Great Read

Hello world. Today’s read is from long time Daily Telegraph columnist Liam Halligan. Halligan has accurately pointed to flaws in the current economic revival attempt and has pointed the finger at the current recovery effort in its unfortunate failures to lead to genuine economic growth.

In the coming weeks I’ll be discussing the economic effort as we approach the next election in 2015.

http://www.telegraph.co.uk/finance/economics/11233155/Recovery-The-UKs-economic-revival-is-far-from-secure.html

Read of the Week

Hello world. This weeks read is from The Guardian and it confirms the unfortunate reality of long and sustained periods of austerity having an adverse effect on economies. This Red Cross study focuses on Europe and highlights a notion I have been writing about for a while now: austerity alone will not result in growth.

http://www.theguardian.com/world/2013/oct/10/austerity-europe-debt-red-cross

Read Of The Week

Hello world. As I mentioned in a previous piece I wrote in October 2012 the Euro zone is in a precarious economic and social position. Having said that, some of the highest earning CEOs reside in the nations most affected by the fiscal consolidation polices being adopted within the area. These policies have contributed to the huge levels of unemployment and led to high levels of social discontent.

This piece is from global economic website Quartz. Take a look.

http://qz.com/92418

How can the EMS crisis of 1992-93 crisis help the Eurozone today?

Norman Lamont on Black Wednesday
Norman Lamont on Black Wednesday

Learning from the past is often the best way to prevent future tragedies but the similarities between the EMS crisis of the early 1990s and the current Euro zone crisis is uncanny. I think there are certainly lessons that should have been learnt from that episode that should have reduced some of the damage the Euro zone is facing today. This is part one of a two part special on the lessons the EU should have learnt from the EMS crisis. 

The fundamental aim of the European Monetary System (EMS) was to consolidate the process of monetary integration amongst member states through monetary stability. Increased economic stability would ensure relatively smooth movement of capital, goods and services that would lead to increased intra-national trade. Additionally, the EMS was devised in order to establish a coherent system in which exchange-rate fluctuations were centralized and reduced in order to promote and maintain stability within the European Union. EU members were advocating for a system of governance that would establish economic cohesion, minimalize exchange-rate uncertainty and safeguard themselves from external shocks. The EMS system could be seen because of the failure of the Bretton Woods system that left many European nations somewhat disillusioned with a scheme that placed international monetary fundamentals in the direct control of the United States.

The EMS comprised of two main mechanisms, firstly there was the creation of an artificial unit of account named the European Currency unit (ECU) and a fixed exchange-rate system named the Exchange Rate Mechanism (ERM). The ECU was a unit of account rather than a medium of exchange, although, it shared the similarities of a common currency, no coins or notes were issued. In effect, it was an accounting unit, which all member currencies were expressed. Nations were allowed to fluctuate within the specific limits of ±2.25%. Additional features of the EMS included the Divergence Indicator and The System of available Credit Facilities. The Divergence indicator was measured in terms of ECU to enhance economic coordination. Hence, it measured the divergence of a nation’s given market rate with the central rate. Despite the system of available credit never coming to fruition, the ECU, ERM and the divergence indicator were mechanisms designed to enhance economic integration and more specifically exchange-rate stability amongst member states.

The importance of the ERM cannot be understated because the very nature of the EMS was to strengthen monetary integration by enhancing stability for member nations. Thus, the systemic failure of the mechanism is arguably the most significant factor contributing to the EMS crisis. The ERM adopted an asymmetrical system in which the Deutsche Mark became the reserve currency, in effect, the members of the ERM handed substantial monetary control to the German monetary authorities. Germany assumed a role similar to that of the United States in the Bretton Woods arrangement. Because monetary authority was effectively concentrated with Germany, when its own domestic interests conflicted with that of other ERM members, it caused severe economic shocks. Both Jones (2001) and Copeland (2005) concur to the suggestion that the domestic economic issues in Germany caused the greatest threat to ERM stability and thus the EMS came under severe threat.

“Because the DM was the linchpin of the system, the fate of the ERM was greatly influenced by developments in the German economy.” (Jones 2001, 56)

The reunification of both German states had severe economic consequences on the ERM members. Firstly, the amalgamation of a large and wealthy nation with a small and less economically developed one had an impact on West German current account. In order to make the transition function, the West German government transferred savings revenue to the East, and the government budget deficit rose from 5% to 13.2%. (Weerapana 2004, 4). This reduction in economic power as a result of the increased structural deficit forced the Bundesbank to increase interest rates in order to reduce inflationary pressure. Unemployment in the UK in 1990 (the year in which they joined the ERM) was 7.1% (Eurostat 1990). Because the UK had effectively handed monetary control to the German authorities in the sense that exchange-rates were determined by the ERM as oppose to the UK government, there was very little in terms of expansionary monetary policies that the UK could adopt.

Moreover, it is likely that the Conservative government at the time would have opted to devalue the Sterling in order to stimulate export demand, which would have increased economic growth through high levels of investment and thus job creation. However, this was not the case and it highlights one of the main problems with the ERM, conflicting monetary interests from nations with contrasting monetary agendas. The dominant German authorities had no incentive to reduce interest rates; the reunification process meant that saving revenue had to be released in order to bring the East German economy to a competitive level, hence high interest rates in order to reduce the internal government deficit. Furthermore, this is a clear example of one of the mechanism’s fundamental macroeconomic failures; it was created in order to establish economic cohesion through marginalizing exchange-rate fluctuations but it left the UK facing high levels of unemployment and high interest rates, due to the lack of economic stability because of a conflict in economic agendas.

On Wednesday 16 September 1992 the UK was forced to withdraw it’s currency from the ERM. Not only did this event drive market confidence extremely low, mainly because of the interest rate fluctuations, which in turn lead to speculative attacks[1] on the currency, it also had severe economic consequences for the domestic economy. McDonald and Dearden suggest the UK currency was increasingly vulnerable to speculative attacks:

”For the UK, international investors watched as growing political pressure to address the recession forced the Government into a series of interest-rate cuts between October 1990 and September 1992.” (McDonald and Dearden 2005, 90)

There are various similarities with the present crisis. If Greece were to leave the Eurozone and affectively the EU, the costs of such a decision may be politically detrimental, but economically beneficial. When the UK left the ERM the decision damaged their economy in the short-run, unemployment levels were high and investment confidence was low, the years following however, saw the economy recover rapidly. Figure1.1 displays the steady fall in unemployment after 1992.

Eurostat.
Eurostat.

Monetary integration had always been an objective for European nations. In order to establish and maintain economic stability within Europe and particularly the EMS zone, domestic nations had to merge monetary policies in order for their goals to be achieved. Hitiris suggests that four fundamental principles were adopted in order for this process to occur; free trade in goods and services and free mobility of capital and labour.” (Hitiris 2003, 128) Domestic currencies could therefore be viewed as a barrier to achieving these economic goals. The realization of an economic monetary union was perhaps best formulated in Jacques Delors[2] report of 1989. The report made several recommendations to improve the efficiency of European monetary affairs through the convergence of macroeconomic affairs. The general theme of the Delors report was clear, the extension of a united economic European union, with little or no barriers preventing the flow of capital between member states.


[1] The most famous example of an individual profiting on short-sell Sterling was George Soros who profited just over $1billion on ‘Black Wednesday.

[2] Jacques Delors was the President of the European Commission from 1985-1995. It was under his premiership that a proposal for a common European

currency and more importantly, a European monetary union was to established. He was the first President to serve three terms.

 

Do right wing parties become more popular during economic downturns?

Golden Dawn: Their sharp rise has occurred during the worst economic crisis since The Great Depression
Golden Dawn: Their sharp rise has occurred during the worst economic crisis since The Great Depression

Clearly the global economy is disarray. Several large economies around the world have still not resumed their pre crisis levels of output and that does not appear to be changing anytime soon. This has several consequences, unemployment across the world, especially in Europe is high, people have less disposable income so spending levels are lower and there seems to be rising support for right wing politics. This has led me to ask a question: do right wing political parties become more popular during periods of economic upheaval? My answer is yes.

Economic stagnation or downturns are periods in which more people lose their homes, credit is harder to obtain, several businesses close down, unemployment & underemployment rise and disposable income is reduced. They occur during an economic upturn, however, the positivity during an upturn far outweighs the negativity, so the effects are minimalized. So if we take the UK for example and we look back during Tony Blair’s premiership, the economy was booming during most of his time, with exception to the downturn of the early 2000s, (dot com bubble) post 2002 the economy is performing well. At the time Britain was pro E.U. and pro immigration and a lot people were contempt to allow migrant workers to come to Britain. Nobody can escape the UKIP hysteria; they were often ridiculed as just another political party whose views on immigration and E.U. membership were extreme. Now Nigel Farage has David Cameron looking over his shoulder. The progress UKIP have made since the credit crunch has been nothing short of remarkable. In this age where the main political parties have lost connection with several disillusioned members of the public, UKIP represent boldness and consistency. But their views are more acceptable during a time of economic disarray. They are saying nothing different from ten years ago, they were anti-E.U. then and they are now. They were anti-immigration then and they are now. And migrant workers coming into Britain is not a recent phenomenon, yet there surge in popularity has transformed them from just another political party comprising of disgruntled former Tories into a real pain to the three main political parties. Moreover, their MEP seat looks secure and a recent YouGov opinion poll shows that public opinion is on their side and politically, immigration is such a contentious issue, politicians know they must tread carefully around it, often lacking the boldness UKIP has, hence there surge in popularity.

UKIP leading the way according to poll
UKIP leading the way according to poll                                                     YouGov

 This surge has stemmed from the fact that the large public sector cuts have affected millions of people. This is on the back of the huge bank bailouts ordered under Gordon Brown for several failing banks and the fact that the large public sector deficit does not appear to be reducing. Economically the UK has a long way to go. It certainly has a huge effect on people’s lives, their mood, thoughts and actions. People think differently during recessions and downturns and this is reflected on the political landscape. Politics provides the avenue in which any citizen can protest against political actions and clearly people are speaking out against the way society is today. And this is because the economy is in such a dire situation.

 Last year in France, François Hollande won the general election. By defeating Nicolas Sarkozy he was elected President. One could suggest that many French voted out of protest in order to remove Sarkozy due to the problems in the economy. The French had similar concerns to the British, mainly regarding its economic woes and social problems based around immigration. Moreover the real story of this election was Marine Le Pen, leader of the far-right group Front National (National Front.) Of the 35,883,209 who voted, the Front National received 6,421,426 of the votes. So 18% of the votes went to a far-right political party. Thus the Front National came third overall. Again, their clear policies struck a cord with over six million people and this was their best election result to date.

The Euro Zone has come close to collapse and nowhere has that been more apparent than in Greece. Greece has always had high levels of public expenditure and around 10% unemployed for the last ten years, so this has added to the high national debt. Who should be blamed is not the issue at hand? If anyone should take responsibility it is the Greek politicians, for overseeing the mess and allowing public finances to spiral out of control. in the midst of this the far-right party Golden Dawn has had a huge impact on Greek politics, their surge in popularity certainly provide and sometimes channels the energy the recession has created. Their anti-immigration policies, much like Front National and UKIP have resonated with people and have provided them with the platform in which they hope to gain considerable election success.

If we look at the UK again, much of what the BNP said about immigration is not that different from what UKIP opine. Where they are on the political spectrum is different fair enough, but in terms of both being anti-immigration they are virtually the same. Yet the BNP was close to bankruptcy and UKIP appear to be going from strength to strength. Times have certainly changed. In an economic downturn people may have less patience for issues such as immigration, social housing and the provision of social services such as education and health care. This is usually because tax receipts have shrunk as a result of higher levels of unemployment, public sector cuts and less activity in the economy as a whole. So people may feel that domestic policy ought to prioritise its national citizens before seeing to the needs of others. What does not garner the same emotion from public attention are the benefits immigrants usually bring to communities. Ethnic minorities make up 6.24% of the Greek population. This figure has been growing steadily, but up until 2005, Golden Dawn were not the force they are now. The Greek economy has rotted since and the popularity of not just Golden Dawn, but right wing politics, especially in smaller parties, has gathered loyal cult followings, what they hope is that it manifests into tangible political success. They are at the very least making their bigger counterparts take notice, especially at local elections.

Personally, I think UKIP and the surge in popularity in far-right political parties highlight the sad state of politics in the UK and the rest of Europe today. However, I genuinely believe in freedom of political expression. For me UKIP provide more problems than solutions because they are virtually a one-policy party and I am yet to be convinced what they would do if the UK were to leave the E.U. In the case of the Front National in France, Le Pen was recently voted the most popular French female politician so she does not look to be losing any momentum.

I am confident that if the global economy was in a better state, more people had jobs and more money in their pocket then I can’t see where the far-right could get their impetus. Blaming immigrants for instance is a weak and flawed argument for the UK at least. There is no doubt that immigrants reduce the cost of labour, but the problems in the UK are more complex than blaming one group. Maybe the UK has got too many immigrants, but what I am certain of is this issue is not a simple case of close the borders and the problems will disappear. I would personally like to see the same energy exerted towards tax avoidance from large multinationals because that could potentially recoup billions in tax revenue.

How UKIP and other right wing parties perform in the next series of elections should be interesting, if the economy is still as sluggish as it is now, I predict well, and if the recovery is looking strong then I don’t think they’ll do that well. My only hope is that the economy starts to show real signs of growth and it will be interesting to see how the right reacts to that.

The Writing On The Wall: Eurozone fail to take decisive action

Eurozone leaders tacit failure to take prompt action leaves Eurozone a long way from recovery.

The current eurozone crisis is not going to end any time soon. Despite Mario Draghi’s so-called “ice-cream,” a pledge by the European Central Bank (ECB) to intervene in the European bond market, the optimism was brief and the current crisis remains more potent than ever. What is most striking  are some of the parallels between the current eurozone crisis and the European Monetary System (EMS) crisis of 1992-1993 and more importantly, the inability of European ministers to act effectively on past mistakes.

Many Greeks and Spaniards have stoned police cars and set fire to shops to protest budget cuts, to little avail. Hitherto, the EMS crisis, although in hindsight is not of the same magnitude, relatively speaking, there are many mistakes that have been repeated during the current crisis. Interest rate harmonization across the entire euro-zone clearly does not work due to the structural imbalances of the Northern, wealthier states and the Southern, poorer states. Similarly, when the UK wanted to reduce interest rates during the 1992-1993 EMS crisis, they were prohibited, due to the dominance of the German economy (sound familiar ?) and when they maintained high interest rates due to several factors, including the reunification of East and West Germany it had a detrimental affect on the British economy. Moreover, this imbalance of economic performance requires a significantly tighter fiscal framework that will complement the monetary framework already in place, without this, the crisis will not be solved and this increases the possibility of another crisis reoccurring in the future. Furthermore, had Greek, Spanish, Irish, Italian and most European nations adopted a much stricter fiscal framework, then the problems of today would be severely reduced.

This has been the hallmark of the eurozone, austerity is the bitter medicine for over indulgence on cheap credit

It should be noted that the legal framework was already in place to circumvent nations from binging on cheap and available credit, but this has proven to be nothing more than hollow rhetoric. The ECB’s decision however to act as lender of last resort should provide the framework for the fiscal unity that the euro-zone has required since its inception. Monetary unity alone is not sufficient, both fiscal and monetary unity is required to harmonize the euro-zone. Nevertheless, by accepting the stringent fiscal reform package, the indebted nations will be relinquishing national sovereignty, which is a consequence of the over indulgence of available credit. Undoubtedly, these are the very beginnings of the proposed reforms and many citizens in the heavily indebted countries may not have the patience to wait until these reforms manifest into tangible results. This transition period marks a significant time for the euro-zone and many nations may feel time is running out. The Stability and Growth Pact was intended to penalize nations with a debt-to-GDP ratio greater than 60%. Clearly, the intentions were correct, but the implementation or rather, the lack of demonstrates the incapability of euro-zone leaders to take decisive action.

The intentions of the SGP were understandable; any union that would amalgamate several contrasting economies needed a stringent fiscal framework in order for it to function appropriately. If we analyse the current euro-zone crisis, the authenticity of the SGP is in question because strict sanctions were to be imposed on any nation who did not adhere to the ‘strict’ conditions set by the EU. If this were the case then several nations including Germany, Italy and Greece in particular would have been punished appropriately for their fiscal mismanagement. Former UK Prime Minister John Major suggests that:

“Southern states over indulged on low interest-rates and racked up debts. When Germany and France over-stepped the criteria without any penalty by the commission, the criteria became toothless.” 

It is fair to suggest with hindsight that sanctions on nations who had failed to abide by the framework set by the EMU would have almost minimalized the severe economic damage that has beset the euro-zone today. Had sanctions been imposed some ten years ago, or even five, then the severe problems that appear only to be appearing now could have been dealt with then.

Nations were meant to be punished if government debt-to-GDP exceeded 60%.

With regards to the realization of the EMU, the SGP was implemented in 1997, two years before the data range in the graph. Despite a prerequisite of national debt being less than 60% of GDP levels, the graph above highlights the inability of euro-zone members failing to deal with nations not following the fiscal framework. This tacit failure to impose sanctions on members allowed certain members continue to let national debt to grow until it became an apparent and uncontrollable problem, hence, the systemic failure of the system itself. Clive Cook of Bloomberg is one of several commentators who have critical views on not only the SGP, but of EU governance in general.

Remember the EU’s vaunted Stability and Growth Pact of 1997, which supposedly put limits on public borrowing — and which Germany, by the way, violated? The same syndrome is evident today. Write a new rule now, worry about enforcing it later. This has been the hallmark of EU governance.”

Moreover, this has been a consistent theme that has underpinned EU and euro-zone governance (or lack of). Despite apparent mechanisms being in place to prevent severe economic shocks, euro-zone nations appear to have repeated some of the same systemic errors, the only difference with the EMS crisis of 1992 and the current crisis is the severity, the current crisis however appears to be of a much greater proportion, with the lasting effects significantly greater.

Clearly, the current economic crisis that is crippling the euro-zone could have been prevented if decisive action was taken to punish nations who did not adhere to the ‘strict’ rules set out in the SGP. Retrospective analysis does little to compensate the fact that the damage as a result of this failure has been catastrophic. There is no easy remedy; the euro-zone must comply with the reform package set out by the ECB in order to have the fiscal harmonization so desperately required in order to achieve the goal of a single currency. Without both monetary and fiscal unity, this crisis will occur in the future, and the consequences far worse, something that seems too difficult to comprehend at this moment in time.