The time is ripe for politicians to act

Next month’s US Presidential election has been a very firm check on any significant economic policy action by politicians not just in America but also in Europe and China.  It has been left to those in charge of the Central Banks to make all the policy running this year.  In response to the weakening economic data and political stalemates over the last six months, both Bernanke and Draghi have taken it upon themselves to take significant policy action and encourage their politicians to do the right thing.

This year, being an election year, it proved impossible to get any bipartisan agreement in the US on anything to do with the budget deficit – the Republicans insisted on no tax rises of any kind, and the Democrats were not prepared to contemplate any spending cuts.  Instead, they created an outcome of Mutually Assured Destruction, in which in the absence of any other agreement before the end of this year, substantial tax increases and spending cuts will automatically take effect from the start of next year.  If fully enacted, these policies would undoubtedly push the US economy into recession in 2013. It is only after the election in early November that the politicians will begin to get to grips with this issue.  The world economy needs a compromise to be effected between the two parties, assuming, as currently appears likely, that one party does not hold all three of the Presidency, the Senate and the Congress.

Markets are currently expecting that such a compromise does in fact occur.  The best time for any politician to make a politically difficult decision is immediately after an election, when any future electoral consequences are as far away as they will ever be.  Mr Bernanke has indicated that he holds an insurance policy in the event of no agreement and he will become much more aggressive with his QE programme, further to concentrate the minds of the Republicans.

In the Eurozone, the politicians have clearly adopted stalling tactics with regard to making a decision on whether to give further help to Greece, and have delayed receiving the Troika report from an initial late August date until mid November, just after the US elections.  The much smaller Cyprus bailout has also been delayed to be sorted out at the same time as Greece.  The Spanish bailout has also been delayed, first by the Spanish Prime Minister, who has regional elections on October 21st and who does not want to be seen asking for money before then. Also by Germany and some EU officials who are concerned about the knock-on effects in markets of a Spanish bailout request, most particularly for Italy.  Dealing with all of these together in November appears to be the preferred strategy, and as in the US markets are expecting there will be a satisfactory resolution (at least for now).  The longer term issues of enforced austerity weakening growth prospects and the lack of competitiveness in the Southern European economies will no doubt create further crises in due course.

China too is going through leadership change, with the new Politbureau team being unveiled just two days after the US elections.  Here too there has been evidence of policy drift this year with the slowing Chinese economy met by silence from the politicians, though the Central Bank have been easing policy a little during the year.  It is not known what the economic priorities of the new leadership team will be, but markets would appreciate an idea of the direction of policies that will be followed.

The last two months of the year thus provide the opportunity for politicians around the world to resolve several uncertainties about economic policy that have been allowed to build up ahead of the electoral time frame.  Some clear leadership in the next few weeks should boost market confidence, but political indecisiveness would be very damaging to markets. The time is therefore ripe for politicians to act.

Democracy – the antidote to Eurozone austerity

Over the last twelve months of Eurozone crisis, the politicians in Europe have in the main been talking to each other rather than their electorates. In fact the conversations have involved Northern Europeans (mostly from Germany) telling Southern Europeans to slash government spending and find ways to collect more tax revenues and the Southern Europeans promising very solemnly that they have always intended to and will do so just as soon as they receive some extra money from the Northern Europeans. The voters have never been asked their opinion either in the North as to whether they want to commit funds to support those in the South, or in the South as to whether they want to go through with the austerity measures their politicians have agreed to. Over the next 18 months there are important votes in France, Greece, Holland and Germany, when the politicians will be courting votes and saying things that are odds with current policy settings.

It is said that in the French presidential elections, in the first round the French vote with their hearts and in the second round with their heads. Well, 30% of the electorate voted for the extreme left or the extreme right in the first round; both reject entirely the idea of deeper European integration and the economic policy of austerity. Further, the centrepiece of Francois Hollande’s platform is the rewriting of the fiscal compact set out in the new treaty to pursue a much more aggressive growth strategy and greater powers to the ECB to lend directly to countries. In this he is on a collision course with Angela Merkel and impact is likely to occur very soon after the May 6 run-off election. The received wisdom is that he will not seek dramatic change to what has already been agreed, and will be satisfied with language that has an aspiration for greater growth without meaningful measures – this would probably the best he would get from Merkel and Germany. The key though is that a clear majority of the French electorate rejected the current policies of austerity.

May 6 is also the date of the Greek general election. The technocrat Papademos who was put into power as the head of a coalition government of the 4 major parties in order to agree the terms and conditions of the Greek bailout, has completed his job and is stepping back to allow normal politics to resume. Northern Europe insisted that all 4 parties in the coalition individually signed up to the terms and conditions of the bailout, in order to prevent any backsliding after the agreement, but there are already problems. Recent polls indicate that 67% of Greeks want to stay in the euro but don’t want the austerity, which can be interpreted as wishful thinking, economic ignorance or that their politicians are allowing them to believe that such a choice exists. It is not clear that those 4 parties would command 50% of the seats in the new parliament, even if they could be persuaded. Already Venizelos, the head of the Socialist party has been floating the idea of Greece going back to the drachma as an alternative to austerity.

The Dutch too are struggling despite being seen as part of the Northern European bloc. The coalition government fell over the weekend because the far right party refused to accept the austerity measures necessary for the Netherlands to get their budget deficit in line with the Eurozone targets. An election now looks likely in Holland.

Once these elections are settled, attention will begin to shift to Germany’s election in September 2013. Here though the politics is reversed, what is popular with the Germans is the notion that the rest of Europe should engage in the austerity necessary to get their public finances in order as Germany has had to earlier this century, so that no further calls on the German purse are made from bankrupt Eurozone nations.

Exposure to the votes of their peoples is going to cause politicians to say and do things that make continued agreement on austerity and bailouts increasingly hard to do.

The Super Mario Brothers – changing European politics

Last November saw the two Marios, Draghi and Monti, take on key positions within the Eurozone; Mario Draghi as President of the ECB succeeding Jean-Claude Trichet and Mario Monti succeeding the Silvio Berlusconi as Prime Minister of Italy. Both were appointed rather than being democratically elected but importantly both are hugely experienced within European politics and highly regarded and trusted by their peers. Both have moved fast to create change in their respective areas and together can be seen to be challenging the old power balance within the eurozone away from a Franco-German dominated politics towards a more truly European version.

November was also the period of greatest intensity in the sovereign debt crisis, when Italian 10 year government bond yields exceeded 7%, threatening a global banking and financial markets disaster. Mr Draghi acted decisively in December, cutting the ECB’s key interest rate and then announcing a new policy of Long Term Repurchase Operations, offering unlimited liquidity to Eurozone banks for a 3 year period at only 1%. This new policy has turned out to a marvellous euro-fudge. To German-minded Central Bankers a LTRO is not equivalent to the Anglo-Saxon policy of Quantitative Easing (aka printing money) that they loathe so vehemently, but is a liquidity-management tool which Central Bankers would be expected to deploy at times of crisis. The liquidity is merely lent to the banking system on the basis of collateral, it is not the creation or printing of new money. However (a) the scale of the operation, being unlimited, (b) the long time period involved, prior to this the ECB had never offered such facilities for longer than 1 year and then only in the darkest days of the 2008-09 crisis, and (c) the 1% rate, a zero premium to the official rate and thus creating no stigma for a weak bank being forced to pay higher rates for emergency liquidity, all meant that the short-term effects of this policy are remarkably similar to those of a policy of Quantitative Easing. The financial markets have certainly responded in such a fashion as the dangers of a eurozone banking crisis have receded.

Mr. Monti was effectively installed by Merkel and Sarkozy after they forced the departure of Berlusconi. Despite having enormous wealth and a population and an economy equivalent in size to France, the lack of growth in the Italian economy and its enormous level of national debt meant that it was seen as the weakest of the large European economies. Monti earned his stripes as the EU Competition Commissioner, taking on and defeating both Microsoft and Hewlett Packard in well-publicised battles over their monopoly powers. He has surprised many with the speed and ambition of the fiscal and economic changes he has forced through the Italian parliament, taking on many of the protected special interest groups which benefit from rigidities in the regulatory system. He is clearly aiming at delivering the significant structural reform to the Italian economy which is so badly needed and which Berlusconi failed to deliver.

Having gained credibility with his actions within Italy, Monti has used the fact that Merkel likes and listens to him to argue with Germany about its single-minded focus on austerity as the only tool to restoring the European economy. In recent weeks the tone of German thoughts on the European economy has changed towards the need for greater pro-growth policies. Italy now has a seat at the top table when these matters are discussed.

Sarkozy and France appear to be the losers in this power shift. Sarkozy was very quick to ensure that he maintained a French presence at the top of the IMF by getting Christine Lagarde to replace Dominique Strauss-Khan, but that has cost him a key voice within Europe, where she was well regarded but it has not really helped in terms of getting the IMF to be pro-Europe. It is noticeable how much quieter Sarkozy has been since Monti’s arrival at the top table. This may reflect his domestic political weakness – he faces re-election in May and with current polls suggesting he is set to lose, he has been forced to ask Merkel to campaign for him in France. The Franco-German axis in Europe which has dominated European politics for the last few years is breaking down as Germany is now the clear leader and then below are a newly-weakened France and a newly-strengthened Italy. A greater Southern Europe perspective is just beginning to have an effect on the way in which Europe is now being run.