Spotlight G20: What should developing countries demand?

Matías Vernengo (also available in Portuguese)

Last weekend, strange news circulated by the Sunday Times claimed that the Chinese government would be willing to inject money to rescue the euro.  The idea would be that China would buy large amounts of European sovereign debt, supposedly in exchange, even more bizarrely, for a greater commitment to fiscal austerity.  Basically, China wants to be the new International Monetary Fund (IMF). If this is true, it is exactly what China and the other developing countries in the G20 should NOT do!

First, it must be understood that the European crisis is not a typical debt crisis, since the Greek debt (and the other peripheral countries’ debt) is denominated in euros, and the European Central Bank (ECB), an European institution, has the power to create euros, if the member countries deem it necessary.  In other words, they do NOT need yuans, dollars, yens, or pesos for that matter, as it would be the case in a foreign debt crisis. [For that point see the interview with Jamie Galbraith linked here].

This is a political crisis, caused by unwillingness of the ECB and the governments of France and Germany to buy more Greek debt, and avoid the contagion to other countries that might follow a default. By the way, the total Greek debt corresponds to about only 3% of Euro-17 area’s income. In plain English, not only is the debt domestic, it is also not that large.

However, the implications of a default could be far reaching and actually affect growth in developing countries. If Greece defaults, European banks, French and German as much as Greek ones, institutional investors and pension funds (mostly in Europe) would be directly hit. But also those institutions holding Credit Default Swaps, bought by agents to cover against the possibility of a Greek default, will suffer, and this would possible entangle investors in the UK and the United States. A Lehman moment may follow, and with that the breakdown of global finance and international trade as in September of 2008.

Thus, developing countries must demand that the ECB and/or the IMF buy more Greek debt, and follow the example of the Fed in the US, that is, pursue Quantitative Easing. That may not be sufficient to get the developed world out of the crisis (more fiscal stimulus is needed for that to happen), but at least it would reduce the chances of a global collapse.