Sean O'Grady: The rescue package was so warmly received because no one understood it
The UK's unfamiliar experiment with coalition government is delivering better results than the three great economic blocs
Monday 25 July 2011
That the second rescue package for Greece – and actually new softer terms for Ireland and Portugal's bailouts too – was so warmly received in the markets may have something to do with the fact that no one understands it. I have yet to meet anyone, be it eurocrat, economist or analyst who has been able to give me a comprehensive reconciliation of the numbers produced by the European Council after its emergency summit. Let alone those journalists who have chosen to specialise in economics, and whose paid job it is to translate the esoteric to the colloquial. "No idea, guv" sums up the journalistic consensus. It was probably the most opaque set of financial figures I have ever come across, not excluding PFI.
I think we understand that the "official funding" amounts to €109bn, though how much will be met by the eurozone and how much by the IMF remains unclear. What we have much less of a handle on is what proportion of the rescue fund will effectively be chipped in by the private banks, as organised by a group called the International Institute of Finance, the international "trade union" for the bankers, which, to its credit, has produced plenty of thoughtful and useful analysis throughout the financial crisis (though much of it obviously self-interested).
The numbers on that range from €12.6bn to €135bn over the next decade or so. You pays your money... The consensus seems to be that the banks will take a loss, or "haircut", of about 21 per cent of the face value of their Greek government bonds. Given what might have happened – total wipeout – they got off lightly. When in doubt it is always a good idea to take a quick look at the banks' share prices, and indeed so it came to pass; they started to bounce before the final conclusions of the EU summit were published, as they seeped out of the conference chamber in Brussels.
Weeks before, I had advised anyone who cared to listen to buy Greek government bonds because, contrary to the supposedly inevitable default, that would never be allowed to happen. I was, on the discount I quoted earlier, 79 per cent right. If I knew how to buy Greek bonds, together with their rich yields, I would have done so. The risk of default was mispriced.
Thus was the potent weapon of complexity used for peaceful, productive purposes. If you can't understand something maybe you can't be that worried by it. Even so, all would agree that there wasn't that much in the deal to be of much immediate help to Italy and Spain, and I would watch these (and not necessarily buy them). There was big talk about beefing up the powers of the bailout fund (good) but conditional on a unanimous vote in the EU Council (bad) and with no extra funding up front (worse).
What seems to be the common factor in the big three real and imminent sovereign debt crises is the political dysfunction they all display. In the jargon, the institutional arrangements of the US, Japan and the euro seem ill-suited to a long-term approach to fiscal consolidation. In plain language, the politicians can't agree what to do, often enough because regional or sectional interests come ahead of the national, let alone international, interests.
The stasis in Japan has been dragging on for years, if not decades, with farmers, construction firms and others seemingly with a vice-like grip on their establishment, always a pretty conservative and semi-corrupt grouping. There was some hope that one of the few good things to come out of the Fukushima disaster was that it might shake the Japanese leadership out of their complacency. Too much to hope for, it seems, and a 200 per cent debt-to-GDP ratio combined with an ageing population spells trouble to come.
In the EU, the political institutions are laughably inadequate to the task; an international gathering in which even the tiniest states have a veto power over decisive action and where there is simply no treasury function at all is not best placed to deal with its deep-seated problems. In the US the founding fathers cannot have foreseen the economic changes that would arise in the 21st century. The checks and balances they mostly wisely built into the constitution were not flawless; today the permanent cold war between the White House and Congress is impeding America from dealing with its greatest single problem.
It has happened before. In the 1930s it was the US Supreme Court that frustrated President Franklin Roosevelt's programmes to fight the depression, and, in due course, the Court had to be "packed" to bed to his wishes. Constitutional scholars can argue about whether that was good or bad, but it is a precedent for what needs to be done. America's constitution is not fit for the economic purpose to which it is now bent, and needs change, ultra vires for this column however. Even if President Obama and the Republicans eventually agree on some resolution, they will still be left with the problem of getting borrowing down, which taxes to raise and which programmes to cut. It cannot be done on one side of the equation alone.
What about Britain? Strange to say the UK's unfamiliar experiment with coalition government is delivering better results than the three great economic blocs I've mentioned – and with no less a challenge. Lest we forget, the UK's debt-to-GDP ratio will peak at around 75 per cent of GDP in a few years time – much lower than the 90 per cent level most economists agree pushes an economy into a sort of death spiral where interest payments become impossible to sustain (Greece and Italy are on 120 per cent plus, by the way). At 10 per cent or so of GDP the annual borrowing requirement was, as ministers always remind us, one of the highest in the advanced world and again unsustainable.
Yet this week's growth figures will provide little cause for satisfaction. The shadow chancellor, Ed Balls, will be going round like a dog with two tails when the figures for growth in the second quarter of this year are announced tomorrow morning.
By broad consensus they are likely to be bad. The only question is whether growth remains weak but positive, or whether we lapse back into negative territory, almost returning the nation to recession. It does mean that the official growth forecast for this year – 1.7 per cent – is looking absurdly optimistic, and we'll be lucky to see 1 per cent in the event.
It also means that the Chancellor's borrowing projections will be badly out of kilter over the next few years. I recall vividly the extra £46bn that the Chancellor admitted he would have to borrow by 2015 when he delivered his last budget; by the autumn he may well have to push that higher. And yet the markets don't seem to care, with the yields on UK gilts not that far off the benchmark safe rate of German bunds.
The reason being that the deterioration in government borrowing the year and next, at last, will be "cyclical" in nature rather than structural – the part of borrowing that won't disappear even when the economy improves. So long as George Osborne sticks to attacking that, he will not be troubled by the markets. Unlike her rivals, the UK seems to have a premium for her political stability and effectiveness built into her risk ratings, just at the time when her electoral system starts delivering hung parliaments, supposedly a Continental, unstable scourge: Something else I confess I don't understand.
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