September 23, 2011
CONTACT: K.E. Schwab
SLIPPERY ROCK, Pa. – Abbas Noorbakhsh, professor in Slippery Rock University’s School of Business is betting on China to bail out financially failing European governments of Italy and Spain in the near future.
“There’s a good chance China, with the world’s second largest economy and over $3 trillion in reserves, will step into the European debt crisis and may help solve the problem, but not without gaining stature and influence on the world stage,” he said. “China is being asked to play a more significant role – maybe like the role the U.S. played after World War II to help rebuild Europe with the Marshall Plan.”
Noorbakhsh, who joined the SRU faculty in 1990 and teaches “Issues in Global Business” and “International Financial Management,” which partially focuses on managing foreign exchange rate risk exposures, said his courses touch briefly on the current default and financial problems facing Greece – much of Europe, and ultimately the U.S.
“Right now financial observers are primarily looking at three scenarios for Greece and the other European countries affected. The underlying problem is that if the Greece government fails, there could be a domino effect it will have on financial markets in the U.S and around the world,” he said.
In recent developments that bolster Noorbakhsh’s thinking, Italy, and possibly Spain, may call on China for financial help. He said a direct consequence of China helping any of the European countries is that China may sell some of its holdings of the U.S. dollar reserves and treasury securities that could lead to pushing up interest rates in the U.S. when the country is trying to stimulate spending and investment to fight unemployment.
“Greece is faced with tons of government debt. Some of that debt is held by Greek banks, some by European banks and some by U.S. banks, but the U.S. does not have huge exposure in this case if the Greek government defaults. What the problem is, is the domino effect, which could create huge confidence crisis in financial markets,” he said.
He said the U.S. might face problems in part because of “credit default swaps,” which are a form of insurance, but may be backed by U.S. financial institutions, thus increasing U.S. exposure and putting pressure on American insurance companies.
He said the size of the Greek financial problems is not as important as the psychological effect such a default might have.
Among the scenarios Noorbakhsh sees as possible for Greece are,:
“The first idea is that Greece undergoes a disorganized default; withdraws from the Euro Zone, which makes use of the euro as the common currency, and goes back to the drachma, its former form of currency. Under this scenario, the country would pay nothing on its outstanding loans – leaving investors, including any banks which have loaned money, as the losers but would gravely endanger the euro,” he said.
“The second scenario is that the European Union somehow provides funding in the form of loans or renegotiated terms. Greece is looking at something like a $435-billion shortfall. The lenders would, of course, ask the Greeks to adopt serious measures of financial austerity,” he said.
Some of those measures are already being taken which is raising the ire of Greeks and leading to large-scale protests against the government.
“The Greek government has already cut some 150,000 government jobs as an austerity step and is talking about selling off $50 billion in state-owned enterprises, such as utility companies that are now owned by the government. Both of these measures are bringing protests from the Greek citizens who fear loss of social networks they depend on,” Noorbakhsh said. He said the government is looking at its pension funds and intending to increase the age for retirement as a way of cutting back its expenses. Some of their ‘privileges’ are much more generous than we have here in the U.S.,” he said.
The third scenario would see other European countries, and possibly the U.S., help restructure the Greek debt. “That restructuring,” Noorbakhsh said, “could end up with Greece only paying 50-cents on every dollar it owes. Of course, this would spread the loss, but for many that would be better than a total loss.”
This scenario would also require participation and agreement by the European Union, the European Central Bank, the International Monetary Fund and others, including the U.S. Federal Reserve. “This is a very complex situation in this global economic system that we live in. The technological revolution in communication and reduction of regulations and privatization over the last 30 years that have had a huge influence on interconnectedness of economic and financial events,” he said. “Thirty years ago it was possible to isolate a financial crisis in one country, but not today.”
Noorbakhsh said Europeans, especially Germans, will continue to oppose bailing out Greece, but he points out the Greek problem is miniscule to the problems being faced by such countries as Spain and Italy. “There are a number of other countries that will fail if a comprehensive solution is not reached,” he said.
Spain’s debt in 2010 is estimated at $640 billion euros, while Italy’s debt is near $1.8 trillion euros.
Not all countries that are part of the European Union are members of the Euro Currency Zone. Only 17 of the European Union’s 27 countries have adopted the euro as their currency. They are Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain.
Noorbakhsh said many of the problems came about because member countries in the Euro Zone have failed to meet the initial economic conditions in formation of the singe currency area.
When the Euro Zone was established, all participating countries were to keep their debt growth to 3 percent of gross domestic product, he said. “And the total government debt must have not exceeded 60 percent of GDP of each member country. Last year; and Greek government debt was about 160 percent of GDP of this country,” Noorbakhsh said. “This is not only the problem in Greece; other countries have violated those initial agreements that they were supposed to hold the line on when they applied for membership.”
“The whole European Union Project was supposed to create a United States of Europe, but there is a problem. Most of the countries have sovereign governments that are independent from each other and are not willing to turn over many decision-making functions to a truly super national European authority. These countries are at different levels of economic development,” Noorbakhsh said. “This makes it difficult to purse unified fiscal and monetary policies to generate similar results in each country.”
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