The Irish Fiscal Stability Treaty – Why the Fuss?

May 10, 2012

The Irish AG Sets the Ball Rolling…

When the Irish Attorney General Máire Whelan, decided in late February to throw the decision over the ratification of the European Fiscal Treaty to the Irish  people in a referendum (since scheduled for May 31st), the euro plunged on world markets and has remained somewhat perilous ever since.  It has become increasingly clear that Europe must be dragged kicking and screaming into making the right decisions for its people, with political considerations eclipsing the need for some proper, sound economic logic. PIIGSty has long endorsed the idea of some degree of European control over eurozone fiscal matters because, put simply, that is what is supposed to glue together every monetary union. Why? Because if you want to play the game, you must adhere to the rules. The rules of the euro are very clear – and all euro-users (including Germany and France) are all culprits of massaging the rules (Stability and Growth Pact – SGP) to suit themselves. Now, its back to basics.

The Historical Background

A recommended PIIGSty study on the euro is provided here. In a nutshell, when the euro began circulating in 2002, the European economy was so strong that any idea of caution was viewed as unnecessary negativity. As economists began to query the honest reporting of the macroeconomic situation in Greece by the Greek finance ministry, the party just continued. Like the drunken older uncle at the wedding, the guests politely ignored him. A bit of an embarrassment – sure! – but hes family now and hes not really having an impact on the grand banquet itself.  When the German Bundesbank in 2005 warned that relaxing strict entry rules to the euro (Maastricht Criteria) and fiddling around with the maintenance rules of the wider euro-union (SGP) to suit those countries who happened to breach them (i.e. France and Germany, at that time – among others) – another huge red light was ignored. To use a separate railway analogy, the eurozone train had been gathering speed down a steep slope, and as the terrain leveled off, the driver worked to release the breaks to maintain the high speed the passengers demanded.

And so we come to the current crisis. PIIGSty has a number of articles on how and why we got here. But what about how Europe plans to avoid a repeat experience. The answer, or part of the answer, is the EU’s Fiscal ‘Stability’ Treaty or Fiscal Compact.

The Point of the Treaty?

The merits behind the Treaty, from the EU’s standpoint, are logical and ultimately imperative – as has frequently been discussed here on PIIGSty.com.  FYI here it is http://www.european-council.europa.eu/media/579087/treaty.pdf

Put simply – centralisation of fiscal control of eurozone national budgets is seen as necessary for both economic and political reasons. Economic – because centralised control means insisting on common standards and avoiding some states freeriding on the backs of fiscally responsible countries (i.e. Germany). Political – because it removes (or at least reduces significantly) the temptation for political leaders to throw taxpayers money around to gain political popularity and advantage. Reasoning is straightforward enough. Considering the complete mess the PIIGS have made of their own finances (some excessively more than others, of course), the Franco-German alliance of Sarkozy and Merkel (‘Merkozy’) agreed at Deauville in 2010 that to protect EMU (i.e. the euro) means achieving 2 particular means:

  1. An agreed crisis management strategy in the eurozone replacing the ‘headless chicken’ approach currently in operation thanks to ambiguous ‘bending’ of the Lisbon Treaty
  2. Formal powers to suspend an EU member state in the Council of Ministers in the event of violation of ‘basic principles’ of EMU

One particular offspring of the Merkozy Deauville love-in was the controversial EFSF (see here). So, how to enhance coordinate fiscal eurozone fiscal policy?

Simple. A souped up Stability and Growth Pact (SGP) with teeth – actual formal concrete power, forcing euro-users to return to 3% budget deficits and 60% Debt : GDP ceilings  –  the same end targets of the current austerity programmes across the PIIGS  along with a collective power to penalise those who don’t respect the rules.

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Economics 101 (#28) Fiscal Policy

February 6, 2012

In these days of austerity and governments scrimping and saving, the most important policy activity of government is fiscal policy. ‘Fiscal’ policy is any action by the government which affects the size or make up of government (exchequer) revenue/income or expenditure/spending. This section will deal with the all important issue of the national debt and how its size and growth affects the overall economy.

Heres the PDF PIIGSty Econ 101 #28 Fiscal Policy

How does a government tackle the national debt?  Like your average consumer with your typical debt, you have to tackle spending in the first place (and so control your overall debt levels) and pay down your debts by spending more money on them. A government does this by slashing public spending (education, transport, health etc) and increasing taxation. But what makes for a good tax system and what tax options does a government have?


Politics of Sovereign Debt Conference (Dublin City University – 12 June 2013)

June 23, 2013

Piigs_Icon_Good-ReadsA very highly timely forum was held in Dublin City University (DCU) on June 12 with experts from across the academic world on the subject of politics/economics of sovereign debt – mainly, the eurozone. The blurb was as follows: “The debt crises in Ireland and Europe require a combination of political and economic analysis. This conference includes cutting-edge papers from leading international scholars.”

Key papers presented were as follows (well worth a read):


Irish Domestic Finances and Prospects for Growth – Reason for Optimism?

May 30, 2013

Piigs_Icon_MusingsThere has been much debate lately over the Irish economy. Ireland has been held in high esteem across European capitals as somewhat of a poster-child for sticking the bailout conditions laid down by the ‘troika’ (The EU, European Commission, and International Monetary Fund – IMF). This means following a plan to shrink the economy and bring the huge gap between revenue and expenditure closer together. There are, of course, only two levers for a country in monetary union (the euro) to do this – raise taxes and/or cut spending – neither is ever popular buts its same across Europe.

On April 30, the Irish Department of Finance released its report on Ireland’s medium term economic on forecasts called the Stability Programme Update (SPU) which each eurozone country must submit to the European Commission annually as part of the European Semester process (aligning eurozone fiscal policy).  The findings were:

Comparison of SPU and Budget 2013 (Presented December ’12)

In summary:

Budget 1

Growth

  • The Irish economy is forecast to grow slower (-0.2%) than the original projections at the time of Budget 2013 in December.

Debt

  • The general government (GG) debt to GDP ratio (an ideal ‘compliance’ ratio and precondition for joining the euro being 60%), is now projected to stand at 123% this year, falling to 116% by 2015, marginally better than originally predicted in December.

Deficit

  • The other Maastricht criterion, that of the ‘excessive deficit procedure’ or EDP is forecast to be -7.5% this year (total revenue less spending), achieving the required level of -3.0% by 2015, as projected in December.
  • The approximate €750m – €1bn savings from the ‘prom’ note deal which will knock a good chuck off the cost of servicing the national debt are assumed to help reduce this figure.
  • On the positive side, the 2012 figure was -7.6%, well within the EDP target of -8.6%. The Irish economy is now performing at or above expectations in this area and the economy remains on target to hit -3.0% by 2015. Good news and politically valuable breathing space for Finance Minister Noonan as he crafts the next series of budgets. However, successive government ministers insist that austerity is not option and the proposed €3.1bn adjustment required this year under the EU-IMF programme is going ahead in the mid-October budget.

All this is line with the European Fiscal Compact (also known as the Irish Fiscal Stability Treaty) which was ratified by referendum by the Irish people on 31 May by a margin of 6:4. This allowed Brussels to push ahead with more formalised procedures under the Stability and Growth Pact (SGP) to penalise countries which did not follow their commitments and get their finances in order, as was the cost of joining the euro in the first place.

On May 3, the European Commission released their own Spring 2013 Economic Forecast (more here)

Budget 2

The differences between the SPU and the Commission forecast are, notably, slightly more pessimistic than the April 2013 SPU update with a growth project of +1.1% for 2013 rather than the Department’s forecast of +1.3%. But the pessimism is uniform. The Commission forecasts a more rapid decline in the current deficit fueled by the ‘prom’ note deal, a further public sector wage deal with unions (Croke Park II/Haddington Road) and other adjustment measures taking effect from the 2013 budget.

Why the pessimism?

Simply put,weak demand for Irish exports. The continuing uncertainly in the Eurozone with Cyprus, Slovenia and others, coupled with political uncertainties such as the unpopularity of French President Hollande and the federal election in Germany this November. Another issue which could negatively affect exports is the expiry of pharmaceutical patents the so-called pharma patent cliff.

The main issue is that despite the relative buoyancy of exports, there has been no real material recovery in domestic demand. What these forecasts agree on is that 2013 may be the pivotal turning point.

Irish Business Employers’ Confederation (IBEC) Quarterly Forecast

The IBEC quarterly review follows on from the SPU, making particular reference to domestic challenges such as unemployment (stubbornly stuck at 14%), weak consumer confidence and domestic demand and the issue of debt.

Budget 3But positively, the Irish economic engine appears primed for re-ignition. The only problem is…Europe.

The key issue is ‘austerity fatigue’ across EU capitals and a renewed emphasis on growth rather than a strict doctrine of austerity. While Ireland appears to be successive, peripherals economies such as Spain, Portugal and Greece remain fragile.  IBEC recommends, as ‘we are 85% of the way toward returning the fiscal deficit (EDP) below the 3% limit…the time is now right to ease back somewhat the pace of fiscal adjustment” – the proposed €3.1bn due in the mid-October budget.

Summary of Irish growth prospects

A number of other studies have also forecast Irish growth ahead, summarised here.

REALGROWTHOn average, Irish growth is therefore forecast at 1.46% (2013) and 2.8% (2014). Far below the ‘Celtic Tiger’ highs of 7%+ but much better than in recent times.

Read more here.


The Core of the Apple (Inc) Issue

May 28, 2013

Piigs_Icon_MusingsDid Apple use advantageous tax rates in Ireland improperly to avoid paying tax due to the American Treasury (and so the American people?)

On May 21 last, the US Senate Permanent Subcommittee for Investigations, tasked with investigating Apple’s tax situation, released their findings (WATCH here) which bluntly accused Apple of ‘shielding’ its profits, exploiting loopholes in the US tax code to shift its profits to ‘offshore tax havens’ , in particular Irish owned holding companies. This allowed Apple to pay a corporate tax rate of 15% far below the headline US rate of 35%. Senator Carl Levin (Democrat – Michigan) outlined how US corporate tax accounts for only 9% of federal revenue, thanks to these loopholes. The overall estimated loss to the US Treasury is $1.9tn in corporate profits to non-US tax havens.

The Double Irish Rule Loophole

In the US, like most major Western economies, a company must pay tax in the country it has been incorporated/registered. In Ireland, a company must pay tax only if its operations are managed on Irish soil. This means companies can register in Ireland (or ‘new’ subsidiary companies of the big US giants like Apple) but not physically operate here, meaning they pay no corporate tax.  This allowed an Irish registered Apple subsidiary to be managed and operated in the US but pay not one dime/cent in tax. Bizarre, but legal. More here

Such a company Apple Sales International did pay some tax, 0.05% on its profits in 2011, as ‘high’ as 2% other years. Apple Sales International generated $74bn in sales revenue between 2009-2012. Another Irish company, Apple Operations International, managed $30bn. The estimated combined tax loss to the US Treasury? $44bn, or nearly $15bn pa – a not unsubstantial figure. Interestingly, these subsidiaries are not technically registered….anywhere.

The Sweetheart Deal

That’s not the whole story. It has since been alleged that Apple received a ‘sweetheart’ tax deal from the Fianna Fáil Government in 1990 under Taoiseach Charlie Haughey, to avail of an incentivised rate, approximately 2%. In exchange, Apple has since provided Ireland with an estimated 3,500 direct employees.

The problem here is whether Apple received incentives or breaks to reduce its bill or whether is purposely sought to negotiate a ‘2% sweetheart deal’. The latter is serious, the former is perfectly legal.

The Irish Finance Minister Michael Noonan and Taoiseach (Prime Minister) Enda Kenny have denied such the sweetheart deal was made. The Committee reject this, and have been supported in this contention by Apple CEO Tim Cook. In any event, Noonan is technically correct. If a company is not tax resident in Ireland (i.e. like Apple Sales International, which has been registered in Ireland but does not manage its operations here) then quoting a figure of $30bn in revenue and proportioning a tax rate (however miniscule) is ridiculous. It should be zero, because there it is inactive in Ireland. The money is ‘held’ offshore from the US and never ‘repatriated’ i.e. paid to the US Treasury. The US wants to get its 35% on this sum but its task is to somehow decipher a labyrinthine tax code.

As Minister Noonan said – “It appears the rate that is being quoted is got as follows: the tax charged in Ireland on the branch activities in Ireland of companies that are not resident here on the one hand, is divided by the entire profit of the companies concerned, as if they were resident here, which they are not, on the other hand.” If Ireland was, in fact, a tax haven then shouldn’t Ireland benefit somewhat from this amount? Yes. Does Ireland benefit? Nope.

Ethics

The question here is ethics and fairness, not legality. In a time of continued austerity, bailouts and hardship – the idea of a cash wealthy American super-company which provides flashy iPhones, iPads and iPods to nearly every man, woman and child (you would nearly think, anyway) trying its best to avoid paying its fair share in tax while the the public are hounded and squeezed for every last euro/dollar/pound/ruble seems just a tad unfair and inequitable.

However, multinationals employs anywhere between 100,000 and 150,000 employees in Ireland and in a recovering country with over 14% unemployment, jobs are currency. The Irish corporation tax level has long been a bone of contention with its EU partners, keen to harmonise taxation to promote fiscal unity across the eurozone and bolster the euro. With the issues of tax havens and fraud featuring strongly on the EU agenda going forward, this issue is not expected to disappear soon. Thens there the issue of being a good team player, especially considering Ireland’s huge efforts to assiduously adhere to the troika bailout programme despite demands to burn the unsecured bondholders, notably those in Northern European banks.

Answer to the original question we posed at the beginning? Apple did nothing illegal. Your own definition of improper is needed to answer the rest.

More detail on this issue is available through this article

*UPDATE 1*

May 30: Joanne Richardson, Chief Executive of the American Chamber of Commerce (Ireland) writes an OpEd piece in the Irish Times, declaring that Ireland is not, despite the Committees findings, a tax haven. Her reasoning is straightforward. As the article states:  The OECD identifies four key indicators of a tax haven, none of which she declares applies to Ireland.

  • No taxes or only nominal taxes (Ireland has a 12.5% Corporate tax rate)
  • Lack of transparency
  • Unwillingness to exchange information with tax administrations of OECD member countries
  • Absence of a substantial activity requirement

She also heralds the fact that, “in December 2012, Ireland became one of the first countries in the world to sign an agreement with the US to improve international tax compliance and implement FATCA (Foreign Account Tax Compliance Act) – an emerging international standard for the automatic exchange of tax information.”

*UPDATE 2*

May 31: The Irish Ambassador to the US, Michael Collins writes to the two US Senators (an unusual step). The letter states:

  • No ‘special’ tax deals are possible under the Irish tax code
  • Restates that the Irish corporate tax rate (12.5%) is only levied on companies which operate in Ireland, and so are tax ‘resident’. That is, after all, Ireland’s definition of a ‘tax resident’ company. By using a US formula for calculating taxable income (as the US Committee does), they are being factually misleading
  • Restates Joanne Richardson’s point on the (4 factor) OECD identification of a ‘tax haven’ which he repeats does not apply to Ireland
  • Ireland is playing a strong role against ‘profit shifting’ and ‘aggressive tax planning’ with the OECD and EU, as part of Ireland’s Presidency of the Council of the European Union through the ECOFIN council.

IrishEMBASSYUS

 

*UPDATE 3*

June 1:  The US Senators reject the interventions, arguing again that Ireland is tax haven.

“Testimony by key Apple executives, including CEO Tim Cook and head of tax operations Phillip Bullock, corroborates that Apple had a special arrangement with the Irish Government that, since 2003, resulted in an effective tax rate of 2pc or less,” the senators said in their statement.

“Most reasonable people would agree that negotiating special tax arrangements that allow companies to pay little or no income tax meets a common-sense definition of a tax haven,” they added.

 


The Quintet Screwing up Europe #3

August 18, 2012

Part 3 of the PIIGSty analysis based on Matthew Feeney’s article of Reason.com continues with an insight into the European Central Bank (ECB) President, Mario Draghi.

3. Mario Draghi ECB President 

Draghi is a relatively fresh addition to the European saga. The colourful choice of former Bank of Italy ( Italian central bank) governor to succeed the shrewd Frenchman Jean-Claude Trichet has managed to stir things up, not least considering the ECB – a bank built on the inflation averse German bundesbank model – is now led by an Italian. Considering the current crisis in Italy with Mr. Monti’s technocratic government desperately trying to piece the country back together after decades of political instability, corruption and fiscal irresponsibility, Draghi is unfairly battling prejudice from day 1. After his recent London pledge in late July to do ‘whatever it takes’ to protect the euro, Draghi has since failed to accurately outline what ‘whatever it takes’ means (because this means very different things to each key player).

In early August, with Draghi alluding to expanding the scale of bond buying using undeniably direct language, the ECB appears set for a showdown with reluctant member states (and a good thing too!) There are signs that the cold German approach is facing a thaw and warming to the idea of the ECB strengthening its bond buying effort to cover the big 2 – Italy and Spain but this isn’t without its domestic detractors. To placate these, government rebels have demanded ECB operating procedures be changed to provide for a German veto (effectively neutering Draghi by politicising the independence of the ECB – so very unlikely to happen). In the meantime, accusations of ECB mutating into a state financier and a ‘bad bank’” are being thrown about.”

While most of the this is typical political chest pounding without substance or particular importance, the reality is that an ECB which unilaterally chooses to dish out bail-outs using mostly German funds could be (pretty fairly) accused of doing this at the expense of Germany’s own best interests. Hence, questions arise as to why Germans would pay in the first place. ECB ‘independence’ remains factually correct as far as any offspring is ‘independent’ of its watchful parent.

A fuzzy ECB is no help when signs of EU solidarity aren’t too convincing. PIIGSty has long said that a collective comprehensive plan to ‘save the eurozone’ is the real Holy Grail eluding European leaders. While Draghi and others continue to drag their feet while promising the sun, moon and stars (yet not a single cent), his words inevitably just adds to uncertainty and inertia as member states publicly argue and the markets bounce around unconvinced. Plans such as ‘fiscal’ or ‘banking’ union – despite German support  – remain completely undefined as the powers that be pray for growth. Without a plan, investors become convinced that messy defaults are just around the corner. Would you invest your savings in Italy or Spanish debt right now?

The Euro-jitters continue…

It hasn’t helped matters that the Finnish Foreign Minister has been speaking frankly to the British Daily Telegraph about the oncoming currency crisis and the necessity to prepare for just the possibility of a break-up. Mr. Tuomioja spoke awkwardly frankly against the changing of current bailout (ESM) rules and the writing of blank cheques for further bailouts and (damningly) voiced a  personal distrust for Mr. Draghi (among others). Although rebuffed later by other Finnish ministers, the consequences of prolonged inaction in Europe are becoming graver as whispers of a managed mechanism for ejecting weak links from the euro resonates across the EU-27.

The inscrutable Angela Merkel is the one certainly on which the European project precariously sits and, as a result, is feeling heat and wrath in equal measure. With her own Bundesbank sounding the alarm over Draghi’s new August announcement of a Italian-Spanish bond buying campaign, her task to thread a very delicate needle at home and abroad is a near impossible one. Eventually though, sanity must prevail and difficult decisions made regardless of the political cost which PIIGSty believes will be forthcoming from her government, when the dust truly settles – possibly this Autumn.

EU Debt Seniority

In the meantime, until a comprehensive plan is published, issues like the seniority of EU bailout debts remain contentious. Under current ESM (European Stability Mechanism – the main bailout fund) rules, seniority means the order of repayment of debt by borrowers in the case of default.  When you throw into the mix a Spanish bank (not sovereign/country) bailout of over €100bn, then the waters become murky.

Ultimately (which will surprise no one) it will take a greater crisis to really give Draghi sufficient cover to deliver a politically acceptable plan – something he has made clear himself. A more interventionist ECB is the last thing Germany will accept and so member states must request a bailout (of whatever form). Small wonder investors are cashing in their Italian and Spanish bonds and preparing for the worst. Draghi must remember – actions do speak louder than words, not least to the markets he needs to tame or a least calm. Like the EU politicians, Draghi should stop waffling about wanting to ‘save the euro’ and actually do it.


The Quintet Screwing up Europe #2

August 5, 2012

Part 2 of the PIIGSty analysis based on Matthew Feeney’s article of Reason.com continues with an insight into the Bank of England Governor Mervyn King.

2. Sir Mervyn King Governor of the Bank of England (BoE)

The British have historically enjoyed their splendid isolation from European entanglements. The Euro-crisis is no exception. With UK growth forecasts set to be slashed, the UK is now staring directly into a double (or even triple) dip recession. The key player here is Bank of England Governor Sir. Mervyn King. A skilled technocrat,  King has – on paper –  a purely independent economic job. In reality, King’s job is infused with politics. Despite what 10 Downing Street tends to say, as recipient of 50% of UK trade, Europe remains a major worry for King.

The job of BoE governor has been bolstered substantially since the New Labour government effectively privatised the bank in 1997 jettisoning it from from the reach of greasy fingered MPs. Not only does the BoE control monetary policy – it has recently supplemented its role as chief banking supervisor under the Tory-Liberal Democrat government’s plans to ‘get tough’ on the unpopular banking sector. King often has his finger on the populist pulse. His desire to see a full split between bank investment and high street activities as well as greater competition between banks is right from the street smart political handbook. King has is in good company with this view. The 2010-11 Independent Commission on Banking (ICB or ‘Vickers’ Commission) under BoE Chief Economist Sir John Vickers, recommended this separation, to remove the ‘casino’ speculative one-upmanship of modern British banks. This was undermined significantly by the softer 2012 UK Treasury white paper which featured watered down Vickers proposals. Again, politics prevail over smart economics – meaning the government (again) wins over the BoE.

Monetary independence meant keeping the pound, allowing the BoE to print money (quantitative easing) as a tool to stimulate the economy. This hasn’t exactly been a roaring success  – production is stagnant, inflation is gradually increasing and the economy continues to shrink and expand in a haphazard wave. Critics lament King’s use of ‘fiscal activism’ which only shocks the spluttering economic engine rather than seeks to get the real tools out and fix anything.

Further measures to stimulate growth seem inevitable.  With another £50bn likely toward the end of 2012, this brings the total pumped in by the BoE to £425bn – to possibly over £500bn in 2013.

Quantitative Easing

Quantitative easing (QE – aka printing money or ‘asset purchase programme’ in British speak) is an unproven and expensive medicine – buts its pretty much the only course any globalised industrial economy can realistically take (For a PIIGSty explanation on QE – see here and here). No one really can know if the patient improved because the fever broke naturally or if the medicine has cut the suffering short. Sure, QE helps finance the deficit by flooding the economy with pounds to spur growth and demand (and preserving current demand) without inflicting the full pain of austerity on the (voting) public. Although austerity or ‘necessary deficit reduction’ is unavoidable, King’s actions mean the Tory led government can  avoid the tougher actions forced down the throats of the PIIGS by the ECB-EU-IMF troika. Hence, QE translates into funding the deficit by any other means.

This means the BoE under King effectively causes inflation, to force growth of a sustainable level (2-3%) to ensure the actual pain is dissipated by growth. Seems like a handy solution? Nope – QE has downsides and as growth forecasts are slashed, the UK cant avoid the facts. Aside from being more a delaying mechanism for inducing painful but necessary long term reform of the economy by avoiding inducing tax rises and spending cuts in the hope that recovery will be swift and make these reforms unnecessary, QE risks devaluing the pound (which helps British exporters) and escalating inflation – two reasons not many would relish Mervyn King’s job.

King as Puppet-master

The British public (reasonably fairly) see King as a puppet master pulling the strings to keep profligate British banks afloat after years of making a balls of things (never mind the inconvenient truth that Northern Rock is set to make an £11bn+ profit over 10-15 years from the original government investment of £37bn in 2007. Of course that has nothing to do with the independent BoE but it is worth noting.) Another factor is that stimulus through a major public works/infrastructure project would be a more bog standard (and potentially far more successful) Keynesian option. A second option would be a direct fixed ‘free money’ to each citizen but this would be a behemoth to administer.

King isn’t afraid of strong statements. In relation to American support for EU political union, he brusquely retorted “Some of our American colleagues take the view it’s easy to solve the Europe crisis. Too many people assume Europe is one country, but we’re not one country, we’re several countries.”

King’s reputation has taken a knock recently with the LIBOR (London Inter-bank Offered Interest Rate) – a rate set in London by 16 key banks acting in consortium – in a scandal where Barclays bank under CEO Bob Diamond was found illegally manipulating the rate over a 4 year period between 2005 and 2009.  This scandal has tainted the obvious successor to Mervyn King, Deputy Governor  Paul Tucker – as King’s chummy relationship with Diamond turned destructive.

Feeney sums King’s role up, saying “Although the British government has embarked on a so-called austerity program, the fact is that there has only been a decrease against projected spending while nominal spending continues to increase. It is only thanks to the inflation created by the Bank of England that Britain is enjoying modest real terms cuts of what will probably be between 3 to 4 percent over the next five years.”  A fair enough synopsis. With growth collapsing – there will be trouble ahead and political pressure on the BoE will be enormous (independence be damned!) King’s action over the next few months may have a huge impact on the EU economy thanks to the size of its British component.


The Quintet Screwing Up Europe #1

August 5, 2012

Matthew Feeney of Reason.com – the rightwing libertarian e-magazine – has penned a particularly thought provoking article that merits some analysis. Feeney identified 5 individuals lurking in the shadows (somewhat…) who might just hold the future of Europe in their hands. PIIGSty will supplement Feeney with its own analysis to give an enhanced overview.

1. Pierre Moscovici French Minister for Finance

The French electorate proved quite the predicable bunch. Francois Hollande as prospective (and ultimately, nominated) Socialist Party (PS) Presidential candidate, led incumbent Nicolas Sarkozy of the Gaullist Union for a Popular Movement (UMP) in the run off opinion polling since August 2010. Hollande won in May 2012 and his PS won the companion legislative election in June. Leftist parties, including the Greens and Radical Party won over 300 seats in the 577 seat French parliament.

During the election, the PS sought a mandate with a policy platform which bucked the ‘deficit reduction’ and ‘reform’ agenda which Europe has assiduously followed since 2009. With the Merkozy ‘austerity consensus’  shattered by the ballot box (those pesky voters!) Hollande sought to promote his plan for ‘growth’ over austerity i.e. an end to cuts for sake of cutting and a halt to pulling money out of European economies for the sake of ‘building confidence’ by returning to sustainable economies. But France after all, was not one of the unruly PIIGS and as the second largest EU economy refused to rustle in the same trough to be thrown scraps by the master. The new French government, under PM Jean-Marc Ayrault, would have a tightrope to walk to protect the welfare state while maintaining growth and stability.

Without cuts , the alternatives to balance the books are always the same – shifting the debt burden onto those who can ‘well afford to pay’ i.e. the upper crust.  Financial gymnastics is never easy. Luckily for Ayrault, the burden for action falls on the Finance Minister Pierre Moscovici. As promised, the election tax plans were realised in July when the new government outlined plans to tax incomes greater than €1m at 75% and incomes up to €1m (over €150,000) as high as 45%.

But with Hollande and Ayrault sticking to their election promises, there are already accusations of watering down and compromise with deficit reduction measures. Raising the minimum wage by 2% has been met with scathing criticism from the left for being too low.

Despite low borrowing costs (bond yields) with French unemployment hovering at 10%, flat growth and weak consumer spending –the tripartite of Hollande, Ayrault and Moscovici are significantly constrained in their efforts at home and are likely to seek to front load cuts in public sector costs to give them more breathing room.  They’re sugarcoatng this by striking an interventionalist tone with the private sector – throwing their oar in with the workers in rejecting Peugeot’s plan to cut 8,000 workers and using state owned financial providers to pump money into cash strapped local government.

Ultimately though, you can’t square a circle – something has to give.

With speculation abound that Moscovici and German Finance Minister Schaeuble could split the chairmanship of the Eurogroup upon the departure of Jean-Claude Juncker (although this is seen as unlikely), the French Finance Ministry’s say in European finance has rarely been so strong in recent years.  The French, unlike the Germans, are warm to the idea of Eurobonds – while both are on the same page when it comes to growing the power of the ECB and enhanced fiscal union.

As Feeney sums it  up “Because France wields a huge amount of influence in Europe, and with the eurozone collapsing, Moscovici’s influence will become more apparent and dominant in the coming months.” Dramatic American journalists…you gotta love ‘em.


WANTED: A European Alexander Hamilton

February 18, 2012

Now and again, sifting through those puffed up self aggrandizing and overly complicated articles (aka messages of doom/rants) written by ‘celebrated’ economists, you find a few golden nuggets that are both enjoyable to read and useful. Robert E Wright (Bloomberg) recently penned such a shining example – ‘Why the Early US Didn’t Go the Way of the Euro: Echoes.’

Obviously its quite timely, although equally obviously, its subject matter is anything but obvious (if you follow me). In the original PIIGSty publication on the euro, I made a few comparisons between the US and the European ‘federation’ experience – mainly that, the Americans nailed down their political unity quite early, allowing a standardised economic federation to follow quite early in the genesis of their union wherein most subsequent US states (ignoring the Civil War, of course) have done so with their feet firmly planted on this solid foundation.  In effect, political union predated full, accepted economic federalism. For Europe, it’s far more complicated although not all that different (at least at one point in history)– except for the fact that the EU is trying to achieve a similar outcome by working in reverse.

Wright adds historical substance to this argument. Below are his findings:

Similarities between the 18th Century US and today’s EU

  • Citizens saw themselves as state citizens first and ‘federal’ citizens second
  • Flow of human capital was open but movements limited due to cultural (ethnic and linguistic) differences
  • Flow of financial capital across state lines limited (local and state banks)

What did the US do?

  • Economic statesmanship was provided by Treasury Secretary Alexander Hamilton (late 1790s). He established the gold/silver standard dollar, federal tax system and the US Federal Reserve (Central Bank).
  • ‘Assumption of state debt’ was proposed which allowed the US federal government to issue debt (bonds) as a federal whole which superseded state bonds, providing a mechanism for the feds to control the whole bond system and also, alleviate state debt (which indebted nations could not resist). This effectively mean that the federal Treasury would pay all state debts, financed by a 4% interest US gov bond. This action bound bondholders, no longer to the states but to the federal US as whole.
  • The action also bound states to the federal government. In exchange, states lost their control over money (couldn’t set interest rates, exchange rates) and their control over their fiscal policy was diluted.
  • The US government refused to ‘pay’ state debts (i.e. bailout states), enshrined in Constitution after Civil War (Post-1865)  in 14th Amendment

Adding meat to this argument is another recent  article (there have been many in recent months) by C. Randall Henning and Martin Kessler.

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Economics 101 (#35) History of Economic Thought

February 7, 2012

Theres an awful lot of revisionism going on lately as governments across the world attempt to battle the economic crisis with competing left and right wing approaches. Conservatives (generally) favour austerity; slashing public spending to get your fiscal house in order (balancing the books) while lowering taxation to promote business growth, entrepreneurship and consumer spending. Liberals (generally) favour government spending or stimuli packages while maintaining (or increasing) tax levels to bring in additional revenue to balance the books while squeezing efficiency out of the current public service, without cutting too deeply (or ‘freezing’ employment). Of course, many countries have adopted a bit of both.

This isn’t a huge surprise. Historically, both doctrines and many halfway house hybrids have had their day, in various forms –  from mercantilism and the classical school to Keynesianism and monetarism, from the 16th century to the 21st. And yes, history tends to repeat itself. Turns out that economics isn’t as predictable  and tamable as some would like to think.

We left the best chapter till last. PIIGSty highly recommends reading it regularly…you’ll definitely need this one (and its a handy conversation starter, at the very least).

Heres the PDF PIIGSty Econ 101 #35 History of Eco Thought