Don't blame the Greeks for the crisis, says Joseph Stiglitz
Interview by George Smith Alexander & Sugata Ghosh
May 26, 2010,ET Bureau
It’s evident that Greece has no immediate fix and over the next decade, other regions of the world may face similar problems. Isn’t it time for leading nations to sit together and reset the entire global debt?
What’s clear is that the current approach in Europe is wrong. The current approach is to try to impose extreme austerity. That will lead to a weaker economy and lower tax revenues, and so the reduction in deficits will be much smaller than hoped. It’s a kind of austerity which failed in Argentina. The current approach of saying that you just have to get rid of the deficit is not going to work and is going to push the world into a double dip or a global slowdown. So, the only alternative is some form of debt restructuring. It is clear that if there was confidence in Greece, it could make step payments. This would be more like two situations — Brazil and Argentina. Brazil had a debt crisis which was helped over by liquidity. It even had a debt write-off. Once the market irrationalities had worn off, it started to grow and now no one thinks of Brazil as having a large debt problem. Most of the countries are, I think, in the Brazilian situation. If interest rate remains relatively low and market remains calm, then they won’t have any difficulties.
But don’t you think that one day China will have to take a haircut on US debt?
No. The US debt is different from other countries’ debt for the very reasons that US promises to pay dollars and the US controls the printing press for dollars. So it will always meet its debt obligations. The dollars may not be worth a lot. The question for the US is will those dollars that they pay is worth what they were worth when China lent the money. That’s a kind of haircut.
As long as countries can go on printing money, we may move from one bubble to another. At the same time, we can’t think of going back to the gold standard
You are right. We understand that the gold standard does not have enough flexibility and it does not work for modern economy; while we are getting into difficulty in getting the other system to work.
Now, one of the fundamental problems is the dollar reserve system. The dollar reserve system is one in which there is excessive reliance on one country — the US — and its supply of money of debt is determined by domestic concerns and not by global concerns. One of the main suggestions of a UN commission I headed was the creation of a new global reserve system. China, France and a lot of other countries supported it. This should be the first priority for the long term.
The current crisis is really caused by the private financial sector. The lesson I take from it is that we have to make sure that we don’t allow the private sector to engage in that kind of excessive risk and not give them what they did. We did the right thing to rescue it. But now we have to live with the consequences.
Well, the Financial Regulation Bill does want to cut risks. But stifling rules could kill parts of the financial market and end up throwing the baby out with the bath water?
No. Quite the contrary, it’s not strong enough. It was watered down. The financial sector paid huge amounts of money to water it down and they succeeded. Just like they bought deregulation, they bought the bailout, and now they succeeded in watering it down, but not as much as they had hoped. This is, you might say, the partial triumph of democracy. But we don’t know whether they will keep it. The administration is on the wrong side.
For instance, one of the provisions is that the US government should not underwrite the risky derivatives that cost $170 billion in the case of AIG. Banks shouldn’t be engaged in gambling and there is a debate on whether AIG was engaged in gambling or insurance. Certainly, if it’s gambling, it should not be government-guaranteed. One provision is to say that if you are FDIC-insured, you can’t write these gambling policies, insurance policies. The administration and the Fed said that it’s an important part of the lending activity. It’s only a few banks that do it. If it’s an important part, it would not be just a few banks. It will be most banks.
Where does that put the future of the US financial sector?
America’s financial system was out of proportion to the size of our savings. We are the largest economy but our savings rate is very low. Our financial markets were larger than proportionate. The reason was that people believed that US markets knew how to manage risks and allocate capital. The lesson from the crisis is that they don’t know. It’s gambling with other people’s money. And that’s going to stop.
Talking about savings, in Japan, the number of people retiring is more than the number of people saving. Soon, Japan may have to borrow externally to meet the deficit and that could push interest cost up
Japan’s debt-to-GDP ratio of 180%, is 50% greater than Greece and the only reason that it avoids trouble is that it doesn’t have to depend on outsiders. Also just to put things in perspective, Greece’s household savings rate is higher than Germany’s. So the notion that the Greeks were profligate is not true. Now, if Japan’s savings rate falls, it will have to depend on outsiders and that could in fact likely lead to higher interest rates. How much higher could depend on all market confidence. Markets have demonstrated a kind of irrationality — irrational exuberance and irrational pessimism. If interest rates remain low given Japan’s tax capacities, it can service the debt. So if global interest rates remain relatively low and people remain confident then I don’t think Japan is necessarily is going towards a crisis. But it’s not out of realm of the impossible.
Be it Greece or Japan, you repeatedly talk of lower interest rates. But given the inflationary fears, you think that’s feasible?
I am sufficiently pessimistic about the global economy. The forecast for US is that we won’t return to normal unemployment before the middle of the decade. So we are talking about an extended period of weak economy. If Europe, and probably the US, go on austerity packages that the financial community is pushing for, the likelihood is even greater.
So, euro and the European Monetary Union will survive
What happened in the last few months has been disappointing. Germany was reluctant to come to the assistance, and when it came to the assistance, the only fiscal framework they talked about is austerity not a solidarity fund. Greece’s problems are largely of outside its boundaries because its major export like tourism is down because of the global downturn. It had a structural problem, but most of the deficit is caused not by the structural problem but by the global downturn. So we are trying to correct the structural problem without doing anything about the surroundings.
The positive is that in the end Germany and the other countries did come to the assistance of Greece. The benefits that Germany and others get from the euro is sufficiently great, the political commitment is sufficiently great and I think it would survive. But it would be on the basis of muddling through, which will mean a lot of global financial volatility. It doesn’t need fiscal union to survive, but what it does need is some form of assistance and more institutionalised than the current programme. There is a risk of it not surviving and that’s the price that is demanded of the countries. Spain is a good story as before the crisis it had a surplus. So no one can complain of a fiscal profligacy.
You have said there is a risk of another financial crisis within five to ten years. Where and why?
The problem with developed countries is clearly very serious. In the US there could be a crisis of confidence in the dollar — we had it before in the 1970s.
But it could also come from emerging markets because what has been happening is that to reignite the American economy we have been flooding the world with liquidity but that has not translated into lending in US. It’s again part of the free market ideology which is give money to the banks and don’t worry about what they do.
But in the world of globalisation they are asking which is the best place to invest. And they are coming out with an answer that the best place is not US. Fed is creating liquidity which is going to other markets, and Fed is saying that’s their problem and not ours.
You had praised RBI and its resistance to some of the liberalisation. Is it a model for other countries?
Our regulatory structure was very flawed. People like (Henry) Paulson who helped create the problem was telling India that you should follow the American way. I am glad that you didn’t follow Paulson’s advice.
So the point I am making is that even if you are fully advanced, you shouldn’t follow the Paulson way. But countries which are not fully developed might want to have different or more regulations or may have the ability to have more regulation. It’s not only that financial markets are more complicated and difficult so you have to have a regulatory structure that changes with the stages of development.
In the next one-and-half years, a lot of US mortgage interest rates will again come up for resetting. Are you fearing another spate of defaults and turmoil in the market?
Not fearing, we know it will happen. We know that there would be more mortgage defaults. We expect the number in 2010 to be larger than 2009. Things are getting worse. That’s one of the reasons why I am not optimistic about a quick recovery. The administration has done almost nothing for the foreclosures. And there are two problems — one of the reset and of course that will get worse once the interest rates start becoming normal. The other problem is that more than a quarter of the mortgages are underwater as real estate prices have gone down by 30%. The one factor in this is that the US government has taken over the role of being the largest owner of the mortgages. So it may be that there will be less problem in the private sector and more in the public sector but it’s all part of the hidden bailout.
On the eve of the Chinese new year, China raised the interest rates. There are fears of a blow-up in China, many of the infrastructure ventures are not earning enough. Isn’t it worrying?
Two things about China which is different from other countries are: first, it is sitting on $2.4 trillion of reserves. It gives a bit of cushion to handle some of the bad debts. The second: when you are a big economy that is growing at 10% a year, the mindset of what is excess capacity changes very dramatically. What you see, disappears before you know. It is true that they have had a supply side model for their economy and it worked mainly because of the success of the export-led growth. They could increase the supply and there is a global demand that always mattered. That model is running out of time. They know it and they are in the process of restructuring the economy and I think they will succeed in doing that. But that’s the major challenge.
And given the slowdown in Europe as well as US, export-led economies will find it a problem.
The export-led growth model will have real trouble. India and China have a very big advantage as they have a vast domestic untapped market which they are beginning to tap. That’s why I am optimistic about India and China. Particularly China’s economic growth at this stage is very resource intensive. Urbanisation, steel base, food consumption — there will be a high demand for commodities which will benefit other developing countries. So their growth will be enough to help Latin America and some of the other emerging markets. But not enough to save Europe and America. In fact, it’s going to present a problem for the US and Europe as the prices of raw materials will go up.
In your book ‘Roaring Nineties’, you had hoped that the future US administration will address the issues which will improve the world as well America. Is there a chance?
The US is so absorbed by the crisis and domestic politics. It was Gordon Brown who took the initiative for G20. It was Brown and Sarkozy who said that we got to have a global regulatory framework. We don’t want to talk about a global reserve currency as long as we have to borrow a trillion dollars every year; we don’t want to upset this particular apple cart as long as people are willing to buy our bonds.
Men like you and Prof Krugman provide intellectual ammunition to politicians who then lead the government to intervene in the market. Do you feel a moral obligation that these things may not work out well?
Much of what we talk about is what I call robust interventions. By that I mean interventions that are simple enough that you don’t have to very fine tune to make them work, even if you have a bad president like President Bush. We have just seen that the government can be very dysfunctional. Paul feels much more about the issue of robust intervention that works even with the flawed institutions. But obviously it goes back to the dynamic view on regulation and taxation. Any system will have constant changes and so there will be mistakes. But then we have to say that we are ready to correct the mistakes when they become evident.