Stürm und Drang: Europe, the Euro & Germany

CW June 2012
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It is difficult these days to write about economics. It's not that there's any shortage of topics to write about but the situation changes so quickly that news is history even as the words hit the paper. The entire world is in crisis but Europe, and specifically the euro, is the current focus of world concern, even claiming the attention of the US President. What makes it even more difficult is the shortage of reliable figures for the amounts of money borrowed, lent and pumped into the economies of Europe, and indeed elsewhere in the world, to stimulate growth.

In February 2011 the Chancellor of the Exchequer, George Osborne, announced Project Merlin, an agreement between the government and the five major British banks, under which those banks would make 190 billion of loans available to companies. Twelve months later, The Independent newspaper reported (Monday 13th February 2012):-

"Lending by Britain's top five banks shrank every quarter last year, official figures revealed today, in an embarrassing blow to the Chancellor's Project Merlin agreement. After taking loan repayments into account, the five - Lloyds Banking Group, Royal Bank of Scotland, Santander, Barclays and HSBC - saw combined net lending slide in 2011, the Bank of England said, including a 3% drop in the final quarter."

In the event, here in Britain the economy has ground almost to a standstill in the first half of 2012 and the government has said that Project Merlin will not be repeated but will make a further 220 billion available to businesses over the next two years.

Even before Project Merlin, the government had embarked upon a programme of Quantitative Easing (QE), beginning in March 2009, to put money into the economy with the hope of galvanising it into action. Between March 2009 and January 2010, the Bank of England's Monetary Policy Committee (MPC) approved the purchase of 200 billion pounds worth of assets, mainly government bonds, to put money into circulation. When the desired effect did not materialise, a further 75 billion was pumped into the economy in October 2011, followed by an additional 50 billion in February of this year, bringing the QE total to 325 billion.

On the evening of Thursday 14th June 2012, the Chancellor of the Exchequer, in his Mansion House speech, announced a further injection of funds into the economy totalling 80 billion to increase lending to business. Simultaneously, the Bank of England will begin injecting 5 billion per month into the City instit institutions to buttress their liquidity.

Nevertheless, all of this is taking place against a backdrop of increasing panic and turbulence in Europe as Spain asks for a 100 billion euro bail-out to prevent the failure of its banks while Greece goes yet again to the polls to try to elect a viable government, and all the omens seem to point to the election of a left-wing, anti-austerity government headed by the Syriza party. In this, Greece is following France and the mood is increasingly set against austerity, while the German chancellor, Angela Merkel, is warning of the need for Europe to 'get real' about its fiscal problems. Germany, quite rightly, has said that it should not, and indeed cannot, bail out the euro alone.

Since coming to power, the British government has made much of its adherence to fiscal rectitude by its programme of austerity measures intended to bring down the deficit. The deficit is currently running at about 120 billion per annum but the trade gap for April rose t to 4.4 billion. Within this shortfall, services were in surplus but trade in goods showed a deficit of over 10 billion, much higher than the 8.5 billion forecast. Overall, the volume of exports dropped by over 7 percent between March and April, shattering the government's hopes that unemployment will be reduced by an increase in manufacturing as the economy 'rebalances' away from financial services. The auguries are not good.

Having said this, we need to look at the deficit figures and the government's claims about its austerity programme more closely. Dr Tim Morgan, of Tullett Prebon, has studied the government's claims and has come up with some surprising figures. George Osborne has seduced the international financial markets into believing that the British government is imposing swingeing cuts in public spending to control the deficit: a figure of 12-15 percent reduction in public spending has been touted. In reality, according to Morgan, the government has only reduced its spending by a ma mere 1.5 percent so far, with only a 5-6 percent reduction even by 2016-2017. Current government spending is actually 20 percent higher than in 2008-09 under the last Labour government and 50 percent higher than it was only 10 years ago. Thus, to repeat, the deficit is running at about 120 billion per year every year and this is adding relentlessly to the national debt.

If Dr Morgan is saying that the chancellor's austerity programme is a chimera, then one has to wonder what it is that is decimating the High Streets of our towns and cities. I can offer only anecdotal evidence, but in my locality, the Bristol-Bath area, shops, offices and cafes are closing weekly. Some of these are small independent business, but many are major chains closing their branches. If this is the consequence of a 1.5 percent reduction in government spending, then I dread to think what a 5-6 percent cut will look like. On 29th November 2011, an article in The Telegraph announced that public sector job losses will reach oover 700,000 by the year 2016-17, far higher than the 400,000 estimated by the government. During this same period the government is expecting the private sector to create 1.7 million jobs, but if current experience is anything to go by this is highly unlikely. The government seems to regard public sector wages as an absolute loss to the economy, not realising that those wages are spent on goods and services. In my locality the impact of those lost wages is all too apparent on the High Street.

Europe remains Britain's biggest single market, accounting for over 55 percent of our exports (Economist, Pocket World in figures 2012) and thus we should be deeply concerned about the state and future of the euro area. Terry Smith, Chief Executive of Tullett Prebon, and a man for whom I have the greatest respect as a plain speaker, maintains that Greece will, indeed must, leave the euro, and that it will be followed by Portugal, Spain, Ireland, Italy and finally, even France. This departure of this last from the euro would leave it as a northern European currency and as such would surely threaten the European project as a whole, the Franco-German axis having been the lynch-pin of the European Union thus far.

The future for Europe is stark. To quote Smith :-

"The simplest reason is that we are going to get austerity whatever people want. There is simply no source of additional money to spend to stimulate growth. The bond markets have had enough of governments who continually run unsustainable deficits. You cannot borrow your way out of a debt crisis."

He further states:-

"There have been no fundamental solutions applied to correct the problems of the Eurozone. You cannot solve a problem of solvency and lack of competitiveness with liquidity and rhetoric. If you could, it would have been solved long ago."

(terrysmithblog.com/straight-talking/tullett-prebon)

Europe is still the world's biggest exporter, accounting for over 16 percent of world trade, almost half as big again as the United States. It is also a big importer and vital to the emerging economies as a market. Within Europe, Germany accounts for over half of all European exports. If Europe fails then the whole world economy will feel the chill winds of that failure. It seems now that such political will as there might have been to resolve the euro crisis has evaporated leaving Europe at the mercy of the international markets. Quite what the political fall-out will be remains to be seen but Greece is looking increasingly like the bell-weather of those changes.

Greece has now been to the polls for the second time in six weeks and has elected a centre-right government which is committed to the austerity measures, albeit with some relaxation of the conditions, but the election, though it has ostensibly delivered a pro-austerity government, has not given a clear signal. The new government is in power only by the merest of margins and must yet again seek to form a coalition if it is to implement the austerity measures. At the present time it is far from certain that this can be achieved and even if the cuts to public spending are made, the social and political backlash may be catastrophic.

Meanwhile, in Spain the banks continue to founder; the yield on 10-year bonds has reached 7 percent. It is now clear that over €100 billion will be needed to bail out the Spanish banking system (Guardian 19/6/12). Daniel Morris of JP Morgan Chase (Bloomberg, 13/6/12) has proposed that a further €300 billion will be needed fully to buttress the Spanish financial system.

What we have at the moment is the ridiculous spectacle of a game of financial 'pass the parcel' as over-borrowed governments borrow money from insolvent banks so that they can lend it back to the banks. At some stage, fairly soon, this Alice in Wonderland economics has to come to an end. It has been said that this is the worst financial crisis since the Thirties. We would do well to remember the political upheavals that followed hot on the heels of that financial crisis, particularly in Europe.

Chris Waller - Permission granted to freely distribute this article for non-commercial purposes if attributed to Chris Waller, unedited and copied in full, including this notice.

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