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


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

More on Maggie

It was

One of the great pleasures of the internet is to see Baron Tebbit, former Chairman of the Conservative Party, saying something like “I was disappointed to read the view of viewtoday, David Simpson, Jangly Guitar Part and others…” Well, if it’s alright for Norm it’s alright for me so I thought I’d take some time to engage with some of my critics.

The thrust of my article for The Commentator last week was that when someone tells you about the party they have planned for when Margaret Thatcher pops her clogs it is generally a sign that they haven’t thought about the matter very much, at least, not in any serious or original way. There was little in the responses to indicate that this observation is wrong and much to suggest it is entirely correct.

Over on twitter @BirleyLabour saw it as an example of “Tory hate for Sheffield” despite the fact that I am from Sheffield and am not currently a member of the Conservative Party (and when I am I’m not a Tory). Still, it’s nice to see the Sheffield Labour Party’s long tradition of idiocy being upheld.

@DaveTomHodges said it was “somewhat odd to write a piece proclaiming the longeivity of Thatcher’s ideas at a time they’re most discredited economically” I asked him which ideas he meant exactly (my answer would have been monetarism, but there you go) and got in reply “why that would be the low global growth over the last 30yrs as a starter. Economic extremists on both sides are v.dangerous!”

For starters, I don’t think low economic growth was one of Thatcher’s ‘ideas’. It might have been a consequence (though I’d argue against that) but it’s not as though she thought sometime before 1979 “Hang on; what we need is lower economic growth” In fact, she is often slated for putting the pursuit of economic growth above any other considerations. The charges against Thatcher are rarely coherent.

Secondly, though, what has economic extremism one way or the other got to do with it? It doesn’t matter whether your ideas are extreme or not, it only matters whether they are right.

After that young Master Hodges drifted into the last refuge of the Thatcher Bashers, some stuff about Chile and Pinochet.

Another vocal critic on twitter was @glynsmith3. His intial response was “Thatchers achievements mmmm. no sorry she’s just an evil cow who destroyed many peoples lives #witch” which rather proved my initial point. He went on to tweet “you are one selfish dickhead. 5 million unemployed, but at least your fucking happy eh.#torywanker” (proving my point again – and it was 3 million) before tweeting “no abuse from me” He eventually asked “pray tell why Thatcher was so good. i did ask 30 messages ago” which suggests he hadn’t actually read the article which had got him so angry in the first place.

I ought to say that not all the response was bonkers. I was pleased to see a few of my fellow Sheffielders agreeing in the comments (Andrew Cadman, Chrisuk1943, and Phil).

And not all the anti responses were barking. My friend Phil, a thoughtful fellow, reflected on Facebook that “the experience of leaving school and trying to find a job in a city affected as Sheffield was circa 1982 gives me the right to dislike someone who caused that affect” This demands more of a reply.

I don’t think anyone would disagree that Sheffield in the early 1980s was a grim place to be. The question was to what extent that was Thatcher caused it. If she didn’t then celebrating her demise is pretty daft.

Thatcher was elected to tackle two problems; inflation and excessive trade union power. The tool she used to tackle inflation was the doctrine of monetarism. This diagnosed the cause of inflation as being growth in the money supply and prescribed the cure as being the slowing of this growth. However, a decline in the growth rate of the money supply would lead to higher interest rates and higher unemployment.

That is, in fact, exactly what happened under the first monetarist government Britain had; Labour in 1976. That year Jim Callaghan, Thatcher’s predecessor, was forced to ask the IMF for a bailout. One of the conditions of the IMF’s loan, not unreasonable given the inflation of 25% the previous year, was a slowing in the growth of the money supply. The Chancellor, Denis Healey, obliged (he had no choice) and unemployment quickly shot up to a post war record of 1.5 million in 1977 where it more or less stayed until Thatcher was elected. Inflation, meanwhile, fell to 8% in 1978 before Labour went on a pre election credit binge and it started heading upwards again.

So given the experiences under Callahan/Healy as well as Thatcher/Howe, we can safely say that the defeat of severe inflation means higher unemployment. There is no other way. If you believe that the inflation Britain was plagued by in the 1970s needed to be defeated you cannot hold the subsequent unemployment against Margaret Thatcher.

You might, however, think that the price was too high and that high and increasing inflation was preferable to the unemployment that was an unavoidable part of getting rid of it. Celebrating Margaret Thatcher’s death because of the unemployment she oversaw only makes sense if you believe this.

The trouble is that economic theory had come to predict and the practical experience of the 1970s had borne out that using a bit of inflation to reduce unemployment only worked for a short time (that short time getting shorter with every dose) and that each dose had to be higher than the one before*

Indeed, this insight came to Jim Callaghan before Thatcher was even elected. In 1976 he told the Labour Party conference that

“We used to think that you could spend your way out of a recession, and increase employ­ment by cutting taxes and boosting Government spending. I tell you in all candour that that option no longer exists, and that in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of infla­tion into the economy, followed by a higher level of unemployment as the next step. Higher inflation followed by higher unemployment”

That was Thatcher’s belief put as well as she ever put it herself.

Quite simply the path of ever higher inflation was the path to national ruin. Thatcher saved us from that at a dreadfully high cost. But anyone who tells you it was available cheaper is having you on.

* The reasoning behind this was that if people expected inflation of 5% they would factor it into their calculations and only nominal magnitudes (prices) would change, real ones (output, unemployment) wouldn’t. So, to spur an increase in output or employment the inflation would have to be unexpected so if 5% was the expected rate the actual rate would need to be, say, 8%.

However, once people factored in the 8% rate the next stimulus would have to be up higher, say 10%…

The IMF: cheerleader of the rich world’s governments

If its Tuesday this must be stimulus

Ronald Reagan’s observation that “a government bureau is the nearest thing to eternal life we’ll ever see on this earth” seems to apply to supra national bodies as well.

The collapse of the Soviet Union left NATO facing an existential crisis worthy of French cinema until Slobodan Milosevic came along. So it is with the International Monetary Fund.

Established as part of the Bretton Woods system of currency management in 1944, the IMF’s job was to lend money to countries which were having balance of payments issues; who couldn’t pay their bills in other words. With their dollar exchange rates fixed, paying the bills by inflating the money supply was only allowed in the extreme circumstances of devaluation as Britain had to do under the Labour governments of Clement Atlee in 1949 and Harold Wilson in 1967.

The demise of the Bretton Woods system in 1971 rendered the IMF purposeless. Floating exchange rates replaced fixed rates so, in theory, no country should have any trouble financing its borrowing; it could just print more money, the effects being felt in internal inflation and external devaluation with the exchange rate adjusting automatically to reflect the decline in the value of the newly debauched currency.

Milton Friedman, an advocate of floating exchange rates since at least 1950, held that floating exchange rates didn’t have to mean unstable exchange rates. In practice, removed from even the questionable discipline of the Bretton Woods system, central banks around the world cranked up the printing presses and debt crises became bound up with currency/inflation crises. The IMF’s role was much as before; covering cash strapped countries while they sorted themselves out as they had to do for Britain under the Labour government of James Callaghan in 1976.

In this not-so-new role the IMF has attracted much criticism. Nobel laureate Joseph Stiglitz, among many others, has argued that the IMF’s lending conditions, generally to balance budgets, protect the currency and free up markets, are counterproductive.

In truth a country with a debt problem will have to move towards budget balance and stabilise its currency at some stage. Critics would argue that the midst of a crisis is not the appropriate time but when countries don the IMF hair shirt they have generally reached a stage where their problems cannot be solved without tackling the fiscal and monetary problems at a fundamental level. The truth is that many of the countries it has helped would have been worse off if it hadn’t been for IMF assistance.

A more serious charge against the IMF is its inconsistency. In 1997 a clutch of South East Asian countries were hit by a currency crisis and the IMF stepped in with its standard prescription of fiscal and monetary tightening with the attendant economic pain. If this was a tough sell for domestic politicians, well, that was their problem.

But when the western economies hit trouble in 2007-2008 the IMF suddenly rediscovered its dusty old copy of Keynes’ ‘General Theory’. It enthusiastically backed stimulus spending in Britain, the United States and Europe. Western politicians were given a much easier sell than their Asian counterparts had been in 1997.

The effects of the tidal wave of stimulus unleashed in 2008-2009 were subject to rapidly diminishing returns. The accumulation of vast piles of debt produced nothing beyond the short term other than higher debt. The gruesome examples of Greece and Ireland saw ‘austerity’ replace ‘stimulus’ as the economic order of the day and, again, the IMF enthusiastically backed it in Britain, the United States and Europe.

Bad economic news abounds. In Britain the service sector and manufacturing sector are struggling. The Eurozone is struggling in the face of tottering banks and battles to reign in spending. The United States economy created no net jobs in August and unemployment is stuck above 9%. Stock markets around the world have been bumping downwards.

If a second dip does emerge from all this it will no doubt enter Keynesian folklore that ‘austerity’ was the culprit. It isn’t. Economies around the world have gorged on cheap credit and are now burdened with its flipside, debt, leaving a vast overhang to be painfully deleveraged away. Further, the period of cheap credit left behind a host of malinvestments; enterprises only viable in an environment of cheap credit. Government and central bank attempts to prop these up and bail them out, soaking up much needed capital, have only delayed the economy’s move to a more sustainable basis.

The IMF may have been taken in by this burgeoning Keynesian myth. This week saw a possible switch back to the policies 2008-2009 with Christine Lagarde, new head of the IMF, calling for renewed stimulus in Europe. Keynes is reputed to have said “When the facts change, I change my mind”. The facts haven’t changed but the IMF’s stance has, repeatedly.

Ludwig von Mises wrote that Keynes’ ‘General Theory’ was “an apology for the prevailing policies of governments”. Governments may have no need of Keynes. They have the IMF in its latest role, cheerleader of the rich world’s governments.