Grexit Gloom or QE Delight?

Dave


I haven't written for a while, sorry, I've had more important things on than saving your bacon. However, Europe is heading for the abyss again, and you might be able to use this to help, and in the process win a few brownie points.


The Greek situation and all the Grexit talk is all very 1930's to me. More politics than monetary or fiscal policy, it still has huge financial implications for all concerned, including us and not least my Portuguese holiday plans.


As we all know, the trouble has been caused by a single currency which has removed the ability of exchange rates to buffer an individual country against it's economic performance without tying their economies together in fiscal harmony. Germany has done extremely well exporting at an artificially low exchange rate for its currency, while the less efficient members of the Eurozone have suffered with an artificially strong currency relative to their own situation. Germany are obviously very pleased with the situation and keen to support the status quo while the others scratch around hoping for some fiscal largesse.


The most that Angela seems prepared to do is authorise some QE, to stave off deflation, so at least the debt of the poorer countries don't grow in real terms while they are struggling. A bit like taking your foot off the windpipe of a man you have parked your car on. What is needed is something more like the UK, where the lower performing bits, economically speaking, are supported by the rest, er, London. Clearly this would make Merkel turn in her groove, and so something more creative is needed.


It is my belief that there is a startlingly simple solution which may well be acceptable to all, and which is only possible thanks to modern technology, therefore it has never been tried or thought of as far as I know. To me, most of the current solutions seem to be out of the Great Depression, some, like QE, with a modern flavour, but they are still grapeshot in approach. What is needed is a more targeted effort and here's how it's done in a way in which QE solves the problems of the Euro as a single currency at the same time.


Put simply, create a new 'Euro' for each member of the zone, and create holdings for this in the ECB. Manage these national currency accounts like investment banking accounts, and include all sovereign debt, bonds etc. Each country's Euro should then have an internal exchange rate against the ECB central 'group' rate, using a formula based on underlying economic performance and designed to mirror the behaviour of a floating currency. Use this or any similar mechanism to inflate or deflate an individual economy as required, and use the imaginary QE money for the exercise. This targets the QE exactly where it is needed. Using modern technology it would also be possible to compute the flows of capital in and out of an individual member economy, and to use these alongside the currency performance formula to calculate the level of QE to be applied to the country account. Therefore if an economy performing badly would have been expected to suffer/enjoy a 20% devaluation of a free floating currency, increase it's euro holdings by 20% of the capital flows.


Of course, the reverse ought to also be the case, for high performing economies, but Angela will hate it and QE money will do just as well.


For Greece, this is not writing down of debt, or waiving bail out terms, it is simply restoring the spending power of the government/country to closer to what it would have been had they kept a floating currency, what it spends it on must be for negotiation, but clearly anything that restores competitiveness would be ideal, and could be spun as equalling an end, or part-end, to austerity. I'm especially thinking of corporate and even personal taxation reductions, to put money directly into the economy.


This is obviously imperfect in that it doesn't in itself make an economy more competitive internationally in a downturn, but it does provide the financial firepower for individual governments to make sensible (agreed) interventions in their own markets with that aim in mind. It therefore uses the QE to solve the Greek question (and the inevitable Portuguese, Italian and Spanish ones which would otherwise follow). And, although it doesn't give Angela much on the surface, it provides future stability for the Euro, and therefore keeps the exchange rate for the group as a whole artificially low in German terms, which is just what she really wants.


As the value of the overall currency holding of each member state can now float, the poorer ones will always have a mechanism to restore competitiveness, so the final caveat is obviously that a system needs to be designed to ensure that the targeted gains in each economy are captured, and not simply used as grant aid to bail it out. To this end, the ECB can, I'm sure, also build in balancing items which will move the interest rates and/or the absolute value of the debts in the member's accounts, according to how they use the largesse and the results that they achieve.


This will be complex to negotiate but once agreement is reached a trouble-free system is surely possible which removes some of the core disadvantages of a single currency when it is not accompanied by complete fiscal unity.


Best regards


Gareth

Memo to Dave

Good morning Dave,

A difficult week at the EU then! I'm not sure Nick is as close behind you as you think, and friendly fire can be more dangerous than any enemy, so remain alert. That said, I think no-one in Europe believed we would use the veto. As a result they piled a load of anti-British moves into their supposed Euro rescue, which is of course nothing of the sort. It is an instrument of further control which is supposed to persuade the loony fringe to behave more like Germany. Which would be fine if they had any industry or exports and wanted to work like Germans at the expense of having a life. They don't, they never have and I can't see them changing. The Euro as it stands is therefore just as doomed as it was and we are best off out of the way. We will probably suffer more than the euro zone if it collapses, as they will just create a new currency at a rate favourable to them ruining our banking system (again), but giving them our financial system as a condition of helping them to clear up their own mess was clearly not something we could agree to and so they can do what they like. We can always print some more money to further devalue the £ if we need to.

This leads me to the ticklish subject of solutions. Clearly the Euro is still flawed, and clearly the puppet dwarf wanted you cornered. There is no way you could have gone with the proposals and Sarkozy knew it, possibly even planned it. Also, we do not know to what extent Merkel is pulling his strings. That is fine, every now and then you have to point out to people that you are prepared to stand up to them, but to really end the bullying you also have to give them a slap. Metaphorically speaking.

The end result so far is that we are excluded from a group which has already revealed that it wants to take business from the UK and make it sit within their countries. This is not what we meant by a single market and we clearly need to get back on the high ground if we are to carry on the fight. I agree with you that London's status as a financial centre is key to Britain's success. It is key to inward investment as well as a revenue earner in its own right. It also has the long term potential to build relationships with the new powers which will in turn drive business and revenue to us. That is why the rest of Europe want our dominance broken up.

However, on the whole I think they have played an obvious hand to extinction. They haven't thought it through to the end. Voices in Germany are saying that if we want to sit outside the Euro we should also sit outside the EU, using Switzerland as a model. Do they really mean that? Switzerland is rich, well-invested and happily neutral. It has a sound banking system and punches way above its weight. If the UK could be like Switzerland and it requires being out of the EU and the euro to achieve, bring it on!

Of course, what the Sarko/Merkel alliance have overlooked is that we are bigger and more dangerous than Switzerland. We have some international trade of our own and a platform on which to build whichever way we choose to go. That is an important phrase - it should be us who choose which way to go. Now that you have been cornered by the dwarf and his mates, who clearly thought they had you over a barrel, if I can mix those two metaphors, they have left you with no choice. Clearly, their next move will be to enact measures harmful to the UK to try and force you back to the table, cap in hand. We cannot afford to wait for that.

Instead, put Europe in play. Carefully and strategically. I dare you.

You are already aware that if you held a referendum perhaps 70% of those who voted would be in favour of leaving Europe. The dwarf knows that and so it must be built into the plan. This will also have the side effect of vastly increasing your credibility with UK voters although I am sure that you would not see that as a  reason to act in a certain way! Here's what you do:

1. Acknowledge that the world is now a very complicated place and that no real 'public' review of Britain's EU membership has ever been carried out.

2. Form a body, composed of eminent economists and businessmen to spend a period, perhaps six months, fully reviewing all aspects of our EU membership and of the alternative.

3. Task them with publicly delivering a fully referenced and researched report, perhaps some kind of balanced scorecard as well, with no recommendations, only numbers.

4. This is important. It must not have recommendations, It is not a review of whether we should be in or out, it is a review of the economic and financial costs and lost opportunity of being in or out, which draws a financial conclusion only. It is not a political document, it is a financial one.

5. It must capture as far as possible all costs and do so on a menu basis so that as things change, for example they remove from our banks the ability to trade Euro derivatives, we can re-assess quickly and easily.

6. The Report must be in the form of a 10 year financial forecast, perhaps with alternative scenarios, so that a fair estimate can be made of our chances of growth both in and out of the EU.

7. Promise the people of the UK now that if the cost of staying in is greater than the cost of leaving that you will immediately call a referendum on the subject. Or reduce our contributions/limit our losses to restore the balance.

8. We all know that such reports can be twisted to a variety of outcomes, but for the good of democracy let us for once do some proper research and share the outcomes with the people, even if they do need some help to make the right decision.

Alongside this you will need to say to our EU 'partners' that you have been forced into a course of action which may lead to you having to make an entirely new offer to them around our membership. This is because all of the others only assess their membership on the basis of what it does for them. We were one of the few countries to genuinely subscribe to the view that a growing and stronger Europe will be better for all of us and we were therefore prepared to contribute. What we have now seen is that a stronger Europe will eat its neighbours when it suits. We are clearly on their menu and the best defence will be attack.

The EU may well spend a period wondering if we will be in or out. That will be good for them. If we decide to stay in after this review it will be because it is best for us or because we want to, accepting that the cost is a price worth paying despite the risk of mugging. If we decide to come out, the report mentioned above will form the basis of a set of benefits which we must set out to capture. We will need a taxation and banking system which is highly robust and ideally provides tax breaks to EU manufacturers, banks and services coming here. We will need investment in our own infrastructure and trading systems, such as those discussed in the Unofficial Big Society Green Paper to control flows of capital, and we will be able to relax laws. Not all of them, and not ones that affect quality of life (especially in working conditions), but ones that we all see add cost and decrease competitiveness. The ones that will have been identified as contributing to our cost of membership in the Report suggested above.

This might sound drastic, but we have yet to see what the EU plan to do to save the Euro, apart from to try and cripple London as a financial centre. We need our own plan and they need to know that we have one. Once the full scale of what we could achieve as an independent nation, right on their door step with tax breaks and new financial instruments and incentives to do business here through less red tape, is clear, the Sarkozy group will be less so. Cosy that is. It might even begin to be apparent to them that to attempt to mug us in such an obvious and brutal way was less than wise. We need to show them that they need us as much, if not more, than we need them.

That in a nutshell is this week's challenge. To turn the tables on them until they regret their actions.

Bon chance!

Gareth