Thursday, 7 November 2013

US Politics and Economics v The UK and Europe - Part 4

There is a considerable difference between the US, and the PIIG economies that was decisive in relation to the consequences of the financial meltdown of 2008, described in Part 3. The US is a single federal state, the EU, and within it the Eurozone, is not. When US banks went bust in 2008, and after the state saw the consequences of letting Lehman Brothers go to the wall, that single central state was able to intervene decisively with a single, centrally determined policy. No such response was possible within the Eurozone.

The closest to it, came not from the Eurozone itself, but from the only other major economy in Europe that has central control over its monetary and fiscal policy – Britain. In fact, it was Gordon Brown's government that took the lead in providing the solutions that were adopted, not just in Britain, but also in the US, and to an extent in Europe. That response involved an effective nationalisation of the main banks, and their recapitalisation by the state. In both the US – under TARP – and in the UK, that nationalisation was effected in one fell swoop. The bankers complained in Britain, that they had been effectively presented with a fait accompli by the government. In Europe, without any central government, without any centralised banking authority, the task of nationalising banks fell to individual states, and was carried out piecemeal, as and when the banks in individual states collapsed.

The reason Britain was able to take the lead is not solely down to the fact that Gordon Brown had a better understanding of economics than most government heads. It was mainly down to the fact that Britain's political system facilitates such decisive action, under most conditions. The Prime Minister's position was described by Lord Hailsham as an elected dictatorship. The PM can push their policy through Cabinet, and because the Government has a majority in the Legislature can obtain parliamentary approval. In fact, for many actions ministers can take executive action without even requiring parliamentary approval.

The difference with the US was shown when George Bush attempted to get backing for the $750 billion fiscal stimulus involved in the TARP programme. In order to implement it, the executive, i.e. the President had to first get the approval of the legislature, i.e. the two houses of Congress. On the first attempt, Republicans, members of the President's own party, voted it down. That was a reflection of the influence, even at that time, that the Libertarian/Conservative wing of the Republican Party sought to impose, in their growing opposition to the huge run up in the budget deficit that Bush had imposed over the previous 8 years.

The consequence was that the DOW Jones index fell by 700 points. Immediately, the President brought in Republican representatives to get them to change their votes, and as is the corrupt manner of US politics, each of these votes had a price, in the form of what is termed “pork”. That is the promise of fiscal largesse for the Congressman's area, to be written into the Bill to be passed. As the next vote took place there was the edifying spectacle of US politics, in which individual representatives held back from voting in order to raise the price the President would have to pay for their vote. I described it at the time in my post - US Democracy 

But, the position in the Eurozone was worse. In the Eurozone there was no central state power that could propose a single policy response that could then be pushed. There was only the EU Commission, and the Council of Ministers that effectively continued to push the interests of the individual states. The result was that the combined global Keynesian intervention, introduced at the end of 2008, quickly brought an end to the economic crisis that followed on from the financial crisis. That was supplemented by the lowering of official interest rates, which pumped liquidity into the system, and in certain places like Britain, gave a further monetary stimulus as millions of families saw their mortgage payments slashed by an average of around £7,000 a year. It stuffed the banks full of cheap cash, but that did not and could not deal with the problem of their insolvency.

It meant that the underlying problem dragged on until it once more broke out with the Eurozone debt crisis, which demonstrated that the European banks were insolvent in one country after another. Where the UK and US had nationalised their banks in one fell swoop, and thereby recapitalised them – though as I will argue later still not adequately – in the Eurozone, a maelstrom was established whereby the fate of the banks was inextricably linked to the fate of their country's sovereign debt, and the sovereign debt of nations was inextricably linked to the fate of their banks. 

That inevitably manifested itself in the weakest economies. Their economies had boomed on the back of cheap credit, running up the public debt. That debt had been bought by the commercial banks of those countries, who used it as ballast for their balance sheet, and on the back of which they also lent money recklessly for property and other forms of speculation. It was only a matter of what was to crack first. Either there would be a run on the banks once more, as they were seen to be grossly under capitalised, as their property loans went bad, and property prices collapsed, or else the governments themselves would face falling bond prices for their sovereign debt, pushing up the cost of their borrowing to unsustainable levels, and thereby also exposing the insolvency of the country's banks. As this all unravelled as a rolling crisis throughout 2010, each government was essentially left to deal with it on their own.

The obvious solution would have been for the European banks to have been rationalised and nationalised, and for them to be recapitalised. It would have been to have financed this via a combination of money printing and the issuing of EU Bonds backed by the strength of the German economy. But, given the political reality of the EU, that solution was not possible, and so a series of fudges took its place. That could only see the problem once more swept under the carpet until it erupted once more. That is the situation now, and now the problem is much worse. In order to hide the extent of the exposure to debt, and the insolvency of European banks, a series of meaningless stress tests have been conducted, each of which has declared banks safe, only for those very banks months later to explode. It has seen the resort once more to the use of convoluted derivatives to hide the extent of the exposure to debt on banks balance sheets. Its reported that for one bank alone – Deutsche Bank – its exposure to these derivatives is equal to the entire global GDP!

But, in a sense, the real crisis, both in the US and in the EU is a political crisis. I will examine why next.

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