Wednesday, 1 December 2010

Tomorrow Could Be A Big Day

For months I have been arguing that the problems of the Eurozone are not that difficult to resolve from an economic theory perspective. All that is required is for the existing soverign debt to be monetised i.e. the Central Bank - the ECB - simply prints money, and buys up the Bonds issued by the countries in difficulty. About a week after I proposed that in the Spring, the ECB did indeed pursue that action, and Stock Markets in Europe, and then globally soared, and the value of the Euro rose sharply. But, it then was announced that the ECB would "sterilise" this action by withdrawing liquidity from the market by selling Bonds to commercial banks. In other words, it was simply moving from one place to another. In addition, it announced that the price of carrying out this action, alongside the establishment of the $1 trillion bail-out facility established by the EU and IMF, was that the deficit countries whose economies were in trouble, would have to implement draconian austerity measures. As this sank in, the markets dropped precipitously, and the Euro once again continued its slide against an already weak dollar. It was no wonder that the traditional money commodity - Gold - resumed its relentless rise against all currencies.

Yesterday, I pointed out that the number of voices calling into question the wisdom of the austerity measures, was rising, including amongst those who have previously followed the Tory Party line. The message seems to have been getting through that austerity measures that send economies into recession, or even just a prolonged period of very slow growth, are the exact opposite of what is needed to allow those economies to grow, and thereby produce the resources to pay off the deficit, and even the high rates of interest they are being asked to pay on that debt. That was demonstrated again today with figures out from the US. The US which is the world's largest debtor nation by far, rather than implementing austerity measures, has been involved in a policy of huge fiscal stimulus for the last 2 years. It had an immediate effect in bringing the US out of recession quickly, and even led to one quarter's growth in excess of 5%. In addition, to this fiscal stimulus, the US federal reserve has also been engaged in the kind of monetisation of debt, I have suggested the ECB needed to implement - that is the US QE and QEII, doses of Quantitive Easing. It seemed as though the effectiveness of those policies was beginning to wear off. In part that is because although the Federal Government has pursued such policies, the State's, often under Republican control, and some with laws limiting the extent to which budget deficits could be run, have been dragging their feet. But, in the last week or so, data out of the US has showed that the economy is continuing to revive.

Today, the ADP employment figures showed that 94,000 new private sector jobs were created in the last month, and it revised its figure for the previous month from 48,000 to around 80,000 new jobs. It also appears that a growing number of these jobs were in the area of new industries, such as alternative energy, demonstrating that the kind of restructuring of Capital I have discussed previously is beginning to happen. One CEO of one of these companies interviewed on CNBC said his company was growing strongly, and despite jobs in the firm paying from $15 an hour, up to $70 an hour, the main problem was recruiting enough workers. The firm was having to invest significantly in retraining workers to fill the skilled jobs being created.

A number of other people interviewed during the day also raised the idea, I have previously put forward, which is that one of the easiest ways of dealing with the debt will be through an uptick in inflation as economic activity starts to grow.

What could make tomorrow a big day, as CNBC, set out is that it could see a step change in the policy of the ECB to follow the example of the Fed. In recent days, EU leaders such as Merkel and Sarkozy have made clear that they are looking for a political restructuring of the EU. In return for a permanent mechanism to deal with events such as the current sovereign debt crisis, including the other idea I have put forward of having centralised EU Bond issuance, so that all countries can borrow at the same rate, they want a much more centralised EU, with much greater control over the economic policies of member states. Tied into the Euro, and with no real possibility of going it alone, Greece and Ireland, have already been given no chocie in the matter, and have effectively surrendered their economic sovereignty to such centralised control. Portugal and Spain are under pressure to follow suit, and it appears that Belgium and Italy will not be far behind.

EU leaders have emphasised that the Euro is a political venture, not just an economic one. They have stressed that for that reason they have no inbtention of letting it collapse, whatever the cost. For traders to be able to pick off small economies and their currencies is one thing, but to take on the whole of the EU economy were it to be clear that the EU stood behind every economy, and the resources of Germany, which dwarfs every other EU economy, and the resources of the ECB, including its ability to simply print money as the US has been doing, is something completely different. Following a meeting of EU Finance Ministers, the French Finance Minister, Christine Lagarde, came out and said that they knew what they had to do, which was pretty much along the above lines. But, she said, it took time for discussions to be held, procedures followed, and new agreements passed and put in place. In the meantime she accepted that the markets were moving by the hour not by the month.

The statement by ECB President, Jean Claude Trichet, that the markets should not underestimate the degree to which they would support the Euro, and implicitly, theroefre, stand behind the debt of the peripheral economies, is then even more significant. Trichet, as an adherent of the Austrian School, has always had an ideological objection to the idea of money printing. It appears that ideology is about to go out of the window in favour of expediency and pragmatism.

There may be another reason why this movement has been expedited. The attempts to stem the contagion by the Irish bail-out clearly failed. One commentator on CNBC today, said she thought that the austerity measures in Ireland were too much for the population to bear, as well as being counter-productive. As opposition to austerity across Europe mounts, Big Capital must be looking at the wider costs of such measures, and at the same time the big-time bond holders must be looking at the same developments and considering the possibility that some Government like Ireland or Portugal or Spain, might give in to such opposition and default on its debt. Two years ago, I wrote that one solution to the Credit Crunch would likely to be that State's would stand behind their banks, that there would be some money printing, and that in addition, new Capital would come in from China and other surplus economies. We have seen varieties of all three. However, into this situation now comes a further complication.

A couple of days ago, shares in China fell sharply. The reason was that traders said that there was an insufficiency of Cash in the Money Markets to finance the growing volume of trades. That is similar to the conditions that led up to the Credit Crunch, but not the same. The latter was a crisis of confidence, arising from an underlying crisis of insolvency i.e. it was not just that the Banks had insufficent cash, but that the assets underlying their Balance Sheets were seen to be increasingly worthless. That is not the case in China. It is a lack of liquidity, and given the high volume of economic activity - which I have previously shown following Marx, generates its own increased volume of money - it is likely that this is due to the large amounts of money that have been flowing Westwards to buy up Sovereign debt. Given the ability of Chinese Authorities to directly intervene into the economy, and direct activity - they have recently been increasing rates and reserve requirements in Chinese Banks - the danger arises for the West that they might act to direct money into the domestic economy, and thereby reduce the flow of funds to the West. The consequecne of that would be to crater the Bonds of those countries in trouble. Under those conditions, the EU and ECB would be left with little alternative but to intervene directly themselves, printing huge amounts of money to buy up otherwise worthless Bonds. It is better in such matters to be ahead of the curve.

If, Trichet does indeed make such a statement, then it will beg the other questions. Merkel has already spoken of the need for EU wide growth programmes. In that case, it makes little sense to destroy the peripheral economies - upon which Germany istelf relies as export markets for its booming industry - and rather leads to the conclusion that the kind of longer term policies of bringing deficits under control suggested by Gordon Brown and others, would be a far more sensible course of action, as the US has demonstrated. But, in that case, the only economy left following the course of austerity would be the UK. How long then could Campo and Clegg, and Foggy Osborne stand out against the tide?

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