Sunday 4th December, 2011

Q+A interview with Russell Jones.

The interview has been transcribed below. The full length video interviews and panel discussions from this morning’s Q+A can be watched on tvnz.co.nz at, http://tvnz.co.nz/q-and-a-news

Q+A, 9-10am Sundays on TV ONE. Repeats at 9.10pm Sundays, 9:05am and 1:05pm Mondays on TVNZ 7

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RUSSELL JONES interviewed by PAUL HOLMES

PAUL HOLMES
For months we’ve heard about Europe’s debt woes in Portugal, Greece and Italy. But this week it took a series of dramatic turns. Central banks worldwide, fearing a freezing and a contraction of the global financial sector, made it easier for banks to earn money. On Wednesday EU commissioner Ollie Rehn said European leaders had 10 days to save the Euro or see the eurozone disintegrate. And in the past 48 hours German Chancellor Angela Merkel has said Europe must stop talking about fiscal union and start creating one, meaning an EU with the power to set debt limits and veto national budgets.

But is it really that serious? That was the first question I put to Russell Jones, Westpac’s Global Head of Fixed Income Strategy when we spoke on Friday. Just how bad is it?

RUSSELL JONES, WESPAC ECONOMIST
It’s pretty serious, quite frankly. I wouldn’t say we’re quite at the end of the world yet, but in economic terms, things are pretty catastrophic at the moment for the Eurozone. The economy is sliding back into recession just a couple of years after it climbed out of the last recession. We have acute financial stress in the banking sector. We have a number of governments threatening to go bust. The Greeks have already effectively done that, but others are also being dragged into a similar situation. It really is pretty unprecedented for the modern world to see quite so many developed economies in quite so much trouble at the same time.

PAUL I know. It’s quite extraordinary, isn’t it? The French Reserve Bank Governor says this week says that the situation for the Euro has worsened over recent weeks. He says we’re now looking at a true financial crisis. How did it come to this? Why?

RUSSELL Goodness me, that’s a question that warrants a very long answer. I’ll try give and you give you the abridged version. Frankly, it’s really an issue of too much debt, particular for governments. The governments in the Eurozone really didn’t obey their own rules for the first decade or so that the euro was in place, and they allowed their fiscal situations to get out of control, and now they’re desperately trying to bring them back on line again. The net result of that is that fiscal policy has been tightened very aggressively right across the board in Europe, and that’s depressing the economy. At the same time it’s also generating stresses in the financial sector. European banks are undergoing what we call a credit crunch - that’s a real unwillingness to lend. They’re finding it very difficult to fund themselves in international markets as well. So this combination of too much debt for the governments and a credit crunch on the part of the banking sector is really producing a very very weak economy at the moment.

PAUL I suppose it’s to oversimplify it, but basically for Europe - is this correct - that the problem is the costs of borrowing make it impossible to pay back the billions the countries owe?

RUSSELL Absolutely. At the moment, the borrowing costs for countries like Greece, Spain, Italy and even some of these so-called core economies like France have been rising very sharply, and it’s now at unsustainable levels, quite frankly. It’s very difficult for them to bring their public finances to heal, to make them sustainable, when they’re having to pay such very high interest rate costs. So there’s a desperate need to get interest rates down as soon as possible, and that’s proving a very difficult process at the moment.

PAUL How likely, then, is it that the euro will collapse in about a week or 10 days? And if it does collapse, Russell, what happens to Europe?

RUSSELL I think it’s very unlikely, quite frankly. I think one shouldn’t underestimate the political commitment to this whole project, which, of course, has been in place for the better part of 70 years now. Policy makers will give up the ghost on the euro only after a very protracted fight. But they’ve gotta start to give in certain areas. We’ve got to see changes in the way the euro’s run. We’ve got to see greater flexibility on the part of the European Central Bank, which has been extraordinarily conservative through this crisis. We’ve gotta see some changes to hold the euro together, and hopefully we’re going to see those over the course of the next seven days.

PAUL So might a couple of those changes be full political union in the Eurozone with complete financial union as well so that we don’t have sovereign nation bonds, you have euro bonds?

RUSSELL I think that’s frankly a very long way off, and the politics of that are extraordinarily complicated. What we might see over the course of the next seven days is efforts to move in that direction. You will see greater oversight, greater integration of fiscal policy of the way that governments spend and the way that governments tax over the period. But full political union, frankly, I think is many years away, if not decades away. It’s a very difficult process to bring together.

PAUL And, of course, the trouble with austerity programmes is it’s a bit like burning the village to save the village, isn’t it? I see the United Nations is warning against worldwide austerity programmes because it will simply depress the world economy.

RUSSELL That’s right. You end up effectively chasing your tail in this environment, especially when you don’t have your own currency, and you can’t offset those fiscal tightening policies with a depression of the exchange rate, and that’s exactly what’s happening to a lot of these countries at the moment. What they need is some kind of strategy to reignite growth, and frankly that really puts the ball very much back in the court of the European Central Bank. It has to slash interest rates, bring them down to the sort of levels we currently have in the United States and the United Kingdom - that’s effectively zero – and it also has to start to, I think, purchase outright government bonds, try and depress long-term interest-rate costs as well. And that’s a much bigger jump for them to take. It’s very politically complex for them. There’s a lot of central bankers in the Eurozone who have very long memories and they look back to the 1920s and the 1940s when policies of outright bond purchases by central banks created hyper-inflation. So they’re very concerned about that. There’s a lot of history involved here which is injecting a lot of inertia into the whole situation.

PAUL A lot of history, a lot of politics. We’re seeing the assertion of the real power of France and Germany. Across Greece we’ve seen riots as a result of austerity programmes, knocking back the old age pension bit and so forth. How long will the German people continue to finance the euro? This is another problem.

RUSSELL I think already you’re seeing a certain amount of reluctance on the part of the average German to pay the bills for countries that they see as having not played by the rules, have really created their own economic problems for themselves. There is already, I think, a groundswell of opinion in Germany developing against this. And at the same time, you’re also seeing political and social turbulence in those countries that are also having to impose now belatedly the austerity on their own economies. Governments are falling. People are out on the street demonstrating. And frankly, given the way that the economy’s going, I can only see these protests, these political and social issues, gathering momentum over the course of the next 12 months.

PAUL And on this side of the world, of course, we look at a disharmonious Europe with some unease. If the euro were to collapse or if the problems were not to be solved, what’s the fallout for a country, say, like New Zealand? What’s the fallout for the Asia Pacific region?

RUSSELL I think the bottom line is that nobody actually escapes. I mean, if you look at the European economy, it accounts for about 20% of global GDP, 30% of global exports and something like 40% of global banking assets. So it has a huge impact on the rest of the world. We’re already starting to see the impact of the weakening of the Eurozone economy and the financial issues it’s facing in Asia, broadly. Exports, for example, from China to Europe have fallen quite steeply recently. Financial tensions, as I say, are already appearing in Asian markets. It’s a little bit like waiting for a tidal wave to arrive; you know it’s gonna come, you’re just concerned about how high it’s gonna be when it arrives. I think at the moment the New Zealand economy is quite isolated from these global events, but they are gonna reach New Zealand shores before too long.

PAUL What happens next? There’s a summit coming up, isn’t there, in a week?

RUSSELL There’s a summit coming up in a week’s time. There’s also a European Central Bank meeting next week. One hopes that the European Central Bank will cut rates and at least start thinking about going down this route of bond purchases. One hopes that the various governments will come together, they’ll solidify the bail-out package that they’ve been discussing for some time, and also that they will start to move towards this process of fiscal unity and political unity in the Eurozone. But we need to see progress in all of these areas if financial markets are going to be stable going into the Christmas period.

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