Hayek on the euro

Tru dat

I’ve just finished a book titled Hayek, Currency Competition and European Monetary Union, the text of the 1999 Hayek Memorial Lecture given at the Institute of Economic Affairs by European Central Bank bod Otmar Issing.

Issing quotes Hayek’s Denationalisation of Money from 1978 saying

“though I strongly sympathise with the desire to complete the economic unification of Western Europe by completely freeing the flow of money between them, I have grave doubts about doing so by creating a new European currency managed by any sort of supranational authority. Quite apart from the extreme unlikelihood that the member countries would agree on the policy to be pursued in practice by a common monetary authority (and the practical inevitability of some countries getting a worse currency than they have now), it seems highly unlikely that it would be better administered than the present national currencies.”

Issing spends his lecture arguing that Hayek was wrong.

Otmar 0 – 1 Hayek

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The left hated Thatcher because she thrashed them

Margaret Thatcher, 1925 – 2013

On Gee Street in London there is a Stafford Cripps House named after the post war Labour Chancellor. In Fulham there is also a Stafford Cripps House which contains a Clement Atlee Court named after his boss. In East London there is the Kier Hardie Estate, named after the first Independent Labour MP. In Clapton there is a Nye Bevan Estate named after the former Labour minister.

So I was baffled when, today, my various inboxes, feeds, and walls were swamped by left wing friends asking how bothered I was by the passing of Margaret Thatcher. One or two seemed rather put out when I responded that I wasn’t massively. As someone who could be considered a ‘Thatcherite’ I believe in the individual not an individual. I’ll leave the veneration of Dear Leaders to the left with their crumbling municipal buildings.

At 87 Margaret Thatcher lived a long life. Insofar as we can tell about the private life of this most resolutely political of people it was also a rather happy one. The daughter of a provincial, middle class shopkeeper, born during the Depression, she went to Oxford, became a chemist, and then became a lawyer. Elected to Parliament in 1959 after a decade of trying she rose against incredible odds to become the first female leader of a major British political party in 1975 and Britain’s first female Prime Minister in 1979. She was accompanied every step of the way by her beloved husband Denis.

Her period in office was marked by internal division and conflict of a degree not seen under any other prime minister of the century. Thatcher took on the Labour Party (three times), the Argentines, the National Union of Mineworkers, and crushed them all. By the time Thatcher left office even the Soviet Union and its miserable communism were history.

But in 1988 Thatcher gave her famous Bruges Speech in which she stated “We have not successfully rolled back the frontiers of the state in Britain, only to see them re-imposed at a European level with a European super-state exercising a new dominance from Brussels.” For the European federalists, including many in the Conservative Party close to Thatcher’s predecessor Ted Heath who had never forgiven the grocers daughter for beating the grocer, this was a step too far.

In 1990 Thatcher was finally brought down, not by a bunch of troublemakers rioting in Trafalgar Square, but by her own Europhile backbenchers, angered by her refusal to sign up to a single European currency. History has proved Thatcher emphatically right.

She brooded on this betrayal in retirement but, judging by her memoirs, she was fully aware of just what she had helped achieve, even if she was typically modest about it. She had taken Britain from an increasingly chaotic, sclerotic, and socialist place, to a place which was on the up again. Internationally she had restored some of Britain’s old standing and seen off the communist threat.

Both in Britain and abroad, with the help of her great ally Ronald Reagan among others, she had shown that the inevitable, onward march of socialism was nothing of the kind.

And, perhaps most uncomfortably for her detractors, she was popular and remains so. She won three elections on the trot. In 2011 a YouGov poll for The Sunday Times placed her firmly at the top of a list of post-war British prime ministers with a whopping 27 percent, more even than Winston Churchill.

The sainted Clement Atlee, architect of the welfare state, nationaliser of industries, and namesake of a court in Fulham, limped home with just 5 percent of the vote behind Tony Blair and, mysteriously, Harold Wilson. The much-vaunted street parties celebrating her demise might be rather more thinly attended than the guests have convinced themselves.

Those who profess to hate Thatcher have committed the error of taking something they believe (or claim to, I’m not convinced many of them are actually serious), repeating it loudly and often to other people who also believe it, and assuming from this fusillade of confirmation that everyone else thinks it as well.

These people can often give you a list of reasons they hate Thatcher, lists which are often so suspiciously similar that you have to question how many are the product of original thought and how many are just being parroted to feign an opinion. Most of them, from the mass unemployment to her supposed destruction of Britain’s industry, are easily dealt with.

But the truth is that she would have been disliked intensely no matter what she did. Owen Jones wrote recently that “Thatcher hate is not kneejerk anti-Toryism, after all, there will be no champagne corks popping when John Major dies, and there was no bunting on display to celebrate the deaths of Ted Heath, Alec Douglas-Home, Harold Macmillan or Anthony Eden.”

But remember that in 1948 Nye Bevan, one of the most venerated and overrated figures in British political history, said, “No amount of cajolery, and no attempts at ethical or social  seduction, can eradicate from my heart a deep burning hatred for the Tory Party.  So far as I am concerned they are lower than vermin.”

Remember also that Bevan didn’t say that about a Conservative Party containing right wing ideologues like Thatcher, Norman Tebbit, or Keith Joseph. He said it about a Conservative Party which contained such Keynesian, welfare-state-loving, consensus-supporting politicians as Harold Macmillan, R. A. Butler, and Alec Douglas-Home.

The left disliked Thatcher because she was a Conservative. It hated her because she thrashed them.

Margaret Thatcher is one of only two British prime ministers to coin an ‘ism’ and unlike the other, Blairism, Thatcherism actually meant something. This is why whether alive or dead she will live on. Her ‘ism’ will be a much more permanent monument than the grey, decayed concrete boxes named after various Labour no marks.

This article originally appeared at The Commentator

Cyprus and banking

Fractional reserve joyride

This is democracy in the European Union. Last week the Cypriot parliament voted down a proposal to secure the €10 billion funding needed to bail out its crippled banks that would have imposed a one off “solidarity levy” of 6.75% on bank deposits under €100,000 and 9.9% on those over. This week the Cypriots were offered the money in return for a deal which shuts the second biggest bank and scoops up €4.2 billion from uninsured deposits and moves the insured deposits (under €100,000) to the Bank of Cyprus where deposits over the €100,000 will be taxed at 40%. The Cypriot MPs, from Churchill to Quisling in seven days, accepted.

The counterproductive stupidity of the proposal has been widely noted. It’s difficult to see how the aim of shoring up Cypriot banks which have had their capital bases ravaged by haircuts on Greek government debt will be helped by a policy which is almost certain to cause a run on those very same banks.

But the strongest reaction was moral outrage that the Cypriot government, at the behest of the troika, was considering simply helping itself to its citizen’s cash. Personally I’m unclear how this is morally different to what governments do all the time. Indeed, in the age of the welfare state, big government, and redistributive tax and spending, it has become the governments raison d’être to do exactly this day in day out.

But we shouldn’t dismiss the idea so quickly. It stems from the notion that banks act as warehouses for deposits; that we go to the bank, make a deposit, and that that deposit sits there until we go back to the bank and take it out. Of course, under a fractional reserve banking system it doesn’t work like that at all. Just like the garage attendants who took Ferris Bueller’s Ferrari for a joyride round Chicago when he left it in their care, bankers lend multiples of our deposits straight out the back door as soon as we’ve taken them in the front door. In this sense, as Detlev Schlichter points out, deposits in banks are not like sticking your money in a safe; rather they are “loans to highly leveraged businesses”

You might say that no one actually thinks on that level when they deposit their money in a bank. Well, firstly, why wouldn’t they? The very fact that a bank pays interest on deposits (however small that might currently be) should be a warning sign that they are not merely humble warehouses. Ask yourself, how many warehouses pay you for the privilege of storing your stuff? They don’t because a warehouse has operating costs; it needs a building, it needs staff. It has to charge the people who leave stuff there, its depositors, a fee to cover these expenses.

A bank also has operating expenses; it too needs the buildings and the staff and much else besides. Yet, as the bank takes in your deposits and incurs these expenses, unlike the warehouse it pays you. It must, therefore, have another source of income, and it does; the yield on its assets, assets bought with your deposits. The bank is able to pay you interest because it is accumulating assets with your cash; the bankers are taking the Ferrari for a ride. That banks pay interest on deposits proves that they are not simply warehouses.

Secondly, are we sure that people don’t act like that? As a personal example, my old flatmate’s mum had money in Northern Rock and when it hit trouble she demanded a bailout. “Why did your mum put her money into Northern Rock?” I asked “Because they offered good interest rates” she replied.

Of course they did. That’s because their funding model, lending long term at typically higher interest rates with money borrowed short term at relatively lower interest rates was, ultimately, as risky as it sounds. Many Cypriot banks were offering rates of a relatively healthy 6% or more, but then they were investing 160% of Cyprus’ GDP in Greek government bonds.

One of the first things they teach you in GCSE Business Studies is that profit is the reward for risk. The high interest rates offered by Northern Rock and the Cypriot banks were indicators that they were engaged in something relatively risky. If you choose to take that risk on then I wish you all the best, but you should not expect a taxpayer bailout when things go sour to turn your investment into a one way bet; heads I win, tails I don’t lose.

The idea that governments must bail out busted banks is rarely questioned nowadays except by those who wish to be labelled some sort of economic ‘extremist’. In his book ‘How Capitalism Will Save Us’, free marketeer Steve Forbes has four index references to Joseph Schumpeter and 14 for creative destruction including one saying that “Washington should have let GM and Chrysler reorganise under existing bankruptcy laws”. Yet he answers the question of why the bailout of Detroit was wrong and that of Wall Street right by saying “The bailout was a necessary evil to avoid a collapse of the global economy”. Capitalism will not save banking, it seems.

But government bailouts of busted banks turn the investment that depositing is under fractional reserve banking into a no lose situation. This encourages risky investing and is how shaky banks become ‘too big to fail’. Goldman Sachs and JP Morgan were bailed out five times in the 20 years before 2008 so why wouldn’t they pile into subprime mortgage debt?

What is happening in Cyprus is undoubtedly a terrible situation for all involved. But if anyone is going to stump up for the bailout of Cypriot banks, isn’t it both fair and sensible that those who do are their investors?

This article originally appeared at The Cobden Centre

Cyprus: The ghost of the West yet to come

Get used to it

When the European Union (with German money) mounted its most recent bailout of Greece, one of the conditions was a 75 percent write down of Greek government debt. For the Cypriot banks, which had made loans to the Greek government totalling 160 percent of Cyprus’s GDP, this was disastrous.

With their capital bases smashed the Cypriot government felt obliged to bail them out. Lacking the funds to do so (in 2011 the IMF reported that the assets of Cypriot banks totalled 835 percent of GDP) it turned to the European Union (in reality Germany again) for a bailout.

The Germans are reluctant to lend money without conditions. If the terms of the bailout are accepted by the Cypriot parliament, in return for the €10 billion corporation tax will rise from 10 percent to 12.5 percent and interest on bank deposits will be subject to a withholding tax.

But the most controversial aspect is the proposal that bank deposits will be subject to a one off “solidarity levy”, amounts under €100,000 at a rate of 6.75 percent and those over €100,000 at 9.9 percent.

This is the eurozone crisis at its most extreme but it only differs from events in Ireland, Greece, Spain, Italy, and Portugal, by degree. And in as far as  government eventually has to tailor its outgoings to suit its income it is really just an extreme version of the situation which will also eventually face Japan, Britain, and the US, probably in that order.

So what lessons does Cyprus hold for those who still have all this to come?

The first concerns the relationship between banks and our politicians. Over the last few years politicians elected to represent the people have rarely missed an opportunity to dump debts on those people in the interests of saving banks and other financial institutions which have hit trouble. We have been told that banks occupy a unique position in our economy such that the laws of economics don’t apply to them as they apply to Woolworths or Blockbuster. They are too vital, we are told, too big to fail.

Functioning banks certainly are a key part of a modern financial system but why should the same be said of the toxic zombies who are blundering round the current financial landscape?

And how did these rotten banks get so big in the first place? It’s because governments and central banks prop them up. Bad banks rarely go out of business, they just lumber on, soaking up and destroying more wealth. Goldman Sachs and JP Morgan were bailed out five times in the 20 years before 2008.

The second lesson is that there really is no such thing as private property. In extremis the government considers itself entitled to any amount of your property it desires even if, as in the Cypriot case, it means revoking its own commitments to protect bank deposits.

But then this is the logical outcome of taxation. If you think that a shortage of government revenue can be solved by the government simply helping itself to someone else’s revenue you really can’t have a philosophical problem with this. If you believe in the 50p tax rate this is where you end up.

The third lesson is the limits of democracy. The Cypriot Prime Minister, Nicos Anastasiades, ran at the last election on a promise to protect depositors. Now he stands behind a lectern explaining why he cannot protect depositors. The greater a country’s debts the fewer are its options and in the euro, with no possibility of devaluation, this problem is exacerbated.

The Cypriots will probably feel much as the Irish or Portuguese did to have their economic policy decided by the Troika of the EU, the International Monetary Fund, and the European Central Bank. They may feel a touch like the Spanish or French did when they elected an anti-austerity candidate only to find that they get some measure of austerity anyway. They may end up feeling like the Greeks or Italians who skipped these intermediary steps and went straight to having their governments foisted upon them by the European Union.

This isn’t just a lesson for eurozone members. Labour currently lead in British opinion polls, appealing to soft-headed types who think that we can back to the big spending and even bigger borrowing days of Gordon Brown if only we tick the right box on a ballot slip. In the United States Barack Obama won re-election last year on the promise that the Chinese will continue to lend the US the money to live it up.

British and American voters might not have been slapped in the face with reality in the same way as the bottom half of the eurozone has thanks to their ability to trash their currencies, but it will come. Sooner or later they will be faced with the fact that a country cannot indefinitely live beyond its means and that voting for snake oil salesmen who tell you there is, is a sure fire recipe for disappointment.

The final lesson though, and perhaps the scariest, is that those in charge are no smarter than the average bloke in the street. It is difficult to find the words for the stupidity of trying to shore up Cypriot banks with a policy which will cause a run on those very same banks.

Cyprus offers a grim glimpse of a possible future for the wider western world: politicians who will sacrifice the people for banks, the expropriation of private property to pay for it, the diminishing options offered by the political process, and idiots in charge. Let’s hope they aren’t coming to a crisis near you.

This article originally appeared at The Commentator

Is the Conservatives’ economic trump card warranted?

Let’s roll

It is part of Conservative Party mythology that it is repeatedly elected to clean up Labour’s economic messes. Indeed, 1931, 1951, 1979, and 2010 saw Labour bequeath the Conservatives a steaming pile to deal with. The only possible exception was 1970 when, following the calamitous sterling devaluation of 1967, Roy Jenkins wielded the austerity axe and got the British government’s finances into something approaching order.

Yet, truthfully, Britain has been plagued with economic mismanagement from both sides of the Commons and Labour could make much the same complaint of the Conservatives.

In 1929 Ramsay MacDonald’s Labour took over an economy wrecked by the attempt of Stanley Baldwin’s Conservative government to peg sterling to gold at pre-World War One parity. In both 1964 and 1974 Harold Wilson inherited the messy aftermath of pre-election booms engineered by Conservative chancellors Reg Maudling and Anthony Barber respectively. In 1987 the Conservatives inherited the messy aftermath of a pre-election boom they themselves engineered.

The Conservatives’ playing of their economic competence trump card always required a fair bit of bluff.

Recent developments suggest that George Osborne might think of delving into the same old bag of Conservative chancellors’ tricks as Maudling, Barber and Lawson. This government has nailed itself to the mast of the economy. Put simply, if the economy is growing healthily come 2015 the Conservatives will win. If not they are toast.

So far it’s not looking good. News that GDP contracted by 0.3 percent in the fourth quarter of 2013 meant that the UK economy continues to flat line. This is nothing to do with so called ‘austerity’ but the entirely predictable and unavoidable consequence of a massively indebted economy trying to reduce its indebtedness.

Either way, whether the dreaded ‘triple dip’ is avoided or not, it is looking increasingly unlikely that GDP growth in 2015 will be of the magnitude necessary to bring re-election.

So with 2015 approaching, Cameron and Osborne might come to look favourably on incoming Bank of England governor Mark Carney consummating his flirtation with Nominal GDP Targeting (NGDPT).

NGDPT starts from the observation that money supply targets proved a poor rudder for monetary policy due to problems of defining the money supply and changes in velocity, and inflation targeting proved unable to prevent asset price inflation. With NGDPT the idea is that the central bank sets a path for nominal GDP growth and manipulates the money supply sufficiently to achieve it.

So, if it’s decided that nominal GDP should grow by 5 percent a year, and nominal GDP looks to be increasing above that rate, the monetary authority engages in the sale of securities so as to suck money out of the economy to get nominal GDP growth back on target.

Likewise, if nominal GDP was growing at a rate below 5 percent, the situation we are currently in, the monetary authority engages in the purchase of securities so as to pump money into the economy and get nominal GDP growth back on target.

NGDPT and the market monetarists who propose it have faith in the power of monetary policy. Austrian liquidation or Keynesian liquidity traps can be blasted out of existence with a sufficient charge of base money. Or, as Ben Bernanke put it in one of market monetarism’s foundational statements:

“the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

You can see the attraction of all this to Cameron and Osborne but will they be allowed to get away with it? The mass production of sterling dictated by NGDPT in our current predicament would, in theory, have the effect of reducing sterling’s value on the exchange markets which will make imports into Britain more expensive and Britain’s exports to everywhere else cheaper.

In practice this is exactly what has been happening. The massive expansion of its balance sheet by the Bank of England has seen sterling crash by 15 percent since 2008 which has propped up British exports (it is this avenue which wasn’t open to Ireland).

But if you devalue to boost your exports of goods and services, any increase in those exports is matched by a reduction in someone else’s. This is why the competitive devaluations of the 1930s, as countries scrambled for a share of diminishing world trade, became known as ‘beggar they neighbour’.

And it looks unlikely that our neighbours are going to let themselves be beggared by Britain’s NGDPT. The Federal Reserve continues to buy $85 billion of bonds each month. In Japan Shinzo Abe is pushing an inflation target of 2 percent in a bid to boost its flagging exports. This will come at the expense of German exports which might cause policymakers in Berlin look more kindly on François Hollande’s calls for a devaluation of the euro. The race is on to see who beggars who first.

This article originally appeared at The Commentator

More referendum reaction

If you supported the euro you were wronger than this guy

One striking aspect of the reaction to Cameron’s referendum speech has been the inability of some to use the word ‘Eurosceptic’ without prefacing it with the adjective ‘rabid’. Some, it seems, are utterly incapable of entertaining the thought that there could be a skepticism towards the European Union which is not based on some mania but on a rational appraisal of the pros and cons.

I assume these are the same people who, as Peter Oborne chronicles in his must read recent pamphlet The Guilty Men, were telling us that Britain joining the euro was a no-brainer and that you could only be opposed if you were mad/racist/xenophobic/all three. Of course, as we all know now, the Eurosceptics were exactly right about the euro.

Indeed, you have to wonder who it is who has taken leave of their rational, critical faculties here. Those who predicted, absolutely correctly, that the single currency would be a disaster, or those who continue, in the face of the evidence, to believe that the undemocratic, bureaucratic, failing EU doesn’t need reform so radical that we’d be better off out if we don’t get it.

2015: Time for Cameron to ‘hug a Ukipper’?

The Battle for Britain

In 2005 the Conservative party crashed to its third defeat at the hands of Tony Blair’s Labour. Michael Howard delayed his resignation to give the Conservatives time to reflect on how they had reached this sorry state and ponder what they should do about it.

Looking back to their last days in power before the 1997 election defeat Conservatives saw three factors at play. First, was their bitter civil war over the European Union; second, the steady stream of sleaze scandals; and third, general public boredom with a Conservative government which had been around since 1979.

But by 2005 most of these issues had gone. Blair had neutered Europe as an issue for the time being by promising a referendum on British membership of the euro. In government, Labour had proved just as sleazy as the Conservatives were. And, after eight years of Labour government, the Conservatives looked ever so slightly fresher.

And still they lost. Even against a Labour government which had bent the facts to send British soldiers into Iraq to remove weapons of mass destruction which weren’t actually there, they had lost. Again the question: why?

A bit of research emerged at around this time which showed that people generally approved of Conservative party policies until they found out they were Conservative party policies. To one group of Bright Young Things this indicated that the problem was one of marketing and the search was on for a salesman. Step forward David Cameron.

Cameron had only been in Parliament for four years before he decided to run for the Party leadership. But he had plenty of political experience; indeed, he had done little else since university. He went straight into a job with the Conservative party. From there he became Director of Corporate Affairs (whatever that is) for a TV company, a role which appears to have involved talking to politicians a lot.

It was this presumed media savvy which won Cameron the leadership in 2005. The party wanted someone to put an acceptable face on apparently popular policies. It didn’t want to be Theresa May’s “nasty party” anymore and Cameron promised to make them “feel good about being Conservatives again”

He and the Cameroons who gathered around him had reached political maturity during Blair’s reign. They had seen how Blair had taken over a party which couldn’t even win an election against John Major in the middle of a recession and comfortably won three elections on the bounce. They believed Blair had managed this by ‘detoxifying’ the Labour brand, by taking on and ridding the party of its madder elements. They determined to do the same for the Conservatives.

On one level this meant delving into Blair’s bag of media tricks. Call Me Dave gave speeches without notes, took his jacket off, went sledging, rolled his sleeves up, hugged hoodies, and at the 2006 party conference he made more wardrobe changes than Elizabeth Taylor in Cleopatra.

But on a deeper level the Cameroons were searching for a ‘Clause IV Moment’, the symbolic point when you tame your extremists and embrace electability. Their calculation was that they could bully and pick fights with their ‘right wing’ and in doing so they would attract support from the fabled ‘centre’. After all, they reasoned, any right wingers who didn’t enjoy being bullied by them had, like Richard Gere, “nowhere else to go

But there was a problem. By 1994 the Labour left had been so utterly discredited that the original Clause IV Moment was simply an overdue act of euthanasia. In theory, and in practice, during the post war period the left wing orthodoxy of high tax and even higher public spending had been exposed as the economic suicide it remains.

By contrast no such thing happened to the ideas of the Conservative right. Indeed, the last few years have seen one formerly ‘controversial’ view of theirs after another be resoundingly vindicated. Immigration is too high. Government is spending too much. The euro is a disaster.

Ultimately the Cameroon strategy failed. After five years of ‘rebranding’, against one of the most incompetent administrations in history, and in the middle of a recession, in May 2010 the Conservatives failed to win their fourth election in a row.

And those right wingers didn’t just sit around meekly soaking up the punishment Cameron dished out to them in a vain effort to impress the Guardianistas. Lots of them buggered off to UKIP. And how did Cameron, the master political operator (sic), respond? He was gratuitously rude to them. Again. In the Telegraph last week Dan Hodges wrote that come 2015 “the vast bulk of [Ukip’s] remaining support will come home, reluctantly, to David Cameron.” No, it won’t. And why should it if Cameron keeps abusing them to solicit a favourable glance from Polly Toynbee?

Cameron’s support rises when he pursues Conservative policies; the EU veto and welfare reform, for example. Now, I’m no Central Office genius, but perhaps there’s something in this? Perhaps it’s time for Cameron to stop his fruitless flirting with some mythical centre (which is, in reality, just a punji trap with the sharpened heads of George Monbiot and Mehdi Hasan at the bottom) and remember that he’s a Conservative?

The long term Cameroon strategy of replacing the Conservative right with the Labour right will fail. Its hysterical reaction to even the mild fiscal medicine administered by the coalition demonstrates that Cameron will never find enough votes from that quarter to replace the real Conservatives he sent off in Nigel Farage’s direction.

As 2015 approaches Cameron might find he needs to Hug a Ukipper. If he carries on this pathetic baiting they’ll probably tell him to get stuffed.

Augustinian economics: Balanced budgets, but not yet

I dreamed I saw St Augustine…it was Ambrose Evans-Pritchard

n his Confessions St Augustine of Hippo recalled how, as a young man torn between the pleasures of the flesh and devotion to God, he had prayed “Grant me chastity and continence, only not yet”. This neatly sums up the thinking of those economists and policy makers today who, faced with spiralling debt and historically low interest rates, acknowledge that this cannot continue indefinitely, but say that some prosperous tomorrow, not today, is the time to address those issues.

An example of this Augustinian economics came from Ambrose Evans-Pritchard in the Telegraph on Sunday. As Evans-Pritchard reported, the International Monetary Fund has crunched some numbers and discovered that the fiscal multiplier is not 0.5 as previously thought but between 0.9 and 1.7.

This means that it was previously thought that each £1 of government spending would generate an increase in GDP of 50p. Now it transpires that each £1 of government spending actually generates an increase in GDP of between 90p and £1.70p. It follows from this that cutting £1 of government spending does not, as was thought, cause GDP to fall by 50p but by somewhere between 90p and £1.70p.

One lesson to take from this is to be wary of econometrics. The spread between 0.9 and 1.7 is pretty wide. If the multiplier is 0.9 it is actually much closer to the 0.5 originally thought than the 1.7 upper bound which is the cause of such horror.

A second lesson is to question the idea that government borrowing and spending boosts economic growth. Economic growth is a deceptively tricky thing to measure so policy makers and economists use a proxy, GDP, which actually measures spending. Obviously any fool can boost their spending (GDP) by borrowing a load of money; what’s more questionable is to what extent this represents economic growth, i.e. the capacity of the economy to generate goods and services.

A third lesson is to be wary of the IMF which changes its mind like most people change their socks. The IMF’s latest stance, after embracing stimulus and then austerity, is that the news about the multiplier suggests an easing of austerity. Greece, with a debt of over 160 percent of GDP, will be better off if it borrows a bit more money. Of course, Christine Lagarde, head of the IMF, assures us that getting spiralling debt under control remains necessary, but explains that “Reducing public debt is incredibly difficult without growth”. Budgetary balance but, like the horny teenage Augustine, ‘not yet’.

Evans-Pritchard agrees that while the eurozone’s runaway debts need to be dealt with now is not the time. “The Greco-Latins should be given more time to cut their deficits” he says, “The AAA creditor bloc should stop cutting altogether until the eurozone is off the reefs”.

Like other Augustinian economists, Evans-Pritchard makes the same argument over monetary policy, writing recently

“Needless to say, I will be advocating 1933 monetary stimulus à l’outrance, or trillions of asset purchases through old fashioned open-market operations through the quantity of money effect (NOT INTEREST RATE ‘CREDITISM’) to avert deflation – and continue doing so until nominal GDP is restored to its trend line, at which point the stimulus can be withdrawn again”

The Augustinians tell us that while our economies are in the tank this is not the time to be sorting our finances. The trouble is that we didn’t do anything to sort out our finances when our economies were galloping along. The same goes for monetary policy.

Our economies are so weak that ultra-low interest rates are apparently called for. But ultra-low interest rates were also, apparently, the order of the day in the years before the crisis. We will deal with all this someday, the Augustinians tell us, but it appears that, as Creedence Clearwater Revival sang, Someday Never Comes.

There is a bigger problem though. Just as patients can become hooked on painkillers so can economies get addicted to short term fiscal and monetary fixes. Consider how Evans-Pritchard advocates for massive monetary stimulus until “GDP is restored to its trend line, at which point the stimulus can be withdrawn again”.

But this is exactly what failed last time. The massive monetary stimulus enacted by the Federal Reserve to stimulate the American economy in the wake of the bursting of the dot com bubble in 2000 led Americans to flock into the real estate market and banks to package and repackage, sell and re sell the new debt that ensued. But as soon as this monetary stimulus was withdrawn interest rates rose as they were bound to. This popped the housing bubble and, with it, much of the world economy.

Enterprises undertaken when interest rates are artificially low will not survive when they rise. Every monetary stimulation contains the seeds of the ensuing bust.

It seems that, whether the economy is up or down, while rocketing debt and low interest rates are really, really serious problems which need to be dealt with, the time is never quite right to cut spending or let interest rates rise. This is the Augustinian creed.

Indeed, it doesn’t seem too hard to imagine Evans-Pritchard or Lagarde kneeling before an effigy of Lord Keynes and beseeching “Grant me a balanced budget and sound money, only not yet”.

This article first appeared at The Commentator

Crisis of statism, not capitalism

In search of that magic money tree

t might not have been the ‘crisis of capitalism’ which some have been waiting so long for, but it is widely thought that the last few years certainly represent a “crisis of capitalism”. But if you think of capitalism as a system whereby profits and losses acting unhindered by the hand of government guide capital to its most productive uses, this is difficult to sustain.

The sectors which blew up and took the rest of the economy with them were riddled with intervention. Banks have their capital adequacy rates set and their bad investments covered by government. The housing market is kept inflated with all manner of tax breaks and politically motivated distortions like Fannie Mae, Freddie Mac, and the Community Reinvestment Act. Behind it all interest rates are set by a small panel of political appointees, much as the price of alum keys was set in the Soviet Union.

But as we see violence on the streets of Athens and Madrid, the Occupy protests in the United States, and unadulterated rage on the pages of The Guardian’s Comment is Free (Cif), there is certainly some sort of crisis afoot. It is, however, a crisis of big government.

Over the last few decades governments throughout the western world have made extravagant spending commitments. In Ireland the welfare budget was tripled. In Greece pastry chefs, radio announcers, hairdressers, and steam bath masseurs were included among 600 professions deemed so “arduous and perilous” that workers could retire at 50 on a state pension of 95 percent of their final salary.

But it wasn’t just small basket case economies doing it; big basket case economies were doing it too. France decided that its workers could work no more than 35 hours a week and still generate the wealth to pay for everyone to retire at 60 and spend a third of their lives as state pensioners. In the United States the Bush administration launched the largest expansion of Federal spending since Lyndon Johnson’s Great Society program of the 1960s. In Britain the Labour government increased spending by more than half in six years.

As long as you didn’t look either too closely or too far ahead, these massive spending commitments looked just about affordable as long as there was plenty of money to spend. And there was. In Britain tax receipts rose by 40 percent between 2001 and 2007. In the United States, Federal tax revenues rose by 30 percent between 2000 and 2007. French tax revenue increased by 30 percent between 2002 and 2008.

But these were the effects of the bubble. These were taxes swelled by property values, house sales, and bank profits on those house sales and the myriad ancillary transactions such as securitisation. With the bursting of that bubble that wealth is gone, if it was even there in first place, and it is not coming back. Nor should it.

That does mean, however, that lots of the extravagant government spending promises made before the bust now stand revealed for what they are; unaffordable in the absence of bubble taxation. And given the undesirability of bubbles, that just makes them unaffordable full stop. No amount of general strikes, protesting, occupying, or posting on CiF will change that. We do not have a mighty oak of a money tree, but a bunce bonsai and, in truth, that’s all we ever did have.

Since the crisis hit we have seen both the unavoidability of this truth and the reluctance of electorates to accept it. In the last few years the voters of Greece, Spain, and France have voted out ‘austerity’ governments only to have ‘austerity’ visited upon them anyway by their replacements (at least they were asked, unlike the Italians). There is a very good chance that this November and in May 2015 the voters of the United States and United Kingdom will discover that reality doesn’t just disappear because you tick a box marked ‘Obama’ or ‘Miliband’.

The amount of money spent by the government has grown inexorably. We have reached its limit. In Britain, since 1964, whether top rates of tax have been at 83 percent, as in the 1970s, or 40 percent, the percentage of national income paid in taxes has never exceeded 38% of GDP.

Whatever the designs of the politicians, the social democrats, the Labour party, the Guardian, or Polly Toynbee, the British people, collectively and unconsciously, seem to have decided that they are not willing to fund a state sector any bigger than this. When the share of state spending as a share of GDP reaches 45 percent or 50 percent, as it has recently, the only way is down. That is where we are now.

If the extravagant spending promises of politicians outstrip both the capabilities of even a well-functioning capitalism to generate the necessary wealth and the public’s willingness to pay for it, that is not capitalism’s crisis, but a crisis of big government. Its time is up.

This article first appeared at The Commentator

The battle of the euro – how much will Germany stomach?

Ever further union

Our European neighbours used to sneer at us Brits for our apparent obsession with World War Two. But the unfolding Eurozone crisis has shown that those same feelings have been always been present in continental Europeans, they just hid them behind a wall of rhetoric about shared futures and broad smiles at places like Maastricht. The question of wealth has shattered the façade.

Back during the wars that it’s now ok to mention again, the Germans used to worry about fighting on two fronts, quite rightly as it turned out. Now the struggle over the future of the euro is also settling down to a war on two fronts: the monetary and the fiscal. At the heart of the struggle is the question of whether, and if so, how German wealth can be transferred to heavily indebted PIIGS.

On the monetary front the Germans are trying to hold the line that the job of the European Central Bank is to fulfil its mandate of price stability.

On the other side of the hill are those – the PIIGS, most eurocrats (though few have the bottle to stick their head over the parapet), the Obama administration, and the British government – who think it should be focusing on employment or GDP growth. To accomplish this they want the ECB to print money which, the Germans believe, would be inflationary and scupper the ECB’s price stability mandate.

This is what lays behind the bond buying plan which the ECB announced recently.

When yields on Spanish or Italian bonds reach a given level the ECB will step in to buy these bonds with newly created euros in an attempt to drive these yields down. Crucially, the programme is, on paper at least, effectively unlimited. Under this programme the ECB can expand the monetary base of the eurozone as much as it likes as long as it is used to buy the sovereign debt of PIIG – something which isn’t in short supply.

The other front, the fiscal front, has also been far from all quiet lately. The German Constitutional Court recently ruledthat the European Stability Mechanism does not violate the country’s constitution. This gave the green light for a program which will see Germany liable to bail out stricken PIIGS directly. The German judges did leave one potential poison pill however; they ruled that any increase in German liabilities beyond €190 billion be subject to a vote in the Bundestag.

Both the ESM and unlimited bond buying represent ways by which German wealth can be moved to PIIGS. The ESM is a frontal assault while Mario Draghi’s bond buying is an oblique approach. Creating money does not create wealth, it only redistributes it. In this case debtors would benefit from having a devalued currency in which to pay back their creditors. In many cases the debtors are PIIGS and the creditors are German. Either way, the result is the same.

Last week the BBC broadcast a show about John Maynard Keynes. The host, Stephanie Flanders, attempted to draw parallels between the reparations imposed by the Allies upon Germany at Versailles at the end of World War One (which Keynes famously opposed) and the demands made by Germany now for fiscal restraint in PIIGS in return for their money.

This is a pretty inexact comparison. The war debts of the Allies were exogenous to the German economy; they were just dumped upon it in 1919. The debts of PIIGS, by contrast, were incurred by them quite consciously. Nothing the Germans did made the Greeks promise to pay pastry chefs and hairdressers to retire at 50 on 95 percent of their final salary.

A more exact comparison, in fact, in comparing the sudden requirement to pay exogenously incurred debt which Germany faced in 1919, is with Germany now. As at Versailles, Germans are being asked to foot the bill for the spending decisions of others.

Given the aggression of Wilhelmine Germany you could even argue that ‘reparations’ are less justified now. Germany’s invasion of Belgium in 1914 might have necessitated Britain’s war expenditures, but what German action could conceivably have necessitated the Irish tripling their welfare budget?

Germans seem to have some inkling of this. The court case against the ESM was brought after a petition was raised with 37,000 signatures. According to a recent poll, 49 percent of Germansnow see the EU as a hindrance.

Keynes wrote of Versailles that “If we aim deliberately at the impoverishment of Central Europe, vengeance, I dare predict, will not limp.” This is not to say we are about to see a rerun of 1933 in Germany, but it is worth reflecting how long Germans will continue to abide by the economic and political arrangements of the euro and EU that exist to redistribute its wealth to others.

This article originally appeared at The Commentator