Chief economics commentator and associate editor at the Financial Times, Martin Wolf has been described by Harvard economist Lawrence Summers as “the world’s preeminent financial journalist.” His weekly column is must reading for government leaders, central bankers, and business executives around the world. And his books, including Why Globalization Works and Fixing Global Finance, address some of the most important trends in the contemporary global economy.
In early December 2011, Wolf was the keynote speaker at BCG’s third European Private Equity Seminar in London. After the meeting, BCG partner Johan Oberg sat down with him to discuss Europe’s sovereign-debt crisis, the future of the euro, its implications for the M&A market, and the role of private equity in today’s volatile economy.
We’re curious about your view on the current sovereign-debt crisis in Europe. Are you an optimist or a pessimist?
I’m not sure I’m either. There are reasons to be a pessimistic, for sure, but also some reasons to be optimistic. What we’ve learned is that the sovereign debt of all euro zone countries is different from the sovereign debt of other countries, in the sense that they don’t have a central bank to back them up. There’s a clear liquidity risk. There are certain policy options—for instance, devaluation—that other governments have which the euro zone countries don’t have.
The market obviously recognizes that and is concerned about their capacity to manage solvency. Once that becomes priced in the market, then these countries can get into a very bad equilibrium where interest rates are too high. They get into a debt trap. That has been happening in some countries, but in the big cases—at present, Italy and Spain—they can still roll over debt. And they probably would be helped to roll over debt. They can bear these kinds of interest rates for quite awhile before it becomes a really serious problem.
Now, in addition to this, there is clearly an element of breakup risk in the sovereign debt crisis in the euro zone. There are people who are actually thinking, “Maybe the euro won’t survive, and in that case there will be huge moves in the new currencies. Germany will go up; Italy will go down. And therefore we want a higher price in Italian debt to compensate us for that risk.” They can’t assess how big the risk is, but it’s there.
How would you rate the probability of either the weak or the strong countries leaving the euro?
I think the strong-currency countries are unlikely to leave the euro, though they have the best option. But it would impose massive shocks upon them. Take the example of Germany. If Germany left the euro, first its banks would be very badly affected, because their assets would be located in other countries whose currencies would now be weaker. And, of course, export industry would be very badly affected.
German industrialists and bankers are clearly aware of this. They’d be a powerful lobby against leaving the euro. In addition, there’s the political commitment to European integration, which is very important for Germany. So I think the Germans are unlikely to leave, and I don’t think the Dutch will leave if the Germans stay. So it’s basically Germany’s decision.
As for the weak-currency countries, their problem is that if they were to leave, the result would be a devastating financial crisis. They would have to impose exchange controls. It would be Armageddon. So I think they’re going fight to the last to try to avoid this. Unless things go terribly badly wrong—which, of course, is not impossible—they will stay in the euro, even if they have to restructure their public debt.
At the conference, you spoke about our facing ten tough years before we turn all this around. What will be the impact on the real economy?
The adjustment process to restore lost competitiveness, reduce fiscal deficits, reduce debt—the combination of those things means very weak growth, falling wages, or at least, falling unit-labor costs. This is an environment in which demand is likely to be very, very weak.
Looking at emerging markets as perhaps part of the solution, how much of an emerging-market lift can we expect, given the better growth prospects of those economies?
There is at least a reasonable chance that rapid growth in emerging markets will continue. But there is always uncertainty about these things, and extrapolation is very dangerous. But it’s at least plausible these markets will become bigger and more dynamic. They are still relatively poor; they’ve got huge unmet needs; hundreds and millions of people are moving into the middle class. It’s logical that one expects these places to be dynamic.
If you look more broadly at the history of the emerging-market economies in the last 30 or 40 years, however, you realize that there have been a lot of ups and downs. Relatively few countries sustain this type of rapid growth. Lots of countries have had a surge of growth and consumption has exploded, but then current-account deficits become too large, and they have a financial crisis. That happened to Turkey in 2001. And Brazil had an important financial crisis, high inflation, and then a big exchange-rate crisis in 1999. So you can’t just assume that all of the emerging-market economies will do well.
In the long run, of course, it seems almost inevitable that the emerging-market countries will lead the way. They contain some 88 percent of the world’s total population and still represent only roughly half the world economy. That is an imbalance, and it’s bound to correct in their favor, sooner or later. They will achieve a balance, become more important, and the developed world will become much less important. But it can be very bumpy.
So in this economic environment, what would you expect to happen to the M&A market?
What drives M&A? First and foremost, it has to be financing. Most deals, though not all, involve debt. Financing is going to be a bit tough. And the conditions of the financial sector, I suspect, are going to be pretty difficult for quite a long time. They are going to be forced to raise prices. They are going to be forced to raise capital. They are going to be discouraged from taking risks, so financial conditions for M&A are going to be poor.
I wouldn’t be surprised, though, if we saw really quite a lot of M&A from emerging countries into developed countries, and, of course, from emerging countries into other emerging countries. We’ve got a lot of activity there. And, of course, there will be developed-country companies looking for M&A opportunities in emerging countries to expand their franchises and to use their skills and knowledge in a more successful way. That sort of opportunistic investment to create global networks is an obvious direction you’d expect the world economy to go.
How do you see the role of private equity in the kind of global economy you have described?
It depends ultimately on what you think private equity does and on what its returns are based. Some aspects of the model are obviously more difficult in the current environment. Financing is more difficult. And if you are buying from the public market and returning to the public market when you exit—well, the future value of the public market is hugely uncertain.
I would assume, therefore, that these massive “megadeals” we saw before 2007 won’t return any time soon. But to the extent that private equity is able to improve management and take out costs and so forth, if that’s the selling proposition of private equity, then the opportunities, I think, are permanent. The core principle private equity has to offer the world is focused ownership and better management as compared to the public market. If that works, and the company is genuinely better managed, then private equity is a good model and it should deserve to succeed and will.
Thank you very much, Martin, it was a pleasure to have you here with us this morning.
Thank you very much.