15 February 2010
JR Max Wheel & Graham Reid
The Greek debt drama has shone a searchlight on the near complete absence of an adjustment mechanism in the Eurozone. Many of us remember the overtures of M. Jacques Delors in the 1990s to bring the UK into the €, which was rightly rejected. What we cannot dismiss is the fact that Delors correctly argued that EPU- political union or at least a fiscal arrangement was a necessary concomitant of EMU-monetary union. Certainly political union was never going to work for the UK but then much of the EU rhetoric is watered down to more practical steps of which a fiscal balancing mechanism was the minimum requirement.
It gives me little pleasure to recall arguments with Bank of Spain officials that this was a serious, even fatal flaw, nor the political expediency views of US diplomatic officials in London that we, the UK should be “in there” – the € that is.
The Greek economy is of course, as well-known, notoriously lop-sided since a good deal of its wealth- exactly how much is hard to measure, resides offshore, thus tax takes on the wealthy are minimal.
The use of cohesion funds to drag up the living standards of poorer Southern European countries as well as the Irish Republic was a perfectly legitimate policy, albeit one that was often subject to outright exploitation. This has now lead to what has been nicknamed “debt intolerance” which probably should be renamed debt tolerance, since it is always easier to keep borrowing than take the politically unpopular route of adjustment and fiscal prudence.
Once embedded in the psychology of politicians, this is almost irreversible, barring a situation like today.
The EU response to date has been nothing short of irresponsible in the extreme. One hopes that tomorrow’s meeting will bring some clarity, but thanks to the Lisbon and Maastricht treaties a “bailout” for fiscal incontinence is a no-no (article 125). Hence a political fix is almost a “given,” short of “booting” the Greeks out of the €, which would be unfair.
Why does it take so long to learn such lessons? Go back to 1925 and Britain’s ill-fated attempt to return to the Gold Standard at the pre-war parity. Keynes in an incisive and highly critical essay-“The Economic consequences of Mr. Churchill” pointed out the folly. An overvalued and inflexible exchange rate results in the only possible solution being that adjustment has to take place by a drop in real output and wages, short of there being a drop in the price of gold. The downward adjustment of real wages HAD to precede the drop in the cost of living to effect this change. This is clearly unacceptable, as is the increase in pension age, today’s new internal fix. The analogue today is the falling value of the € against most major currencies. This is not some happy coincidence, naturally leading to increased exports for Eurozone major economies through competitive devaluation. Many of the weaker or heavily indebted are energy deficient and rely on USD denominated commodities for essential imports.
Spain’s situation as a significantly bigger economy is even more worrying. Unemployment is approx 20% of the workforce, the Madrid Government is under serious pressure, and Spain’s largest banks embarked on an unprecedented investment foray into Latin America, where they own some of the biggest and most powerful banks from Argentina to Mexico. Given the alarming state of Spanish real estate and construction, always a major driver of growth in recent years, the consequences of any problems arising in Latin America will impact directly on them. Portugal and Ireland are also deeply mired in debt, So, is the whole Euro project edifice about to implode? If you listen to many hedge fund managers, yes it is a better than evens chance.
We have long argued that the Great Recession or whatever you wish to call it, would end up in currency wars, the modern day equivalent of beggar my neighbour policies of the 1930s.
It is not merely the Eurozone that demands a rethink and radical overhaul, it is the whole nationally based system of fiat money at stake. The US could claim that its post WWII economy enabled the USD to play the role of an international reserve asset currency. This is no longer the case since its national and international monetary interests have been diverging for years. We proposed (to considerable initial derision) a new SDR standard, which we will revisit in more detail in a further article setting out some practical steps along that stony path.
Addendum: Greek offshore economy.
It seems that at least one independent estimate puts the figure at approx 30% of the size of recorded GDP. According to The Observer, see Will Hutton article Observer:14/2/10, the shadow economy — i.e. the non-tax-paying element — runs at 30 per cent of the total: “Uncollected tax runs at 13.5 per cent of national output per year – more than the deficit. The Civil Service is over-manned and corrupt. Everyone mercilessly tries to profit at someone else’s expense.” If so that would up the level of GDP from approx $ 343bn(2008 nominal) to $445bn approx $102bn base on declared 2008 GDP That figure would have to be adjusted downawards by approx 6-7% due to the effects of the downturn.