As we get ready for the meetings of the IMF and World Bank this coming week-end a familiar Euro crisis is brewing again. Yesterday Spanish ten year bond yields rose more, to 6.16%.  This week Spain is planning to tap the 12 and 18 month money market on Tuesday, and to raise 2 and 10 year money on Thursday. It needs to carry on borrowing, to keep pace with its deficit, to pay all those public sector bills. Some are alarmed at how much it will have to pay to carry on borrowing.

        Spanish shares have been falling. Markets have raised more doubts about some Spanish banks. The government has taken powers to be able to move in and run any regional government in Spain which does not do a better job this year of running its own finances. In March Spanish banks were borrowing Euro 316 billion from the European Central Bank, a large sum.

          The original idea of the EU in response to earlier versions of the crisis was to set up a big “firewall” or fund of money to bail out countries in trouble. They then wished the IMF to put a lot more of its members money at risk to back up the European funds.  This has been held back by German reluctance to sign up to a very large European fund, and by US resistance to the idea that it should contribute through the IMF when Euroland does not do more for itself.

          The Germans successfully pegged the total funds available from Euroland and the EU to a possible Euro 800 billion, of which 300 billion is already pledged to Greece, Portugal and Ireland under existing programmes. Much of this money has to be borrowed by the European Stability Mechanism in due course, which is a Luxembourg intergovernmental organisation backed by the credit ratings of the Euro area countries.

             The IMF is being asked by the Euroland countries to have more money available to stand behind the possible borrowed funds the Europeans might raise on their own credit account. Japan and China are indicating that they might  put some money in. They do not wish the Euro to flounder, and they would like the Euro to stay higher against their currencies for trade reasons. So too might some of the other emerging market economies. It is unlikely the US will change its stance from “No”, as it is difficult to imagine Congress and Senate voting to ratify such spending, especially in an election year. The UK’s position is also undecided.

                 The truth is large firewalls cannot solve the big underlying problems. The emergency funds dispensed so far have bought some more time. This time has to be used to tackle the underlying huge imbalances. Somehow member states in the Euro have to show they can finance their budget deficits in the normal way without needing subsidised finance. Somehow the Euro zone has to finance its trade with itself comfortably. Somehow the zone has to strengthen its banks without forcing yet more austerity and recession on the weakest countries. That would be a useful agenda for the IMF to work through. Instead the Euro part of the discussion may turn out to be yet another talk about the extent of firewall funds, who pays the bills and when they might get set up. Instead of discussing how to finance failure, more thought needs to be given about how to get member countries out of the need for subsidised loans in the first place.

 

              Several contributors want to hear more about the many ways in which the EU affects or controls our lives. There are all too many ways, following years of EU directives and regulations, based on the huge powers transferred in The Treaties of Rome, Nice, Amsterdam and Lisbon, to name but four that rarely get mentioned.

              In recent years the EU has been granted large new powers to regulate banks and financial institutions. This week-end reports ciruclated that the EU is now considering imposing capital surcharges of as much as 10% of a bank’s assets on EU large banks on top of the minimum 7% capital ratio required already.

              The aim is to stop EU banks getting into the mess they got into in the 2008-12 period. That is a worthy aim, but this remedy does not seem to be based on any sensible analysis of why various large EU banks got into difficulties in that period or what is needed to get us out of the mess. There is little  recognition that Central Banks and regulators got it wrong as well as the commercial banks, producing a toxic mixture. It does not tackle the problem we have often discussed here, of weak banks lending money to overborrowed countries, which in turn undermines the value of the loans to those states made by the banks. The way the Regulators and the ECB have encouraged banks to hold more of their own government’s debt has caused problems for banks in countries like Greece and Portugal, instead of strengthening them.

               Forcing banks that are weak to hold much more capital does not ease the problems we face. Rather it intensifies them. It will mean that banks are even less able to finance recovery in weak economies. It will help drive asset values down further, leading to more bankruptcies and further losses for the banks. If a weak bank is told to hold more capital  relative to its lending, its easiest option to c0mply is to lend less. If banks in recession ridden economies lend less, asset values for things like property are likely to fall further. More firms go bust, and more assets return to the banks for fire sales. The banks lose  more money, so they hold less capital. They then need to lend less again, to comply with the Regulator’s wishes. A country can get into a downward spiral.

                 This regulatory policy, alongside the policies demanding higher taxes and lower public spending, will reinforce any deflationary tendencies in these weakened economies. The EU does not need less growth. It needs more. We need counter cyclical regulation. This is the worst kind of regulation, which intensifies the cycle. It makes things worse.

 

         I did not watch the Grand National. I saw some of the events on the TV news later. Surely it is time to change the course and the race so that the safety of horses is looked after?

          No-one would find it acceptable if a couple of drivers died in every Grand Prix car race. Formula One has responded to driver and spectator worries about past fatalities of drivers by making the circuits safer and improving the safety of the cars. We can now enjoy Formula One racing  in the knowledge that the death of a driver is extremely unlikely, even in a  bad crash.  

          So how can we enjoy a race which has led to the death of  two horses in 2011 and another two fine horses in 2012?  I am not suggesting legislators should ban the race, but I am suggesting all those in the racing industry should recognise that there is now a very strong feeling amongst many of us that the injury and death rate is unacceptably high. It is time the racing authorities took sufficient action, as Formula One seems to have done.

 

        Out on the doorsteps  the voices of  voters can be heard complaining of just how much money government takes from them in differing ways. There are many complaints about public sector car park charges, the Congestion Charge in London, the Council Tax, taxi licence charges,  planning fees, Stamp duties, Child Benefit withdrawal, tax credit changes, higher National Insurance, rising  postage stamp prices, the failure to increase the Age Allowance for pensioners, the charity tax allowance changes: I have even had a strong complaint about ice cream vendor licence charges. From public sector workers come worries about their pension contribution increases and the worsening of the terms of their pension plans.

           The doorsteps are reflecting the growing feeling  I have that we have reached tax saturation point. Councils are looking for all sorts of fees and charges to raise, as a way to maintain spending levels without large Council Tax increases.  Central government is looking for ways to tax individuals more, including  their own public sector employees, through increased taxes, charges and deductions. Some on the doorsteps demand more cuts in spending, and give examples of less desirable or wasteful expenditure they could do without. Many others are more reticent than in previous years about demanding more spending, as they appreciate that money is tight and that maybe we are up against the limit.

          There is a growing frustration with all political parties. People do not feel the parties are listening to them about how squeezed they feel. In one nearby Council area I was told that a single person ice cream vendor in a  van has to pay £3000 for an annual licence, on top of his fuel duty and VAT on inputs, National Insurance and Income Tax. At the petrol pumps  the best part of £1 a litre is now paid as tax on every litre of diesel. If you travel 20,000 miles a year on busienss in a 40mpg diesel your fuel tax bill would be around £2000. Someone trying to buy a modest one bedroom flat in Central London would pay £20,000 or more in Stamp Duty for the privilege. A typical Council Tax bill is now well into four figures.

             For small businesses the level of compliance costs with regulations, licence fees, initial banking charges, and the continuing round of public sector fees and charges can be enough to put people off starting, or to drive the business under in the early years. Tax saturation is a serious condition which undermines enterprise, reduces demand, and makes many individuals and families feel bad about their own personal circumstances. That is why government and local government need to ensure every pound they spend is well spent, on a cause supported by many voters. The country is down about the extent to which people on modest incomes are having to pay the government’s bills.

 

I thought this government was going to extend our civil liberties. They made a good start, removing the threat of compulsory ID cards, and changing detention without trial. I have no wish for them to increase the surveillance of the state, and hope Mr Clegg wins his battle over the latest database issue.

Nor do I think it a good idea to cut the tax relief available for charitable giving. As I wrote on 8th April here, that policy is at variance with the Big Society idea.  The Treasury needs to grasp that large donors to charities do not make money themselves out of the gift – they are just being generous. The charity gets the extra advantage from the tax break.

I was surprised to hear Vince Cable say he did not want this proposal. Not because I expect Vince to keep to collective responsibility and defend the government, but because I thought the limitation of total tax relief available to the rich was a Lib Dem idea brought into the budget.

As I have been trying to point out for some time, one person’s tax avoidance is another person’s rational tax planning, is the government’s encouragement to better behaviour. A lot of tax avoidance has a moral purpose – to give money to charity, to save for retirement so you are not a charge on the state in old age, to save for a  rainy day to avoid benefit claims or to set up an enterprise which may have a wider social purpose. That is why governments of all persuasions offer a series of tax breaks, and why many people take advantage of them.

The charity break is perhaps the most altruistic. It is certainly the one with no benefit to the donor, other than a feeling of doing good. I am not surprised that a campaign is building up to change this proposal. I am glad the Prime Minister has said this is a consultation, and they are listening carefully.

The truth is simple. All the time the state spends so much more than its normal level of  income there will be stresses and strains trying to collect more. The government  has discovered that a few very rich people happen to be very generous to larger charities. They have eyed this money, as being an easy way to raise more tax. They are discovering it is not as easy as they thought. It comes down to a simple question – is what a Cancer or disability charity doing more valuable work than the government? Many people think so. They would prefer the rich person to give their money to the charity rather than giving it to the state. It can’t go to both. Parliament has to make a choice.

The sad truth is that even if the state took all the donated cash instead of charities, there would still be a huge gap between state spending and state revenues. This a very simple question – should the state get the money or should a charity – either way the rich person gives it away. How you answer such a question will say something about what sort of society you want to live in.  Should a rich person be made to give more to the state, or encouraged to give more to a good cause by offering tax relief to the charity?

 

            Part of the planned recovery of the UK  economy from the recession, credit crunch and over extended public sector is forecast to come from an export boom. Yesterday’s figures for March were disappointing, but they are just one month’s figures. They show a fall  in exports of goods from January to February, a rise of £1 billion in the overall deficit, with exports of services still yielding a very handy £5.4 billion surplus.

           Within the goods export figures, the weakeness was greater with the rest of the world than with the rest of the EU, despite the gathering economic weakness on the continent.  What more should be done to improve the position?

            The Prime Minister and other leading Ministers are well aware of the need to improve the UK’s export performance to the faster growing parts of the world. They realise that the EU market is going to be stagnant at best for some time to come, given the obvious stresses in the Euro and the policies of mutual deflation being pursued there. They are hopping on to planes to take senior business people off to Asian, Middle Eastern  and Latin American destinations, and  doing their bit as super salesmen where government can make a difference or is expected to be in support.

             Meanwhile, back home, it is taking time to create  the extra factory output needed when the UK does have a success on its hands. Consider the case of Jaguar/Land Rover. Last year they launched an attractive new vehicle, the Range Rover Evoque. It was clear from the pre launch expressions of interest, and from the early reviews and orders, that this was going to be a big hit. Now there are  frustrated UK buyers, told to wait six months for delivery, now facing a minimum of nine months wait for their vehicle. It is taking time  to crank up production to the levels needed to satisfy buoyant home and export demand. Home demand may in part be import saving, as the prospective purchasers may otherwise  opt for a foreign made vehicle.

               UK manufacturing is restricted in output when it has popular products. It takes time to get planning permission, to recruit and train a good workforce, to negotiate all the regulatory hurdles, if you can obtain the capital  needed to establish the larger plant.  Meanwhile energy intensive business is under pressure from the high energy costs that a UK and EU base entail compared to US and emerging market competititors. The government is trying to abate the high prices for the largest users of energy through subsidy, but energy cost remains an obstacle to successful competitive manufacturing in the UK. it needs instead to trigger more energy developments, and to pursue a policy of cheaper energy instead of interfering with the market in a way designed to raise prices.

 

 

 

The Governing law

 

Changing a currency entails dealings with several  jurisdictions depending on the transaction or agreement.  There are broadly four categories we need to consider. There are agreements and contracts within the country leaving the Euro. There are contracts and agreements between people and companies in the exit country and people and companies elsewhere in the Euro zone. There are agreements and contracts between people or companies in the exit country, and people and companies outside the Euro zone. There are contracts and agreements between people and companies outside the exit country using the Euro for their own purposes.

 

Contracts and agreements between people and companies within the exit country.

 

These contracts and agreements can be changed by domestic law in the exit country. If the recommendation is accepted that these should be changed automatically into new currency contracts and agreements, the exit state needs to pass the relevant law making it clear this has to happen.

It would be wise in the new law requiring this to deal with the issue of whether adversely affected parties could appeal to European jurisdiction against the change. The domestic law could include a clause pointing out that the exit country has now become an EU country with a derogation over belonging to the Euro. It could also explicitly suspend appeal on these matters to the ECJ. This could be buttressed by a decision of the EU to say that the EU approves of the decision to convert these contracts into the new currency, making an appeal futile or impossible.

 

Contracts and agreements between people and companies within the exit country and people and companies within the rest of the EU

 

This is a more difficult set of cases, if the decision is taken to convert these into the new currency as well. Lenders from other EU countries will lose from devaluation, though borrowers will of course benefit.  Unless express legal action is taken there could be law suits by losers from outside the country complaining about the compulsory conversion of their contract.

If the decision is taken to proceed with compulsory conversion of these contracts it would be wise to change EU law expressly and accordingly. The EU could pass a regulation  denying redress to individuals and corporations who had lost money as  a result of the compulsory switching of their assets to a different currency.

 

Contracts and agreements between people and companies within the exit country and people and companies from outside the EU

 

Varying these contracts would be an assertion of extra territorial powers, which might be going too far in the circumstances. The easiest option is to leave these contracts and agreements in Euros, as the Euro survives as a trading currency if one or a few countries leave it.

 

The EU did of course assert such jurisdiction when it established the Euro. By destroying big trading currencies like the DM and the French franc it forced conversion of contracts and agreements. It got away with it, without a big legal challenge to its chosen course of action.  Were the EU to decide to abandon the Euro and to return all countries to their own currencies, then it would have to take a similar legal risk to the risk it ran when establishing the currency. There would be limited point in people challenging the decision, as the Euro would cease to exist, making enforcement of the Euro contracts impossible.

 

The decision could be taken to convert all these contracts into new currency. Individual contracts might be exempted, depending on the governing law determining the contract. It would be a matter for individual negotiation and decision in the light of the general policy and the governing law in each case. The author has ascertained that the US might accept such assertion of power over US nationals  if it were endorsed and supported by the IMF.  It is recommended that the EU does not seek to assert jurisdiction on non EU individuals and companies  if presiding over limited exits from the zone.

 

Contracts and agreements between people and companies outside the exit country in Euros.

 

In the circumstances where the Euro continues as a main currency, it would be best to leave all these contracts in Euros.  Whilst some of them relate to assets and liabilities within the exit country, neither the EU nor the exit country government have clear powers over the contracting parties. It would seem to be a needless complication to try to assert power to convert against the wishes of one or more of the contracting parties. They might decide to do so for their own reasons, but that can be left to private negotiation.

 

Contracts between people and companies in countries remaining in the Euro area

 

There can be a genuine choice of options here. The EU as a whole would have the legal clout to enforce compulsory conversion of contracts into the new currency. There would, however, be no pressing need to do so, as the contracting parties would still be working on most of their other budget matters in Euros and may well have Euro streams of revenue.

There is a case for the compulsory conversion of Euro contracts relating wholly to exit country assets and liabilities into the new currency. There is also a case for leaving it to individual negotiation. For the sake of simplicity  I recommend not seeking compulsory conversion.

 

 In the late 1980s and early 1990s people used to tell me that Sweden proved you could have high public spending and economic success. There was no need to keep public spending as a percentage of output down as they did then  in the US, no need to go in for raw capitalism like America. I was urged to love the Swedish model.

As often with these things just as people urged others to follow, the weaknesses of the chosen example were about to become plain. In 1992 the Swedish crisis started. It all looks very familiar. It was a combination of an Irish/ Spanish style property crash and banking crisis, and  a state finance crisis all rolled into one.

The Swedes nationalised their problem banks, but on tougher terms than the UK did in 2008. It cost them around 4% of GDP, but they got some of it back later when they resold the banks once restored to health. They had their own sub prime crisis.

The state also decided that its welfare programmes were too generous, and its borrowing levels unacceptable. They settled on fiscal rules designed to eliminate  state borrowing  in future. Between 1994 and 1998 they eliminated their deficit. They cut all sorts of welfare benefits to make them less generous. It was not what politicians wish to do, nor was it friendly to the many now out of work.

Unemployment benefit, originally paid with no waiting period at 90% of previous earnings (up to a limit) was cut to 75% of past earning with a 5 day delay. It was limited to 300 days of claim. Eligibility for disability pension was tightened. To receive a basic pension an individual had to show 40 years of residence.  They tightened the definition of a work injury to make a substantial reduction in work injury claims.  Health insurance was made meaner.  In 1993 and again in 1996 they cut the pension indexing payments.  In 1996 they cut Child Allowance and withdrew the supplement for more than 2 children.

Once Sweden made her spending cuts, got to a balanced budget, and following devaluation of the krona, the economy started to perform better. I’m not sure that was the Swedish model my advisers had in mind.

 

           The Euro crisis is returning. Yesterday the cost of borrowing  ten year money for the Spanish government  hit 5.98%, following a giddy rise in the last few days. The government was forced into announcing another Euro 10 billion of cuts, this time in regional government’s health and education spending.

          Some of you may recall that recently we read of the most austere budget ever in Spain, with Euro 27 billion of cuts. This was the new government’s fevered attempt to get the Spanish public sector deficit down to 5.3%, from the 8.5% it ran at last year. In 2011 the then government overshot its target of a 6% deficit by a mighty 2.5% of GDP (around 27 billion Euros). This year the new government budgets to overshoot the old 4.4% target by just 0.9% of GDP. These are still large numbers.

            The spin, as ever, differs from the reality. The Euro 27 billion most austere budget included Euro 15 billion of “cuts” announced last December.  The austerity is tougher on the private sector than the public. It includes large increases in gas and electricity prices to cut the state subsidies. Income Tax goes  up by tapered amounts, with a rate rise of 7% more on the higher incomes.  Companies are expected to pay Euro 12.3 billion more . They aim to get Euro 2.5 billion from a 10% no questions asked tax for anyone bringing offshore money home.  I cannot see that being too popular.

            Central government personnel costs will rise by  1.3%, in a” tough” stance that includes a pay freeze! Like many governments, the Spanish one announces strict measures implying they are mainly public spending cuts, but in practice they are more to do with squeezing the private sector to pay for the bills. Yesterday’s news was for spending cuts in sensitive areas administered by regions often hostile to the central government. It was more an invitation to a row than  anything else. Meanwhile unemployment benefit payments and interest bills surge.

        The problem with all this austerity, as many now point out, is it can be self defeating. Spain needs a private sector led recovery. Instead the government is squeezing family budgets at all levels of income. This may produce a worse decline in national output than the government allows for in its figures. This in turn may produce less revenue, widening the deficit further. Yesterday’s  move to appease the market gods may not succeed. Many EU countries need to run their public sectors more efficiently and do less through them. It would help if the EU showed them how, by cutting back on its own expenditures and requirements placed on EU member states. Instead, they just demand more, whilst also demanding that the member states borrow less. It is not a winning formula. Expect some more bad news from the markets. Spain denies she will need to put more capital into her banks, but some of them are having a hard time in the markets as well.

 

 

               Most people want their government to collect sensible amounts of tax and to provide decent services for the money. They wish the government to uphold the law against criminals. They think most our problems are ones coming from too much law,  not too little, or from imperfect enforcement of laws we do have against criminal activity.

               Modern bureaucratic  government seems to think most of the problems come from the actions of the people.

               Health officials want people to be less fat, to eat a better diet, drink less alcohol, take more exercise. They may be right that this would make people healthier, and delay their time with doctors and hospitals to older age. Meanwhile the public wants the NHS to be there for them whatever they do. Some resent the taxes and regulations used to try to change our lifestyles.

               More resent the work of the green police. The latest idea that if  you want to apply for a home improvement, the Council can make you undertake various energy improvement works at the same time is going down badly in some quarters. People feel that if they worked hard and manage to have a little money left over after all the Income Tax, National Insurance and VAT they should be allowed to spend it on a home improvement of their choice, not on improvements of the government’s choice.

               Motorists are often on the wrong end of the official view of how we should behave. There is endless expensive fiddling with the road network to try to change motorists behaviour in many places.

               Tax policy has become a Clapham Junction of differing signals. Higher taxes to stop binge drinking, smoking, travelling abroad, travelling by car or plane, using roads in Central London, making good profits, earning a good income and employing people. Tax  breaks to promote going by bus (fuel duty),  going by train (subsidy), saving for retirement, saving generally, lending to the government, and giving money to charity.

                 Now the government sees the need to define aggressive tax avoidance, a legal but morallyrepugnant activity. The best way to stop morally repugnant tax avoidance is to define it and make it illegal.

                 Many members of the public want the government to concentrate on what it spends, and get better value for the money, instead of telling us what to spend.  The more governments think it is about the way people behave, the more voters will it turn it back on the government and complain about the way they behave. Let the one without sin hurl the first legislative stone.