These now really are Testing Times for Europe



With Germany still saying AUSTERITY and Greece saying NO, there’s a new dimension to the problems of the Eurozone. Siriza has arrived with a flourish. The European Central Bank is caught in the middle.  So far they have said austerity is right for Greece, but not for Germany.  Germany isn’t helping the situation by practicing what it preaches.  As Keynes pointed out in the thirties - if everyone practices austerity at the same time, their economies will decline together, or at least not grow as they could.


Some of us have a lot of sympathy for the Greeks.  As elsewhere in Europe, the people who caused the problems are not the ones paying the price.  With unemployment at 26% and youth unemployment, leaving out those in education, at 57%, with public sector salaries down 23% and the minimum wage down 22%, output has dropped 25%.  Where will growth come with that scenario?  What business would be foolish enough to invest in that climate?  How can the Greeks possibly find the growth to pay the taxes to pay off their debts?  Those debts total 175% of GDP, way higher than that of any other country in the EU.  It has been obvious for some time, we need new answers.


There haven’t been new answers because they all have big risks attached to them.  If Greece left the Eurozone, the pressures would increase on Italy, Spain and Portugal.  Investors would think they might abandon the euro too and demand higher rates of interest to counter the risk.  If, alternatively, some of Greece’s debts were written off, debtors in those other countries would want the same indulgence.  It is called the domino effect.


Is it pure guesswork to speculate what will happen?  I think not.  There is very little doubt but that we will muddle through - as democracies usually do.  With all its problems, Greece is still a democracy.  Having had occupation, civil war, military rule, and corrupt governments all within living memory, the Greeks have just had a very civilised revolution.  There is no doubt that Brussels and Franfurt will listen to the views of the people and  Angela Merkel will find a way, as usual, to outface the hard-nosed purists in the Bundesbank.   No one wants Greece to leave the Eurozone, so debt pay-back terms will be eased and many creditors will take a haircut.  We will be reminded that there are obligations on lenders to lend wisely, just as there are obligations on borrowers to borrow wisely.  It will be seen that Greece is not going to leave the Eurozone and thus lenders will cautiously come back.  Inflation will also play its part, reducing the value of the nominal sums of money involved.


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That brings us to the second big financial story of the last couple of weeks.  The European Central bank has at last resorted to Quantitative Easing.  The US started it, the UK followed, the Japanese joined in recently, and now Mario Draghi has succumbed.  The Germans have been opposed to the move - still remembering the years after the first world war - so it has been delayed until we have had real signs of deflation.  With price falls in the last few months - not just oil - there is a danger that demand for goods and services will fall, as an expectation that prices will fall further takes hold.  That’s deflation: growth stagnates, debts cannot be paid off, and the economy spirals further down.


It is too early to say whether Quantitative Easing is the right medicine for the slowing European economy.  Low interest rates was the first weapon tried by the ECB to get investment and demand increasing but, with all the uncertainty in the world resulting from other events, this hasn’t worked.  By now increasing the quantity of money in the economy, the ECB is hoping  for some inflation. If prices go up people should spend before prices go up further.  In the UK, similarly, low interest rates, haven’t led to the hoped for investment and Quantitative Easing has merely inflated asset prices - particularly housing.  Will Quantitative Easing work for the Eurozone?  Even George Osborne will be hoping so!


QE isn’t enough in itself.  The ECB can only set the framework.  As Mario Draghi has said before, governments have got to step up to the plate.  If industry and consumers aren’t spending, governments must.  OK,  they will leave debts for future generations to pay off, but if expenditure is on sensible infrastructure then it is asset for the future to balance the liability.  If housing or a school is built, that benefits future generations, while, in the meantime, creating jobs increasing the tax take.


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And now to the third dramatic event of the last couple of weeks  - Switzerland has unpegged the Swiss franc from the euro.  Switzerland has led a charmed life ever since Napoleon found he wasn’t welcome.  Avoiding wars which raged around it, and more recently deciding not to join either the EU or the Eurozone, though surrounded by both, little Switzerland has grown rich on high quality exports and a financial market which asks few questions of its clients.  All this adds up to a remarkable factor in the money markets of the world. Quite out of proportion to the size of the country, the Swiss franc holds a place of honour alongside the dollar, the pound sterling and the Japanese yen.  The Swiss franc has been where you go when you are uncertain of where else to go.  The demand for Swiss francs as a stable currency rose so high in 2011, when the financial crisis hit the markets, that the Swiss National Bank pegged its value at 1.20 to the euro, to stop it rising further and endangering Swiss exports.


Now it has been unpegged and it trades around 1 Swiss franc to 1 euro.  The implications are profound across Europe.  The Poles and Hungarians who took out mortgages in Swiss francs now have to find 20% more zlotych and forints to pay them back.  All those currency traders in the ludicrously large currency market, mostly in London, who borrowed Swiss francs to buy more speculative currencies, have huge losses to unwind and some are already declaring bankruptcy.  [West Ham’s sponsor, Alpari, is one of them.]  The margins are so small in currency trading that bets have to be enormous to make a worthwhile turn.  Traders typically borrow 100, even 200, times their own resources and the Swiss franc has been a currency of choice.  150 bn Swiss francs are reckoned to be out on loan.   As for the Swiss themselves, they have had to shoot themselves in the foot.  Roche and Novartis pharmaceuticals, Nestle, Swatch and other big Swiss exporters now find their prices up by 20% when they try to export.  The important tourist trade will be hit.  Competitors elsewhere get a boost.


Why did the Swiss National Bank do it?  At least partly it was because they got wind of the Quantitative Easing by the European Central Bank.  As was on the cards, the euro is trading 11% down on what it was before, and the Swiss would have  had to keep buying even more euros to maintain the peg.  


The Swiss are a victim of their own success.  No doubt they saw the dangers of their economy overheating as hot money flowed in.  But what could they do?  They had solved a problem for their exporters with the peg, but it was unsustainable with effective devaluations elsewhere.  


A proper peg is 80% the right answer.  That is, join the Eurozone!



Keith Tunstall




                                                                                                                                

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