One of the reasons behind the creation of the euro was that member states were fed up of their currencies coming under constant speculative attack, the ultimate aim of which was to destroy the ERM (European exchange rate mechanism). It seemed safer to band together in a single currency so as to be stronger together and thereby avoid the weakest in the pack being picked off by predators.
Twenty or so years later it is now the euro countries’ sovereign debt that finds itself under speculative attack from the obscure and modern vindictive gods who are collectively known as “the markets”, probably with the ulterior motive of destroying the euro itself. “Plus ça change, plus c’est la même chose.” Maybe the answer is in turn to band together in a single debt to avoid the weakest being picked off, that is to issue euro-bonds.
At present, however, this is a non-starter as the self-styled virtuous northerners are not ready to subsidize their perceived profligate southern partners. If views on this are to change it would require a degree of “economic governance” or enforced fiscal integration and discipline that is incompatible with current forms of democratic control.
I have recently been reading Keynes’ “General theory” (1936) of which many passages still seem highly relevant. A few quotes will illustrate: “A conventional valuation which is established as the outcome of the psychology of a large number of ignorant individuals is liable to change violently as the result of a sudden fluctuation of opinion due to factors which do not really make much difference to the prospective yield.” It is on these fluctuations that the speculator makes his profit. He is concerned “not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public.” Keynes concludes that “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.”
Speculators then play a game of making short term gains on fluctuations in price that feed on often irrational expectations. They are in no way interested in making a long term investment that gives them a slow return as an income, merely in making a quick profit on the difference between buying and selling prices. They are not interested in the good of the economy and how that benefits you and me. They do not care for economic fundamentals, they are only interested in guessing in which direction the herd will next stampede before it does. Mass movement is indeed now reinforced by such things as computer programmes that automatically sell securities when they fall below a certain price. Then there are rules on the kinds of assets which banks have to hold as capital which oblige them to off-load bonds when their rating falls below a certain level.
Speculators thrive on uncertainty. It is in their interest to spread rumours and provoke wild swings as it’s on the difference between the ups and the downs on which they make their money, not from any reasoned long-term investment in what is economically sound. Speculators are like fraudsters who take out an insurance policy on a house and then burn it down to make a claim. Only the house they are setting fire to is the one in which you and I live. We need to lock them up so we can live in peace and security.
Keynes argues that speculation is the disadvantage of having a system geared towards liquidity; that is the ability to sell anything at short notice to turn it into cash. He jokingly argues that to deter speculation, purchases of securities should be made more like marriage, difficult to render asunder. The much debated idea of a financial transaction tax in part seeks to slow down the mad spiral of speculative transactions and would be a step in the right direction if it could be made to work. Only without all countries on board it would merely displace financial business from one continent to another. The financial transaction tax also has the attraction of taking money back off these wretched people for the benefit of the state which previously bailed them out. The financial sector of course who would have to pay the tax argues strongly against it. Instead of listening to the arguments of the “too big to fail” brigade we should consider what is best for the real economy. The truth is that the vast bulk, about 90%, of financial transactions in markets today are purely speculative.
Keynes was of course talking mainly about speculators’ behaviour on the stock market; the dilemma now is that this same behaviour is being applied to government borrowing, which intrinsically is a totally different form of financial activity and investment. Let me explain why.
Ever since ancient times states have tended to find the need to spend more money than they could levy through taxes and have therefore had to borrow. Initially this was often in order to fight wars. As notions of what the state was about evolved in the last century the purpose of borrowing became more to fund the providing of stimulus to the economy and a social safety net. Latterly however, it has also been to bail out the financial sector itself. Over the last three years because of this the average rate of OECD country endebtedness has risen from 78% to 92% of GDP. In the same way as in the past if the state didn’t borrow enough, it could lose the war, at present starved of cash it will probably likewise fail in these three modern aims. So basically by refusing to lend to sovereigns at a normal rate of interest the financial sector is shooting itself in the foot, by slowing down the economy and depriving itself of its life-belt.
Normally for a bank, the difference between lending to a sovereign and to a private company is what follows and this basic premise needs to be recalled during the current hysteria. Businesses can go bust so you may lose the money you lent them. Countries, however, do not usually go bankrupt: governments can make their citizens and businesses pay more taxes; or, quite simply, they can print more money (though that would have the effect of depreciating the monetary value of the loan in real terms, so creditors might not find it a good idea to lend to countries who tend to do this). Therefore, usually, lending money to a sovereign state is risk-free and should command a low rate of interest, whereas lending it to a private company is iffy and should command a high rate. So far so good, and for decades this was the basis for a cozy relationship between states and the financial sector that lent to them, which even includes the man in the street making a modest investment for a rainy day. Buying sovereign bonds as long as they give you a return higher than the rate of inflation represents a safe place to park savings and is an essential part of your portfolio: not sexy but reliable. This basic relationship grounded on confidence has now been shattered by the behaviour of speculators who have scared markets into losing that confidence.
Having lost interest in poorly performing shares speculators have turned their attention to bonds. The trouble is they treat bonds like shares, not for keeps and a slow return, but for buying and selling for a quick profit. They have introduced into the bond market an instability that just wasn’t there before, creating huge problems for states and the real economy. The old assumption that the sovereign will always pay has been undermined by hysterical talk that he might not repay your loan. It’s a bit as if suddenly, for no real reason other than a malicious rumour, Joe Bloggs’ bank suddenly becomes convinced he is not able to keep up his mortgage payments and so decides to double his rate of interest overnight because in their eyes he has become risky. As long as Joe Bloggs quitely was paying 3% he was perfectly solvent and could go on paying forever, now he has to pay 6% very soon he will be reposessed. The “markets” by demanding usury type rates of interest of perfectly viable states will inevitably force them into default. This bad-mouthing becomes a self-fulfilling prophecy. They are playing a very dangerous game and they need to be stopped for our general good.
How did we get here?
Firstly, as mentioned already, following the finacial crisis and subsequent recession shares seemed to be going all one way and were less of interest to speculators so they turned their attention to bonds.
To cause a stir and create uncertainty (as is their modus operandi), they started to put it about that ratios of public debt to GDP that had been high and a fact of life for decades were all of a sudden unsustainable, when in fact for some time now states and in particular euro area countries bound by the Stability and Growth Pact have been patiently working on bringing the public debt gradually down. Only unfortunately it had recently shifted back up because of the need to bail out a previously irresponsible financial sector which had got itself into a long-term mess by making too many bad loans for a short-term profit. It seems a bit rich that the very people who the generous taxpayers helped out should now roundly turn on states for their burgeoning debt which has been caused only by rescuing them in the first place. In fact it beggars belief, but this is the obscene truth.
First and foremost in rocking the boat are of course the ratings agencies. These same people, Standard and Poor’s, Moody’s and co. are those who recommended investors to acquire sub-prime mortgage backed assets as triple A. Not only did they fail to see the financial crisis of 2008 coming they actually caused it. Quite why any creedence should be paid to these people is beyond me. And yet what they say moves markets. Even worse respecting their ratings is actually part of our banking capital adequacy rules. That needs to be changed immediately. We need a properly independent public body to recommend which sovereign bonds are investment grade, not some outfits owned in turn by the New York based financial sector.
Have you ever also stopped to wonder why it is that it is euro area sovereign debt which is under attack and not US debt, when in absolute terms US debt is bigger and in relative terms just as high ? It is true the Americans can print as many dollars as they like and so will always be laughing all the way to the bank, but as I said earlier a depreciating currency in itself is not a particularly good recommendation to invest in that country. No, actually apart from a slight downgrade by Moody’s last August when Congress came perilously close to not adopting the package that at the eleventh hour prevented a US default, a downgrade which was not actually commensurate with the risk, these American ratings agencies are staunchly patriotic.
It’s always the European countries they are gunning for. To put it simply, some Americans (and many British too) do not like the success of the euro in becoming the world’s sceond currency and challenging the dollar’s hegemony. If they could sink the euro that would suit them. More immediately though, by attacking the euro area, they divert attention from the parlous state of the US public finances and economy.
Let me hasten to add that oficially the American administration, rather than the private sector, is deeply worried about the euro as they realize a disaster in Europe would be bad news for the US economy.
Since I’ve shared one conspiracy theory with you, try also this one for size, think it over.
Following the end of the cold war and the crowing victory of capitalism over socialism, following the disappearance of an alternative widespread narrative to keep capitalism in check, the real big vested capitalist interests in the financial sector are greedy for more and more and more money and power. Let’s be frank this is where the real global power lies, many multinationals have a turnover bigger than the GDP of a medium-sized state. In fact big business and the financial sector would like to see the disappearance of the state altogether as it gets in the way of their freedom to do business, what with the state’s annoying tendency to tax them and curb their activities with rules and regulations. They conveniently forget that it has been the state that has boosted the economy for their benefit when the market has failed and that it is the state which has saved them from going under during the financial crisis.
No, they want to reduce the state. They lecture us that it is unsustainable, living beyond its means, profligate, irresponsible, that it cannot afford things which it actually already could when in was much poorer immediately after the war (education, health care, social benefits etc). What they are in fact against is redistribution away from their rich selves towards the poorer. It is not for the rich few, led by the speculators, to decide what public policy is, it is for democratically elected governments. We should not let ourselves be dictated to by them.
In fact their policies are wrong and self-defeating. In Keynesian terms what we need right now is not austerity and spending cuts but government stimulated consumption to boost employment if we are to avoid a serious recession. In the country where I live, Belgium there has been no government with powers to take new initiatives for over a year, so there have not been the same cuts as in other euro countries, and guess what, Belgium has the highest growth rate in the euro area.
So what of Greece ?
It’s true that Greece only entered the euro on the basis of falsified accounts which didn’t show the real position of its public finances and it should therefore never have joined. However, decision-makers at the time were happy to turn a blind eye (as indeed they had already done towards Italy’s and Belgium’s debt): it was politically expedient to let Greece in just in time for the launch of the notes and coinsin 2002, that way of the 15 EU member states at the time all 12 who wanted to be in (i.e. except United Kingdom, Denmark and Sweden) could be.
The Germans later insisted on the Stability and Growth Pact to enforce fiscal discipline on euro members but that in turn soon lost all credibility when among the first not to meet it were Germany and France themselves who were let off its strictures.
I personally don’t think all of this matters much in the sense that the euro is a political project as much as an economic one and its creation was a supreme act of political faith and commitment to European integration, as much as a bold economic experiment. The numbers to a certain extent were window dressing based on theory rather than practice. Romano Prodi, the President of the Commission, once famously described the pact as “stupid” for not permitting expansionary economic policy to be pursued by governments when needed. He then had to come and eat humble pie before the finance ministers (I was there) but he wasn’t wrong.
The fact of the matter is as a currency the euro has retained its value well against the dollar for over a decade and has become the world’s second currency. A currency that is the accepted means of payment among 327 million people because of its sheer mass is not about to disappear overnight. Although sound public finance is one of the euro’s entry criteria, that doesn’t mean it’s about to implode because several of its members according to its own criteria do not have sound public finances. It may well depreciate even if it hasn’t done so much yet, but it’s not going to suddenly disappear just because it hasn’t been around for that long. There is this totally unrealistic hype that if a member defaults that’s the end of the euro. In the United States a number of states in the federation, including California, have technically been in default but that has not changed much about the dollar.
The notion that Greece might leave the euro is also absurd. There is no treaty provision for exit, the process of joining is described as “irrevocable”. There is no drachma to go back to. Even if there were, Greece would be far worse off having to pay back its debts in a currency (euro) inevitably appreciating against its own (new drachma). Just imagine anyway the glee of the markets if they managed to force Greece out. Having tasted blood the next day they would be baying for Portugal, then the day after that Ireland, then Spain, then Italy. There would be no end and the euro would certainly unravel. Greece’s exit is the last thing the euro needs.
In the meantime Greece may well default. So what. The euro will fall in value against the dollar and even Chinese renimbe (but not against the Swiss franc as last month they pegged themselves to us, so the euro can’t be all that bad, after all the Swiss aren’t stupid financially) but that would be great news for our exports and jobs.
Some banks may go under and maybe it’s about time we let some go instead of this “too big to fail” nonsense.
I remember as a sixth-former being told by Sir Keith Joseph (a Tory grandee at the time) the great capitalist myth that the entrepreneur is a noble being who takes a risk and may be successful or may equally lose his shirt. It seems today that there is a general reluctance on the part of the financial sector to lose any clothing at all. Moral hazard rules.
Yes and our pension funds will all take a hit, that’s yours and mine. The finacial sector’s problems will feed again into the real economy dragging us all down. Maybe then we will have learned our lesson and should just go ahead and nationalize them all, because let’s face it their job is too important to the economy to be left in the hands of a few self-interested gamblers. Then we could oblige them to lend to governments at a reasonable rate of interest in return for services rendered. Yes, the probably forthcoming Greek default poses some interesting scenarios.
Yet in all of this the euro itself will not go away and those who would have you believe that are just milking your anxiety so they can speculate on it.
