The people have spoken in France and Greece. They do not like this austerity business one little bit. Can you blame them? After all it was not the people who caused the problem so why should they suffer while the banks get off scot-free?
But what are the implications? What could happen and how best can you insulate yourself? In this series of two posts, I will tell you what I believe should be done at a Euro level, what are the implications for various countries and what you can do in this context.
After last Sunday’s elections in France and Greece the markets have remained stable so far because they expected the results. The Euro has hardly moved. Good – we can breathe.
France is central to the whole issue so I start there.
Having discounted his victory, the markets will give Francois Hollande the benefit of the doubt for a short time and be fairly relaxed, thinking perhaps that ultimately Germany rules the Euro anyway. But it may come that, should his policies not bear fruit, the markets will react and set French yields substantially up. Remember that in their enthusiasm, French banks are the most exposed to Greek and other southern Eurozone debt.`
Hollande’s economic position is in some respects closer to Obama’s than was Sarkozy’s who hitched himself to the rigid German approach and paid for it at the polls. We have seen that the US has created jobs and grown its economy but France has one of the most regulated labour markets. How easy will it be for a Socialist government to relax labour laws? Not at all, I suggest so don’t expect a smooth road ahead. In his election campaign, Hollande was promising to tax the rich and somehow this was to pay for loads more teachers and so on. All good stuff but the rich are pretty nifty at evading tax and Switzerland is not far away.
This is all of course from a conventional economic viewpoint. Maybe Hollande can repeat the success of President Roosevelt’s New Deal although this would be very difficult to do in a very different world. We will see. But before then two serious problems need to be tackled.
The big questions
The issues that require Hollande’s persuasive skills are:
1. The European Central Bank is not a central bank like the Bank of England or the Federal Reserve. It is not a lender of last resort and this is a fundamental weakness in a currency where there is no central control over spending. This is deliberate of course because all countries should hold to the Maastricht criteria, shouldn’t they? So it would not be needed. But they don’t behave and the markets cannot be sure that if one country or another runs out of money, the ECB will step in and avoid a liquidity crisis – ie the investors will lose all their money. Hence the current high yields being demanded by the markets – 7% is not far short of an unsecured personal loan from your listening bank.
Unfortunately the markets didn’t realise this so lent money as if there was no tomorrow, which just shows how stupid banks can be. The ECB must become a lender of last resort and issue Eurobonds on behalf of all Eurozone members. Otherwise bond yields will remain high, particularly for southern Eurozone members, and that is a massive cost to the individual governments.
This means that fiscal union and budgets set centrally (at least in percentage terms) will be essential, as foretold by Oscar LaFontaine back in 1998. As a quid pro quo all members would then pay the same low interest rate to service their debt. So far the Eurozone countries have been trying to have their sovereign cake and eat it but with appointed technocratic governments in some countries, there is a de facto loss of sovereignty anyway so what’s the difference? OK Greeks have just chucked their government out but more about that later.
In addition the ECB will need to be persuaded that a little inflation in the north would not be a bad thing either and could help promote growth. The macho inflation target of 1% ±1% has always seemed to me to be deflationary and nothing is worse than deflation as anyone with fixed costs will know. The BoE’s 2% ±1% target seems much more sensible.
2. The other problem is the German attitude. Will Chancellor Merkel change her position against the national view that Germany is propping everyone else up? Will Germany drop its opposition to Eurobonds with its (by now) irrational fear of inflation? It may be that the pfennig will drop and the German people will understand that being in the Euro gives them enormous benefits with an open market and full employment. It is not a zero-sum game and supporting the likes of Greece is a small price to pay, particularly as they end up buying Greece as an extended holiday home. Austerity measures on the other hand throughout the Eurozone will become self-defeating and harm Germany exports.
France as the Eurozone number 2, is the only country that can do this. There are clear benefits in cutting the enormous risk to French banks and as a socialist, Hollande could pull it off where Sarkozy would have had no hope. To be fair, this was something like the policy of the late departed President Bling but I hope Hollande will have no problem in pursuing it.
This is part 2 of the Great European Project and I do wonder whether the initial formation of the Euro was deliberately vague, expecting at some time these problems to arise but hoping it would be later rather than sooner!
Why should the ECB and Germany comply?
Let’s think of the consequences of them leaving their collective heads in the sand.
It would not be a good idea for the southern European states to end up in anarchy and unrest. You cannot carry on cutting jobs and expecting things not to blow up. People have lives and when pensioners start committing suicide in public, not just the national politicians should notice but also the international paymasters. Free will and history shows that they have considerable power, albeit passive, which has been enhanced in this internet age as the Arab Spring has demonstrated only too clearly last year. Brussels beware – it is a short flight from Athens, Madrid, Lisbon and Rome.
Politicians in the north need to heed this lesson and stop strutting the stage with macho mutterings about cuts, cuts and more cuts. Things are balanced on a knife edge and the big question is therefore will Hollande manage to persuade both the ECB and Merkel?
I will discuss the consequences next time and implications for the UK ….