Yesterday the Chancellor’s remarks included news that he is revising the treatment of overseas profits for companies headquartered in the UK, and offering a 10% rate of Corporation Tax on profits earned from new products.
This is welcome news, If the details are worked out sensibly it will stem the loss of businesses from the UK for CT reasons, and help the growth of business here. Tax competition works.
Open Europe has just published a useful guide to what pro Euro advocates have said over the years. (www.openeurope.org.uk) It includes such gems as
Angela Merkel 1st March 2010 ” We have a Treaty under which there is no possibility of paying to bail out states in difficulty”
Greek Finance Minister 1999 ” We must enter the euro with a clean sheet on all the criteria”
Mr Barroso 5 Feb 2010 “The euro is a protection shield against the crisis”
Will Hutton 2003 “Although there are worries about one exchange rate and one interest rate for a whole continent, the advantages more than outweigh the disadvantages ” etc etc
I have been touched by several good suggestions for the response to the important letter from Penny Maws about the Irish loan. However, as it has come into my possession I thought you might like to see the original.
Dear Mrs Maws,
Dame Lucy has asked me to reply to your letter. She wishes you to know that she intends to treat it as a draft, and suggests that on reflection you withdraw it. She was not pleased to be troubled over a week-end with such a pointless intervention.
Dame Lucy pointed out that no Minister has raised any issue concerning the legality of the monies they have agreed to spend, so there is no need to produce any further briefing on this issue. The Chancellor himself has said that the previous Chancellor did commit the UK to acting in this way.
She thinks it obvious that “exceptional occurrences” is a deliberately wide ranging phrase, different from natural disasters. It is more than adequate for the purposes in question.
She was particularly dismissive of your lack of understanding of how the European Union works. She points out as further reassurance that any case would ultimately fall to the European Court for decision. Who, she says, would be foolish enough to raise this matter of authority in such a forum at such a time?
She suggest that in future you should think before assuming that these important matters had not been thought through by your boss, Dr Roy Spendlove, and herself. At a time of considerable financial tension it is important to show solidarity to the common endeavour.
She accepts this may come up in Parliament, which is exactly why UK Parliamentary approval will also be sought.
I will not file your incoming draft and look forward to your telephone confirmation that you wish to withdraw it.
Yours sincerely,
Helga Petersen
Assistant to Dame Lucy Doolittle
European Section.
Today there will be plenty of spin around, following the E85 billion bail out agreement (Part 2) for Ireland. There is a sense of deja vu, as we had similar spin before after the previous meeting which we were told had saved the Euro and stopped the contagion.
We need to check the small print over the future bail outfund for Euro members after 2013, the permanent replacement for the Stabilisation Fund. Will the UK be out of this, as most Conservative MPs wish? The government implied to us when trying to sell the Irish loan that The UK was just going to help a near neighbour. They hinted that the UK would not be bailing out other countries later. There will be disappointment and votes against if the UK is expected to become a permanent member of the Euro rescue club when we are not members of the currency itself.
The announcement of the new bail out fund can itself be read two ways. Governments hope it will be seen as a sign of strength, a symbol that there is a long term intention to save the Euro with big money to back it up. Critics may say it shows that the governments recognise they have not yet fixed the problem, and see the need for more bail outs stretching into the future. The way to save the Euro is not to keep lending more money to overborrowed countries or weak banks. The way to solve the problem is to stop the countries borrowing too much in the first place, and to regulate the banks so they have strong balance sheets, not weak ones.
What the politicians say about this package matters much less than what the markets do. I do not expect the borrowing rates for Portugal, Greece and Spain to suddenly snap back into line. The Euro itself is falling this morning , which will help a little. The Irish package partly vindicates the markets. The markets said Ireland needed a bail out as it could not borrow enough at low enough rates in the normal way. The EU has now lent it more at rates well above German Euro rates. In other words the EU has accepted the idea that Euro sovereign debts have different values depending on which country we are talking about. The EU has decided that Irish sovereign debt should require an interest rate of more than twice the German level, closer to the rate the market says is right.
Taxpayers in the countries having to make the loans may well object to being paid less than the market rate for the risk they have to run. The Irish may well feel hard done by for having to pay a higher rate than the EU charged Greece,a rate which makes restoring sense to their public finances more difficult. No-one should feel good about this messy compromise. The questions to ask are how much more pain will the EU inflict on Euro members, and can the non members avoid being dragged into the crisis?
1. What is the money to be spent on?
2. What is the legal base for the EU Stabilisation fund which includes non Euro contributors?
3. How will the Euro area raise the money from the special purpose vehicle for bails outs, and at what likely interest rate? Who stands behind the special purpose vehicle?
4. What is their forecast of the increases in interest payments in Ireland over the next two years?
The following copy letter has come into my possession. It is from Mrs Penny Maws, legal adviser to Dr Roy Spendlove at the Division for Miscellaneous Projects. She is writing to Dame Lucy Doolittle, the Director of the Unit for co-ordinating cross cutting initiaitives and partnerships. I am still finding it difficult to locate this body and cannot vouch for its authenticity or accuracy, but find its points very interesting.
Dear Dame Lucy,
I hope you do not mind me writing directly to you. I do so because there is an urgent matter where we need your help. Dr Stronglove is on sick leave , and then has to go to an important Brussels conference on the co-ordination and co-funding of miscellaneous projects, so I write in his absence.
As you may know we were copied in to the recent government correspondence about the future Irish loan. I am just a little concerned about the legal basis for the whole European Financial Stabilization Mechanism insofar as it relates to the UK, a non Euro member. As you may recall, the total fund was estimated as being up to E500 billion. E440 billion of this is to be raised on behalf of Euro member states only, under an intergovernmental agreement through a special purpose vehicle. That seems well based legally, and does not include the UK.
The remaining E60 billion is to come from EU sources including the UK under Article 122.2 of the Treaty of European Union.(TEU). I am aware that the previous Chancellor of the Exchequer was given a full briefing on this and gave poltical consent to it in May just before the change of government but after the General Election. I am also aware that the new government has agreed to live with the results of his actions on advice that they cannot be changed, whilst at the same time criticising them in public.
My concern is to ensure that the government’s position is as watertight as possible should any outside person or company venture a legal challenge of the basis for making payments under this Article. As you know, there have been challenges in the past when European matters have been debated in public, even when these have been easily brushed aside in the courts.
The Article in question says:
“Where a member state is in difficulties or is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control, the Council, on a proposal from the Commission, may grant, under certain conditions, Union financial assistance to the Member state concerned. The President of the Council shall inform the European Parliament of the decision taken.”
In this case there is no doubt that the Commission proposed, the Council consented, including the previous government of the UK, and the European Parliament was informed. The issue revolves around the power to make a grant or loan in the case of a country which has borrowed too much.
Clearly we cannot argue that this was a “natural disaster”. Our case rests on the sub clause of an “exceptional occurrence beyond its control”. Some might try to argue that excessive debt in some member states is not “exceptional” but common. Others may argue that debt levels are matters that can be under the control of the Member state if they wish.
Our critics wish to suggest that this whole Clause is about natural disasters, and limit the payment of monies to floods , hurricanes and other similar exceptional events. I think we can dismniss this, as clearly the clause covers both natural disasters expressly, and other “exceptional occurrences” which may not be from natural causes.
However, we do need to strengthen our defence to the notion that the debt levels of member states are not under their control. I suggest we commission more work on the relationship of banks’ debt to state debt, to see if we can find supporting arguments from there. Such work will also, of course, need to cover how we regulated the banks. If we go to a defence based more on bank finances than state finances, it may help but we would be vulnerable to a counter charge that the banks too should have been under Member state regulatory control.
I am sorry to trouble you with this, but I felt the work we need to buttress our legal position needed your approval, and resources from your department to make sure the government’s position is as challenge proof as possible. I understand the UK Parliament may be asked to strengthen the position by voting expressly for the loan which would be helpful. That still leaves open the chance of challenge to the use of TEU 122.2 in general, which affects other non Euro member states as well as the UK.
Yours sincerely
Penny Maws.
In 1997 I published the Penguin book “Our currency, our country” setting out the case against the Euro. Amongst its predictions were:
“There have been riots in the streets of France against the spending cuts the currency scheme requires. Three quarters of the German people are opposed to the abolition of the DM, despite their government’s insistence that it must go aghead. 1 in 8 Germans, 1 in 8 French people, 1 in 8 Italians and almost 1 in 4 Spaniards are out of work. Despite that, their governments think that donning the single currency hair shirt is more important than promoting growth and prosperity.”
“You cannot have a single currency without a single interest rate, a single banking policy, a single budget policy and a single Finance Minister or Central Bank Governor. You are led inevitably to a single taxation policy and a single economic policy”
Current plans for European union “are likely to cause greater tensions between countries and peoples in western Europe than if we had no such plans”
“The single currency is like rejoining the Exchange Rate Mechanism, locking yourself in and throwing away the key”
“There is no single right rate for the pound against the DM”
“The Council of Ministers and the Commission would gradually seek more and more to control budgets and deposits”
“Ministers would be left defending tax increases or spending cuts which they had not wanted and probably disagreed with”
“The European authorities are introducing taxation by the back door, using national governments as their tax collectors. In recent years one of the ironies has been the fact that European rules have insisted on budget cuts and budget reductions in domestic policy in each country whilst expanding the European budget. It is this that will lead to ever more common taxation and the harmonizing of tax rates at the higher end of the range. It is this which above all else will render European countries less competitive”
“The single economic policy of the Treaty is incomplete. It is all about exchange rates, money and inflation;it ignores jobs, income and output.If pursued to its conclusion, it could easily alienate the voters of Europe, who think jobs and income are more important than financial matters…. One currency, one Bank,one interest rate would lead inevitably to one budget and one economic policy, as politicians struggled to cope with the unruly forces the Euro unleashed”
It should by now be clear that the proposed Irish loan is not the answer to the problems of the Euro. This week-end the Finance Ministries should be humming with effort. They should see the drift to a loan package for Portugal. All the rhetoric deployed on Greece and Ireland telling us a loan in time saves nine has not worked.
They should recognise that the bond markets have started to take them on in Iberia. Portuguese ten year yields have soared through 7% and Spanish ones through 5%. They may discount the alarmist talk that Belgium too is at risk when they see that Belgian rates are still pretty low and Belgian debt not a huge problem. They should admit that careless talk costs loads of money. They need to repair the damage done by all the briefing about the instability and about the need to invent a system of default.
The supporters of the loan have a touch of the TINAs – there is no alternative they say. You opponents of a UK loan , they accuse, want to see the Euro collapse . Nothing could be further from the truth. I understand how much political capital is invested in the Euro project. I do not wish our neighbours ill, as we do trade with them. I wish them to sustain and grow their prosperity for their own sakes and ours.
I have two major disagreements with the supporters of the Irish loan. I do not see why the UK should be part of it. Euroland has several large and rich countries that can borrow the money needed for it. It should be club members, and club members alone, who pay the bills of their club. I believe they will do so if the UK declines to make a contribution. The main Euro members clearly think it is in their interests to lend the money. One of the main points of helping keep the UK out of the Euro was to avoid us being dragged into expensive rescues, made inevitable by the faulty design of the institutional structures of the Euro. The UK is not in a strong financial position, so we should be doing all we can to avoid additional borrowings ourselves.
My second argument against the loan is more altruistic. I do not think a loan is the answer to Ireland’s problems. I find it odd that they agreed a large loan in outline, without agreeing what it was for or the terms of the borrowing. The Euro area is lurching towards a series of bilateral agreements between EU states and individual Euro countries at financial risk. If the rest of the EU mutually guarantees too much debt for the weaker members, it becomes a money go round or chase to the bottom. There will be knock on effects to the credit rating and interest rates of the stronger countries.
I suggest it is time instead to do some basic thinking about how a normal single currency works, and to make the compromises between the weak and the strong which are needed to allow the zone a more stable future. This still entails the stronger paying some of the price for belonging to a zone with the weaker ones, but does so in a more orderly way.
The truth is simple. The exchange rate, interest rates and money growth that suit Germany do not work for many other members of the zone. The markets are now differentiating sharply. All Euro zone members share the same exchange rate and the same short term interest rates fixed by the Central Bank. They now have wildly different long term government borrowing rates.
The weaker states need a lower currency value. The states with weaker banks need more money in circulation and more money available to support their banks from the Central bank. The stronger countries are pushing for repayment of the special facilities made available to weaker banks, and are keen to keep money fairly tight to put off inflation.
Instead of an Irish and a Portuguese and a whatever loan package the Eurozoen could take the following measures:
1. Agree that special financing continue to be made available to weak banks on demand by the ECB
2. Produce a new plan to strengthen the weak banks, selling off assets and businesses where possible, reducing the size of distressed asset pools, writing off where appropriate, raising new capital where possible, cutting costs, finding new profitable lines of business. The markets should be reassured that as this goes on the ECB will do what it takes to keep all the main banks open and liquid.
3. Allowing the bank to print some more Euros, and buy in some of the lower priced sovereign bonds to show that the Eurozone stands behind its members and does not countenance default on sovereign debt within the zone. It is the Eurozone, not the US or UK, which needs to prop its bond markets and show some common purpose for a change. The Eurozone will not get easily out of its debt crisis without creating more money.
4. Working with high deficit countries to produce deficit reduction plans that are credible. The aim should then be to restart proper financing of these countries through the official bond markets.
5. Coming up with policies which promote enterprise and private sector led recovery. The EU needs to abate its appetite for higher taxes and more rules, so that economies like Greece, Ireland and Portugal have more chance of competing in world markets and earning a better living.
I have been impressed by the detail and concern shown by several contributors to my questions on the new system. I will send the evidence to the Home Secretary so she can consider it properly with her officials.
When the European political classes put their expensive spin doctors behind the need for a bail out, there were two assumptions behind what they said. Firstly, a bail out for Ireland would stop contagion to anywhere else. Secondly, a bail out for Ireland would help solve Ireland’s problems. It is difficult to understand why they believed either of these two things.
They already knew that a bail out for Greece to stop contagion had not worked. Barely seven months after the Greek crisis we were deep into the Irish crisis. If they watched the markets they would have known that the markets were already putting pressure on Portugal as well. As the crisis is all about a country’s ability to borrow and the price it has to pay to borrow, they should watch the government debt markets. Yesterday the price of borrowing for these countries rose again, despite the bail out.
Prior to the Irish loan Ireland could borrow in the markets at close to 8% for ten year money. It now has to pay over 9%. Portugal had to pay around 6% but now has to offer over 7%. Greece still has to pay almost 12% despite its bail out on May 2nd. Yesterday even Germany experienced rising costs to borrow, with its rate going up to 2.7% from 2.5% a few days ago. There is no evidence in these rates that bail outs appease the markets. Indeed, it looks as if one bail out just eggs the market participants on to demand a bail out for another troubled sovereign.
These rates for Greece and Ireland imply something far worse. If you thought that these governments would pay all the interest on time and repay the amount of the loan in full when stated, and still remain in the Euro, it would be sensible to sell German bonds and buy Greek or Irish ones. You would make so much more in the same common currency with “similar” sovereign risk. Over ten years you would earn a sum greater than 90% more of your initial investment in extra income on your Greek bonds than German ones. Clearly by a big majority investors do not expect the countries under pressure to be able to meet all their obligations in full, or they expect them to leave the Euro at some point. The defenders of the Euro have a lot of work to do to reassure people and bond markets that Greece and Ireland will honour all their debts, so that Greece and Ireland can settle back to borrowing at something closer to German rates of interest. I hasten to add I am offering no investment advice on these matters on this site.
So why don’t enough people believe the loan packages for Greece and Ireland will solve their problems? They must fear that the remedy of cuts in spending and higher taxes will not allow the economies to grow quickly enough to curb unemployment with all the cost and waste that brings, or to allow the deficit to reduce quickly enough through more buoyant tax revenues. They must be worrying that these countries could get into a vicious circle of more cuts, less tax revenue, more cuts, less tax revenue. With interest rates as high as they are the country will find an increasing proportion of its public spending absorbed on paying interest charges, leading to the need for further cuts in other spending to try to balance the books.
What would work better? Leaving the Euro would be the simplest solution for distressed countries, allowing them to devalue against Germany and make themselves more competitive again more quickly without so many direct wage cuts. They would still need to control their deficits by spending curbs and growing the tax revenues, as the UK and US have to do with their own floating currencies. They would have more scope to settle the pace of these changes for themselves, and to set tax rates and regulatory burdens that were attractive to enterprise and capable of fostering the faster growth in output they need.
The little discussed issue is why the European Central Bank chose this moment to demand a reduction in its support to Irish banks and their refinancing by the impecunious Irish state.The loan we are all being asked to contribute to is basically a loan to refinance the borrowings Irish banks have been making from the ECB. Couldn’t the ECB have carried on lending enough for a bit longer, and in private worked out a faster and better plan for tackling the problems of the Irish banks with those banks and the Irish government? Such a solution might not have spooked the bond markets as much as their chosen course. If they go on upsetting the bond markets as they have been doing, they might find it makes solving their currency and debt problems more difficult, not easier. In this case, careless talk costs money. Lots of money.