Tuesday, May 11, 2010

Sacrifices to Market Gods?

Anatole Kaletsky of the Times writes, Stop making sacrifices to the market gods:

Dr Johnson, speaking about the politicians of the 18th century, said that patriotism is the last refuge of a scoundrel. Outright accusations of treachery to the nation have become rare in today’s politics, but they have been replaced by rumors about economic treason and betrayal of market confidence. In today’s financially obsessed world, confidence has become the last refuge of the humbug.

In the past few days we have heard repeatedly that our politicians are risking the country’s credit rating or threatening sterling or facing retribution in the bond markets. Political leaders have been forced to take decisions of immense historic importance within days, or even hours, to satisfy arbitrary deadlines laid down by supposedly implacable financial markets. Any political action that a media commentator or a business leader happens to disagree with is attacked for undermining business and consumer confidence. Like Greek oracles, who claimed to hear voices from Olympus, financial analysts hold forth on television, invoking market confidence and insisting that no sacrifice is too great or too painful to propitiate this new god.

Britain’s politicians, trying to agree on the shape of the next government and the future of the electoral system, have not been the only ones bullied into decisions that could transform their nations for decades ahead. A far more spectacular example of political panic in the face of the markets was the trillion-euro bailout for Greece, Spain and Portugal conjured up in Brussels over the weekend.

The world would be much better served if politicians calmed down and the media paid less attention to the short-term gyrations of financial markets in response to political events. Among the main beneficiaries of a more sceptical attitude to the opinions of business leaders and financial markets would be businesses and investors themselves. Luckily for Britain, our politicians are proving more robust in the face of financial bullying than those of continental Europe. There is, however, a danger that British politicians will become so inured to the ephemeral fluctuations of financial confidence that they start disregarding the genuine long-term interests of British business and finance on which the country’s prosperity depends.

Consider what happened on Monday this week. Over the weekend both the pound and the euro were said to be threatened with collapse: in Britain’s case because the country was in political limbo; in the euro zone because the Portuguese and Spanish bond markets would suffer a meltdown if a rescue package was not announced by the time that Asian markets opened at around 1am, European time.

The Liberal Democrats wisely ignored the deadline and continued to negotiate for the best deal they could get. In Brussels, by contrast, European finance ministers panicked under pressure from the European Commission and President Sarkozy. The result was the biggest single programme of public borrowing in history by any group of nations. For Britain, this deal will increase the Government’s financial liabilities by some €10 billion (almost double the national insurance increase that featured so prominently in the election campaign) to protect the European Central Bank from undertaking the monetary policies that the Bank of England has already adopted in response to the financial crisis.

For Germany, this deal was much worse, reversing all Angela Merkel’s promises, undermining the Maastricht treaty’s principles of national budgetary independence, turning the euro from a Teutonic hard currency into a Mediterranean soft currency and converting the European Monetary Union into a union for the transfer of German taxpayers’ money to the southern countries derisively characterised as the Club Med.

Whether any or all of these consequences could have been avoided by allowing more time to debate is unclear. In the long run, some institutional mechanism for transferring Germany’s excess savings to the poorer countries of Southern Europe was probably inevitable for the euro’s survival and for the prosperity of German manufacturing companies that rely on Mediterranean markets.

Surely, however, one of the most important financial decisions in EU history, which will now lead inexorably to the creation of a federal budget running into trillions of euros, should not have been taken in one Sunday night sitting, on a proposal that had not even been mooted until the previous Friday, and at a time when Britain did not have a functioning government and the German finance minister was suddenly in hospital.

Why, then, did European leaders descend to this farce? Part of the explanation probably lies in Machiavellian politics. For Paris, Brussels and the Club Med countries, the distraction of last week’s elections in both Britain and Germany offered an ideal opportunity to overcome these two countries’ resistance to an enormous bailout and a giant step towards European fiscal federalism.

However, the ostensible reason was the necessity of agreeing a package before the Asian markets opened on Sunday night.

Now let us compare how financial markets reacted on Monday morning. The euro jumped by 2 per cent in the hours immediately after the bailout announcement, while the pound fell slightly in response to the lack of clarity about the next government.

By the end of trading on Monday, however, the euro had fallen back and yesterday it was weaker than before the bailout announcement, with every sign that the long-term downward trend that began last year would continue in the months ahead. The pound, on the other hand, has stabilised and continued to strengthen against the euro. And despite the warnings about a run on sterling and a collapse in bond markets, many of the smartest people in financial markets believe (as I do) that the real financial problem for Britain in the year ahead will be an excessively strong pound.

The lesson from this week’s experience is that politicians should pay less attention to financial and business “confidence”, and focus instead on underlying economic conditions and business interests.

If a government squeezes business profits with excessive taxes, high interest rates and over-regulation, this will genuinely hurt the economy and could cause an exodus of investment and jobs. If a government helps business by curbing inefficient public spending and improving work incentives, this will genuinely strengthen the economy. These are the true political realities that determine business confidence. All the rest is humbug.

With all due respect to Mr. Kaletsky, what he's claiming is pure nonsense. First, European leaders and the ECB dragged their feet, jawboning the euro down for weeks. He makes it sound as if they made a rush decision while drinking French wine.

Second, unlike Mr. Kaletsky, I fear that the UK is next in terms of feeling the wrath of bond vigilantes. And make no mistake, when the speculators attack, the Bank of England will be forced to take action, meaning more quantitative easing. The UK is extremely vulnerable right now, and a minority government won't respond as strongly when the crisis hits.

Finally, politicians are responding to legitimate concerns. Speculative attacks jolted Europe's bank funding system, wreaking havoc on credit markets and posing a real systemic threat.

As I wrote in my last comment, the trillion dollar gamble was needed to fight off the very real possibility that Europe and the rest of the world would fall into a crippling deflationary depression.

And while there is much truth to what Alex Jones is claiming below - namely, that just like TARP, this bailout is robbery - I find it hard to believe that some very bright people are not able to understand how targeted quantitative easing and government action can help restore confidence in financial markets, allowing credit to flow freely in the real economy.

It's not sacrifices to market gods we should worry about. In this crisis, silence and inaction would have sacrificed a whole generation into an economic abyss the likes of which they have never seen before.

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