Friday, 30 April 2010

Britain Is not Greece

In the last few weeks the Tories have tried to boost their claims that its necessary to deal with Britain's Budget Deficit, by comparing the situation in Britain with that of Greece. If the country doesn't accept the scope and urgency with which they want to cut into vital Public Services, they claim, then the Bond Markets will turn on Britain, refusing to lend other than at exorbitant interest rates, and forcing Britain to go to the IMF as it did in 1976. It is nonsense.

The situation in Greece is serious, but the basis of the crisis has to be understood, and it should not be overstated. The fundamental basis of the crisis in Greece, as I said in my blog the other day, Beware Of Greeks In Need of Gifts, is the fact that Greece is part of a single currency area, but that area does not have a single sate operating a single fiscal policy, and does not have a single Debt Management Office. In Britain, for example, the Government's Debt Managment Office sells Government debt into the market. The proceeds from those sales might be used to finance spending in Tyneside or in Cornwall. Yet, if Tyneside came to raise its own finance on the markets it would undoubdtedly face different conditions than would Cornwall or some other part of the country, precisely because the economic conditions in Tyneside are different from those elsewhere. Local inflation will be differernt, as will the level of economic growth, and so the likelihood of being paid back, and the amount lenders think they can charge for lending would differ accordingly.

Any country within a single currency area should have the right to borrow at the same rates as any other country within the area in return for having given up control of its currency, and interest rate policy. But, that can only be the case if there is a single Debt Management Office. An EU debt Management Office would sell debt to the markets, which would be priced according to how the markets viewed the area as a whole. But, there is a further concomitant to this. Such a situation can only work if fiscal policy is determined centrally too, or at least the biggest part of it. It would mean that the budgets of each state would, like Local Government in England, and largely like that of the States in the US, be determined in large part by what the central state agreed with them. Any state that wanted to increase its spending ove that level would have to make up the difference by higher local taxes, just as Local Government has to impose higher Council Tax, or levy higher charges on its services here. If the EU is to continue to exist - and the idea that a single market can exist for any length of time without a single currency, and single state is utopian - then it will have to centralise further both economically and politically. This is the contradiction at the heart of the EU, and that lies at the basis of the current crisis facing Greece, Spain, Portugal, Italy and Ireland.

European Capital, and its political representatives have a choice to make. They can forget why they set up the EU in the first place, as a larger economic unit necessary to take on the large economic power of the US - now supplemented by a large Asian economic bloc forming around a China-Japan axis - and go back to inefficient, competing small nation states, each pursuing a beggar-my-neighbour policy, or they can bite the bullet, and address the problems of constructing a Federal United States of Europe.

The answer to the problems of Greece and the other PIGS, in the immediate term is quite straightforward. Initially, Greece has to be bailed out to prevent it defaulting. But, the initial bail-out will almost certainly not be sufficient. Moreover, the markets have already turned theeir attention to Portugal, and Spain's credit rating has already been downgraded with more to come. Unemployment in Spain, has gone over 20%, which is essentially Depression levels. It is quite possible to bail-out Greece with loans from the richer EU countries. Essentially, what such a bailout is, is an application of the principle set out above. The richer countries with good credit ratings simply borrow the money, and lend it at low rates to Greece. But, if it comes to further loans, if it comes to bailing out with even larger amounts the other economies then this would begin to reduce the credit rating of the EU as a whole, it would increase the borrowing costs for the richer countries too.

The answer then is simple. The debt of these economies has to be monetised. In other words, the European Central Bank, which has been printing money to feed into the commercial banks during the financial crisis, to prop up liquidity, would have to be instructed to print more money that could be directly handed over as low rate loans to the PIGS, thereby reducing the need to borrow on the markets, and removing the pressure on interest rates. But, such a policy cannot be implemented under current EU systems precisely because it would encourage states to simply run up large debts in the knowledge that money would be printed to cover them. neither the ECB, nor the major EU economies would want to pursue such a policy, because the implication is two-fold, firstly it would mean an increase in inflation, and secondly it would mean a fall in the value of the Euro.

Yet, it appears that the foreign exchange markets have already discounted something along these lines happening, because the Euro has been under pressure against the dollar and Asian currencies for some weeks now. That pressure cannot be explained on the basis simply of a bail-out. If the EU bailed out Greece, and simply borrowed money to cover it, then the consequence would be that this would push up interest rates within the EU. But, usually when interest rates rise within a curency area thee consequence is for the currency itself to rise. The fall in the value of the Euro can only be explained on gthe basis of investors betting that at some point in the future thee debt will be monetised.

But, in fact, that might not be a bad thing from the perspective of European Capital. Had the financial meltdown, and more particularly the consequent recession not occurred, the crisis in Greece and the other PIGS would have been masked, and delayed. Part of the problem these economies have faced is that they have been saddled with a strong currency at a time of very weak economic activity, and recession. From a low of $0.8 to the Euro not long after its inception, it rose against a weak dollar to almost double thaat level! That mae importss into the EU cheaper, and exports more expensive. At the same time, the other big economies China and Japan were printing huge amounts of currency to keep their currencies weak in order to continue exporting to the US, and other Asian currencies followed the value of these regional giants. If the Euro was to weaken at a time now when global economic growth is beginning to ramp up at a pace faster than most economists had anticipated, it would be a huge boost to the main EU economies such as Germany that rely heavily on exports to drive their economies. Under such conditions, the problems of debt become manageable, and the increasse in liquidity becomes quickly absorbed in a rising volume of economic activity rather than rising inflation.

And, it is necessary to place the situation in Greece and Europe into context. This is not the scenario of 1930's Depression that the world was facing 18 months ago. China grew by 12% in the last quarter, a staggering figure for the world's second largest economy. The US has today posted a provisional figure of 3.2% growth for the First Quarter of 2010. For the world's largest economy, and one that is developed that in itself is not shabby, but is actually below the predicted figure of 3.6%, and below the figure of more thaan 5% posted in the last quarter. It is, however, the third consecutive quarter of growth for the US, and was accompanied by strong figures for consumption and investment.

Last year I predicted that there would be a recovery that saw a sharp rebound based on the rebuilding of inventories that had been liquidated, followed by a short plateuaing effect as businesses continued to increase activity, but was checked as the inventory rebuilding was completed. O Ye Of Too Much Faith. That has pretty much been what has happened both in Europe and in the US. But, without any unforeseen exogenous shocks to the system, I would expect to see endogenous growth begin to increase from herein.

What is puzzling is that within this process Sterling has been pulled down along with the Euro. I say puzzling, because although Britain can, and I think will, monetise its debts in the way I have suggested for the Eurozone, and can do so precisely because it can print its own money, and although Britain has large debts, comparable in absolute terms to those of Greece, the conditions are wholly different. In fact, for months now, Britain has faced much higher rates to insure its debt than has say Germany. But, as one City Economist said some months back that is bizarre. The only purpsoe for such insurance is against the possibility of default. But, does anyone serious person beleive that Britain IS going to default on its debts???? In reality, the cost of tht insurance should be close to zero. The markets do not always price things rationally, and sometimes as Stiglitz points out the invisible hand is invisible precisely because it isn't there! If I were a currency speculator I'd be using that mispricing to bet on the value of Sterling rising considerably compared to that of the Euro.

Britain is not Greece, or even Spain or Italy. Britain may have huge Public Debt, but unlike Greece, which can't even get its own citizens to pay their taxes, much of that debt is owed not to foreigners, but to British citizens, to Pensikon Funds that invest billions of pounds for up to 40 years in order to guarantee future pension payments, to British companies, and to rich British people who seek to diversify their wealth from being just in shares into Government Bonds, precisely because they know they will get their money back. In addition to that on the other side of the Balance Sheet, Britain has itself huge overseas investments built up over centuries of Britain's overseas activity and Empire. There is a big difference between the person who has a huge mortgage on a small flat, and who has no other assets or income to cover the payments when they fall due, and someone who has an even bigger mortgage on a mansion, who might be struggling to cover the immediate payments, but who has several other properties they could sell, and from which they are already receiving rent payments, should they need to.

And, although the Tories keep referring to Britain having to go to the IMF in 1976 this is a sham. There was no need for Britain to go to the IMF, and there was certainly no possibility of the IMF not lending money to Britain if they failed to comply with its requirements. The truth in 1976 was that Britain could have met its obligations if it chose, for the reasons set out above. The reason Healey went to the IMF was simple. In the 1970's working class militancy was still strong. There had already been significant campaigns against cuts, and there was a flowing ove of that into the Labour Party. Some Councils like Lambeth had been refusing to implement cuts, and there was growing industrial action as workers having thrown out the Tories, were refusing to bear the cost of Capital's crisis. By going to the IMF, Healey achieved two things. First, he was able to paint up the crisis as worse than it was, and thereby frighten the population if not into restraint by militant workers, at least into developing a climate of public opinion against them. Secondly, by claiming that the cuts and conditions of restraint to be imposed were not what he and Callaghan wanted to impose, but were being imposed on them by "foreigners", by the IMF, they were able to shift responsibility from themselves, and divert anger to those "foreigners" - a not too uncommon feature of British politics.

But, as I have said before the conditions then are not the conditions now. In 1976, the world was entrenched in the Second Slump as the post-war Kondratiev Boom ended. The prospect of using Keynesian policies, sucking up unused Surplus Value from the private sector to promote growth in order to pay it back later, was no longer an option. Today, in a Kondratiev Boom it is. It is not in the interests of Capital to provoke a crisis through massive cuts. Even if the Tories attempt it should they win the election, the Capitalist State will frustrate their efforts. There will be attacks on Benefits and Welfare, on easy targets, and some tinkering around the edges, but the central structures of the Capitalist State, and its function in stabilising the economy will remain pretty much untouched. Inflation is rising and will rise much more to liquidate the debt, workers living standards will fall as wages fail to keep up with inflation - which is why the Tories NOW propose to link Pensions to incomes not prices - and longer term interest rates will rise, as Bond investors demand a higher return to cover the reduced real value of the income stream. But, given the underlying potential of the British economy in the context of a rapidly growing world economy none of that signifies the kind of doom mongering that is being promoted.

If it really was the case that any incoming Government would then be out of office for a generation as a result of thee measures needed to be undertaken, as the Governor of the Bank of england is reported to have said to US economist David Hale, then it is a certain fact that the Tories and Liberals would be doing everything in their power to lose to Labour.

No comments: