Friday, 20 June 2014

Renzi leads the push for less austerity

This article is from the World News section of the Financial Times of today:

Show him how Renzi
Europe’s centre-left leaders, led by Italy’s Matteo Renzi, are pushing for a loosening of the EU’s tough budget rules as the price for their support of Jean-Claude Juncker to be the next European Commission president, a drive that risks reopening the debate over eurozone austerity ahead of a summit next week.

The move threatens to become particularly contentious in Germany, where the government’s deputy chancellor, Sigmar Gabriel, leader of the junior coalition partner Social Democrats, unexpectedly backed Mr Renzi’s drive this week.
   The endorsement has prompted a rebuke from Chancellor Angela Merkel and her finance minister, Wolfgang Schäuble, who have warned that any softening of the fiscal rules adopted at the height of the eurozone debt crisis would send the wrong signal to financial markets.
   “The only problem that some countries have is that they have to stick to the rules,” Mr Schäuble said yesterday ahead of a meeting of eurozone finance ministers in Luxembourg.
   Centre-left leaders, including Mr Renzi, are planning to co-ordinate their efforts at a meeting in Paris at the weekend.
   Italy has long argued that the rules should provide flexibility for more investment spending in national budgets, a change that many EU leaders view as a thinly veiled attempt to skirt requirements for euro-zone countries to keep deficits below 3 per cent of economic output or face sanctions.
   The issue is particularly vexing for Italy and France, which have struggled to emerge from recession and run the risk of breaching the rules if they attempt to ease fiscal restraints to spur growth.
   France is projected to miss the threshold both this year and in 2015, when it is required to fall back into line; Italy’s deficit is under 3 per cent, but its national debt is well over EU limits and must quickly be reduced.
   François Hollande, the French president, has been careful not to make a public call for any formal change in the rules, mindful of his need to maintain smooth relations with Ms Merkel and to retain what little credibility he still enjoys domestically over his commitment to reform the economy.
   But the clear signals from Paris are that it is backing Mr Renzi’s drive. French thinking includes the possibility of not counting in deficits some investment costs in areas such as energy and the digital economy.
   Mr Renzi’s government is demanding flexibility in using EU and Italian development funds for infrastructure projects without adding to its deficit.

This shows the growing stature of Prime Minister Renzi in the EU.  He is doing the work that President Holland was elected to do but shied away from.

Renzi should tell Merkel and Schuable that wrong signals to the financial markets would be sent if they continue to pursue deflationary policies for countries already in distress.   Schuable should be reminded that the first to break the Euro rules in 2003 was Germany and that we are still paying the consequences for that as it gave a licence to everybody else to break the rules.

Wish Renzi well!

Tuesday, 17 June 2014

Taxation for the 21st century

This article was published in The Malta Independent on Sunday 15 06 2014

It is not often that a book dealing with economic and financial matters creates vibrant discussion in the wider society as has been the case with Thomas Pikkety’s “Capital in the 21st century”.

Pikkety tracked, amalgamated and analysed data related to income and wealth in various countries going back two centuries and concluded that inequality in various countries, but particularly in the United States, has now grown to the same levels that were last seen in the Belle Epoque[i].

Pikkety’s argument is that unless we wish to go through the same experience of the 20th Century where excessive inequality was scaled back by the horrors of two world wars that sandwiched the great depression of the 1930’s, governments should set economic policies that reduce excessive inequality.

The beneficiaries of present inequalities have used all arguments in an attempt to discredit Pikkety and defend the status quo.   They have depicted Pikkety as a re-incarnation of Karl Marx with a mission to destroy capitalism and restore a socialist society.    This is a gross exaggeration as Pikkety in no way challenges the benefits of controlled capitalism that must tolerate substantial inequality among society to ensure that people are motivated to deliver to the best of their abilities. There is no argument about the power of fair capitalism to extract people out of poverty as is happening in China, India and other emerging markets that are giving a fair chance for the markets to work while controlling excesses.

Pikkety’s core argument in his seven hundred page book is that capitalism builds its own dynamics that concentrates wealth in the hand of the few and if such dynamics are allowed to build on their own momentum, especially considering the rent-seeking potential of those in possession of excessive wealth, within a generation wealth will be in the hands of very few who inherited their riches and this would become socially less acceptable than when wealth is the hands of the few that can actually claim they worked for it.   Basically he argues that society can accept that Bill Gates[ii] is super rich because he pioneered Microsoft but will struggle to maintain acceptance if Bill Gates’ wealth is inherited by his (not necessarily deserving) descendants.

Unfortunately as with so many things in life the diagnosis comes easier than the solution.   Pikkety recommends the introduction of a global wealth tax but this is as feasible as Honduras winning the Brazil World Cup.   However the absence of a practical solution does not mean there is no problem.

To some extent we can argue that in Malta we do not have a problem of extreme inequality and that we somehow have hit a fair balance between having sufficient inequality to maintain the enterprise spirit to generate growth and development and  offering a social structure which prevents extreme poverty.   We have also adopted policies that maintain fairly good equality of opportunities giving flexibility for people to move up the social ladder according to their skills rather than their parentage.

In this context one can understand the importance of free education up to university and beyond, the stipend system which give students from families in low levels of society a fair chance to overcome the social barriers that would otherwise condemn them eternally to their low social status, and the free health care system.     We must ensure sustainability of such policies that have protected the social fabric of society.   We must avoid the extremes one finds in the USA where the atrociously poor share sovereignty with the incredibly rich.  To maintain such sustainability we must inevitably question from time to time whether the system can carry the load of universality where the rich and poor are equally entitled to free health care rather than focus the scarce resources of the public purse only on those that cannot afford it.

This brings me to the need that we from time to time challenge the status quo entrenched in our systems of taxation and to open a debate about whether changing circumstances merit adopting our systems of taxation for the 21st century.

We have a system of taxation that discriminates in favour of unearned income and against earned income.   Whereas earned income is taxed at 35% at the margin for income over sixty thousand Euro, we have final withholding tax at 15% on a variety of unearned income (investment income and property rentals) irrespective of their quantum.   Furthermore we have no taxation on capital gains.

We have to open a discussion about whether this is socially just and whether it is conducive to becoming an economy based on enterprise rather than on rent seeking.  We have to take into consideration that in order to protect our attraction as an international investment centre we have to continue reducing direct tax rates. This could be forced on us by international competition and could address the offensive differential in tax rates applicable to earned and unearned income.   However how would government protect its finances while reducing direct tax rates to competitive international levels?  Probably it will have to make up for loss of direct tax revenue by compensatory increases in indirect tax rates and by relying on taxes on capital rather than taxes on income.

Which would bring us back to many of Pikkety’s arguments.  Should capital gains continue to remain tax exempt?   Not even in conservative USA are capital gains completely tax exempt although they are taxed at much lower rate than earned revenues.

Should we continue to tax earned income at the highest rates but exempt inherited capital other than real estate completely from inheritance and donation taxes? And why should real estate be treated differently from other asset classes, simply because it is less mobile and more visible?

There are no easy answers to these questions and changes to taxation systems have to be done with hands that have the sensitivity of  a brain  surgeon.   But this discussion has to start among society so that our political leaders will gain the courage to plan the necessary changes for the longer term in the knowledge that society has been involved and all points of view have been taken into account.

[i] The Belle Époque or La Belle Époque was a period in history that is conventionally dated as starting in 1871 and ending with the start of World War I in 1914. This period was characterized by optimism, peace in Europe, new technology and scientific discoveries. The peace and prosperity in Paris allowed the arts to flourish, and many masterpieces of literature, music, theatre, and visual art gained recognition. The Belle Époque was named, in retrospect, when it began to be contrasted to the horrors of World War I.
[ii] In the particular case of Bill Gates most of his wealth has in fact been donated to his charitable Foundation so Bill Gates may not be a fair example of the risks that Pikkety defines.


Friday, 6 June 2014

The ECB answered... in part but ready to do more

In my article on the eve of yesterday's ECB meeting I argued that the ECB must take concrete measures to keep the Euro area economy from moving too close to deflationary territory and to move inflation gradually nearer to its target of below but close to 2%.

I explained the following menu of choices and below each in red I explain what actually the ECB has delivered following its meeting yesterday:

a. reduction in official interest rates - but these are already every low and a shave of 0.15% is symbolic but hardly effective.

The main refinancing rate was reduced from 0.25% to 0.15%.   A shave of 0.10% which is symbolic more than tangible.

b. charging banks negative interest rates for excess reserves parked that the ECB rather than used to lend to private sector to promote investment and consumption.
The deposit rate it pays to banks for their excess liquidity has been reduced by 0.10% from 0% to minus 0.10%.  The move to negative interest is a record to be noted piercing through the zero bound.  As this is uncharted territory the ECB was prudent to test the waters by a very small breach to the zero bound limit.   Its effectiveness will mostly be through the foreign exchange markets by weakening the exchange value of the Euro as speculators avoiding keeping idle Euro in expectation of exchange gain if they have to incur negative interest charges.

c. offering banks generous long term repo facilities to give them cheap funds to lend longer term to industry and private economic operators.
Various measures were announced under this heading.  Sterilisation of the securities market programme was suspended and this will on its own inject some EUR 165bn into the money markets.  The credo that increased money supply will automatically lead to increased inflation will be set to test. 

The collateral framework was eased by lowering acceptnce criteria by including special assets such as credit claims to accessing liquidity windows offered by the ECB making it easier for banks to access cheap liquidity.  Targeted Long term Refinance Operations ( TLTRO) for some EUR 400 bn were launched for 2014 offering banks cheap long term funding conditional on it being channelled to lend to non-financial sectors.

d. consider some sort of asset purchases ( through quantitative easing) especially if directed to lift assets from bank's balance sheet - through securitisation of their loan book - to allow space for new lending without demanding fresh capital

As anticipated the ECB considered quantitative easing (QE)  a bridge too far but it pre-announced that an  Asset Backed Securities purchases program is in the works to launch if further monetary support is needed.  The ECB needs time for setting up the financial infrastructure to securitise bank assets to make this particular QE measure effective in the Euro area without crossing the Rubicon of using QE for buying sovereign bonds.

The ECB has delivered as much as it could at this point. Whether this will be enough depends a lot not just on how much these measures repair the broken down monetary transmission mechanism to channel credit where needed, mostly to SME's in crisis countries, but also on how much the EUR will weaken against the USD, GBP and Yen on the foreign exchange market as investors have to come to terms with negative interest rates which could be increased ( made even more negative) if necessary.

Wednesday, 4 June 2014

Tomorrow the ECB must answer

Before the answer, the question:

In a monetary union like the Euro that is not underpinned by a common fiscal policy, should monetary policy carry a greater role to protect or restore  the necessary equilibrium in the union or can it simply accept that it is only responsible for achieving the inflation targets and the rest ( unemployment, economic stagnation, balance of payments problems) is not its problem?

Dominated as it is (through its culture, statute restrictions and location) to strict monetarism doctrine of Deutsche Bundesbank (BUBA), the European Central Bank (ECB) has generally tended to argue for the latter rather than the former.   At least under Trichet the ECB used to argue that it had only one compass for the control of inflation and for the rest it was up to the politicians to take care of through fiscal and other economic policies.

The depth of the Euro area recession, the great disparities between the economic fortunes of member countries in the Euro area with Germany and Greece at different extremes but sharing the same currency and monetary policy, and the arrival of Mario Draghi as President of the ECB, has changed that.

But most of the change has been verbal rather than through practical policy measures.   Draghi's 'whatever it takes' to save the Euro pledge in July 2012 was sufficient to restore order to a market that was spiralling out of control,  threatening the sustainability of the Euro area banking system and of the Euro itself.   The introduction of the OMT ( Outright Monetary Transactions),  which remained unused to date, was sufficient to persuade the markets that the ECB was serious in giving substance to the 'whatever it takes' pledge even though the Bundesbank is still trying to have the German and European courts declare that the OMT is ultra vires the ECB mandate.

Now we are at a stage where words are no longer enough, for three reasons:

1. Inflation in the Euro area is coming in consistently far below the ECB's 2% target and the latest May 2014 reading at 0.5% means that some Euro area countries are in outright deflationary territory.

2. The risk of deflation causes terror to monetary authorities, far more than the risk of inflation.

3. In the MEP elections voters have clearly revolted against German inspired austerity polices and they demanded sustainable economic growth to which the ECB can contribute  by a more imaginative monetary policy.

So tomorrow the ECB has to take measures that it has never taken before, as extreme situations demand extreme solutions,  Their menu is:

a. reduction in official interest rates - but these are already every low and a shave of 0.15% is symbolic but hardly effective

b. charging banks negative interest rates for excess reserves parked that the ECB rather than used to lend to private sector to promote investment and consumption.

c. offering banks generous long term repo facilities to give them cheap funds  to lend longer term to industry and private economic operators.

d. consider some sort of asset purchases ( through quantitative easing) especially if directed to lift assets from bank's balance sheet - through securitisation of their loan book - to allow space for new lending without demanding fresh capital.

There are other things the ECB should do, but they are still considered a bridge too far to keep the Germans on board.   The ECB should license the ESM as a credit institution and fund the ESM to recapitalise periphery Euro area banks that need capital to repair their balance sheet and start acting as reliable channels to deliver the monetary policy instrument to places where it is most required.

A bridge too far may become feasibly near if the threat of deflation persists.

Sunday, 1 June 2014

The people have spoken

This article was published in The Malta Independent on Sunday - 01 06 2014

We had a weekend of elections and the people have spoken loud and clear.

On the local front the MEP election results gave a huge endorsement to PL government and thumbs down to PN opposition in a degree much bigger than one could reasonably foresee.

The PN can fool themselves to their heart’s delight if they rejoice electing, by a whisker, three MEP candidates whilst ignoring that in first count votes they lost to PL with even a bigger percentage margin than their disastrous performance of March 2013.

The message for the PN, if they want to take it, needs little sophisticated interpretation.  I quite agree with their Leader that any analysis report would be superfluous because there is very little to analyse. 

In fact if such a report were to be written it could be condensed in one simple sentence:  The PN have lost because they have yet to accept the people’s verdict with humility and remember they are in Opposition. 

At least until last weekend they still had not accepted the role designed for them by the electorate at last general elections. PN still operated as if they had a God given right to govern.  They behaved in defiance of the people’s mandate as if by obstructing the Government confrontationally and by spreading doom and gloom even where there is evidence of daybreak,  the PN was pursuing God’s will to be restored to government irrespective of the electorate’s will.

This attitude suits PL well in the short term but too much of a good thing could be deceptive.   PL must guard against over-confidence and must proceed as if their majority is a mere handful. 

In many ways while giving a round endorsement to government policies the people were also protesting against the PN’s defiance.  Labour’s exceptional performance is a mixed result of their own merits and their opponents’ deficiencies.   They can control the former but not the latter.

Last weekend’s MEP elections had significance beyond our shores. There had been
some trepidation that mainstream  parties would lose ground to radical protest movements.

Protest parties did well in some places. The UK Independence Party (UKIP), whose leader had predicted “an earthquake” in the election, came first in the UK.  France also saw an “earthquake” – the phrase the French prime minister used to describe the first place performance of the country’s Front National, which advocates the dismantling of the Eurozone.

In Greece, first place went to Syriza, a party opposed to the austerity measures that accompanied the country’s bail-outs. Protest parties made gains in many other countries, not just in the periphery but also in ‘core’ Eurozone countries including Germany, where a breakthrough was made by Alternative fuer
Deutschland, a new party that favours a Eurozone break-up.   They probably command little sensibility to how much Germany has gained from the Euro through avoiding the loss of competitiveness they would have suffered from appreciation of the Deutsche Mark if they still had their own currency.

But we had surprises on the Europhile side as well.   Matteo Renzi in Italy  showed what can be done by a young leader who offers the sort of political leadership the Italians have been long yearning for; the leadership that Berlusconi had promised but failed to deliver.

There is so much in common between Prime Ministers Renzi and Muscat:
·         Both are leaders of socialist parties
·         They are roughly of the same age
·         They are both having their first experience as Prime Ministers
·         They were both chosen to lead their party when it was practically non- electable
·         Both worked miracles in turning round the fortunes of their party They accept a challenge and go head on to win it
·         They communicate exceptionally well to deliver unity of purpose
·         Both command an appeal beyond the traditional boundaries of the party they lead.
·         Both are strong pro-Europeans
·         They both believe that growth not austerity is the solution to Europe's problems
·         Both want Martin Schultz to be the next Commission President
·         They both fight excessive bureaucracy and let nothing stand in the way of getting things done
·         They are both election winners
·         They lead the only two EU governments that have been roundly endorsed by their electorates in last weekend’s MEP elections.
Pity that the other main socialist Prime Minister in Europe seems cut form a different cloth. It is indeed worrying that in an important country like France the main political force is now the far right Front National of Le Pen whose policies are ultra-nationalistic bent on dismantling all that true Europeans built over the last six decades where the continent enjoyed unprecedented period of peace and economic development.

Why is the French electorate behaving so differently from the Italian and Maltese electorates?

Simply because President Hollande is failing to deliver on his main campaign promise to be a valuable counter-weight to the power of Chancellor Merkel in the Council of Ministers of the EU. Where it matters Merkel is still calling the shots and preaching the merits of austerity and expecting all EU countries to become perfect images of the motherland. This does not work. The EU is a union of nation states with their own individual identities but wishing to share their economic fortunes in a spirit of social solidarity.

Following last weekend’s result France would do well to team up with Italy and Malta and seek support from other states whose economic growth is being restricted by misplaced austerity measures.    They should join forces to press Germany and other core Euro countries to let the ECB operate autonomously according to its mandate and lift the pressure for the ECB to fight non-existing inflation; to let the ECB do whatever it takes to save the Euro and repair the transmission mechanism which is blocking the delivery of its monetary accommodation measures to the places where it is most needed.

Without growth sourced by efficient credit markets for Italy’s SME’s, Renzi cannot deliver.   He needs to use his newly acquired political capital to bring a fresh approach to EU’s economic management in the second semester when Italy enjoys the Presidency. That is the most effective and apt response to the significant protest vote delivered by European electors last weekend.  They must be listened to and Europe must change.

Countries in the Euro must not only share their currency; they must also share their economic fortunes. Those that are not prepared for this must graciously exit the common currency so outside the core currency bloc the EU becomes a looser arrangement as demanded by voters in UK and Denmark.   This double act of deeper integration at the core and looser arrangement for the periphery is the only way forward for the EU to remain relevant.