Bank Of England Governor Mervyn King Issues Warning

With the EU crisis in Europe all around us, it isn’t the first time Mervyn King has warned of economic troubles ahead, and even this time he kind of says that things might be OK: we might be able to muddle through… but on the other hand, look more closely at what exactly he did say this week.

“We have been through a big global financial crisis, the biggest downturn in world output since the 1930s, the biggest banking crisis in this country’s history, the biggest fiscal deficit in our peacetime history, and our biggest trading partner, the euro area, is tearing itself apart without any obvious solution,” he said.

“The idea that we could reasonably hope to sail serenely through this with growth close to the long-run average and inflation at 2pc strikes me as wholly unrealistic.”

That last paragraph is what caught my attention… Could he, in his quiet way, be warning of hyperinflation around the corner? Well… he could, of course, but looking at the rest of what he says suggests he doesn’t expect it, unfortunately for the doom-mongers (myself included). He says,

“We don’t know when the storm clouds will move away. But there are good reasons to believe that growth will recover and inflation will fall back. Along the way we will no doubt be buffeted by winds from unexpected quarters.”

Well, if he wants to take a balanced view and avoid panic, I suppose he would say that, wouldn’t he? And anyway, he’s due to retire shortly: I’m sure he hopes to be out of the way before the Euro-shit hits the fan. And let’s face it, there is a lot of it out there. In particular, the British banking system is possibly the most highly exposed of all – most of these indebted Southern European countries owe most of their debt to British banks. When they default, our banks break. And with European politicians doing as little as possible to fix the problem, we, and they, are likely to be in big trouble.

Me, I’m buying extra cans of food to stash in the cupboard: if another, worse, banking crisis or collapse may be on the cards in the near future, it is possible that there will be no currency available for a few days while things are sorted out.

What Went Wrong?

Europe’s politicans are much criticised for continually kicking the can down the road rather than actually dealing with the Eurozone’s problems, but on the other hand, those problems are enormous. The whole single currency idea, while exciting, was economically naive. The idea that uncompetitive, inefficient, bureaucratic Greeks and Spanish could compete on equal terms (equal prices) with hyper-efficient Germany and even reasonably efficient France, was misconceived. Not that it was impossible – it could have happened – but in the event, rather than investing in their countrys’ infrastructure, the PIIGS (Portugal, Ireland, Italy, Greece and Spain) blew it on easy credit for property booms, expensive cars purchased with low-interest loans, well-paid cushy government jobs, and not much else. Ireland, it has to be said, did do some of the right sort of investment, but still most of the Euro-income was wasted. People blame their governments but it is the people’s faults too – they voted for profligacy and bloated government, and they got into excessive debt personally as well. Probably they didn’t know better, but now they do. However, now, it is too late.

The infrastructure they should have been developing consists of the essential services that profitable businesses rely upon but that only governments can realistically provide. These include reliable postal services, minimised government bureaucracy and interference, laws to limit business liability and to protect property rights, reasonable and fair legal systems, fast Internet, good transport systems (the Greeks did some of this), crime control, and so on. Profitable business requires the rule of law but tempered with a reasonable attitude and the minimum of government interference, fines, corruption and so on. This has simply not happened. Instead, in countries like Spain they would rather give businesses massive fines for minor infringements, and see the golden goose close down rather than be reasonable about it. And they attach fines to property not to businesses or even individuals, so no new business can start up in the fined premises as they would then become liable for the fine… Stupid? I seriously considered doing business in Spain at one point (it has a nice climate), until I found out how arbitrary and unreasonable the ‘system’ there is. Even living in that country is risky – the government can take your property without compensation at any time. Now they wonder why they have 2.5 million empty properties there, businesses collapsing all over the place and foreign retirees and business-people leaving in droves. Somebody needs a slap upside the head! In Italy the mafia needs to be crushed once and for all. In Greece the government bureaucracy needs to be largely sacked, and so on, and on. Doing business in these countries is largely a waste of time and money.

What Can Europe Do?

Well, that’s a tough one. I’m no economist, but the truth is they all say different things anyway, and their prescriptions and plans for Europe and the rest of the world have got us into this mess in the first place. Clearly, whatever the solution that is finally arrived at, it is unlikely to be easy, especially on the citizens of the PIIGS.

First of all, in seeking a solution, we need to look at what is wrong. That comes down to two things. 1) the PIIGS (and others) are uncompetitive, as discussed above. 2) They are now weighed down by massive unpayable debts. When they default on their debts, which they are in the process of doing at the moment, the formerly rich lenders – Northern Europe – will suffer too as their banking systems become paralyzed: nobody in the world’s markets will be willing to do business with insolvent banks.

So, here are some possible alternative solutions.

  1. Austerity Measures. Well, Europe is trying this, but it isn’t working. The point of austerity measures is to a) pay back the debts (fat chance) and b) make the PIIGS more competitive by forcing on them the efficiency changes they should have been investing in over the last decade or so. In reality, although this is logically very sensible, it is too late. They are trying to do too much too quickly. It is just too tough for people to endure. How would you like a 40% pay cut, a 20% tax increase, and longer working hours? Greeks are rioting on an almost daily basis and I can’t really blame them.
  2. Print Money. Governments are trying this too – they call it ‘Quantitative Easing’ and it is used when the banking system siezes up to give them some more money, or at least cheap loans, so they can avoid going bankrupt. They can also lend ‘bail-out’ money to the PIIGS. This can loosen things up to some degree, but it comes with significant risks as well. Firstly, it increases the amount of debt in the system, and the PIIGS are already in too much debt. This causes a burden on growth and business in the long run (money is wasted repaying debts instead of building infrastructure), so it makes it more difficult for the countries to become competitive. Secondly, there is a significant risk of hyperinflation. More money chasing fewer goods results in price increases. In the case of hyperinflation, this process can get completely out of control and whole nations can be utterly impoverished in weeks. Also, bailing out Greece is one thing: bailing out Spain and Italy quite another. The vast sums that would be required would be really dangerous economically, both for the PIIGS with the massive debt burden it would impose and for all of Europe with the hyperinflationary risk and the fact that, in the end, it is still just a short-term sticking-plaster and not a real solution. The problems will just re-emerge later. And be worse.
  3. The PIIGS can exit the Euro. If they revert to their own currencies, they can devalue them instead of trying to sell goods at artificially high Euro-defined price levels. This will free the log-jam for a while but it won’t actually help those countries to become competitive in the long run. Constantly devaluing is just by-passing the need to build infrastructure and reduce government parasitism. Let’s face it, these countries used to do this before the Euro and it never made them wealthy or truly competitive. Exiting the Euro is at best a short-term solution with a large risk of a perpetual downward spiral for these countries if their governments don’t bite the bullet of competitiveness and efficiency.
  4. Break up the Eurozone altogether. Forget about the Common Market, the European Dream, and go home. Just have a bunch of independent nations on the continent and that’s it. The problem with this is that it would take us back to the position in Europe in the first half of the 20th Century: various countries overly-inclined to go to war with each other in order to settle their various greivances, many of which wars were caused by the sorts of economic imbalances a united Europe was meant to solve. Probably, this is the wrong solution and hopefully it will not be tried. This is also a reason that countries like Greece will not leave the European Union altogether. They may well exit the Euro currency, though, as might all the PIIGs. It is also possible that all EU members will have to abandon the Euro by the end of this crisis, but I don’t think they will want to abandon the European Union altogether. Something has to be done to prevent war in Europe and the EU is the last best hope, as the saying goes.
  5. Have a Dual-Euro Currency. One Euro for the North, and another for the PIIGS at a lower value. This could help the weaker economies develop competitiveness over time as they slowly devalue relative to the Northern economies, while building infrastructure under the control of a central European authority of some sort, voted for by their own people (ideally). As lack of control over their own currencies is a big part of the problem, a solution like this would ease the pressures considerably and give those countries time to get their respective acts together. I don’t see any big disadvantages to this solution, as long as the two currency zones remain politically united with the North.
  6. Political Union. Get rid of the national governments as much as is feasible and run everything at the level of the EU. In effect, the EU would become a federal super-state, like the USA or Canada or (erm…) the ex-Soviet Union. If matters of economics and infrastructure, law and order and so on were determined centrally, the PIIGS would not have to compete with other countries – they would all be part of just one country. Their business laws, property laws, taxes and government spending would all be run according to the same model. They would benefit from regional development funds, and infrastructure development, all centrally controlled. It could work, provided each country’s unique culture and style was respected by the Federal Union. It could also fail to work, if the central authorities lack democratic accountability – a major problem with the EU as it is currently constituted.

So… what do you think?


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