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Friday, 27 January 2012

Sad Tidings

Since the summer of 2008 central bankers, finance ministers and government spokesmen from all over the world have been saying that they understand how the world sank into depression in the nineteen thirties, and they have offered reassurance that they would ensure that such behaviour was not to be repeated now. Yet now we see serious signs of a slide to depression in Europe, despite the strong growth in emergent economies and tentative signs of recovery in the USA.

One small but glaring example of political stupidity has recently being enacted in the daily news in the UK. Politicians and journalists demanded that the board of the Royal Bank of Scotland should renege on the contract that they made with their chief executive, which was approved by the then Labour government. The failed bank had been nationalised and Stephen Hester accepted an offer to manage it as a patriotic duty: the remuneration was well below the norm for bank CEO jobs. He has performed at least satisfactorily. On his appointment the bank's board set a salary-plus-bonus package; but now the woodentops have questioned whether the bonus is 'earned' and whether the concept of a bonus is acceptable in principle. The screeches of politicians and the media eventually had their perverse effect, and Hester agreed not to take that which he was contractually entitled to receive. This furore demonstrates astonishing ignorance of the scandal in finance: the so-called bonuses that are in fact commissions on turnover for gambling in derivatives, futures and swaps. The traders constantly expand the coverage and range of the 'products' that they devise in cyberspace, finding new markets and discovering - sometimes creating - new counterparties. Before the crunch their daily trading exceeded months of material world trade, in nominal value; and bizarrely they have continued 'developing' the market since the crisis began. After the crunch the real-world-related trade done by the retail banking subsidiaries of the finance conglomerates was restricted by new capital requirements and constrained by the caution that is endemic in a recession; and their merchant banking activities [managing new issues of companies' shares and bonds, facilitating mergers and acquisitions of businesses, and offering analysis of firms and of markets] were all constrained by the cautious mood of investors. Therefore in providing notional profit for the conglomerates casino banking became even more important than it had been during the boom. Some of the notional profit from the traders' activity could be used to bolster the conglomerate's consolidated balance sheet; but most of it had to be paid the the traders in their 'bonuses', according to their contracts. The many successful traders were paid far more than the senior executives of the firms for which they placed their bets but it was considered normal that the executives' pay should be bolstered to reflect the size of the consolidated balance sheet that they were responsible for; and on that scale Mr Hester's £1million salary plus £1million bonus is peanuts. The fuss has completely misdirected mass anger and perverted public perception: and this is a typical of political rhetoric about the economy, which apparently follows the press in regarding contracted rights as subject t withdrawal on whim.

Political posturing and point-scoring are having even worse and more durable effects on the European mainland. In recent days the Greek government has refused another 'final offer' from non-governmental holders of Greek debt; and a further last chance is anticipated this weekend. Greece has promised to arrange billions of euros-worth of debt settlement by the middle of March, which it will only be able to do if the other eurozone countries and  the IMF lend it the money. The other eurozone governments, orchestrated by the Germans, Dutch and Finns, have indicated that they will not provide the loan unless the Greeks settle the 'private' debts. A suggestion from Berlin that economic discipline might be imposed on Greece by a Commissioner who would control all state spending and oversee taxation has provoked fury in Greece, and embarrassment elsewhere in the EU. Propaganda and graffiti all over Greece have already harked back to the occupation in the Second World War: the appointment of a Commissioner [presumably controlled from Frankfurt] could well provoke revolt. The mere expression of the idea makes an eventual Greek exit from the eurozone more probable. It will make life simpler for the Greeks if they can first settle with their private sector creditors as a member state of the euro, then exit the system to manage their own restructuring of the economy

Angela Merkel's speech to the Davos assembly last Monday clearly implied that a Greek default is preferable for her to any toleration of demands for an unlimited bailout from Germany. The Germans' reluctance to risk their own prosperity has been increased by the antics of hedge funds. These professional chancers have bought Greek debt at significantly discounted prices. In many cases they have also bought Credit Default Swaps [CDSs] created by financial buccaneers, some of whom work for subsidiaries of the financial conglomerates. If the Greek debt is restructured the hedgies will profit by selling the assets for more than the knock-down prices at which they bought them. If Greek debt can be consolidated the CDSs would not be activated and the premiums that the hedge funds have paid for the swaps would go into the top line income of the firms that sold them. So the huge lobbying power of the financial conglomerates can be put behind the opportunistic option that the Greek debt will first be restructured [with the financiers taking a 'haircut' that they have already allowed for in the business plans] leaving them with some value, expressed in euros, before the Greeks slink away from the eurozone. The odds are that the lobbying will be successful: while the politicians' blustering about keeping Greece in the eurozone will ultimately be nugatory.

Chancellor Merkel has also repeatedly stated that the problems of the eurozone would be speedily resolved through closer integration of the member states. But her vision of integration would focus on establishing discipline over the finances of all the member countries: it would not entail Germany opening up her reserved to support the debts of other countries' governments: and still less t support the debts to which their banks have exposed themselves. Her argument is exactly contrary to what bankers based in London, New York and the far east want to hear: so they assume that the current state of the EU and of the eurozone economies is unsustainable, consequently they discount the euro in global markets where it it traded against the yen, the pound and the US, Canadian and Australian dollars. The weaknesses of the EU and especially of the euro are increased by the political rhetoric which follows the ideological basis on which the EU institutions have developed. Besotted politicians ignore the corruption that is endemic in the unaudited and unaccountable Commission; the obvious lies on which the euro was floated; and the counter-intuitive Franco-German policy of giving even more powers over member states to the sclerotic Brussels bureaucracy.

Now, to add to the mess, the probable winner of the coming French presidential election has come up with a Manifesto - a long list of policies that he promises to introduce if he wins - including a strong counter-Merkel bias and attacks on the finance sector [with scarcely-veiled threats specifically to undermine London's leading role in financial markets. M Hollande proposes to reverse all the measures of economic discipline that have been introduced by the Sarkozy regime: which would further put him at loggerheads with Germany and would undoubtedly lead to a major [further] downgrading of France's debt by the rating agencies. His election would undermine the current consensus, and thereby threaten the future of the euro as French debt joined Italian, Spanish and Portugese debt as 'junk'.Sarkozy has responded by announcing the unilateral  imposition in France of a tax [0.01%] on 'financial transactions': it is not yet clear [and may never need to be clarified, if Sarkzy looses] as to what range of transactions the tax will apply to. Whichever  candidate wins the French election will be at loggerheads with Germany, or with the UK, or both. Sarkozy will support the new EU treaty today - in principle - but by the time that the deal is formally due for ratification [probably in March] the divergence of his policy from Germany may stymie the completion of the new deal.

Britain's tentative planning to cope with a eurozone collapse needs to be beefed-up, urgently: as does contingency planning for that scenario in China and the USA, and all their trading counterparties.

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