In the October 1996 edition of Trends we wrote this about the embryonic euro area: "The alchemy behind the strong euro: 2.9%
The creation of a single European currency has been hailed by all the EU governments as a kind of wonder drug to ensure long-lasting relief against economic stagnation. As 1997 budgets are submitted to national parliaments for approval, it is amazing to see how they all provide for a deficit of exactly the same proportions: 2.9% of GDP. And the accounting used to arrive at this monolithic shortfall is creative indeed. Sales of state assets are treated as recurrent revenue and economic growth is cheerfully forecast at 2.5% a year, even in countries that are backsliding into recession. Government officials throughout the Union are counting on a strong currency and tame inflation to make the difference. Only Germany is considering structural reforms, Even Italy and Spain, which have just experienced a steep downturn, are presenting themselves as paragons of virtue. Yet one need not be a financial comptroller to surmise that even the cooked 1997 budgets will be about the same size as the ones for 1996. Tax revenues are down, pointing to a weakening trend in domestic demand.
In Switzerland, where a sixth quarterly drop in GDP hammered home the fact that we are still in recession, the SNB has lowered short-term interest rates to bedrock level and injected huge quantities of liquidity into the banking system to force down our overvalued franc. Deficits at every level of government—federal, cantonal and municipal—continue to climb precipitously as unemployment worsens.
In France the Juppé government is holding its course, convinced that next year's recovery will prove the wisdom of its policies in time for the 1998 election. Yet voters are weary of waiting for the promised land, a fresh vision of which is forever being painted for the next six months. Consumption has been kept artificially high by heavy discounts on sales of new cars. Joblessness is rising and there is concern about possible new layoff plans.
Raymond Barre contends that the jobs situation in Europe will not improve until workers are worse off staying home than working for the minimum wage. Sadly, the political courage needed to put this idea to work is lacking.
Germany has been the one country brave enough to adopt deep-running reforms, though they only address some of the problems. Thus, a pleasant surprise for Europe can only come from its economic powerhouse with help from an upturn in the UK, provided exports of capital goods remain strong."
Germany
September 2011 will be a crucial month for Europe. Germany now has to face up to its responsibilities: in the midst of an export boom driven largely by euro weakness, will it torpedo the Union's babelish unity for the sake of lowly domestic politics? On 7 September the German Constitutional Court will rule on the lawfulness of the bailout funds set up by the European Union. Then, on 23 September, Germany's upper house of parliament will vote on the expanded powers of the European Financial Stability Facility (EFSF). If either body says no, Europe will face an unprecedented financial crisis.
Even with Germany's blessing, we will see several years of economic stagnation in which national budgets will have to be balanced. No matter who wins in the various elections slated for 2012, the new governments will be walking a tightrope. Confidence, that all-important ingredient for reviving growth in consumption, can only be restored—and gradually at that—by cutting public spending and raising taxes. Not until then can the lunacy of running up debt at any cost be put to rest. Many European governments have already courageously set a virtuous example. There is scope for optimism medium term in that European governments have understood the markets' message, a message dictated by common sense.
United States
In 2009 we wrote that while governments had rescued the banks, they were now thrust into the front lines. They are still there. The financial collapse of any large government would bring down the entire banking system. In this respect there seems more to fear from the US than from Europe. Given the bitter struggle between the Democrats and the Tea Party ayatollahs, failing a huge blow-up no one looks ready budge until 2013. With the annual deficit running at 10% of GDP, debt held by the public will exceed GDP in two years' time. Manhattan's top 100 billionaires pay 7% in taxes, on average, while an executive with an income of $250,000 pays 25%. Most US companies pay no taxes and even receive subsidies or tax credits. Won't Google receive $700 million in annual tax credits for several years if it buys Motorola Mobility?
What does the Tea Party hope to gain, other than a social upheaval, by eliminating unemployment benefits and overtaxing the middle class? In Las Vegas, the former pinnacle of gambling and real estate, the queues at soup kitchens lay bare a system run amok and dying. If the US continues to deflate consumption by slashing social security benefits while freezing taxes on the ultra-rich at rock-bottom, then obviously it will end up in a severe recession with violence in the streets. America cannot withstand long-term unemployment exceeding 10% while at the same time the big companies pay more to their CEOs in bonuses than they do in corporate tax. The hundreds of billions of dollars kept abroad by affiliates of US firms to avoid taxes would easily suffice to balance the federal budget. Consider Michele Bachmann, whose clinic was subsidised by the government. Listening to her preach, as if she was chosen by God, brings back pre-war memories.
Taxation, a normal practice done away with by Washington lobbies and lawyers paid to find loopholes, must be urgently restored in the US and in Europe as well. Otherwise we will be headed towards a collapse of all paper currencies and an explosion in the price of gold.
A bit of common sense and professionalism on the part of our politicians would soon bring back that modicum of confidence that has vanished. It is sad how upcoming elections can drive political animals crazy.
Switzerland
Meanwhile Switzerland too has become a major source of instability. The Swiss National Bank's miscues have prompted unparalleled speculation around the world. Our franc has been knocked about as wildly as sugar, cocoa and pork bellies. It is now 30% overvalued and is sending the Swiss economy to the bottom. Machine tools, tourism, banking and farming are entering a deep crisis the consequences of which, by the year's end, will be dire for a country that sells 75% of its exports to the European Union.
The franc's surge against the dollar is equally devastating. Suggestions from various quarters include lowering wages and paying frontier workers in euros. The only effective solution would be to take radical action by setting a euro peg at 1.30, with all the risks that would entail. If the situation continues as it is now, Switzerland will be in recession before 2011 is over and unemployment will shoot up dramatically.
Orphaned traders
The markets are volatile. High frequency trading now accounts for 60% of dealing in equities on the New York Stock Exchange, most of it generated by index rebalancing, options and ETFs. The business has turned virtual, and everyday investors have fled for fear of being taken to the cleaners. The sell-off in August was one of the most savage since 1950. It pointed up the absurdity of today's hypertrophic world of finance, a world that has been severed from economic fundamentals but that lobbies in America and the UK prevent from being dismantled by financing the campaigns of politicians bent on re-election. In conditions like these, gold is a must in any portfolio, along with shares in well-managed international companies that pay a high dividend. Once September is over we will be able to think about 2012.
PS – Glencore has plunged 30% since its IPO at a pumped-up price. Paulson has had a disastrous month and is down 30% year to date. Even the best pros are being hammered by the markets' hellish volatility. Rumour has it that the loan granted by the Bankia group to Real Madrid to buy Kaka and Ronaldo has been tendered as collateral to the European Central Bank to raise cash. If Bankia runs into difficulty, would the ECB president, Jean-Claude Trichet, find himself as Real Madrid's centre-back?
All the best to everyone as we get back to the grind.