The UK has no need to fear Germany. The UK has no need to be impolite to Germany. The UK should resist the temptation to lecture Germany on how to lead the Euro zone.

             There are unwelcome signs that the UK/EU relationship is becoming strained. The Coalition  government seems nervous about the impact of faltering economies on the continent, and concerned about recent policy moves. Germany and the EU seem annoyed at the UK government’s “grandstanding ” from outside the Euro, and insistence it should be in the room. The UK wants to play but does not want to pay.

            It is easy for the UK to correct its part in the faltering relationship. UK Ministers could and should answer all enquiries on the state of the Euro, Euro bond markets and the like with the tedious but safe formula “We have no wish to provide a  running commentary on the Euro”. They should not wish to undermine it. Nor should they be in the business of trying to buttress it. They should avoid comments that disagree with Germany on it, and comments which avoid disagreeing with France. As France and Germany disagree, that means keeping quiet.

               What the UK government needs to do is to articulate strongly and clearly the UK’s wishes. This has to be in the  form of a flexible  approach depending on how the Euro area evolves. It is safe to assume that any fix for the zone entails much more detailed centralised control by the EU over Euro member states. No UK government could join it. We need to explain that we require a different relationship with the increasingly integrated zone.

                         The immediate threats to the UK are fourfold. The first is the attempt to establish extra territorial jurisidiction over UK financial markets, to exclude us from Euro business. This needs forceful rejection by political and legal means. The second is the rapid push to complete regulatory control of all financial activities in London by the EU. This too needs firm rejection by legal and political means.  The third is the impact of EU energy measures on UK energy prices, which is becoming a major obstacle to retaining and growing industrial activity in the UK.  Now the UK Chancellor has identified the issue, the government needs to take a remedy to Brussels for discussion. The fourth is the general burden of cost and complexity pushed onto the UK by the EU budget and regulations. The UK needs to seek powers and money back.

                    Just getting a vague promise of movement on Working Time is no longer sufficient. UK growth and prospects now depend on moving some of the roadblocks to growth imposed by Brussels. The UK government has to say it needs a renegotiation and it needs it now. It will put the results to the people in a referendum. That should get Germany’s attention. It is then up to them whether the UK votes on a package the people  are likely to accept, or on the current deal. Polling shows 80% of the British people do not think the current deal is satisfactory.

           The OBR as expected has revised its forecasts down considerably.  13 % growth has been reduced to 8.4% over the period 2010-2015, compared to my forecast of 7.5%. I fear they are still on the optimistic side for the last two years of the strategy, but the differences are not now so large.

            The OBR says that total borrowing 2010-2015 will now be £563 billion, compared to their forecast of £451 billion in June 2010 and £485 billion in March 2011. They are now a little higher than my forecast of up to £550 billion, with a central figure of £520 billion. I apologise for not being pessimistic enough.  It reminds us that they see a strong relationship between growth in output and growth in tax revenues.

           Spending remains on the same overall total. The extra deficit arises from a sharp downwards revision to their forecast of increased tax revenues. Readers will remember I always queried the likelihood of an extra £172 billion of tax revenue for Year 5 compared with the last Labour year.

           There is a small shift from current to capital spending within the same increases in total spending.  Over the five years capital spending will increase by a total of  £5.8 billion. Current spending will be £1.1 billion less than the old plans in 2014-15.  Total spending rises from £669.7bn in 2009-10 to £736.4 billion by 2014-15, an increase of 10% in cash terms.

          Today we are told the OBR will produce far worse forecast figures for growth and borrowing.  That will come as no surprise to readers of this blog. I have argued for the last four years, from the Economic Policy Review onwards, that the trend rate of growth of the UK is now around 1.5%, not the 2.35% official forecasts assume. I am sticking with my forecast of 7.5% growth for this Parliament. Expect OBR to come down closer to this from their 13% plus forecast.

           That’s why I have assumed £520 billion of extra borrowing this Parliament, compared to the £451 billion June 2010 official forecast, and the £485 bn revised forecast in March 2011.  What today will confirm is that the official  June 2010 forecast, their Autumn 2010 forecast and their March 2011 forecast were all wrong, by their own admission. Today’s is likely to be closer to the truth because it will be more pessimistic.

             The problem that poses for the government relates to the structural deficit. The government has promised to eliminate this. It has said it will not eliminate the cyclical deficit, the bit that rises and falls according to growth, unless and until there is enough growth. If the OBR now thinks the trend growth, the reliable growth over a period of years, is lower, the structural deficit must be higher. They will probably say less of the borrowing each year will automatically disappear as the economy picks up. That makes the task tougher.

           I doubt there will be many interviewers asking why the OBR got it so wrong for so long. If some of us without their  resources for forecasting could see the post credit crunch world with a looming Euro crisis would mean  slower growth,  why couldn’t they with all their money and advantages?

          Most commentators on the Euro crisis assume that if Germany wished to save the Euro she can do so. Only the failure of the latest German bond auction has caused any doubt to creep in.

          Commentators are right to think that Germany is now very powerful within the EU. The Euro lacks a sovereign power, an authority who can make the decisions. Mrs Merkel is the closest it has to that. Mr Sarkozhy is trying to stay alongside her, but in practice the main shots are being called by Germany.

           In a way this is  all a confidence trick. If you judge German power by votes in the EU, or by her proportion of population and wealth, she is just the largest minority partner amongst many. If you judge her by the popularity of her view that the EU needs to exert much more budgetary discipline over its members, then she should be significantly outvoted by the south led by France, who favour looser money and borrowing more as the answer. If you judge her by her capacity to pay the bills, again you would have a more circumscribed view of her writ. After all, rich West Germany struggled for several years to meet the substantial bills of Eaastern Germany when they rushed headlong into a monetary union on terms very favourable to the East. Many German voters do not feel like repeating that generosity on a continent wide scale. Germany is not rich enough, and does not have enough borrowing power herself, to do to southern Europe what she did to East Germany.

               So how has Germany emerged as sovereign elect of Euroland?

                 The truth is many countries on the continent are frightened of Germany. They huddle together and seek German protection. They accept the lectures on the need for them to be more Germanic, to adopt the Northern Protestant work ethic, to rein in deficits and earn more money and pay more tax. This they see as the necessary price to bind Germany into the new Europe. This is the necessary letting off steam so that Germany in the end accepts the need to transfer more grants, to allow more bond buying, to accept that integration comes at a price to German taxpayers.

                  The southern petitioner states know that in the end they will get more out than they put in financially. The small northern hard working states that cluster around Germany’s borders know that their economies and societies spill over the common borders. They think they can never be truly independent, so they may as well go along with a scheme which gives them a small voice in common policy making to offset the powerful effect of the German neighbour on their local economies.

                As a result the Euro crisis seems to be an agonising political journey for Mrs Merkel and the German Parliament and electorate. It is a race between the markets and Mrs Merkel’s willingness to say Yes to bond buying and Euro printing on a big enough scale to buy them time. So far she shows she wants to get much more integration and budgetary discipline before allowing any more borrowing. Maybe it’s brilliant brinkmanship. Maybe it’s realism. Maybe she now fears the Euro is too dear and too big to save. After all, she knows the true cost of the DM  East-West amalgamation, and just how difficult that was for Germany.

          This was the most difficult question I was asked on Thursday following my lecture in Oxford.

          My reply reminded the audience that so far the EU elite had been proved wrong about the economics. Their plan to bring the economies together through the Exchange Rate Mechanism was shattered by the markets. Instead of proving the economies of western Europe were converging, the ERM reminded all but the most ardent federalist that the economies of western Europe are very different. They had different growth rates, inflation rates, and public debts. In consequence their currencies fluctuated and changed when allowed to do so, and burst out of a scheme designed to restrict them. They thought the ERM  would bring together inflation, debt, performance. The opposite happened.

           Instead of accepting the warning, the EU decided to leave out the necessary long period of encouraging convergence of performance and move directly to a single currency. They reasoned that this was the ERM countries could not be forced out of. If the problem with the ERM was the market ability to sell currency A and buy currency B against the wishes of the EU, then if they removed those currencies the new scheme would be market proof.

          Some of us warned them that the new pressures were bound to arise elsewhere. Some of the pressures would be painful in the real economy. Some areas would have very high unemployment. Others would have high inflation and hyper activity or bubbles. So it proved. We also warned that if they did not keep to their promised debt disciplines there could be similar pressures in the debt markets to the ones which had destroyed the ERM in the currency markets. So it proved. We are now living through just such a crisis. There are unwanted new built homes in Ireland and Spain, huge debts throughout the southern countries, and the aftermath of a bank and property bubble in several countries.       So my answer as to whether  they can  be right was simple. No, they were not right in the past, and they are clearly not right today.

                So why then do so many powerful and intelligent people, officials and governments want to be wrong? Why do they revel in being wrong? Why do they specialise in ridiculing and belittling their critics, who have been proved comprehensively right so far on the economics of their various schemes for merger?

               The answer lies in the politics. There are many who strongly want a united Europe. They decided the trade, financial and monetary route was the best way of doing it. They did not fancy their chances of holding  a series of referenda in members states to gain approval to the establishment of a new country called Europe. They decided on a crab like sideways approach to union. They still want it. They plan to use the crisis of the Euro not to break up the EU but to have more EU. They see it as an opportunity, a chance to persuade the cowed and frightened peoples of Europe that more EU is the only option. 

                There is now the immense power of vested interest. The EU commands substantial resources. It makes many grand sounding and well paid appointments. Many in the political elite exchange jobs with those in the administrative EU elite. Why would they want to damage that? That’s why when the EU says all member states must cut their own budgets, they put the EU budget up. That’s why, when the markets say no-one should go on lending to some of these countries, the EU belatedly decides to lend, having secured control of the member state’s economy first. That’s why , when countries vote “No” in a referendum they are told to vote again. That’s why now the EU favours unelected governments, and moves rapidly to deny any referendum.

             The Parliamentary debate about the Autumn Statement is likely to be about the small numbers that have little impact on the scale of the problem. Labour will probably call again for a £2 billion a year bankers’ bonus tax, and think of ways of spending it a few times over on well intentioned schemes. The truth is spending an extra £2 billion or even an extra £10 billion does not make much difference in a £1500 billion economy.

             The Coalition government will rightly say that they need to have a credible path to cut the deficit, or else they could lose market confidence just as Euroland has lost market confidence. A country which has to face soaring interest costs can get into a vicious spiral like Greece and Portugal, where the extra cost of  borrowing forces them to cut other more worthwhile expenditures. This in turn can cut output more, and reduce tax revenues further. They then need to borrow yet more, but the interest cost is always against them.

             Labour do not deny this worry. They say their modest spending ideas can be paid for from extra tax on unpopular people. They now complain that the deficit under the Coalition is coming out at higher levels than planned. We are all deficit cutters now. Labour, after all, enacted law to require a halving of the deficit.

           So the issue is how do you cut the deficit?  Coalition plans to “limit” extra borrowing to £451 billion this Parliament were revised up to £485 billion in March. Few in the mainstream media noticed this. On Tuesday the OBR/government is likely to increase this extra borrowing to well above £500 billion for the 5 years. People will notice this. The mood has changed and the markets are circling other countries with debt problems.

           In order to preserve the confidence of lenders to the UK it is vital the government shows a credible path from here to cut the deficit, assuming lower growth than past plans. We have to live with a weak Euroland economy for the forseeable future. Privately financed infrastructure, and sensible measures to lend more to well based private sector business plans will help.

             Best of all would be a determined effort to shift most of the £1.2 trillion gross  liability of the state owned banks into private sector hands. RBS must be broken up, and three new banks that are strong enough to lend and trade without taxpayers support are needed. If they could inject say £30-50 billion of well based new lending into the economy from their private sector sources, that could generate some growth. They could help pay for the reservoirs,broadband links, toll roads, airport capacity and other things we need. They need to lend to good profitable schemes, not bubble lending like 2007.

              On the government’s own figures the UK state has outstanding liabilities of £3.5 tn. Shedding most of the banking risk would greatly improve the UK’s true credit standing. The government also needs to show it has new ideas to curb the growth of public spending, and has a will to achieve an affordable public sector pensions settlement. Then it can truly say it is tackling all three main areas of debt and worry. It needs to show strikers on Wednesday that there is a serious problem of pension affordability, and show it intends to grapple with it sensibly and fairly.

Here are the slides from the Euro lecture: The Future of the Euro(All Souls).

Today we hear that Belgian bonds have been downgraded. Another day, another problem for the architects of the Euro. They are getting to the point where investors do not wish to lend to any of the Euro area countries, because investors have grave misgivings about the longevity of the currency and the stability of the individual states seeking to borrow money.

I argued yesterday that orderly break up would be the least damaging way of proceeding. If each country had its own currency and Central Bank again, they could start to compete and put in place a domestic growth strategy that might work. There will be substantial  losses, but those losses are already there in the system, within the banks and bond holdings. The argument is over how quickly they should be taken, and how the pain should be distributed.

If they wish to carry on with their currency they have to get much faster and bolder at creating their EU state and all purpose Central Bank, to give the currency chance of life, backed by a credible sovereign capable of making the necessary decisions. That poses all sorts of difficult democratic issues.

Some of you have misread my point about top ranks in the navy and army. I do agree we have too few principal warships – that is a different argument. I was not criticisng the Navy for having too many senior officers. I was contrasting them with the army. The Navy has 422 officers of CAptain RN rank and above. The army has 2588 officers of Lieutenant Colonel rank and above. This I think is an interesting comparison.

Peter Bone MP has just circulated figures from the OBR to remind us of the large leap in the costs of our contributions to the EU. At a time when government talks about the need for budget restraints the UK faces a 116% increase in its net contributions to the EU, comparing 2010-15 with the five preceding years. Net contributions are the amount we pay in ,less the rebate, less the money we get back as EU spending.

Over the five year period gross contributions are forecast to rise by 8%, but net contributions more than double. This shows just what an expensive folly it was on the part of Mr Blair to surrender part of the UK’s very valuable rebate won by Margaret Thatcher. He did so in return for the promise that they would reform the Common Agrilcutural Policy in a way which lower its costs substantially. There is not much sign of that happening. The loss of abatement works out at around £2 billion a year of extra cost once if is fully phased in. This means they are also forecasting reduced EU spending in the UK relative to contributions.

Many of my constituents and correspondents do not feel we are getting value for the £41 billion the OBR says we will have to pay into the EU over the next five years. At a time of budget restraint people will naturally become very critical of such indulgence.

We read that Mr Barroso has told Mr Cameron he has to choose between protecting the city and having influence at the top table. That should not be the choice at all. The UK PM should simply defend the UK interest. The UK interest is not to help Euroland preside over its disaster or seek to influence their ill fated scheme, but to get us out from as much of the collateral damage as possible.

Over the last five Labour years gross expenditure was £12.4bn, £12.5 bn, £12.7bn, £14.1 bn and £9.5 bn.
The OBR forecast for 2010-11 onwards is £12.3 bn, £13.3bn, £12.8bn, £13.6bn. and £14.3 bn
The net figures for the last Labour years are £3.9bn, £4.6bn, £3.3bn, £2.5 bn, and £4.7 bn
The net forecasts are £7.6bn, £8.5 bn, £7.7bn, £8.3 bn and £ 8.9bn

There are other figures released by the ONS this week that have also attracted attention. These show that the 2010 figure shot up to £7.4 billion net and rose to £13 bn gross after abatement. If you extrapolate these figures you can up with a bigger headline than £41 billion for the five years.

It is also important to distinguish between the abatement which is a good thing because you get cash back, and the EU spending which is also taken off the gross contribution. This is far less satisfactory, as the spending may not offer good value or be on things you want to spend on. Taxpayers have to pay the gross bill, after the abatement. It still needs higher taxes to pay for the EU spending.

I have always wanted to start deficit reduction with big cuts in EU budgets. It’s a pity such a popular policy is ruled out by the undemocratic constitution of the EU.

I will be giving a lecture in the Old Library at All Souls College, High Street Oxford at 4pm on Friday 25th November.