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EU can learn from China's example
By John Ross |
September 20, 2011, Tuesday
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Print Edition
LAST week marked the third anniversary of the collapse of Lehman Brothers. A new wave of the crisis that event symbolized is clearly unfolding in the eurozone. US Treasury Secretary Timothy Geithner last week warned of "a catastrophic risk" in Europe. Former British Prime Minister Gordon Brown, speaking at the World Economic Forum's summer Davos in Dalian, northeast China's Liaoning Province, argued the present situation was "more serious" than in 2008.
It is unnecessary to make a comprehensive comparison to see that some aspects of the financial crisis in Europe are certainly worse than in 2008. The crises of some small peripheral eurozone economies - Greece, Portugal and Ireland - are too well known to need repeating here. Regarding large eurozone economies, in 2008 the interest rates necessary to persuade investors to buy Italy's 10-year state bonds only reached 5.0 percent, in August this year it was 6.3 percent. Last week, after large-scale purchases by the European Central Bank, it still stood at 5.5 percent.
Most serious of all is the strain at the core of the European banking system. The rates on credit default swaps by European banks are 50 percent higher than at the worst point in 2008. Two of Europe's largest banks, Lloyds Banking Group and RBS, suffered catastrophic falls in their share prices after 2008 - in dollar terms they are respectively down 95.3 percent and 97.2 percent.
Now two more large European banks, Barclays and Société Générale, have continued during the summer to see falls in share prices of almost the same magnitude, down from their peaks by 83.4 percent and 86.7 percent.
It was due to this grave risk of a major European banking collapse that the US Federal Reserve, the European Central Bank, the Bank of Japan, the Swiss National Bank and the Bank of England intervened last week to offer "unlimited" dollar loans to European banks in the next three months.
These developments clearly have potentially important consequences for China's economy. These include:
? The European Union is China's largest export market. In the second quarter of 2011 EU economic growth was only an annualized 0.9 percent. Further slowing of Europe's economy under the impact of the new financial crisis will have negative consequences for China's exports.
? The injection of dollars into Europe by central banks, if it does more than simply replace private sources of financing, it could spill out into inflationary pressures elsewhere. In recent months, China's fight against inflation has benefited from a downward trend in international commodity prices, but a new monetary risk has been introduced that this trend will halt.
? Share prices of China's main state owned (for example, ICBC or China Construction Bank) or privately owned (for example, China Merchant's Bank) banks have not shown the types of falls of Barclays or Société Générale. But severe international downward pressure on bank share prices exists and this trend will have a depressive effect on China's share prices.
But while China clearly needs to monitor the risk of contagion from Europe carefully, the eurozone could study with benefit China's experience in the last three years.
The core of the economic crisis in Europe is clearly the collapse in its investment. Since the start of the recession, eurozone GDP has fallen by US$204 billion - in inflation adjusted and fixed parity purchasing power prices. But private consumption declined by only US$29 billion, while the net trade balance increased by US$32 billion and government consumption rose by US$91 billion. However, fixed investment fell by US$290 billion - ie the recession in the eurozone was wholly due to the investment decline. A similar pattern exists in the US.
China, in contrast, headed off any equivalent downturn in its economy in 2008 by a stimulus package directly targeting investment - particularly in infrastructure and housing.
US economists such Robert Barro and Gregory Mankiw, an advisor to Republican presidential candidate Mitt Romney, are now rightly arguing that the core of the "Great Recession" in the US and Europe is the investment fall. British Business Secretary Vince Cable is also now calling for a program of infrastructure investment.
China's economic policy makers, if they wished to engage in point scoring, could comment on this new realization by saying: "We could have told you this three years ago. Because we acted to stimulate investment, our economy has grown by 30 percent in three years while Europe's remains in crisis."
But the situation is too serious for silly games, and China's policy makers have no interest in crises in other parts of the world economy.
Policy makers in China need to watch Europe for the risk of its crisis affecting their economy.
John Ross
John Ross is currently visiting professor at Antai College of Economics and Management, Shanghai Jiao Tong University. He was consultant to Fortune Global 500 companies and from 2000 to 2008 London's director (currently equivalent to vice mayor) for economic and business policy. He has written on China's economy for 20 years.
It is unnecessary to make a comprehensive comparison to see that some aspects of the financial crisis in Europe are certainly worse than in 2008. The crises of some small peripheral eurozone economies - Greece, Portugal and Ireland - are too well known to need repeating here. Regarding large eurozone economies, in 2008 the interest rates necessary to persuade investors to buy Italy's 10-year state bonds only reached 5.0 percent, in August this year it was 6.3 percent. Last week, after large-scale purchases by the European Central Bank, it still stood at 5.5 percent.
Most serious of all is the strain at the core of the European banking system. The rates on credit default swaps by European banks are 50 percent higher than at the worst point in 2008. Two of Europe's largest banks, Lloyds Banking Group and RBS, suffered catastrophic falls in their share prices after 2008 - in dollar terms they are respectively down 95.3 percent and 97.2 percent.
Now two more large European banks, Barclays and Société Générale, have continued during the summer to see falls in share prices of almost the same magnitude, down from their peaks by 83.4 percent and 86.7 percent.
It was due to this grave risk of a major European banking collapse that the US Federal Reserve, the European Central Bank, the Bank of Japan, the Swiss National Bank and the Bank of England intervened last week to offer "unlimited" dollar loans to European banks in the next three months.
These developments clearly have potentially important consequences for China's economy. These include:
? The European Union is China's largest export market. In the second quarter of 2011 EU economic growth was only an annualized 0.9 percent. Further slowing of Europe's economy under the impact of the new financial crisis will have negative consequences for China's exports.
? The injection of dollars into Europe by central banks, if it does more than simply replace private sources of financing, it could spill out into inflationary pressures elsewhere. In recent months, China's fight against inflation has benefited from a downward trend in international commodity prices, but a new monetary risk has been introduced that this trend will halt.
? Share prices of China's main state owned (for example, ICBC or China Construction Bank) or privately owned (for example, China Merchant's Bank) banks have not shown the types of falls of Barclays or Société Générale. But severe international downward pressure on bank share prices exists and this trend will have a depressive effect on China's share prices.
But while China clearly needs to monitor the risk of contagion from Europe carefully, the eurozone could study with benefit China's experience in the last three years.
The core of the economic crisis in Europe is clearly the collapse in its investment. Since the start of the recession, eurozone GDP has fallen by US$204 billion - in inflation adjusted and fixed parity purchasing power prices. But private consumption declined by only US$29 billion, while the net trade balance increased by US$32 billion and government consumption rose by US$91 billion. However, fixed investment fell by US$290 billion - ie the recession in the eurozone was wholly due to the investment decline. A similar pattern exists in the US.
China, in contrast, headed off any equivalent downturn in its economy in 2008 by a stimulus package directly targeting investment - particularly in infrastructure and housing.
US economists such Robert Barro and Gregory Mankiw, an advisor to Republican presidential candidate Mitt Romney, are now rightly arguing that the core of the "Great Recession" in the US and Europe is the investment fall. British Business Secretary Vince Cable is also now calling for a program of infrastructure investment.
China's economic policy makers, if they wished to engage in point scoring, could comment on this new realization by saying: "We could have told you this three years ago. Because we acted to stimulate investment, our economy has grown by 30 percent in three years while Europe's remains in crisis."
But the situation is too serious for silly games, and China's policy makers have no interest in crises in other parts of the world economy.
Policy makers in China need to watch Europe for the risk of its crisis affecting their economy.
John Ross
John Ross is currently visiting professor at Antai College of Economics and Management, Shanghai Jiao Tong University. He was consultant to Fortune Global 500 companies and from 2000 to 2008 London's director (currently equivalent to vice mayor) for economic and business policy. He has written on China's economy for 20 years.
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