Bail outs are not the right medicine

 

               First we are told that providing a new loan to Greece, or Ireland, or Portugal, creates a line in the sand, prevents the contagion spreading. As each sucessive loan demand showed, that did not work. The incoming tide of debt erased the lines. The contagion spread. The mixed metaphors were too weak to face  the facts. 

           Then we are told a loan package for a troubled country will be linked to tax rises and spending cuts which will sort the problems out. In the case of Ireland it emerged that the banks needed another E24 billion to satisfy the incoming government. In the case of Spain they are putting sums into their banks at risk which the market fears will still not be enough.

           A loan package from the EU and IMF achieves two things. It firstly offers the country subsidised credit compared to market rates. That’s why they ask to borrow, as they are finding it too dear and difficult to borrow in the normal way. The subsidy is paid by the lending countries.  Secondly, it claims to offer a policy change which will curb the deficit, mend the banks and put the economy onto the right course.

         Such a policy change, if convincing, would remove the need for the subsidised  loan. If the markets believed that the country concerned was taking sufficient action to curb its deficit or mend its banks, then that country would be able to borrow in the market again at sensible rates. If the market is not persuaded, then we need to ask why the IMF and EU do not insist on deficit reduction measures that carry conviction. The interest rate on Greek and Irish debt did not subside to more normal levels once the policy changes demanded by the lenders were announced.

          It is possible the markets are wrong and the EU is right. As taxpayers contributing to this folly it  would be good if for once they were. The markets are concerned that the policy changes do not allow more rapid growth in the damaged economies. Without decent growth deficit reduction is a far more painful process. Tax rises can result in lower revenues. Business investment and new jobs can be diverted elsewhere. With no devaluation countries locked into the Euro can find it difficult to export their way out of trouble. There are conditions when locked into the Euro when countries can be forced into round after round of tax rises and spending cuts if growth does not come through to ease the pain.

       I would recommend strongly that instead of sitting down and discussing the terms of a bail out loan, the EU should discuss with Euro members the terms of that country’s new economic policy designed to restore market confidence. It is a matter of general Euro area concern, as the European Central Bank stands behind them all. Only if they re-establish market confidence can these countries be sure of a better future.

        Meanwhile, it would be  helpful to have a statement from the European central Bank about how much state debt from Euro members it is prepared to buy, and how much support it can give to Euroland area banks. There is a danger the ECB could build up very large positions in the weaker countries and banks. Then one day they might decide, as they did with Ireland, that they need to cut their positions. That can trigger difficult negotiations at very difficult times for the country concerned. Maybe there should be more transparency and stability in this crucial area of policy.

This entry was posted in Blog. Bookmark the permalink. Both comments and trackbacks are currently closed.

32 Comments

  1. lifelogic
    Posted April 9, 2011 at 6:48 am | Permalink

    Clearly bail outs are just subsidised further lending how is this likely to solve the government and structural problems of the country. How can they enforce sensible government thereafter anyway?

    Off topic:

    Praise where it is due to the BBC radio four’s “More or Less” a maths/statistics program usually with left wing BBC bits thrown in.

    In the second half of the program though (after the usual left wing Miliband/Brown/Ball’s type nonsense of continuing to borrow and waste money doing nothing useful – just to help save the economy).

    They explain that the graph leading up Clegg’s social mobility initiative “Opening Doors Breaking Barriers” does not actually adjust for “regression to the mean” and so it seems is at best to be a large exaggeration of social disadvantage at a young age. Clegg’s “bright but disadvantaged children overtaken by the age of 5” speech was much reported.

    Is no one numerate in Clegg’s department (or government in general). Do they just look for a graph that shows what they want politically and just not care about the truth? I suppose, as Clegg did Social Anthropology at Cambridge, he can perhaps be excused as basic maths such as “regression to the mean” is perhaps beyond him. But worryingly the BBC inform us that the person who did the initial work, apparently a professor at The Institute of Education, is now doing some work at the Treasury.

    Needless to say they console their left wing listeners with some consoling balm at the end about much other social mobility evidence.

    Also on the BBC “Any Questions” we learn from the somewhat left wing, John Sergeant that when they placed an add for a very junior political researcher at the BBC and they got 3000 applications. Surely at least 100 of these could have done the DG job better than the current incumbent does- perhaps for £20,000 or so?

    Why are BBC staff paid so much when there is such demand to work there and for next to nothing?

    All are still on BBC iplayer as is the fascinating program “The Cuckoo”.

    • acorn
      Posted April 9, 2011 at 9:32 am | Permalink

      For those not familiar with the regression artifact. http://www.socialresearchmethods.net/kb/regrmean.php

    • forthurst
      Posted April 9, 2011 at 4:26 pm | Permalink

      I think it a reasonable assumption that the Institute of Education fosters Cultural Marxist theories; the poison in our education system has to have leaked in from somewhere. One of the tenets of Cultural Marxism is that ‘race’ does not exist; from this they would presumably deduce that a group of children from different ethnicities would on average develop at the same rate: unfortunately the premise is wrong as has been extensively established elsewhere.and therefore any conclusions drawn from it are false.

      It is vitally important that our politicians do not take advice from those without the professional competance to give it.

    • lifelogic
      Posted April 9, 2011 at 5:38 pm | Permalink

      Regression to the mean is also often used to justify speed camera cash cows as they are usually installed after a few accidents on a stretch of road and next year, perhaps as is more normal, there are no accidents and the cash cow gets the credit – such bogus statistics are used to justify the next cash cow.

      Similar to the one red bus is greener than 52 cars or similar claim so often made.

      And they expect us to believe them on their “the science is settled” global warming projections and their Euro bailouts when they make such basic maths errors!

  2. Euan
    Posted April 9, 2011 at 7:21 am | Permalink

    Couldn’t agree more. The EU is doing exactly what has been done here and the US – steal enormous amounts of taxpayers money to subsidise big banks folly and government overspending. As with any other interference in the proper running of markets it will only delay and make worse the final reckoning. Far better to put finances in order and let things take their course which would involve restructuring debt and eliminating deficits.

  3. Iain Gill
    Posted April 9, 2011 at 9:35 am | Permalink

    personally i think the british people on average would rather help portugal out than pump money into pakistans schools, its not just the ecomomic mismanagement its the totally crazy priorities

    • Stuart Fairney
      Posted April 9, 2011 at 9:35 pm | Permalink

      Methinks they would rather do neither. Of course they are free as individuals to do one or other, or both if the freely choose to.

      But there is no freedom here, only coercion enforced by the threat of kidnap for the tax serfs.

    • APL
      Posted April 10, 2011 at 8:55 am | Permalink

      Iain Gill: “british people on average would rather help portugal out than pump money into pakistans schools ..”

      Point is Iain, there are plenty of people – real British people who can organize and collect the cash from individuals who want to donate. These organizations spring up all the time whenever there is a disaster. We clearly don’t need the politicians to do it for us.

      • Iain Gill
        Posted April 10, 2011 at 5:18 pm | Permalink

        yep i agree this should be left to charity from people giving of their own free will

        but the priorities are badly wrong as well

  4. Nick
    Posted April 9, 2011 at 9:38 am | Permalink

    That can trigger difficult negotiations at very difficult times for the country concerned. Maybe there should be more transparency and stability in this crucial area of policy.

    ===============

    OK – EU buys all of Ireland’s debt.

    EU sells all of Ireland’s debt.

    What price will they get? 10 cents on the Euro?

    OK, that’s a 90% default, and I suspect Ireland would agree to that.

  5. Pericles
    Posted April 9, 2011 at 9:40 am | Permalink

    Well, yes, Mr. Redwood, but this is part of the advice the politicians — on both sides of the Atlantic — were offered when the first of the financial institutions was baled out in 2008.  The politicians (which term, I’m sorry to say, includes you), anxious to preserve the source of their campaign funding, are to blame for the interminable cycle of baling out.

    It would have been better to let the ship sink and to build one with a sound hull.

    ΠΞ

    (Who ever designed this site needs to look at the ‘tab indices’ :  they’re all over the place.)

    Reply: I argued against the bank bail outs they pushed through and proposed a cheaper and less risky way of handling the banking crisis, where bank shareholders had to sell assets and take more of the hit.

    • lifelogic
      Posted April 9, 2011 at 5:53 pm | Permalink

      You were quite right about the bail outs which were done in an absurd way. RBS group (ie Cameron or the Government) is now recovering value for RBS shareholder by over charging its good customers and worse pulling cash back all over the place with a huge onward effect on employment and jobs.

      Is that what he wants how does he expect the private sector to take up the slack if he pinches all their money back?

    • Pericles
      Posted April 13, 2011 at 9:55 am | Permalink

      I apologize, Mr. Redwood ; I had not intended to imply — as I carelessly did — that you had voted for the bale-outs, only that you were a member of the body of politicians that had collectively done so.

  6. English Pensioner
    Posted April 9, 2011 at 10:03 am | Permalink

    Where is the money all coming from? Britain is in debt, yet somehow it is lending money it doesn’t have to Ireland and Portugal.
    The whole thing seems like a giant Ponzi scheme to me – a country with no money lending to others with no money so that they can pay back their debts.
    Are we sure that Bernard Madoff hasn’t been appointed an advisor to the European Central Bank?
    Or perhaps it’s all a fairy tale written by Hans Christian Anderson along the line of the “King’s new clothes”!

    • Stuart Fairney
      Posted April 9, 2011 at 9:56 pm | Permalink

      You put your finger on it exactly. Fiat money is indeed something of a Ponzi scheme and the central banks and politicians are terrified of the possible collapse of a system that allows them to create “money” out of thin air, just like Mr Mugabe did recently.

      I don’t know of any fiat currency systems that last much more than about forty years or so. Nixon came off Bretton Woods in 1971 ~ whoops.

      It is entirely possible that we will revert unwillingly, to some kind of commodity backed money system (which as a value and a measure and a store of worth, is exactly what money is of course). This may happen formally or it maybe necessary to do so as the hapless Zimbabweans were forced to informally as I believe some people in the US are already doing.

  7. Edward.
    Posted April 9, 2011 at 10:03 am | Permalink

    Euroland marches to the tunes of the German bandmaster, if the southern members and Ireland want to restore their nations finances and economies.

    They will either have to march to the same tune, restructure, cut labour costs, silence the unions, close inefficient industry and re-order a complete overhaul of their manufacturing base [or what there is left of it] and cut out massive and ingrained: waste, inefficiency and fraud.

    All these renovations should have been insisted upon before they joined the euro, because making the necessary changes after they joined, is already too late. Therein lies a tale, of petty jealousy, political impatience, rapaciously greedy banks and nationalistic vainglorious folly.

    There is another way out though.

    If they refuse to make the changes, the alternative is to, default and leave the euro and float their individual currencies, I know which option is the more liklier.

    End of political union, hooray.

    • sjb
      Posted April 9, 2011 at 9:10 pm | Permalink

      “To be free with one bound the peripheral euro economies would almost certainly have to take a haircut – effectively devalue – their sovereign debt. This would place the banks, which hold government stock as part of their capital in serious danger. Government guarantees of retail bank deposits would become irrelevant and savers would see their nest eggs wiped out.

      This is precisely what happened in Argentina in 2002. The result has been disastrous. Whereas the rest of Latin America has prospered, Argentina has been left in the slipstream. Middle class savings were wiped out, there was huge capital flight by the wealthy, foreign banks declined to lend and output slumped. Eight years on the government is still seeking to rebuild its credibility, the banks are distrusted and inward investment is slow.”
      http://www.dailymail.co.uk/money/article-1374985/ALEX-BRUMMER-EU-weaklings-seek-avoid-Argentine-style-default.html

  8. Javelin
    Posted April 9, 2011 at 10:04 am | Permalink

    As someone who works in investment banking at the coal face I take the view that each of the three have different issues. Greece needs to sort out its tax, Ireland needs to pay more tax and Portgual needs to spend less. However the bottom line is none of the three countries can afford to pay for the debts they have built up. So what this means is that if they default AND sort themselves out the markets won’t be too harsh with them. Basically tough t*ttys to investors who bought their bonds and didn’t do due diligence on their toxic fiscal habits. So defaults will not be the end of the world and Governments should have more confidence.

    The second point is that I think the EU are using this opportunity to take fiscal control of European countries. They are starting this by saying they want to be able to veto budgets (for the PIGS) but as with all things the EU it’s a power grab and eventually they want all taxes to flow through them. I think that Trichet is going to keep raising interest rates and try to bring Spain (via the housing Market) to it’s knees. I also think when Spain falls then Italy will fall soon after……

    • zorro
      Posted April 9, 2011 at 6:24 pm | Permalink

      The EU are looking at the financial risks as an opportunity rather than a threat. Ireland is now a vassal of the ECB under Teutonic ‘political’ leadership. The EU will use the ‘Euro’ (now that countries are in) as a way of hoovering up their assets on the cheap and this is something which these countries will not be able to avoid…one way or the other….I will say it again, they will not be allowed to leave the Euro.

      zorro

    • lifelogic
      Posted April 10, 2011 at 7:51 am | Permalink

      “The EU are using this opportunity to take fiscal control of European countries” of course they what did you expect? It is all about power or other peoples money to the EU.

  9. StrongholdBarricades
    Posted April 9, 2011 at 10:12 am | Permalink

    Is it a bail out or is it a loan?

    If we are acting as receiver, which bits do we now own?

    • lifelogic
      Posted April 11, 2011 at 9:01 pm | Permalink

      Nothing – just an unsecured loan to largely insolvent country.

      Good plan!

  10. Denis Cooper
    Posted April 9, 2011 at 10:27 am | Permalink

    In part it was the recognition that eurozone bail outs would be the wrong medicine which led to their use being prohibited by “European law”.

    So law-biding citizens of this country would be right to ask why its Prime Minister is continuing to connive at the administration of an illegal medicine, when if they commit even a minor transgression of “European law” they can find themselves being severely punished, and that with the full approval of their Parliament which will do nothing to protect them from its vagaries.

    Are government ministers now above the law as laid down by Parliament, which statute law incorporates all “European law” by virtue of the European Communities Act 1972 and subsequent amending Acts?

    If so, shouldn’t we the citizens have been told that the rule of law has been discarded, and we are now living under arbitrary rule?

  11. acorn
    Posted April 9, 2011 at 11:38 am | Permalink

    Too late JR, the damage has been done. The only way out is a massive dose of inflation in everything except wages. The BoE is making hay while the sun shines.

    It must be obvious by now that common currencies without common fiscal and monetary frameworks, don’t work. The Euro is the best example but the US dollar has had a similar affect on the US States. It also leads to out of control “federal” governments who print the money. The Barnett formula is the mask for a similar common currency affect with the four countries of the UK. Particularly Scotland, where there is no correlation between tax receipts and Scottish government spending.

    My German contacts want out of the Euro. If you ask them if they are prepared for the hit on German exports to other EU countries when the Euro drops like a stone; they say “we handled East Germany, we can handle the EU, we know how to do it”. They don’t seem concerned that the European banks, will fall apart when their massive toxic debt piles get exposed in the process of bringing back the Deutschmark.

  12. cosmic
    Posted April 9, 2011 at 11:40 am | Permalink

    Never lose sight of the fact that the Euro is primarily a political project, not a monetary one, if you attempt to apply normal financial logic to it, you will be perplexed. If you see it as a political scheme, everything snaps into place.

  13. Neil Craig
    Posted April 9, 2011 at 12:10 pm | Permalink

    The possibility of bankruptcy is the ultimate difference between capitalist and socialist societies. I am not convinced that capitalism is in all ways superior but it does allow the pruning of failure which gives the former its long term edge. Nations are not the same as companies to be pruned, but national government structures are. Keeping a bankrupt company going without restructuring is not doing the employees any long term favours and the same applies to countries.

    • Gary
      Posted April 9, 2011 at 3:07 pm | Permalink

      Neil,

      Countries with the “luxury” of their own money printing press don’t go bankrupt they just inflate their currency asymptotically to zero. The effects are indistinguishable from bankruptcy. This is sold to us as a virtue.

  14. Damien
    Posted April 9, 2011 at 12:32 pm | Permalink

    The first Irish bailout was merely a down payment to be shortly followed by a hasty drawdown of 24e billions under the latest banking stress test. Ditto for Greece and Portugal.

    The question now is what follows and what can we do to prepare for the inevitable default by Ireland next year and if the contagion spreads to Spain?

    For Ireland to service its debt on the present terms means that the austerity measures would be so great as to bring the economy back into recession/depression. The Irish will therefore default as the lesser of two evils.

    Before this happens we will know for sure if Spain is blighted also. Spain is too big to fail and too big to save. Germany has the most exposure to Spain so a lot rides on whether their electorate will bailout Spain also.

    The UK should remain focused on restoring its own financial credibility which will be facing increasing challenges as the austerity measures kick-in. External pressures will increase in the form of rising oil prices, especially as the unrest in the Middle East and North Africa continues. Brent crude is now $126 and oil options for May 17th are at $200. Any extended period of prices above £150 would risk a double-dip recession in the europe periphery including the UK(and or more likely the Bernanke QE3). Keep in mind that it was oil shocks in 74/75, ’80,’90,2001 and ’08/’09 that led to recession ( three of which were middle east shocks).

    Gold continues to rise faster than they can print money! Friday price $1474 oz

  15. Gary
    Posted April 9, 2011 at 3:01 pm | Permalink

    The market will have the final say, no matter what the financial clerks attempt. The only thing those clerks can achieve is to make things much worse. It is written in history, and common sense. This won’t end well.

  16. Gary
    Posted April 9, 2011 at 3:18 pm | Permalink

    This is the statistical formalization of the statement : “There is no way to avoid the bust after a credit bubble”

  17. Lindsay McDougall
    Posted April 10, 2011 at 2:13 am | Permalink

    “I would recommend strongly that ……………………………………… the EU should discuss with Euro members the terms of that country’s new economic policy designed to restore market confidence.”

    But the whole point is that there are no such policies unless
    (a) The country leaves the Euro zone OR
    (b) The ECB runs a monetary policy that produces Euro inflation and allows the country to borrow long rather than short. And it’s not just one country, it is several.

    If (b) were to happen, the German electorate would chuck Angela Merkel out, so it isn’t going to happen. Back to (a); for our own sake, we must insist on it. Nobody has given me a good reason why a UK that believes in a Europe of Nations should want the Euro to survive. The fact that David Cameron wishes it is NOT a good reason; away with the cult of the leader.

  18. David
    Posted April 11, 2011 at 12:00 pm | Permalink

    The recent unfolding of the whole situation in Europe only proves that the countries that refused to pour their resources into the rescue packages were right. There must be some systematic solution to this problem instead of providing more and more money and hoping that the contagion will stop spreading. As for Portugal I would like to know whether there is any guarantee or agreement saying that the new government will stand by the decisions that are being taken right now.

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

  • John’s Books

  • Email Alerts

    You can sign up to receive John's blog posts by e-mail by entering your e-mail address in the box below.

    Enter your email address:

    Delivered by FeedBurner

    The e-mail service is powered by Google's FeedBurner service. Your information is not shared.

  • Map of Visitors

    Locations of visitors to this page