A Free Lunch for Europe

In three short years Angela Merkel has gone from being the Superwoman to the Boggiewoman of Europe.  Having faced down the Euro crisis of 2011-12 she became the heroine of the hour – being fated around the world and the re-elected at home in 2014.  Her unwavering commitment to securing the Euro based on secure fiscal framework has made her the Mistress of Austerity.  It was she who enforced the bail-out process and the “Fiscal Pact” that accompanied the money.

Here's looking at you PIIGS

Forgive and Forget

The Greek crisis is about the only story being covered by the financial press.  It’s the perfect seasonal pantomime not unlike Cinderella – a damsel in distress (Greece and its distressed debts) the drama of a tight deadline (Greece could run out of cash in March), comedy villains (the Trokia of the ECB, the European Commission and the IMF), a grumpy old maid (Angela Merkel) a handsome prince (Alexis Tsipras, the Greek prime minister, and his henchman Yanis Varoufakis, the finance minister).  The only questions are; where is the Fairy Godmother who might save the damsel in distress and will there be a happy ending?

George and Yanis - could this be the start of a special relationship?

Floating free from Germany

Mario Drahgi has called for more integration and “sweeping powers” for the ECB to control fiscal policies and efforts to reform the Eurozone's economy. Is this “joined-up” thinking is a throw-back to the darkest days of the Euro crisis, when it became obvious that there was lack of cohesion between member states?  Or is this a power grab by the ECB, using the interminable recession, as an excuse to take control of a “fiscal and economic union”.  Currently the ECB owns interest rates and sets budget targets (roundly ignored by all but Germany), in this new and enlightened world the EBC would like set tax rates and drive to through supply side reforms to drive productivity and competiveness.

Drahgi believes in the “importance of each country sticking to its commitments under the stability and growth pact “and that this should now be beyond debate”.  He would like to go further by saying that in matter economic “sovereignty should be exercised jointly” – what a great line!!  What are the things that could do with harmonisation?

1. Actual interest rates
2. Rates of business taxation
3. Minimum wages and hours of work
4. Actual spending limits (properly enforced)

Living in Harmony

Germany's most important export is unemployment

Some time ago I posted a short piece entitled Austerity may be Wunderbar, the simple message in this blog was that Germany was the problem in the EuroZone not the solution.  Having joined the Euro at a grossly undervalued rate the German economy has been on the PIIGS back for the last fifteen years.  The net result of this competitiveness advantage was that in the years 1999-2008 German was able to re-boot its ailing economy by exporting cheaply to its European Partners where all control of credits markets had lapsed.  

It's not just cars, but unemployment, that Germany exports

On the PIIGS back - time to dump the Euro

It’s a life time since the Great Depression but the events on the twenties and thirties maintain a strong hold on our economic and political psyche.  During the intervening years the gold standard has figured prominently as the boogieman that deprived countries of the policy options required to combat the deepening slump. Firm evidence for the overly restrictive nature of the standard is provided by the economic rebound enjoyed by most countries choosing to exit the system, Britain being foremost in this regard.  What’s puzzling us today is why countries stayed wedded to the gold standard for so long.  The relative merits of the gold standard depended on the valuation on joining;  France joined as an under-valued currency whereas Britain re-joined in 1925 as an over-valued currency, this meant that when recession struck Britain was at a significant disadvantage to France and other competitive economies.  Without room to manoeuvre (easing monetary policy and lowering interest rates)  Britain ended up in economic and political turmoil, with an unemployment rate of  25% and the collapse of the Labour government who did not return to power until 1945.

The politics of Austerity – north south divide

There are two threats to recovery in the Eurozone, one is rising interest rates an inevitable consequence of Europe being two years behind the US in the recovery cycle and the second is politics.  It could prove to be a long hot summer in the PIIGS economies and in the dusty hallways of the European Central bank (ECB).  The good people of Italy, Spain, Ireland, Greece and specifically Portugal are being asked to endure years (potentially a decade) of austerity.  This Lutheran penance is being applied on these warm blooded catholic nations by the iron will and ice cold determination of German and Dutch bankers supported by the EU and the IMF.  The cheer leader for this chilling approach is Jeroen Dijsselbloem, Dutch finance minister and president of the Eurogroup, the Eurozone’s finance ministers.  His determination that these indebted economies on the fringe of the Eurozone should bail themselves out at breakneck speed is at the heart of the politics.

A grown up Germany needs a new partner

Modern Germany (the Federal Republic) is now 64 years old, which is pretty young in comparison to most other nation states in Europe.  But for this adolescent state the question of maturity is becoming important as Europe looks for leadership and a new sense of direction.  Angela Merkel has done a sterling job over the last 2 years in corralling the broken Southern Eurozone states into recovery mode.  However, there is a subtle difference between crisis management and business as usual.  Whilst countries like Spain, Italy and Greece have had no option today, they may be less inclined to kowtow to Berlin in the future. 

Troika make Portugal suffer - We should remember our oldest ally

As the Scots ruminate on whether they should throw the towel in on over 300 years of partnership with the English it’s important to put our alliance with the “Jocks” in perspective.  The English have much older and more solid alliances and in particular we have been bound to Portugal by treaty since May 1386.  In fact our diplomatic friendship goes even further back to the 1147 Siege of Lisbon, when English Crusaders en route to the Holy Land stopped and helped Portuguese King Afonso Henriques to conquer the city occupied by the Moors.

The Dutch cap set to create another financial crisis

The Dutch have made a few decisive contributions to the global financial system since the debacle of the Tulip-mania the first recorded financial bubble,  of 1636-1637.  An episode in which tulip bulb prices were propelled by speculators to incredible heights before collapsing and plunging the Dutch economy into a severe crisis that lasted for many years.  

This 'glorious' history did not appear to hold back Jeroen Dijsselbloem,  chairman of the eurozone finance ministers. who has led the charge on Cyprus.  The final deal is that Mr Anastasiades (Cyprus's PM) agreed to the closure of Laiki, the island’s second-largest bank, and the radical restructuring of Bank of Cyprus, the country’s biggest. In both banks, large uninsured deposits of more than €100,000 will be used to pay for the bailout; in Laiki, senior bondholders will also be “bailed-in”.

Cyprus - When a bail-in is not a bail-out

The last minute deal done in Brussels to cement the €15.6bn bail-out for Cyprus is, as with everything in Europe, something of a fudge.  The bail-out is required to re-finance both the Cypriot banks and the Government. The troika of the IMF, the EU finance ministers and the ECB have agreed to hand over €10bn of the loot but only if Cyprus can find the other €5.6bn.  Given that the country is bust the only immediate source of finance left on the island is private capital held by the insolvent banks.  The Cypriot government have decided that they cannot raid (tax) all deposit holders so the money will be raised exclusively from savers with bank deposits in excess of €100,000 (the insurance limit).  The blanket ‘tax’ will take no account of income or the value of other assets (property, stocks, etc.) and will probably have a disproportional impact on overseas investors who were attracted to Cypriot banks by the benign regulatory regime and overly generous interest rates.  Many of these investors are Russian and they may well have to take a haircut of over 20%.  Quite apart from the distasteful precedent of getting foreigners investors to finance the bail-out, the solution raises some other important questions.

Since the ECB put together its fighting fund to rescue the failed economies in the Eurozone there has been a principle that Banking debt and reconstruction would be separated from government solvency.  So in Spain a number of banks have been bailed out in advance of the deal to resolve government indebtedness.  With Cyprus there was apparently no willingness to use European Stability Mechanism (ESM) money directly to recapitalise the banks, even though that is being done successfully with the Bankia in Spain.  By linking government debt and banking debts the troika risk the flight of capital from fragile banks all over Europe.  If you had over €100,000 in an Italian bank this morning what would you do?  The answer is - move it to Switzerland!  This may be a good time to buy shares in UBS!

The second major issue is that to successfully raid private deposits in Cyprus the government will have to put in place capital controls to ensure the banks don’t lose deposits.  Russian depositors were threatening to remove their spoils if they are subjected to any kind of a haircut.  Any significant fight of capital would quickly render these organisations insolvent;  as almost no amount of capital is sufficient for a bank which has lost the confidence of its depositors.  These temporary capital controls replicate what happened in the Icelandic banking crisis, where temporary controls have proven impossible to remove.   Interestingly to have these controls within the borders of a “single currency” is in breach one of the basic principles of a single currency; as by introducing capital controls Cyprus is creating its own currency within the Eurozone. 

So the results for the Troika is the worst of all worlds;  they have had to inject money into Cyprus at the same time as guaranteeing its exit for the Eurozone, they could have saved themselves  €10bn and simply pushed Cyprus into default!  Additionally, they have probably destroyed any confidence the wider European public might have in the ESM.

ECB mess up in Cyprus

Why does the Eurozone’s bail-out of Cyprus and its banks matter, when the island contributes only 0.2% of the EU GDP?   Up until a couple of days ago it didn't matter and we were expecting the European Central Bank (ECB) to swot this annoying fly with ease, but we should have known better.  Rather than find the full amount required to restructure the Island and its banks, €17 billion, they have appeased German taxpayers and come up with a deal for €10 billion.  Both of these numbers are insignificant in the scheme of things.  This change of heart now raises a number of important questions that hang over the multi-trillion € restructuring required in Spain, Italy and France.

The ECB grabbed the €7 billion bail-out saving from the clients of Cyprus’s outsized banks. As expected a one-off 10% levy will be imposed on all deposits over the insurance threshold of €100,000 before banks reopen after a bank holiday on Monday, hitting wealthier savers. What had not been anticipated was a 6.75% 'haircut' for all other savers. Perhaps the Cypriot government wanted to spread the pain around rather than penalise non-resident depositors and de-stabalise its important relationship with Russian.  This crass local decision could now set off a series of events that impact the global economy.

Some insurance scheme

The ECB are still facing the restructuring cliff with the much larger economies of Spain, Italy and France, all of whom need support.  This deal in Cyprus sends a strong signals to the rest of Europe that: all savings are at risk, shareholders / bond holders are to be protected and within this framework of unfairness almost any tactic might be employed.  This could have three important results:

1. Large number of savers will start to withdraw their savings from banks, further weakening the already broken banking sector.  This will have the effect of lowering bank liquidity ratios, which the ECB are so keen to increase.
2. There could be further political unrest over the escape trick the bond holders (other banks in the EU) have pulled to avoid any 'haircut'.  A sense of unfairness could become the spark for political crises that will finally trigger a full blow economic melt down
3. Perhaps most dangerous of all is that no one will know what to expect next time. If the ECB's restructuring tactics vary from country to country how do other States prepare themselves politically and economically for this restructuring?  Well, they can't and probably won't!

As the home-made bomb thrown in Sarajevo in 1914 sparked the Great War in Europe, let's hope a €6 billion mistake doesn't light the touch paper on a multi-trillion € financial crisis that the ECB was empowered to contain.

Get more doom and gloom from the FT

http://www.ft.com/cms/s/0/e36274d4-8fe3-11e2-ae9e-00144feabdc0.html

Savers to the slaughter

Ben Bernanke’s (Chairman of the Federal Reserve) was hauled up in front of Congress to explain the rationale behind the Fed’s third, $85bn-a-month round of quantitative easing (QE), and to evidence that the benefits still outweigh its costs and risks.   Bernanke is in the same mould as our own, ex-Chancellor, Geoffrey Howe who’s debating style was described by Denis Healey as ‘…like being savaged by a dead sheep’ – but Bernanke got so angry that he told one of his inquisitors “none of the things you said are accurate”. Ouch!

Denis Healey - great eyebrows!

So what’s got Bernanke’s blood up?  My guess its nervousness that QE is actually the wrong thing to be doing.  He spent quite a bit of time warning Congress on the economic dangers ahead.  He picked out oil price increases and the inflationary pressure this will bring.  Although no one has the foggiest clue what the benefits of QE might be there is broad agreement on the dangers and top of the list is stoking up future inflationary pressure.  As the Fed’s own projections for growth in 2013 in December were at a pretty impressive 3 per cent one wonders why they want to pour more fuel on the fire.  The other risk that the Bernanke was keen to high light was the turmoil in the Eurozone, which took a turn for the worse yesterday as the Italians voted for chaos and disaster rather than more austerity.   Surely the Fed needs to keep its ‘power dry’ to help shore up the US banks in the event of a Euro meltdown rather than throwing banknotes off the roof of the Empire State building (about as scientific as QE).

The real danger of this blind faith in QE is that it gives the Republican Party a juicy bone to chew on.  With all the other important Fiscal decisions that need to be made, with Republican support, hanging on to QE seems to be unnecessarily dogmatic.  If the Fed needs further evidence of the worthlessness of asset purchase schemes (QE) they should look at the experience we have had in the UK where we have burnt through over £375 bn ($578 bn) in QE since 2009.  This has had the effect of:

1. Crippling savers throughlow interest rates / high inflation
2. Supporting thousands of  ‘Zombie’ companies that are limping along tying up valuable capital and resources
3. Soaking up valuable financial resources, which we may need when the wheels final come off the Eurozone (watch out for the German election in September)

Caligula's comeback

Recessions and the associated economic retrenchment that's required is painful but it does have some entertaining fringe benefits.  General speaking the music gets better and certainly the politics gets more interesting and this is absolutely the case in Europe.

Oh what joy the Italians bring to current affairs, to wake up the morning after their election to find that over a quarter of the electorate have, in an absolutely critical election, voted for a failed comedian and a bunch of policies that set out what politicians shouldn't do rather than how to save the crumbling economy.  In the maddest political moment since Caligula ( Roman Emperor from 37 AD to 41 AD) decided that he would promote his horse Incitatus to be a consul.

Incitatus 

Grillo's policies include:  a New electoral system, based on proportional representation; halving number of MPs; end of public funding of parties, fixed term for MPs. Support for renewable energy, free internet provision, Voting age reduced to 16 (from 18) and 18 for the Senate (from 25) and a Referendum on leaving euro. 

The result of this aberration is that we now have a hung parliament in which the dullest politician in Europe holds a third of the seats, Beppe Grillo the modern day Caligula holds a quarter as does Burlesqueoknee, (the worst politician in Europe), the rest being held but Super Mario Monti - the technocrat ex premier. One can only surmise that:

1. One third of the population of Italy are even duller that Pier Luigi Bersani - the centre left leader
2. A quarter of the population were paid by Silvion Berlusconi to vote for him
3. A tenth of the population are devoid of any political nous and voted for the failed technocrat
4. And the final quarter are horses that believe they are in with a chance of being one of Grillo's consuls

The Four Musketeers

If pigs - could fly

The most troubled Euro economies have be given an acronym PIIGS, used by international bond market, and the economic press to refer to the broken economies of Portugal, Ireland, Italy, Greece and Spain. The bad news in that there is now a new member of this wayward group and it's new member is France.  So the new acronym will now have to be - IF PIGS!


Whilst the recent degree of calm surrounding the EURO might be good news for the world economy it doesn't help France.  As rates in the sovereign bond market have eased the Euro has strengthened against the Dollar and the Pound, this leaves the French economy in a more parlous productivity position, with its goods priced out of foreign markets.  Also France has rapidly become less competitive  relative to other economies in the Eurozone as high unemployment elsewhere has squeezed down wages in the peripheral economies, whilst France's labour laws keep costs high at home.



This is the major reason why Francois Hollande is calling for an exchange-rate policy (coded language for devaluation) , the last thing on the Angela Merkel's mind.   Germany has always wanted a strong currency to drive productivity, particularly since it has a captive export market in the less productive Eurozone.

Why is this important?  

We Brits always enjoy it when the French are in a tight spot, but this situation could be even more enjoyable than normal, particularly for Dave (Cameron).  As Dave musters support for his renegotiation his natural ally would be Germany, they will need Britain to counterbalance the more socialist tendencies of Hollande.  These tendencies look set to become more so and less aligned to Germany and this could be our big opportunity to divide and rule.  Some time ago I  derided  Boris Johnson for promoting the idea of an 'Outer Tier' of EU members not in the Eurozone - but as this French economic disaster unravels he might actually be right!

Dave's Speech

Not much in the speech, certainly nothing new.  But the politics are interesting of course. By committing to an in-out referendum Dave is hoping to put UKIP on ice at the next General Election (2015), if he doesn't do this then the fear is that the centre right vote will be split and Labour will be back in power.

I guess Dave is hoping that the other parties will opt to be anti-referendum, which would further shore-up the core Tory vote, or would it.  The really interesting scenarios arise from ones prognosis of the Euro negotiations, if they go badly Dave has signaled that he will campaign for withdrawal and this quite likely. So here are some of these scenarios modeled out.  Maybe Dave is betting on a poor deal from Europe and the freedom to campaign for withdrawal, because this looks his most likely road to success.

When Harold Wilson tried this referendum trick in the '70ies he managed to con the country that his 'new deal' was substantially better - when it was anything but!  Dave will be under much greater scrutiny so it will be very difficult to prove that the new deal is different, but countered against this a number of Europeans will be desperate for us to stay in! So let the fun begin!

One Direction for Dave

So Euro speech day is now tomorrow as Dave tries to up-stage Obama's inauguration (I dont think so Dave).  Some of the speech has leaked to an impatient press and the Spectator has some snippets.


http://blogs.spectator.co.uk/coffeehouse/2013/01/david-camerons-delayed-eu-speech-extracts/



Britain is unusual in that its most powerful politicians openly question their country’s membership of the union. It is isolated among sizeable EU countries in its determination to change fundamentally its relationship with the union. Much more than Mr Cameron implies, Britain is alone. But there are things that we have in common as poll below suggest.  Asked if The EU is going in the right or wrong direction the stats as presented as a %

This is interesting and Dave can build on the fact that many people in the EU feel that The EU is heading in the wrong direction - in fact 52% of us think this is the case, obviously the Greeks, Italy and the Spanish have a problem but even  countries like Belgium and Holland are as negative as we are.  So we have an opportunity to use this disaffection to recast the EU into a more productive Union for those in the Eurozone and those outside.  So we're all in the same boat -

This could be Dave's big moment in history but its nor likely to eclipse Obama's big day!