Category: Uncategorized

          The spin was fine. The Greek people had voted to save the Euro. The “right” parties had enough seats and votes to form a government which would support the loans which support the Euro membership. The spin was designed to reassure markets that the Euro is safe in our time.

         The markets did not see it quite like that. Initial sharp rallies petered out. The cost of borrowing for Spain and Italy rose further. In Spain’s case the cost of 10 year money remained clearly above 7%, the level that many say makes it unaffordable. The battle for Spain is now more important than the rows over Greece.

         The politicians gave out differing messages when interpreting the Greek election results. The Greek “victors” sounded more like the Greek opposition, saying there now had to be changes to the loan agreements to make it easier for Greece to survive economically. Germany repeated the mantra that Greece had voted for the Euro and for the disciplines embedded in the loan agreements.  In the days ahead Greece has to form a Coalition government, that government has to seek changes to the loan terms, and the rest of Euroland has to respond. If they are too generous to Greece they may find other nations with special programmes want better terms. If they are too tough they make it difficult for the new Greek government to sell it to the Greek people. If they are too generous to Greece they call into question the disciplined framework which many- not just in Germany – think essential to Euro success. If they demand too much austerity with no currency or monetary relaxation possible to compensate, the Greek economy could continue to fall badly, making it impossible to pay for all the remaining debts.

        Most of this is theatre. It is based on an unlikely set of assumptions.  The Greek loan agreements for the period up to 2020 are based on the assumption that the Greek economy starts to grow from the beginning of 2013, and carries on growing for each of the seven years up to the end of the decade. Few private sector forecasters would endorse such a forecast for such a long and unpredictable time period. If by any chance the Greek economy does not soon embark on a steady and long period of growth, all the numbers of the loan agreement will be wrong. Tax revenues will be lower, state spending higher, and Greece will need to borrow more to get through.

          It all asumes  that the Greek banking system copes well with the pressures. Let us hope it does. However, some in Germany are nervous about the extent to which  large German bank surpluses are being lent via the European Central Bank to the weaker members of the currency union. Somehow the deficits on trade accounts need to be financed. Somehow plenty of money needs to be supplied to banks in  weaker economies to meet demand for cash withdrawals or transfers as they arise. The surplus countries have to allow this to happen and to be happy with it for the union to flourish.

          We are invited to believe that the Greek election is between a couple of old parties, the political establishment, who “wisely” wish Greece to stay in the Euro, and some wild new parties who wish to be “irresponsible” and leave the currency.

          The problem with this view is that all parties in Greece, and most Greek people, want to stay in the Euro. The argument is not, unfortunately, about an orderly withdrawal. The argument is over the terms of staying in.

         The old parties have shifted their position. They moved from saying Greece has to stick to the deal, to saying they want to make some improvements for Greece. The EU spinners obligingly let it be know that these reliable parties would probably be offered a sweetener on victory.  The new parties, full of anger and strong rhetoric, have also during the campaign moved their position. Syriza has toned it down a bit, and conceded that Greece does need some austerity, and needs to negotiate a new settlement.

           The week-end press was briefed to warn of a firestorm if the challenger parties won. Mrs Merkel, meanwhile, has indicated there will be no renegotiation even for the “reliable” establishment, let alone for the tearaways.

             The future of the Euro and the future of Greece in the Euro remains poised, as always. It all depends on the whether the Euro area digs in and allows no change to the deal or not. They are discussing when they bow to the inevitable, not how to keep Greece in as a happy and compliant member. That latter is not an option from any Greek government. Greece. after all, recently reneged on on a lot of her debt. That was under the old “reliable” parties who said they were delivering the loan agreement which was said to save Greece.

          The inconclusive nature of the election result is not surprising. If the old parties do in the end have a majority, this will be spun as a victory for the Euro, but it solves none of the outstanding problems. It still leaves Greece struggling to hit any of the targets for the loans.  The people cannot see a sensible choice to back with a firm mandate. The political parties all want to stay in the Euro, so that means they all end up offering a variant of the same policy! The Euro is destroying democracy, as some of us predicted. No serious party in Greece has told the electors the truth, that the Euro is not right for them. They are all trying to stay in a scheme which does not work. The only differences are the severity of the rhetoric about possible easing of the immediate pain of the loan terms that the Euro has forced upon them.

         Some parts of the water industry eventually lifted their ban on hosepipe use this week, after weeks of forecast and predictable downpours. (See this blog about a very wet drought on May 24th “Water,water, everywhere…”).

         On cue, I met representatives of the industry and the regulators this week to hear about the opportunities for more competition. We heard how more extensive competition for the supply of water to business in Scotland has had favourable results. Costs have been reduced by £140 m overall, and prices are down  a little. Service quality and flexibility has improved substantially. Those industries that want reliable supply now have more assurances that they will get the volumes they want when they want them. Those that need different quality standards or different additive patterns might now get them.  Above all, industry representatives said how different the approach of the water businesses now was. It used to be  take it or it leave, and prove the water industry wrong if you challenge its bills or its supply. Now  there is a more normal wish by the Scottish  water  industry  to help the customer and respond to customer needs.

       In England the government says it wishes to increase competition for business customers, but is still adamant that the poor old long suffering retail customer has to put up with a monopoly. Introducing lop sided competition means the regulator has to watch like a hawk to make sure the industry does not shift costs from the competitive side to the monopoly side in an effort to be more competitive where they need to be. It also means retail customers are cut off from the advantages of keener prices and more flexible service. Does anyone think a competitive business would keep customers on a hosepipe ban for so long during floods as the monopolies did? Does anyone think a competitive industry would charge as much, and insist on just one standard of water for all customers? Would a competitive industry use so much high quality drinking water to clean cars and flush down the drain?

          There are three things I do not like about some monopoly water companies. The first is the refusal to supply the amount of water customers want when they want it. A hosepipe ban in a period of high rainfall is no problem for gardeners, but it does stop you keeping cars, patios and other outdoor items clean, and prevents watering new plants if you happen to put them in when it is not raining.

          The second is the high and rising price. The regulators seem to be in cahoots with the industry, accepting the case for extra investment – which is needed – and then accepting it has to be funded by price rises rather than by more efficiency, and better use of assets. Competition would cut prices and boost efficiency.

        The third is the endless hectoring. The monopolists lecture customers, telling us we use too much, and telling us we need to cut back on use. They do not know how much many of us use, because we do not have individual meters. For all they know I might be very frugal with my water use, yet I still get the lecture. Water is the ultimate renewable resource. There is a water cycle.. We are not arguing about depleting some precious and scarce asset. We are talking about how much we use as the water  passes from clouds to sea.

           The government should go the whole hog. Introduce competition for all.  If it is, as some say, a natural monopoly, it will do no harm and make no change. If, as is the case, it is a potentially competitive induistry, we should see more supply and lower prices.

The Governor of the Bank of England in a doom laden speech told us that the Euro crisis leaves a “black cloud of uncertainty” hanging over us. This, he says, damages confidence. This leads to “lower spending” which “leads to lower incomes and a self reinforcing weaker picture of growth”.

He is right to say that the Eurozone catastrophe is bad for confidence. It does do damage to export prospects, and to wider confidence. However, if he wants to find out why spending in the UK has been depressed recently, he should also look at the big impact high UK inflation has had on real incomes. There has been a progressive squeeze on our real incomes. It began at the end of the Labour era thanks to their massive bust and the collapse of output. It has continued under the Coalition, thanks to the Bank’s singular failure to control inflation. Inflation has been running twice as fast as wage increases in the private sector, leaving people strapped for cash.

Will this latest scheme help? I have two main worries about it. The first is, it does nothing to relieve the squeeze the banking regulator is placing on the banks. Some of them will still lack balance sheeet strength to put more loans on their books. Second, they still are not breaking up RBS, our largest bank. This bank is not functioning well as disunited conglomerate. Why don’t they get on with creating some banks that work from amongst the assets and liabilities they hold in RBS? These very large banks do not seem very interested in lending money to individuals and small businesses. It appears that we are a nuisance, unable to pay the very high fees their senior executives expect. They can charge big business and governments these high fees, so they prefer to go that way.

The new scheme will need some detail on who takes the risk. If the Bank is to lend to the commercial banks against their new loans, the big issue is how much of a haircut or discount will the Bank apply to the loans offered as collateral for the borrowing, to protect the Bank and therefore the taxpayer? In addition, how will the Bank ensure the new loans being financed by the Bank of England are genuinely new loans? Commercial banks could offer exisiting clients new terms for old loans and present these for Bank money, unless there is an effective anti avoidance provision in the scheme.

Germany has been here before. The political union of East Germany with West Germany was cemented with a currency union. The politicians decided to do it at the political rate of 1 ostmark to 1 DM, a very favourable rate for ostmark holders. The Central Bank’s advice to do it more slowly, or at a lower rate for the ostmark was ignored.

The result was a very expensive and long job to try to get East Germany up to somewhere near West German living standards. The one independent study of the costs to West Germany puts them at Euro 1.3 trillion over the first twenty years. Today the cost is around Euro 80 billion a year.

It was a much easier task than uniting the Euro currency area. All the people involved spoke the same language. Most of them felt they belonged to the same country. A politically acountable government was put in charge to take the main decisions, which had authority and consent from most of the people. Labour migration was relatively easy to the richer places, owing to the common language and sense of common nationhood. Around one quarter of the population of working age left East Germany to get jobs in West Germany.

Despite all these advantages, it was a long and difficult task. It created tensions between the two Germanies. Some in the West complained that the East Germans relied too much on subsidy and needed to raise their game. Some in the East felt the support of West Germany was too grudging, that they did not show enough sympathy and understanding for how East Germans thought about it all.

If it cost that much to unite the two Germanies with a single currency, how much do people think it will cost to unite the 17 members of Euroland? Why wouldn’t it cost several times the Euro 1.3 trillion it cost Germany? I read rumours of a further bail out for Spain in discussion. Yesterday Spanish ten year borrowing costs rose about 7%, the level which is said to be too costly. Italy did succeed in raising some new borrowings, but at high rates. It looks as if it is going to take a lot more subsidised lending to save the Euro. At some point the markets will ask just how much of this extra credit can Germany support?

It is suddenly fashionable on the continent to talk of a banking Union. The EU assures us this is one way that they can advance their goal of “deeper economic integration”. They see this as necessary to help save the Euro.

Reading the EU’s document on what a banking union would look like, the first thing that emerges is they are well on the way to having one for all 27 member states of the EU anyway. There has been huge change in recent years, bringing into play the European Banking Authority, the European Securities and Markets Authority, and the European Insurance and Occupational pensions Authority. These bodies at the moment co-ordinate and supervise the national regulators. The wish now is for them to do more, regulating the larger institutions in the EU directly, and becoming more detailed in how they tackle the national regulators. There will be more pressure for harmonised standards and approaches. They are floating the idea of one pan Euroepan bank deposit guarantee scheme, for example. The EU did intervene in the ways EU governments aided their banks during the crisis, and did impose some state aid rules on the subsidies.

The UK should have a problem with all this. If the Euro area wants a centralised approach to regulating its banks, that is one thing. If they wish to use the institutions of the 27, and impose the results on the UK, that should be another thing. The safest way for the UK to approach it is to insist that the Euro area has its own rules and institutions, but that would duplicate the institutions the 27 have already set up. The least bad way would be to give the new banking tasks to the European Central Bank, writing firmly into the rules that the powers only relate to Euro member states. If the EU 27 common institutions are to be used, the UK has to exempt itself from the application of their rules to us if it wishes to keep control over how it regulates its important financial service industry.

There are also problems for Euroland. The EU thinking seems to be in favour of higher capital and cash requirements. Whilst these would have been eminently sensible 7-10 years ago, to stop the bubble, today they may well delay the recovery. So far there has been little evidence of the restructuring , writing off and closing down the EU says it favours. The system is thriving on massive bail outs of damaged institutions. This does not provide a sure basis for growth. When linked to strict controls on the stronger banks, it produces a toxic cocktail of anti growth policies. Some in Germany are also now trying to limit the damage of this proposal, as they do not fancy Germany having to help guarantee the bloated balance sheets of weak banks all round the Euro area.

It was interesting to hear the retiring Head of the FSA effectively blaming the government and the Bank of England for the collapse of Northern Rock this morning. Apparently the FSA recommended helping Lloyds to buy Northern Rock before the run on it. At the time I recommended the Bank simply made more loans available to Northern Rock, on good security, to replace the wholesale money that had dried up. That would have been cheaper and easier than the route they followed. Allowing Lloyds to buy it reflects the regulatory support for mega merger banks, which was part of the problem of that era.

The UK’s exports of goods to the rest of the EU is a little under 10% of our total output. That means that if, for example, there is an EU recession and we lose 10% of that business as a result, the UK economy will lose just 1% of output. At a time of little or no growth that is not helpful. It compares with the government forecasts of Uk growth averaging over 2% per annum.

However, at the same time the emerging market economies are likely to grow at a decent pace. The UK sells too little there at the moment. Exploiting the growth in those economies, and building up our low market share, we could offset a possible 10% fall in EU exports by a compensatory increase in non EU exports. The government is rightly seeking to help companies export to these faster growing markets. This will be an urgent priority not just for the next year but for the next decade, as the Euro scheme and banking problems in Western Europe damage its prospects.

There is also considerable scope to replace imports with home manufactures and services. That too could offset any loss of output from Euroland contraction. All these routes would be helped by the actions to promote UK growth we have often discussed here.

Sometimes trying to fix a problem can make it worse. Confidence is a precious flower. Pulling it up by the roots to see if it is healthy, or watering it too often, may not be wise.

It looks as if other member states and some EU officials wanted to organise a Spanish banking bail out before the Greek problems reappear following the Greek election. Spain’s government seemed to want to delay, and issued denials, before agreeing to a hastily compiled press statement last week-end confirming a future bail out of the banks using EU money.

It has led to a series of questions that do not necessarily have good answers for the Euro.

1. When will the new bail out fund itself be able to borrow the money to fund the Spanish banks? All bail out funds from other Euro members will need to be raised from markets,as all the main Euro countries are borrowers.
2. Will the EU loans, effectively made to the Spanish state to pass on to the banks, have priority over other Spanish government debt? If so, that reduces the credit worthiness of other Spanish state loans.
3. Even if the new debt does not have priority, Spain’s own credit rating is damaged, because the state now has more debt to assist weak banks.
4. How does Italy in particular afford her share of the Spanish bail out? Does it make sense for Italy to have to borrow more to help Spain, when Italy hersef has refinancing stresses ahead?

The model of big bank bail outs instead of controlled administration for the weakest is always problematic. It is especially problematic when large sums have to be found to prop the banks by states whose own credit rating is already on the slide and whose cost of capital is rising to high levels. The bail out has put both Spain and Italy’s borrowing costs once again under the market’s cosh.

           Some have pointed to a paradox in what I argue. I both agree with the government that you cannot get out of a state borrowing crisis by borrowing more, and propose that more credit in the private sector would be a good thing to get the economy moving. These statements need not be contradictory.

            It is true that some individuals and  companies overdid the private sector borrowing in the heady years of 2004-7. Some banks clearly went too far, building huge portfolios of risky debt and other financial instruments.  I am not advocating that these individuals or companies shoulod borrow more. They are having to cut their borrowings and sell off some of their assets to repay debts. That is a necessary process to get over the inflation of assets and asset prices of the pre Crash period. The banks have now slimmed down their balance sheets considerably, and are in a position to expand a bit if only the regulators would let them.

           The private sector, however, remains larger than the public sector and includes a large number of credit worthy individuals, families and companies who could take on more debt for sensible projects and purposes. The aggregate level of private sector debt got too high by 2007. It has come down a bit since then. The totals allow scope for the unborrowed and those with little gearing to borrow some more.

            That is where the role of the banks needs changing. Today credit worthy smaller businesses cannot get credit at all, or only at a very high price. Larger companies are put off epxanding, partly because they are concerned about demand, and partly because even they may be worried about working capital facilities needed if they do expand. If people cannot get mortgages for new homes, housebuilding suffers. If people cannot get mortgages for second hand homes, all sorts of activity related to home improvement and buying and selling suffers. If people cannot get loans to buy new cars, the motor industry suffers.

            Some say that too much credit in the past has greatly extended house prices, and these should now be allowed to fall further. It is true that mortgage banks lent far too much prior to 2007, extending higher multiples of joint incomes and allowing a fast appreciation in home prices. There has been quite a big adjustment outside London since 2007. Central London has stayed high owing to strong foreign demand, often based on cash not mortgage money.

            Whilst I agree that home prices are still high relative to income, I am also conscious that falling house prices puts people off making other purchases and makes them less adventurous with their other capital where they have some. We need to establish a sensible clearing price in the market for homes soon to foster recovery. It may not be as low as some would like, but allowing further large falls with a very restricted supply of credit will undermine banks further, leave homeowners feeling bruised and lacking confidence, and may not even in the short term help the first time buyers. They may, after all, delay as they see prices falling.