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 ….
It will be interesting to observe from over here. You don’t mention France pursuing any serious labor reforms in regards to hours worked, retirement, and the size of government. Does that mean you don’t think those steps are necessary, or is it impossible to make those changes in Europe?
The issuing of bonds seems to be just putting a band aid on the problem rather than repairing the problem.
@DD – thanks for dropping by! Don’t get me started on French labour laws and general protectionism! Reform is impossible – the streets would literally be covered in manure or worse. I suspect the police would join the strikers.
France has incredibly inflexible legislation. There have been cases of companies having to fold overnight yet because the requisite 3 months notice to staff was not given, the directors have ended up in jail. The case in mind was a small British company. France is totally unlike most other European countries, particularly the UK, in this respect. I guess in the US, Chapter 11 trading may have enabled the company to continue for a short while but this is not generally available elsewhere.
Apart for 60,000 more teachers, Hollande’s election platform included reducing the retirement age from 62 to 60. I think France still has a 35 hour week on paper and the train drivers have recently been on strike because their retirement age was under threat – at 50! It was an arduous life in the days of steam but they disappeared years ago.
All the same, France does pretty well, partly from agricultural subsidy from the EU (mainly at the expense of Germany and Holland) which are slowly reducing but also because it is a major tourist haven. It has 50 million tourists a year despite high prices, mediocre food, poor sanitation, closed restaurants in the summer time and, in the south, rudeness!
Despite this, and unlike Maria, I do like France! There are aspects in which France is very well organised – they have not been hit by high fuel prices because 75% of their electricity is nuclear and they are particularly good at large strategic projects. They also buy largely French goods – until recently it was almost impossible to get any non-French wine or cheese for example.
My point was that Hollande is likely to push for growth and in this, he is right plus as France is a big economy, it has much more clout particularly with Germany. Sarkozy was a poodle to Merkel but Hollande is much quieter and less flamboyant. I hope he will persuade Merkel and Brussels.
So it is possible that Europe will become closer to the US position over the past couple of years which has led to a lot of new jobs being created although probably not in France where the public sector is 58% of the economy. Fortunately Europe is not France!
The issue of the bonds is not that it is a band aid. All governments issue bonds but in the Eurozone, they were issued by the individual governments but denominated in Euros. Therefore Germany was paying only a few percent while Greece, Italy and the like had to pay 7% and more.
Because the ECB does not act as a banker of last resort, bonds cannot be rationalised. This was madness when the Euro was formed but I think it was to persuade those sceptics that they would not be ‘losing sovereignty’. So the solution must eventually be to harmonise the bonds which effectively means that the ECB must be able to discipline the individual countries and there will be fiscal union. Only then will the Euro work properly.
It was this sort of thing which has kept the UK out of the Euro and will IMHO continue to do so.
I’m afraid we’re moving closer to Europe than the contrary. As you mention, reversing entitlements is a very difficult thing to do. As our populations get healthier and live longer a retirement age of 50 is ridiculous and even 65 seems silly. Who wants to spend the last twenty or thirty years of life doing nothing while getting a government pension (apparently too many).
Significant job growth will only come from private investment. And until Europe makes that investment less of a hassle, and less costly with its over-regulation and onerous rules, Europe will see little growth.
With no growth, but also no austerity on the spending side, it will be scary to watch.
@DrD
It has puzzled me for a long time that the actuarial warnings of longevity were not heeded earlier by pension plans – or by governments. Since WW2 we have extended our life expectancy by approximately 1 year every 4 years (or maybe that is slowing down now with obesity etc). So a scheme that was devised expecting people to retire then die after about 10 years is clearly not fit for purpose.
What is needed is more flexibility in work and retirement which has begun to happen in the UK. However I am not convinced that abandoning final-salary schemes that are common in Europe is fair. There is the argument that it should be normalised average salary instead but the liability of a pension fund is spread over a lot of years.
Pensions scandals in the UK some years ago where companies raided the pension pots (or stopped contributing to them) has meant that pension valuation is now included in company accounts. Unfortunately the bean counters don’t seem to recognise that they shouldn’t just add the two figures together!
But I agree with you – who wants to spend their last 30 years or so doing nothing! So the idea is to go out with a bang if you can…. 😛
You are right about growth of course. In much of Europe the state sector is large. This is not always bad – the state sector provides much that is needed by way of education, health care, transport of some sorts, general planning and culture. And as the state sector picks up the welfare tab when someone loses their job whereas a former private employer has no further liability, you can’t compare the two. So it is not always sensible to make a lot of low paid public workers unemployed because the loss of tax revenues and economic activity is often greater than the ‘gain’ in a reduction in wages bill. The public sector should use the most efficient business approaches but it is not a business.
The problem I think is not so much the state sector in Europe is too big but the private sector which is too small. The other problem is that it is much easier to create public sector jobs than get the private sector to do this because their function is not to create jobs but make a profit.
Anyway more on the goings on in my next post!