Thursday, 31 May 2012

The crisis in Greece and arms purchases

Jim Stewart: Recent comments by the Head of the IMF (Christine Lagarde, Guardian Newspaper 26th May) in laying the blame for the crisis in Greece on Greek people (Greek people should help “themselves collectively by all paying their tax”, and that it was now “pay-back time” for Greece) have proved controversial. Overall Lagarde is quoted as stating that “she has more sympathy for children deprived of decent schooling in sub-Sahara Africa than for many of those facing poverty in Athens”.

Hostility to Greece

Taking these views at face value, and ignoring the calculus as to how different levels of deprivation might be compared and the role of the IMF in fostering such deprivation, they are not unique. The head of Deutsche Bank has described Greece as “a failed state ... a corrupt state” (Guardian newspaper May 26, 2012). Der Spiegel (5/10/2012) quotes newspaper coverage citing growing sentiment in Germany that Greece may leave the Euro and that this might be a good thing as a Greek exit could make the euro stronger and could also have a “disciplinary effect on other countries”. At the same Spain and Italy are regarded with sympathy in contrast to Greece. An article in the New York Times states ‘Greece, on the other hand, is roundly criticized for lying about the true state of its finances again and again, before and after joining the euro zone, and its failure to take any of the numerous steps demanded by its creditors to modernize its economy and — a particularly sore point — its tax collections. Its status as a special case is underscored time and again’.

Recent comments by the minister for Finance in Ireland to the effect that Greece leaving the Euro would have little effect in Ireland as “it is very far away” and the only item purchased from Greece is Feta cheese are part of the same pattern. Such comments are far removed from EU declarations on solidarity.

What has changed? In Ireland Greece is the example to be avoided. The Minster for Foreign Affairs in Ireland is quoted as stating a default would “place Ireland in the same situation as Greece” (Irish Times, 27/4/2012).

In the case of Germany, anti-Greek sentiment is partly motivated by economic nationalism. Der Spiegel quotes the head of CSU (Horst Seehofer) as seeing a Greek withdrawal from the Euro as the best option and states “We must preserve Germany’s economic strength. That’s more important than Greece remaining in the euro zone”.

A key feature of much of the comment about Greece and the Euro is its relative lack of analysis. One reason for this is that much of the comment originates from a political position which is closely aligned to the position of the current government in Germany.

Take for example comments by Mr Asmussen (described by the Guardian newspaper as Germany’s representative on the ECB council) who stated: "Greece needs to be aware that there are no alternatives to the agreed bailout program, if it wants to stay in the euro zone" (Reuters May 8 2012). More political still are comments by the President of the Budesbank who is quoted by Reuters as stating "If Athens does not stand by its word, then that's a democratic decision. The result is that there is no more basis for further financial aid" (Reuters, November, 5, 2012).
This lack of analysis is reflected in comments that Greece will be required to leave the Euro. Greece cannot be required to leave the Euro. Greece may itself decide to leave the Euro but again the mechanism for this is unclear, but there is no mechanism by which other countries can require Greece to leave the Euro. Even if Greece were in some sense to leave the Euro, the large black economy is likely to mostly trade in Euros, and elements of Greek banking will move offshore to other Euro area countries.

Military Spending by Greece

A lack of analysis is also reflected in the failure to consider the implications of the size of military expenditures by Greece as indicated by stocks of military equipment (see Table (1).

Greek Military Equipment (In Service)

(1) Wikipedia note that military equipment is from German, French, American, British and Russian suppliers
(2) A total of 170 new Leopard (German) tanks were delivered between 2006-2009.

Greece was among the world's top five largest recipients of major conventional weapons for 2005-2009, and was third place for 2000–2004. The transfer of 26 F-16C from the United States and 25 Mirage-2000-9 combat aircraft from France accounted for 38 per cent of the volume of Greek imports for the period 2005-2009 (SIPRI Trends in International Arms Transfer 2009, p. 5). Greece was the largest importer of German conventional weapons in the period 2007-2011 and the second largest importer of French conventional weapons (source: SIPRI Trends in International Arms Transfers 2012). Since Greece joined the Eurozone until 2010 military expenditure has varied between 2.3 and 3.4% of GDP, compared with 1.4 to 1.5% of GDP for Germany and 0.6 to 0.7% for Ireland. Since joining the eurozone cumulative military expenditure for Greece amounts to around €63 billion (Source here). Even in 2011, Greece continued to import arms and has outstanding orders for five German submarines.

Yet it is difficult to find any reference to arms spending as a contributory factor to the fiscal and economic crisis in Greece, by outside commentators or by Greek commentators (see for example Costas Simitis, former Greek Prime Minister, writing in the Guardian 27th April, 2012).

It is also inconceivable that the Minister for Trade in France in 2005-2007 (Christine Lagarde) did not approve of arms exports and it’s likely financing by French Banks. Again it is inconceivable that exports of arms from Germany were not approved at a political level and financing provided by German banks. Expenditures on imported military equipment do not lead to economic growth but rather the growth of international debt. By facilitating such expenditures Germany and France bear some culpability for the predicament now faced by Greece. This should be recognised in terms of bilateral aid to Greece to help achieve genuine economic reform, productive investment and basic levels of affordable health care provision. Lecturing Greeks to pay tax while at the same time offering no positive vision will ensure the Greek crisis continues inside or outside the Euro.

Krugman - on just about everything

Nobel Laureate Paul Krugman's visit to Britain has given rise to a number of interviews and articles. Click here here to read a full transcript of his very wide-ranging interview with the Independent's Ben Chu. Seperately, in a piece reprinted by Social Europe Journal from the New York Times, Krugman takes a look at that mythical Irish creature, austerity-generated recovery.

Wednesday, 30 May 2012

Has the State any Business in Business?

Sinéad Pentony: TASC held its first lunchtime seminar yesterday. Paul Sweeney considered the question - ‘Has the State any business in business?’. Paul’s presentation put the issue of privatisation in the current context; identified the winners and losers in privatisation; and how/where it fits into industrial policy. The presentation draws a number of conclusions including the need for a more nuanced approach – privatisation is not a black and white issue; and there is a need for more diversity in the forms of ownership, as set out in the recent report by The Ownership Commission, which was chaired by Will Hutton.

Tuesday, 29 May 2012

Our problem is not the EU - our problem is ourselves

Colm O'Doherty: Earlier this year, in Davos, Enda Kenny spoke about moral failure and its responsibility for our economic crash. He said that easy access to credit had spawned greed to a point where it just went out of control completely and ended with a spectacular crash. There was an immediate outcry in Ireland on foot of his comments and he was accused of playing the blame game. However, with the referendum on the fiscal treaty now being debated across the country, it is timely to ask some hard questions about ourselves – can we be trusted run our own affairs in a fair, just and moral way? If we are not externally regulated, do we run the risk of handing over our country to greedy business people and greedy politicians as we have repeatedly done over the past thirty years? Greedy capitalism and the inequalities it rests on, triggered the economic crash.

As Finnish academic Antti Kauppinen points out the sub-prime loans given out in the US to poor people, who because of historical injustices were unable to access mainstream credit, triggered the world wide crash. Inequality lit the fuse which started the meltdown in the US. Inequality in Ireland has been well documented by Combat Poverty, the Irish Anti-Poverty Network and the OECD. Our fiscal policies are the core problem here. The policies which spawned our economic crisis have their origins in Leinster House rather than Brussels. Regressive taxation policies which re-distributed income from the least well off to the middle and upper classes through tax breaks encouraged reckless property speculation. These policies have been repeatedly endorsed by the electorate over the past twenty years. The tax base has been narrowed to a point where we have an extremely low tax-to-GDP ratio. At 28.2% in 2009, the total tax-to-GDP ratio here was the third lowest in the EU and the second lowest in the euro area. The ratio in Denmark for the same period stood at 48.1%. It is no wonder that we are reliant on bail-outs from the EU to fund public services. Clearly the State cannot fund essential education, social protection, activation and health services on an income which is lower than that achieved in Slovakia and Bulgaria. While this ratio was on an upward trend between 2002 and 2006, it has decreased by four percentage points from 2006 to 2009.

As Antti Kauppinen, commenting on the layers of greed capitalism which were enshrined in our tax system, said in a recent address to the Policy Unit in TCD:

In Ireland, we know the ethos of greed reached the highest offices in the land . From an outsider’s perspective, the number of former Taoisceachs and ministers hauled in front of tribunals is comical. If the elected representatives of people use their position for personal enrichment at the expense of ordinary people, why would businessmen hold themselves to higher standards? As if personal example wasn’t enough, Ireland as a country has pursued its self-interest at the expense of others with its now sacrosanct low corporate tax rate.

So rather than scapegoating the EU for the inequalities which have been key to the inflation of our home-grown economic bubble, we now need their assistance in protecting us from ourselves. We need to raise our corporation tax to pay for our public services. We need to widen our tax base so that the high earners and wealthy members of Irish society pay their fair share. The path to follow is greater austerity for the rich. At present a person earning over 32,800 Euro enters the 41% top tax rate and is paying the same rate of tax as an individual earning multiples of their income. Structural inequalities in Irish society are patterned by the differential opportunities available to individuals to gain economic, social and cultural capital. In simple terms, the dice are loaded in favour of the well- off promoting their class interests through a tax system which takes no account of their favoured position in an unequal society. Their social contract is more important and is afforded a superior status - they cannot be required to shoulder a greater share of the financial burden resulting from our economic crash because this would cause them to flee abroad.

By increasing the tax revenues available to the State we can reduce our level of borrowing from the EU and the IMF. At the very least, if taxing the rich is not an option, then they should have to pay more for services and receive less in state support so that funds can be directed at the most vulnerable and disadvantaged in society. These are direct actions which can be taken here and now by Irish citizens. It should be obvious to everybody that a myth that was used as a fig leaf for our Irish model of greedy capitalism - that American levels of tax (low) can produce Scandinavian levels of public services (high quality and expensive) - was just a myth. What is hard to understand is why anti-treaty voices on the left have decided that the enemy is the EU, when it is clearly our own brand of greedy capitalism which has forced austerity on the less well-off citizens of our state. It is not hard to understand why the 'no' campaigners on the right want to blame the EU and cut us loose from fiscal regulation. Libertas and other neo-liberal voices supporting unfettered and de regulated capitalism are opposed to the managed capitalism promoted by the EU. Sinn Fein’s implicit view that everything native is good and that everything foreign is bad is consistent but doesn’t square with the facts.

Citizens voting on the treaty need to seriously think about the damage caused to our society by home-grown taxation policies which have clearly favoured the well-off and re-distributed funding from public services to speculators. They need then to make links between our fiscal insolvency, the ongoing need for financial support from the EU and these inequitable and unsustainable taxation policies.

Sunday, 27 May 2012

How bad is Greece?

Rory O'Farrell: Government deficits can be broken down into two parts: interest payments and the 'primary balance'. The primary balance includes everything other than interest payments; so it includes social welfare, money raised through taxation, salaries etc.

Greece is often portrayed as a basket case that just can't get its act together. However, as can be seen (click graph to enlarge), Greece's primary balance is better than France and Netherlands. Greece's problems are largely due to the legacy of the past.

Thursday, 24 May 2012

NERI Information note on the Fiscal Compact

Tom Healy: The note presents some important facts and insights - not all of which have got an airing in the public debate to date. The document may be downloaded here.

Fiscal treaty is a social, political and economic threat

I humbly draw your attention to the Irish Times today, in which the Tasc Economists Network is mentioned at the end.

Tuesday, 22 May 2012

TASC submission on unemployment

Sinéad Pentony: In a submission to the Oireachtas Committee on Jobs, Social Protection and Education, TASC has looked at a number of key questions.

The submission provides an overview of unemployment, which clearly illustrates the scale of the crisis and who is being most affected. There are clear inequalities in the labour market within and between generations. Those previously unemployed in craft and related areas represent over one third of those who are on the live register and this group is more likely to have lower levels of education and skills. Almost one third of young people are unemployed. The reasons for this include a lack of jobs, low levels of education and training coupled with limited work experience and the fact that young people are more likely to lose their jobs in economic downturns.

The submission also considers the measures that Government is taking to address the problem, which includes reform of labour market activation policy – Pathways to Work, and the Government’s Action Plan for Jobs. These measures include some long over-due reforms, but they will not address the unemployment crisis, as it is primarily a demand-side problem – the demand for labour is less than the available supply of labour and addressing this issue requires a targeted programme of investment and economic growth.

Finally, the submission considers the issue of youth unemployment and puts forward a number of recommendations that include improving the quality of existing policies aimed at providing young people with valuable work experience and training; assessing the feasibility of providing a ‘Youth Job Guarantee’; assisting young people to become entrepreneurs; and targeted education and training initiatives aimed at young people with no formal qualifications.

Guest post by Arthur Doohan (II): Debt realities

Arthur Doohan: In five years we have gone from being the "pinup stars" for EU growth to being the "posterchildren" for austerity and, like a nodding dog in the back of a car, our leaders are as clueless now as they were then about the road taken and final destination.

Some of that 'clueless-ness' can be seen in 'loose talk' going around at present about the relationship between Ireland and the EU and the other EU member countries. An awful lot of this loose talk revolves around how damaged that relationship would be if the Irish people choose not to join in the Fiscal Compact. A further chunk of the 'chit-chat' revolves around the question of where else we would borrow 'the money' from when (much more so than 'if') we need a further dose of 'austerity medicine'.

I will skip over the blatant inconsistency of a Government that insists we are on the correct path with light at the end of the tunnel under a fully funded and committed financial program while at the same time hastening to arrange the paperwork on yet more borrowings. But not without pointing out that the Taoiseach has recently reiterated and reaffirmed that the existing borrowing program supersedes the envisaged ESM facility that may be provided by the Fiscal Compact.

I will also skip over the issue of whether the Fiscal Compact is a smart or pragmatic or sensible or even a 'pro-European' step to take.

I will skip over these things to state some boring, practical banking 'facts of life'.

There is an 'old saw' from the banking world which states that if you owe the bank 400,000 you have a problem, if you owe the bank 4 million you both have a problem and if you owe the bank 40 million the bank has a problem.

By the end of 2012, all financial sectors of the Irish economy, its households, businesses and the State, will be massively in debt. The State particularly will have a debt/GDP ratio about 120%. This is the level at which it becomes a very dicey proposition for both borrower and lender to go any further into debt.

But the most important thing about this debt is that this money is ALL SPENT. It is not sitting on deposit in a Swiss bank account.

You can debate all you like about whether we did the right things with that money. You can argue until you are blue in the face about whether we can repay it and grow our economy at the same time. You cannot deny that the money is gone and that all that remains is our promise to pay it back.

Those who lent it to us have no lien on the State. There is no court they can turn to enforce any security or charge because there is no such court and they have no security. And, once again, the money is not on deposit somewhere where they can go and seize it.

The only choice our lenders have is on what terms to lend us any more money. A refusal by them would put us into default.

So the issue is not where we can borrow. The issue is on what terms we will continue to repay.

Now, that is the hard practical business reality of it. If that is an uncomfortable truth for you, you should be aware that this is the reality that confronts every lender to every State that gets into financial difficulty. It is not some uncharted territory or some nightmare of eternally shattered reputation and financial purgatory. The experience of Iceland proves that. In fact, the experience of Ireland after it's 1993 devaluation proves that. And anyone who suggests that devaluation and default are different things betrays their hopeless ignorance of the mindset and disposition of the investment and bond trading communities.

One of three things will happen in our near term future. The happiest and least likely is that we will resume some solid growth in the economy and will slowly but steadily repay these debts over a fifteen to twenty year span. The unhappy probable outcome will be that we will have weak growth and the economy will move sideways for a decade or two. The unhappy possible third option is that there will be a default which may, or may not be, 'graceful' and 'managed'.

If and when that day comes for Ireland, some people will seek refuge in economic theories, some hope in protection of laws and regulations, some will seek solace in the arms of supra-national entities and a few will still seek help from deities. But the reality is that bankers and accountants will sit down with the politicians and thrash out what can be paid and seek to extract as much as possible for themselves and their clients.

If a country has leaders who care about it and who have some ability and some understanding of how the real world works, when they sit down to negotiate at that post-default table, then a positive and helpful result can be achieved for the people while being fair to the lenders.

Before that day comes it is still possible for leaders to start us down the path of a more sustainable debt burden that will in the end be fairer to both the borrower and the lenders by simply starting to talk realistically about these overarching realities. But they have neither the ability, the expertise, the self-confidence nor the courage to rock the 'European boat' and are content to be errand boys for the apparatchiks and the bankers by continuing on the path to default while asking us to swallow ever greater doses of pointless austerity.

Monday, 21 May 2012

Ireland and EFSF access

Tom McDonnell: It was pointed out on this blog a few weeks ago that Ireland would be able to obtain access to new funding from the EFSF provided the Government applied for that funding before 1 July 2013. Ireland would also need to negotiate a new Memorandum of Understanding.

It is the position here that Ireland will need to access further official lending beyond the current 'bailout' programme and that the Government should make an application in the first half of 2013.

The Minister for Finance appeared to acknowledge last Tuesday in the Dáil that Ireland would indeed have access to further EFSF funding in the event the Government applied before 1 July 2013. The discontinuation of the original Greek programme, and its replacement with a new programme, suggests that countries in existing programmes do not have to wait until their current programme finishes before beginning a second programme.

Thursday, 17 May 2012

Guest post by Arthur Doohan: It's the economy, stupid

Arthur Doohan: "...most of the people ...were unhappy… Many solutions were suggested for this problem, but most of these were largely concerned with the movements of small green pieces of paper, which is odd because on the whole it wasn't the small green pieces of paper that were unhappy." - Douglas Adams.

Or to put it another way, there is nothing wrong with the Euro as a currency and plenty wrong with how much debt we expect our economies and our households and our taxpayers and our citizens to bear.

As a medium of exchange and a unit of account the Euro has been a complete success. As a store of value it is facing some challenges.

These challenges arise from the fact that we Europeans have misvalued our property assets by a considerable margin and the wealthiest of us are trying to get the poorest to bear an unfair share of the burden of those mistakes.

The property mis-valuation occurred at a time when the German economy was in the doldrums, post re-unification and post the 'DotCom bubble'. German bankers and bondfund managers were getting very little return on their Euros in the German economy. It was perfectly natural for them to seek investment opportunities abroad, especially as the newly minted currency made it easier to measure, price and transact business opportunities.

What was not perfectly natural was for them to forget the rules of prudent investing, to mimic what US and UK banks were doing and to ignore what external advisors were telling them. But as the erstwhile chair of Citigroup, Chuck Prince so neatly expressed "You've got to keep dancing while the music plays!"

That the regulators in the EU and domestic economies also abandoned their responsibilities and let the music play at an ever faster tempo at the same time is perhaps just another case of hubris in the postpartum roseate glow of the newly arrived Euro. But that does not excuse their trying to shift the blame for the coming of Nemesis.

The Euro was and is well designed. It is a fine piece of engineering, built largely by the French and the Germans, who know a thing or two about building. But the Euro is the financial equivalent of a car, not a plane or other anti-gravity device. By refusing to use it in the way it was intended to be used and by refusing to keep national debts and deficits in check by the fines and other mechanisms built into the Euro design the politicians and bureaucrats have made fools of themselves and a mockery of the patient efforts of two generations of statesmen.

What they have done is the equivalent of driving it off a cliff. What they are doing now is the equivalent of trying to ……well, actually I don't know what they are trying to do because they keep changing their minds. First, it was guarantees, then it was bank recapitalisation, then it was austerity, after that it was a 'unique bond transaction with retrospective contract changes' and now it seems we are to have 'austerity with growth'….

If a country has too much debt or is paying its civil servants and other non-exporting workers too much in salaries and benefits then changing currency in order to partially writedown those debts and reduce those costs is the equivalent of shooting yourself in the foot in order to learn to hop.

The point that I wish to get across is that the fault is not with the Euro and is entirely with what burdens our economies are trying to carry. Abandoning the Euro does not solve Greece's problems or anyone else's. It most cases it will make them worse because the dislocation effects of the 'defenestration' and because of the knock-on effects in the wider EU.

The borrowers are being made to suffer because of the mistakes and the greed of both the borrower and the lender. This is business and it turns out to be 'bad business. There is no moral superiority of the lender over the borrower. Both are equal parties to a contract, willingly if stupidly, entered into. Making Greece jump through hoops to save the blushes of greedy bankers and feckless regulators and stubborn politicians will be fun while the 'wheels are still turning'

If Greece abandons or is forced out of the Euro the debts of Greece will still be denominated in Euro's and the only thing that will have been achieved will have been to make it harder for Greece to get Euros to pay us with.

Returning to my car analogy I will close with another Douglas Adams quote about going over a cliff….

"It's not the fall that will kill you, it's the landing…."

Sony Kapoor's growth compact

Sheila Killian: Sony Kapoor proposes a Growth Compact here - worth a read, especially Title III on taxes: Member states, particularly those facing unsustainable fiscal deficits, shall undertake to increase tax revenues from taxes that have the least negative impact on growth and preferably deliver a double dividend by penalizing activities that are harmful which would include An EU-wide increase in carbon taxes the revenue from which should be split between financing public investments, closing deficits and decreasing employment taxes at low levels of income particularly in countries that are facing very high levels of unemployment A Union co-ordinated but Member State implemented approach to implementing levies on bank balance sheets that are structured to discourage excessive dependence on short-term wholesale funding that was one of the major causes of the financial crisis A Union co-ordinated but Member State implemented approach to implementing Financial Transaction Taxes along the lines of the UK based Stamp Duty with a goal to broaden the tax base to include bond and derivative markets. Such a tax, it is noted, can be implemented at the level of individual Member States so unanimity is not required. The tax should be structured in a manner that particularly penalizes high-frequency trading and trading in financial instruments that are excessively opaque or complex A Union co-ordinated but differentiated approach to implementing / increasing taxes on passive wealth such as land value taxes, property taxes, estate taxes and wealth taxes

Wednesday, 16 May 2012

So what do the markets think?

The victory of Francois Hollande in the French Presidential contest provides a further insight into the operation of the bond markets. It is frequently argued that there can be no retreat from ‘austerity’, which in reality is simply the transfer of incomes from labour and the poor to capital and the rich, because the bond markets will recoil and long-term interest rates will soar. This is important as significantly higher long-term interest rates could, unchecked, choke off recovery.

As the new French President has made some gestures in the direction away from ‘austerity’, then it should be expected that at least French long-term interest rates would rise as a result. But French government bond yields have fallen since the Socialist victory, by 18bps (basis points, equivalent to one hundredth of a percentage point, or 0.18 per cent). Ten-year French government bond yields declined to 2.79 per cent1, lower than before the election.

Click here to read the rest of Michael Burke's post.

Tuesday, 15 May 2012

Mad and madder still

Tom Healy: Forget 2012. Imagine 2062. In the United States of Europe let there be a poverty brake. If the structural poverty rate goes above 0.5% in 2 consecutive quarters an automatic correction and excessive poverty proceedure kicks in leading to sanctions for countries that continue. Meantime a constitutional amendment is required to enshrine a right to a basic income for all citizens.  Will the markets be impressed? By what measure will human well-being be assessed? Alas in the long run we are all dead said Keynes. Remember him.

Eurozone crisis: Updated version of Varoufakis' and Holland's 'Modest Proposal'

Yanis Varoufakis and Stuart Holland have reworked their 'Modest Proposal for Resolving the Eurozone Crisis'. Click here for Version 3.0.

Monday, 14 May 2012

European Monetary Union: Doomed to fail or just another stepping stone?

Tom McDonnell: With talk of a Greek exit from the Euro now being treated seriously it can be informative to consider past experiences with monetary union. The normal fate for currency unions has been eventual failure and dissolution, and the history books are full of examples of such failures. By and large having some pre-existing form of centralised political union in place appears to greatly improve the chances of a monetary union succeeding. Classic examples of resilient monetary unions include the USA, the UK and in some respects even the former USSR.

Nineteenth century Europe had the Latin Monetary Union (LMU) based on the French franc and centred on France, Belgium, Switzerland and Italy, as well as the Scandinavian Monetary Union (SMU) between Sweden, Denmark and Norway. Both the LMU and the SMU broke apart because there was no central institution to enforce common monetary policy and because of divergent fiscal policies motivated by domestic concerns.

Perhaps the most famous example of a de facto currency union was the gold standard which developed internationally from 1870 onwards. The gold standard was a system of fixed exchange rates based on convertibility to gold at set prices. The system came under severe pressure following the stock market crash in 1929 and finally came unravelled in the early 1930s when virtually all countries abandoned gold convertibility.

The outlines of a new international monetary system based on the convertibility of certain national currencies into United States dollars was agreed in July 1944 at Bretton Woods. The US dollar was itself backed by convertibility into gold, and this meant all participating currencies were indirectly pegged to gold and therefore to each other. Under the Bretton Woods system countries could devalue their currencies under certain agreed conditions. The Bretton Woods system began to fray in the late 1960s as the United States became increasingly unable and unwilling to sustain the dollar's exchange rate with gold. Eventually dollar convertibility was terminated by the United States in 1971.

The currency instability of the 1970s prompted a series of attempts to stabilise exchange rates in the European Economic Community (EEC). The first of these was the ‘Snake in the Tunnel’ system designed to peg the EEC currencies to one another within narrow bands. The Snake in the Tunnel system had broken down by the mid 1970s. The next major attempt at monetary coordination was made in 1979 with the launch of the European Monetary System (EMS). The EMS was based on a system of narrowly fluctuating exchange rates known as the Exchange Rate Mechanism (ERM). In practice the Deutsche Mark quickly became the anchor currency of the EMS and the system was characterised by repeated devaluations by member states.

Post-reunification expansionary fiscal policy designed to support the rebuilding of the former East Germany, combined with the Bundesbank's ultra-tight monetary policy, forced other countries to keep interest rates at extremely high levels to support their currencies and prevent capital outflow to Germany. A number of European currencies came under speculative attack and Sterling’s membership of the ERM was suspended by the British Government in September 1992. Italy withdrew the following day and the ERM was effectively dismantled in 1993 when the fluctuation band for national currencies was extended to 15 per cent. As with previous failed attempts at fixing exchange rates, the system was undermined by conflicting policy goals in the different countries and by the inability of member countries to harmonise monetary and fiscal policies.

Despite these setbacks, the push for monetary union continued as it was claimed that unpredictable exchange rate fluctuations were incompatible with the EU's fully open and competitive internal market. This perspective drove European Monetary Union (EMU) and policies aimed at convergence between the various EU economies in areas such as inflation and fiscal discipline. These policies were intended to create the conditions for a viable currency union. One lesson drawn from the ERM experience was that systems of fixed exchange rates will eventually buckle under the strain of divergent domestic policies and objectives. Thus, in preference to yet another system of fixed exchange rates, the decision was made to pursue a single currency as well as a single monetary policy under the control of an independent central institution. Eleven national currencies were made convertible to the Euro at established rates in 1998 and the Euro was officially launched the next year, with monetary policy and enforcement falling under the authority of the independent European Central Bank (ECB).

It remains to be seen whether this latest experiment in monetary union will succeed. It is now clear that EMU has major fundamental design flaws and if history is a guide then the odds of success do not look great. On the other hand, Europe's persistence with the idea of monetary union suggests that mistakes will be learned and the attempt renewed.

The real question is whether the mistakes will be learned in time to prevent the currency union from imploding.

Friday, 11 May 2012

Are things getting better, or worse?

Michael Burke: The EU Commission Spring 2012 economic forecasts have just been published. It is likely that the downgrading of current growth forecasts will receive some media attention. The EU Commission is now forecasting just 0.5% real GDP growth for Ireland in 2012, followed by 1.9% in 2013. These are significant reductions made from the Autumn 2011 forecasts. Then, growth of 1.1% was projected for this year and 2.3% for 2013.

No doubt, supporters of government policy will point to the fact that there is some growth forecast at all. Even this meagre level of increased activity is better than the average for the Euro Area as a whole, which is expected to contract by 0.3% this year. Surely, this means that the ‘austerity’ medicine is working in Ireland, if, strangely not elsewhere? Well, no.

Back in Spring 2010 the Commission’s initial forecast for Irish GDP in 2011 growth was 3%. It is now estimating that growth was less than one quarter of that level, just 0.7%. Similarly, the initial forecast for 2012 growth was just 1.9% (made in Autumn 2010). Again, it is now expected to be about one quarter of that growth rate, at 0.5%. The outlook for growth is getting worse, not better.

As is well known, the GDP data can be misleading. As Ireland is a weight-station for overseas profits booked to avail of low taxes, other indicators are needed to gauge real activity. In Spring 2010 the Commission was forecasting that both employment and domestic demand would expand, by 0.4% an 2% in 2011. It now expects the latter to have contracted by 3% and to continue to do so over the forecast time horizon (til 2013). Employment was initially expected to grow by 0.4% in 2011. It is now assumed to have contracted by 2.1% and will not expand til 2013, according to these forecasts. Altogether the Commission expects that one in seven jobs will have been lost during the Irish Depression, even if its forecasts do not prove to be overly optimistic once again.

But what of the sole indicator which is now said to be targeted by the government and the Troika, the judge and jury of all economic policy, namely the structural (or cyclically-adjusted) budget deficit? The EU Commission now forecasts that this structural deficit (SD) will rise in 2013 to 7.9% of GDP, from 7.8% in 2012. This compares to a SD of 7.3% of GDP in 2008, when ‘austerity’ began.

In terms of the actual, measured deficit this is now expected to be 7.5% of GDP in 2013, compared to 7.3% in 2008. Even this miserable performance has been achieved by the simple expedient of cutting government investment. In 2008, in the dog days of the previous government the level of state investment was equivalent to 5.2% of GDP. It is now projected to fall to 2.3% of GDP. Without this decline, the actual deficit would be 10.4% of GDP.

The economy is not improving. Domestic activity is contracting and jobs will continue to be lost. Government finances are not improving- they are deteriorating. Apparently, An Taoiseach and others are ‘keen to talk about investment’ with the new French President. But it is only by the disastrous method of cutting investment in Ireland that a new sharp upsurge in the deficit has been temporarily postponed. Even so, both the SD and the actual deficit are rising.

‘Austerity’ isn’t working, even in terms of deficit-reduction.

The structural deficit just got worse

Michael Taft: The latest EU Commission projections are out and, if anything, they show an even higher structural deficit than what the Government is projecting. This provides a perspective on what additional austerity might be in store for us under the Fiscal Treaty.

The EU Commission’s Spring Economic forecasts shows Ireland‘s structural budget balance to be far and away the highest in the Eurozone – at 7.9 percent for 2013. The Eurozone average is 1.8. We are much higher than Greece (4.5 percent), Spain (4.8 percent) and Portugal (4.6 percent).

The EU projection compares unfavourably to the Government’s own projection of 6.9 percent for 2013. In nominal terms, the EU is projecting a structural deficit over €1.6 billion higher than the Government for next year.

What is particularly noteworthy is how sluggishly the deficit is falling. Between 2011 and 2013, factoring in €7 billion worth of fiscal adjustments, the structural deficit falls by a mere 0.5 percent. The Government is hoping for a fall of 1 percent.

The EU doesn’t make projections outward to 2015. However, if we were to take 2013 as the starting point and use the Government’s pace of deficit reduction, we’d find a structural deficit of 4.5 percent for 2015. If this holds, the structural deficit has deteriorated and the gap between the EU projection and the Fiscal Treaty target has now widened to €7.2 billion. The Government estimated that it would be €5.4 billion.

To date, the Government has refused to engage with this issue. Instead, it insists that increased investment and micro-economic reforms will raise our productive capacity and that this will be enough to close the structural deficit gap without any further fiscal adjustments. However, whatever about the talk of growth and investment, the Government is doing the exact opposite as discussed here.

This is, of course, all a bit speculative as we don’t have EU projections out to 2015. But, with the new EU projections, we could now be facing into a higher structural deficit than that projected by the Government with a much slower decline. All things remaining the same, this means that the gap between the structural deficit and the Fiscal Treaty target just got larger. And, potentially, the amount of austerity needed just got greater.

New Department of Finance Economics and Banking Divisions

Nat O'Connor: The Department of Finance has established an Economics Division to focus on economic planning and performance monitoring. (RTÉ report here). This seems like a good idea, but we'll have to wait and see how much has really changed.

From the Departmental website, they also now have a new Division on Banking Policy. There's also an interactive presentation on the 'banking landscape moving forward', which is a very high tech format compared to how policy is normally presented. On the positive side, it perhaps allows the complex system of banking regulation to be presented as a coherent whole, but I'd be worried if the fancy graphics distract from an analysis on how robust the new policy is.

All of this seems to stem from the 2012 revision of the Department's Statement of Strategy 2011-14.

Taking as read the easy comment that 'we should have done this years ago', it will be interesting to see how much improvement is achieved and how willing the new Divisions will be to engage with the wider profession of economists and economic/business analysts. It would be a sign of changing thinking if we were to see more civil service economists making public presentations at academic seminars and generally opening up on their assumptions, interpretation of data, etc.

Thursday, 10 May 2012

The Spanish crisis, thirteen defaults to date

Tom McDonnell: As well as being World and European football champions Spain also currently holds the distinction of having the world record for number of sovereign defaults. Spain defaulted six times on its external debts in the period between 1557 and 1647 and a further seven times between 1809 and 1882. Thirteen in all.

Spain will clearly be the key battleground of the debt crisis. Already things do not look good and the bank recapitalisation process is now set to begin in earnest. The Spanish Government nationalised Bankia yesterday. This may well prove the first of a number of nationalisations. Veteran observers of the Irish bank bailout will watch with great trepidation as this story unfolds and the full scale of the losses in the Spanish banking sector become clear.

According to the European Commission Spain is unlikely to meet its deficit targets this year or the next while yields for Spanish 10 year bonds were 6.171% as of this morning, a level that is unsustainable over the long term. Arguably Spain is now insolvent and it could easily totter into a bad equilibrium whereby it is de facto locked out of private markets and requires rescuing by a bailout fund. Over at the FT Nouriel Roubini and Megan Greene are pessimistic. They argue that:

"The only way for there to be a happy ending in Spain is if action is taken swiftly in Brussels, Frankfurt and other European capitals. But that is not likely to happen. The eurozone periphery and Spanish crisis look like a slow-motion train wreck."

The bailout packages (EFSF, ESM) as designed are inherently fragile in nature and certainly not suitable for a country of Spain's size. Worsening figures in Spain and the threat of a fourteenth external default could be the catalyst for the ESM to get a banking licence. That would completely change the dynamic of the debt crisis.

Wednesday, 9 May 2012

Is Ireland achieving its targets?

Rory O'Farrell: Sometimes in the debate on the plan with the Troika people point out that we are in recession so the plan has failed. However, the stated aim of the Troika plan is not to return us to growth. The stated aim is to return us to the markets, in order to finance the national debt. Therefore when we criticise the Troika plan we must distinguish between whether the aims are appropriate aims, and whether the plan is achieving these aims.

We are often told that that Ireland is meeting its targets, the plan is on track, and so the plan is achieving its stated aims. Is this the case? In March the EU released its winter review of the Economic Adjustment Programme for Ireland. Page 63 of the document (page 66 according to adobe) shows Ireland getting a clean sheet, hitting 6 out of 6 targets, a performance any hurling All-Star would be proud of.(Click graphic to enlarge)

So should we give the Troika plan a medal? No. Page 62 of the pdf (Adobe page 62, document page 11) containing the ‘Memorandum of Economic and Financial Policies’ shows the original targets from December 2010. Ireland was on target up to 6-months after the plan was introduced, but has missed all other targets. Rather than hit 6 out of six, we score a measly 2 out of 6.

When we are meeting the targets, it is only because the targets are being changed. It is as though the ref sees the sliotar sailing right and wide, and so signals to the umpires to move the posts to meet the sliotar. That’s not lovely hurling.

Tuesday, 8 May 2012

Euro crisis solutions: An ongoing debate

Tom McDonnell: The Irish body politic and especially its commentariat will no doubt spend the next few weeks obsessing and navel gazing over the fiscal compact and its perceived impact on Ireland. Yet in truth the real debate that matters is the one going on at the Euro zone level. The institutional and policy architecture of the Euro zone is deeply flawed at a structural level. These flaws have been cruelly exposed by the response to the debt crisis and by the failures leading up to the banking and debt crisis. How Europe now decides to respond will decide the future shape of the Euro zone and it is in that intellectual space that Ireland must begin engaging in.

There are a number of useful 'non-official, non-Irish' resources on the Internet for those interested in the debate:

The Eurointelligence feed ( is probably the best free daily resource on the Euro crisis that is out there. It combines news and media reports from around the Euro zone with high quality analysis. See here.

Over at VOX EU there is a lively debate going on about the merits, or otherwise, of austerity. See here.

The Social Europe Journal is another site worth a visit for its analysis of the crisis and for a constructive, albeit damning, critique of current policies.

Well worth a look at from time to time are the CEPS, Project Syndicate and Breugel websites while John McHale helpfully adds a few additional links here. Yanis Varoufakis provides the perspective from Greece here.

Across the atlantic Paul Krugman and the idiosyncratic Brad DeLong regularly provide external and often scathing perspectives on the official response to the Euro crisis.

Finally, the Financial Times and the Guardian usually conduct rolling live blogs whenever the latest Euro zone drama erupts.

This is just a small selection. We are in the midst of a multidimensional crisis with multiple targets. There can be no silver bullet in such a scenario. Nevertheless there are viable solutions out there that can, taken as a package, ensure the viability of the Euro zone over the medium-term. And not just a Euro zone where unemployment and poverty concerns are seemingly always secondary to concerns like narrow price stability.

Some of these solutions will undoubtedly be politically difficult. Ultimately Europe's leaders will need to decide what their vision for the Euro zone is, what is sacrosanct, and what is negotiable. Indeed they should be obliged to articulate their vision. This would bring a degree of much needed clarity to the discussion.

Will the Fiscal Treaty Cost Us?

Michael Taft: Will the Fiscal Treaty – in particular, the notorious structural deficit rule – require additional austerity? John McHale of the Fiscal Council says it won’t. He accepts that in 2015 the gap between the Department of Finance’s projected structural deficit (3.5 percent) and the Fiscal Treaty target (0.5 percent) is €5.4 billion. But then he argues that growth can wipe that deficit out:

‘Growth affects both the denominator and the numerator of the structural deficit as a share of GDP. (For simplicity I assume that actual and potential GDP grow at equal rates post 2015.) The denominator effect is straightforward. For the numerator, we could use the standard coefficient used by the European Commission for Ireland that assumes that the reduction in the deficit is 0.4 times the change in nominal GDP. (This coefficient is usually used for doing cyclical adjustments, but it should also be applicable for measuring the impact of changes in nominal potential GDP on structural balance in the absence of discretionary adjustments to tax and expenditure parameters.)’

On this basis John does some calculations – using a more conservative co-efficient of 0.2. He finds the structural deficit is effectively wiped out by 2019 / 2020 without any additional austerity because growth has done all the heavy lifting.

I would suggest that this line of argument is flawed. First, I assume the co-efficient he uses refers to the cyclical sensitivity measurement of 0.4. This measurement is used to deconstruct the deficit into its ‘cyclical’ and ‘structural’ components. Essentially, you measure the gap between the real GDP and potential GDP growth and then apply the 0.4 to see how much of the gap is cyclical.
And herein lies the first problem – the 0.4 is an instrument to define the cyclical component of the output gap. It is not a measurement which defines the relationship between nominal growth rates and deficit reduction – whether it is the general or structural deficit. It is analogous to using a car clamp to change a light bulb. It is the wrong instrument. As the Department of Finance puts it:

‘Indeed, by definition, reducing the structural element of the deficit will require policy action. . . .‘

The whole point of structural deficit measurements is to determine what the deficit will be when the economy returns to full capacity. If the economy is firing on all cylinders and there is still a deficit, then the Government must take policy action to correct this, because growth cannot.

In doing his calculations, John assumes that real and potential GDP grow at the same rate. Never mind that the Government estimates that real GDP is growing at twice the rate of potential GDP in 2015 (yes, I know, this suggest that the economy is ‘over-heating’ – one of the absurdities with the model that the Department of Finance is using). If the output gap is zero, there is no role for applying the 0.4 co-efficient because there is no cyclical component to measure.

Seamus Coffey does his own calculations based on John’s more conservative co-efficient of 0.2 and applies it to GDP growth (though Seamus does say ‘There is no way of knowing what this’ co-efficient is). He comes up with a similar result to John.

But there is a problem here. Why use a conservative 0.2 co-efficient? If you believe that 0.4 tells the story, go with it. And why, use a nominal growth rate of 3.5 percent? The Government claims that in 2015 the nominal growth rate is 4.5 percent. So let’s go with that.

What do we get? We find that the structural deficit turns into a structural surplus without doing anything.

And what a surplus! By 2019 we will have a structural surplus of 2.5 percent. We outdo even the Germans. We get to go to the top of the class.

Is this likely? No. But we don’t have to argue the toss about cyclical sensitivity measurements or coefficients of elasticity. We merely have to go to the IMF’s own projection – which helps because (a) they stretch out to 2017 and (b) they assume, like John, no fiscal adjustment after 2015. What do they find?

In percentage terms, the reduction in the structural deficit is minimal: less than 0.1 percent of GDP each year.

But why should this surprise us? If there is deficit left over after the output gap is closed (after the economy returns to full capacity), what remains is the structural deficit which requires ‘policy action’ to reduce.

Political Implications

But there’s more to all this than duelling statistics. The Government and their austerity supporters have co-opted the language of progressives to avoid answering a fundamental question: what the cost of the Fiscal Treaty will be in terms of future austerity measures. They are now talking about ‘growth’ being the main instrument of deficit-reduction. The Government has even gone so far as to say that investment will grow the productive capacity and, therefore, reduce the deficit. Some of us have been saying that since the start of the crisis – UNITE and the trade union movement, TASC, contributors on Progressive-Economy; all we got was ridicule and scorn.

Here’s how the Department of Finance puts it:

‘Indeed, by definition, reducing the structural element of the deficit will require policy action, though not necessarily taxation and expenditure adjustments. Other options are available . . . . Such measures include labour market reforms - some of which are already in train - together with investment in technology and infrastructure to boost the productive capacity of the economy. To this end, the Government has established NewERA and the Strategic Investment Fund . . .

This ambitious programme of microeconomic reforms, by boosting the productive capacity of the economy, is expected to help reduce the structural element of the deficit by the middle part of the decade. For example, reforms along the lines of those set out in the Action Plan for Jobs 2012 and the Pathways to Work initiative, aimed at addressing some of the skills mis-match in the labour market, should help lower the unemployment rate. This would have a structurally beneficial impact on the public finances, on both the revenue and expenditure sides. In other words, the structural fiscal position is set to improve with these microeconomic reforms.’

And, yet, yet – the Government still refuses to provide a projection for this. If they are convinced that investment and labour market reforms will boost our productivity, they can project this – through the ‘potential GDP’ which measures the contribution of labour, capital and productivity.

This is all a charade. At the same time as the Government is assuring us that growing our potential GDP will reduce the structural deficit, they are actually revising downwards potential GDP.

In the last budget, the Government projected that our productive capacity would grow by 3.4 percent between 2010 and 2015. Only a few months later, the Government is now projecting growth at 2.4 percent. This revision downwards reflects their lower GDP projections.

In other words, we are going forward by going backwards.

This is the ultimate game plan. Stonewall any questions about the cost of the Fiscal Treaty with talk of growing our productive capacity even as you revise downwards our productive capacity. ‘Prove’ that growth will reduce the structural deficit by using variables that have little reference to structural deficit reduction. But don’t ‘prove’ it too much because it will look nonsensical. Ignore what current projections (IMF) have to say about all this. Even ignore the definition of a structural deficit. Above all, abandon your austerity clothes and don the robes of an expansionary programme – even as you promise to cut public investment next year and cut spending on public services and social protection by even more than you did this year.

Do all this. But don’t call it austerity.

Thursday, 3 May 2012

The Fiscal Compact - crisis resolution?

Tom McDonnell: Sebastian Dullien has a useful piece on the Fiscal Compact over at the Social Europe Journal.

Sebastian correctly argues that none of the Fiscal Compact rules will make a direct impact on fiscal policy for at least half a decade. In part this is because most countries are already in an Excessive Deficit Procedure (EDP) agreed with the European Commission. Ireland’s current EDP ends in 2015. The Stability and Growth Pact and the Six Pack, rather than the Fiscal Compact, are driving the current austerity.

And the austerity itself is a major part of the problem. The cumulative effect of each Euro zone country accelerating the austerity drive is a recipe for prolonged stagnation and high unemployment across the continent. Sebastian calls for a longer adjustment period, a reorganisation of public investment financing with the European Investment Bank playing a central role and a move towards euro-bonds or some form of European debt redemption fund.

One hopeful sign is that Francois Hollande is evidently calling for the ESM to be given a banking licence. See here.

Germany will resist. Hollande’s success or failure on that issue will go a long way to determining the outcome of the crisis. With a banking licence the ESM (or indeed the EFSF) could perform real time unlimited Lender of Last Resort functions. Without such an institution in place it is difficult to see how the Euro can survive in the long run.

Wednesday, 2 May 2012

Terrence McDonough on the Fiscal Treaty

IRELAND MAY well need a second bailout after 2013. And as treaties are currently worded, a No vote on the fiscal compact treaty will forbid us from accessing funds from the European Stability Mechanism (ESM).

It is claimed this situation will result in disaster, and that even if we believe the fiscal treaty is a serious mistake, we have a gun to our head. In fact, Ireland will have a number of options in this event.

Click here to read the rest of Terrence McDonough's opinion piece in today's Irish Times.

The Promissory Notes: Deal or No Deal? No Deal

Tom McDonnell: The ECB has informed the Irish Examiner that the Irish Government has submitted no documentation to the bank pertaining to renegotiation of the terms of the promissory notes. The report is here. The quote from the ECB is here:

"Having duly looked into this matter, we would like to inform you that the ECB did not receive any documents from the Irish Government on the renegotiation of the terms of the promissory notes."

It's important to remember no deal was actually done with the ECB leading up to March 31. As the ECB stated in response to the multi institution shenanigans and gymnastics leading up to March 31:

"The ECB is not part of it, as it is the redemption of the promissory notes and a subsequent reduction in emergency liquidity assistance provided by the Central Bank of Ireland.

The ECB also clearly stated how it expected to be paid in full and on time. Unsurprising if it never even received documents from the Irish Government.

Well done to the Examiner on ferreting out this very useful bit of information.