John Baron is Conservative MP for Basildon and Billericay. He managed portfolios for charities, pension funds and private clients as a Director of Hendersons and then Rothschild Asset Management. He remains a member of the Securities Institute. He now writes a regular column for the FT’s Investors’ Chronicle magazine.
Once again there are siren voices suggesting further tens of billions of pounds should be given to the IMF to help the Eurozone through its crisis. This is economic illiteracy. Trying to cure a crisis caused by excessive debt by piling on yet more debt is a fool’s errand. Yet Parliament may be asked to do just that despite such a policy contradicting the Government’s own austerity policy at home. Instead, the Eurozone should be aggressively tackling the root cause of its crisis – which is a lack of competitiveness. They have the tools at their disposal, but lack the political will.
To us Eurosceptics, the Euro project was always flawed. Binding divergent economies together without fiscal union was, and remains, a massive mistake. But this economic lesson of history was ignored in the quest for political union. The Eurozone leaders have finally realised their mistake. However, fault lines are already appearing in the new fiscal compact. And the market remembers how readily the Eurozone countries ignored the last fiscal strictures when the Euro was born.
These Eurocrats are failing to solve the crisis because they refuse to address the fundamental cause of the problem. Governments are failing to pay their way in the world because of a lack of competitiveness. These Eurozone economies continue to fall behind their competitors. Germany is the exception, but then its exporters have benefitted from an artificially low currency courtesy of the weaker Eurozone members.
The only true long term remedy for these economies is to become more competitive, to generate growth and therefore close the gap between what they spend and what they earn. But there is little sign of this happening. I see very little of the sweeping supply-side reforms that are needed to accomplish this. The political will simply doesn’t exist. Until this happens, all other measures are sticking plasters – and the market knows it. In the short term, relief may be provided if the ECB relents and starts printing money. This decision remains in the balance. But it is not a long term solution. There is no evidence quantitative easing generates sustainable economic growth.
Instead, the Eurozone politicians want to keep the sticking plasters in the hope that fudges and fixes will see them through. Without the ECB stepping in, this requires a lot more borrowed money. Italy alone needs to roll over £300 billion of debt in the coming 12 to 18 months. No wonder Eurozone politicians are looking to the IMF. They fancy their chances. By putting Christine Lagarde, a former French Finance Minister, in charge of the IMF they have put a debtor in charge of the debtors’ prison. It will not work.
The Government cites the fact that no country has ever lost money lending it to the IMF. But things may be different this time for two reasons.
This recession is very different – a dangerous statement for an ex-fund manager, but one which economic history suggests is correct. Recessions during the last 60 years have always been destocking events, where the problem has been a fall in demand. In response, the Keynsian approach of stimulating the economy – if necessary by borrowing – has usually done the trick. By contrast, this recession is a deleveraging recession. It has been built on excessive debt. Governments in particular have lived beyond taxpayers’ means. Demand is not the issue; excessive debt is. The only remedy for this recession is to par down the debt – not to add to it. This will take some years. By keeping interest rates artificially low at both the short and long end of the curve, Western Governments can help by allowing inflation to erode the debt. This dark art was practiced by Governments during the post-war period. But it is not a solution.
The second reason why throwing further borrowed money at the crisis via the IMF will fail is that such a policy fundamentally ignores the importance of devaluation to recovering economies. Usually, there are three elements in an IMF package: reduced spending, increased revenue and the ability to allow the currency to devalue. That last component is important because a weakening currency helps to take the strain off the economy. Without it, austerity packages have to be that much worse.
To my knowledge, the IMF has never lent to a country that could not devalue. This is why the Government line that only three of the 53 IMF packages go to the Eurozone is disingenuous. There is a fundamental difference. In these three IMF packages, devaluation is off the table. This will make the austerity packages worse and the prospects of default higher.
I question why the IMF should be getting involved at all. Everyone knows any additional IMF funding will be directed towards getting the Eurozone through this crisis – if only on a short-term basis. This goes well beyond its brief. But then the rules were discarded some time ago. The debtor in charge of the debtors’ prison has admitted on record that the previous bail out arrangements broke the rules, but this could be justified because we all had to rally round to save the Euro. I have very little confidence in the IMF at present. The IMF signed off the initial Greek package and look what happened: the situation went from bad to worse.
This is all the more galling given that the Eurozone has it within its own resources to solve the crisis. If it had the political will, it could send a very clear message to the markets that it was willing to undertake the supply side reforms needed to improve competitiveness. The markets are all about confidence. If they believe that the politicians had a longer term solution then they would allow the Eurozone to buy time in the short-term. And the Eurozone has the firepower to do just that. The Bundesbank has reserves of £180 billion, £130 billion of which is in gold. The ECB could become the lender of last resort. The quantitative easing pursued by the US and the UK could be introduced if only as a short-term measure to buy time. The Germans’ understandable concern about possible inflation could be assuaged, at least for a short period, in order to save their dream of political union. But this must be for them to decide.
What is harder to understand is why politicians outside the Eurozone cling to the mantra that we must save the Euro. All the evidence suggests this is making the recession worse. The austerity packages have to be more severe because countries do not have the option of devaluation. Yet since 1945 there have been over 85 instances where countries have left a currency union and in the vast majority of cases, those countries have benefitted. Despite the voices warning of doom and disaster, the UK’s recovery started immediately we left the ERM in 1992. The sky will not fall in if the Eurozone breaks up. We will still want to buy German cars, French wine and Greek holidays – they will be cheaper after devaluation.
The Eurozone leaders and those who advocate resolving the crisis by further increasing debt need to wake up to economic reality before it is too late. The numerous summits, various initiatives and loan agreements have all failed to restore confidence. The Eurozone is a dead man walking. Throwing good money after bad is not the answer. Having the political will to restore competitiveness is.