"I am optimistic about the economies' growth outlook"
- Laurence J. Kotlikoff
Although last Thursday the Eurozone policy makers managed to come to a consensus to enhance the EFSF up to 1 trillion euros and to write down 50% of the Greek debt, the economists are nevertheless concerned about the European economies' growth outlook. Such decision is perceived by many experts as only a temporary solution to a given problem; they also indicate the existing possibility of a new recession. This in turn might adversely impact the US economy and global financial stability as well. In this respect Dukascopy has interviewed an expert in Economics, Dr. Prof. Laurence J. Kotlikoff.
1) What is your forecast of the upcoming economic developments? In what way can the new recession be different from 2008?
There was a decent growth of numbers from the Q3 in the US of 2.5%, so I think that 2011 is going to end up with a positive growth outlook. The fact that Europeans have come up with over a trillion euros in funding to shore up their banks and buy the bonds of troubled countries, like Spain and Italy, as well as making a 50% haircut on the Greek bonds points to a better outlook.
I think history is repeating. 3 years after the Lehman Brothers bankruptcy and a severe global recession the financial system is still vulnerable and operating with such "trust me" banking system, where there is no transparency of the financial companies, particularly, no real information about what assets the companies hold and what liabilities they owe.
If last Thursday the European policymakers had not got together and had not made a deal on the Greek debt, there might have been a run on the banks already. The markets are very volatile, they are going up and down all the time because the system has not been fixed and people recognise how fragile it is.
Nevertheless, I am optimistic about the economies' growth outlook. I think they will manage to get through in the next year with positive growth. I assume that there is at least 30% of chance of US growth to be 0% or 1% negative growth in the next year.
2) Can you list the top winners and losers in case of a new global recession?
If a new global recession occurs, the US and Europe would suffer the most. Developing countries, such as China, India, Chile and Brazil have huge internal markets and will be better-off. Australia which has strong business relations with China will not be impaired heavily either. However, the stock markets of these countries could drop a lot if a major recession drives the US and European stock markets down.
If we take Europe, the situation is still quite troubling there, although the European policy makers have agreed on the rescue plan. It is still not very clear if the German taxpayers will be willing to pay for the Greek or Italian debts because it means that German tax increase would be on the line. The European Central Bank's position regarding more money printing is also unclear. There are still many question marks about the rescue strategy. For instance, there is a lot of concern about Italy which has an enormous amount of the government debt. The debt has to be rolled over and Italy is seeking for private investors who would buy its debt at a reasonable price, otherwise, it will be forced to ask for a bail-out by the EFSF.
Another issue about this situation is that the indebted countries are encouraging other Eurozone members to pursue a reckless fiscal behaviour assuming they could be bailed-out by Germany or France.
3) What should be done to rectify the problems with the European sovereign debt crunch?
I would argue that a centralised European fiscal system would not be enough. It is also required to move to what I call limited purpose banking which implies that the financial intermediaries are the mutual fund companies which are not leveraged. If they acquire government debt which defaults in time, consequently, the assets of the mutual funds go down, and both the shareholders and the investors take a loss, but there is no collapse of the whole financial system. The point here is that the entire European crisis we have seen in the last year and a half has not been so much about the Greek, Italian, Spanish, Portuguese or Irish bonds. It has actually been about the European banks who hold too much of the debt.
What is required is a system allowing the troubled countries a possibility to default without jeopardising the whole banking system. The limited purpose banking which has been endorsed by many prominent economists and policymakers in the US and abroad, which I discuss in my book "Jimmy Stewart Is Dead: Ending the World's Ongoing Financial Plague with Limited Purpose Banking", that is a way to have a financial system that is safe from governmental bond defaults.