Rebounding into a slowdown
RT: What are the likely impacts of the current financial situations?
PM:“I think, you can see the impacts from the scale of the exposures of the European banks to these countries. If you look, for example, at French and German banks, they have about $300 billion of exposure to Portugal, Ireland and Greece, and yetanother $320 billion for Spain.You´ve got over $650 billion worth of the exposure – those are large sums of money. If this crisis persists, Portugal, Ireland and Greece, as we would expect, will inevitably be forced to default or restructure on their debt. That clearly would have a negative impact on domestic activity, either domestic depressing impacts through banks less willing to supply credit and the confidence effect obviously is quite clear.”
RT: Where are the other weak spots in the global economy?
PM:“The weak spot that really comes next is Japan. Japan has been able to finance itself and run large deficits for a very prolonged period of time. The Japanese debt to GDP ratio is 200% – it’s beyond Greek levels, it’s beyond anything in Europe. And yet they are able to finance themselves, a little above 1%. The reason why they’ve been able to do that is that they have a huge surplus of domestic savings and domestic investors willing to buy their debt. As time goes by, Japanese domestic savings start to diminish. And we think, they are close to the point now where there will be a structural deficit of domestic savings, at which point they start to rely on foreign borrowing. And foreigners are less willing, I think, to finance the Japanese government at 1% than Japanese domestic investors. The Japanese Government already spends one fifth of its revenue on debt service. Every 1 basis point, or 1%, rise in the cost of capital to the Japanese government means you have to divert roughly a quarter of tax revenue to debt service. So, you can clearly see that even interest rates at German levels would really leave the Japanese Government short of revenue to supply service security, education or other factors. So, the increasing likelihood of the shortage of domestic savings in Japan, we think, will trigger a crisis in Japanese domestic defunding.”
RT: 2008 showed the world economy needs to be more financially secure. What steps have been taken to prevent other crises?
PM:“I think, policy makers have long been on the intent, but probably short on action. At the time the crisis hit, banking systems in Europe and the U.S. were never short of capital – they had debt in their capital structure, they had deposits and they had equity. Had the debt holders in the capital structure – who were really largely responsible for financing the crisis – had they been forced to take the losses they should have taken, then really a lot of problems could have been avoided. But unfortunately what happens is that the policymakers decided to put tax payers into the capital structure between equity holders and the bond holders. So that all the losses that should have been taken by bond holders were taken by the taxpayer. That situation, it seems to us, hasn’t really changed that materially. It’s not clear yet whether there’s a process or a procedure for debt holders to be forced to take losses in the event of another crisis. And that said, obviously, in the process of concentrating the banks after the crisis, we’ve made even bigger banks, and if they were too big to fail previously, they are probably even bigger and even more too big to fail now. But if you look at Barclay’s, its balance sheet exceeds the U.K. GDP, JP Morgan is a quarter of the size of the U.S. economy – these are vast financial institutions.”
RT: Meanwhile Russian economy seems to be improving lately. What could change that situation?
PM:“I think, the main vulnerability in Russian is obviously inflation. With the inflation running let’s say 9% and close to that annualized every 6 months, the risk is that policy tightening acts to depress activity just at the time when the global economy is experiencing a slowdown. Monetary policy tightening in China, the U.S. economy showing the signs of a slowdown, the crisis in Europe that we’ve talked about, and the impact on Euro activity.The risk is that the monetary policy in Russia probably tightens more at this point in the cycle, than would be necessary, given what is happening exogenously.”