Once upon a time lots of European countries decided they wanted to be friends with each other.That was a very good idea.
They had a history of being enemies, and fighting. That was a very bad idea.

They formed a club. They did a few things together. They planned what to grow and farm together. They did a bit more trade with each other. They managed to stay friends for many years. Emboldened by their success, some of the ring leaders of these countries said, “let’s now become very special friends. It’s boring just being good neighbours. I know how to show we are the best of friends. We will share a bank account with each other.”

They asked some wise men (yes they were mostly men) how you could do that. They said it was all a bit complicated for countries to do that sort of thing. You first had to share a currency, and to do that you needed to bring all your different currencies closer together.

All the country ring leaders said they thought that sounded lovely. They would do just as the wise men told them. They would make their currencies stay at the same rate against each other for ever so long. Once they had done that, they could easily then swap all the currencies into their shiny new common currency. Hey presto they would be sharing a bank account together. It all sounded ever so modern. They said it would mean they would all show great solidarity. Some said they liked solidarity though they were not quite sure what it meant or entailed. It would be All for One, and One for All, they were told. Who could disagree with that?

So they told all the world that they now had a special relationship. They told all the nasty wolves in the financial markets that if they tried to mess them up, they would spend loads of money stopping the wolves. The wolves would be foolish to try to take them on.

The problem with wolves is they can’t help themselves. They often don’t believe nice people like government leaders. So when they were told what rates the currencies would trade at, they said “We don’t agree. We think you’ve got it wrong”.

So every time the wolves sold a currency, to try to get it down below the European prices, the countries spent billions of money stopping them. The trouble was, the more they bought, the more the wolves sold. The debts got bigger and bigger, as the governments tried harder and harder to keep their currencies up. The Germans, who had the best currency, got fed up with owning more and more of the weak currencies. They started asking themselevs why they had to do that.

Then one day the governments saw they had spent too much, but still the nasty wolves were selling. So they gave up. It turned out that though they really did want to show solidarity to each other, propping up the pound sterling was just too dear for them. Italy and the UK and other smaller countries were pushed out of the super friendly money club. The Germans were no longer prepared to spend loads of their money keeping it all going. There had to be some limits to solidarity after all.

Tomorrow we will learn how the doughty European governments were not to be beaten by the nasty wolves. They were going to have their common bank account after all.

PS Whilst I am writing the fairy tale (3 day serial) please write in with your issues and worries.

The UK was right yesterday to rule out giving more money to the IMF to finance a currency. The Chancellor, asked to commit Euro 30 billion to IMF resources to defend the Euro, sensibly pointed out that the IMF is there to lend money to distressed countries against the security of better economic policies, not to aid currencies. He could have gone on to say it is not there to try to defend a currency bloc which is following the wrong policies, was improperly constituted at the beginning and has broken its own rules ever since. It is great to see the UK government offering tough love as advice, and protecting the UK interest. The Euro does not need a bigger bail out fund. It needs reconstruction, and policies which allow its subject economies to grow.

Yesterday in the Commons also served as a reminder of just how much power previous governments have given away to the EU. The Chancellor’s main task was to present his findings to the Commons following the Vickers Report into banking. That should have been work enough for him. He was kept on a long conference call until almost the last minute for his appearance in Parliament, discussing the Euro’s problems with many othher Finance Ministers. Our Ministers today have to be involved in two governments at the same time, which is demanding.

When it came to his announcement, the Chairman of the Treasury Committee and others asked about how far the UK is now free to do as it wishes on banking regulation. The Chancellor explained that the EU was now considering the Vickers Report with a view to seeing how much the UK can do without infringing the EU’s growing mastery of financial regulation. There are queries about whether the UK is any longer able to impose its own capital requirements on banks, one of the three main recommendations of the Report.

The government correctly wishes to implement the Vickers preference for more competition in the banking industry. So far the plans just revolve around the disposal of branches by Lloyds which were demanded by the EU competition authorities. It is I suppose good news that in this area the EU is following a policy which I think is a good one, but I would like to see the UK show some independence of spirit in going beyond the recommendations of the EU in this important area as well.

The Uk as a late entrant to the EEC had to accept many of the rules and schemes that were already in existence when it joined. Subsequent enlargements ,and four major Treaties strengthening Brussels powers and competence later, and the EU is even less to the UK’s liking than at the outset.

France wanted a comprehensive centralised agricultural policy to subsidise many small and inefficient farms. The aim is to keep agricultural prices high,impose barriers against non EU farmers, and send substantial subsidies to the domestic farmers. Germany has gone along with this as well. The UK has under successive governments claimed it wants a more open market based system, with freer entry for products from poorer countries, less subsidy to inefficient farms, and lower prices for consumers. France has never been willing to concede these changes. Mr Blair needlessly sacrificed an important chunk of the Thatcher rebate for promised reform of the CAP which never materialised.

France believes that the purpose of a single market is to regulate everything that goes on in an otherwise free market. The regulations are usually based on the preferences of the largest companies with a presence in the EU, especially those French and German companies that are good at lobbying the legislators. France sees single market measures as ways to keep out unruly competition. They often damage smaller entrants or make innovation difficult. France seems to be able to use these rules to her own advantage, whilst the UK often finds these rules put British interests at a disadvantage.

In 1972 the UK began the break-up of the sterling area. Various justificiations were offered at the time, but the imminence of EEC membership and the development of the snake, an early forerunner of the ERM and the Euro, probably influenced UK Treasury thinking. The French and others felt that running a large sterling area for non EU countries was not compatible with taking membership of the EEC seriously. It is curious to note that the same logic was not applied to the French franc zone. The West African and the Central African franc currency areas have survived the Snake, the ERM and Euro membership for France.

The UK makes a bigger net contribution to the EU than France, yet France persists in making the UK rebate the cause of special disagreement. The rebate was invented to deal with the grossly unfair financial deal that applied to the UK, mainly because the farming policy was so skewed against UK interests. The UK pays far too much in for the alleged benefits of membership. If it’s free trade and friendship you want, it should not cost anything like the UK’s subscription.

Soon the EU increases the levies on art transactions made in the London market, likely to switch more business to New York.

The UK thought it was joining a cricket club, that would play by the rules. It turns out it has joined a multi sports club, and has to pay for the rugby, football, swimming and ice hockey, even though it still only wants to play cricket. Meanwhile, it appears that the Uk takes the rules more seriously than other club members.

The most striking feature of this week’s government announcement of new ways to tackle problem families was the figure work. Apparently the 120,000 worst problem families in the country cost taxpayers on average £75,000 a year. That is the cost of benefits, housing, social work, police time and the rest, as a small army of state emoloyees try to provide support and discipline to families in need of practically everything from their neighbours – or the state as they are known.

The government is right to ask where all this money goes. Why do we need so many different staff and agencies to tackle these problems? Couldn’t one person go in and sort out a range of issues, whether they are in the housing or schooling or benefits box? Will the appointment of a single point of contact by each Council work? Will Councils co-operate? Will they choose people with authority and judgement? Will these new guardians defend the public interest and public purse, or will they take the line of least resistance, acting as advocates of more state money for the families they have to handle?

How can the state, on behalf of the taxpayers, ask for responsibility, discipline and effort from the families it is helping? What should we, and our representatives expect? If a costly education is provided for the children, shouldn’t they turn up? (the poorest areas receive far more per pupil than the richer areas) If they turn up, shouldn’t they show some willingness to learn, some understanding of the power of education to lfit them out of benefit dependency and relative poverty?

If benefits and housing are provided to the adults, shouldn’t we expect those adults to make every effort to find and hold down a job? If training is provided, how much willing participation should we expect? If they live in higher unemployment areas, how much understanding should we show of slowness in finding work? How far, if at all, should we ask them to travel to do a job?

These questions have been around for years, but there has been a reluctance to ask them. It has been an easy answer for government to invent some new programme with a new title, recruit more people to tackle problem families, and to say it is all a matter of resources. Now we have got to the point where every problem family receives an average of £75,000 a year we are entitled to ask what happens to all the money. Surely for that amount we could start to bring the number of problem families down?

What do you expect in return for your money being spent like this? What sanctions if any should the state impose, if families ignore the help and remain a trouble to their neighbours and themselves? What should these new officials do to make a real difference?

The French attack upon the UK’s debts, deficits, inflation and growth rate looked like an attempt to deflect attention from France’s plunging rating. There have been two big differences so far between France and the UK. The first is the UK can print and devalue to keep its debt afloat, whilst France is locked into the Euro. The second is UK government debt rests on very low AAA rates of interest, whilst French borrowing rates have risen above the comparable AAA levels.

The French and others who were very willing to criticise the Rating Agencies for failing to mark down dodgy credits in the private sector prior to 2007, are now having a hissy fit about the Agencies daring to downgrade sovereign debt in good time, before their struggles become more obvious. The Ratings Agencies are doing their job by downgrading overborrowed and overborrowing sovereigns. As Greece shows, countries can renege on their debts. The Agencies do not seem to be leading the markets, but usually follow them. The Euro area threats of downgrades came after the markets had pushed up interest rates in many cases, and after many private sector commentators had warned of problems ahead.

I suspect the French anger about the UK is mainly owing to the need to provide some offsetting publicity at a time of downgrade discussions for France herself. It is also likely that a President trailing in the polls reckons bashing Britain could win him an easy good headline or two in the French press. He has long held a wish to blame Angla Saxon capitalism for any French failings, so these latest rants just carry on with that government tradition.

The main French protagonists say they are doing it as tit for tat, as a response to some UK criticisms of the Euro and the French position. I have long argued that Ministers should have just one line on the Euro “We do not provide a running commentary on the Euro”, with background briefing that the UK has no wish to say or do anything that could make the position of the Euro worse. However, I do not accept that Ministers have said things that justify this very personal attack on the UK in retaliation.

All of this will feed the groundswell of anti EU sentiment in the UK. If our closest friend and ally on the continent sets out to rubbish the UK’s economy and credit standing, it is a far from friendly act. Were France to succeed, it would push up UK government borrowing rates, making us all poorer as a result, as the state had to pay more for its credit.

I agree with Mr Clegg’s wish this morning to condemn xenophobia and chauvinism. It’s a rising problem in many continental countries, as the politics of anger emerges from the troubles of the Euro. I am an open minded freedom loving globalist. Our message should be that we like our new century, which is bringing prosperity and opportunity to many of the world’s poor in Asia and Latin America, thanks to their hard work and enterprise. We should seize the advantage this brings us as well, offering new markets and many millions of new consumers. Over the next ten years Asia and Latin America will rise as a growing proportion of the world’s wealth and trade, and the EU will shrink. The UK’s outlook and foreign policy should reflect that reality.

Mr Clegg says he wants the Euro area members to be able to use the EU institutions to enforce their proposed fiscal pact. He should be careful lest he gets what he wishes for. This pact may well intensify the Euro countries economic struggles and the politics of discontent. The UK needs to be careful to avoid ourselves being more entangled with a failing currency project, which will have a great cost in subsidies, transfer payments, losses on loans, unemployment and economic misery in all too many countries.

           Last night I was the guest speaker at the Bow Group’s Christmas drinks. I told them a short European fairy story about countries that wanted to share a currency with each other. I will write it out  nearer Christmas for this blog. It has either a happy or an unhappy ending – you can take your pick. You might like to think up your own ending for your contributions.

           It is intriguing to hear how popular the draft new treaty for the 17  is proving with admirers of more EU government. They are often the kind of people who think more government spending and borrowing are a good idea. This pact recommends the opposite. It proposes big cuts in spending and big rises in taxes to get deficits down to very low levels by recent standards. If you do this whilst maintaining the rigid single currency, it will be deflationary. They probably like the tax route more than the spending cut route, which will squeeze private sector demand and encourage more businesses to go elsewhere to carry out their activities.

            The aim of the pact is to give legal force to EU control of budgets and deficits. They rightly argue that if you share a currency with your neighbours you do effectively share a bank account with them. The European  commercial banks all bank at the ECB. That means your overdraft is a matter of common interest. If one borrows too much, it reflects on the currency and the credit rating of the rest.

              Germany has been fighting to preserve her taxpayers from having to finance the overdrafts of the weaker states. The markets are making that harder and harder. The investors who can pay for these deficits are saying they want Germany and the other strong countries to underwrite the borrowings of the weak, if they are going to lend more to them.

                  Germany cannot accept this huge liability. Instead her Chancellor says that the EU must stop the weaker countries running up such large bills and borrowing so much. There has to be central control of the overdraft, to avoid Germany being drawn into bailing out the weaker areas.

                     This is all sound logical northern commonsense. It is not necessarily well thought through democratic politics. If they are going to press ahead with the new fiscal controls for the 17, Ireland may need a referendum on these new powers. After all they are fundamental. How can you say you are still a sovereign nation, if your spending, taxing and borrowing plans have to be agreed with the EU? How can you claim you are independent if  you diverge from the agreed EU plans, and face a fine or other punsihment for your trouble? What powers do your Parliament and the electorate have left, if these crucial issues are settled by technocrats in Brussels?

                     So far the EU has got away with putting technocrat governments into Greece and Italy. As EU plans will require higher taxes and lower spending, there will be a need for political salesmanship of the highest order to explain to voters why these measures are needed, and how they are going to work within the framework of the rigid Euro. If the EU has taken away too much national democratic accountability, it will make this important task that much more difficult. Elected governments will be impotent to change the policies, and will spend their time blaming the EU. The EU will stand remote, unable to engage directly with the electors it is having a big impact on.

                   The EU would be wise to grasp that the Euro crisis is not now just a currency or bond market crisis. It is not just a matter of high stakes economics. It goes to the heart of what a functioning western democracy does. The Euro scheme will come to test and stretch the limits of accountability, and sorely test the patience of voters.

             Some of you have complained about the idea of progressive taxation, some about the use of the word to describe a system which takes more from the rich than from the poor. I used the word because it is the term commonly used to describe tax systems which take more from those with more income and wealth. The alternative is poll taxeor fixed per hominem taxes. Some argue consumption taxes are “regressive”, hitting those on low incomes more. Yet if you look at VAT in the UK, because items like food are exempted, the rich pay proportionately more VAT as well as Income Tax, as all luxuries attract the full rate tax.

             Some of you suggest a flat tax. This is still a tax which taxes the rich considerably more than the poor. If person A is on £20,000 a year, and the flat tax is 20% with the first £10,000 of income tax free, they pay just £2000 of tax, or 10%.  Someone on £100,000 of income pays £18,000, or nine times the amount of the person on the lower income, at 18%.  When Mr Osborne said he liked flat taxes, it still left him supporting the general notion that that the rich should pay a lot more than those on low incomes.

             The June 2010 Red Book set out illustrations of how progressive the current UK system is. A family with one child on an income of £10,000 a year receives  in 2011-12 £6150 from the state  in tax credits after allowing for income tax and National Insurance. Someone on £20,000 a year pays a net  £1800,  on £50,000 a year pays  £14,405, and on £100,000 a year £35,405. The person on £100,000 a year pays almost twenty times what someone on £20,000 a year pays, if they have one  child.  

             Recent budgets have increased the tax on the higher earners, and increased the net payments from the state to lower earners. The top decile of earners have been asked to pay £1600 a year more on average as part of the budget measures to curb the deficit.

            In the March 2011 Red Book the Treasury gave their latest numbers on overall contributions to the state or drawings from  the state. These were based on 2008-9 figures, so the latest would give more to the low income groups and take more from the high income groups. They showed that the top 10% of income earners contributed  around a net £30,000 a year on average, the next 10% around £18,000 a year and the third  from top decile around  £14,000. The bottom three deciles of income recipients  all received money from the state, with the second lowest income group getting most at around  £3000 a year. These figures show benefits received minus all direct and indirect taxes.

             I would be interested to hear views on whether this is fair?  How progressive would you like the system to be?  How progressive can it afford to be, without discouraging people from work or from risk taking?

There has been much sound and fury but little progress in Euroland in the last few days. Far from them saving the Euro, they agreed to differ on some things, and agreed to delay on others. We were told the Uk was isolated, yet most of the nine non Euro members have reservations and none have finally signed up to the package.

At the end of the long meeting of Heads of government in the EU in Brussels last week, the Heads of State or government of Euroland issued a statement.  They agreed a “new fiscal compact and strengthened economic policy coordination”, and “the development of our stabilisation tools to face short term challenges.”

The Statement was not also made by the nine non Euro members of the EU. We were told verbally they were in support but they did not put their names to it.   At the end of the Statement it says  these other countries “indicated the possibility to take part in this process after consulting their Parliaments where appropriate”. That is very weak language, and implies the nine did not sign up to the whole agenda of the 17, and decided  to play it long to gauge Parliamentary and public reaction at home.  It is not quite the UK isolated story we read about. It appears that several countries outside the Euro have reservations about agreeing to major controls on their budgets by the rest of the EU.

The aim of the agreement for the 17 is to create a stronger central economic government for the whole area.  They wish to build on the Stability and Growth Pact, the European Semester (budget approval and control), the new macro-economic imbalances procedure and the Euro Plus pact.  They want these  rules to be more legally binding on the 17 than the old rules proved to be.

At the heart of the new elements in the proposal is the fiscal rule. Each state is to run a balanced budget. They are not allowed to run a structural deficit of more than 0.5%. Were this rule to be applied to the UK today, it would mean additional spending cuts and tax rises to the tune of £60 billion a year to eliminate most of the structural deficit. There would also need to be additional cuts or tax rises for countries with an overall debt higher than 60% of GDP.  Any country failing to produce a budget which conformed with these rules would be required to produce an alternative, and could face sanctions.  Again, if this applied to the UK it would mean additional cuts or tax rises to start to reduce the debt.

The Statement had less to say on stabilisation.  They say they will rapidly deploy the leveraging of the European Financial Stability Facility. They do not explain how they will borrow the money for it.  They wish to speed up the use of the new ESM to July 2012, still a long seven months away. They say they will pay more financial resources into their funds, without specifying how much by whom and when.

So where do we go from here?  The Euroland area countries have decided to adopt these new proposals in March or at an earlier date. They still want them to be incorporated into Treaties of the whole EU, but clearly this is not possible all the time the UK and other members refuse or  want to discuss and delay. The markets will judge the package by how much money it puts on the table to deal with the large balance of payments imbalances, and the state borrowing demands in the weaker countries. Little progress was made on this. When it come to completing a fiscal union, there was modest progress by the 17, but much more work to be done on what legal framework can be used, how these rules can be enforced, and how you get from the high debts and deficits today to where they say they want to be.

This article was published in collaboration with PublicServiceEurope.com.

               The bad tempered EU meeting last week did little to save the Euro. We still do not know how much money they will have to rescue troubled countries, or to intevene in wobbly bond  markets.

               Meanwhile, the non Euro members have seen the text watered down about their possible involvement in the new budgetary controls envisaged in a new Treaty. There was clearly less agreement amongst the 26 than the spinners said. The socialist candidate for French President wants the whole thing re negotiated. There is going to be plenty of time to do so. There will be months of argument ahead on how much new power the EU should have over budgets that used to be set by democratically elected governments.

                     I cannot believe the Times story today will come true that the UK is seriously thinking of concessions to try to stitch this all back together. The public has been misled by suggestions  this “agreement”  can save the Euro, and into thinking all the other 26 now agree. It turns out there is a lot of arguing to do before they have a new legal agreement for the 17 plus, with the 9 not so keen. The UK is well out of it.

                    They are embarked on a long process to build a new hospital for the Euro, when what they need is a better lfie support system for the Euro’s ailments in the bond markets today.