Category: Blog

 

             I expect the Coalition will win the vote this afternoon on tuition fees. I have been asked for my thoughts on the policy.

               Dr Cable’s package is not the policy I would have designed myself, but I think it preferable to Labour’s alternative of a graduate tax. A graduate tax would drive more able people away from the UK, leaving those higher paid who stay paying a higher Income Tax rate than the 50% already imposed. It would truly be a tax on knowledge, and would not help the universities or encourage better choices by students in the way the Cable scheme will do.

                   I have pressed for more University independence, and for better access funds and scholarships. I wish to see more scholarships for able students of whatever financial background, as well as access funds for those from lower income families. I will vote for the proposals reluctantly, as I dislike the main alternative more.

 

             Yesterday’s debate on the EU was lively. The strong view from most on the Conservative benches was the same – we want effective  action to curb any more  powers going to Brussels, and get powers back. The Bill places a “referendum lock” on the transfer of new competences, but it does not tackle the immediate issues of more powers going to regulate business, bail out the Euro, strengthen economic governance, build a stronger EU diplomatic service and increase EU Criminal Justice powers. My speech in the  debate appears under “Debates” on this site for those  interested.

 

                  There has been some surprise expressed that someone from the Office of Budget Responsibility confessed that monetary unions usually  fail. The correct statement is monetary unions usually fail, unless they help drive the creation of a new or united country. The US monetary union and the German monetary union were part of the federal constructions in those two emerging countries in the nineteenth century. The Latin Monetary Union and the Scandinavian monetary unions failed, because those countries did not complete or maintain political union.                   

                  The Latin currency union was created in 1865 by France, Belgium, Italy and Switzerland. Other countries joined later. The absence of a Central Bank and central monetary authority, the decision of the Papal See to issue devalued silver coins, the gap between silver and gold prices, and finally states’ borrowing needs for the First World War broke the Union, which was effectively ended by the War and given the last rites in 1927.

                     The Scandinavian currency union of Sweden, Denmark and Norway lasted from 1875 to 1914, with common banknotes from 1901.  The termination of Sweden and Norway’s politcal union in 1905, followed by the demands of war finance,  killed the monetary union.

                      Ireland’s monetary union with the UK was ended  on 30 March 1979. Ireland enjoyed a freely floating currency against sterling until entry into the Euro in 1999.

 

             Finance Ministers are considering what further steps they need to take to tackle Europe’s debts and deficits, and wayward currency union. It is time to review the options that face them.

1. Germany leaves the Euro, recreating the DM. The other countries would devalue against Germany. easing some of the trading tensions and imbalances. The smaller Eurio zone would take stronger powers to control debt and deficits. They would still need to fix the banks.

2. Greece, Ireland, Portugal and Spain leave the Euro. They would devalue, and have to sort out their own deficit problems more quickly to reassure markets and allow them to borrow at lower rates.  They might need more help or some help from the IMF. The individual states would have to act as gurantors of their leading banks where needed.

3. The peripheral countries persuade the Euro authorities to buy in more of their bonds to get the interest rates down, and to print more Euros to allow some devaluation of the common currency. In return the stronger countries take more control over borrowing and debt totals for all Euro members.

4. The German scheme of demanding more haircuts for bond holders in over borrowed countries and poorly financed banks prevails. The EU quickly enters the next phase of the Euro crisis, with market attacks on other countries and banks leading to bigger guarantees and ECB intervention. More powers are taken in the centre to control debt and deficits, but the rules are rapidly broken to allow bail outs.

5. The European authorities rapidly come of age, agreeing to issue more EU sovereign debts. The member countries have to accept more common taxation, more transfer payments around the Union, and mutual guarantees of the EU debt.  The EU develops a proper financial government, with central decisions on how much common debt to issue and where to spend the money raised.

 

             I attended a fascinating seminar in Oxford on Saturday evening about whether the prison population could be safely reduced. Let me share some of the thoughts and facts with you which emerged, on a topic where I claim no expertise.

               We were told that between 1918 and 1939 the prison population averaged around 10,000. Only 1,000 prisoners were in for more than four years.  Today the prison population in England and Wales is around 88,000. 37,000 are in for more than four years or for an indeterminate sentence.   11,367 prisoners were foreign nationals in March 2010, more than the typical inter war total of all prisoners. 

                   72% of the male prisoners are said to be suffering from two or more mental disorders, 66%  used drugs in the previous year and 67% were unemployed before prison.   Half are scarcely literate and have no qualifications. More than 3% of the male prison population is said to be ex servicemen.

                    At the same time as witnessing a surge in prison sentences there has been a large reduction in the use of fines. These roughly halved from 1992 to 2009.  At any given time around 7,500 are serving sentences of under one year. 61% of these will be reconvicted within one year of release.

                     No-one can be pleased with the social portrait these figures reveal. The country does not behave well towards ex servicemen, often leaving them without homes and jobs to go on discharge from the services, and with little support or back up to help them adjust to civilian life. We do not manage to treat enough drug users before their addiction becomes chronic and leads to other crimes to support their habit. Short sentences are too short to train, improve or reform criminals serving them, but often add to  the difficulty for the criminal  finding home and job by legal means on leaving prison.

                          Between 1992 and 2009 violent and sexual crimes, the most serious crimes, remained fairly constant in numbers. Burglary halved, whilst drug offences more than doubled. The anatomy of the prison population tells us that we need to be much tougher and more successful at getting people off drugs and getting people into lawful employment. Of course the electorate  expects long custodial sentences for criminals who have committed serious crimes and repreesent a further threat to the public. For others, surely we want prevention or punishment that suits the crime and makes re-offending less likely, not a racing certainty.

 

          It is not that unusual for MPs in a governing party or coalition to be split three ways. Many votes have some government MPs voting against and some abstaining.

           What is unusual is for Ministers to be contemplating abstaining on their own policies! Indeed, that is against the rules. As I understood the Coalition Agreement,  the provision to allow Lib Dems to abstain on tuition fees only kicked in if Coalition Ministers could not reach agreement on the topic. As they demonstrably did reach agreement, around the proposals of a senior Lib Dem, there should be no question of Lib Dem Ministers abstaining. They are bound by collective responsibility.

         Coalition MPs are regularly divided over the issue of the EU. We have seen up to 37 Conservatives vote against – on the issue of the EU budget – and more abstain. Within the government there are also important differences of view. The Hagueites seem to want to give more powers to the EU, proposing the expansion of the diplomatic service, expansion of Criminal Justice powers and accepting a new Treaty to strengthen economic governance. The sceptics, like Liam Fox, Owen Paterson and Iain Duncan Smith presumably disagree with this approach and should be fighting to resist it from within the government.

             It is entirely healthy that there are disagreements within Cabinet over  big issues, and disagreements with the backbenches. What is the point of Cabinet government and Parliament if there we are not allowed to disagree and debate?  There has been a healthy debate on tuition fees, and doubtless some Lib  Dems will stick with the view they put to the electorate in May. Their Ministers have moved on and proposed a new policy to the government which it has accepted . It is now their duty to vote it through.

 

                     If I had sent a sales force with a good new product to sell in 21 countries of the world I would have been very disappointed if they came  back with just one success. I would have been  even more worried, if the target was to sell to 12.

                       The recent discovery that only one overseas Fifa voter backed the UK World Cup proposal  goes alongside the news that we still sell more to Ireland than to India, Brazil and  China combined. We have to ask what don’t we understand about the modern world?

                          Let us assume in the case of Fifa that their stated reasons for our failure were true. We hear they wanted  newer territory to take football to. We understand they like bids with plenty of new construction and a great legacy from all the work. What had happened to our market research? Such a brief meant either we should not compete, as it was not for us, or it meant a different vision for any UK bid. Why didn’t our bid concentrate on how we would spread the word, sell the tickets and the passion around the globe and make the World Cup relevant for countries without a great football heritage? Why didn’t we offer to  harness some of the future  huge UK Overseas Aid budget for football related projects in poorer countries as a central part of the bid?

                 Taking the wider problem  of how we export more, there are the questions of whether we make the right cars, machinery and electronic products for developing markets. If we do, are we good at explaining and adapting them to different conditions? Clearly some of our best companies do, and are very successful exporters.Overall the results still are a long way off the pace.  

                   We also need  to discuss the issue of inducements. Sensible British business people know the UK has a tough law against bribery and uphold it in all their dealings . This was extended in 2002 to include making a UK business person responsible for the action of any independent business agent working for them in an overseas territory. As there are some overseas countries where incentives or personal favours to the purchaser are more common  it means there are  territories where any law abiding UK business person is wise to avoid, or expects to fail with some of their straight forward inducement free offers. Is this true of the UK’s leading competitors? Where do sensible client entertaining, explanatory trips and seminars and free samples end, and unreasonable personal benefits for a customer begin?

(This post was written for Citywire and adapted for this site)

Many readers of this site think the best answer to resolve the Euro crisis would be to announce the intention to re-establish independent currencies across Europe. They could each find their own level and economies would start to improve.   This is not about to happen because the Euro is a political project. The fact that it does economic damage does not matter very much to its creators. That is why they will instead make more moves to create an economic government of Euroland, and have to do so.

Every successful currency has a sovereign to take care of it. The Euro is an orphan currency. It is a currency in search of a country to love it. Given the rolling sovereign debt crisis in Euroland, and a smouldering banking crisis, it is time to ask will someone be a good parent to this struggling adolescent money?

Traditionally sovereigns placed their stamp on the money and placed their force, their Treasury  and economic policy behind it. The sovereign decided how much to issue and whether to debase it.

Modern democracies behave in a similar way, though they often use a so called independent Central Bank to make some of the important decisions for them. In practice the Central Bank only maintains its independent action whilst it continues to please the sovereign. Parliaments and Congress can change the rules governing the Central Banks, change the targets, change the personnel when need arises. They can even change the money, as the German government instructed the German Central Bank to do when they surrendered the DM.

The Euro lacks some of the usual arrangements. There is a so called independent Bank, but it changes policy quite frequently and clearly listens to the ebb and flow of political debate about whether to buy in bonds, whether to monetise any debt and whether to change interest rates. Like other Central Banks, in the middle of the Credit Crunch it joined in a co-ordinated lowering of rates and related actions which arose out of Finance Minister discussions. Unlike sovereign countries, the Euro lacks a single authority drawing up a single state budget, single political control over the levels of sovereign borrowing, and a single issuer of sovereign debt.

The architects of the Euro recognised the potential weakness. They said Euro area governments had to keep their stock of debt below 60% of National Income, and keep annual deficits below 3%. Unfortunately they did not enforce the governance to ensure this happened. Some states borrowed far more. They were free riders at the lower average rate for a bit. Now they face spiralling debt costs, as markets have come to realise there is no EU sovereign guarantee on states’ debt.

A single currency area also needs strong banking regulation, capable of keeping all the main  banks in the system solvent and liquid. The Central Bank either has to do the regulating itself, or be confident in the banking regulator. The Central Bank has a duty to supply liquidity to all banks should need arise.  The ECB has done this for much of the time, but recently announced it wished to reduce the amounts lent under special facilities. In particular it wanted a refinancing of Irish banks which led to the week-end crisis of the Irish state financing.

The ECB has to be comfortable with the solvency regulation of main Euro area  banks. If it has any doubts it needs the ability to sort these out in private with the bank concerned and or the bank regulator. All banks in the system must be deemed to be solvent and seen to be solvent. They should then be offered whatever liquidity it takes if there is a run on their deposits or wholesale funding. To reassure investors it is likely the Euro authorities have to conduct new tests and hold private discussions with each bank, and make sure every bank has a plan to strengthen its position where this is needed.

This week has seen major advances in the task of finding a parent for the Euro. We have the first issue of EU bonds with an EU sovereign backer, as they raise money for the Euro bail out fund. We have more support for Euro area banks announced by the ECB. They  now need to use the time they have bought to create a true sovereign. That is  an economic government of the Euro area that controls debt and deficits and ensures strongly regulated banks.

 

The Euro crisis is especially worrying given the state of the European banking system. In practice the EU member states stand behind their major banks. State finance and bank finance is almost one and the same thing. Problems in banks require state support, as recently seen in Ireland. The more the member states put money into their banks, the worse the deterioration in their own finances and the more strains are placed on their government bond markets.

The EU authorities understood this and undertook stress tests of the main banks in their system. They published the results in July 2010, showing  that seven banks out of 91 studied needed additional capital to have sufficiently strong balance sheets to withstand  a double shock. The Committee of European Banking Supervisors confirmed that no major bank studied was insolvent, and that all had sufficient capital to survive  even if the two shocks materialised.

The authorities envisaged the right kind of shocks. They proposed that there could be a double dip recession, with no growth in 2011. This may well happen in Portugal and Greece, on  the EU’s own forecasts.  They argued that there could be losses on EU member states government bonds, commonly held by banks as assets.

The problem with the stress tests, mentioned extensively by commentators at the time, was they were not particularly stressful. The test to ensure banks could cope with a sovereign debt problem only wrote sums off the bonds held in banks’ trading books. The Regulators assumed that the longer term holdings of bonds by the banks were fine as they could hold them to maturity and would not therefore incur losses. The stress test assumed a 75 basis point increase in 10 year borrowing rates (an additional 0.75%) and another 70 basis points on top for the EU average to allow for markets pushing up the borrowing rates of weaker countries by more.

These figures led the testers to cut 23% off the value of Greek bonds, 12.3% off the value of Spanish bonds, 12.8% off the value of Irish bonds, 14% off the value of Portuguese bonds, 10.2% off UK bonds and 4.7% off German.

As we have seen in the Greek and Irish crises, the markets can be more punishing than this. Yields on 10 year Greek debt have risen to 12% and on Irish to over 9% compared to 2.5% on German. Banks do lose money on their holdings as well as on their trading books, if you mark the bond value to market prices. There is also an impact on confidence and the valuations of other assets like property in the affected countries which might also damage the banks.

The Stress tests revealed that five Spanish banking groups would have Tier One ratios below 6% if the conditions of the tests took place. Diada (3.9%), Espiga (5.6%), Civica (4.7%), Unnim (4.5%) and Cajasur (4.3%)  (figures assuming the double hit) were all thought to need extra capital. The German Hypo Real Estate bank and the Agricultural Bank of Greece also failed the test.  Several others were close to the 6% cut off, including Allied Irish and the Greek bank, Piraeus.

Investors in recent days have worried that a more severe test should have been applied. Banks could lose more on their government  bond holdings than imagined. In addition, the property sectors in Ireland and Spain are weak, with rising amounts of empty property and falling prices in many locations. Property remains a fundamental underpinning of banking activity, representing a high proportion of the collateral used for loans.

So what should the authorities do? In the short term there need to be reassuring statements from the European Central Bank that it stands ready to offer whatever liquidity these banks need. As all the main banks in the European system are said to be solvent and creditworthy according to their EU Regulators. Tthe Central Bank has to ensure they stay liquid even if the market loses confidence in them and withdraws funds.

In addition it looks as if the banking Regulators need to work  behind the scenes with the most vulnerable banks, and  agree an action programme with each to raise its ratios and cut its risks. Banks can do this by selling assets, making more profit, selling whole businesses to others, writing off bad debts and losses, raising new capital, merging with better capitalised  rivals and in a number of other ways. When they reach an agreement with a vulnerable bank about a clear way forward this should then be announced to the markets so they can see that their doubts and worries are misplaced.

All this will be easier if the economies of western Europe are growing. Consumer debt is less risky if people have jobs and can look forward to rising wages. Business loans are less risky if business is expanding and turnover rising. Property debt is less risky if property is in demand and rents have stopped falling.

We will look at the way to get faster growth  tomorrow.

 

                    The EU officials who are planning how to save the Euro are following a kind of economic sado-masochism as their  strategy. They can enjoy watching member states struggle as they pile on the controls and requirements for them to cut spending and raise taxes.  They themselves put up their own budgets and salaries and send the bill to the Union members. The states in difficulty have to enjoy the results of the strategy,  saying thank you for the bail outs and cuts which represent the policy.

                      There are four elements to the approach. The first is to offer loans on quite expensive terms to any state that needs financing. Greece and Ireland have been through the process. The Union is able to use the loan negotiations as a means to exerting more control over the budget of the state concerned. There might be more such bail outs. The cost of Portuguese, Spanish and Italian borrowing is rising despite the Irish bail out “to stop contagion.”

                           The second is to tighten discipline over the budgets of all member states. The weaker ones are meant to take heed of what is happening to the states going through bail out, and cut enough off spending or put taxes up sufficiently  to avoid a similar fate.

                            The third is to take new powers for the Union to control budgets more strictly in future, limiting the amount any state can borrow in the common currency. States will  be fined or made to lodge special deposits with the centre if they are errant. This way the Union hopes to avoid a repeat of the current debt crisis.

                           The fourth is to impose new rules on how states borrow after 2013. They will require states to put a clause in any loan agreement to say that if the state gets into difficulties it may reduce the amount of interest or the amount of capital it repays. This would replace the current de facto decision of the Union to bail out member states so they can repay existing borrowings.

                            This is a compromise policy which is unlikely to work. If they succeed in controlling budget deficits after 2013 the warning to the bond markets is needless. In the meantime it is spooking markets and making it more difficult for states to raise money. Preventing a future problem does not solve the current one.

                                 Markets are unimpressed by the bail outs, because they fail to address the underlying problem, the lack of growth in the struggling states. Wiithout growth,cutting the deficits and paying the interest is going to be very difficult if not impossible. The EU’s policy has led it to forecast no growth for Greece and Portugal next year.

                              Later this week I will set out some of the other options the EU has to save the Euro which would work better.