QUELS CHOCS POUR SORTIR DE LA CRISE? Prof. Dr. BRUNO COLMANT Membre de l'académie Royale de Belgique

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1 QUELS CHOCS POUR SORTIR DE LA CRISE? Prof. Dr. BRUNO COLMANT Membre de l'académie Royale de Belgique

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3 Several issues to deal with Recession and huge social issues : unemployment, digitalisation Public debt : pensions, future welfare, taxation The euro : lack of congruence, redomestication, QE 3

4 First, the subprimes 4

5 Then the disaster " Je pensais que nous achetions seulement une maison!" 5

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7 Crises = catalyst for the globalization cycle Velocity of production factors : capital, labour and information 1893 & & Agriculture, train, car, telephone Urbanity, radio IT Internet and credit Credit leniency followed by massive deleveraging Seismic replication of 2000 crash? Systemic risk, but non diversifiable/ insurable 7

8 The reality of a deflation Homeopathic growth, low demand, underutilization of production capacities Fall of money velocity Increase of the real interest rates... compensated by a redomestication of public debt/retail savings at no costs How to get out of a structural deflation: > Nobody knows, reason why the political/monetary policy mistakes are unforgivable > Lower/negative rates are ineffective > QE? Bank QE (with the ECB being the bank controller?) And a unknown : how long will the "social factor" remain stable? 8

9 Velocity of circulation of money has been divided by 2 in 20 years with a strong dip after 2008 Velocity of the circulation of money for three monetary aggregates [ ] M1 M2 M M1= Currency in circulation + Overnight deposits, M2 = M1 + Deposits with agreed maturity <2 years + Deposits with 3 month notice, M3 = M2 + Repurchase agreements + Money market fund shares / units + Debt securities up to 2 years Source: Eurostat, European Central bank 9

10 1 ECONOMIC FORECAST Inflation in Europe is heading towards the 0-bound and below Eurozone inflation 4% 3% 2% GIPS- countries inflation 4% 3% 2% Belgium Greece Spain Italy Portugal 1% Eurozone 1% 0% 0% -1% -1% -2% -2% -3% -3% 01/ / / / / /2014 Source: ECB, Eurostat, HICP index 10

11 Interest rates attain all time lows Evolution interest rates [%, ] 6% 5% 4% 3% 2% 1% 0% 01/ / / / / / / / /2014 Euribor IRS 10y ECB Source: Bloomberg, ECB, Roland Berger analysis 11

12 Interest rate volatility will induce high risks for all market players in the next years Evolution of interest rate in the Euro Area Interest rates in the Euro Area [%, ] Comments Q Q Q Q Q Q Q Q1 Long term interest rate 2) Short term interest rate 1) > Low interest rates over a longer period of time can have various negative side-effects: Insurers face challenge of low current yields vs high historic guaranteed returns Intensified search for yield behavior by institutional investors Profitability pressures on bank net interest margins > Sudden interest rate increases will have a negative impact on all financial institutions and for the governments 1) Three-month money market rates 2) 10-year benchmark government bond yields Source: OECD, Roland Berger 12

13 The relationship between financial institutions & governments becomes more and more imbricated Evolution of Bank sovereign debt detention Banks sovereign debt detention globally increases 1) [ ] Comments Nov 2011 Nov ) Base=100 in january 2011; Excluding insurance; Nationality of debt is not precised by ECB Italy Spain Portugal France Euro area Germany Belgium > European banks hold increasingly important amounts of sovereign debt of euro zone, especially in periphery countries > Increased domestic intimacy between banks and governments may induce systemic fragility (vicious spiral) > EU finance ministers agreed on the rules to force losses on creditors in failed banks, putting in place a piece of a banking union that could share the costs of future bank bailouts: Progressive reduction of interdependency > Financial repression through regulation, leading inflation rate to surpass interest paid for savings Source: ECB, Roland Berger 13

14 Government debt is increasingly owned locally Belgian government debt [EUR bn] Foreign holdership (61%) (60%) (59%) (55%) (48%) (44%) > New regulation is pushing both banks and insurers towards low risk investments > Additionally, we see that an increasingly larger share of government debt is being taken up by Belgian investors Domestic holdership 110 (39%) (40%) (41%) (45%) (52%) (56%) 2012 > This implies that a significant share of new house-hold savings were used to pay for increasing govern-ment debt Source: Debt agency, Roland Berger 14

15 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% % 80% 70% 60% 50% 40% 30% 20% % of countries with annual inflation over 20% of countries in default or restructuring Total public debt/gdp (word average) 15

16 The euro? A political decision with insufficient economic ground : monetary federalism BUT budgetary confederalism Windfall effect (monetary expansion, German rating, low rates) Monetary mobility but increased government pressure The euro is genetically recessionary 16

17 What are the key problems the euro? A country weakens its own banking system Nobody considered the insolvency/bankruptcy of a country whereas the euro is like borrowing in a foreign currency > Financial repression (low rates, mandatory holding of public debt) > Redomestication of public debt (debt migrates back to its origin) > German logic : domestic private savings must finance domestic public debt > Risk : rescheduling, etc. (Greece, Ireland, Cyprus) > A banking union : not a pre-nationalization of the banks? 17

18 Absent significant restructuring, required internal devaluation is large Required real exchange rate adjustment sizable within the Euro area Macro model Assuming no structural change and economies at potential GRC IRE ESP PRT ITA GER FRA Initial imbalance (mid 2008) Start of Euro area debt crisis (mid 2010) Euro area debt crisis escalates (Q2 2011) Most recent jobs (Q2 2013) End of GS forecast horizon(q4 2017) NIIP : Net International Investment Position: external financial assets minus liabilities Source: Goldman Sachs Global Investment Research 18

19 Welcome to euro austerity : a suicide Unemployment rate : 12,1 % Austerity fuels recession that requires more austerity The same mistake as in the Thirties (Hoover, Brüning, Laval, ) Risk of a global nationalization Self-destructive 19

20 Unemployment Spring 2014 forecast of the European commission Belgium 8.2 Germany 5.1 Greece Spain France 10.2 Italy 12.5 Netherlands 7.3 United Kingdom 6.3 Euro zone 11.4 UE

21 Laval deflation (1935) 21

22 Weimar (1923) 22

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25 The situation today > Debt deflation Massive deleveraging of assets (Fisher) > Consequences Impact on demand, recession, unemployment > Liquidity trap (Keynes) Deleveraging makes monetary stimulus ineffective What should we do? > Market are telling the answer : increase public deficit (US example), debt and monetize the debt! > But the cohesion of the Euro is at stake! > So we are caught in a deadly trap : Euro cohesion prevents budgetary stimulus German rigidity prevents monetary stimulus (debt monetization) > The final solution : A clean-up of the public debt through inflation or debt rescheduling in weaker cases 25