“Clearly, Field Marshal Haig is about to make yet another gargantuan effort to move his drinks cabinet six inches closer to Berlin.”
- Captain Blackadder [Rowan Atkinson], from ‘Blackadder Goes Forth’, written by Richard Curtis and Ben Elton.
By some accounts, the general populace in Europe during July 1914 was largely unaware of the imminence of war until the end of the month. “Enjoying the warmth of a golden summer, Europe’s citizens turned their attention chiefly to news of more local importance.” And then a network of alliances, and events, exerted their inexorable gravitational pull, drawing what would become millions into a pan-Continental mincing machine. Archduke Franz Ferdinand had been assassinated on 28 June. Austria-Hungary issued an ultimatum to Serbia on 23 July, and issued a formal declaration of war on 28 July. Russia and Austria-Hungary mobilised on 30 July. Germany demanded that Russia demobilise on 31 July. Germany and France ordered mobilisation on 1 August. By way of response, “Stock exchanges panicked and many were closed.” But it was a bit late by then. As the saying goes, if you’re going to panic, panic early.
The definitive text that addresses this human frailty is Irving Janis’ ‘Groupthink’ (Houghton Mifflin, 2nd revised edition 1982). Janis examined a number of US foreign policy disasters, including failure to anticipate the Japanese attack on Pearl Harbour; the Bay of Pigs fiasco; the decision to escalate the Vietnam War, and concluded that all of these decisions had incorporated groupthink, “a mode of thinking that people engage in when they are deeply involved in a cohesive ingroup, when the members’ strivings for unanimity override their motivation to realistically appraise alternative courses of action”. William H. Whyte apparently first used the term in 1952:
Groupthink being a coinage – and, admittedly, a loaded one – a working definition is in order. We are not talking about mere instinctive conformity – it is, after all, a perennial failing of mankind. What we are talking about is a rationalized conformity – an open, articulate philosophy which holds that group values are not only expedient but right and good as well.
Janis went on to develop the theory, stating that
The more amiability and esprit de corps there is among the members of a policy-making ingroup, the greater the danger that independent critical thinking will be replaced by groupthink, which is likely to result in irrational and dehumanizing actions against outgroups.
Here are some suggestions. The great euro project itself was a creation of groupthink (sparked by “illusions of invulnerability creating excessive optimism and encouraging risk-taking”). It was reinforced by “unquestioned belief in the morality [primacy in political and economic theory] of the group [primarily and initially France and Germany], causing members [other, later euro adopters] to ignore the consequences of their actions.”
As tensions and obvious fault-lines started to develop in the common currency zone, groupthink was there to ignore them. Closed-mindedness on the part of the euro zone’s political leaders “rationalized warnings that might challenge the group’s assumptions” and “stereotyped those opposed to the group [not least among which, the UK] as weak, evil, spiteful, impotent or stupid.”
Groupthink continued to exert its pressure toward uniformity, incorporating the “Self-censorship of ideas that deviate from the apparent group consensus”, together with “illusions of unanimity among group members, where silence is viewed as agreement”. There was “direct pressure to conform placed on any member [of the EU] who questions the group, couched in terms of ‘disloyalty’.” And there were “mind guards – self-appointed members [the European Commission among them] who shield the group from dissenting information.”
Consensus-driven decisions [the adoption of a common currency without a common Treasury or unified tax-raising authority and the abandonment of rigorous selection criteria for the adopters] caused the establishment of a unified currency bloc destined for failure, fuelled by the groupthink practices of
Incomplete survey of alternatives
Incomplete survey of objectives
Failure to examine risks of preferred choice
Failure to reevaluate previously rejected alternatives Poor information search
Selection bias in collecting information
..and not least,
Failure to work out contingency plans.
Another suggestion: just as they lost the plot in the run-up to war in 1914, the stock markets have been largely absent without leave of their senses as the euro zone moves inexorably toward explosion in 2011. Groupthinkers – Keynesians, more or less to a man – continue to believe that this is a problem that can be solved by the ‘big bazooka’ deployment of yet more money, more taxpayer milk dispensed from the giant teat of government. The reality is more prosaic, and more worrisome. Last week, the BBC’s Sarah Montague interviewed Kyle Bass, one of the relatively few investors who not only identified the sovereign debt crisis ahead of time but was able to profit from it. She resorted to the standard, lazy canard of citing speculation for the downfall of governments when the reality is that if governments don’t like the message they’re hearing from the bond markets, then they shouldn’t borrow more than they can afford from them. Or in Kyle Bass’ terms, “don’t hate the mirror because you’re ugly”.
The problem is two-fold but not distinctly so in that the culprits – ill-disciplined, over-indebted governments; and ill-disciplined, under-capitalised banks – are really joined at the hip,
two spent swimmers, that do cling together
And choke their art..
Forget bail-outs (although the euro zone authorities are unlikely to). The only ultimate resolution can be, in Bass’ words, massive debt restructurings and write-downs. Countries that have “sailed into a zone of insolvency” cannot be ‘resolved’. Their debts have to be written down. He also points out the inconvenient fact that only the UK and the US have made any progress in recapitalising their banks. But before we get to the fun of the debt restructuring endgame, we are likely to have to endure more fatuous money-printing at the behest of economically illiterate politicians and policy-makers. So there are two actionable conclusions: one is to maintain a defensive posture with regard to both debt and equity investments, especially in a European context. The second is to take advantage of any sell-offs to rebuild exposure to the one asset that is being fundamentally supported in this environment, namely monetary metal (gold and silver – and the mining companies represent arguably an even more attractive method than the physical of gaining inflation and currency insurance, given the unfolding macro outlook).
Or you could pin your hopes on wishful thinking. The eurocrats certainly are.
In explaining the conventional thinking behind ‘Why there could never be a war’, Captain Blackadder explains to Private Baldrick that
..in order to prevent war in Europe, two superblocs developed: us, the French and the Russians on one side, and the Germans and Austro-Hungary on the other. The idea was to have two vast, opposing armies, each acting as each other’s deterrent. That way there could never be a war.. [but] You see, there was a tiny flaw in the plan.. It was bollocks.
Before what came to be known as the Great War, Britain was the leading power in Europe. Many expected her to wait on the sidelines as the various power blocs clashed. Britain finally entered the war on 4 August 1914 on the back of a guarantee to maintain Belgian neutrality dating back to the 1839 Treaty of London. By 1945 and after two world wars and over a million of its servicemen and servicewomen dead, Britain had passed on the baton to the United States, and was inevitably diminished on the global stage. A policy of splendid isolation did not prevent her entry into hostilities in 1914. One can only hope that its equivalent today, in the form of our non-participation in the euro zone, will lead to a somewhat better relative and absolute outcome. It is quite clear that our current entente with the French is not entirely cordiale. Somebody should gently suggest to M. Sarkozy (and Frau Merkel for that matter) that when it comes to Europe, Britain has already done enough. If you break it, you pay for it.
One can read The Daily Mail for its coverage of the royal family, snapshots of British life, or, if you are like me, the headlines. On Saturday, guest contributor Ian Morris, Professor of History and Classics at Stanford University, served up this classic example:
The perils of the begging bowl: Exactly 100 years ago China was ‘rescued’ by European loans. The result was a century of misery. Now the boot is on the other foot.
Morris continues to explain that 100 years ago, in 1911, the last emperor of China had just been toppled. The newly formed Republic of China was penniless (yuanless?), and desperate for loans to keep it afloat. European investors, flush with cash in what was the still prosperous pre-World War I era, flocked to Beijing to make loans to keep the newborn country afloat.
Today the eastward journey continues, but it is not made by Europeans looking to invest their savings. It is instead European politicians looking to secure loans to keep their unsustainable experiments afloat for a little while longer. While this great European experiment with the welfare state is now obviously insolvent, an attitude remains that we are only in the midst of a liquidity crisis. This view is wrong. No amount of loans can save a country from a crisis of insolvency, as has proven to be the case in Greece recently.
A more important question to ask is whether Europeans should be seeking bailouts to keep the current system afloat.
The Republic of China, formed in 1912 supported by European funds gave way to The People’s Republic of China in 1949. The latter demonstrated itself to be the most despotic regime of the twentieth century. The impoverishment of citizens by other regimes, Nazi Germany or Soviet Russia, pale in comparison to the hardships endured by the hardworking Chinese over the last century.
Several centuries ago, China was the most prosperous nation on Earth, far exceeding even Europe in terms of wealth and technology. The Industrial Revolution changed this, but China still managed to maintain its competiveness, particularly by trading with the newly arriving European entrepreneurs as shipping improvements made trade between the continents increasingly possible during the 19th century.
The loss of the Emperor in 1911 set in motion the key steps that would place the nation’s future in the hands of its eventual tyrant leader, Chairman Mao. Funds provided by wealthy European investors fomented this shift, allowing freshly flailing regimes to secure a political foothold in the late teens and early 1920s.
One must ask, with the fortune of hindsight, whether such financing was beneficial. Fostering what would later become a tyrannically regime must surely be viewed with less than rose-coloured glasses today.
The European states may not seem tyrannical in comparison to China. The point is that they are examples of countries with failed policies. One must ask if searching for ways to continue these erroneous policies is beneficial for the Europeans that must live with them. Europeans with an eye for history need only look at a similar policy pursued 100 years ago for the answer.
Eurozone leaders ordered their banks to raise additional capital last week to prepare for a partial Greek default. The continent’s banking industry didn’t yet receive a direct financial injection but will be allowed to appeal to national governments and the European bailout fund for assistance.
A recapitalization of Europe’s financial industry was championed by the International Monetary Fund and the United States as well as countries whose banks are excessively exposed to Greek debt, notably France. It is why President Nicolas Sarkozy liked to enable banks to tap into the European Financial Stability Facility that was set up last year to help countries, not companies, in financial distress so his fiscal challenges wouldn’t be aggravated. German Chancellor Angela Merkel insisted that banks raise capital from their own governments before raiding the bailout fund.
It’s a better plan, but one that will provide only temporary relief to Europe’s sovereign debt crises before making it worse.
Europe’s leaders agree that Greek debt levels have reached unsustainable heights. Its public debt is now worth 50 percent more than its entire economy and is projected to growth further in the coming years as Athens struggles to rein in spending substantially. Greek debt will be “restructured,” which means that roughly half won’t be paid back. European banks that have loaned to Greece could be in trouble. Even if they aren’t, other banks and investors might worry that they are, causing the market to tank. “Recapitalization” is designed to prevent that from happening.
In the short term, it could, but several weeks later markets would likely start wondering whether pumping billions of euros into a financial system that’s bloated with debt is really an intelligent strategy.
Western banks have been hesitant to loan money, to each other and to businesses, since the 2008 financial panic when the investment bank Lehman Brothers collapsed. American and European central banks lowered interest rates in response, allowing banks to borrow cheaply in the absence of private sector confidence.
The European Central Bank has been more prudent than its American counterpart, the Federal Reserve, and didn’t buy sovereign bonds, from Italy and Spain, until this summer. The Fed, by contrast, has been financing American deficit spending by printing trillions of dollars for more than two years. Both have supported banks in the expectation that they would continue to extend business loans and mortgages.
They haven’t really—not enough to stir an economic recovery, anyway, because they realize that the market is still full of dislocations and excesses.
If there weren’t central banks or if they hadn’t intervened, those dislocations and excesses, build up in an era of “cheap money” when financial institutions knew that they were “too big to fail,” would have been cleared out in 2008 when Lehman collapsed and threatened to sink half of Wall Street with it. Prices that did not reflect real demand, especially in housing, where government policy had encouraged people without sufficient income to apply for mortgages, would have deflated—considerably.
Default and deflation however, along with potentially huge losses in personal savings, are politically unacceptable. So instead of failing, the institutions that created the crisis are now on life support while the housing market in many Western countries, and construction with it, is stuck. Homeowners aren’t willing to lower their expectations while buyers aren’t able to purchase at the prices they charge.
Recapitalizing banks after they bought worthless Greek bonds when they should have known better isn’t just wrong; it’s not going to work. If writeoffs are also expected for Portugal and maybe Italy and Spain, investors will realize that no matter how big the EFSF is made to be, the solvent countries in the north of Europe can’t afford to compensate them for their losses indefinitely. If the ECB also turns on the printing presses (which it doesn’t want to), that will be the clarion call for investors to get out. Interest rates on peripheral bonds will skyrocket.
The political willingness to reform structurally rather than cut several billions of euros in annual spending is virtually nil in Greece and Italy. These states are already bankrupt and waiting for Germany to pull the plug. It is king in the land of the blind (or broke actually) but doesn’t have the cash on hand to bail out half of Europe. Some countries just won’t change until they’ve hit bottom. The sooner the better, for the longer banks have to wait for the inevitable, the longer they’ll avoid investing in enterprises and loaning to other banks — they don’t know which will survive the reckoning and which won’t. Recapitalization would thus make the problem worse by providing a false sense of security that cannot last.
This article is based on one previously published at Atlantic Sentinel
Slovakia’s parliament recently voted against the proposed increase to the EFSF. The BBC’s Rob Cameron says “a second vote could be held soon and is likely to succeed”. This policy paper from INESS explains why Slovak politicians should stick to their first answer.
Slovakia should refuse an increase in the size of EFSF (European Financial Stability Facility) and enlargement of the scope of its competences for following reasons:
The proposed solution to the sovereign debt crisis, based on redistribution of national debts in the form of EFSF, has proved ineffective throughout the 18 months since its inception. The “disease” continues to spread to other countries. Even the catastrophic scenario has come true – the European Central Bank has even had to come to the aid of Italy with its enormous debt. The crisis is not one of liquidity, but a problem caused by the insolvency of indebted countries and of many creditor financial institutions. Increasing the borrowings of insolvent nations will not address this crisis of insolvency, but will worsen the situation and will endanger the financial health of the other members of the Eurozone and weaken their access to financial markets (see the case of Italy).
Political leaders have not been mandated by the voting public to bring about fiscal centralization, which naturally follows such a debt union.
The suggested solution introduces the unsubstantiated transfers of wealth from taxpayers in one country to the owners and creditors of financial institutions who lent to the troubled countries.
The EFSF and ECB operations are misleadingly described as a rescue of these countries. In reality they constitute a bailout of these countries’ creditors. If this proceeds it will lead to the growth of nationalistic tensions in the EU and so create risks for its long-term stability. In turn this will endanger the existence of the common market and its cornerstones, the free movement of goods, people and capital.
Historical experience shows that the main precondition for long-term stability of monetary union is the maintenance of a credible commitment not to bail out any member. The long-term stability of the Eurozone and the euro currency would, contrary to the views expressed by the creators of EFSF, benefit from the bankruptcy of Greece. EU leaders are preventing this at any cost. For this reason, saying No to the increase of EFSF does not mean the end of the monetary union.
GDP is not the appropriate indicator to measure the wealth of Slovak population. Employee compensation and hence ability to pay taxes are substantially lower in Slovakia than in other Eurozone countries (with the exception of Estonia). Hypothetically, if all guarantees as per currently proposed EFSF were called (total amount: EUR 780 bn.; Slovakia’s share: EUR 7.7 bn.), our cost would reach 35% of total general government revenues – the highest share in the Eurozone. EUR 1000 of debt would burden the Slovak taxpayer twice to three times more than the German. To cover potential future costs brought about by membership of the EFSF, we would need to increase taxes twice as much as our neighbour, Austria.
The ‘solution’ to the European sovereign debt crisis via EFSF will therefore prove particularly expensive for Slovakia. Slovakia’s main competitive advantage is its relatively low tax rates compared to other members of EMU. The proposed expansion of EFSF will lower this competitive advantage. It will also hurt Slovakia with respect to the central European region, where few governments will be part of EFSF. The inability to keep Slovak taxes low will lead to lower economic growth, and slower catch up with the higher living standards of the more developed countries.
Slovakia has already passed costly reforms of social welfare system. Slovaks have also paid the bill for an extremely expensive (10% GDP) recapitalization of the Slovak banking sector just ten years ago. The acceptance of costs of bailout of wealthier countries with unreformed social systems and insolvent banking sectors would substantially eliminate the positive effects of these painful reforms. To accept the debts of wealthy and profligate countries will mean that the Slovak taxpayer has tightened his belt in vain.
The size of the Fed’s balance sheet is now about $2,843 billion, up from about $800 billion three years ago. The huge increase in the Fed’s balance sheet stems from bailouts, quantitative easing, and other central bank “liquidity” operations.
…
The Fed’s capital base is $71 billion. That represents about 2.5% of its assets, or a leverage ratio of 40 times its capital. This ratio would have been considered unthinkable prior to the crisis: it is about four times greater than that permitted by the new Basel proposed rules for commercial banks and simply demonstrates that the bailout format and quantitative easing do not make these problems go away. If the patient has been incorrectly diagnosed, taking the wrong medicine will not cure him.
This capital to asset ratio means that a loss on its assets of 2.5% would be enough to make the Fed, by any normal standard, insolvent – unable to pay its debts.
Read the entire article to find out just how likely this is.
In 2008 Eurostat reported that Ireland was the second richest country in the EU.
Less than three years later, Max Keiser presents us with a very different picture, of an Ireland few could have imagined.
There is blame aplenty and no shortage of wonderful writers in this country to expound their various theses on who or what was to blame, but not many focus on the central bank and its money.
When savings collapse and the total debt per taxpayer climbs to nearly 500,000 euros, one doesn’t need to wade through 900-odd pages of Ludwig von Mises’ Human Action to suspect interest rates might have been to blame. Higher interest rates would have discouraged this level of borrowing, and increased savings — real savings.
One also realises that an average wage of around 35,000 euros (and falling) will never repay a total debt (still climbing) of 500,000 euros per taxpayer. Everyone knows this, but to face it would require the politicians to make themselves most unpopular in Brussels, and prompt some very uncomfortable conversations with bankers and property developers, with whom they had a very cosy relationship. Much easier to shift the obligation to service the debt onto the taxpayer and even raid his pension.
It seems childish to break it down to this level but the creditor’s relationship was to the bank or property developer. At what point did the contract stipulate that in the event the creditor could not be paid, the taxpayer would step in and shoulder the burden?
As a foreigner in Ireland, I have been moved by the stoicism of the people, but the degree to which it is being called upon is unjust. The shifting of debt obligations onto the taxpayer is simply not acceptable and one wonders how long it will be before the people decide to follow the more boisterous attitude of other small nations who are starting to make a stand (Finland, Iceland and Norway).
For over a decade we have heard reports of China’s increasing world dominance. Yet while Beijing has amassed a large war chest of savings over the past decade – $2.5 trillion remain under its control – it has been cautious in waiting for a rainy day to put its savings to use.
The times they are a changing. One day prior to his arrival in Madrid for an official visit, Chinese Vice President Li Keqiang announced that China had the utmost confidence that Spain would recover from its economic malaise. And to put China’s money where his mouth is, Li made an open-ended pledge to “help” (read: “bail”) out Spain in the future.
Citing China’s stance as a “responsible investor” with a long-term view of European financial markets, Li assured investors that purchases of Spanish public debt would continue. Moreover, the man who is widely reckoned to become China’s next premier commented on Chinese support for Spain’s austerity measures, and confirmed the conviction that Spain would achieve a swift economic recovery.
While Spain’s austerity measures are admirable, there is still a long way to go. With a deficit of 9.3 percent of GDP for 2010, and 6 percent forecast for this new year, total debt will grow to 62 percent of Spanish GDP by the time this year becomes bygones. That is, it will be 62 percent of GDP as long as GDP does not collapse further than it already has been. While GDP contracted by over 2.5 percent in 2009, and the final tally for 2010 still to come, the future debt load of Spain is more than a little uncertain.
Meanwhile, Spain’s own Socialist Prime Minister Jose Luis Rodriguez Zapatero noted that the Chinese commitment will “play a key role” in financial stabilization. This seems to be a signal that the stabilization that Zapatero is talking about is different than that which China reckons to be “investing” in.
Real stabilization will not come from having a bailout by different words. The Eurozone economy – of which Spain is a not insubstantial part as the fifth largest economy – is in the midst of a deteriorating debt crisis. Continued bailouts are band aid solutions to the wrong problem. When faced with a crisis of insolvency the solution is not continued doses of more debt. What are needed are drastic cuts to expenditures.
Spaniards, or anyone for that matter, should not be fooled into thinking that Beijing’s generosity will solve any problems. If anything a bailout will exacerbate and prolong the pain which has already been assured by the excesses of the past. When you wake up with a hangover, drinking more does little to numb the pain. More alcohol may get rid of the morning shakes, just as this “bailout” may calm market jitters, but at the cost of a more severe eventual withdrawal.
Philipp Bagus, in his new book “The Tragedy of the Euro”, explains lucidly how the European debt crisis emerged. Southern European countries joined a currency union assumed to be unbreakable. Any eventual signs of trouble with any of the weaker countries – the PIIGS of today – would by necessity be attended to by the strong. Incidentally, with reports of Belgium and even France someday requiring external aid, the list of the strong is quickly shrinking. Adding fresh troubled economies to its scope is not helping this situation either. On January 1st Estonia became the 17th country to enter the Eurozone. While Estonia ran a budget deficit of 8 percent of GDP last year it is only a matter of time before the new addition joins the ranks of the needy.
Unfortunately for Spaniards, what commentators are commonly missing (besides the fact that this bailout will breed more painful adjustments down the road) is that the pain of this bailout will fall mainly on Spaniards.
Guaranteeing a bailout will assure the government that they can continue their spending binge for a little while longer. Necessary cutbacks will not be enacted, as they will not be deemed as necessary. While the punch is still flowing, drink up. Without meaningful budget cuts there will be no improvement in an already tenuous fiscal situation. How long can insolvent countries keep getting bailouts to keep them going?
China has deep pockets, enabling it to keep bailing out troubled Europeans for a long run. But we all know what happens in the long run. Surely such a fate for Spain is worse than some short-term pain today.
The European monetary union is being held together tenuously. After putting €110bn. on the line to save Greece earlier this year, the tab increased by €85bn. as Ireland reluctantly accepted a recent bailout package. While the €750bn. shield brokered by the IMF and EU member states seemed adequate not even one year ago, the outlook grows gloomier by the day. Instead of questioning whether the fund is large enough or has the authority to act quickly enough in an emergency, we should reassess what the original purpose behind it was.
Germany fronted almost €120bn. for the fund, over €1,500 for every German man, woman and child. While it is perhaps not surprising that the EU’s largest economy and population pledged the most support, Germany faces a much starker rationale. The survival of the EU relies on the survival of its periphery. A strong German-centric EU will need help from its core to realize this future. Survival of the periphery, however, may not be in any one individual country’s best interests. So goes the common argument for the maintenance of Europe’s political and monetary unions.
In a recent commentary Mohamed El-Erian points out that the continued support of the periphery is straining Germany’s balance sheet. German government bunds have seen their rates surge over the past weeks, despite the country’s continued dedication to austerity. It shares the same fate as its periphery, without any of the “benefits” of a German funded bailout.
Luckily for the Germans, they largely control a key tool to Europe’s future – the European Central Bank. By continuing to purchase periphery (PIIGS) debt, El-Erian reckons that the ECB can alleviate Germany of this increasingly burdensome role. What he misses are the implicit costs that will result, as well as the promotion of dangerous consequences already in place.
The choice Germany faces is not between straining itself fiscally or inflating its problems away via the ECB. Germany may opt to exit the Eurozone, thus avoiding the bureaucratic costs of its less prudent neighbors. Indeed, after Berlin passed an €80bn. austerity package earlier this year, other Eurozone countries continued their prolific spending programs. The EU’s Treaty of Maastricht “strictly” prohibits member state deficits greater than 3 percent of GDP except for exceptional and temporary circumstances. The Irish deficit could reach 14 percent of GDP this year. Greece is close behind at 13 percent. Although the circumstances affecting these countries do seem exceptional, they are increasingly reckoned as anything but temporary.
Troubled counties such as Ireland would do well to exit the Eurozone to allow their currencies to devalue in an attempt o regain a competitive advantage. Germans will also find their own exit positive.
Continuing to fund bailout packages for less prudent neighbors is not a sustainable nor equitable situation for the Germans to be in. Turning to the ECB to inflate the problems of these periphery countries may be a short-term fix, but at what cost? Germans would be “punished” for not directly bailing out their neighbors with an inflated currency.
While every German man, woman and child has already had to fund the European Financial Stability Facility to the tune of €1,500, an inflated euro would decrease the value of every hard earned euro not already pledged. El-Erian correctly concludes that “The situation this time suggests good economics should play a greater role. Rather than simply doubling up on a faltering liquidity approach, the time has come for Germany to lead a more holistic solution focused on addressing the periphery’s debt overhang and competitiveness problems.”
An exit from the Eurozone and abandonment of the euro would do much to allow individual member states the necessary currency readjustment to regain their competitiveness. Euro membership could be a beautiful thing if it meant that member countries followed the rules – reduce or eliminate deficits and not promote inflationary solutions. Germans, indeed, should quit funding unsustainable situations with bandage solutions, and instead focus on the root problem. The German dilemma between fiscal bailouts and inflation need not necessary cause European-wide problems. A third option exists. Exiting the common currency would do much to remove the root of these problems, both for Germany and the periphery.
About 60% of private sector pension schemes “have clear rules” entitling retirees to annual increases in their pensions in line with RPI (Retail Price Index);
RPI is presently increasing at an annualised rate of 4.5%. The Government´s new price basket – the Consumer Price Index (CPI) – is presently growing at 3.2% per annum.
Steve Webb, our Pensions Minister, is today publishing a “Consultation Paper” which appears to be a precursor to legislation to override the contractual provisions of such pension contracts. If the proposal is adopted, pension trustees will be able to substitute the term “CPI” for “RPI” in these agreements.
I have not read the Consultation Paper, but I would hazard a guess that the thinking behind this initiative lies in the belief that our business environment will benefit from this measure since many funds are technically insolvent, or close thereto. Business needs this sort of government help and, net net, we will all be better off.
As readers of any of my previous articles will know, I do not pretend that our economy or banking system is looking particularly healthy. However it seems obvious to me that the root of the present problems lies in the original distortions to the banking market in particular, and a raft of other economic clunking fist intrusions in other sectors.
When will our new leaders stop following in the footsteps of the Old Labour belief that the Government can regulate and legislate to fix the economy? Does our Government believe that the best of all worlds is one in which a civil servant interferes in every limb of business?
Many pension funds are insolvent. This is not a post-’08 crash problem. For decades actuaries have been optimistically under-estimating longevity of cohorts of retirees and the soon to be retired.
But a pension fund is no different from a stand alone business, it has shareholders, debtors and creditors. It is run by managers. Should it flirt with insolvency the present laws encourage negotiated solutions among its stakeholders. If a deal cannot be agreed then all sides know liquidation can be invoked. What is wrong with this legal template? How does Mr Webb come to think that there is a problem here to be addressed by further laws?
The proposal also grabbed my attention for another reason. Its authors assume that the present positive differential between the growth rates of RPI and CPI will continue for decades. I noted the bland reference to “Treasury forecasts” as some sort of authority. Goodness me! Have our new ministers learnt nothing in the 7 months since they inherited responsibility for our Civil Service?
As a believer in social cohesion I am also deeply concerned. The unions are belatedly waking up to the reality that the banking bailout of ’08 was a mistake, that its only long term effect will prove a mass transfer of wealth from workers and taxpayers to bankers and holders of bubble assets, whose prices remain artificially inflated by continued government market distortions.
If Mr Webb wants to be remembered as the Minister whose actions proved the final straw before a wave of strikes and civil disorder gripped Britain in 2011, he should press ahead with his proposal.
