Where to draw the line (2)

This article was published in The Malta Independent on Sunday - 16.11.2014

Where do you draw the line between the arguments of core and periphery eurozone countries about how best to restore the economy to normal growth and avoid the dangers of a lost decade and a perilous slip into deflationary debt trap?

Before presenting both sides of the argument, I should mention that between the core and the periphery there are countries referred to as ‘coriphery’, including France, who have never asked for an EU bailout and never (so far) suffered any loss of access to financing their sovereign borrowing requirements on the capital markets at normal interest rates, and yet whose economy is plagued with structural problems and is seriously in breach of Euro Maastricht Treaty conditions landing them under the watch of the Commission through Excessive Deficit Procedures.

According to the German (core euro) economic doctrine, growth can only come through hard, economic restructuring, irrespective of the pain and social consequences involved, to restore the competitiveness that periphery euro countries have lost through excessive spending and high borrowing without comparable efficiency gains. According to this doctrine, competitiveness cannot be regained through demand-stimulating measures, whether fiscal or monetary, but should be addressed at source through internal devaluation. Internal devaluation means the rollback of government expenditure involving painful wage and entitlement cuts, accompanied by new tax measures to raise more government revenue as well as measures to enforce taxation and fight evasion so enhancing public revenue flows. This doctrine preaches that excessive deficit problems cannot be resolved by undertaking further deficits to stimulate the economy, even if such additional borrowing were possible.

In arguing the way they do, Germany and core euro allies point to the sacrifices they had to make post-2003, when they were the first to infringe the Maastricht rules, and how such sacrifices have helped to restore their competitiveness so they now have a budget in balance and a Balance of Payments surplus of seven per cent of GDP.

When criticised that their approach lacks any dose of the solidarity that is required to keep any union together, not least a monetary union, the Germans point to the risks of moral hazard that such solidarity would generate. Moral hazard means that were Germany to get generous through solidarity measures, the periphery problem countries would go soft on the need to restore their economies to competitiveness and would just persist in their old ways, knowing that big daddy will ultimately have to pay their bills.

The other side of the argument – made by the euro periphery countries, especially Italy, Greece and Spain, as well as coriphery France – is that economic restructuring cannot be carried out in a recessionary or even deflationary environment and that stimulation of demand across the whole eurozone is a pre-condition for successful economic restructuring. They point out that Germany’s restructuring in the noughties was largely facilitated by the bright international economic environment and by the deficits that periphery euro countries were running at the time to buy their BMWs and Mercs from Germany. By analogy, unless Germany uses its ample fiscal space, while periphery countries are addressing their deficits, the periphery countries – for all their sacrifices – will continue running on the spot or, worse, slip into deflation.

They argue that unless Germany reflates its economy by stimulating demand and raising its inflation to three per cent or more, the ECB target two per cent average inflation for the whole eurozone can never be reached. If Germany continues to justify a balanced budget with a strong balance of payments surplus and an inflation rate of less than one per cent, then in order to restore competitiveness, periphery euro countries will need to have a three per cent inflation differential, which would put them into a deflation, negative two per cent inflation, basically a debt trap that blocks any economic growth.

Periphery countries point out that there is a limit to how much pain they can load on their electorates without risking the very workings of democracy that underpins the Union. The electorates will accept restructuring if it happens in the context of economic growth so that those who lose their job through waste-cutting and expenditure retrenchment will have a fair chance of finding alternative productive employment. However, restructuring in the context of a recession or even depression flies in the face of all Keynesian teachings which delivered so much prosperity in the post-war period. This will ultimately lead to democracy mandating demagogue extremists, irresponsible enough to take nationalistic unilateral action that will lead to the dissolution of the euro system and the EU itself and will undo the great post-war political achievements in Europe. Front National in France,Syriza in Greece, Cinque Stelle and Lega Nord in Italy, all in different measures, profess either more German solidarity or departure from the euro (and by consequence from the EU) if they are ever elected to power.

Where should the line be drawn to enable a compromise between these two extreme positions and to work collaboratively on a programme to re-set euro countries collectively on a route to prosperity?

To my mind there are three conditions required to form a compromise that will be politically acceptable and economically effective:

Firstly, Germany and other core countries have to accept the high level advice being rained upon them by the US, the IMF and other international sources that they must use their fiscal space to stimulate internal demand and therefore create better prospects for the euro periphery restructuring. Germany has just announced a balanced budget for 2015 ignoring all US and IMF pressure to do the opposite. US Finance Secretary Jack Law says this will mean a lost decade for Europe. Germany insists that it must be an example of fiscal discipline for the rest to follow.

Secondly, a massive infrastructure investment programme has to be undertaken in Europe to create demand and increase the economic capacity of the region. This investment has to be financed outside mainstream budgets through funding by the European Investment Bank (EIB) and private sector involvement. The EIB will have to bolster its resources for this purpose by issuing low coupon subordinated capital and debt instruments which may be bought by the ECB through its asset purchase programmes (a European style of quantitative easing) and, if necessary, by demanding more capital from member states. New Commission President Juncker has pledged such an initiative to the value of €300 billion.

Thirdly, the ECB must engage in more aggressive loosening of its monetary policy, expanding its balance sheet by buying EIB debt and, if available, corporate and bank debt (sovereign debt purchases remain highly contentious and should therefore be avoided). In addition, the ECB should fund the European Stability Mechanism (ESM) to force-feed European banks with additional capital, even beyond the shortfall identified in the stress tests, to ensure that European banks are strong and capable of funding European growth and investment opportunities. Such capital funding should be reversible, in the form of redeemable preference shares, in order to maintain investors’ confidence to invest in bank equity so that, once confidence is restored, the preference shares will be redeemed and dilution of equity investors avoided.

Surely, a compromise with these elements is possible if Germany and its core allies accept that it is not in their interests, or in the interests of sustainability of the great advantages they drew from the EU, to remain so rigid about arguing that the adjustment has to come from the deficit side only.  

Either a compromise is reached, now that a new Commission with fresh energy and vision is in place, or it will have to be reached at 10 seconds to midnight somewhere down the line, when crisis is about to blow the euro and the EU apart.

Russia struggles to understand its place in the world

I will be the first to agree that the West (NATO) could have taken measures to avoid the escalation of the present crisis in Ukraine.

When President Obama had visited Russia early in his tenure and expressed the wish to press the relationship reset button this could have been followed up with open dialogue to help Russia find its respectable place in the world's new order of things.


Negotiations could have led to a diplomatic solution for Russia's interest in Crimea.  A Hong Kong type of solution should have been possible whereby Crimea remains Ukraine sovereign territory but it is given out on a long lease to Russia.

The rights of ethnic Russians in Eastern Ukraine could have been safeguarded by a new Ukrainian constitution that gave these regions a high degree of autonomy whilst keeping them under Kiev's tutelage.

Russia could have been offered more time to accept that in a world order where China is the counter-balance to the US in a bi-polar world, Russia and Europe had a common interest in joining forces to make a common front to ensure that their interest is protected and not just become the ham and cheese in a bi-polar sandwich.  Ukraine's wish to  their further their EU membership ambition could have been framed on a long term basis to keep Russia as part of the deal including measures to protect Russia's interest.   Better take longer to reach destination than hurry and meet expensive roadblocks on the way which would still delay or outright deny reaching destination.

Putin however lost it all when he took unilateral illegal action invading and annexing Crimea and taking extreme liberties with Ukraine's eastern border with Russia.

Putin is prejudicing Russia's honest and respectable place in the world.  The Russian people all yearn for democracy.  They yearn for clean honest politicians who protect their interest not those of friendly oligarchs.  They yearn for strong governance, press freedom, and individual civil rights. Russian people do not deserve the sanctions that Putin's macho action has served on them.

Russian people deserve to see their country's natural hydrocarbon wealth being used to develop their economy and diversify it away from total reliance on oil and gas which expose it to economic irrelevance as technological breakthroughs will lead the world towards low carbon energy use.

Russia place in the world is not taking sides with China against the US.   Russia place in the world is in Europe.   Russia could be a major European player making Europe ever more relevant as China continues to grow its weight in a new world order.

Unfortunately its seems that unless Putin presses the reset button in this weekend's G20 meeting in Brisbane Australia, Russia will have to wait a post-Putin era to find its place in the world.

Why Clinton's syndrome is not working for Obama

The success of President Clinton in beating incumbent President George H W Bush ( Senior Bush the 41st President) in the 1992 Presidential elections is linked to his 'it's the economy stupid' syndrome.

The concept is that if a President manages to get the economy working the right way than he is likely to earn favour from the electorate and gain their vote.  On the contrary if a President leads during a time of economic downturn  he faces a nearly impossible task of sustaining his popularity and ultimately conserve the democratic mandate.

Why is this not working for Obama whose Democratic Party performed so badly in the Mid-Term US Congress elections this week so that the Republicans now have control of both Houses of Congress, the House of Representative where they increased their majority and the Senate where they overturned a Democratic majority?

And all this in a background where President Obama holds strong credentials for an almost miraculous economic turnaround.    When Obama was sworn in as President in January of 2009 unemployment in the US exceeded 10% and was increasing with a momentum of  700,000 per month.    The financial markets were in turmoil, the US auto industry was on its knees and the stock markets had lost their bottom.

Since then US economy has recovered, exceeded its pre-crisis levels, and is cruising towards its long term growth trends,   Employment is increasing at around 220,000 per month, unemployment is below 6% and the Stock Markets are beating all time highs except for Nasdaq which is at its highest since the artificial peak of March 2000.

There are two possible explanations:

Either "It's the economy stupid" syndrome does not work anymore as society has evolved

Or       The economy is not doing as well as the data suggests.

My opinion is that it is none and both of the above.

The economy is doing well but the growth is benefiting only the rich and the banks.   The workers and other fixed income middle income sectors of societies have not seen any growth in their earnings or any increase in their standard of living.   The middle class people are angry for Obama as they judge him that he bent on his knees to get the economy going again but failed to take the necessary fiscal measures to spread the economic benefits across society.  Little do they care that Obama really had no choice but to fix the banks and stimulate private sector investment as without that the US would still be where Europe still is - deep in a never ending recession.

Little did voters care that Obama has been the most obstructed President in recent history where Congress blocked practically everything he proposed after passing Obamcare before the House of Representative Democratic majority was lost in 2010.

Result of this week's mid-terms was that voter turnout was just 33% and two thirds of the electorate stayed away from the polling booths as they felt that Obama had not made a difference in their lives.   They felt that the 'Yes we can' battlecry of 2008 was not for them but for those that had caused the crisis in the first instance.   So whilst the Republicans went out to vote the Democrats mostly stayed home.

Obama paid 'The price of inequality' which has increased in the US under his leadership and there is not much he can do about it in the last 2 years of his tenure when the Republicans would only agree on business friendly measures not on a liberal agenda to spread the wealth down to the base.

Where to draw the line

This article was published in The Malta Independent on Sunday - 03.11 2014

Life presents many difficult occasions where decisions have to be made by drawing a very fine line - and the decision-maker is severely tested as to where that line should be drawn. We have had several such instances in recent days.

Take UK’s decision to stop participating in search and rescue operation to save illegal immigrants who choose to make themselves hostages to destiny by attempting to cross over to Europe from North Africa in rickety over-crowded boats.  

I had previewed this stance in my contribution in this column on 7^th September where I expressed:

“The more we improve conditions for giving a welcome to asylum seekers worthy of human beings and children of the same God, the more we are motivating others to risk their lives in illegal boat crossings, in the process enriching the merchants of death who organise such human trafficking. By helping the ones that come ashore we would be risking the lives of those who would be motivated to follow suit.

It is the same argument used in kidnapping. If one meets kidnappers’ demands for ransom, one could be saving the hostage’s life but in the process putting at risk the lives of many innocent people who could become victims of kidnapping as the criminals become emboldened to enrich themselves by expanding their activities. The principle is generally that there should be no negotiations with criminals and we have seen the brutal killing of journalists at the hands of heartless Islamic fundamentalists in the pursuit of this principle.   Why should it be different in the case of irregular immigration?” 

The result of the Mare Nostrum initiative taken by Italy clearly showed that the more effective the rescue operations, the more people are encouraged to risk their lives and, consequently, the more tragedies actually materialise. Britain has drawn the line.

Another case where the decision to draw the line is painful relates to publication of all the details related to reports about a well-known clergyman who is reportedly being investigated for repeated sexual indiscretions. All citizens are equal under the law and their positon or status should not entitle them to any privileged treatment. However, every person is entitled to be considered innocent until proven guilty and disclosure of too many details at a time when investigations are still in process could do more harm than good.

Obviously, no one can deny the media their right to keep the public informed on issues of general interest in cases where they feel their sources are reliable, the evidence is pretty convincing and the normal rules of ethics are respected. This last criterion is, however, very subjective and the media is itself exposed to the risk of sensationalism. My view is that there should be high ethical standards about disclosure in cases that are still under investigation and where no charges have yet been brought.

Respect of ethical standards demands that disclosure where charges have not yet been formalised can only be justified in cases where the media has valid reasons to suspect that the authorities, be they clerical or civil, are showing too much respect to the person being investigated, and that the process is moving purposely slowly as some form of protection while attempts are made for accusations to be withdrawn during the investigation stage. This is not an easy line to draw, either.

Another difficult line to draw is in the judgement about the contract execution skills of Energy Minister Konrad Mizzi primarily, and the Cabinet in general, following the admittance that the new gas-fired power station will not be ready within the two-year limit that was promised in the election campaign.

According to Opposition spokesmen and their media faithful, this is so big a failure that Dr Mizzi and the Prime Minister should join hands and resign as they have defaulted on a crucial electoral pledge that formed the basis on which they secured the people's mandate.

I am all in favour of people being held accountable for their promises and politicians in particular more so. However, judgement should not be based on one particular pledge but on the whole electoral package. If politicians were to resign if they fail to deliver on a particular pledge we would have the instability of political changes every few months.

Furthermore, Minister Mizzi has gone on record to say that the plan is still on track, although moving at a slower pace than anticipated, and that the shortcoming will, in the end, be about delayed execution rather than total abandonment. Frankly, Dr Mizzi has not defended himself sufficiently well from those who are seeking a full pound of flesh for an ounce of failure.

Nowhere in the Labour manifesto was there any pledge about foreign investment and cash infusion into Enemalta, which will make a very substantial contribution to putting its finances on a sounder footing and, in the process, reduce the government's substantial contingent guarantee exposure on Enemalta's debt profile.

Anyone who does not understand the advantages and importance of such a foreign investment is either blind or just prejudiced. All countries, developed and emerging, are bending over backwards to get Chinese investment for their infrastructural needs, as governments are fiscally tight to fund such developments. Even at the micro level, Chinese investors are prominent all over the place, not least in the UK and Germany, whose leaders are regular visitors, with trade delegations to Beijing.

Furthermore, Chinese investment in Enemalta, insofar as domestic operations are concerned, will be a minority one. Our sovereign will still have strategic control over the organisation, whilst the minority shareholder will infuse external discipline to ensure that it is managed in the interests of the organisation and not, as happens when there is full state ownership and elections are on the horizon, in the interests of the fortunes of the party in government.

So, all in all, Dr Mizzi may be delivering later but potentially delivering more. He should be delivering not just the new LNG power station but a Chinese investment with much-needed new funds in a strategic organisation that was practically bankrupt and that was ( and still is - pending proper execution of the deal with the Chinese) bringing down the sovereign financial structures and our sovereign credit ratings.

Only this week, Moody's has confirmed our A3 Stable rating. They said they had refrained from up-grading Malta's credit rating as merited by our much improved macro-economic and fiscal performance, as they prefer to await the proper execution of the deal with the Chinese regarding the investment in Enemalta so as to be sure that the contingent obligations through government guarantees for the borrowing of Enemalta will not become real.

Where does one draw the line? Is it better for Minister Mizzi to deliver what he promised on time or to deliver more, much more, but somewhat later so that all the additional elements are properly integrated in a coordinated project?

For the time being, I support the Moody's way: reserve judgement until the work-in-progress reaches its final destination.