Beware Abandoning Europe, Mr Cameron

This is an extract of an article published on January 13th 2013. It can be read in full on the Daily Mail website here.

Article Daily Mail January 2013The Obama administration has voiced its concern about Britain’s future in Europe. Some prominent business leaders are getting nervous that political posturing could result in the UK sleepwalking out of the European Union. Prime Minister David Cameron is under pressure from his right wing and the rising UKIP vote to renegotiate the treaty and hold a referendum on EU membership.

The key question in this increasingly heated debate is whether the UK could become a Switzerland or Norway with a trading agreement with the Union.

During the past two decades Britain has looked mainly west towards America for political and economic inspiration rather than east towards Europe. As the headlong rush into globalisation emasculated the unions and kept real wages low, demand had to be stimulated in new ways.

Under the last Labour government, Gordon Brown and Ed Balls took their guidance from Federal Reserve supremo Alan Greenspan and Wall Street.

Following the US example, wage increases were replaced by increased limits on credit cards and rising mortgages on the back of the asset bubble.

When Margaret Thatcher came to office in 1979, private household debt stood at around £60billion. When Labour got into office in 1997 it had risen to £750billion and when the Coalition took over, it had reached £1.45trillion.

Instead of government debt being reduced during the boom years, the opposite happened, with the rescue of the banking sector completing the disaster.

Taking the lead from the US in economic strategy has been an unmitigated disaster not only for Britain, but left other countries such as Ireland, Spain, Portugal and Greece. It even influenced such countries as Switzerland, France and Germany, as their banks were trying to become global players, pay their managers Wall Street salaries and adopt the casino culture.

Fortunately, in the northern European countries the excesses were not quite as pronounced, but they now have the unenviable task of bailing out their profligate southern neighbours. Following the US lead during the past decade has not been a great success and no wonder open-minded people all over Europe are looking for alternatives.

A lot of my German business colleagues regret, as I do, that Germany and Britain did not get together as leaders of Europe, as Helmut Schmidt and other German chancellors had hoped.

Britain is approaching the crossroads and my hope is that leaders will look at the alternatives carefully and not be influenced by political expediency.

Maastricht Criteria Did Not Do The Job

Following German reunification, Germany’s European partners, particularly France, were getting increasingly keen on making progress along the road to a common European currency. For France this was a way of wrestling power away from the almighty Bundesbank and getting a handle on the levers of economic power through a new European Central Bank.

German central bankers were reluctant about losing power – and were also seriously concerned whether a common European currency would be as stable as the hard D-Mark. Similar concerns were felt by a number of politicians as well as the great mass of the German public, for whom inflation had remained a red rag.

To pacify them, the German government insisted that all countries which wished to join the Euro club should give guarantees on inflation and the causes of inflation, which were believed – as so often in the past – to be in the arena of excessive public spending.

The result was a ceiling on total public debt of 60 per cent of GDP over time and an annual government deficit limit of 3 per cent of GDP. These plus some inflation targets were eventually agreed as the main entry criteria for members of the Euro area. They became known as the Maastricht criteria.

This article was first published on the German-British Forum in May 2009

Following German reunification, Germany’s European partners, particularly France, were getting increasingly keen on making progress along the road to a common European currency. For France this was a way of wrestling power away from the almighty Bundesbank and getting a handle on the levers of economic power through a new European Central Bank.

German central bankers were reluctant about losing power – and were also seriously concerned whether a common European currency would be as stable as the hard D-Mark. Similar concerns were felt by a number of politicians as well as the great mass of the German public, for whom inflation had remained a red rag.

To pacify them, the German government insisted that all countries which wished to join the Euro club should give guarantees on inflation and the causes of inflation, which were believed – as so often in the past – to be in the arena of excessive public spending.

The result was a ceiling on total public debt of 60 per cent of GDP over time and an annual government deficit limit of 3 per cent of GDP. These plus some inflation targets were eventually agreed as the main entry criteria for members of the Euro area. They became known as the Maastricht criteria.

However since their inception the world has changed dramatically. Inflation was comprehensively beaten as a result of globalisation. The fall of the Iron Curtain and the world-wide GATT free trade agreements, leading to the entry on to world markets of products made with cheap labour forces, resulted in national demand being dwarfed by global supply – causing persistent downward pressure on prices and wages. Simultaneous deregulation of the financial services sector allowed a worldwide credit boom and asset appreciation – particularly in the Anglo-Saxon world, where house prices in particular went through the roof. Corporate and consumer credit took over from public debt as the main drivers of economic expansion.

Central banks meanwhile followed the prevailing wisdom of gearing their monetary policies to fulfilling narrow inflation targets. Governments and central banks alike congratulated themselves on achieving non-inflationary growth for more than a decade – and averted their collective eyes from other sources of disequilibrium and eventual turmoil that were building up in the world economy.

They became Gordon Brown-like “no more boom and bust” legends in their own lunchtime. Take Britain for example. If, in pre-globalisation times, the UK had experienced the public spending of the last decade, together with the accompanying corporate and private household debt increases, the country would have had suffered inflation. Instead, Britain, like the US, was able to finance massive imports, experienced a huge deterioration in its current account deficit and got its economy totally out of balance.

The same thing happened, only the other way around, in the leading “saving and exporting” countries, Japan, China and Germany. Instead of spending and importing, Germany reduced public debt (and domestic demand) by raising VAT at the beginning of 2007. Very laudable: unfortunately Spain and Ireland – which were experiencing massive deteriorations in their current account deficits as a result of debt-fuelled economic expansion prompted by the European Central Bank’s “one size fits all” interest rate policies – should have done it instead, to damp down their own excessive domestic demand.

It is fashionable to blame commercial bankers and investment bankers for the malaise of the global financial system. But central bankers and governments are also responsible, in some ways culpably so. They have to accept their share of the blame – have to start thinking of amending and re-prioritising some of their key indicators.

The causes for inflation and imbalances are more diverse and international than ever. The way forward is to adopt the aggregate of public and private debt as percentage of GDP as the main criteria for stability, rather than just public debt. If Italy has a low private household debt, it can be allowed more public debt during times of getting the imbalances under control.

If Britain’s private households are now rebuilding their balance sheets by starting to save and by reducing their borrowings, then higher public debt could be allowed for a certain period – to achieve macro re-balancing of the economy. Similar calculations must be made for any new countries aspiring to join the Euro and for all existing members. The European Central Bank needs to be given broader targets and new parameters for gauging stability in the future, rather than maintaining its narrow focus on inflation. The same goes for the Bank of England.