Friday, February 3, 2012
The Chinese Question: Liquidity or Solvency?
Once again the EU is trying to get China to commit a few hundred billion of its foreign exchange reserves to shoring up Eurozone sovereign debt. The European “stability” mechanisms (EFSM and ESM) need more money, and no one in Europe is willing to lay that much on the line. China says it would be willing to step in, but under one condition: that its investments are guaranteed.
This is perfectly reasonable. China is still a largely poor country, and there is no reason why its people should risk losing their savings in order to help manage the affairs of much wealthier Europe. At the same time, however, their demand exposes the fundamental dishonesty of Eurozone policy.
Except for Greece, the official line is that all sovereign debts will be honored and all fiscal targets met. The rescue facilities exist only to provide bridge loans that markets are unwilling to extend at a reasonable cost. With enough liquidity, austerity and reform, financial sustainability is assured.
If this were really the case, however, there would be little risk in giving the Chinese the guarantee they demand. And no one seriously expects such a guarantee to be offered.
The reason is that the true situation in the Eurozone bears little relation to the optimistic talk still issuing from summits like the one just concluded in Brussels. Greece is only the first in line; Portugal too will need debt relief and perhaps also Ireland. Spain faces an entire banking system that may well be technically insolvent, and it can neither survive a banking collapse nor come up with the funds to forestall one. All the severely indebted countries are at risk from the gathering recession, and the need for further recapitalization of the banks across the continent is a further risk.
In the face of this frightening public and private debt overhang, the official policy has been to lend, lend and lend some more. The ECB has turned back the doomsday clock by lending half a trillion or so euros at close to zero interest to private banks in return for their own lending to overstretched sovereigns. So-called bailouts, like the next tranche at issue in Greece, are also loans. Politicians give stern speeches about how debt cannot be the solution to debt, and then they find more spigots for lending: beef up the European Financial Stability Mechanism, bring on a permanent mechanism, go door to door in China.
But if the problem is not liquidity but solvency, this avalanche of credit is profoundly wrongheaded. The solution for insolvency is always the same: write down existing unpayable debts and generate income—transfers if necessary—to forestall new debts. In the current environment each is associated with an immense political-economic challenge, since the first requires confronting the European financial oligarchy and the second creating a true, zone-wide fiscal entity (the feared transfer union). Achieving either alone would be a miracle; accomplishing both is almost beyond utopia.
At least we can thank the Chinese for clarifying the contradiction at the heart of the current policy charade.