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20
SEP 11

What impact will the European crisis have?




The potential for European countries and their banks to default on debt raises the question of what impact these defaults would have on the global economy.

• What impact will the European crisis have on the rest of the world?
• What has been learnt from the 2008 financial problems?

If the economic crisis in 2008 did not demonstrate some serious financial problems the recurrence of the problems this year certainly does. The reaction from Governments to the first round of financial institution failures was to prop up the current system, but this has not fixed the underlying issues. This time around the reaction must be more strategic.

The Vickers Commission has recommended that retail banking be ‘ringfenced’ from other functions of the bank to ensure that the Government is not forced to bail out investment banking sections of banks in the United Kingdom again. John Kay noted in a recent article for the Financial Times that lending to businesses and farms accounts for only three percent of total bank assets and liabilities in the United Kingdom. He notes:

“We need to get back to banking as usual: not banking as it was in 2007, but banking focused on the needs of depositors for a haven for their cash and on the needs of business for funding productive investment.” – my emphasis.

Our Government needs to take its own measures to ensure that it does not back financial practises that cause our economy harm. In New Zealand, retail funding makes up approximately two thirds of bank business, but the key is only to support productive economic behaviour.

The same philosophy must be used to change economic policy. An overvalued currency, capital imbalances, and a bias towards housing and land have been bemoaned by the Government and its officials but so far little has been done.

Thursday’s Monetary Policy Statement from the Reserve Bank was a typical example. There was some talk about Swiss intervention to reduce their currency, whether non-tradable inflation would be a better target for the Reserve Bank and on additional tools that could be used. Unfortunately there was no action.

The first crisis saw the same policy decisions that led to the crisis reinforced. We must not waste a second crisis.
 


tags: european crisis, vickers commission, productive investment, rbnz
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