Showing posts with label Economy. Show all posts
Showing posts with label Economy. Show all posts

Sunday, October 20, 2013

The Low Tax Problem of a Global City

A few weeks ago, Michael Goldfarb published an article in the New York Times highlighting the growing crisis in London property. His view- that Prime London property has become a global currency- has been said before, and rightly. However the timing of his article hit the zeitgeist of growing anxiety about the mismatch between London as a place to live, the capital of the United Kingdom, and London as a playground of the globalized rich. 

The squeeze in London is having a strongly negative effect on large areas of British Society, and the influx of hot money from places such as China, Russia and the Arab World- not to mention crisis-hit EU member states is not just undermining the social fabric of London but the economic fabric of the UK.

At the Liberal Democrat conference in Glasgow, several London based members made the point that these apartments now owned by the global uber-rich are often left empty, so at night you see few lights on in Mayfair and Belgravia- and the impact on the city is a kind of hollowing out.

The fact is that the taxes which are payable on Prime London property are so low as to represent a gigantic enticement to the emerging investor class of China to fill their boots in London, at the expense of the cohesion of the the city and the lifestyle of the British people.

It seems to me self-evident that the cost of this influx of investment has created social problems way in excess of the benefits. If the coalition government in the UK actually wants to fix the housing bubble, they should not be trying to distort the market still further by attempting to create even bigger mortgages: they must instead impose the appropriate level of property taxes on those assets which are held to the benefit of foreign, non-resident owners. Doubtless unscrupulous legal and accounting advisers will try to create UK domiciled structures, but as elsewhere in the world, notably the US, HMRC should be allowed to look through those structures to determine ultimate beneficial ownership.

The London property market is wrecking British competitiveness, and without decisive intervention, to remove the low tax incentive for foreigners to invest, this will become permanent and crippling burden for the UK..    

Monday, July 09, 2012

Playing the blame game as economic recovery is delayed again

As the economic crisis of the West grinds on, I find myself noting that the mistakes of policy are more and more political mistakes, and that the failures of leadership are more and more failures of political leadership.  Attempting to create a safer banking system by forcing increases in reserves, through Basel III or restrictions in concentration, is in fact having almost the precisely opposite effect to that intended. The increase in reserves has not made banks safer, but it has forced a dramatic shrinking in bank balance sheets. The result is a crash dive in lending- especially to the critical small and medium enterprises sector. This is now getting to the stage where, in the words of a senior banker operating across the Baltic and Nordic markets who I was speaking to over the weekend: "within five years, no bank will be able to afford to take on SME lending". This continued credit crunch carries not only short term implications, but also long term implications, since the creative destruction of capitalism requires a healthy ecosystem of SMEs in order to grow.

I have noted before the failure of political leaders to understand the technical implications of the legislation that they are passing, however the scale of the mistakes at virtually all levels of policy making reflects not only a failure of understanding, but of vision. As the 29th or 30th emergency summit on the Euro passes with repeated failure to engage with the strategic crisis at the root of the single currency debacle, it is easy to become frustrated with the inflexible positions of Germany and France.

To a degree the positions of the EU leaders are now so well rehearsed that it is easy to believe a new stability has already been achieved. In fact the reality is that the gaps remain largely unbridgeable. The alienation between the Germans and the French is palpable, and the determination of France to create more wiggle room for themselves is matched by an increasing German determination to impose an unflagging and inflexible discipline. Meanwhile the British position: half in/half out, attracts opprobrium and contempt for the UK in equal measure from virtually everyone. As much as the British hope that the Germans are seen as the villains of the peace, the fact is that it is the image of the UK that is now the most negative one. Isolated, introverted and largely ignorant, the ability of the UK to project its point of view is now quite weak in economic affairs. "Punching above its weight" is the cliche that British diplomats like to use to describe the position of the UK, yet after the badly mishandled Cameron veto, it is clear that the position of Britain in EU economic debates is rather less than its size admits. Meeting German foreign policy officials in the past few days was a shock: not merely contempt but ill disguised loathing of the "the island" is now the standard view in Berlin.

Yet the need for wide scale political reform is just one more thread in this crisis. The institutions of Western capitalism are being challenged: externally from Chinese state capitalism and internally from the astonishing misapplication of capital that a corrupt and mismanaged banking system has built up over the course of the last twenty years- a disaster which was largely orchestrated in the City of London. Now the politicians in a vain attempt to close the stable door long after the horse has bolted are making further critical mistakes.

Recession is indeed the new normal, and it could be another decade before the situation changes. A ten year depression is on the cards, and at the end of it, Europe will have gone from being about 25% of the global economy to less than 7%. The power and influence of Europe will go the same way. After nearly four hundred years as the cockpit of human history, Europe is poised to become a backwater- and the failure of the political systems at both European and national levels is becoming a major factor in the implosion of Europe. 

And Britain, both for its politicians and its financiers, is getting a lot of the blame.

Tuesday, July 03, 2012

Time for remorse

Bob Diamond is a figure who it is hard to love. 

Ever since he made the comment that the "time for Banker's remorse was over", he left a huge hostage to fortune, in the event of anything going wrong at Barclays.

As we now know, something has gone wrong, and in the event, Mr. Diamond's bullishness has become his downfall- the time for remorse is now is the almost inevitable headline in most newspapers.

Yet, although Bob Diamond may not be the most sympathetic creature, the reality is that - as his own resignation shows- he has not been in control of events.

The fact is that the huge banking conglomerates carry within them the seeds of their own destruction. The interconnected nature of the global financial markets has created vast black boxes within the various banks, where few- if any- can understand, let alone control, the risks.

The resulting lack of transparency has allowed financial malpractice and even criminality to flourish unchecked. All the Basel III and other regulations have done has been to increase the insurance premium for a bank failure, without actually tackling a) the financial crimes of the past years and b) improving the efficiency and honesty of the international banking system. Instead of creating greater competition, the governments and regulators have responded to the crisis by forced mergers and shot gun marriages: not only concentrating bank ownership- in many cases into the hands of the hapless tax payer- but also concentrating credit risk, market risk and indeed the risk of fraud, into ever larger institutions.

Now, the LIBOR rate fixing scandal clearly proves large scale collusion of virtually the entire banking system in criminal activity. It is inevitable that inquiries and investigations will find further issues- and the cleaning of the stables will take many years. Unfortunately this will also mean that the repair of the banking system will also take years- and that in turn is likely to mean that credit conditions - at least in the West- will remain tight and growth flat to negative for many years too.

Yet even this necessary catharsis will probably not solve the crisis: that can only come from a large increase in competition and far more transparent market conditions. The regulators should be considering how to break up the financial conglomerates into different, separate businesses.

After the Great Depression, Investment banking was separated from deposit taking. One of the major causes of the crisis has been that investment banks gained control over deposit bases and then used them for both highly leveraged and highly speculative activities. It is clearly time to restore the status-quo-ante and ensure that simple market intermediation can not ever again become position taking businesses based on depositors money.

The fall of Bob Diamond is a satisfying story of hubristic arrogance facing a humiliating nemesis- and sure, I too let out a little cheer at the fall of a seeming villain. However with the sole exception of Vince Cable, there are few who have actually "got" what the problems in the financial markets really are- and certainly the Chancellor and the Prime Minister, with their coterie of hedge fund friends, still seem lost in the face of the repeated hammer blows to the system.

It is not enough for Mr Osborne to announce inquiries, parliamentary, judicial or otherwise: these are, in the approved manner of Sir Humphrey, simply substitutes for real activity. The time has come to draw up a green paper and then a white paper for the wholesale restructuring of the banking system to be carried out by legislation before the next election in 2015.

It is not a time for inquiring what we should be remorseful about: it is a time for legislative preparation in order to avoid some remorseful day that may come again for us in the future. 

It is a time for action, not emotion. Action this day.

Wednesday, June 13, 2012

Management greed is Anti-Capitalist

A lot of anger is directed towards those in the corporate world who earn large salaries. Sometimes, in my view, that anger is not truly justified: for example, when an entrepreneur takes out income based on their ownership of a company, I -for one- tend to see it as just reward for those who take a risk with their capital.

However, listening to Martin Sorell on the Radio trying to justify his large remuneration, despite the objections of the shareholders in WPP was not an example of just reward. 

The fact is that Martin Sorell does not own the company he founded and built any more- his ownership is less than 1% of the shares- which still represents £800 million- after several sales, not least following his divorce from his first wife in 2005. he may have founded it, and built it but now he no longer owns it.

However, Sir Martin, is insisting on a substantial increase in his remuneration, to reflect, as he sees it the success of WPP over the past year. Yet, he does not seem to know the difference between being an employee and being an owner. The actual owners of the company- the shareholders- are being asked to forego their just reward in favour of a man they now employ.

This is a major part of the current economic crisis: those who invest risk capital may lose all they invest, while the managers of that risk capital, receive massive pay-offs, virtually regardless of performance. More to the point, even when shareholders vote against a management remuneration package, the remuneration committee may overrule the vote, since it is deemed to be merely "advisory". Now the shareholders of WPP will show their displeasure by voting against the re-election of the chairman of the WPP remuneration committee in large numbers.

If Marin Sorell wants to take a higher reward, he should buy out the shareholders, whose money he took when he sold the company.

To my mind it seems clear that these votes of the shareholders should not be merely advisory, they should be binding. The fact is that in large public companies, the management are employees who do not, in general, put up the risk capital to fund the business. Yet, they take rewards out at levels that imply not only ownership, but preferential ownership- they take out more than the shareholders.

This level of greed is undermining the very basis of capitalism: that those who take the risk should get the reward. It is our pension funds and our savings that are being compromised by the cozy cabal of management and irresponsible asset managers. It is absolutely time that asset managers who invest on our behalf were forced to take their fiduciary responsibilities more seriously, and time that managements had a much greater discipline imposed on them: by tightening the law if necessary. 

Friday, June 08, 2012

Are Greece and Paul Krugman decadent?

Amidst all the Jubilee hullabaloo in the UK, the second- and ultimately more significant- story remains the ongoing crisis in the Eurozone and the continued instability in the markets. The signs of a slowdown in the Chinese and the American real economies have put further pressure on the Eurozone economies that are still struggling to return to growth. 

The ongoing restructuring of the Spanish banking system has alerted the markets to the fact that their remains a significant capital requirement, even after the forced mergers of the Cajas. However, despite the more hysterical of the comments from UK commentators and politicians, the fact is that the Spanish economy does not have the same long term government problems as Greece does. The deficit issues are a function of the the banking system breakdown, not the series of policy mistakes that hampers Athens even beyond the banking crisis. As a result, although serious, there is far greater trust offered to Madrid- and that solidarity from Berlin offers far greater security for future recovery to Spain than to Greece.

Yet in the Baltic, there is growing frustration that the Mediterranean economies as a whole are not prepared to accept the restructuring that has already taken place in Estonia and Latvia, and over a longer period, in Germany too. Articles such as "Is Greece too Western to pull off a Baltic Rebound?" carry with them the clear implication that "Western"="Decadent".

If Greece will not act to save itself, then why should the poorer Baltic Countries act to save them from themselves?

Which brings us to the latest twitter-sphere spat against Paul Krugman. 

Krugman and his -shall we selective- use of charts to criticize the austerity policies of Estonia raised a fury in Tallinn, which was well expressed by President Ilves . So, a serving head of state took the unusual step of publicly rebuking the economist.

In fact such a dishonest approach to data presentation by Krugman is also decadent.

It underlines why Nassim Taleb regards academic economists as little better than witch doctors. Following Krugman's sloppy thinking would certainly undermine the moral hazard that should underpin any capitalist society.

The fact is that in economic policy, the soft options are just as ineffective in the long term as they are in most other spheres of life. That is what Krugman and the Left does not understand.     

Monday, May 28, 2012

Crying Wolf

Viewed from the perspective of the Euro's newest member state, the British political and media narrative still seems completely off the point with regard to the single currency.

To reiterate: this is not a currency crisis, it is a debt crisis. The majority of the members of the Euro zone have controlled their deficits and are retrenching their debts. It is where deficits are not being controlled- in Greece and in the Latin bloc that the crisis has its centre.

There are two sources of deficit pressure: one is fiscal incontinence, that is to say that the structure of debt is wrong or as the result of welfare or other general calls on the public purse government expenses are not being controlled versus government income. The second is the need to recapitalize the banking systems following a largely property inspired meltdown. The scale of the recapitalization is so large, because governments have undertaken not merely to compensate depositors, but all those, including bond holders, to whom banks owe money. In my view, that has been a serious mistake. The -originally Irish- plan to give a blanket guarantee to the banks was intended to maintain confidence in the sector, but has also has removed the moral hazard of owning bank debt and increased the burden on the public purse one hundred fold.

The impact of the banking crisis has been multiplied if the home nation of the bank, for whatever reason, has lost control over public spending and therefore debt. This largely applies to Greece and the Latin bloc: In Greece,a mixture of corruption and a weak state tax system has left the country with a huge hole in its economy, and the meltdown in confidence is creating a feedback loop where public debt is now unsustainable: Greece passed a point of no return and therefore required a rescue. As we know, the risks are increasing that Portugal, Spain and even Italy may also require rescuing.

Despite the doom laden pronouncements of British newspaper columnists, the route to a general rescue of the Latin bloc is actually pretty clear: Boost the powers of the ECB to include banking oversight, and backstop the banking system with full intervention by the ECB on the one hand, while on the other creating, in however limited a way, a common Euro treasury that can issue common government bonds. 

So why has this not yet happened?

The answer clearly lies with Germany.

The fact is that the Euro was created without such powers for the ECB and without a treasury because the Germans believed that the benefits of the single currency would be so clear that no government would want to break the rules: following German discipline would bring German prosperity. In fact for the majority of the Eurozone members, that is precisely what it has done. 

Meanwhile, it has not been politically acceptable in Germany to provide an open credit line to countries where business and political ethics have been a major cause of the crisis. . Instead of German discipline creating general European wealth, the fear is now that Latin indiscipline could create inflation and instability in Germany.The question for the Germans is whether the countries requiring rescue have the political will to bring their government spending under control

We are about to find out.

Far from "Germany" -or "Brussels", in the British media speak- ramming through measures against the popular will, there is real concern over the issues of democratic accountability. Probably the single greatest reason for not including greater powers for the ECB and a common treasury at the outset of the Euro project was the concern over whether these institutions could be held to democratic accountability- and if they could not, then that would contravene the German Basic Law which, for obvious historical reasons, rests on a complete commitment to democratic rules. If the Greek election chooses a workable government, committed to spending control, then Germany has already signaled willingness to fund a rescue for Athens. Meanwhile later this week Ireland is poised to vote in a referendum as to whether they can accept the proposed- more limited- measures currently on the table, again that signal of democratic assent is what European leaders are waiting for.

Germany has not yet made up its mind. However, the outline of a solution that permits the rescue of Greece and the Latin bloc is now clear. The question is whether, for political reasons, Germany is free to take that path.

But the alternative is not- as the UK media would have you believe- the total and chaotic break up of the single currency. The fact is that at least 9 countries: Finland, the Netherlands, Austria, Slovakia, Slovenia, Luxembourg, Malta, Germany and of course Estonia are perfectly capable of complying indefinitely with the currency regime as it currently stands, and they may be joined by Latvia and Lithuania within a matter of 18 months or so. Ireland too has demonstrated that it can maintain its membership, despite the crisis they have endured. A single currency can certainly survive- indeed in Estonia the idea of a return to the Estonian Crown is dismissed with a laugh.

The key question is France. If newly elected President Hollande chooses fiscal indiscipline, it could be the parting of the ways for the Franco-German "motor". However, the pressure on him not to do so will be immense. Likewise, despite the breakdown of the Belgian government system over the past 20 years, the pressure on the country to solve its crisis would probably lead to the EU seat of administration ultimately retaining its Euro position. With France and Belgium in, then the lifeline to Italy is also set to remain in place. The Euro in more or less its current composition survives- but that survival depends on common political will.

The crisis is coming gradually to a head. The choice is whether to proceed with the Latin/Greek rescue on the basis of a renewed political commitment to reform, or whether to endure the exit of Greece and possibly other states from the single currency. That choice depends on the voters of Greece (and Ireland).

Meanwhile, the UK seems increasingly incapable of addressing their own deficit/debt crisis. The idea that the debt crisis can be solved with increased debt is simply false. The demonstration outside Nick Clegg's house over the weekend was a not very subtle form of intimidation, and will certainly be resisted. However, the fact remains that the British tax system is a very expensive burden on the state. Without a root and branch reform and simplification of the tax code (which is, as I have mentioned before, five times longer than the German code and about fifty times more expensive to administer per person than the Estonian tax code) then British structural reform is still dead in the water, despite the modest signs of hope in the private sector.

David Cameron should resist the temptation to lecture the rest of the EU, when his own crisis is in many ways more severe than the Eurozone- even some of the worst of the members. Although the country has taken short term benefit from devaluing its currency against the Euro, without greater government discipline, the UK will simply end up with higher inflation- and a poorer population. The waste and inefficiency of the UK has lead to the squandering of billions- and the coalition so far has been only very tentative in tackling this- and Labour, the source of so much waste when in office, refuses to even acknowledge the question.

Meanwhile the British media should also resist the temptation to give into to anti- EU prejudice. The panic stories such as "Immigration guards in place for Euro collapse" are more or less absurd. The crisis may well continue for some time yet, but that does not mean the collapse of European civilization as we have known it- even under most of the worst case break up scenarios, the Euro economy recovers within 4 years-, indeed most of the Europhobes want the currency to break up for precisely this reason.

Meanwhile the outline of different solutions for the survival of the Euro are already on the table. 

The more foam flecked doom-sayers have been predicting disaster for years. I think they are going to be wrong this time too. 


Monday, April 30, 2012

A Spring contrast

In Tallinn Spring is slowly advancing into Summer. The Sun begins to offer some warmth and the days are growing long.

In London the weather is less good. The rain and storms, that seem inevitable once a drought is declared, are clearly depressing the national mood. In the year of the Diamond Jubilee and the London Olympic games, the national mood still remains rather bleak.

Although the local elections will probably be a nasty mid term shock to the coalition government, the elections that really matter to Britain are happening elsewhere. The likely change of government in Paris may see significant changes in French policy- and the demise of the Sarkozy part of the "Merkozy" partnership may simply be the prelude to a change in government in Berlin next year.

Europeans have grown weary and disillusioned with the austerity program that has been imposed at the behest of the right wing-led government in Germany. The meltdown in Spain and the continuing crises in Greece and Portugal leaves few in the Eurozone immune. If Germany will not agree to fiscal transfers, which it unilaterally deems unconstitutional, then since no other transfers have democratic legitimacy, the result will be the evisceration of the banks in Germany and France (and the UK) that retain their exposure to the southern Eurozone.

There are no good choices for dealing with the crisis, and still the UK remains in the firing line, despite its independent currency. Indeed the slowdown of the UK economy is coming partly as the result of the steady appreciation of Sterling against the Euro over the last year.

As Mervyn King told David Hale during the 2010 general election campaign, those who won that election have taken on a poisoned chalice- and many will view the UK local elections as a striking testimony to that possibility.

Yet it may not be so.

The UK has begun to restructure- and the political pain is still being  inflicted, yet as the British debt levels begin to level off, there is already some benefit. Confidence in Sterling is strong, despite economic numbers that are comparable with the weaker Eurozone members. The coalition remains stable and its application of policy-  whether you believe in the policy or not- is consistent. It may even be that the UK, far from undergoing a double dip recession, is actually growing faster than recorded, and growth may be more robust still.

So as the storms envelop the country in gloom, it is worth considering that the crisis, as with the weather, may yet improve. 

Meanwhile in Estonia, the sun begins to shine more brightly and the better weather leaves us- to coin a phrase- with a spring in our step.   

Thursday, March 29, 2012

Boom, bust and the price of property

The release of the latest revision to GDP growth in the UK makes grim reading. The British economy slowed by more than expected, and the outlook for recovery is flickering at best. Incomes have not kept pace with inflation, and the increase in taxes and cuts in government services has helped to cause a sharp contraction in the general British standard of living. Even for those on well above average incomes, costs such as insurance, university tuition fees and now energy prices are really hurting the middle class. For those below median income it is house rents and petrol prices which are beginning to have a crippling impact. The standard of living in London even for those on median income levels is now exceptionally poor. 

So how come housing costs in Central London have continued to rise?

The short answer is that it is not the British buying. Russians, Arabs, Chinese and others have been buying bolt holes in London, that is certainly true, but more than that, it seems that these buyers are putting together portfolios of properties: buying several at once. London property as an asset class has become like old master paintings and classic cars, an investment class in its own right, and international investors have rushed to get in.  However the economic consequences for the UK look like becoming dire. The historic ratio of average house prices to average earnings was for many decades between 3-3.5 times. Now the ratio for London is already headed back to the peak of seven times that marked out the height of the housing bubble. From the point of view of the British economy, London has detached itself from the rest of the country. Yet, the workers who are the foundation for services in the capital are being pushed ever further out.. Even the best paid professions now find they must pay exceptionally high compensation in order that the talent they wish to attract will not suffer an unacceptable fall in living standards if they move to London. As these costs mount, London is losing the competitiveness  that made it an attractive centre in the first place. In short the situation in London looks like a classic bubble.

The only question is when and how this time bomb can be diffused. Perhaps, post the Olympic Games, we may see an adjustment, but despite the fact of London being an international city- indeed probably the premier global  city in Europe- the disconnect between the asset prices of London and those of the rest of the UK can not be sustained. Either a sharp recovery takes place in the rest of the UK or there is a sharp fall in London.

Given the entrenched problems in the British economy at present, my money would be on the latter option. 

Sunday, January 29, 2012

Another critical week

As Monday looms ahead, there is now the real probability that Greece could default this week. 

No one knows what happens in that event: the policy makers and many market practitioners now think they can cope- but the reality is that no one knows.

I think we are about to find out whether Mrs. Merkel's policy of masterly inactivity will actually work.

I don't think it has, and I suspect that the impending Greek default could well lead to the failure of Hungary and Bulgaria.

This feels like the calm before the storm.

Friday, December 16, 2011

Sarkozy: the bunny boiler

Well, of course the British press will respond to the gale of nonsense being pushed around by the Sarkozyites. The noise of discredited British "journalists", however, is nothing serious.

What this drivel from Paris means though, is that France under Sarkozy has indeed decided that the French national interest is best served by there being not a rival to France for the affections of Berlin. The problem is that the obviously conflicted nature of the British relationship with Europe is more attractive to Berlin than Sarkozy's obsessive lurve-fest for Germany.

Germany does not want a Federal Europe.

Germany has therefore not delivered what Paris wanted, but instead of hating the thing which you love, the French have decided that "if only Britain was not around, then Germany would love us and deliver a Federal Europe": hence this absurd "declaration of dislike" against the UK. Of course the UK is financially weak, and almost all the French say is true but... the UK doesn't have to function within the dysfunctional and unfunded Eurozone and France does. So, as France faces the loss of its AAA and the UK does not, there is an inevitable annoyance. Germany needs to stand up to the plate for France but won't, but meanwhile the UK can survive without German help, at least for a while.

I think the response from everyone across the Channel is... Tough.

Sarkozy will lose power in six months. His behaviour towards the UK has been outrageous, but never mind. France usually takes a while to recognise the  value of a relationship across the Channel. So does Germany.

Anyhow the back pedaling on all sides after the inept British veto is already sidestepping the tantrum of the priapic and foolish French President. After his seeming triumph, he is discovering that every playground fight diminishes BOTH partners. So if the UK is weakened, which it is, then so is Sarkozy.

I am sure the French voters may have noticed.

Adieu Nicolas!

Thursday, December 08, 2011

Mr. Cameron goes to Brussels

The weekly Parliamentary riot that is the British Prime Minister's Question time must have reminded Mr. Cameron how fractious his own party is, when it comes to the European Union. The problem is that the freedom of action that the government has on the issue is pretty limited. The Franco-German diktat, organised my "Merkozy" is pretty much the only game in town, since any proposal has to have the support of the German treasury. From the point of view of the UK, we have been outplayed and outgunned by the slippery French President. 

That is... for now.

Britain has been isolated for two reasons, one real, one a matter of perception. The first is that the UK did not an will join the Eurozone. The second is that British comments, however well intended usually sound like existential criticism of the Eurozone itself.

However ignoring and isolating Britain on such subjects as the financial transactions tax may let backfire on "Merkozy", because they are not just ignoring a British position, they are failing to understand the likely market reactions to their own policies. The Germans have made a critical mistake in trying to tackle the sovereign crisis in isolation. The near collapse of international funding for Eurozone banks has been the result. The crisis has two aspects: the risk of Sovereign default and the risk of banking collapse, and "Merkozy's" ideas were only looking at the problem of sovereign default. The transaction tax proposal is lunacy in the context of European banks that are on the brink of collapse because they can not access market funding- one can only think that it is being put forward simply to be a "concession to the UK", when it withdrawn.

In fact David Cameron, to the chagrin of his backbenchers, is going to Brussels in a fairly pragmatic and open minded mood. However, he should not underestimate the cards he has in his hand, even if he is greeted with a certain froideur or even contempt by "Merkozy". 

Firstly, the Nordic bloc of solvent states remain closer in thinking to London than to Berlin/Paris- and although Spain and Portugal are supplicants to "Merkozy", there is a certain resentment as to the way the Franco-German motor has become a Franco-German directory. The UK is not as isolated as Merkozy would like. This means that simply not imposing a transaction tax will not be sufficient bone to offer David Cameron.

It means that Mr. Cameron can impose conditions on a treaty of 17 as well as on a treaty of 27. The provisions of the single market must not be weakened, and if they are and what "Merkozy" means by a 2-speed Europe is an inclusive and exclusive market, then Cameron must veto.

In fact Mr. Cameron now has the opportunity to remind the other 26 states that the UK is not to be treated like Spain, Italy or Greece, the actions of the coalition government are bringing our financial house into order: it is not the British AAA that is under threat. The issue is how to present this declaration of British power. So far Britain has appeared arrogant and patronising. Now Mr. Cameron should put on a new attitude. 

Merkozy has been preceding on the basis of Caligula's motto: 

Oderint dum metuant: Let them hate me, as long as they fear me.

It is time to put Merkozy in their place: the undermining of democracy and the outrageous contempt displayed to the other sovereign states must stop. David Cameron has some sharp teeth: he should not be afraid to show them to the French and Germans who have brought the European financial system to the brink of collapse. By being determined and forceful, Mr. Cameron could return from Brussels not just with a few token concessions to sell to his backbenchers, but with a whole new working relationship.

Tuesday, December 06, 2011

Red Alert from the Bank of England

The Bank of England made the following statement this morning:
In light of the continuing exceptional stresses in financial markets, the Bank of England is today announcing the introduction of a new contingency liquidity facility, the Extended Collateral Term Repo (ECTR) Facility.
This Facility is designed to mitigate risks to financial stability arising from a market-wide shortage of short-term sterling liquidity. There is currently no shortage of short-term sterling liquidity in the market. But should that position change, the new Facility gives the Bank additional flexibility to offer sterling liquidity in an auction format against the widest range of collateral.
Obviously this follows on from the coordinated action last week, but it underlines that the liquidity crunch that nearly took place carries risks for all non-US$ holders.
The rumour that suggests that we came within a few hours of the total collapse of the short term funding market can only be reinforced by today's statement.
Very Scary Indeed.

What nearly happened in the markets last week makes my blood run cold

In the middle of last week, exceptional measures were announced by a coordinated group of six central banks: the Fed, the ECB, the Bank of England, the Bank of Canada, the Bank of Japan and the Swiss National Bank. In effect they agreed to supply virtually unlimited Dollar liquidity to the market. The result has been a sustained market rally over the past few days. However it is only now beginning to sink in what lay behind the central banks' decision and how close the financial system just came to collapse.

It is now clear that the funding cycle, even for the best credits in Europe was getting dangerously short. Whereas a major industrial, like Unilever, could expect to fund US Dollar exposure for at least 30 days, by the beginning of last week, this was down to three days. If it was bad for industrials, it was becoming impossible for banks. US Dollar holders were not prepared to provide funds to several major Euro-zone banks at virtually any price.

They were simply unable to gain access to the US Dollar market.

Although this still has the status of market gossip, it seems all too likely that a significant number of the largest Eurozone banks would have collapsed last week unless the central banks had done what they did. Just to repeat, last week, the Eurozone came close to a multiple collapse of some of its largest brand name banks because they were not able to access funding in Dollars.

So clearly the action of the central banks was critical, but while necessary, it is not sufficient to address the crisis of funding. It is clear that several major houses do not have an independent future. A major banking restructuring is now very much on the cards.

The German government has refused to address the private sector until the Eurozone fiscal/sovereign crisis is stabilized. Last week's near disaster shows how short sighted that policy has been. The fact is that the debt crisis can only be solved by coordinating debt write-downs and restructuring across both public and private  credits.

We had a very close shave last week, but while the liquidity issue is addressed, at least for the foreseeable future, the solvency issue is not. I do not think it is a coincidence that Commerzbank is being forced to take immediate remedial action to boost its capital ratios. 

Others will follow very shortly. Further retrenchment will follow. So in addition to a major fiscal contraction, the Eurozone must now deal with a large-scale contraction in bank funding. 

It is hardly a surprise that S&P has put all of the Eurozone countries on credit watch for immediate down grade

In the face of the determination of Berlin to impose fiscal control without actually providing credit support, it is a moot point as to whether the price for the Euro is actually worth paying. Even if the Eurozone governments believe it is, the years of recession ahead, amounting, lets face it, to a second Great Depression may see the voters changing their minds rather quickly.

So far the politicians are betting that closer fiscal union will work in the medium term.

Given the odds, that is not a bet I would be taking.

Thursday, December 01, 2011

Taking on more debt does not solve the debt crisis

The usual suspects have been out in force on the subject of the British Chancellor's Autumn statement. The mostly left-wing commentators have been imploring Mr. Osborne to switch to Plan B. "The cuts"- they say- "are too severe, and will damage growth". 

I am almost tempted to say "what cuts?"

In fact, "If only..." because, although the government has talked big on the subject of government spending cuts, the fact is that the deficit remains close to its record high, and every month that passes adds yet further billions onto the national debt, which is already stretched way beyond the normal limits for a AAA credit risk. The coalition has established credibility with the financial markets, and retained its AAA- for the time being- but it is still a question of statements of intent rather than goals that are being achieved.

It is just as well that the UK government has gained a breathing space, because even compared to the peripheral Euro zone countries, the toxic legacy of Labour's debt binge has left the British economy in a very precarious position indeed. In fact, one could almost say that the scale of the problems in the Eurozone have distracted attention from the UK's own miserable debt plight.

The fact is that leverage in general is becoming ever more dangerous- which is why the UK private sector paid down over £ 9 billion of mortgage debt last quarter. Unfortunately, the British government has not been able to do the same thing- but that does not mean that it should stop trying.

The Labour government wasted billions on the public sector, and the bloat that remains is crippling the UK economy. Even now, and for several years to come according to the IFS, public sector jobs are set to pay better than the private sector. That is in addition to the fact that public sector workers are entitled to pension benefits that have had to be abandoned in the Private sector, because they were literally bankrupting the companies that were funding them. If the UK does not change the rules on public sector pensions now, then it will face a future where it will not be able to fund those pension liabilities at all. The strike in Britain yesterday, called to protest against those necessary changes, may or may not have been a damp squib- but the fact is that the government has no choice, and indeed arguably the changes may still not be sufficient to bring the pension funds back to any kind of solvency.

This week came close to seeing a meltdown in the global banking system. The interbank market froze- as it did at the time of the Lehman collapse in 2008. The central banks have been forced to flood the market with extra liquidity, but there is no doubt that there is the very real prospect of both a sovereign default and a banking collapse. The ability even of governments, to place more debt into the market is being severely limited.

That is what the left wing commentators don't get: unless the UK addresses its debt, it may not be able to access the debt markets at all. It is not a question of funding growth through added public spending, it is a question of national survival. The public spending that Labour funded was the creation of non jobs in regulation and control, restricting the ability of entrepreneurs to generate real wealth creation. the cost of that is crushing. Doing more of the same will not solve the crisis- it will inflame it.

So while this government considers how it can find money to invest in critical improvements in infrastructure, the burden of unproductive pensioners and excessive pay and benefits in the public sector must be reduced and this talent must be put to more productive use. It is not enough to create "make work" jobs, they must be jobs that add value and create wealth. 

Tax inspectors don't do that.

Thursday, November 24, 2011

The Credit Crunch Part II

The failure of the German Bund auction yesterday is being written off as being of relatively minor significance. It is not- it is critical. If the Federal German government is unable to attract bids for nearly half of the Bunds that they offer, it tells you that the rest of the credit market is also closed. Banks are unable to access even the interbank market, and we are seeing the system come under renewed strain.

Already we have seen the collapse of the Lithuanian bank, Bankas Snoras, which has also been dismissed as being of little significance. However, the fact is that there is now a serious liquidity drought across central and eastern Europe, and this is spreading. There are strong rumours of a major liquidity crisis in the Russian banking system- and again the failure and subsequent recapitalization of Bank of Moscow is being dismissed as being of minor significance, simply the result of the political fall of Yuri Luzhkov. In fact it may well be that the fall of Luzhkov was the result of the bank failure, not the cause.There is plenty of anecdotal evidence that Russian capital markets are under severe strain.

There is a cumulative body of evidence that suggests that liquidity in the European credit market as a whole is draining away and that the crisis is now testing bank balance sheets- even those with state guarantees- once again.

The fact is that despite the persistent pressure of policy makers to keep interest rates low, the markets are no longer prepared to put capital at risk when returns are being kept artificially low. In other words, there is likely to a significant rise in rates. In fact for the general customer this has already happened, but not yet for banks, which have been trying to take the opportunity to recapitalize themselves with higher margins. Now the regulatory need to bolster bank balance sheets is colliding head on with the renewed tightening of the market. If Germany itself is suffering a buyers strike, then it is clear that the Euro banking system is under severe pressure.

The pressure on sovereigns has eased a little with the advent of new governments in Rome, Athens and Madrid, but that has merely refocused attention to the banks themselves. The Eurozone banking system could be poised to break down without further emergency measures.

With German Bunds now trading around the level of Gilts, the crisis takes yet another lurch downward.

Monday, November 21, 2011

Housing crisis.. government prepares to act (OH NO!)

The stupidest feature of the Blair-Brown government was they way that they responded to every situation with a detailed policy outline or eye-catching "initiative". No aspect of economic or political life could remain undisturbed for long. More criminal justice bills, for example, were passed in their period of office than in the previous ten governments put together. From bulldozers to benefits, more and more of our lives became subject to government intervention and regulation.

It was a disaster. The OCD Brown, both as PM and under Blair undermined our competitiveness, created a class of benefits dependents, demoralized teachers, health care professionals and the police- among others-  by repeatedly second guessing and overruling their experience and advice.

It was a breath of air to have the coalition put a pause on legislation and to seek to repeal some of the more crass mistakes of this Labour mismanagement. 

So it was with a feeling of groundhog day like despair that I read this morning that the government has decided to ACT on the housing crisis in the UK. Of course there is not a housing crisis in the UK yet, but on current trends there will be a problem soon, unless there is more construction of new housing permitted across the country. In the past the state has managed the process directly, by building social housing- council housing, we used to call it- but now the proposal is to provide government guarantees to banks to support mortgages to first time buyers.

Doubtless the ministers and the Prime Minister who is making the announcement this morning will congratulate themselves on an exciting and original idea to stimulate the housing market into growth once more.

Except it is not an original idea- FDR thought of it in 1930s America and created the federal mortgage protection agency that became known under the friendly acronym Fannie Mae. Yes, you have heard of it, because it is the essential bankruptcy of Fannie Mae that has been one of the major problems that the US government has had to deal with.

So, I have started my day shaking my head in much the same way as I used to when Labour were in power: muttering through gritted teeth "surely they can not be so self deluded as to not understand the consequences of this foolish action"

But of course, they are and they don't.     

Saturday, November 19, 2011

Testing China to destruction

A major characteristic of the Great Recession is the way that chronic and long-term problems finally lead to an acute crisis. The public sector profligacy in Greece or the high debt position of Italy are the consequence of decades of policy mismanagement. The US deficit is the result of long term political deadlock, while in the UK and Ireland the roots of the crisis lie in an obsession with property, rather than production, as the key to wealth. Policy mistakes, misallocation of capital, unfunded pensions, poor productivity have been festering for decades. It is only now that the pressure that these put on economies finally leads to crisis.

We have, up until now, mainly seen the crisis hit the Western world. The United States still faces a political struggle to control its deficit as the parties refuse to compromise and, as with much else in the political discourse of the USA enters instead into an arid discussion on matters of the constitution. Yet Business America has coped better than elsewhere, and while the state sector continues to drag the country down, the USA is increasingly well placed to recover.

The European Union and especially the Eurozone faces a far more grim prospect. Without major structural changes, the single currency can not survive, yet those necessary changes are still resisted and the process of reform is very slow. Eventually- for such is the way of the European Union- there will be a compromise that creates a new stability, but until that compromise is achieved, the outlook is dangerous and uncertain.

The conventional wisdom is that Europe and America- and probably Japan- are declining powers in the face of the new powerhouse of Asia, China. That may be so in the longer term, however it is not certain, and the crisis has only just started to lap against the shores of the Middle Kingdom. If the roots of the crisis in the West lie in a property bubble, China has a huge property bubble, which is about to burst. If the roots of the crisis in the West lie in too much state intervention, then nominally Communist China has plenty of misallocation of resources and inefficient capital. If the roots of the crisis in the West lie in policy mistakes of politicians, then how many more mistakes have been made in a system where the power of politicians is untrammeled? 

Now that the overheated Chinese property market is slowing sharply, it is clear that China too is joining the crisis- it is not the safe haven that some were suggesting. Indeed long term China bears, like Hugh Hendry, are dramatically outperforming. In fact, the crisis coming to China will begin to test the major Chinese weak spot: its political system. Ever since 1989, and repression of the Tiananmen Square protest, there have been questions about the long term political stability of the Chinese Peoples Republic. With an upsurge in protest in Chinese society, it may well be that the impact of the bursting of the property bubble could lead to major political instability.

The impact of the repeated policy interventions of the Greenspan years at the Fed did not smooth the cycle: it lengthened it. All the problems of the boom were stored up, until even the shock and awe of the Fed could not stave off the required re-balancing. After the longest boom in history, we seem to be set for a prolonged period of retrenchment and austerity. As that happens, many of the ideas of the boom: that debt and deficits don't matter, that inflation is banished, that you can have too much cash, that governments can not go broke- all are being tested. 

Yet the critical thing that underlined the prosperity of the boom was the huge shift in production to the seemingly limitless labour market of China. Now, we can see that this labour market is not limitless, that inflation in China is reducing their productivity and competitiveness, that there are financial and political risks in China (just as there is a risk to your intellectual property). The result will be that China comes under much greater scrutiny as a place to base manufacturing- and already, several American companies are repatriating production of some high-end goods.

As with so much else in the Millennium Depression, our most basic assumptions about the world order are being challenged- and China will not be immune from that either.    

Thursday, November 17, 2011

Euro breakdown is bringing us to closer to catastophe

The economic crisis that began in 2007, became a banking crisis in 2008, a sovereign debt crisis in 2009, a Euro crisis in 2010 has now become a political crisis in 2011. All of the deficit countries in the Eurozone, the so-called PIIGS: Portugal, Ireland, Italy, Greece and Spain have now seen their governments replaced (in Spain, that will actually take place after the election this weekend, though the result is not in doubt). Germany seems to have won the argument that harsh economic discipline is the only solution to the protracted restructuring that seems to be required.

The stereotypes that have been flying around: that Greek dishonesty or Italian indiscipline are the root of the crisis may appeal to a certain kind of headline writer, but in fact the crisis has been caused as least as much by German indiscipline and banking incompetence. Of course Chancellor Merkel has much to gain by being portrayed as an inflexible, "iron" Chancellor, but the reality is that unless Germany can find some flexibility to allow the ECB to become a true lender of last resort to the Eurozone banking system, then the single currency in its current form is doomed.

While technocratic, un-elected, governments take office in Athens and Rome, in countries which have a very recent history of fallen democracy, we can see a short-to-medium term strategy taking shape. The weakest economies will get a does of German discipline, while Germany considers the prospect of full fiscal union if those economies can be stabilized.

A two-speed Europe is already decreed.

However the two speeds may be a standstill- at best- in the core Eurozone and a major reverse in the periphery. 

The failure of the capital markets has already caused an investment drought, for those countries inside the EU, but outside of the Euro. In Central and Eastern Europe, it is already clear that the Eurozone banks that have been most active in the region are looking to make an exit, in order to retrench their home operations. UniCredit has already put several of its operations up for sale, intending to maintain their operations only in Poland. Commerzbank is set to do the same. Yet these countries are already suffering from a serious capital shortage. In the UK, the lack of investment is already causing a significant increase in unemployment. In Spain the already horrendous unemployment numbers are getting worse.

The consequence of the kind of restructuring that Germany is asking for, will be a huge increase in the numbers out of work. The next year will see levels of unemployment not seen since the hungry thirties. The implications for the kind of restructuring that is under discussion are unemployment rates that in some countries will top 50%.

With democratic governments already suspended in Athens and Rome, the European political elite may believe that it can ram through their policies without consent "in order to save the Euro". However, the price is simply not worth paying. Far better to restore the shock absorber of independent currencies and attempt to ease the pain of the inevitable restructuring under the control of governments that have the consent of the governed than to maintain this suicidal policy mixture.

The "Merkozy" Paris-Berlin axis is said to be under strain. To my mind, the polices that are being followed can not but lead to massive unemployment and a major political breakdown unless Germany simply opens its moneybags- which they are understandably reluctant to do.  Yet without major flexibility and compromise from Berlin, the economy of all of Europe is headed for meltdown.

Relying on German flexibility to save the currency strikes me as dangerous as relying on Greek probity. This is the moment of truth for the Euro. Without German shock and awe in the financial markets, the economic outlook is for a major contraction in Europe, accompanied by huge unemployment and significant political instability. 

We are back to the 1930s in Europe. 


Tuesday, November 01, 2011

Greek gamble pulls Euro to the brink

The decision by the Greek Prime Minister, George Papandreou, to submit the Greek austerity measures to referendum could be seen as a reassertion of democratic control over the relationship between Greece and the rest of the Eurozone. In a way it is a laudable expression of the democratic rights of the Hellenic Republic.

In practice, the two or three months of uncertainty that will result, before any referendum can take place, look like being a Greek revenge upon the rest of the Eurozone. The fact is that the markets will most likely deliver a verdict long before the Greek people are able to. It is an astonishingly high stakes gamble for the Greek government, and it is a gamble that could drag other countries beyond the point of no return, and they too fight to restore liquidity and in some cases, solvency.

It may well be that Mr. Papandreou can win a referendum, but he may also face the collapse of his PSOK party, as certain defections today seem to hint. The breakdown of the Greek government at this critical time would render the terms of the rescue plan currently under discussion rather academic, and even as it stands, the terms are not as stiff as the markets would like.

The problem now is time. The Spanish government is facing a comprehensive defeat in the general election scheduled for 20th November, so new ministers will be coming into office in Madrid. The Italian government is on the brink of a major change, as Silvio Berlusconi finally runs out of road in his legal and political battles. In France, President Sarkozy faces an uphill battle to gain re-election in May 2012. Even the German government is facing a trouncing in a run of local elections, that will limit their options even before the Federal election in 2013. The fact is that the window of opportunity for a deal to be agreed and to stick is going to be be lost as the political calender increases uncertainty.

The risk is now that Greece becomes a side show as the crisis spreads to Portugal, Spain and Italy. The markets certainly see the risk, and the next few days will see both the EU finance ministers and the ECB attempting to bolster the markets as far as they can. In fact they will be trying to make the best of a very bad job.

The Euro which only yesterday seemed to be on the brink of muddling through, is now facing a further cycle of uncertainty and pressure. The risk of a chaotic end-game has increased. The telephone wires across the continent are going to be hot tonight as very worried European leaders seek to consult.

If Mr. Papandreou loses his gamble, Greece will leave the Eurozone- and they may not be the last country to do so.   

Wednesday, October 26, 2011

Blaming the Germans

In all financial transactions there are credits and debits. For the last few years there have been a lot of debits in Greece and the other, so-called, PIIG states. The converse has been that there have been a large number of credits in Germany.

Germany is not a paragon of fiscal rectitude- indeed it was Germany that first softened- by breaking altogether- the financial criteria by which the members of the Euro-zone are judged, but which they now insist must be applied strictly to other countries. Germany has amassed its credits by benefiting from a fixed exchange rate with the weaker economies of the south of Europe. The German economy has been out competing the rest of the Eurozone, which has been unable to balance their economies by either allowing their own currencies to depreciate, thus making their goods cheaper, or by allowing a German currency to appreciate, thus making German goods more expensive. This German free ride has caused considerable economic damage to those countries that are unwilling or unable to match the German policy of greater efficiency.

Now there is a bill to be paid: German industries benefited and provided capital to the German banking system, which in turn recycled capital into more loans to precisely those countries that were the debit to the German credit. Alas the capital can not now be repaid. The result is that the German banking system is now critically exposed to the southern tier of EU states.

Either the German banking system takes a major hit, and has to be recapitalized by the German state, or the debit states need to be rescued... by the German state.

The problem is that Germany refuses to do the one thing that would alleviate the crisis: backstop the rescue fund, the EFSF, with the full faith and credit of the ECB. This touches a serious nerve in Berlin, because such a policy carries with it a significant risk of inflation.

The problem, as always, is not that Germany wants to take over the EU, but that they definitely do not want to take over the EU.

Yet it is precisely the leadership vacuum that the Eurozone and the EU itself now faces that is creating an existential crisis. If Mrs. Merkel can not take decisive action, it will be taken by the markets. Then there will be debits amongst all the EU governments, and credits on a lot of trading desks,