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By David Howden, on 5 January 11
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.
By David Howden, on 20 December 10
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.
By Gordon Kerr, on 8 December 10
The Daily Telegraph reports today that:
- 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.
By Gordon Kerr, on 19 November 10
Britain and the Eurozone hover on the Brink of Banking and Monetary Collapse. Our response? More Regulation.
The European Central Bank’s head, Jean Claude Trichet, appears to have realised what a mistake he made in single-handedly engineering the bailout of Greece only six months ago.
As I pointed out at the time this was simply a massive transfer of wealth from taxpayers to banks, funds and other investors in Greek Government bonds. Those smart and wealthy investors are now banking these profits very rapidly as we can observe by noting the rises in credit default swap prices.
Yesterday M. Trichet announced plans to raise Euro interest rates and decrease long term support for the banking system. It will be interesting to see if and by how much rates are raised since the Spanish banking system will probably collapse if Euro rates rise by even 1 per cent.
Why will this happen? It was a poorly reported consequence of the bailout two years ago that a significant consequence of forcing rates to zero is to inflate asset prices. Both effects are forced and hence, to use the popular term of the decade, unsustainable. The crash that we are about to experience will be far greater than that which would have occurred if the ordinary rules of capitalism had been allowed to operate in 2008. Sanity could have been restored to the banking system had governments stayed out of the mess. Liquidations would have led to changed business models and the appreciation by consumers of banking products that governments cannot protect them from losing money.
And what has the UK Government’s response been during this joyous week, which has already been widely reported as a good time to bury bad news?
In addition to pledging that we will donate several billion to the Irish cause, it has been announced that those who make their living by selling us mortgage products must take a course in mortgage loans.
This is yet another example of what Kevin Dowd has labelled “sham regulation”. The presence of an accreditation mark on an IFA’s business card is intended to imply that the consumer should trust his mortgage advice and sign up for the loan he recommends.
Let me recommend that sellers and buyers of these products take a very short education by reading and understanding the rest of this article. If enough of you lobby the FSA, these few words might even be adopted as the new FSA official mortgage education qualification.
When considering mortgage loan offers there are only two relevant criteria:
a) The length of the fixed interest period;
b) The all-in cost of the loan.
I would mention a third, but much less important point: break costs. Borrowers’ circumstances may deteriorate and the consumer should be aware of the costs of defaulting or switching lenders during the fixed period. Simply ask and compare.
Let us consider point a). Why do I focus on fixed rate loans, when historically in the UK and today in many countries like Spain floating rate loans were / are much more common? The answer is simple. The financial risk of a home purchase is usually considered to comprise only the risk of up or down variance in the house’s value after purchase. This assessment only applies to houses bought for cash. If a loan is required the consumer should quickly decide whether he wishes i) to take this amount of risk or ii) twice this risk.
Buying a house and borrowing on a floating rate basis amounts to taking roughly twice the house price risk because if rates rise not only do house prices usually fall but of course your payments rise as well. Therefore borrowers who wish to expose themselves to one times the risk of the house price variance should borrow on a fixed rate basis.
Point b) the all-in cost, can be calculated by entering all payments into either an Excel spreadsheet or even some calculators. All fees at inception and redemption should be included. Then press the “Net Present Value” button and compare the offers. (For the less financially savvy reader, NPV is simply a way of expressing a stream of payments over time as a cost today. For example, if the interest rate is 5% you would be indifferent as to a choice between paying £100 away today or £105 in one year’s time).
That is the end of the mortgage loan training course. Set out above is a universal guide. No other criteria matter – least of all the identity of the lender, unless you take a floating rate loan and expose yourself to being gamed by the bank. Many lenders brazenly jack up the rates they apply to loyal customers and offer “discounts” to new borrowers. These banks rely on lethargic consumers not to refinance quickly. This risk is almost impossible to assess in advance and is another reason to fix your rate for as long as possible.
It would be wonderful if the FSA’s official course were to comprise no more than the above few paragraphs, but sadly I fear the actual course will be replete with mumbo jumbo and simply constitute yet another barrier to entry into the financial services business. Mortgage industry hucksters will thus receive state support for their present modus operandi, namely the maintenance of the pretence that, like a Savile Row suit, you are a very special customer and need an expert, like me, to tailor a loan to your specific requirements.
By Gordon Kerr, on 26 July 10
A lifelong friend in a senior position at a major UK bank confirmed to me privately that last week’s news that banks were approving 4 out of every 5 loan applications from small businesses was nonsense.
Fortunately our Government has not been so easily duped.
The Daily Telegraph reports today that Vince Cable is considering plans to force banks to lend. It publishes this direct quotation from the Business Secretary:
What we would question is whether banks should be paying out dividends and bonuses when that money could be used to … support small business lending.
The original fuzzy thinking behind the bailout was to protect depositors and prevent a system meltdown and economic chaos. In late 2008 Kaletsky wrote passionately in praise of the bailout, claiming it was the only way to stave off the then threat of mass unemployment and civil unrest.
Even those in favour of the bailout recognise that economic chaos now looms starkly on the horizon given the seizure in both the interbank funding market and in turn the trickle of bank loans finding their way to borrowers. The Government bailout team either didn’t consider this risk at the time or were incapable of designing a bailout contract that would ensure that future loans were made. Therefore Mr. Cable has no choice but to act, or else the very economic chaos that triggered the bailout will ensue anyway.
Doubters of my conclusion that Cable should be praised may question how banks can declare such sizeable profits without making loans. The answer to this is that there are still massive quantities of debt available for purchase at below par prices in the capital markets. Why lend money out in the real economy in an accounting environment where the most you can recognise as a profit in your books, if the borrower performs optimally, is about 2% of the amount loaned every year?
If the alternative is to purchase a bombed out “alphabet soup” structure at say 60 pence in the pound then the annual profit can be enhanced by marking up the price (and adding this unrealised gain to your annual profit statement) since all the other banks are doing the same thing. The annual profit line is also greater since central bank funding comes at the “official” rate that is much lower than the interbank market rate.
In early 2009 the ECB and Bank of England invited banks to fund alphabet soup purchases from a separate pot of taxpayers money called the “Discount Window”. The Discount Window is not part of any market at all, so the banks were delighted to accept all such funding offers. Given the scale of this activity prices of such assets have risen gradually and steadily and so another bubble is inflating but the nature of the accounting regime (the ease with which a profit can be recorded without a transaction occurring) hides this bubble from the eyes of scrutineers.
And so our banks have been very active in the last 18 months, not in the real economy but in the world of alphabet soup bonds.
Therefore I conclude that Cable is brave and correct to design measures that force banks to lend or else banks will continue to operate as state backed hedge funds rather than drivers of the real economy.
But on the other hand, what about moral hazard? The notion of forcing banks to lend has been widely mooted in the press and usually dismissed on three grounds:
- How can the Government ever hold banks to account if loans which we taxpayers have forced banks to make go bad?
- Forced loans is a concept blatantly at odds with the official position that the government does not control banks, we taxpayers are merely substantial shareholders;
- Bankers are skilled market operators and therefore we cannot interfere with their compensation contracts. The more we define their role the more difficult it will be to maintain that senior bankers are not just highly paid civil servants.
All three points are entirely correct and prove that the idea of forcing banks to lend is ridiculous.
And so we have established that Cable’s plans to force banks to lend to small businesses are both commendable and ridiculous in equal measure.
This conclusion says more about the wisdom of bailing out the UK banks than any rant ever could.
By Chris Neal, on 2 November 09
Chris Neal outlines his tax payers’ revolt.
In October 2008 Messrs Brown and Darling assured the British tax payer that we had a reasonable chance of recouping or even making a profit on the £50 billion plus we were pumping into rescuing our banks. Sweden was held up as an example of how this was possible from the state rescue of their banks in 1992. In actuality, Swedish tax payers only recouped about half of their ‘investment’.
The Swedes did not have to deal with an unelected Brussels official able to mete out decrees based on stringent European Commission rules on competition and state aid. Dear Neelie Kroes (pronounced Nelly Crows) has it seems now told Darling that he must sell. Even yesterday Alistair Darling told us that he would take a “longer term view” in selling the state owned banks selling only when “the price is right” and “It’s not going to happen tomorrow morning but it is going to happen over the next three or four years”. He went on to say this “Because the taxpayer had to put a lot of money in to stabilise the system, equally the taxpayer ought to get that money back.”
Quite right Alistair, glad you’ve worked that out.
Nelly last week almost ended the hopes of Lloyds essential capital raising dangling her Damaclesian sword by threatening to impose draconian conditions on UK banks rescued by the government. Nelly has a loud whistle and loves nothing more than to interfere in the game by blowing for penalties and describes herself thus “My job is about acting as referee. If we think of the European economy as a football match, I set and enforce the rules of the game. We make sure it is a fair match and that there is punishment for people and companies that break the rules and spoil the game for others.” I couldn’t but help notice her use of the Royal “we”!
I have no problem with correct controls being in place to protect and encourage competition and can see the justification for a Competition as well as a Monopolies and Mergers Commission. It may well be good for competition to see the British banks split. What is implicitly wrong here is that the timing imposed by this unelected unaccountable Brussels official is likely to cost U.K. tax payers billions by not waiting until the recovery is complete. Why should Nelly have the right to interfere in this way?
The suitors are made up of foreign banking groups, large retailers and I expect Virgin, will we see Spain’s BBA, a Chinese bank, Tesco or maybe Sir Richard smiling broadly as we are forced to sell more of our Crown jewels? They will be buying British tax payer assets at knock down prices and able to make billions out of us going forward.
The Tax Payers’ Revolt
Nelly, Alistair, and Gordon need to be told that they are our banks so please get your hands off!
If you intend to give them away then give them to us, the tax payer, the shareholders and the customers of all the composite parts.
We want a nationwide mutual and by the way we want the Post Office as well!
Our business model would ensure current accounts have 100% deposit cover and savers can choose to lend their money via mutual funds that lend to businesses or individuals within our community responsibly.
We will go to tender to appoint the management of our bank to an operator in exchange for 15% of our net profits, establish a community charity fund with 10% and share the remaining 75% amongst ourselves.
The European Question
New Labour have emasculated Parliament, led us into a federalist interfering European state that preaches democracy but is anything but and betrayed us by denying us the promised referendum and for what purpose? Could it be to elevate Blair and Milliband as European President and Foreign Minister, unelected, unaccountable and even more uncontrollable, or to leave any future British Government and Parliament with no more power than a local authority beholden to top down dictates from Brussels by the same people who have presided over the last twelve years? Neelie Kroes is just one example of how Europe will impose its will.
Tim Montgomerie wrote this weekend on Conservative Home:
I’m told to expect a “muscular” response to Lisbon’s ratification and a manifesto commitment to fight for repatriation of key powers from Brussels. One member of the shadow cabinet told me that ‘we don’t need a mandate to renegotiate from a referendum… A manifesto mandate will be just as good’. CCHQ is worried that a referendum could easily become about issues other than Europe. ‘Imagine,’ said one key official at CCHQ, ‘if we are in the middle of very, very difficult budget cuts. The unions and our political opponents would urge voters to use the referendum to kick the Tory government in the teeth. A manifesto mandate is safer, cleaner, less distracting.
This has to be the correct way to deal with Brussels as once the Constitution/Treaty is ratified then it is indeed a case of stable door, horse bolted. If all else fails then I have found one clause in the treaty to encourage my classic liberal colleagues “the Treaty of Lisbon explicitly recognises for the first time the possibility for a Member State to withdraw from the Union.”
Oh for Cromwell to wander into Parliament and confront this Labour Government with an updated version of his speech from 20th April 1653:
It is high time for me to put an end to your sitting in this place, which you have dishonoured by your contempt of our democracy, and defiled by your practice of top down government; ye are a factious crew, and enemies to all good government; ye are a pack of mercenary wretches, and would like Esau sell your country to the Brussels federalists for a mess of pottage and a title; and like a Judas betray your Queen and country for a few pieces of money; is there a single virtue now remaining amongst you?
Is there one vice you do not possess? Ye have no more sense of democracy than my horse; you have sold our Gold; which of you have not barter’d your conscience for the whips? Is there a man amongst you that has the least care for the good of the Commonwealth? Ye sordid prostitutes have you not defil’d this sacred place, and turn’d Parliament into a den of impotent lickspittles, by your immoral principles and wicked practices?
Ye are grown intolerably odious to the whole nation; you were deputed here by the people to get grievances redress’d, are yourselves become the greatest grievance. Your country therefore calls upon me to cleanse this Augean stable, by putting a final period to your iniquitous proceedings in this House; and which by God’s help, and the strength he has given me, I am now come to do; I command ye therefore, upon the peril of your lives, to depart immediately out of this place; go, get you out! Make haste!
Ye venal slaves be gone, not to Brussels by Eurostar but to your shires to beg the forgiveness of the people you purport to represent! So! Take away that shining bauble there, and lock up the doors. In the name of God, go!
Further Reading
By Steven Baker MP, on 25 October 09
Lloyds will announce within days a controversial £23 billion fundraising that will bolster its balance sheet and finally repair the damage caused by its disastrous takeover of rival HBOS.
The fundraising, being finalised this weekend, will be one of the biggest seen in London.
The bank will ask shareholders to inject about £12 billion through a rights issue. Taxpayers, who own 43% of Lloyds, will have to cough up about £5 billion.
via Lloyds seeks £23bn to exit state scheme – Times Online . (Emphasis mine.)
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