German conversion

When George Magnus speaks, the economic world stops to listen.   George Magnus is one of the few economists that saw the financial crash of 2008 coming,  He publicly warned in the first half of 2007 that a credit crunch will come when the US property bubble bursts.  

He is Senior independent economic adviser to UBS, who unfortunately did not follow his warning and took trading positions which caused them much pain and losses when the credit crunch came.

Magnus publishes Economic Insights once a month.   The May edition just published is titled:

Germany, the rest and the Euro: Whatever next?

 

I think that the crux of the May 2013 Insight is captured by this paragraph:

 

"If Germany's famed savings excess and external surpluses endure, it will by definition, have to keep lending to debtor countries but this is likely to become increasingly contentious politically, and damaging economically.   The only viable alternative is for Germany to change its economic model, accept important compromises to its economic, budgetary and financial priorities, and accede to a structural system of transfers, which is how all monetary unions work, but which is seemingly anathema to its government and people."

 

 I don't know if by co-incidence or otherwise but soon after Magnus opinion was published, somehow suddenly there was a change of tone coming from Germany.   Suddenly the need for growth and solidarity started being emphasised, the risk of a lost generation of unemployed in periphery countries came on the agenda and austerity started taking a back seat.

 

Click the link below to read Der Spiegel's article  published in yesterday edition.

 

Der Spiegel 27 05 2012 : austerity About Face' German Government to gamble on stimulus

 

Then today my friend Andreas Dombret, a member of the Executive Board of the Bundesbank, has just been interviewed on CNBC and he spoke only about growth with a positivism that we have not heard for a long time from  any Bundesbank official.

 

Readers of the Blog know that I have long been arguing that equilibrium in the Euro area can only be reached if adjustment effort is made not only by countries in deficit but also by the countries in surplus.   We cannot have equilibrium with every country in surplus.  The maths just does not add up.

 

It is never too late for sense to prevail.

 

 



Tonio Fenech bad mouths himself

I could not believe it when I read it in The Times this morning.    See how ex-Minister Tonio Fenech defended himself from accusations that he bad mouthed Malta when he recently met an IMF delegation :

Despite not being named, fingers were immediately pointed at Mr Fenech, who when contacted denied badmouthing the country, adding that he had a clear conscience.

“I had an official meeting with the IMF during which I strongly defended Malta’s position in terms of its banking sector and that it cannot be compared to Greece. As a member of the Opposition I expressed doubts on how much the Government can stick to its financial target. I don’t know if this is considered as badmouthing but I have a clear conscience,” he said when contacted yesterday.

“As any Opposition is expected to do,” he said he had expressed his opinion that the Government was not in control of its finances.

“I didn’t badmouth the Government but I carried out my duty as the Opposition. Is the Government expecting the Opposition not to criticise it? Does it want to muzzle us? If Joseph Muscat is credible in his democratic credentials, he should not call us traitors,” he said.

If you are confused you are sane.  There is nothing wrong with your brain.   But I can't say the same about Tonio Fenech.

The new Labour government adopted the same budget he proposed in November 2012 and he voted for it in parliament.   The deficit figures for 2012 went beyond the 3% under his watch.

So Tonio Fenech is bad mouthing himself.  If he thinks that government is not in control of its finances it is because of the state of finances he left behind.   There is nothing a new government can do in less than three months either to improve what it found or to lose control over a stable situation.

Coming so soon after his stupid atturance that he owes no one any apology for not refunding in full the hush hush EUR 500 per week salary increase he took behind the electorate's back, it would be advisable if Mr Fenech keeps his mouth full of holy water till he recovers from the election shock.

Valletta's Monti (Flea market)

Rumour has it that the Valletta Monti is to be moved from its present location at the lower end of Merchants Streets to Ordinance Street.

Many have expressed dismay about this change of venue arguing that Ordinance Street is near Valletta's main entrance and the location of the Monti there goes against the general upgrading of City Gate both externally as one approaches from the Floriana side and internally as one passes through the gate.

I disagree.   The Monti is an integral part of our tradition and culture.   It should not be hidden in an inaccessible part of the City.   It should be where the people find it most convenient.   Ordinance Street fits the bill quite nicely as it is not in the direct line of entrance as tourists walk into the City but is nicely tucked away on the left at the first turning down Republic Street.

A properly organised Monti should add life, colour and character to the city.

Those who are criticising the chosen venue seem to be assuming that there will be a mere transportation of the present set-up lock stock and barrel.   If it were so they would be right to show apprehension.   But I should believe that the Monti in the new venue will be organised differently.  It should be equipped with standard stalls on the lines of those occasionally set up on special Sundays in Bisazza Street Sliema.

There are many beautiful cities in Europe where open are markets are in peak locations in the City core.    The Salzburg Christmas market right in the square outside the Salzburg Cathedral easily comes to mind.   Not only it is not an eyesore.   It is an attraction.

Wherever it is decided to locate the Monti, and I think Ordinance Street and Hastings perimeter are locations that should be considered, the Monti needs to be upgraded and discipline has to be enforced to ensure that standards are maintained throughout.

Time to get serious about party financing

Following the earthquake brought about by the 9 March election, the pieces have now fallen into place, with only the election of the PN deputy leaders still awaited to complete the new political formations.

It is therefore time to get serious about introducing democratic order to the long neglected issue of party financing.

Before making suggestions about this or that measure, there are issues of principle which need to be exposed, discussed and decided upon.

These are:

· Should political parties be financed by the state in a controlled manner or should we merely attempt to have transparency regarding private political donations?

· If state financing is adopted, how can individuals be deprived of their constitutional right to donate their property to whomever they wish?

· Should political parties be forced to be just that, i.e. stand-alone political parties, or are they to continue being business organisations with commercial interests in media, travel and telephony?

· What is to happen to the real estate owned by the political parties, excluding their main headquarters?

Let me go into these four issues in greater detail.

Should political parties be funded by the state through taxpayers’ funds?

There are strong objections to the adoption of taxpayers’ funding for political parties. Many object to adding to the taxpayer’s burden and others object to the very principle of seeing their tax euros going to fund political activity.

I think that such objections are out of order. Like it or not, there is no escaping the fact that political parties are the main instruments for the execution of democracy. Democracy is sacred and dear to us all, and if the taxpayer will not finance it directly, somebody else will. Those who are given the opportunity to finance political activity will consider their funding as an investment for gaining preferential access to – and special treatment from – the party they have financed to win government.
For all the lip service that politicians pay to ‘no strings attached’ funding, I remain unconvinced that, in practice, it really exists. Governments could develop conflicting loyalties in their duties to the general electorate as against their obligations to their financiers.

Many argue that this could be controlled by insisting on transparency, with donations above a certain threshold required to be officially declared. But who says that formal declarations, even if rigorously applied, would remove a conflict of interest?

If the threshold for undeclared donations is sufficiently high it will be relatively easy to circumvent the flimsy control of public declaration by making donations below the threshold, using several donors as fronts for the ultimate string-puller. And if the political organisations are to be allowed to run their side-line business activities through subsidiaries or joint-ventures, what control can be exercised to distinguish between genuine revenue and donations dressed up as business revenue (such as advertising on political media at inflated prices) which would have the same effect as an outlawed donation reaching the same beneficiary through a legal channel?

As for the objection about taxpayers being loaded with this additional burden, one should question whether society is not already loaded with it (and more) through the loss of corporate governance resulting from private political contributions.

How can individuals be deprived of their constitutional right to donate their property to whomever they wish?

Were the model of state financing to be adopted, and private donations become outlawed or restricted to very low thresholds – like, for example, €25 through the telethon type of funding – would this not be an infringement of the right of every individual to dispose of their private property in any way they wish? Could such a measure be constitutionally challenged?

I am no constitutional expert, but such a restriction would not be breaking new ground at law. This principle has already been adopted in respect of the hereditary transfer of immovable property to the Church, which was outlawed to prevent clergymen persuading moribund parishioners to secure a place in heaven in exchange for donating their earthly treasures to the Church.

Even if constitutional impediments do exist, we can work our way around them. By forcing the full declaration of such donations, the amount received would go to reduce the grant that the state would give to the political parties. So whilst not rendering such donations illegal, or prohibiting them altogether, there will be no incentive for the donor to give them, or for the political party to seek them, as what is gained from such donations would be lost from state funding.

Stand alone political parties, or business conglomerates?

Whatever form of control is introduced, whether complete state funding or disclosure above a certain threshold, the question of whether political parties are to be allowed to operate commercial activities outside their core function has to be addressed.

If political parties are allowed to proceed with commercial activities outside their core political function, I very much fear that any funding control that is imposed could easily be vitiated by dressing up donations to appear as normal business revenue. The only difference would be a loss of tax revenue as, whilst political donations are not allowed as a valid tax expense, it would be quite likely that donations dressed up as advertising or telephony charges would be accepted as a tax expense deductible against taxable revenue.

I find it strange that, after the state has found it necessary to divest and privatise all commercial activities to allow more space for the private sector, such activities are now being encroached upon by the political parties. It does not make sense!

What is to happen to the real estate owned by the political parties outside their main headquarters?

Apart from their headquarters, both our main political parties are reportedly asset rich, especially with regard to the ownership of immoveable property.

Their local centres in prominent locations in most towns and villages do not even start to tell the whole story. They also own various other properties which are not being put to any use.
Yet both parties have substantial debts which they incurred mostly to build their headquarters and their media organisations. Repaying such loans without asset sales represents substantial challenges.
Both main parties should put their heads together and see what property they truly need to carry out their political activities. Do they need clubs in every town and village? Maybe three or four regional centres would be enough in present day realities.

The rest of the properties they do not need could be catalogued and valued and an arrangement similar to the one reached between the government and the Curia be negotiated in order to cancel the debts of both parties and ensure they are prohibited from borrowing under whatever arrangements are finally reached to control political party funding.

This is not meant as a blueprint but as an exposition of the issues that must be addressed if a fair and lasting solution on the subject of political party funding is to be found.

This article was published in The Malta Independent on Sunday 19 05 2013

What's wrong with our education system?

To answer this question one has to understand what exactly our education system is meant to deliver.

Is it meant to deliver technically competent graduates and college students with the right academic skills needed to land  a productive job in the real economy?  Or is it meant to deliver in addition good citizens capable of participating in life beyond its economic aspects to render life on these islands a positive experience?

I have more than a mere impression that whilst our system is delivering academic knowledge probably as good as systems in other successful countries, we fall way behind in helping our students come through our colleges and university with a sense of good citizenry.

There is too much emphasis in our curriculum on academic content, often far beyond the level in other countries ( e.g. our MATSEC A levels contains stuff that students in other countries cover in their degree studies).  But there is little or no content meant to educate beyond academic knowledge.   The Systems of Knowledge content is too little and focused only in  the 2 years between secondary school and university.   Such content should be an integral part of the curriculum from primary to degree.

In economics there is a prevailing school of thought that our traditional measure of GDP and GNP is largely insufficient to capture and measure the richness and quality of life of citizens.  There are many studies which try to include other measures beyond strict economic measurements to capture the quality of life, with such measures often referred to as Happiness Index, Life Satisfaction Index, Well Being Index, Life Expectancy Index and such like terms.

When measured in such terms invariably Scandinavian countries and the Netherlands finish very close to the top of the rankings.    These are countries that include  in their education curriculum strong content related to education for being good citizens.

I have just finished reading a formidable book on this subject by Jeffrey Sachs titled THE PRICE OF CIVILIZATION.   I wish to share its message about the importance of teaching our students to be Mindful Citizens of a Mindful Society in all its facets:

Mindfulness of self:

The need for personal moderation to escape becoming slaves to mass consumerism and to understand that once our basic need of food, shelter, clothing and education are attended to, additional consumption does not automatically lead to more happiness.  Other non-economic factors can contribute better to additional happiness. These include good governance, more trust in the community, a happy married life, and sharing quality time with family and friends.   This teaches how to protect ourselves from the false attractions of conspicuous consumption, bombarded as we are by aggressive marketing techniques trying to sell us solutions to needs we do not really have.   As one expert put it  " living doesn't cost much, showing off does"



Mindfulness of work:

Unemployment and the risk thereof is the single most important source of unhappiness.  Students need to be thought the importance of  productivity and flexibility in order to protect their rights for job security, vacation time, training and development and information about the employers' corporate affairs and corporate governance standards.

Mindfulness of knowledge:

This is meant to make students aware of the complexity of the economy and that only scientific and technical expertise can help 7 billion people on an overcrowded planet causing unprecedented ecological stress, survive and prosper whilst meeting the aspirations of its inhabitants.  This involves scientific breakthrough for high yield food production, renewable energy sources, recycling of industrial materials and efficiency of resource use.   The experts cannot and should not be allowed to issue solutions to these problems without the involvement of informed public opinion.

Mindfulness of Others:

Happiness cannot be achieved if extreme social differences are allowed to live shoulder to shoulder.   The rich and high earners must understand that paying fair taxes is a price they have to pay to live in a civilised society. Whilst a market economy is needed to deliver efficiency and growth, society must be mindful to guarantee a minimum standard above the poverty trap to those who genuinely cannot participate in the economy.

Mindfulness of nature:

This is not a tree hugger's plea.  It is an imperative for survival when the earth's air, water, land, and climate are all under threat.  Market forces cannot address these threats.  They are more likely to exacerbate them as the need to register short term gains often come at the expense of long term sustainability.

Mindfulness of the future:

Citizens need to be educated to move away from their political leader's mind-set that the future is till the next elections.  Citizens must learn to hold their leaders accountable for taking decisions that are front loaded with sugar but back ended with costs.  We cannot give tax cuts but fail to make necessary infrastructural investments.   We must not build comfortable parliaments before we build efficient road systems.    We must not promise expensive heath care system which is supposedly free but inaccessible to those that really need because of long waiting lists.

Mindfulness of politics:

We cannot have a society that accepts unquestionably the serious democratic deficit through an unregulated system of political party funding.   US politics are in the grips of strong business lobbies as America suffers from the dead end of corporatocracy as politicians are more loyal to their financiers rather than the public that elected them.  Malta desperately needs to follow the best European practice in this regard to ensure that we have governments for the people and not vice-versa.

Mindfulness of the world:

Recognition that today's world is deeply inter-connected and that no significant event in part of the world leaves the rest of the world untouched.  The collapse of Lehman Brothers in the US caused an international financial crisis.   SARS and H1N1flu viruses did not respect national borders.   Carbon emissions in the US and China cause environmental problems in Africa.   Terrorism, instability, extreme poverty, hunger, climate change and shifting global power are common agenda affecting all countries, rich and poor, and can only be solved through international co-operation not beggar thy neighbour policies.

Through learning about a Mindful Society our education system is more likely to deliver citizens that see value beyond money, that can pursue true happiness in acountry with high standards of corporate governance and free from the bind of self-destructive consumer addictions.

Bank fix does not need treaty change

Letter published in the Financial Times 16.05.2013 - page 10

 

 

Sir,

 

In the EU when one wants to kill an idea without appearing to do so one says that it is very good but its implementation requires a treaty change. That is what Wolfgang Schäuble, the German finance minister, did in his article “Banking union must be built on firm foundations” (Comment, May 13)

 

Of course a banking union needs to be built on firm foundations, but equating this to a treaty change is a non sequitur. The EU has one institution that has been granted full autonomy and can act independently of national parliaments to execute its policy to keep inflation in the eurozone close to but below 2 per cent. For the European Central Bank to do this it needs an efficient monetary transmission mechanism. If this mechanism is broken and needs a banking union and an effective resolution authority to clean up insolvent banks and recapitalise them, then this is already within the terms of reference of the ECB.

 

It is shameful that Europe had to involve the International Monetary Fund to sort out its fiscal problems. The European Stability Mechanism can perform this function by it being rendered a division of the ECB operating independently of national parliaments to clean up insolvent banks and to recapitalise such cleansed banks through monetisation without reliance on national governments.

 

What the US did with fiscal policy through the troubled asset relief programme, the EU can do through monetary policy through the ESM/ECB. All this can be reversed with a profit as the US experience has shown, and it is indispensable if the EU is to emerge quickly from a recession now in its fifth year in many countries. Without sorting out insolvent banks and bringing them back to health through monetised recapitalisation, the recession will drag on relentlessly.

 

Alfred Mifsud

Balzan, MALTA

The pressure on Germany is rising

A common theme in my recent posts regarding the Euro crisis, or really the crisis of the countries that have been bailed out and have to absorb substantial austerity measures at a time of sharp economic contraction, has been that these countries cannot bear the adjustment pain all on their own.

I have repeatedly stressed the point that Germany and other countries in the German bloc ( including Austria, Finland , Netherlands, and possibly Poland) need to reflate their economies to create stronger internal demand and create rising deficits which can absorb the run down of deficits in the austerity countries.

In particular one can refer to my two recent posts:

Anti austerity revolt

and

Both wrong

There is a rising chorus of senior economists making the same argument and warning Germany that their attempt to create A Europe in the German image will backfire with dire consequences.

See this quote from an article titled ' The German model is not for export', published in The Financial Times of 8th May 2013 written by Martin Wolf , their senior economic editor:


The implications of the attempt to force the eurozone to mimic the path to adjustment taken by Germany in the 2000s are profound. For the eurozone it makes prolonged stagnation, particularly in the crisis-hit countries, highly likely. Moreover, if it starts to work, the euro is likely to move upwards, so increasing risks of deflation. Not least, the shift of the eurozone into surplus is a contractionary shock for the world economy. Who will be both able and willing to offset it?

The eurozone is not a small and open economy, but the second-largest in the world. It is too big and the external competitiveness of its weaker countries too frail to make big shifts in the external accounts a workable post-crisis strategy for economic adjustment and growth. The eurozone cannot hope to build a solid recovery on this, as Germany did in the buoyant 2000s. Once this is understood, the internal political pressures for a change in approach will surely become overwhelming.
Europe will not become a bigger Germany. It is foolish to believe it ever could. The eurozone will either achieve a better-balanced resolution of its difficulties or break up. Which of the two will it be?

That remains the big unanswered question.

But the question has to be answered soon after the Germans choose their next Chancellor, whether to re-mandate Merkel or offer Steinbruck the SPD challenger a chance to avoid the great dangers of continuing with Merkel's austerity above all policy. 

The Germans must learn to re-embrace Keynes, or the Euro has no future.

And on the fore-front of the necessary change of course there must be the European Central Bank (ECB).   President Draghi must continue showing his mettle to extract his organisation from domination of German thinking and ensure that the ECB acts as central bank is designed to act when facing an existential threat for its currency.  Otherwise the ECB will be like a fire-engine without water in its tanks.  Who needs one?

Growth needed to avoid the pain in Spain

This article was published in The Malta Independent on Sunday - 05 May 2013

The PN refused government’s invitation to participate in the Action Committee for Economic Growth.  They maintained that such participation would go against the constitutional role of the Opposition in a parliamentary democracy.   They did so whilst emphasising their commitment to contributing constructively for Malta's constitutional, economic, social, and cultural development.

It is strange that the PN parliamentary group has decided this before the leadership election which is due imminently. For prudence sake one would have expected them to allow the elected leader to have the final say rather than have his hands tied before he is elected.

I find it contradictory to refuse to participate in such broad based consultative organ yet declare commitment to contribute constructively for economic development.

Long term policies for economic growth are very much the business of the party in Opposition. As an alternative government they should wish to influence the economic scenario they would one day find when the wheels of democratic alternation place the responsibility of governing back on their shoulders.

Economic growth requires productive investments. And even the best and most calibrated investments will take several years to analyse, plan and execute and several more years after that to start delivering the expected returns.

If PL in opposition had adopted the same reasoning when the PN in government wanted its co-operation to develop the financial services industry on the basis of consensus, we would not have the successes registered to date in this sector.

The government is there to govern for the term of the legislature. The Opposition is there to constructively oppose and watch over the government. So the Opposition’s stance would have been  understandable if they were offered any executive role.  But nothing should stop government and opposition working together especially on policies which span several legislatures and where consistency is needed especially in the eyes of foreign investors who demand stability of policies irrespective of which party is in charge to execute them.

I still remember when in the heat of the summer of 1998 in my role as Chairman of Mid-Med Bank we were working with HSBC on the IPO on international markets of the then Maltacom . The instability of Mintoff voting against the Labour government in parliament started undoing the good work we had done in the road shows with foreign investors.

I organised a conference call with such investors and invited Mr John Dalli, then the main opposition spokesman for the economy and finance, to re-assure investors that if there a change of government the IPO terms would be honoured. John Dalli did not think twice accepting and helped us save the IPO from failure.

The country's interest should come above those of any political party. Economic growth is everybody's business.   We must never allow our country to be dogged by political pique that is causing so much pain to stronger and bigger countries, like Spain and Italy.  It is not co-incidental that where the government and opposition co-operated overtly in the national interest as in Germany following the re-unification, such countries are now economically dominating others where long term economic policies were not co-ordinated across party lines in the national interest.

Consider the situation in Spain.  Spain is suffering from all the illnesses that make the current crisis so difficult to resolve.   It has to deal simultaneously with the fallout from a real estate bubble, a credit crunch, the clean-up of its banking sector and all this whilst undergoing a crushing internal devaluation to regain international competitiveness and severe fiscal tightening to return public finances to a sustainable path.  As a result Spain is in the 5^th year of what seems an interminable recession, have an unemployment rate of over 27% (which is not worse only because immigrants returned to their home country and increasingly young graduates are seeking careers abroad) and are experiencing a sharp contraction in consumption demand (and by consequence a sharp deterioration in the average of standard of living).    What a contrast to Spain before the crisis of 2008 when it had one on the highest consumption growth rates, a fiscal surplus of 4% of the GDP and a very low level of national debt.

Spain was living an illusion and none of the political parties, in government or in opposition, had the courage to tell the truth to their people.   Nobody wanted to take the punchbowl away as the party was running wild.   Being locked in a monetary union their Central Bank could not use the interest rate policy tool to calm down property speculation.  It could have imposed quantitative and qualitative credit control on its banks, but it failed.   Spanish banks found it easy to borrow on the cheap on the wholesale financial market to fuel the credit binge of property speculators.

Private households turned property speculators taking on leveraged credit risk which could only be justified if one believed that property prices would continue to rise eternally above the rate of retail inflation. The economy lost its balance as everyone found it easier to avoid hard work involved in manufacturing and innovation and instead jumped on the gravy train of easy property speculation where quick profit could be made on borrowed money without too much hard work.

Government itself enjoyed swelling revenues from taxes on property transactions and booming consumption.   It helped to keep public sector debt and deficit low.   But all this changed once the property bubble burst.   The construction and property industry that had become the motor of the economic engine went into reverse gear.   Property prices collapsed rendering many bank loans uncovered, unserviceable and irrecoverable.  The Banking sector suffered heavy losses which turned banks into under-capitalised zombies incapable of servicing the economy through new credits.  Government finances went into large fiscal deficit as revenues collapsed and social expenditures for unemployment and social assistance were triggered just when government needed to finance recapitalisation of its banks to save them from total collapse.

Now compare that to Germany where there was cross-party collaboration for social spread of the pain to integrate the Eastern former communist part of the country; where the Socialist government under Schroeder engineered Agenda 2010 giving a high dose of flexibility to the German Labour market with the collaboration of the Unions and without suffering piques from political opponents that could have instigated  the electorate to refuse short term pain as an investment for long term gains.

Certain policy decisions need to be modelled to span several legislatures and need cross party political collaboration for the country to take the unpopular decisions that sometimes it has to take to keep it sustainable for the long term.   The Action Committee for Economic Growth could have been a perfect forum for modelling such action plans with wide support from the political class, the economic profession, social partners and civil society.   It could have been the right forum to sensitise current generation on the need to keep a balanced economy and the need to avoid over-consumption of resources that may be needed by future generations to ensure that we leave them a better world.

Should we worry about Spain and its pain?   Not only we should, but in addition we must never allow our economy to fall into a Spanish type of disequilibrium.  Through the EU we must help Spain to overcome its problems, as given its size and the adjustment process that still lies ahead of it, the Eurozone of which we form part, can never resolve its debt crisis before Spain recovers.

It is doubtful whether interest rate reduction that was announced by the ECB this week will be a tangible way to help ease the pain in Spain and elsewhere, as given the already low level of interest rates and the broken transmission mechanism in the European financial system, such reduction may not travel down the pipes to where it is needed.

ECB President Draghi has every cause to feel frustrated by the broken financial transmission mechanism but it is useless blaming banks for it.   Many European banks are sick and sick patients may lose taste even if offered the best food.   Banks need healing which can only come from cleansing of insolvency by enforcing losses on debt holders followed by substantial recapitalisation  through a programme to be monetised by the ECB though the ESM so as to break the pernicious link between the banking system and the sovereign fiscal account which continue to exert mutually reflexive distress.

Draghi’s frustration should be directed towards those that are denying ECB to function properly and use whatever non-conventional measures are necessary to protect the EU from an endless recession or outright depression, especially now that we have evidence of inflation falling well below the benchmark 2%. The hinted negative rates are not the answer.   Their collateral damage would be too high.   The answer is monetisation to undertake restructuring and recapitalisation of Europe’s zombie banks provided this is followed by a Banking Union and Common Deposit Insurance.   Strong countries cannot rightly accept banking union before banks are cleaned up, losses forced on debt holders where insolvency is proven, and then properly recapitalised.

Under such scenario the monetisation and recapitalisation will be capable of being reversed in the medium term as banks are restored to health and profitability and the ESM can privatise its possibly at a profit.

Anti-Austerity revolt

Albert Einstein is reported to have defined insanity as  doing the same thing over and over again and expecting different results.    It seems that many in the EU, but not all, are realising their own insanity in trying to solve Europe's never ending recession by further rounds of austerity.

Italy finally has a new government that is committed to reverse some austerity measures to give  chance to the economy to grow.   They join the crusade started a year ago through the election of Hollande to French Presidency meant to shift German dictated EU policy from total focus on austerity to restructuring with growth policies.

Hollande relationship with Merkel is reportedly quite chilly and France is quietly building alliances with countries sharing anti-austerity feelings in order to force the issue with Germany after the elections due there in September.

He seems to be succeeding.  Apart from having Italy's new PM Enrico Letta clearly under his wings, this week Hollande won new allies.   Ireland's  Head of State, Michael D Higgings,  warned that the EU must drop its 'hegemonic' economic model or risk social upheaval and loss of popular legitimacy.   Slovakia Prime Minister Robert Fico quipped how was it possible to cut public finances and expect government to have enough resources to support economic growth.

This follows surprisingly clear pronouncements from the EU Commission President Barroso that the policy of austerity had reached its practical limits.

It is only Germany and its northern allies who remain steadfast in their belief that austerity and growth are two sides of the same coin.

But even assuming that one can declare victory for the anti-austerity protesters, the obvious question is ' after austerity, what?' as the Economist is asking this week.

Nobody should run away with any idea that uncontrolled government spending, even if it were possible ( which it is not, especially for those countries under bailout conditions), is an effective solution.    The monetary union can only be salvaged if there is fiscal discipline and the 3% to GDP maximum deficit and the zero deficit ultimate objective must remain in force even if applied flexibly to allow countries under bailout more time to reach the fiscal objectives through growth not just austerity.

But economic restructuring in order to regain international competitiveness must not be abandoned.   The Agenda 2010 objective launched by former German Chancellor Schroeder and which converted Germany from a sick economy to a very competitive outfit should be a blueprint for other EU countries.    Excessive job protection to those already in employment must not work to keep the unemployed out of the labour market.   Social solidarity must be offered to those truly needing it as otherwise it cultivates dependency rather than efficiency and effectiveness.

However most of all the ECB has to be re-tooled to function as Central Banks normally do.   Who needs a fire-engine if its bowsers are dry or cannot use the water to put out the fire?

Europe will not re-discover growth before they clean up their zombie banking systems. 

Arguments for a banking union and a common deposit insurance scheme will fail before such clean up takes place.   Who will accept shared responsibility for insolvent banks?

The ECB should be mandated to force write-off of debt holders in such insolvent banks and then to recapitalise such restructured banks by large scale monetisation through the ESM.   Burdening the sovereigns with such recapitalisations is useless.  It would simply reinforce the pernicious link between the sovereigns and the banks and will reinforce their reflexive mutual distress.

The ECB has to be mandated to use non-conventional monetary measures to protect the EU from the risk of deflation, following what seems a never ending recession, and should be implementing such non-conventional measures with urgency when they see the inflation departing so materially to the downside from their target 2% inflation benchmark.

ECB President Mario Draghi said yesterday that he is frustrated seeing the banking mechanism broken and failing to transmit the signals of the ECB to ultimate borrowers.  He should be frustrated with those who are prohibiting the ECB from acting as a proper central bank.