Month: November 2011

We are going to hear two constant refrains in what passes for economic debate in the UK. We will be told that our exports to the EU are crucial to our economy, and will be at risk in some unspecified way if we dare to demand a renegotiation of our position or a referendum. We will be told that the the UK economy is not growing quickly, owing to the cuts.

The EU lies are the easiest to rebut. There is not the slightest shred of evidence that if the UK seeks to better deal or a referendum on membership of the EU it will damage our trade with the EU. The trade is guaranteed by WTO rules. As the rest of the EU sells us a lot more than we sell them, they will not want to disrupt it in any way. They have more to lose than we do.

EU goods trade probably accounts for around £120 billion of our output. (EU exports adjusted for the entrepot factor) That’s around 8% of our total National Income. It’s important, but not nearly as important as the 92% that is not dependent on selling things on the continent. Since 2008 the government figures show that our exports to the rest of the EU have anyway fallen by 6%, whilst our exports to the rest of the world have risen by 4%. So the trend has been going against the EU before the crisis. Slowdown in the EU and collapse in the weaker EU economies will accelerate this process.

On the radio yesterday Lord Skidelsky was kicking off the ridiculous argument that the Uk economy has slowed down owing to large cuts in public spending. The interviewer and the other participant failed to point that that public spending is up in real terms according to the govenment’s own figures since 2010. No-one mentioned the planned borrowing of at least £122 billion this year, or the additional borrowing and spending announced in the March 2011 budget.

Why on earth do they want to debate something around a completely wrong version of the facts? The question they should have asked Lord S is “Why has the UK economy slowed when real public spending is up, and public borrowing remains at near record levels?”. Why can’t any of these commentators bother to read the numbers? Why does the BBC insist on suppressing the true numbers, so there can be no debate about what is going on as opposed to what is being spun?

Neo Keynsians love high levels of public spending and borrowing, and say they stimulate the economy. They need to be asked why public spending at nearly 50% of GDP, and borrowing of more than £10 billion a month, is not stimulus enough. They should be asked how much more borrowing would it take to get faster growth, and would anyone lend us the money? Could it be that spending more in a wasteful or less productive way, and borrowing more than the country can afford, could be a road to ruin rather than a welcome shot in the arm?

Sometimes it is a good idea to see the big picture. For many years now the west apart from Germany has decided to live beyond its means. It has imported its lifestyle from China and other emerging markets, and borrowed money to sustain the spending. More recently a collapse of private sector bank credit and a squeeze on real incomes has started to adjust the way individuals borrow too much. Instead governments have taken up the task of spending and borrowing way beyond the tax capacity of the country concerned. In the case of the more extreme countries, they have been borrowing 10% of national income for extra state spending. This entails borrowing at least one pound in every five spent in the public sector.

Certain European countries decided to bind themselves into a currency union with Germany. Germany kept her costs down, and exported large quantities of manufactured goods to the weaker states in the zone. They ran up large borrowings to buy the goods, inflated their house prices, and spent too much in their public sectors. These countries cannot devalue to get into a more competitive position. They now want Germany to grant and lend them the money to carry on spending. Germany is reluctant to do so.

The US and the UK printed money to keep interest rates down, and allowed their currencies to devalue, to help price themselves back into world markets.

The Euro area is running out of opportunity to sustain the high levels of spending and borrowing. Money lenders are saying to several countries in the zone they are no longer willing to lend at an affordable rate, or at all. The EU and the IMF impose substantial cuts on public spending. The banks are weakened by the losses on the government bonds. They find it difficult to finance a private sector recovery. The more the economies decline, the less tax revenue there is, and the bigger the deficit.

What passes for political debate is usually about tackling symptoms, or seeking to delay the inevitable. Continental politicians hope that China and Brazil will come to their aid and bail out problem countries, or anticipate the IMF arriving with cash infusions for Italy on top of the three countries it is already supporting. If markets fall they seek to prevent shorting, only to discover the market still falls as owners sell. They shuffle governments around, hoping that markets will be impressed if a new team comes in to supervise the old policy.

The truth is markets will only calm down and refinance states at affordable rates again if governments not only say they intend to live within their means for a bit, but manage to do so. The public sectors of the overborrowed states need to do less, and do it better. A lot could be achieved by applying good management techniques to tasks in hand. I know of few public sector activities where it would be impossible to reduce the cost by 10% without damaging the service. The public sector does have to raise pension ages and change future pension entitlements. It does have to cut out less desirable activities and delay some desirable projects.

Savers and investors in markets do not believe the European states are going to transform themselves quickly enough and cut their demands for cash. Until they do so, the crisis remains. There is no choice between cutting public spending and getting growth going. Controlling public spending is a necessary but not a sufficient condition for growth. China does not have to lend us the money to buy her goods and live beyond our means. She can turn to making more goods for her own population. The West has to do better at paying its way in the world, and has to learn to live more within its means.

Yesterday’s casual approach to the Italian debt markets by the Euro area does not breed confidence in the currency. It is true the European Central Bank intervened to buy some Italian bonds. It did not do so on a scale sufficient to get the yields down to acceptable levels.

Leaking rumours that France and Germany are now ready to slim the Eurozone down, and press ahead to fiscal union with a smaller group of countries will merely fuel the bears and help exacerbate the crisis. As one who has consistently preferred splitting up the Euro zone and doing it quickly as the best solution, I just wish they would get on with it. How many more jobs and busiesses do they wish to see destroyed first, before they bow to the inevitable? It is interesting to see the President of the Commission battling to hold the Euro and ever closer integration together under the EU, whilst France and Germany are musing about creating a new club for a few.

There has to be a plan on how to fight the battle of Italy, if they are serious about keeping their currency and getting it to work. Are they going to get the IMF to advance the large amounts of money Italy will need to pay for her running deficit and refinance her expiring debts? Are they hoping that Germany will relent, and allow the ECB to buy up so many Italian bonds, that the Italian state can still borrow at affordable rates? Are they about to announce major quantitative easing, overcoming all the German fears of inflation and unorthodox monetary actions? How are they going to prevent the bank market freezing up, on fears of more losses on sovereign bonds?

It is all very well for them to encourage changes of government, and hope that people more enthusiastic about complying with the Euro scheme will arrive in power in each problem country. They are still left with the difficulty that their plan may not work. Just cutting spending and trying to squeeze down deficits that way may not succeed. If the banks are broken and cannot increase their lending, and if the southern member states remain uncompetitive with no ability to devalue, the austerity medicine may not cure the patient.

IMF packages normally entail monetary medicine and devaluation as well as spending cuts. The Euro area is trying to do it without important parts of the cure. Why do they think it is going to work?

Meanwhile, new governments have to follow the old remedies. Their task of gaining and keeping consent for these policies is going to prove difficult.

Today the markets cut up rough on Italian debt. Ten year bonds now yield 7.4% and one year money is priced at 9%. Pundits have told us 7% is the danger level, the point at which borrowing becomes too dear for the Italian state.

We await news from the Euro leaders what they now plan. Does Germany overcome her resistance to the ECB lending to Italy and printing more money? Does Italy now have to petition the IMF for funds?

The markets are moving much more swiftly than the politicians. The problem is jobs, businesses and standards of living are all being chanced on the roulette wheel of the Euro. Is anyone in charge? What is their plan now?

               Left wing critics of  market economics talk about markets as if they were just a small overpaid bunch of bond and currency traders they do not like. Markets are places for us all.  The large financial and banking markets are used by almost everyone. Let him who has no hedge fund to back his pension or no financial product to power his charity throw the first stone.

              The Trade Union which criticises the market often has an investment fund invested in bonds and shares. The Trade Union official who condemns  a market oriented approach will often have an invested pension pot, a mortgage, a credit card and a range of other financial products. The vicar who dislikes global capitalism enjoys money from funds  managed by the Church Commissioners. Unlikely people can have pensions and savings tied up in hedge funds, managed futures and other portfolios using futures, options and geared financial instruments.

              The market serves poor and rich alike. One person’s money is as good as another’s: there is no discrimination. The divergences in choice and lifestyle come from differences in access to funds, not from differences of other treatment.

               A late friend of mine used to host guests from the USSR visiting London in the days of communism. The people allowed to visit were trusted communists. He would take them to Marks and Spencers on Baker Street. They would be bowled over by the range and quality of the products compared to Moscow stores of the time. They would ask if this great shop was reserved for party members or members of various elites. They would be suprised to be told M and S was for everyone.

                My friend would then take them to Harrods. He would say this is where many of the elite shop. They were even more impressed. They were surprised to learn that no regulation  stopped the  unemployed or the former criminal shopping at Harrods, just as nothing  stops the billionaire buying at M and S. The western retail market was much freer and more democratic than their soviet controlled shops.

                  The main argument against capitalism in western democracies is it can leave some people behind, with too little or no income. The great western democracies have moved to tackle this by offering financial help to those who might otherwise get left behind. Anyone with some money can use it to buy whatever they like whenever they like, as long as they can afford it or can  borrow to buy it. Countries that have tried to replace the market by state planning, allocating goods to individuals and families, have usually created lower living standards as well as greatly restricting personal freedoms.

                     The market place is the ultimate democracy. Individuals can express their preferences or offer their services whenever they like. Only in a state planned system do they have to combat rationing, quotas, and  form filling as well as facing  the threat of  criminal penalties if they abuse the system.

                   Democracy understands how outcast people can feel in a wealthy market economy if they have little or no money. That is why all mainstream political parties agree with some redistribution of income and wealth, and all agree with financial assistance to those who cannot provide for themselves. The political debate should not be about the superiority of the enterprise system, or about the desirability of taking care of those who cannot provide for themselves. The debate should be the narrower one of how generous should we be to those who need state support, and how should people qualify for it?

            There is now much discussion of the immorality of the market. The latest fashion is to say that financial deregulation, dated conveniently to 1986 to place it under Margaret Thatcher, caused people to suddenly become self centred, materialistic and greedy in a way which has wrecked our finances, markets and banking ever since.

            This is bad history and sloppy politics. There was  a continuous rise in the volume and detail of financial regulation in the period 1986- 2011. Most of this period in the UK saw the country governed by a left of centre government with a large majority. They had the power to reverse any trends and deregulations they did not like. They themselves completely changed the system of financial regulation in 1997, 14 years ago. They formalised more of the regulation, and put the banks under a large new body of law designed by  the FSA.

            The truth is the last decade saw an explosion of extra regulation by both the UK and the EU. It saw substantial regulation by the global banking regulators of Basle. Collectively they made a huge error of judgement, allowing too much bank credit to be sustained on too small a banking foundation. It was a case of bad regulation, not deregulation.

           Markets were never moral. They did not enjoy a golden age of good behaviour. There were always some  greedy people and companies in them.  Markets are neither all bad nor all good. Saints buy from sinners. The moral lend to the immoral. Nasty people make things for nice people. Christians trade with atheists.  Markets are the results of the choices and actions of millions of people and companies deciding what to buy and what to sell. A market does not have a collective view or a moral outlook.

            When a market is moving rapidly in one direction then it can be a useful fiction to say “the market is optimistic because…” or the “market does not believe in Greek state finances because…” Even in these more extreme conditions every transaction needs a buyer as well as a seller. Buyers and sellers by definition usually  have different views.The attribution of an attitude or opinion to a market is an attempt to explain price movements by trying to identify the motivation of the majority of traders.

              Markets are amoral. They are a babble of voices, a mixture of the well informed, the opinionated, the frightened and the optimistic, the lost and the wrong headed. They are important ways of allowing people to change their assets, raise cash, invest and make economic decisions. They are not places to come to a single moral conclusion.

            That is why markets need regulating. That is why politicians are elected to write laws to control them, or to impose a moral view on the actions of the many. It is generally agreed in a free society that we need laws against theft and damage to other people’s property. We need a law of contract, and some law to ensure honest dealing. We need laws to stop individuals and companies gaining too much power in ways which can distort a market or can prevent other people enjoying proper access to it.

            Markets allow the moral to flourish if they wish by using the market. Investors can invest in moral ways. Entrepreneurs and charities can raise money for good purposes from the market. Large companies in recent years have pioneereed better employment practises, better products and services, and the greening of their actions. Market pressures and market money allowed them to do these things.

              Governments have to decide how to prevent abuses and immoral purposes stalking the markets. They have done so through a myriad of regulations. Some of these work and are needed. Some have failed. Some have been badly implemented and missed the targets. We do not have unbridled greed because we have insufficient financial regulation. Markets are never going to abolish all greed. Regulators have to decide what to stop and how to stop them. If the left now thinks there is too much greed, we are entitled to ask why did they do so little to stem it between 1997 and 2011?

                         Today the EFSF did manage to borrow another 3bn euros. It had to pay 1.77% more than German bunds for ten year money. The trillion euro geared fund now probably has 6.5 bn euros to call on, but has to make payments to existing clients.  

                          Meanwhile we learned that the European Central Bank has bought 9.5 billion of  sovereign bonds in the last week, probably including Italian ones. Despite this Italian 10 year money rose to a new high for this century, and worried the governments about how Italy could raise the money it needs to borrow.

          Contemporary politics and much media commentary concentrates on getting the IMF/EU packages through and into effect for Greece, Portugal, Ireland, and to discussing the need for one in  Italy. There is rejoicing when governments change, coalitions form, or even better when there is a government of national unity to close down dissent and opposition.

          All have to sign up to the packages, and anyone who disagrees is said to be  unhelpful, endangering the whole edifice.

       The problem occurs if these policies do not work. Where then is the alternative team and the alternative policy to offer hope or to get it right?  IMF programmes have worked in the past when public spending reductions have gone alongside devaluations and monetary and interest rate manipulations. Getting IMF packages to work in Euroland is altogether more difficult, as they have no control over currency and interest rates, and may find deficits rise rather than fall as economies contract.

            There has been argument over the Chief Secretary’s use of a £40 billion figure for the UK’s contribution to the  IMF yesterday on TV. I have been back and checked the Hansard record of the Committee I attended to hear the government’s case for an increased subscription on July 5th 2011. The Minister said:

            “The subscription is drawn in the IMF’s unit of account and currently stands at 10.74 billion SDRs which is approximately £10.7 bn at today’s exchange rate. The Order will raise the subscription to 20.16 bn SDRs, equivalent to £20.15 billion.”  It appeared we were being asked to approve an extra £9.5 billion.

            Apparently the figure including borrowing will be double the new total in this speech. Had I been told  that at the time it would have made no difference to my action, as I voted against the increase anyway when it came up for vote in the Commons  on 11 July.  Others must say if it might have affected the way they voted, where they voted to approve the Order. I thought an extra £9.5 bn was too much given the UK’s current financial position, and the possible use of these funds for Euro area rescues that may not work as intended. Double that would  in my view be worse.

PS  The Prime Minister clarified the position this afternoon. Parliament did vote to approve a couple of Orders in 2009 and 2010 to increase the UK  borrowing resouces for the IMF, so the government does have permission to make up to £40 bn available.