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

Winning the productivity race

Seven years on from the start of the Great Recession the slump looks set to go on and on.  Even David Cameron who seldom mentions the economy was stirred this week to reinforce the message that - the worst may not be over.

Certainly, in the UK we have had some growth but we still have high levels of government debt and a crippling trade deficit and our main trading partner is in real trouble.  It is now certain that the major economies in the developed world will never recover the lost demand that has opened up between actual GDP and the trend line established over the last 20 years.  This puts us in new territory, as in every other recent recession the global economy has always been able to close gap in “temporary” lost demand during the expansion phase of the economic cycle.  In real terms, people in virtually every developed country will be poorer at the end of this economic cycle than in 2007!  This is a pretty stunning revelation – we have forgotten how to grow!
 

What a hedgehog knows

When, in 1948, Mikhail Naimy  wrote “The more elaborate his labyrinths, the further from the Sun his face” he was already living in a world that was being over-run by complexity.  Most of the greatest insights in art and science since the end of the Second World War have been conceived in a dense soup of analysis.  There will no more be simple insights that change the world – mastering the complexity is everything.  The keen amateur who is able to think freely and creatively is no longer taken seriously;  the potting shed had been replaced by the data centre such is the explosion of data and variables required to understand the problems we face. We are living in the age of the Fox (who knows many small things).
This up-tick in complexity is obvious in the world of macro-economics as the simple relationships between money, prices, capacity and rates of interest no longer seem to work.  Also old certainties about productivity and wealth have been debunked – this is an uncomfortable world for the Hedgehog – (who only knows one big thing).  Obvious problems create resolutions that can be faced with bravery, although tactics may vary we can unite behind a shared vision or oppose it full on.   If the problem is too complex to articulate then there will be no solution only a vacuum.

Where are the hedgehogs

Time up for QE

No one really understands it and because of this opinions are all the more divided and intransigent. Despite this incoherence the market has understood enough to know that it drives asset prices and confidence in future prices.  It is QE – quantitative easing.

Ben Bernanke - the Godfather of QE

QE is where Central Banks print themselves some money to buy bonds and other instruments from the banks, the idea is that this puts cash / liquidity into the economy increasing the money supply and making credit more freely available.  Under “normal” conditions of growth (+2-3% annually)and inflation (around 2% annually) equilibrium this would drive up aggregate demand (growth)  and inflation as the banks push this extra liquidity out into the market in the form of loans.

Solving Secular Stagnation

There is now a sense of gloom that pervades the corridors of power in the developed world, six years on from the Lehman Brothers' default and the ensuing “great recession” we are still in the economic dead-zone.  In particular Europe is marred by low growth, high unemployment, falling prices and the worry is that this is the “new normal”.  Most economist are satisfied that the problem is poor aggregate demand, caused by falling investment in both the private and public sectors combined with diminishing disposable income - wages have been flat for years.  This malaise has been characterised as “Secular Stagnation” (SS), a term made famous by Larry Summers a former Head of the US Treasury department.

Larry Summers - feeling the torpor of Secular Stagnation

The IMF gives more poor advice

The IMF have made some interesting pronouncements over the last few years – having missed the credit crunch and the “great recession” that followed they at first endorsed the UKs plan A and then decried it just as it was starting to work – so we shouldn’t hold up too much hope that the Fund will have anything sensible to say on the matter of European recovery.  No one was too interested when they published their World Economic Outlook, which is normally like a school report – “the UK could try harder”, “France needs to apply herself and complete home work on time” – you get the picture.  But this time round it was a bit more specific and surprisingly so; normally the IMF is reasonably hawkish, looking to solve problems through monetary policy (what would expect, it’s a bank) but in this report the IMF suggest substantially increased public spending on infrastructure investment, and across much of the world.   It asserts that when unemployment is high and interest rates are low, the benefits will be greater if investment is paid for by increased borrowing, rather than cutting other spending or raising taxes. Most interestingly, the IMF declares that good infrastructure investment will reduce rather than increase government debt burdens as public infrastructure investments pay for themselves.  Confusingly the whole 44 page synopsis of the WEO highlights a number of risks to the world economy – political risk in Russia, property bubbles, shortages of natural gas, etc;  but report hardly mentions the debts run up by governments and leverage in the banking system - convenient eh!

Christine Lagarde Head of the IMF points the way forward

Cutting Taxes and Axing Osborne

In 2010 the Tories had plan A, deficit reduction, and by and large the British public bought the idea, which was simple, “We have to cut the deficit because sky-high public debt will kill growth and investment and lead to long term depression”.  Some of this proved to be wrong but enough of the narrative still works.  In all polls that ask the question “who do you trust to manage the economy?” the Tories are in a comfortably lead. We Brits have a long memory and the Brown / Balls bubble will not be forgotten and more recently Ball’s idiotic call for a plan B made him the laughing stock of Westminster.

Despite the Tory’s hard talk on deficit reduction the reality is that progress has been hampered by the coalition’s bargaining (with the illiberal Lib Dems), which ring fenced welfare, the NHS and pensions from the ravages of austerity.  Nearly all the cuts imposed in this Parliament have been born by spending departments that receive less 40% of the entire public sector budget.  There have been some interesting results – less spending on police has reduce crime, less spending on “enterprise” has helped growth take off, lower spending on Europe has made Europe even less popular and a huge increase in international aid has seen our stock in the world fall dramatically!

Bonny Prince Alex

Prior to the union with England Scotland had a long and glorious tradition of following the wrong leader and creating the wrong alliances and this poor judgement eventually created the need for union with England 1706, when the Scottish Parliament voted by 106 votes to 69 for dependence.  Since the Union there have also been a number of moments when the Scots have thrown their lot in with leaders (Bonny Prince Charlie for one) and alliances (The French) who offered more than they were able to deliver.

Queen Anne's floral badge of Union

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

Where no hawks dare to fly

The doves at the Fed led by the chief "cooer" Janet Yellen have found a new reason to keep interest rates at an historical low.

Not a hawk in sight

The latest buzz words are “Pent up wage deflation” and they provide an elaborate excuse for ultra loose monetary policy. The essence of the idea is that in the Great Recession of 2009-2011 the market rate for jobs fell appreciably but that because wages are "sticky" and actual wages remained flat. This stickiness of wages is a function organised labour (Trade unions), employee nervous to move jobs and employers who are reluctant to loose key staff.