Europe may have dodged the bullet with its $1 trillion rescue package, but the panic attacks are not yet over, says Russell Napier, strategist, CLSA Asia-Pacific Markets. In an interview to DNA, Napier surveys the debt landscape of developed economies in the West, and fleshes out the implications for India and China. Excerpts:
Will the $1 trillion rescue package in Europe end fears of a sovereign default and therefore beat back the ‘wolf packs’ of the market?
It ends these fears in the short term and even in the medium term, but many countries within Europe still have to deflate to become competitive. That’s the way the single currency works. And that invariably means reducing wages. That is a difficult thing to do. So we haven’t solved the longer-term problem, which is the deflation in these countries. But it does buy several months’ time. Even when the pain eventually comes, it won’t mean default, or the break-up of the euro.
What it means is that the ECB has to get more aggressive with its monetary policy. I expect there to be a second panic, but that time the European Central Bank will be more aggressive in its response. We should expect to see more bad headlines out of Europe in the coming months, but the ECB has taken steps in the right direction, and we’ll see more of that.What they’ve done over the weekend is quite small actually, so there’s plenty more to come.
Was there a risk of seeing a Lehman-like implosion of the global financial markets, or were the markets overreacting?
It was for real. There are times when central bankers like to see yield spreads go up and liquidity tightening, but you don’t want to see that just as you’re struggling out of the world’s biggest recession since the Second World War. To allow yield spreads to go up at this stage was not acceptable, so it was inevitable that we’d see something like this. Had we been going through a huge economic boom, and this had happened, perhaps it would be different, but we’re not. So they had to act quite quickly.
What will a roadmap to European retreat from the crisis look like?
There’s really only one roadmap that is socially and politically possible and that is growth. Some people say that the roadmap is cutting back all the deficit and the country deflating and becoming competitive, but that is not really practical. The only way out of it is to grow, and the European Central Bank has to create the conditions for growth. Japan is a good example of what happens if you don’t have growth: your fiscal deficit soars to very high levels. Europe doesn’t have the luxury of going to those levels, because unlike Japan it also has high private sector debt.
The big thing this weekend is inflation: we know that however this ends, however many more panics there are and however much contagion there is, the governments will seek to inflate their way out of it: not like Japan.
Beyond today’s news cycle, and having seen the resolve of governments, does solvency of sovereigns remain a big issue?
The issue of solvency will be what it is for a generation of governments. It’s not just Europe, it’s for most developed sovereigns, and it will be there for a generation. But there’s a crucial difference. This is why Greece was so different from, say, the US. Greece does not have the ability to print euros. And therefore you can genuinely question its solvency: can the government of Greece get enough euros to pay back its debts? The answer is: only if they can tax them from the people.
And it was becoming obvious that they couldn’t. And that’s not the case with, say, the US and the UK. They can print money. So a deflation could raise risks of default in Greece, but it can’t raise big questions of default in the UK and the US. Frankly, the sovereign debt crisis that is inevitable across the world will have to wait until there is reasonably high levels of inflation. That’s what will push government bond yields up. That’s what will get people panicking. That is going to be sometime away yet, but it’s definitely coming. The government bond markets will be in inflationary panic.
There’s one other important aspect. The thing that really sets off a sovereign debt crisis may be inflation in Asia. In this business cycle, Asians will have to go for an independent monetary policy. That will mean much less buying of US sovereign debt, and that could be a catalyst. So when we talk of inflation being the cause of a sovereign debt crisis, let’s not forget that it could be inflation from Asia, and that is already significantly higher than inflation in the West.If you’re watching inflation in the US, you might think it’s not a big worry. But inflation in Asia is higher, and there’s every reason to be concerned about a sovereign debt crisis in the West.
Are fears of the demise of the euro exaggerated — or do they remain relevant?
The euro is a political experiment; the whole political raison d’ etre for Europe is behind it. A break-up would be an economic catastrophe; so the euro will survive. But let’s come back to the bottomline of how it survives. If it needs the Europeans to ban shorting of government debt, impose some form of capital controls, or force certain people to buy bonds, all of these things will happen before the euro breaks up. Euro breaking up is so not on the agenda that Europeans would go that route before they would let the euro break. People in the market tend to forget that sometimes. They think that the politicians would let the markets slide. Politicians will more likely close the markets before they let the euro break up.
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