A Night at the Opera …

… with apologies to the Marx Brothers

On the evening of 19 October, the FT’s rolling blog reported, the most senior politicians, diplomats and officials of the eurozone (EZ) and with Christine Lagarde (of the IMF) in train, gathered in Frankfurt. They had an appointment – a night at the opera with M Trichet ECB president (retiring) and Draghi ECB president (incoming). They also decided to go through a pretence of wrestling with deep policy issues on the future of the eurozone with M Sarkozy dramatically dashing from a Parisian maternity ward to get to Frankfurt on time.

With the passage of the past few weeks one has gone from initial disbelief to growing incredulity to the final realisation that actually, in both the EU and the US there is a now almost complete incapacity to formulate and implement anything approaching a coherent set of economic and financial policies capable of addressing the series of interrelated problems besetting both economies. In Europe there is on the official view first the Greek problem, second, the banking crisis and third, the finalisation of EFSF2 – the package agreed in outline (which is to say not agreed at all and no more than a fraudulent pretence) three months ago.  All three issues are inter-related but they are also three quite separate bits. In the US the EZ crisis also has real implications for American banking – and thus the prospective triggering of a global contagion.  To be fair to the Americans they have banged on at the Europeans (Obama and Geithner in particular) but to no avail whatsoever. Again though (Democrat) Washington also is paralysed: a Republican/Tea Party politics, deeply reactionary but entirely coherent holds the political balance. They are using it in effect to unpick those small remnants of the New Deal and Johnson’s Great Society (as well as their antecedents in nineteenth century progressivism) that have survived the last couple of decades. They also believe the wrong side lost the Civil War, the Federal Government is unconstitutional, the Federal Reserve is adulterating the dollar – and an awful lot else. They have a visceral hatred of banks (but hate Washington much more) – something they share with Occupy Wall Street.

In Europe the balance between the supranational institutions (such as the commission) and national governments (whether acting collectively through the European council, bilaterally a la Merkozy or unilaterally per Finland) has shifted dramatically during this crisis. Probably this collapse within the commission predates the crisis but was not exposed until the outbreak. The commission in particular has proved utterly ineffectual from the beginning – the decision by the Irish government of the day to introduce the bank guarantee unannounced is evidence of a chaotic body, leaderless, composed of unmemorable flunkies and countless ‘presidents’. In this situation governments see only cutting and running in perceived national interests.  The one institution within this framework to have functioned coherently – the ECB (which is actually not an EU institution) – has been consistent in defence of the indefensible. It has doctrinally pursued central bank ‘independence’; the disconnectedness of monetary from fiscal policy; the primacy for it of ‘inflation targeting’; the duty of governments to implement ‘market liberalisation’ measures and austerity on a grand scale (the NAIRU model); and its non-involvement in banking regulation.  The ECB argues that all of this is consistent with its own statutes and the treaties of the Union. Further, no other course of action advocated by anyone else is remotely legal – and fundamentally important, that is the way the world should be.

To be fair to the Fed (and indeed the Bank of England) such a view of the world is quite simply nuts. QE is the order of the day, inflation figures are ignored and the talk even is of targeting nominal GDP. One problem in both the US and the UK is that other forces on the political landscape act in a countervailing manner. In the UK for example the government coalition is pushing through spending cutbacks and generalised austerity. Government in the US and Europe is engaged in policies that amount to competitive deleveraging –whether of households, public bodies or banking. But if everyone contemporaneously deleverages then the world simply shrinks. In this scenario the world of commercial undertakings sees no rationale in anything other than hoarding on balance sheets and disengagement from investing. This is a liquidity trap, Richard Koo’s debt deflation or balance sheet recession – call it what you will. It comes to the same thing, dysfunctionality and depression.

Another problem in the EZ, the UK and the US is that bankers have been left off the hook: having calculatedly defrauded hundreds of millions of people, destroyed lives, neighbourhoods, communities and businesses they have pressed government everywhere to accept they must not be held to account, their losses must be socialised and that officialdom must also be their backstops for the fresh excesses and crimes they plan.

The latest news from Greece gives us a glimpse, granted in extremis, of where this public policy leads. The latest (20 October) quarterly assessment by the troika (ECB/IMF/European commission) is being reported by Reuters with inter alia the following quotation,

The (joint European Union/European Central Bank/International Monetary Fund) Commission services recommend the sixth disbursement to Greece to take place as soon as possible: as soon as the agreed prior actions on fiscal consolidation, privatisation and labour market reform, which were announced by the government, have been legislated

The FT’s Peter Spiegel’s filing as published on the paper’s rolling blog, says the €8bn is to be paid over but

… the report paints a dire picture of the path ahead, saying Greece’s “debt dynamics remain extremely worrying”.

“When compared with the outlook of a few months ago, the debt sustainability has effectively deteriorated given the delays in the recovery, in fiscal consolidation and in the privatisation plan, as well as the perspective of bank recapitalisation,” the report finds.

This is lunacy: Greece is going down the plug-hole but the troika asserts, it’s not our fault it’s their own.

Politicians generally chase their tails, pursue perceived national interests and privately kowtow to banks which in turn are intent on again minimising and/or not absorbing any fallout from resumed crisis, whether Greek haircuts, Volker rules or Vickers schemes. We are led to believe that the coming weekend meeting in Brussels is going to fix things up. Why would anyone on the basis of all evidence to date, accept such a proposition. And of course reading the German runes they don’t see this as final either. There is one other aspect. Again from the FT rolling blog and from a Credit Suisse note by analyst Andrew Garthwiate, commenting on the prospective deal from the week-end, an emperor has no clothes moment (our emphasis):

In a perfect world, [the deal] would also address the most critical issue (growth). The first three [Greece, bank recaps and ring-fencing contagion] look likely to be resolved over the next weeks – but we struggle to see the Euro-area returning to growth quickly (even if there are announcements related to EIB infrastructure spending). Bottom line we think a re-leveraged EFSF of €1.5 – €2trn is required – and that would be enough if growth returns (and thus the leverage calculations get no worse) and fiscal commitments are maintained.

Ah yes! That thing called growth and something called investment. Is there someone called Keynes just walked into the room? One suspects not: after all as Garthwaite puts it … “In a perfect world …” One might look forward to a night at the opera?

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