Monday, 18 February 2013

What I Learnt From The Coin.

Last month saw Congress pass yet another measure to raise the debt ceiling, the latest measure delays the date the debt will reach its limit until May the 19th. This sets up another round of political wrangling and drawn out negotiations over deep cuts in social spending and defence. As the debt level approaches the level raised by Congress, Republicans will dig their heels in, holding both the US and global economy to ransom by using the threat of economic crisis as leverage in their quest to reduce Government spending and re-establish an America with a small state . On one hand President Obama has previously said he will refuse to play games with regards to the debt ceiling, however Republicans have stated in response that these negotiations are ‘necessary’ for the country. So as agonising as it is, the games will go on.

The reason that the debt ceiling puts the President in such a predicament is the confusing way in which power is divided between Congress and the President. Congress sets the budget, if this involves a shortfall of tax revenue relative to public expenditure, then the President is forced to borrow the difference. What makes this situation different from other countries is that Congress also has the power to limit the amount of debt the country can have. As this level approaches, they put pressure on the President to halt the levels of borrowing, created by their budgets. The President could stop borrowing past the amount Congress needs to implement its budget, but this would result in the Government spending money which it has not been financed. This would have dramatic consequences for the US and global economy, especially with regards to confidence in the dollar as a means of payment, which would be extremely dangerous for global stability and consequently has never been allowed to occur. This raises the question - for what reason does the Debt Ceiling actually exist? Part of the reason is that Congress benefits from creating a problem that only it can solve, allowing it to use the threat of economic destabilisation as leverage to fight against any changes in Government spending or taxation that it opposes.

As for the so called deficit hawks in Congress Obama may reason that they are not in fact deficit hawks at all. Many of the Republicans demanding that the Government deficit be reduced were supportive of the previous President quickly turning large surpluses into deficits with tax cuts to the wealthy and massive military outlay, which together, according to estimates from the Congressional Budget Office, account for a staggering $600 billion of the current deficit today. To put this in perspective according the Office’s estimates by 2019, if current policies are sustained, almost 50% of the total government debt will be accounted for by these two Republican policies. The economic downturn instigated by the burst of the housing bubble along with the failure of adequate recovery measures that attempted to fill the substantial hole in total spending left by the private sector, account for the majority of the current deficit. Clearly in principle therefore Republicans have no problem with sustained deficits. A more appropriate term for them would perhaps be Spending hawks or Welfare hawks, who use self-created deficits to demand the current President cut programs they deem to have no value, these being mainly welfare and health provision which the GOP have wrongly claimed are the main reason for the current deficit.

Because of these frustrations, discussion in some quarters has turned to how the President could get around the obstacles set before him by Congress. One idea was to use the constitution that protects US debt to simply ignore the deficit limit - wanting to avoid all the legal entanglements that this would involve Obama has refuted this option. Next was the infamous “trillion dollar coin” suggestion. Queue the right-wing comedy. ‘How about a twenty trillion dollar coin or even a 100 trillion dollar coin?’ was a common question amongst critics. Stephen Colbert provided probably the wittiest gag: "we should have known a coin was Obama's solution to everything - it was right there in his slogan: CHANGE”. Meanwhile news stations have kept themselves equally amused with clips Dr. Evil and Homer Simpson with a trillion dollar note.

Moving onto the serious discussion of the logistics of the plan Fox News reported that the amount of platinum needed would sink any boat used to transport it as it would weigh 17,774 tons or using their alternative unit of measurement - 89 blue whales! This clearly ignores the simple fact that there is no more reason for the coin to actually be worth one trillion dollars than the paper used to make a $20 note actually be worth $20. Meanwhile those who tried to sound more serious stated that the coin would create massive levels of inflation and destroy the value of the dollar, comparisons with the hyperinflation of Zimbabwe Dollars were especially popular. All this served to prove the point that those hired to inform the rest of us have little understanding of money creation or even basic economics. Economic theory states that in certain conditions, i.e. with depressed demand and interest rates unable to fall any lower, an increase in the money supply does not lead to inflation. Banks today create trillions of dollars by the simple act of lending, which has had very little inflationary effect, as evidenced by the rates of inflation in the US as well as other advanced nations with a highly developed banking industry. In fact in the UK, around 97% of the total money supply has been created by the financial sector and not the Bank of England.

Putting it simply, the creation of more money is not the alien concept it has been made to seem and is only inflationary under certain conditions. But even this misunderstands the central concept of the coin. The one trillion dollars credited to the treasury would be offset by selling assets or borrowing from banks so that borrowing would continue as normal. In other words this is just an accounting trick. This is not an economic solution to the debt in the longer term. Instead it is aimed to get around the political problem of the debt limit set by Congress. As the fiscal cliff showed us by claiming several points of GDP growth, political problems have economic consequences which explains the enthusiasm of some to avoid yet another messy and costly round of negotiations.

Therefore what has been revealed by this round of debt ceiling talks is that the majority of people influencing the debate in Washington either do not understand the concepts discussed or do not want to engage in serious debate about the role of money and debt in the economy. Perhaps before the next round of negotiations begins, this issue should be addressed.

Thursday, 7 February 2013

The European Integration Question: Economical or Political?

 Author: Thomas Viegas

With European nations struggling at present with the Sovereign Debt Crisis, which has engulfed the region, intense debate over the progress, desirability and future of both economic and political integration within the single market area has amplified. Originating in the aftermath of the Second World War, the creation of the European Coal and Steel Community (ECSC) in 1951 was declared by Robert Schuman, then French Foreign Minister, to be "a first step in the federation of Europe". Since then the Treaty of Rome, the Single European Act and the Maastricht Treaty have all contributed to furthering of economic and political integration between the nations of Europe. However the extensive economic problems that several countries in the Eurozone now face can only be solved with collective action and further integration. This has led to questioning whether it is possible to do this without deepening political integration within Europe as well. 

Economic integration is defined as “the elimination of economic frontiers between two or more economies’ with a frontier being any ‘differentiation over which actual and potential motilities of goods, services and production factors are relatively low”. Furthermore this type of integration refers to both market and economic policy integration, with the former however remaining the essence of economic integration. The fundamental motives for economic integration between economies are that, in theory, it will lead to increases in overall trade, actual or potential competition and growth rates within the integrated area. Moreover consumers in the area should experience lower prices, greater quality variation and choice as integration forces the allocation of resources to be more efficient.

Political integration has been defined as “the process whereby nations forego the desire and ability to conduct foreign and key domestic policies independently of each other, seeking instead to make joint decisions or to delegate the decision-making process to new central organs”. The keys features of this type of integration are its implications on sharing and delegating amongst member nations, the transfer of national sovereignty to pooled sovereignty and the creation of supranational institutions. Empirical studies have shown the consequences of increased integration include increases innovation and economic growth and the level of competition within both economic and political markets. There has been continual debate over whether political integration is a condition or a process and whether it has an ‘end point’, this is particularly important when considering the long term objectives the European ‘project’.

The current Crisis has exposed severe flaws in the economic integration process between Eurozone members, whilst also showing that political integration affects the optimality of the monetary union. The major flaw is the failure of a federal system in the zone to assist convergence in growth, as funds would be able to be allocated where they were needed in the case of asymmetric shocks (shocks to individual states). The crisis has resulted in the massive divergence of growth between ‘core’ states (Germany, France and Austria) and the ‘periphery’ (Spain, Portugal, Ireland and Greece). The argument for such a system uses the example of the US in which the federal budget redistributes income across regions, thus offsetting parts of the interregional differences in income.  

The cry for common bonds, or ‘Eurobonds’, to be issued has also been mentioned to allow troubled countries to borrow at a lower rate then they currently do from international markets. Not only would this consolidation of national budgets and debt would create a common fiscal authority which would protect member states from the prospect of defaulting, it would also be a very visible and constraining commitment that should ‘convince’ markets of the long term future of the union. In addition  the call for a ‘banking union’ between member states , to guarantee deposits of any individual in the zone, was strengthened when Ireland guaranteed all deposits for customers while others nations did not. In addition the necessity of a distinct eurozone budget has become apparent to allow the union to function much better because it would smooth the impact of asymmetric shocks too.

However these potential economic policies have encountered large political difficulties. The idea of a Federal system within Europe is one with extreme complications. The main one being that the policy would result in national governments surrendering the only available economic instrument left, Fiscal policy. Furthermore it would not only mean substantial changes in individual nation’s constitutions (assuming it would get past a referendum) but it would also have to be sold to the taxpayers of the zone that they would be financially assisting their ‘fellow European citizens’. At present these drawbacks appear unlikely to overcome due to upcoming national elections and the vocalness of citizens in core countries, which have already had to subsidise large bailout packages. The call for ‘Eurobonds’ has been met with strong resistance from nations, especially Germany, who enjoy negative real rates to borrow currently, who feel that this would increase the moral hazard risk. The risk being that, now with implicit insurance, members would issue too much debt.

Discussions over a joint ‘banking union’ have begun between the zone’s finance ministers but have already run into problems. The degree to which the ECB would have supervisory control has caused divisions, with Germany claiming that the supranational body should only monitor the 60 largest banks in the area while France believing  that the  Bank should be responsible for monitoring of all such institutions. The prospect of a distinct eurozone budget looks extremely bleak due to the inability of all EU members to agree on a collective budget for 2014-2020 and agreement looks increasingly unlikely. Moreover the current 2012 budget for the EU totals 0.98% of the regions Gross National Income and an effective budget for the eurozone would need to be considerably larger.

The drive for increased economic and political integration would involve the evolution of supranational institutions in the region. As mentioned before further economic integration would mean further powers being transferred to the European Central Bank, an organisation that was built to be completely independent from national governments. The loss of financial policy, already with the monetary type, to a body that is not accountable does not appear politically desirable. The prospect of the European Commission and Parliament to have greater influence in the management of regional policy is also small. Much debate already ensues over the usefulness of the Common Agricultural Policy (CAP) and with these institutions already heavily involved in competition, trade and industrial policy making; the giving up of more powers to Brussels would question the requirement of national governments.

The process of both economic and political integration between European economies has been largely interdependent and the deepening of the former type requires an increase in the latter. The economic situation that the continent was in after 1945 forced collective political action, which resulted in furthering economic ties between nations to improve prosperity in the region. The continuing removal of economic barriers between European economies led to successful economic growth in the latter half of the twentieth century, thus reinforcing the need for the former to induce the latter. The current Sovereign Debt Crisis however threatens the continuation of both types of integration. It has become obvious that the longevity of the integration process relies on furthering economic ties between economies but whether the political integration process has reached its ‘end point’ remains to be seen.