March 25, 2012 6:48 pm

Europe’s bailout bazooka is proving to be a toy gun


Welcome back to the crisis. And it’s set to get worse once the markets discover that the eurozone is about to fudge the increase in the European rescue umbrella. The argument I am hearing is a wonderful example of circular logic: we don’t need a bigger umbrella because market pressure has eased.

Well, the market pressure has gone up again recently. Investors are concerned about Spain. Over the weekend, Angela Merkel was preparing for one of her celebrated U-turns, by letting out a trial balloon in the German press that she would, after all, be ready to accept an increase in the rescue operation.



But the arithmetic is tedious and most statements you get obfuscate the issue through double-counting. The US and other members of the Group of 20 leading economies want the size of the eurozone’s contribution of the total umbrella to be doubled from the current €500bn to €1tn. In that case, the International Monetary Fund would put up a further €500bn. To get there, the eurozone would have to do two things. First, it would need to merge the €440bn European Financial Stability Facility, the temporary umbrella, and its permanent successor, the European Stability Mechanism. Second, it will have to make the EFSF’s share permanent because the EFSF is due to expire next year. Both of these measures would be necessary to reach a total of close to €1tn. But Ms Merkel is not going to offer that. Not even close.

As I understand it, she is ready to offer only a partial merger and only for a transitional period. Specifically, the Germans are proposing to tack on the existing commitments of the EFSF – the programmes for Greece, Ireland and Portugal – to the ESM. That would get us to a ballpark of €700bn.

The trouble is that you cannot just add these numbers. Once the old programmes expire, they are gone. Any new money will have to come from the ESM. Over time, the ceiling will revert to €500bn. This deal would, at most, give a small, temporary increase in the ceiling.

Still, it would raise Germany’s maximum risk temporarily from €211bn to about €280bn. This presents a huge political problem for the chancellor because it would require a vote by the Bundestag, which had previously agreed that the total liability of €211bn must not be broken. The €211bn figure has taken on symbolism in the German debate. Ms Merkel and other politicians have pledged many times not to break it. It is not clear she would get the support for such an increase.

The CSU, the Bavarian wing of her party, is opposed. After Sunday’s election in the Saarland, her coalition is facing an even bigger test in North-Rhine-Westphalia, which holds early elections in May. Remember, elections there messed up the first Greek programme.

A total merger of the EFSF and the ESM would raise Germany’s risk temporarily to about €400bn. I find it hard to see how the German parliament would simply accept a near-doubling of the risk, after having been told time and again that this would not be necessary. And even this would not satisfy the rest of the world, since this is only a temporary increase.

The usual European response to such a stand-off is the use of creative accounting. I have heard the suggestion that one couldstretch” the callable capital of the ESM. That would leave the magic number of €211bn untouched. But it would also mean that the total rescue capacity can be no higher than €500bn at any time.

The outcome would still look more like a toy pistol than a “big bazooka”. It took the markets several weeks to understand the significance of the recent political and economic developments in Spain. It may take some more until Germany’s stance on the ESM is understood.

But it is only if you consider the two together that the real significance becomes clear.

The current ESM is big enough to handle small countries, but not Spain. I expect Madrid eventually to apply for a programme, specifically to deal with the debt overhang of the Spanish financial sector. But even a minimally enlarged version of the ESM will not be big enough.

What this stand-off tells us is that we are approaching the political limits of multilateral programmes. If you want to claim funds of such size, you need joint and several liability – ie all eurozone countries need to be jointly liablenot individual liability among member states.

Call it a eurobond, call it what you like. If you do not want that either, then you have to accept that there is simply no backstop for Spain. As I said, welcome back to the crisis.

Copyright The Financial Times Limited 2012.


China’s Stability Gambit

26 March 2012

Stephen S. Roach

BEIJING – The first principle that I learned when I started focusing on China in the late 1990’s is that nothing is more important to the Chinese than stability – whether economic, social, or political.

Given centuries of turmoil in China, today’s leaders will do everything in their power to preserve stability. Whenever I have doubts about a potential Chinese policy shift, I examine the options through the stability lens. It has worked like a charm.

Stability was on everyone’s mind at the annual China Development Forum (CDF) held March 17-20 in Beijing. Hosted by Premier Wen Jiabao, with many ministers of the State Council in attendance, the CDF is China’s most important international conference. Yet, literally two days before this year’s CDF began, the controversial Bo Xilai was removed as Party Secretary of Chongqing.

As a strong candidate to join the Standing Committee of the Politburo, China’s inner circle of leadership, Bo’s sudden demise was stunning. There was a palpable buzz in the air as we convened in the Diaoyutai State Guesthouse.

The formal sessions played out predictably, placing great emphasis on the coming structural transformation of China’s growth model – a colossal shift from the all-powerful export- and investment-led growth of the past 32 years to a more consumer-led dynamic. There is now broad consensus among China’s senior leadership in favor of such a rebalancing. As one participant put it, “The debate has shifted from what to do to how and when to do it.”

Many of the other themes flowed from this general conclusion. A shift to services-led growth and an innovations-based development strategy were highlighted. At the same time, there was considerable concern about the recent resurgence of state-owned enterprises, which has tilted the distribution of national income from labor to capital – a major impediment to China’s pro-consumption rebalancing. The World Bank and the China Development Research Center (the CDF’s host) had just released a comprehensive report that addressed many aspects of this critical issue.

But the CDF’s formal proceedings never even hinted at the elephant in the chambers of Diaoyutai. There was no mention of Bo Xilai and what his dismissal meant for China’s domestic politics in this critical year of leadership transition. While it is easy to get caught up in the swirling tales of palace intrigue that have followed, I suspect that Bo’s removal holds a far deeper meaning.

Chinese officials faced the risk of a dangerous interplay of political and economic instability. Hit by a second external demand shock in three yearsfirst, America’s subprime crisis, and now Europe’s sovereign-debt crisisany outbreak of internal political instability would pose a far greater threat than might otherwise be the case.

Bo personified that risk. He embodied the so-calledChongqing model” of state capitalism that has been ascendant in China in recent years government-directed urbanization and economic development that concentrates power in the hands of regional leaders and state-owned enterprises.

I spent some time in Chongqing – a vast metropolitan area of more than 34 million peoplelast summer. I left astonished at the scope of the city’s plans. Orchestrated by Chongqing Mayor Huang Qifan, the principal architect of the spectacular Pudong development project in Shanghai, the goal is to transform the Liangjiang area of Chongqing into China’s first inland urban development zone. That would put Liangjiang on a par with coastal China’s two earlier showcase projects Pudong and the Binhai area of Tianjin.

Yet this is the same state-dominated development model that came under heavy criticism at this year’s CDF – and that stands in sharp contrast to the more market-driven alternative that has gained broad consensus among senior Chinese leaders. In other words, Bo was perceived not only as a threat to political stability, but also as the leading representative of a model of economic instability. By dismissing Bo so abruptly, the central government has, in effect, underscored its unwavering commitment to stability.

This fits with yet another curious piece of the Chinese puzzle. Five years ago, Wen famously warned of a Chinese economy that was in danger of becomingunstable, unbalanced, uncoordinated, and unsustainable.” I have repeatedly stressed the critical role that Wen’sFour Uns” have played in shaping the pro-consumption strategy of the “Next China.” Wen’s critique paved the way for China to face its rebalancing imperatives head on.

But, in their formal remarks to the CDF this year, China’s senior leadership – including Premier-designate Li Keqiangdropped all explicit references to the risks of an “unstableChinese economy. In short, the Four Uns have now become three.

In China, such changes in language are no accident. The most likely interpretation is that those at the top no longer want to concede anything when it comes to stability. By addressing economic instability through pro-consumption rebalancing, and political instability by removing Bo, stability has gone from a risk factor to an ironclad commitment.

There can be no mistaking the Chinese leadership’s core message nowadays. They are the first to concede that their growth and development strategy is at a critical juncture. They worry that the “reforms and opening up” of Deng Xiaoping are in danger of losing momentum. By addressing the interplay between economic and political risks to stability, the government is clearing the way for the next phase of China’s extraordinary development. I would not advise betting against their commitment to achieving that goal.


Stephen S. Roach was Chairman of Morgan Stanley Asia and the firm's Chief Economist, and currently is a senior fellow at Yale University’s Jackson Institute of Global Affairs and a senior lecturer at Yale’s School of Management. His most recent book is The Next Asia.

Copyright Project Syndicate -

March 26, 2012, 7:27 p.m. ET
In the Middle Kingdom's Shadow
Americans worry about competition from China. So do some of its Asian neighbors.

The West is obsessively asking how China's economic rise will affect it. The less-asked—but equally significant—question is what China's meteoric growth will do to the rest of Asia.

The answer to this question has changed in the last decade. In the late 1990s, as Asia was coming out of its financial crisis, the consensus view held that China was a threat. Asian powerhouses such as South Korea and Thailand, with their battered economies, couldn't compete with the unscathed Middle Kingdom. But as these countries revived, the region learned that all could benefit from China's demand for specialized components and primary products.


Today China remains an opportunity to many of its neighbors. Bilateral trade figures illustrate the emerging differences. China helped Japan, Taiwan and South Korea earn an annual trade surplus of $210 billion in 2010, up from $30 billion in 2000. These countries export technology-intensive components to China, which possesses the scale required for assembling them into finished products finally sold to the West.


The story for Southeast Asia is more complex, since its natural resources and labor skills duplicate China's, instead of complementing them. To wit, the Philippines and Malaysia have cheap labor to offer, but no advanced technology. This region experienced a trade deficit with China in the late 1990s, which swung into a surplus some years later, which has now again weakened. This means Beijing is contributing less to Southeast Asia's growth.


The politically charged issue for countries such as Thailand, the Philippines, Indonesia and Malaysia is how China's development has affected wages. Beijing's exceptional investment rates upgraded its technological capacity, solidified infrastructure and bettered skills, all of which ensure that industrial labor productivity increased by 10%-15% annually since the mid-1990s.


Meanwhile, real wages in China surged, but because productivity surged faster thanks to investment, the world preferred China as its factory floor. Real wages have continued to increase rapidly, but since productivity increases have moderated recently, unit labor costs have started to rise. This is only now affecting some labor-intensive product lines.


In contrast, real wage growth in Thailand, the Philippines, Malaysia and Indonesia was in line with GDP growth for much of the 1990s but then fell off sharply and either declined or stagnated over most of the past decade. China's declining unit labor costs put pressure on these countries, which weren't investing enough to expand productivity anyway, to limit wage increases. That was the only way to stay competitive.


Most observers of Southeast Asia's economies initially thought they were suffering for country-specific reasons, but it was their position in relation to China in the global production chain that really mattered. Multinationals today decide the location of their production based on the relative productivity of labor and wage costs along with other logistical advantagesall of which China offers.


Over the last two years, Chinese manufacturers, most famously Foxconn, have raised wages, but that doesn't detract from China's overall strengths. Location considerations within China also matter, and some firms are moving inland, where costs are cheaper than on the coast.


China could steal more business from Southeast Asia, thanks to surging energy prices and the complexities of a dispersed supply chain. The Middle Kingdom already boasts research and development facilities, as well as the linkages that come as technology companies like Huawei expand globally. This encourages firms to integrate all their production inside the country.


China used to be the place where countries could export their components and raw materials, have them processed, and import them back. Now process-related imports have fallen to 30% of China's total imports from 40% over the past decade, and exports to 40% from 55%.

.So China may now be growing at the expense of Southeast Asia, but the latter could take a leaf out of Beijing's playbook, increase investment, and learn to play to its own comparative advantages.


Mr. Huang is a senior associate at the Carnegie Endowment for International Peace and a former country director for the World Bank in China.
Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved

The growing Spanish crisis calls for a fiscal union
Stephen King
March 26, 2012

Just when you thought it was safe to go outside, it turns out that another storm is gathering on the eurozone horizon.

Spain was always on the ‘one to watch list. It now finds itself in that most awkward of positions: the financial equivalent of a vicious circle. The interest rate on its sovereign debt is rising, the economy is stalling and the government is fast losing the enthusiasm to deliver the austerity demanded by Brussels. The process then repeats itself.

Reflecting both the economy’s descent into recession and the significant budget deficit overshoot last year, the Popular government led by Mariano Rajoy informed Brussels earlier this year that it was aiming for a budget deficit this year of 5.8 per cent of gross domestic product, significantly higher than the 4.4 per cent agreed earlier. An almighty row then broke out – one that essentially focused on the degree to which Spain is able to enjoy fiscal sovereignty – which led to a compromise deficit target of 5.3 per cent.

Even if that number is achieved – and with 17 autonomous regional governments in Spain all happily spending away, there is no guarantee that it will be – the thorny matter of reducing the deficit further to 3 per cent of GDP in 2013 remains.

For an economy shrinking rapidly, deficit reduction on this scale is not easy. Whatever one thinks about Greece’s initial fiscal problems, for example, they were made far worse as a result of subsequent economic collapse. In the autumn of 2010, the International Monetary Fund thought Greece would shrink by a rather modest 2.6 per cent in 2011. We now know the economy last year fell around 7 per cent. The Greek fiscal position was bad not only because of a lack of effort but also because the economic problems were far stronger than expected.

Major deficit reduction in the wake of economic collapse is near enough impossible, particularly when the population starts to protest. Spain is preparing for a general strike on March 29. Yet the more Spain resists deficit reduction, the greater will be the suspicion that the authorities are merely dragging their feet. Perhaps, for example, they’re hoping for further help from the European Central Bank Long Term Refinancing Operations to push Spanish yields back down, thereby saving the day for the government, for its banks (now up to their gills in Spanish government debt thanks to the carry trades generated by the first two LTROs) and for the single currency, without the need for excessively painful austerity.

Here, then, is the problem. Have Spanish yields risen because investors no longer believe the country is either willing or capable of delivering the necessary austerity? Or have they risen because investors think the eurozone’s creditor nations – and their acolytes at the European Commission – are just running out of patience? Either argument could be used to explain the rise in yields yet there’s a world of difference between deliberate slippage on behalf of the Spanish and a loss of confidence on behalf of their eurozone partners.

Olli Rehn, the EU commissioner for economic and monetary affairs, has made his views known. He’d like more fiscal pain in Spain.

“Because there was a perception Spain was relaxing its fiscal targets for this year, there has been already a market reaction of several dozen basis points on yields of Spanish bonds,” he said. The fault, according to him, lies solely with Spain and it is up to the Spanish to convince investors that they can bring their fiscal plans back on track.

This has become a familiar lament. Yet it does not deal properly with the interaction between growth shortfalls and the cost of borrowing within the eurozone. In the old days, weak growth was synonymous with low interest rates. In the topsy-turvy world of the eurozone, weak growth is now more often associated with high interest rates. Austerity, by delivering even weaker growth, leads to even higher interest rates.

The only way to get around this problem is to recognise the symbiotic relationship between creditors and debtors. In the eurozone, that means a fiscal union, not the constant bullying of debtors by creditors.

The writer is HSBC Group’s chief economist and the bank’s global head of economics and asset allocation research. He is the author of ‘Losing Control: The Emerging Threats to Western Prosperity’