By Zhang Yuyan
BEIJING, Sept. 11 (Xinhuanet) -- The developed countries are currently struggling in the mire of the sovereign debt crisis. In terms of the ratio of national debt to GDP, the U.S. has exceeded 100%, while Europe as a whole has already reached 80%. Moreover, the PIIGS (Portugal, Ireland, Italy, Greece and Spain) are close to or over 100%, and Japan is even higher up to 220%. What’s worse, this ratio is expected to rise in the coming years. The debt crisis has brought a drop in investor’s confidence and volatility of the financial markets. It has become an important cause for the weak recovery of the global economy, the increasing risk that the world goes into decline once again, and even for the social conflicts and turbulence in Europe and United States. For the moment, the debt crisis has become the keywords for the world economy in 2011 and a determinant variable of the trends of the global economy in 2012.
A crisis in reality would usually lead us to find its reasons in history. When we recall history, we can find that the sovereign debt crisis have happened frequently for long, and sometimes was even worse than today’s. The record for the ratio of national debt to GDP among powers was set by Britain in 1815, when the figure reached 275%, while it again reached 250% in 1945. In France, the ratio reached 150% in 1932, and 110% in 1945, compared with 115% for the United States in the same year. By 1999, the ratio for Greece and Italy had exceeded 100%. Yet, the reason that these countries still count among the rank of developed countries until today is their solutions which have been “developed” to deal with the sovereign debt crisis
To alleviate and overcome the debt crisis, economists have given a variety of prescriptions. One is to increase taxes, which is also the first of the five measures of debt reduction listed in the book The Cash Nexus (2001) by Niall Ferguson, a professor of Financial and Economic History at Harvard. It includes capital tax levied on bondholders and wealthy groups. Despite the apparent decline in the global economic growth and the tax increases would generally do harm to economic growth, many economists still emphasize increase of tax revenue by taxing on the rich. They believe that this is the critical way to change the fiscal situation unable to make ends meet for long term. The policy has another positive effect which is to placate the anger of the people from the uneven distribution of income in developed countries, especially America. This anger was fully demonstrated in the spread of turmoil in Europe which started in London in August, and the big “Occupation of Wall Street” parade which happened in September.
Although politically hard, almost all the policy advisors or makers require highly indebted countries to curtail spending directly or indirectly and to tighten their belts. Ferguson did not list this among his five ways for “Debt Repudiation”, yet Jacques Attali, the consultant of the former French President Mitterrand, listed reduction of fiscal deficit as one of the eight tools to solve the debt crisis in his book National Bankruptcy (2010). Canada was a successful case among the nations which went out of the debt crisis by expenditure austerity in history. In 1995, its ratio of debt to GDP was higher than 100%. Later, by carrying out a resolute and rapid cutting of the expenditure in its budget by 20%, the country restored the confidence in its market. The fiscal austerity in the PIIGS has now paced up, and France with not much confidence has also joined in them. The heated debate in the U.S. between the Republican and the Democratic congressmen about the adjustments to the upper limit of the national debt in August not only highlighted the dramatic partisan conflicts in politics, but also reflected the dilemma policy-makers faced.
Creating an investment environment with low interest is considered conducive to both the alleviation of the interest burden in debt and economic growth. At present, the nominal interest rate in the main developed economies has been pretty low, and the space left for monetary policy is limited. Comparatively speaking, the Euro zone has bigger space for lowering the nominal interest rate than Japan and U.S., but the latter has the advantage that it can carry out the Quantitative Easing Monetary Policy or similar policies with different names. This is the reason why people pay special attention to when, how and on what scale the next round Quantitative Easing Monetary Policy (such as QE3) would be carried out by the Federal Reserve. As to the possible inflation in which it might result, “Dr. Doom” Roubini regards it as the least concern in near future, since the developed economies will become rather sluggish and the outcome of deflation is not impossible.
Both Ferguson and Attali agreed that a debt crisis should be solved by economic growth. They also acknowledged that it would be difficult to do so in times of crisis, despite the fact that an increase in expenditure is the most basic and reliable way. At this point, it would be critical how to both cut down government expenditure and reduce the degree to which it might hurt economic growth. In order to find the best balance between the two, Professor Joseph Stiglitz at Columbia advocates for the structural adjustments in fiscal expenditure and taxation within fixed budget constraints to increase the expenditure in education, roads, ports, R&D and energy. On the other hand, Professor Paul Krugman at Princeton suggests increasing government expenditure as much as possible in a short term to support economic growth. If the devastation of the debt crisis today was the cost for a long and steady growth tomorrow, it would be worth taking the risk to increase budget deficit, because there would be no taxation without growth, and then there would be no expenditure.
As a way for a state to “default”, inflation appears in the lists of measures which both Ferguson and Attali described for us to deal with national debt crises. This is an “accepted” way to cover up default and most frequently used. The “most successful” case is none other than Germany after World War I. The inflation rate high as 1.2 trillion times reduced German national debt nearly to zero. Kenneth Rogoff, former IMF chief economist, is well-versed in history. It is his suggestion that the inflation rate in the U.S. should be maintained at a level of 4%-6% in the coming years. Besides encouraging investment and consumption, the basic aim of the suggestion is to dilute the sovereign debt and make the ratio of debt to GDP more sustainable. Although it is unfair, it is the most straightforward and inevitable step sooner or later you have to take to speed up recovery. According to Attali, a 6% inflation rate could reduce the ratio of American national debt to GDP by 20% in five years. Moreover, it is frequently used in American history. Between 1947 and 1997, the nominal national debt for the U.S. increased by 12 times, yet the ratio of national debt to nominal GDP declined by 50%.
In dealing with war and solutions to the national debt crisis, Ferguson and Attali have different opinions. Ferguson is concerned with the relation between war and increase of the national debt, while Attali regards war as a way to deal with the national debt. After all, when we look into history, we can see that wars could bring both debt to some and huge wealth to others. In his book A Financial History of Western Europe (2000), Charles P. Kindleberger -- late MIT Professor of Historical Economy -- described in detail the war reparations Spain paid to Napoleonic France and the 5 billion francs indemnity paid by France to Prussia after the Franco-Prussian war. The two payments could be used as revenue and repayment of debt as well. However, in the world today, it is inappropriate or at least ineffective to solve a debt crisis with access to wealth through military plunder and enormous war reparations. Even so, however, the possibility to repay the debt by waging a war still cannot be excluded, since a forced adjustment to the relationship between creditor and debtor during wartime is much easier to be accepted than peacetime.
Both Ferguson and Attali agreed on the issue of default, which refers to deferred payment, debt restructuring or compulsory debt swap, rather than government bankruptcy. The history of nations in the modern world can also be seen as a history of default. From 1800 to 2009, the world has gone through 250 international defaults and 68 domestic defaults. Among them, eight happened in France, 126 in Latin America, 63 in Africa, and 2 happened in Germany and China respectively in 1932 and 1939. In 1893, Greece had a massive default, which resulted in a credit interruption as long as half a century. From 1800 to 1945, the average credit hiatus caused by temporary or permanent termination of interest and principle repayment was six years. Although the federal government of United States has never had a history of default, it was on the brink of default due to heated congress disputes in August and a media debate on “technical default”, which became the direct reason for the downgrading of U.S. Treasury bonds. If a U.S. default risk is just a transitory phenomenon, then default in Greece is almost the reality. In order to make the European debt stabilized, Roubini argued that those countries unable to reduce debt through such means as inflation, expenditure austerity and economic growth should engage in the process of debt restructuring or conversion from debt to equity. He also added that the countries unable to regain their competitiveness so as to realize economic growth in the medium term after the reduction of debt should exit from the Euro zone, which means that Greece would be the first to bear the brunt.
The debt crisis that developed countries are going through comes from the governments which try to rescue troubled banks by carrying the “problem asset” burdens on their backs (that’s why the ratio of national debt to GDP in the last few years had risen more than 30 percent). It has also to do with the de-synchronization of monetary integration with financial integration in the process of European unification. Professor Edmund S. Phelps from Columbia thinks that the direct reason for the outbreak of this round of debt crisis is a larger risk involved in bank loans to sovereign states. Yet sovereign debt has neither collateral nor contract guarantee, and there is no way to force a government to fulfill its obligations to repay it. “The Basel Agreement III” identifies national debt to be risk-free, which makes banks more eager for government bonds, so that much of the bonds from the “problem states” are stocked in banks. This then leads to a double tragedy: irresponsible governments go on excessive borrowing and risks are transferred to banks. In view of the dilemma caused by the great impact the sovereign debt crisis has on economy through the banking system, Phelps advocates a change in bank regulations, enabling banks only to loan to the governments which really have the will and capability to repay. A typical example of the “Phelps diagnosis” was the downgrade of two French banks which held so many bonds from the “problem states” and later caused a panic in the market.
In addition to Phelps’ unique perspective, two more points are beyond the range of what Ferguson and Attali discussed. Firstly, the sovereign debts of both U.S. and Europe exist in the form of their own sovereign currencies, which means the money they owe is in dollar or euro printed by themselves. Since the two currencies are key international currencies, it theoretically means that the Federal Reserve and the European Central Bank could do self-salvation by playing the role of international lender of last resort. The reason that Britain was able to survive was closely related to the role the pound played as world currency. Secondly, despite the fact that the Euro system can’t act like the Federal Reserve at the moment, for instance in implementing the Quantitative Easing Monetary Policy, it doesn’t mean that the European Central Bank would never become the next Federal Reserve in the future. For Europe, it may also be a way to solve the sovereign debt crisis through the legislation that can change the actions of its central bank, making it assume the responsibilities of both price stability and promotion of economic growth.
No one likes crises, yet a crisis always contains opportunity. The nations with heavy debts usually can rely on external rescue to ride out of a storm, as long as they accept the conditions raised by the rescuers. In fact, the seed of the trouble the PIIGS face today was planted the moment the Euro zone was launched. All the political leaders involved in the founding of the Euro zone understood that a Europe without financial integration would be in a crisis sooner or later due to the opportunistic behavior of individual nations. However, at the beginning of its founding, the financial integration of the Euro zone lacked much of the political basis. In view of the fact that European unification had become an inevitable choice for European nations to exert their influence in the coming international power games, the process of monetary integration started before the financial integration. Therefore, it can be said that the European debt crisis is a crisis in expectation. The leading countries in the Euro zone could take advantage of the debt crisis to put forward conditions by helping heavily indebted countries to achieve the goal of financial integration, at least to some degree. Indeed, European financial integration has been in process as the crisis spreads and deepens. At the end of September, the German parliament has passed the bill on expanding the European Financial Stability Facility (EFSF) which enables its share of loan guarantees to increase from 123 billion to 211 billion euros. One of the conditions is that the European Commission should have greater financial function.
If any conclusion should be made to the article, I would draw it as follows. Firstly, after they create bonds, human beings can also find solutions to deal with a debt crisis. They have come a long way through cycles and conflicts to today. Secondly, the sovereign debt crisis will be like an incurable chronic disease which will accompany human society and break out from time to time in a long period. Thirdly, sovereign debt itself is not necessarily the enemy of mankind. In a sense, developed countries were the first to join the game of national debt and are still the big players today. Fourthly, the debt crisis which the developed world is going through is not more dangerous than the previous ones. Thus, the impact it has on the present or future real economies might be smaller than most people think. Fifthly, similar to the previous debt crises, some solutions are there for the crisis this time. As for which one or ones to choose, it mainly depends on their political feasibility. Sixthly, to some economies of systemic importance, this round of debt crisis also brings opportunities. It would have relation to do with the future world pattern whether they could take advantage of the opportunities. Seventhly, the debt crisis will ruin credit, damage market and aggravate economic fluctuations to varying degrees. Combined with other factors, we can roughly judge the risk of recession that developed economies would face in the coming year and they might step into a period of low growth in a period as long as three years. The global economic growth was also be affected by the burden.
To add one last word, Ferguson’s five ways for “repudiation” are: First, direct taxation on the rich and the bond holders; second, cutting down debt interest through legislation; third, deferred payment of debt (default); fourth, Inflation; fifth, improving the growth rate of real economy. Ways to alleviate the national debt summarized by Attali are: First, higher taxation; second, less expenditure; third, faster growth; fourth, lower interest rate; fifth, higher inflation rate; sixth, waging a war; seventh, seeking external rescue; eighth, default or debt restructuring. The ways of repudiating are various and elastic, which mean that future generations would still have chances to create.
The developed countries are currently struggling in the mire of the sovereign debt crisis. In terms of the ratio of national debt to GDP, the U.S. has exceeded 100%, while Europe as a whole has already reached 80%. Moreover, the PIIGS (Portugal, Ireland, Italy, Greece and Spain) are close to or over 100%, and Japan is even higher up to 220%. What’s worse, this ratio is expected to rise in the coming years. The debt crisis has brought a drop in investor’s confidence and volatility of the financial markets. It has become an important cause for the weak recovery of the global economy, the increasing risk that the world goes into decline once again, and even for the social conflicts and turbulence in Europe and United States. For the moment, the debt crisis has become the keywords for the world economy in 2011 and a determinant variable of the trends of the global economy in 2012.
A crisis in reality would usually lead us to find its reasons in history. When we recall history, we can find that the sovereign debt crisis have happened frequently for long, and sometimes was even worse than today’s. The record for the ratio of national debt to GDP among powers was set by Britain in 1815, when the figure reached 275%, while it again reached 250% in 1945. In France, the ratio reached 150% in 1932, and 110% in 1945, compared with 115% for the United States in the same year. By 1999, the ratio for Greece and Italy had exceeded 100%. Yet, the reason that these countries still count among the rank of developed countries until today is their solutions which have been “developed” to deal with the sovereign debt crisis
To alleviate and overcome the debt crisis, economists have given a variety of prescriptions. One is to increase taxes, which is also the first of the five measures of debt reduction listed in the book The Cash Nexus (2001) by Niall Ferguson, a professor of Financial and Economic History at Harvard. It includes capital tax levied on bondholders and wealthy groups. Despite the apparent decline in the global economic growth and the tax increases would generally do harm to economic growth, many economists still emphasize increase of tax revenue by taxing on the rich. They believe that this is the critical way to change the fiscal situation unable to make ends meet for long term. The policy has another positive effect which is to placate the anger of the people from the uneven distribution of income in developed countries, especially America. This anger was fully demonstrated in the spread of turmoil in Europe which started in London in August, and the big “Occupation of Wall Street” parade which happened in September.
Although politically hard, almost all the policy advisors or makers require highly indebted countries to curtail spending directly or indirectly and to tighten their belts. Ferguson did not list this among his five ways for “Debt Repudiation”, yet Jacques Attali, the consultant of the former French President Mitterrand, listed reduction of fiscal deficit as one of the eight tools to solve the debt crisis in his book National Bankruptcy (2010). Canada was a successful case among the nations which went out of the debt crisis by expenditure austerity in history. In 1995, its ratio of debt to GDP was higher than 100%. Later, by carrying out a resolute and rapid cutting of the expenditure in its budget by 20%, the country restored the confidence in its market. The fiscal austerity in the PIIGS has now paced up, and France with not much confidence has also joined in them. The heated debate in the U.S. between the Republican and the Democratic congressmen about the adjustments to the upper limit of the national debt in August not only highlighted the dramatic partisan conflicts in politics, but also reflected the dilemma policy-makers faced.
Creating an investment environment with low interest is considered conducive to both the alleviation of the interest burden in debt and economic growth. At present, the nominal interest rate in the main developed economies has been pretty low, and the space left for monetary policy is limited. Comparatively speaking, the Euro zone has bigger space for lowering the nominal interest rate than Japan and U.S., but the latter has the advantage that it can carry out the Quantitative Easing Monetary Policy or similar policies with different names. This is the reason why people pay special attention to when, how and on what scale the next round Quantitative Easing Monetary Policy (such as QE3) would be carried out by the Federal Reserve. As to the possible inflation in which it might result, “Dr. Doom” Roubini regards it as the least concern in near future, since the developed economies will become rather sluggish and the outcome of deflation is not impossible.
Both Ferguson and Attali agreed that a debt crisis should be solved by economic growth. They also acknowledged that it would be difficult to do so in times of crisis, despite the fact that an increase in expenditure is the most basic and reliable way. At this point, it would be critical how to both cut down government expenditure and reduce the degree to which it might hurt economic growth. In order to find the best balance between the two, Professor Joseph Stiglitz at Columbia advocates for the structural adjustments in fiscal expenditure and taxation within fixed budget constraints to increase the expenditure in education, roads, ports, R&D and energy. On the other hand, Professor Paul Krugman at Princeton suggests increasing government expenditure as much as possible in a short term to support economic growth. If the devastation of the debt crisis today was the cost for a long and steady growth tomorrow, it would be worth taking the risk to increase budget deficit, because there would be no taxation without growth, and then there would be no expenditure.
As a way for a state to “default”, inflation appears in the lists of measures which both Ferguson and Attali described for us to deal with national debt crises. This is an “accepted” way to cover up default and most frequently used. The “most successful” case is none other than Germany after World War I. The inflation rate high as 1.2 trillion times reduced German national debt nearly to zero. Kenneth Rogoff, former IMF chief economist, is well-versed in history. It is his suggestion that the inflation rate in the U.S. should be maintained at a level of 4%-6% in the coming years. Besides encouraging investment and consumption, the basic aim of the suggestion is to dilute the sovereign debt and make the ratio of debt to GDP more sustainable. Although it is unfair, it is the most straightforward and inevitable step sooner or later you have to take to speed up recovery. According to Attali, a 6% inflation rate could reduce the ratio of American national debt to GDP by 20% in five years. Moreover, it is frequently used in American history. Between 1947 and 1997, the nominal national debt for the U.S. increased by 12 times, yet the ratio of national debt to nominal GDP declined by 50%.
In dealing with war and solutions to the national debt crisis, Ferguson and Attali have different opinions. Ferguson is concerned with the relation between war and increase of the national debt, while Attali regards war as a way to deal with the national debt. After all, when we look into history, we can see that wars could bring both debt to some and huge wealth to others. In his book A Financial History of Western Europe (2000), Charles P. Kindleberger -- late MIT Professor of Historical Economy -- described in detail the war reparations Spain paid to Napoleonic France and the 5 billion francs indemnity paid by France to Prussia after the Franco-Prussian war. The two payments could be used as revenue and repayment of debt as well. However, in the world today, it is inappropriate or at least ineffective to solve a debt crisis with access to wealth through military plunder and enormous war reparations. Even so, however, the possibility to repay the debt by waging a war still cannot be excluded, since a forced adjustment to the relationship between creditor and debtor during wartime is much easier to be accepted than peacetime.
Both Ferguson and Attali agreed on the issue of default, which refers to deferred payment, debt restructuring or compulsory debt swap, rather than government bankruptcy. The history of nations in the modern world can also be seen as a history of default. From 1800 to 2009, the world has gone through 250 international defaults and 68 domestic defaults. Among them, eight happened in France, 126 in Latin America, 63 in Africa, and 2 happened in Germany and China respectively in 1932 and 1939. In 1893, Greece had a massive default, which resulted in a credit interruption as long as half a century. From 1800 to 1945, the average credit hiatus caused by temporary or permanent termination of interest and principle repayment was six years. Although the federal government of United States has never had a history of default, it was on the brink of default due to heated congress disputes in August and a media debate on “technical default”, which became the direct reason for the downgrading of U.S. Treasury bonds. If a U.S. default risk is just a transitory phenomenon, then default in Greece is almost the reality. In order to make the European debt stabilized, Roubini argued that those countries unable to reduce debt through such means as inflation, expenditure austerity and economic growth should engage in the process of debt restructuring or conversion from debt to equity. He also added that the countries unable to regain their competitiveness so as to realize economic growth in the medium term after the reduction of debt should exit from the Euro zone, which means that Greece would be the first to bear the brunt.
The debt crisis that developed countries are going through comes from the governments which try to rescue troubled banks by carrying the “problem asset” burdens on their backs (that’s why the ratio of national debt to GDP in the last few years had risen more than 30 percent). It has also to do with the de-synchronization of monetary integration with financial integration in the process of European unification. Professor Edmund S. Phelps from Columbia thinks that the direct reason for the outbreak of this round of debt crisis is a larger risk involved in bank loans to sovereign states. Yet sovereign debt has neither collateral nor contract guarantee, and there is no way to force a government to fulfill its obligations to repay it. “The Basel Agreement III” identifies national debt to be risk-free, which makes banks more eager for government bonds, so that much of the bonds from the “problem states” are stocked in banks. This then leads to a double tragedy: irresponsible governments go on excessive borrowing and risks are transferred to banks. In view of the dilemma caused by the great impact the sovereign debt crisis has on economy through the banking system, Phelps advocates a change in bank regulations, enabling banks only to loan to the governments which really have the will and capability to repay. A typical example of the “Phelps diagnosis” was the downgrade of two French banks which held so many bonds from the “problem states” and later caused a panic in the market.
In addition to Phelps’ unique perspective, two more points are beyond the range of what Ferguson and Attali discussed. Firstly, the sovereign debts of both U.S. and Europe exist in the form of their own sovereign currencies, which means the money they owe is in dollar or euro printed by themselves. Since the two currencies are key international currencies, it theoretically means that the Federal Reserve and the European Central Bank could do self-salvation by playing the role of international lender of last resort. The reason that Britain was able to survive was closely related to the role the pound played as world currency. Secondly, despite the fact that the Euro system can’t act like the Federal Reserve at the moment, for instance in implementing the Quantitative Easing Monetary Policy, it doesn’t mean that the European Central Bank would never become the next Federal Reserve in the future. For Europe, it may also be a way to solve the sovereign debt crisis through the legislation that can change the actions of its central bank, making it assume the responsibilities of both price stability and promotion of economic growth.
No one likes crises, yet a crisis always contains opportunity. The nations with heavy debts usually can rely on external rescue to ride out of a storm, as long as they accept the conditions raised by the rescuers. In fact, the seed of the trouble the PIIGS face today was planted the moment the Euro zone was launched. All the political leaders involved in the founding of the Euro zone understood that a Europe without financial integration would be in a crisis sooner or later due to the opportunistic behavior of individual nations. However, at the beginning of its founding, the financial integration of the Euro zone lacked much of the political basis. In view of the fact that European unification had become an inevitable choice for European nations to exert their influence in the coming international power games, the process of monetary integration started before the financial integration. Therefore, it can be said that the European debt crisis is a crisis in expectation. The leading countries in the Euro zone could take advantage of the debt crisis to put forward conditions by helping heavily indebted countries to achieve the goal of financial integration, at least to some degree. Indeed, European financial integration has been in process as the crisis spreads and deepens. At the end of September, the German parliament has passed the bill on expanding the European Financial Stability Facility (EFSF) which enables its share of loan guarantees to increase from 123 billion to 211 billion euros. One of the conditions is that the European Commission should have greater financial function.
If any conclusion should be made to the article, I would draw it as follows. Firstly, after they create bonds, human beings can also find solutions to deal with a debt crisis. They have come a long way through cycles and conflicts to today. Secondly, the sovereign debt crisis will be like an incurable chronic disease which will accompany human society and break out from time to time in a long period. Thirdly, sovereign debt itself is not necessarily the enemy of mankind. In a sense, developed countries were the first to join the game of national debt and are still the big players today. Fourthly, the debt crisis which the developed world is going through is not more dangerous than the previous ones. Thus, the impact it has on the present or future real economies might be smaller than most people think. Fifthly, similar to the previous debt crises, some solutions are there for the crisis this time. As for which one or ones to choose, it mainly depends on their political feasibility. Sixthly, to some economies of systemic importance, this round of debt crisis also brings opportunities. It would have relation to do with the future world pattern whether they could take advantage of the opportunities. Seventhly, the debt crisis will ruin credit, damage market and aggravate economic fluctuations to varying degrees. Combined with other factors, we can roughly judge the risk of recession that developed economies would face in the coming year and they might step into a period of low growth in a period as long as three years. The global economic growth was also be affected by the burden.
To add one last word, Ferguson’s five ways for “repudiation” are: First, direct taxation on the rich and the bond holders; second, cutting down debt interest through legislation; third, deferred payment of debt (default); fourth, Inflation; fifth, improving the growth rate of real economy. Ways to alleviate the national debt summarized by Attali are: First, higher taxation; second, less expenditure; third, faster growth; fourth, lower interest rate; fifth, higher inflation rate; sixth, waging a war; seventh, seeking external rescue; eighth, default or debt restructuring. The ways of repudiating are various and elastic, which mean that future generations would still have chances to create.
(Source:Cssn.cn)
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