, as the national debt is created, the solution to the crisis also appears. Second, the sovereignty debt crisis is like incurable diseases unexpectedly falling on the human beings. The debt itself is not people’s enemy. Third, a look at the world tells us that many developed countries are often bogged down into the debt crisis because they have played the debt for a long time. But they are better at solving the crisis than emerging economies. Fourth, the current debt crisis sweeping over the developed countries is no worse than the crisises in history. The fifth one is how to choose the approach to solve the debt crisis. The European debt crisis is a 70% political and 30% economic, currency and finance issue. My final comment is that for China this crisis is actually an opportunity to take actions.
The huge debt has caused heavy burden to the world economy. Will it be a serious problem and how worse will it become? Qian Mu, a Chinese historian, has given a very interesting remark. He said that if we find issues in our real lives, we shall search for the answer from history. Generally speaking, the sovereign debt crisis might impact the investors’ confidence, shake the whole financial market and slow down the world economic recovery. The economy might even slide into recession and trigger a chain of social and political conflicts.
However, a study of history shows that the sovereign debt crisis actually has existed for a long time, rather than a recent phenomenon. In the year 1845, the debt-to-GDP ratio of Britain hit 250%. In French history, its debt-toGDP ratio exceeded 100%. The ratio also reached 115% in the U.S. after the Second World War. Since the era of Roman Empire, debt crisis has happened in countries like Greece. This is also why the French president Sarkozy said it was a mistake to invite Greece to join the Euro zone, because Greece is almost the byword for debt crisis. During the 210 years stretching from 1800 to 2009, there have been more than 250 sovereignty crisis (the government default) in both developing and developed countries, including Greece, Germany, France, covering almost all countries in the world. There was even one debt crisis in the period of Republic of China, when the government could not repay the debt it had issued.
How many approaches are there to solve the debt crisis? Neil Ferguson, Harvard professor of financial history, summarizes five approaches: the fist is to levy taxes on the wealthy or the holder of government issued bonds; the second is to legitimize the reduction of interest on debt, the third is to defer the debt payment, the fourth is inflation, and the final one is to increase the economic growth rate.
Different countries have different solutions to this debt crisis. The U.S. levies taxes on the wealthy group, which pacifies the anger against income inequality of developed countries. Also, it raised the government income to avoid the chance of social upheaval, like the social movement “Occupy Wall Street”.
Greece has curtailed its public spending by reducing 3.2 billion budget plan, which accounts for 1.5% of Greece’s GDP. Also, it cut down its number of public servants by 15 thousand, considering the large scale of the public servant sector. In the past the Greek government offered public positions even to dock workers to win more votes. It was easy to let these jobs in the government system, but difficult to drive them away. Also, the average salary in the private sector also goes down by 22%, which might ignite huge social conflicts.
Another solution is keeping low interest rate. Take the U.S. for example, during the recent meeting on interest rate, the Fed decided to keep its federal funds rate between 0 and 0.25, while its European counterpart stays at 1%, a historical low of European central bank. Such a low interest rate has many advantages. On the one hand, it might stimulate the economic growth and the negative interest rates in Europe and the U.S. could achieve such an outcome. On the other hand, it could relieve the burden of high national debt, because the short-term low interest rate has connection with the long-term interest rate. Finally, the low interest rate could raise the price, and if the price is up, all difficulties will be easily settled.
Then what is the most under-cover approach to solve the debt crisis? The answer will be inflation, which is also the most frequently used. After the First World War, Germany was forced to pay huge debt and to clear the debts, it took advantage of its 1.2 trillion inflation rate. Roger, former chief economist of International Monetary Fund and famous economist of the U.S., once pointed out that in the future five years the U.S. inflation rate shall be kept between 4% and 6%. If the 6% inflation rate maintains for five years, the U.S. debt-to-GDP ratio will reduce by 20% without any other measures to adopt.
What is the biggest problem for Europe? The commercial banks shall buy those high-credit financial products, but they think that the national bonds or sovereign bonds contain no risks. Therefore they bought too much of the national bonds, making their countries unable to repay the debt. The commercial banks were downgraded as default risks emerge and this will trigger the disorder of the whole financial system. The downgrading of commercial banks has happened in France and Italy, because they hold the bond assets of problem countries. Therefore, this debt crisis has a very unique feature, which is that the commercial banks hold large amount of sovereignty debts. How to solve such a problem? Mr. Phillips gave his solution, which is to cut the connections between sovereignty debts and commercial bank assets and their capital adequacy rate. Until now only Greece has experienced debt restructuring. In my opinion, the debt crisis in Europe and the U.S. would not become serious, because in the U.S. the Fed is the capital lender and has the ability to issue capital, and the European bank would follow the measures taken by the U.S. Fed, which leaves it various chances.
The general view on the cause of European debt crisis is the conflict between a unitary currency and divergent financial systems in different countries. But could we doubt the predictive ability of the founding designers of euro? They must have known that the various financial systems of European countries and the irresponsible development of some will lead to serious problems. But it was not time for them to raise such an issue, because after forfeiting the currency sovereignty, many European countries were not willing to give up their finance sovereignty and this would have been politically impossible. It would have to rely on a serious crisis to let these countries accept a unitary and binding finance system. So from such a perspective, this debt crisis is a long-awaited one. These countries have to forfeit their finance sovereignty by allowing their finance budget to be discussed in the European Union after passing domestic parliament; otherwise they could not gain the financial assistance to help them go through such a crisis.
Are there any risks? Of course there are. If the risks are not properly managed, the whole Euro zone will suffer great losses. Now a trend has emerged that Europe is unifying its finance system, which has also been accepted by most countries. Only Britain in the 27 EU member countries has a negative point of view, and the new member country Czech has also accepted such a trend. If the conditions in Greece are becoming worse, then it might be forced out of the union. So generally speaking the European Union is undergoing a unification of finance system. We should also attach great importance to the role played by Germany during the debt crisis. Germany will become the main driving force of the integration of finance system, which might exert profound influence on the global geopolitical landscape. The U.S. will be the last country willing to see the emergence of Germany-led Europe. Also, many small countries in Europe have their own considerations. Leaders in Luxemburg once commented that it would be impossible to imagine the collapse of Euro zone, because if it happens, the small countries like Luxemburg will have no power status on the world stage. The widely known G20 actually include 19 countries and European Union. Therefore, small countries could make their voices heard by playing their strength in the European Union and if the Euro zone disappears, the existence of European Union will be immediately put under threat. For these small countries this is really hard to imagine.
As conclusion, I would like to share some of my opinions on such a debt crisis. First, as the national debt is created, the solution to the crisis also appears. Second, the sovereignty debt crisis is like incurable diseases unexpectedly falling on the human beings. The debt itself is not people’s enemy. Third, a look at the world tells us that many developed countries are often bogged down into the debt crisis because they have played the debt for a long time. But they are better at solving the crisis than emerging economies. Fourth, the current debt crisis sweeping over the developed countries is no worse than the crisises in history. The fifth one is how to choose the approach to solve the debt crisis. The European debt crisis is a 70% political and 30% economic, currency and finance issue. My final comment is that for China this crisis is actually an opportunity to take actions.