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Beware of Greeks bearing “gifts” – debts?

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.

Who’s afraid of the SDR? Should the US$ continue as the reserve currency?

By Graham Reid & J R Max Wheel

January 2010

Many world leaders and finance ministers are calling for changes to halt the problems created by wild gyrations in exchange rates which have grown since 1971 when the US$ gold peg was abandoned. No serious attempt has been made to tackle this problem even though The Federal Reserve Bank of San Francisco highlighted it as long ago as 1975. Interestingly this 1975 paper was authored by Hang-sheng Cheng, whose points should have been taken on board by policy makers and his name is a wonderful irony in the current situation!

President Sarkozy of France, Dominique Strauss-Kahn, the managing director of the IMF, Dr Mervyn King, Governor of the Bank of England, Angela Merkel, Chancellor of Germany, Chinese central bank governor Zhou Xiaochuan, the Russians, the Canadian’s the Indians, leading economists; the list is endless of those searching for a solution.

This week Dr. King voiced his concerns that G20 was in danger of becoming a talking shop and a photo call opportunity if it did not follow up with action on the strategies agreed at its meetings. He suggested that the IMF should come under its umbrella to undertake this ongoing work. As a concomitant, the SDR should be widened to incorporate all the G20 currencies.

The writers have long held the (minority) view that the US economic hegemony is over and with it the exclusive role of the US$ as the world’s reserve currency. We have argued that an enhanced role for the IMF and the SDR is essential to prevent currency manipulation by Governments whether by apparent indifference or outright refusal to allow appreciation in a new game of beggar thy neighbour by the major economies.
Joseph Stiglitz’s UN expert panel said an SDR-based reserve system “could contribute to global stability, economic strength, and global equity” and “would be feasible, non-inflationary, and could be easily implemented.”
The UN Conference on Trade and Development (Unctad) 2009 report called for the creation of a new global reserve currency. While calling the dollar-based system a “confidence game” of financial speculation, the UN called for a new global reserve bank to manage the new currency.
One landmark effort to “manage” exchange rates was the Plaza Accord of 1985 when coordinated action by the major Central Banks lead to a 51% decline in the value of the US $ against the yen.. The World has moved on since then, for Japan, read China. The chances of another Plaza Accord look very remote. Hence a new standard is needed. The SDR can and should in our view fulfil this role.

A global economy must have a global standard of reserve asset. The US$ cannot usefully provide this any longer, except as part of a wider basket of currencies.

Each time this is mooted, it is argued that this cannot be achieved. The arguments are part technical, it is a unit of account not a currency, it would have to have liquid spot, forward and futures markets, a proper yield curve like major currencies. All of these issues are perfectly possible for a revised SDR.

The other and far more serious objection is political with the US frightened of having reduced influence.

A global system cannot rest on the naked self-interest of a single country. The G20 effort to increase SDR issuance deserved half a cheer; it now needs to look seriously at this alternative to stop countries’ blatant attempts at manipulation. These have consequences. Sound money must be a policy goal as it is a major factor for financial stability. It inhibits currency debasement and the threat of future trade and currency imbalances.

It won’t be easy or quick. It will need political will and strength of purpose to create a more stable financial world that will benefit all.

It is now time to stop the talking shop and the photo calls and do something useful.

About the Authors

Max Wheel. I am a business consultant and freelance writer based in Cambridge UK. I worked in the financial services industry for over 30 years, in commercial, investment banking and in insurance at Lloyd’s. (yeah, yeah but not paid the fat cat salary!). I hold an Economics degree from the University of Leeds (clearly not much of which is relevant now) and speak a number of European languages: some well, others modestly. I initially started this blog because I felt strongly that the public was being misled over the economic issues of the day, both Graham and I wrote pieces for the dailies. I saw much of the chaos at first hand in Latin America’s so-called lost decade of the 1980s and realised we had not only learned nothing but seem to have forgotten everything.

I felt strongly that much information and news was opinion passed off as fact and deserved to be challenged. I work as a Volunteer Business mentor for The Prince’s Trust charity in Cambridgeshire. When not at work I spend my time bird-watching and endlessly repairing a narrowboat.

Graham Reid. Like Max, my career was in financial services for 35 years encompassing Private Banking, Insurance, Investments, Tax consultancy, and latterly in Risk assessment and mitigation. Academically, my speciality is Mathematics, a mind broadening experience that has helped me to question perceived wisdom and search for new solutions better equipped to provide real answers to complex problems.
As author, and co-author with Max, of numerous articles on solutions to the current economic fiasco, I maintain my day-to day interest in attempting to point political and economic thinking in a positive direction towards a more stable financial world. Now living in France, I have ample time to pause for thought in between investigating the wines of Bordeaux and St. Emilion.

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