The EU and the Eurozone. What Should be Done Next?

Superficially, the easiest thing that could have been done by the EU in the last 24 hours would be to force Germany to open its coffers to 'save' the euro by buying all the bonds that may be issued or guaranteed by the puppet governments that have been installed in Greece and Italy, and may be installed in other economically failed countries. The spokespersons for the 'markets' - and representatives of the Obama Administration - will continue to press for a 'solution' on these lines whenever it appears that the new solution to the euro crisis is open to question.

In the 'markets' so-called hedge funds and other speculative investors have been stockpiling at-risk bonds when they could buy them cheaply, in the expectation that Germany would eventually be forced to 'support' them at higher prices. Germany has declared its commitment to the European Union, and to the euro, for decades and the marketeers think that pride and stubbornness will not let them back off from supporting the new dispensation. The Obama team of died-in-the-wool pre-2008 bankers have done pretty well to consolidate the position of their former employers since the big bail-out of the rationalised banks that were cobbled together in 2007-9.But they are well aware that the ramshackle result could begin to crack if the euro was disrupted, causing the US banks' holdings of euro debt to loose value. The US has been calling-in the moral obligation that is supposedly owed by Europe for US investment in defence during the cold war of 1947 to 1991. Time has moved on. The sensibly selfish basis for US policy, past and present, is clearly recognised and contemporary Europeans do not recognise a continuing obligation.

Germany in 2011-12 does not recognise an ongoing obligation specially to assist European countries that suffered occupation or destruction during the second world war. Huge reparations have been paid, the balance sheet has been cleared, and the anti-German current within Greek protest against financial stringency is self-defeating.

Germany should in no way feel obliged to assist a bankrupt state that got itself into the mess that its proconsular ruler is trying to resolve. Greece is uniquely in that perilous situation at this moment. The Greek people will suffer dramatically lower living standards for an indefinite future because Greek governments doled out more resources than the country had generated continuously for the past three decades. Though different parties won elections from time to time, each government had a popular mandate; and it is the misfortune of modern citizens in any state that they collectively carry responsibility for the accumulation of debts that the elctorate consented to being accumulated.Any Greek could have discovered that their huge salaries, early retirement ages and evasion of taxation were not only exceptional but also blatantly unaffordable when set against national economic data. The typical citizen may have chosen not to take cognisance of the facts: that dereliction alone stimulates fair-minded aliens to inhibit any sypathy for the unfortunate elderly who now have dramatically reduced living standards and no prospect of mitigation in their lifetime.

Economists have been allowed to dominate economic policy with the assertion that 'markets' are efficient. They have handed it down as 'scientific fact' that governments should so arrange affairs that markets are the drivers of the economy. This is utterly ludicrous. Markets are creations of human beings, and only have any life to the extent that human beings take part in them. The people exist under the protection of the state, they can make contracts because the state and its courts-of-law recognise them as legal persons. The companies that exist in markets are licensed to exist by the state. The contracts that people and companies make are only enforcible if the state's courts recognise them to be valid. The state has an unqualified precedence over any business structure and this is an inescapable fact: for Economists and their dupes to presume otherwise is profoundly dangerous.

People have an infinite capacity for cheating, crookery, and fraud; as much as they have the capacity to be creative in the arts and sciences. A few hundred people - mostly science graduates, many with PhDs - have become adepts in black arts that enable them to create derivatives and credit default swaps. They can - and some of them do - set up deals that are designed deliberately to exploit other market participants. They invent and trade in fantastic 'instruments' such as 'shadow shares' that enable a pension fund to put its money into bonds but in parallel with that to buy notional shares, with a promise that if the 'real' bonds fail and the notional shares retain value, then the firm that has sold the shadow share package is contractually obliged to give the pension fund value equivalent to the gap between the value of the bonds that they hold in comparison to the then value of the notional shares. The idea that any financial firm would be able to deliver on such a promise in the event of systemic market failure, without the sort of government support that the banks were given in 2008, is absurd. The contract - and the pension fund with it - would most probably be wiped out. But while the contract is operational [and untested] fees are paid to the conjurers, the pension fund managers get their salaries and the Trustees draw their fees or allowances: only the fund members stand to lose.  The financial services providers have become even more blatant than they were before 2008 in the absurdity of the 'products' that they have offered; and the gullibility of their clientèle seems to be undiminished. The providers made Greek and Irish state debt appear to be sounder investments than they were, by enabling the holders of the bonds to 'hedge' those purchases with derivatives or ghost shares.

Markets that include such cajolery and sheer brass cheek among their trading methods, selling 'products' on which millions of peoples' future incomes depend which have no substance, are profoundly 'imperfect'. It is blatant that knowledge and understanding of the products and of the risks that are inherent in them are not equally understood by purchasers and the people who unknowingly depend on the outcome of the contracts. Essential rules of the system must be defined by the state, the traders must continue to be licensed by the state and the products must be subject to classification by the state. The infantile version of the Tobin Tax that has been proposed in the EU would have no significant impact in regulating the markets as they have evolved in London and New York. It would primarily be a regressive imposition on the day-to-day bank and insurance transactions of the mass of the population. If 'complex products' are to continue to be regulated as financial assets, much more intrusive regulation - more comprehensive than what is currently being proposed by the EU financial regulator - is needed.

But a completely different approach would be more sensible. At the very least, derivatives and most 'swaps'.and many futures and other 'asset classes' should be classified as betting slips; which is the simple truth. As bets, they should be regulated in the UK by the Gambling Commission, not the Financial Services Authorities. They should be subject to gambling tax and not susceptible to regulation by the EU Financial Services Commissioner and his empowering legislation. By trying to exempt Britain - specifically the 'City' - from any new restrictive EU financial services regulation David Cameron has had a Pyrrhic victory. He has not got any significant exemption for British financial services [which he repeatedly points out is 10% of the economy] and he does not have any inkling of the basic fact that much of the 'industry' that he is trying to protect is not finance, but gaming. The appropriate regulatory change should speedily be implemented: then the EU system of financial regulation would not apply.

It would make an amazing positive change to the continentals' perception of Britain and of the activities of the City if the suggested reclassification were to be carried out. If the British Treasury and Cabinet Office will ever be capable of taking this point, they can frame a regulatory regime that will be seen by the rest of the EU as exemplary. Britain's detractors would be wrong-footed and the rehabilitation of the UK would be facilitated. The City need not suffer any great loss of business, insofar as the players can convince their clients that the betting slips that they have been buying to hedge their investments will still serve the same purposes under a more appropriate and honest regulatory regime. I have only a scintilla of doubt that the City lobbies will oppose any reclassification of their 'proprietary' activities because their pride will be offended by their being classified as bookmakers and their greed will baulk at paying higher taxes on a different basis and possibly experiencing some loss of business. But the City and the government have a golden opportunity to escape the very real threat that the new Europe will much more massively deflate the City's income under its tightening and uncomprehending regulatory regime.

Away to the west Dublin has developed huge 'financial services' expertise that is currently underemployed. A swift-footed Irish government - safe within the carapace of the revamped eurozone - can go a significant way to develop a high-level bulk betting regime that could capture a great deal of the market that the City of London stands to loose. That threat [and the possibility that the Swiss may dabble in these markets]  may help to persuade the City that here is a way forward.

Intelligence and Common Sense

Quarter of a century as a university academic and two decades in the City have taught me that some of the people of highest academic attainment, who can be hugely articulate, are either obtuse on some issues, or unconsciously filter unwelcome realities of everyday life from their observation, or uncritically accept political opinions [as was the case with many of the scholarly communist die-hards of the nineteen-sixties and seventies]. Some remarkably able individuals combine all these characteristics. I have no idea whether or not Rowan Williams falls into one or more of these categories, but his behaviour and utterances indicate that he may well fall into the range.

His outpouring in the Financial Times today is an example. He writes as the Archbishop of Canterbury, aware that the heathen press [largely by quoting 'liberal' Christians] has gleefully dissected the conspicuous failure of the Chapter of Saint Paul's Cathedral to cope with the aftermath of the chaos by which the police allowed rent-a-crowd to come to rest next to their church. Appropriately he expresses sympathy with a carefully constructed argument for reform of the global economy that was recently promulgated by the Vatican. Much of this is simply restatement of classical church doctrine: some of which has been seen as impractical in an essentially secular business world. Rowan Williams chooses to add an emphatic endorsement to the Sarkozi-led campaign to introduce a global 'Robin Hood Tax' on all banking transactions.

The concept of a tax on transactions was adumbrated forty years ago by James Tobin, who proposed that there should be a levy on foreign exchange transactions which were growing in number and volume on a purely speculative basis, unrelated to the requirements for foreign currencies in 'real' international trade. The objective was to check the growth of the economically pointless money-making scam, which brought good earnings to the clever dealers who were creating a new market; and healthy profits to the firms that bankrolled their dealing. The current 'Robin Hood' proposal is not closely related to Tobin's idea. The context is the aftermath of a near-collapse in what is called 'the banking system', which is still being played-out with millions of jobs lost and declining living standards being imposed on the people of dozens of countries that had broken the Iron Law of Wages. The general public have become increasingly well aware that at least some people who are rather confusingly described [and stigmatised] as 'bankers' are still receiving remuneration that is a great multiple or nurses' or teachers' wages for performing 'socially useless' functions. The Sarkozi idea is to 'punish' the 'banks' with a tax on all transactions, the money to go to socially desirable causes in the 'real economy' [or maybe, actually, to help governments to service the debts that they have incurred in rescuing the banks].

Such a tax would merely be a nuisance. If it is imposed on transactions like paying wages, putting money into personal accounts and taking it out, issuing mortgages and other everyday 'retail' transactions, it will simply be levied on the [relatively] poor;  making them marginally worse off. If it is imposed on 'wholesale' transactions by some countries and not by others, it will simply remove trade and national income from the taxing countries to those that do not charge it. And if it is levied at the rate that is proposed [around 0.3% of the deal] it will not be at all painful for the financiers. It is a silly idea, based on misunderstanding reality.

There is a ground for a much larger tax - more than 10% [maybe much more] - on all those transactions that are unquestionably the issue of betting slips: derivatives, most swaps, and all futures that do not explicitly assure funding for demonstrable transactions in the 'real economy'. All this 'casino banking' should be recognised for what it is: gambling. It should be regulated in each country by the Gambling Commission - or the equivalent - and it should simply be banned in countries where gambling of other kinds is prohibited. It does not provide any 'financial service' to the economy that produces human subsistence. Some derivatives are used to 'hedge' some socially-useful transactions by pension funds and other essential agencies: alternative 'products' can be used for these purposes, and these should be used after exiting positions can be unwound during a transitional period. If the gambling continues, and with it the risk of instability in the finance sector is potentially increased, the citizens of the countries where it is permitted will at least be able to see the extent of the risk to which they are exposed because the tax returns will show how much is being transacted in this speculation. If there is some socially-useful aspect to this whole business, as some defenders of the system have claimed, it will also become clear and the regulatory system could be adjusted accordingly.

The Importance of the Lottery

Unless a person has an outstanding artistic or sporting talent - which can bring about a meteoric rise to the Premier League, the Top Ten or the Turner/Booker Prize - the chances of anyone gaining significant net wealth [or even a high income] from conscientious work are negligible. Hence tens of millions of people participate in the National Lottery, which has enabled thousands to fulfil or to exceed their dreams and is seen by the unsuccessful millions as the only way out of the trivial round of work or the dire attempt to remain optimistically human in receipt of benefits. The apparently-conspicuous exception to this rule of modern life, which has been selected for vituperation from almost all other segments of the population, is so-called 'banking' where bonuses and incentive payments, rather than conventional salary-and-pension packages, have provided a minority of staff the 'telephone number' annual remuneration to which so much publicity has been given
.
Most of the activities for which the huge incentive payments are made are various forms of gambling: using cyberspace betting-slips known as derivatives, options, futures and swaps. The players in these heady games do not bet with their own money. The bets are mostly entered 'on tick' in the names of the employing firms and they can be supported by the funds in the 'real-world' sections of the banks; and in the pension funds, sovereign investment funds and other sources from which the City derives its 'working capital'. Although the punters are awarded their bonuses according to the reported profitability of their punts, they are actually paid in deferred shares in their employer company [which dilutes the value of all pre-existing shareholders' assets] and in cash which is drawn from the profits that are taken in worldly money by the real-world banking business.
No betting tax is levied on these activities in which trillions of dollarsworth of bets are placed [and accepted]: while people of modest means must pay the appropriate duty on their lottery tickets and all their other bets in which they risk their own funds.
The complex of activities whose over-development enabled the financial crash of 2007-8 to take place has been described as 'casino banking', and regulators all over the world have belatedly acknowledged this simple fact. In the United Kingdom the Vickers Committee was established in 2010 to advise the government on what preventative measures would protect real-world, economically-necessary banking from the other, higher-risk activities that proved so ruinous.

 To nobody's surprise the committee has proposed the separation of essential banking from the other activities that financial services complex organisations undertake. This can be achieved by the separation of the two streams of business into separate companies, but most commentators expect a less dramatic solution whereby the different segments of a complex financial services organisation each perform in their own specific trading areas, with each trading unit sufficiently capitalised so that it will not become a drain on the reserves of the other sectors of the company.
This is a necessary first step towards ensuring that no bank would ever again be too complex to be transparent or too big to  be allowed to fail. But such separation is not enough to overcome the inherent risk of contagion from one unit to the others within a company, and thence on to other companies.
And even before the government has announced any programme for the implementation [or partial implementation] of the Vickers recommendations the focus of bankers' and regulators' attention is being diverted by the proposal from the European Union that there should be a tax on all banking transactions - in the widest sense of that term, so that derivatives and futures trade would be levied at the same rate as retail banking transactions, mortgage contracts and initial share sales. If such a tax were imposed throughout the European Union, including the City of London, it is believed that Europe would loose a massive amount of trade to jurisdictions where the tax was not imposed. The attention of the UK government immediately focussed on how to counteract this threat to the volume and profitability of the sector, with a consequential weakening of the focus on separation of 'real' and 'casino' activities.

A transaction tax on financial transactions was first proposed many decades ago by the US Economist Tobin, who suggested that the increasing volume of foreign-exchange transactions could be curbed by a small tax on each transaction. Putting a restraint on currency transactions was popular among governments and regulators because money-trading was increasingly being undertaken as a punt for profit rather than to make currencies available to 'real' businesses to fund their purchases. To impose such a tax on all finance transactions would make access to banking business and mortgages more costly for ordinary people and small businesses: which could push some of them into insolvency in the hard times that followed the credit crunch.
A Tobin tax could be appropriate for 'inessential' foreign-exchange trading: were it possible practicably to differentiate transactions that supported the real economy from 'casino transactions'. It is not possible to do this simply and clearly.

Another, more realistic, possibility is to charge the ordinary rate of betting tax on all categories of casino transactions [derivatives, swaps, futures, etc]. Betting tax has the huge advantage that it is payable when the contract is made, so the state would receive the revenue regardless of the outcome from the deal. It could be provided in the regulations that if the parties to any transaction could demonstrate that it genuinely enabled a real-world non-financial firm to spread properly-identified risk, the contract could then be exempted from betting tax. These cases could be dealt with retrospectively, with the tax repaid after any successful appeal.. This proposal directly tackles the need to differentiate the casino from real-world banking, and to discourage excess. So I will refer to it on future occasions