Friday, 2 January 2009

A Healthy New Year ZIRP

2nd January 2009
The Malta Independent - Friday Wisdom

2008 was the year that was. While most are probably happy to see its back as it walks out of the door into history books, I am confident that in the due course it would be re-evaluated as a landmark year that brought about real change, the benefit of which will only be visible in the fullness of time.

The financial crisis is painful but it is a cleansing process from the excesses of high finance and back to basics sort of structural adjustment. This should form a better basis for sustainable growth.

The election of Obama as the 44th president of the United States broke all the rules of accepted convention. It is a victory for non-conformism as the US electorate got electrified by the message of change and disregarded the unconventional superficialities that Obama came all wrapped up in, being an Afro-American without much Washington experience and being the first post baby-boomer to reach such high office.

2008 was not shorn of geo-political instability including events of terrorism and war. Painful and undesirable as these are at the point of their occurrence, they do in fact offer prospects for solutions to deep rooted problems.

The sharp spike in the price of oil followed by a sharp fall, to almost unsustainable level, could have considerable long-term benefits. The spike has probably imprinted in consumers’ minds, in a manner no educational programme ever could, the need to change their energy consumption patterns. It has also facilitated governments’ job to adopt policies taxing energy use and crediting conservation.

The terrorist attacks in Mumbai have been dramatic and condemnable. But for all the posturing, India and Pakistan have behaved rationally in not allowing such event to raise tension on the Kashmir border to go beyond tipping point. Could these events lead Pakistan to take more seriously the need to control Muslim fundamentalism on its borders with both India and Afghanistan?

The hostilities currently underway in the Gaza strip are extremely sorrowful. Hamas rocket attacks on Israeli civilians and Israel’s incommensurate reaction are both condemnable. But in the end something had to happen to shake the status quo so that the Palestinians do something to patch up their internal divide between Hamas and Fatah and for world to put pressure to bear for progress on a final status two state solution.

2008 was the year of financial turmoil, of mega bank bailouts and of the return to Keynesian style government intervention to stabilise the market following catastrophic failure of free and loosely regulated markets. 2009 will likely be the year of increasing unemployment and of the ZIRP. That is the acronym for Zero Interest Rate Policy. Monetary Authorities are either at or cruising towards zero interest rates in an effort to smoothen the recession and avoid the risk of its morphing into a full scale depression.

2009 will be the year which will give a real test to the structure of the euro single currency monetary system following its highly successful first decade. Claims that the currency zone would fall apart or would be an unstable soft currency have proved groundless. For all the pain of undergoing economic restructuring without having the possibility to adjust the external value of the currency, there are many countries planning and accelerating the process to join the system including previous doubters as Denmark and Sweden whilst none of the present members, for all their ouches, are seriously contemplating leaving it.

Still, I think the real test for the euro is yet to come. The first ten years were relatively free from major economic turmoil, and evolved in the context of low inflation and high economic growth. The going will be harder now that we are heading into a recession and with constituents economies registering highly divergent record of efficiencies through restructuring. Countries like Italy and Greece, with high deficit and public debt, will find it hard to compete with the same currency used by Germany who restructured so successfully that efficiency gains means that its unit labour cost is the same today as in 1999 while Ireland, Italy, Spain, Greece and Portugal are experiencing unit labour cost increase of between 20% and 30%.

Now that the financial turmoil is forcing operators to price risk more correctly we are seeing great divergence in the interest paid for the same bonds in euro issued by Italy and Greece compared to Germany. If Italy and Greece now loose the euro benefit of low cost public sector financing, they will have either to seriously restructure or risk default on their sovereign debt. Without economic growth to oil the wheels of the monetary union these problems will have to be faced for the euro to do as well as it has done in the first 10 years.

Given that we have a liquid economy where all public sector debt is domestically financed, we do not have the same pressures of Italy and Greece even though we are also lagging behind in the due restructuring of our economy. And this is where health comes in.

Politicians feel good about themselves giving re-assurances that the public health service will remain forever universally free, in spite of exploding operational costs, following a massive capital investment in the Mater Dei Hospital. Yet realism should force us to accept that unless re-structured, free universal health services will lead to its gradual degradation forcing those who can afford to seek recourse to private health services and those who cannot just to lump it.

A healthy new year means we have to start serious discussions about launching a compulsory basic national health insurance scheme leading all hospitals, public and private, to offer competitive commercially based services. Social responsibility will then provide for those who truly cannot afford to pay the relative insurance premium to be socially assisted by the State to do so.

I wish you all a healthy new year.

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