The Euro, Past, Present and Future

“Our role as central banks is to guarantee price stability in the Eurozone. I’m convinced that the future of the euro is fundamentally linked to the support of the population, and that this support depends on the confidence Europeans have in the stability of their money.”  

“The mandate is deeply rooted and stems from the lessons learned during the seventies and eighties," he said. "It’s when a central bank ensures price stability that it contributes the most to durable growth.”  

“Governments must take on their responsibilities and not subcontract them out to monetary policy.” 

Jens Weidmann, Bundesbank President (article)

The persistent Euro crisis has garnered much media attention in the aftermath of the credit crunch. With benefit of hindsight many have concluded that the Euro was always doomed to fail from the start, with both sides of the political spectrum fervently believing they were correct all along. In Britain, right wing thinkers always believed that 'Brussels' never had a solution and should stay out of Individual Nations affairs. The left initially thought the Euro to be a good thing, seeing old currencies as symbols of Imperialism, but would later object to the Austerity imposed on member States. The left during the seventies were opposed to the common market, while the right were in favour. When the European Exchange Rate Mechanism was in use it was the right who were generally in favour. After the pound was ejected the left could claim it was a disaster made by the Tories; after the event had occurred.

You can see the confusion and schizophrenic nature from both ends of the political spectrum. History has shown both camps to support one form of monetary union, but then to oppose another. There has never been a thorough discussion on the Euro in mainstream politics with either end of the spectrum unable to rationally determine what the real issues are. 

Claims have been made that "You can't have monetary union without political union" or "A Nation and its Government should always have control of its own money supply", to "You need the power to devalue in order to regain competitiveness". All are stabs in the dark, as these were never raised as issues back when the currency was created. Only when catastrophic events have transpired do these so called shortcomings come forth. Like all events in history, it is never a simple yes or no, and requires a rational look of what caused the current situation to arise.

During Bretton Woods I, when the US was on it's quasi Gold Standard, they pegged the dollar to gold allowing only foreign central banks to redeem their dollars for gold. With increased deficits by Kennedy and then by Lyndon Johnson this spending had to be paid by someone, therefore the government does what it usually does, it printed money to pay the difference. When the Bretton Woods agreement was created the Keynesian's proclaimed that redeemability of the dollar for gold would cause no issues as institutions would never need to claim. Unfortunately for them they didn't count on Jacques Ruff advisor to former French president Charles De Gaulle. 'They run deficits without tears', thus Ruff advised De Gaulle to call the Americans bluff and trade in the paper promises for something that the American Administration couldn't create out of thin air. Others followed suit.

The rest as they say was history. Bretton Woods I was abandoned, in which we moved to the current global monetary system we still have now. The erratic fluctuations of the currency markets during the seventies accompanied with widespread financial turmoil prompted many European nations to look for solutions to stabilise trade, thus the chaos became one of the prime reasons for the single monetary currency created two decades later. (Taken from a previous post)

After the post war era Western Europe progressively moved towards economic integration. Many reasons exist, to combat American dominance, to unify against Eastern Europe, to enable greater trade - it was always a strength in numbers philosophy. 

Prior to the Euro, Europe had the ERM which attempted to tie the various currencies on the continent to the German D-mark; which at the time was one of the hardest currencies in Europe. It was doomed from the start as fixing currency exchange rates is a foolhardy scheme. It was price fixing and like any attempt to fix market prices it fell apart in the end. The principle however was to maintain low inflation among member nations and to stop political pressure to devalue in a race to the bottom. The right wing in Britain joined the ERM under Majors Government, despite the Majority Conservative Euroscepticism we see now. 

When the Euro was created nations who had an association with soft currencies clamoured to obtain membership. Its easy for complaints to be made towards the Euro now when austerity is imposed, but when the single currency was introduced it was seen as an economic boon by such countries.  Nations such as Spain, Greece and Ireland benefited greatly from the introduction of the Euro. Inflation fell, interest rates stabilised, capital investment spending increased. The whole point of the Euro is to ensure inflation is kept low by borrowing inflation credibility from the old Bundesbank who had a long history of doing just that. Interest rates fell across Europe in part due to this factor. Bond markets could therefore ask for a lower rate of interest on Greek or Italian bonds as Monetary Policy had been handed over to the more competent Germans. Historically Mediterranean countries would erode the value of their bonds with expansive monetary policy, but when these powers were absolved to the ECB, markets lowered prices for such Government debts.

A similar mechanism happened here the United Kingdom, whereby monetary automonoy was taken out of political hands. In 1997 the new Labour Government gave interest rate decisions to the Bank of England, a supposed neutral organisation. The idea was to take such decisions away from politicians who had in the past set interest rates to create inflation, and/or economic booms during election times. Both sides of Parliament, agreed that this was a good policy. The rest of Europe did something similar to the above, it handed monetary policy over to the Bundesbank. Another example of the contradictive nature of mainstream thinking.

The principle in keeping inflation low is a good thing. This spurs capital investment and production so that citizens can obtain better living standards. The more stable a moneys purchasing power is, the better off its people will be. The faster a currency devalues over time, the poorer its economy and people will be.

Many of the countries however still worked under the spend now, act later mentality. Government and consumer debts kept rising along with off the record liabilities. The European Welfare state was supported by this illusion, along with heavy Government corruption, rigid regulation or absurd employment traditions. The Credit Crunch was just the spark to highlight all these underlying issues to the market that has since demanded the bankrupt countries get their house in order. Markets have been trying to do this by asking for higher rates of interest on bonds; increased risk means the return an investor requires should be higher. This is the markets price mechanism trying to force bankruptcy/spending reform upon the political system. Without this dynamic the old political system tricks people to believe that an easy fix is within sight, allowing Government spending to get out of control. The problem is whenever these prices have been raised, a bailout fund is announced in an attempt to bring these prices back down. Initially the markets predictably put money on the new policy but not for long as markets know the underlying issues are only compounding.

The quotes taken from the Bundesbank President are exactly the reason the Germans have such a strong reputation in financial markets for running a sound currency during the Post War Period. It also highlights cultural differences between the Germans and the Mediterranean countries, who historically had Governments that pursued high inflation for their political failings. The periphery countries want all the benefits that accompany the common currency, low inflation, low interest rates, real terms capital investment, while at the same time oppose the fiscal constraints that help foster such benefits.

The simple problem with the Euro, or any money controlled in a monopolistic manner, is its openness to abuse. Money should be provided, like all goods and services, by a free market, competition, consumer sovereignty and choice. Thats the real issue behind the Euro and the solution not just to its ills but all problems that will arise with Government controlled money. 

We are witnessing the end of the Euro as many analysts/pundits/commentators are proclaiming, who state it should never have been created (usually these were the same people who were saying the UK should have joined, or were selling their Dollars and buying Euros a few years back). It is impossible for any commentator to predict what Governments will do, however I believe the Euro has the potential to prosper from recent events, only if the Germans maintain a hard line. This will entail Government defaults, bank collapses, members leaving, but if they decouple the currency away from political pursuits it will be a sound currency relative to others.

The real crisis will be if the Germans do not uphold a hard line. Many are distracted at the crisis occurring in Europe but are unaware of the crisis building up in nations who are overstretched, but still have monetary autonomy. Countries like Japan, the UK and the US are the ones who will have real problems. Their spending is also out of control, but the politicians are just using monetary tools to mask their problems. Interest rates for Government bonds are low in such countries because the market knows they will just monetise their debts if there are no buyers. Its certainly not because they are any more creditworthy. However this postpones any reforms that need to occur, with the situation getting worse. Look at Japan. Its debts are astronomical and will no doubt have great problems during the decade.

The Euro, if it is managed correctly, will be a strong contender to challenge the Dollars world reserve currency status. If this occurs, contrary to popular opinion, I believe the UK will eventually join as we continue to mismanage pound sterling. 

As mentioned in previous posts, I believe the 21st Century will be a great Century for liberty, individual freedom and human innovation. Statism, Monarchies, dictators have all had their time in the West. Such nations will increase individual freedoms as the states role diminishes over time. It will be an evolutionary process, not revolutionary. I also believe that the Euro may be a step towards the abolition of Government control over money. Its a pseudo gold standard that has the potential to stop endless devaluations for political means. As the state shrinks, people will realise the state is not required to help run our lives with money also falling under a similar observation, we don't need our Government to issue money. The Euro may well be run by Government officials, but its not tied to a single nation or a unified political system. Therefore the Euro, to some extent, decouples political affairs from monetary policy. We are a long way from free market money, but the Euro could be the start of a long path towards such a goal.

Recession

First it was Club Med that experienced a relapse of sluggish economic growth with Spain and Greece slipping back into negative growth. The reasons outlined by the 'experts' who caused the original depression were, "The currency wasn't flexible", "There was no devaluation", "Governments couldn't deploy monetary measures", all because such powers had been centralised to the ECB.

Then the UK recently slipped back into recession. Yet it has consistantly devalued, it has consistantly printed more money relative to other Western nations and it's Government has deployed uber loose monetary policies to try and "solve" the growth issue. However the UK has still come a cropper too. 

UK pay in real terms has fallen more then anywhere, inflation is higher relative to other countries, the country is still running a large budget defecit (just as  Keynsians claim this is whats needed), it has printed hundreds of billions, nationalised industry, had historically low interest rates that are very negative when taking into account the current inflation rate and the currency has been  devalued considerably. All of the above are always touted by Keynsians as the solution however it has done the UK no good what so ever. None of this suprises me, nor should it suprise the reader of this blog.

A lot of claims have been made that the UK has fallen back into recession due to the austerity measures. However all of the above does not indicate austerity but reckless government spending, as bad as under the previous Labour government. Cameron and the Conservatives are performing exactly as I thought they would, no spine and all sound-bites. Indeed it is worth repeating:

The Tories may be historically comfortable in this setting but how many grass root Lib Dem supporters are going to swallow the medicine? Defection of many to Labour is inevitable. And remember - "things were going 'well' under Brown". This could cast the Tories in the wilderness for a decade if they practice what they preach. There's only so long you came blame the previous government for the mess. Give it a year and people won't be seeing Labour mess but will instead switch their view to Tory mess. Just like Thatcher. People forgot the Labour mess in the 70's, they just remember the early eighties.

It seems the recent local elections have also reflected this mood (I realise some of the votes will be on local issues, but more commonly its used if people support current policies). Labour regained a number of councils and increased its share of the vote. Cameron is the latest scapegoat, the problem being unlike Thatcher he's not fixing anything and has to contend with stronger opposition with his Government having no ruling majority like Thatcher had. He's reliant on money printing, negative interest rates and a huge Government deficit. There's nothing austere about his politics. Ed Milliband keeps moving towards the center ground, refusing to trip up on left wing questions, such as questions on Union strikes, and maintains a consistent view with Ed Balls re-iterating the need for growth, ie more money printing and fiscal deficits. 

Public opinion in the UK is changing towards running deficits to support growth, a dangerous combination. Individual freedom, free markets and liberty create growth. When a Government tries to create growth it does the complete opposite over the long term. Running deficits, spending money on public works, creating inefficient and wasteful entities, removing entrepreneurship - all this does is stifle societies economic fabric. Socialism will always collapse for that reason. If I was a politician I could campaign for growth. I could promise that I would create employment, create public works projects, hand out subsidies, tax the rich. It's incredibly easy to do but this will never create the prosperity we all desire. 

Unfortunately the UK is slipping into this mindset where Government needs to increase spending once more. So far we have only endured mild stagflation but it will intensify going forward as people once more seem to be seeking for state intervention. Growth is peddled as a solution, but sustainable growth can only ever come from the free market, not Government Spending.

Its not only the UK that has lurched towards the left and away from 'Austerity'. The recent French elections have opted for a Socialist leader, Hollande, who like all Socialists has promised the earth but like any politician has no means to deliver. France already spends beyond its means yet has opted to spend, well, more. Policies will be watered down as market reality hits. 


Greece continues to be rudderless with the elections bringing no clear decision. Extreme parties such as the far left and right have gained at the expense of the  usual popular moderate parties.


I detailed the problems with PR in a previous post and Greece is a classic example of the problems caused. As a student of history it reminds me of many European Countries during the 1930's, similar to Germany, when Hitler rose to power. When crisis hits, people seek radical alternatives. The Greek people went for the extreme right and left, just like what happened in Germany 80 years ago. No one could form a Government, so Coalitions were formed, in Germany's case the moderate right aligned with Hitler's Fascist party believing they could moderate his views and was seen as the only option against the communists to uphold the status quo and form some sort of Government. Well what a mistake that turned out to be.


Times have changed, so I think the Greeks will see sense on the second election (although I may be wrong), but PR gives extremes platforms to perform on. Under first past the post systems that we have in the UK, it means people stick with moderate conventional politicians as extremes struggle to field candidates in all seats. People therefore vote for a party that will likely get the local seat. With PR, there is no such check and people can vote for extremes knowing full well there is not a number of seats to win, its a percentage of votes which gain seats, this in turn makes extremes more appealing. Extremes always offer people simple solutions. Problem is that whether its the far right or left, they always endorse catastrophic policies resulting in a complete erosion in individual liberties. Both ends of the spectrum believe its my way or the highway, and persecute anyone who gets in their way.


Greece now has the problem of no effective Government. Just like 1930's Germany, the moderates have to seek help from extreme parties in order to try and form a Government. The anti-austerity parties seem like they will get their way.


Recession. More Government Chaos and no real solutions. Some things never change.

We have no Solutions Yet

"Don't be fooled. Don't fall into the government's trap. Lenders and debtors will sit at the same table, having agreed to skin the people alive."

Aleka Papariga, Greek Communist Party Leader

The ECB and IMF have yet again decided to lend Greece more money in order to 'avoid' contagion which would lead to a tsunami of defaults across the financial world. The Greeks can't pay but who cares, I don't think any Western Government can. 

'Tough talking' British Prime Minister Cameron told Ed Milliband during this weeks PMQ's Punch and Judy show that if Labour were in power, then we would have a Greek crisis. Yet what is the current Governments approach? Inflation is rising. The BoE have now admitted they don't give a monkeys about Inflation. Despite it being more than double their official target they have stated that more QE (money printing) may be 'required'. The rate of inflation is now predicted to stay above target for the next two years. Of course, what they don't say is they plan for it to stay around for the whole decade.

David Cameron is a showman, all talk and no action, a modern day Ted Heath, as I previously said before he came to power. He has been in power for over a year, yet the Government continues to spend more money, 

"During April and May, the first two months of this fiscal year, the Government borrowed £27.4bn according to figures released last week, up from £25.9bn during the same months in 2010."

The majority of people are wrong that Cameron will solve our problems. A valuable lesson in life is that people are not able to see trends. They see the current time-frame, and extrapolate. When Cameron talks of 'austerity' and 'cuts' the public believes we will be back to boom times again soon. Cameron is no Thatcher. The Governments loose monetary policy may inflate tax receipts, but spending will rise as costs always catch up. Thatcher raised rates, lowered spending and let business go to the wall. Until this happens, then the current rhetoric is all fluff.

History is repeating itself again. Britain in the 1970's had some of the highest inflation in the developed world. Fast forward 40 years and its the same again, we are world leaders in the Western inflation league table. Germany meanwhile has less than half our inflation rate, and their earnings, unlike ours, are rising in real terms,

"Real earnings, that is, the price-adjusted gross monthly earnings of full-time employees, rose by an average 2.0% in the first quarter of 2011 on the same quarter of 2010. As also reported by the Federal Statistical Office (Destatis), nominal earnings increased by 4.1% in the first quarter of 2011 compared with the first quarter of 2010. Consumer prices were up 2.1% in the same period. The increase in real earnings was the second highest since the beginning of the time series in 2008, while that in nominal earnings was stronger than ever before in the given period."

Yet Germany imports every drop of oil, and the majority of food, just like the UK. UK wages in real terms continue to decline,

"Average pay rose at an annual rate of just 1.8% a year in April, according to the Office for National Statistics (ONS), while the consumer prices index was running at 4.5%."

Inflation is a monetary phenomenon. Keynesian's will point to the symptoms of Inflation and tell the public that these are the causes, for example increases in workers wages. Government friendly economists state that if wages do not rise, then inflation should be subdued. It doesn't take an economist to work out this is just plain illogical thinking. The above clearly disproves the theory. German wages are rising twice as fast, but the inflation rate is half as much. By any scientific measure this Keynesian law wouldn't even hold at primary level education. 

Now is a time to reign in loose monetary policy, but not for the UK, its time to print more. If history is a guide the UK will have negative wage growth and high inflation for a long time, just like in the seventies. Worse still, we will accept it. Its a culture thing. Similar to the Greeks, as the quote at the top of this article reads, believing their problems are inflicted by others, when in reality it is all their own reckless doing. They wasted money for years.

The rise of union strikes have also become more prominent. So rather than lacing up our boots to go work, like the Germans, we decide not to turn up to work, compounding inflationary pressures, eroding our global market competitiveness and lowering real term wage growth. Marvelous! I believe people are free to do as they please. Strikes however are always a waste of time and do not raise peoples living standards. It seems to me that their living standards are already quite cushy compared with many,

"The calculations show that a mid-ranking teacher on £32,000 a year will receive a final salary pension that is the equivalent of having built up a £500,000 pension pot. This is 20 times higher than the average private sector scheme, according to figures from the Office for National Statistics."

Rather than sulk, how about they spare a thought for future generations. State pensions will be non existent, despite the fact we pay National Insurance, the greatest ponzi scheme in existence and the new pension standard is to be put on a private contributory scheme (if you are lucky) that is no where near as previous non-defined schemes. 

Previous generations fought a war, underwent rationing during the 1940's and 1950's, left school at 15, worked for 40-50 years and got a paltry state pension, if they lived that long. Meanwhile many boomer's were the first generation that got a free University education, gained greatly from credit booms from substantial asset inflation in items such as houses and to top it off were given gold plated pensions. A generalisation, of course, my mum left school at 15, never went to University and won't have a gold plated pension, but for many of her generation this was not the case. However this is how economies should work, the next generation has it better.

Subsequent generations now have to pay for their University education. They will never see their state pension as it keeps riding on further into the sunset. Private pensions are minimal in comparison. This is not how the next generation should have to live. But hey, that's governments, they take money from the future to buy off present day votes.

Circumstances will improve, the free market will see to that. As the Government creates more problems the only way to solve them will be to expand the price system and allow free markets further reign over the economy. It always happens. The end of this current age of stagflation will result in further moves towards free markets. Just like the last stagflation. In the current climate I see no solutions yet, just more compounding of our current problems. The solutions will come, just not quite yet.

Where is the deflation?

"The Chinese government is expecting its economy to expand around 8% of gross domestic product in 2011, same as in recent years, but it has raised its inflation target to around 4%, indicating Beijing isn't willing to sacrifice growth even though fighting inflation is a top priority.

State television reported the new numbers Tuesday, citing Zhang Ping, the head of the National Development and Reform Commission. Next year's inflation target is a full percentage point higher than this year's target of 3%."

News that China will raise its Inflation target

If you were to believe the experts it is deflation we have to fear. Its just round the corner. Its a battle we must win. A depression must be avoided which apparently is caused by deflation. In the real world people are seeing costs rising all the time. Not just in the West but in emerging economies also. The Chinese authorities have raised their inflation targeting metrics in order to keep their bubble, sorry growth, moving up. A rule of life is governments always bend the rules. Its sets them. Free markets allow people as individuals to set the rules. Participants mutually trade with one another under an amicable agreement. The state takes at will and by force. Inflation is one such example, it benefits no one in society in the long run, only the government over the short term.

The fact that the target has been moved upwards should not be a surprise. This is what's going to happen everywhere, across the globe. Here in the UK our Inflation has risen yet again. Its now been above the target for over a year now and what are the "inflation fighters" (that is Mervyn King and his MPC comrades) doing about it, Nada. Zilch. They have already raised their inflation targets, they just haven't told the unsuspecting public. There's more price increases in the pipeline:

The increase in VAT from 17.5% to 20% that will come into effect next month will be used to "mask" more extensive price rises according to accountants at KPMG.

They claim almost two thirds of retailers and consumer product manufacturers plan to increase their prices by more than the planned VAT hike in January.

Martin Scott from KPMG told the BBC why he believed retailers would raise prices by more than just the VAT hike next month.

All this inflation is causing Government bond prices to stay high. Well I say high, but we haven't seen anything yet. They will go double digit over the course of this state induced disaster. Double Digit may seem high in today's environment buts that's what you would have thought when Interest Rates were single digit back in the seventies. In the US they eventually went above 20%. Ouch!

Well at least the banks are ok now. They were small fry. We have moved on to more impressive bailouts like, err, countries? Ireland, Portugal - what about when Italy and Spain need assistance? They in turn get bailed out by Germany or France or even the UK. Hang on, aren't we bust also? Yep. Fractional reserve banking, fiat state monopoly money, you have to admire it. The Governments legalised ponzi scheme. No one has the money for any of these bailouts. Deflation will never happen because Governments know this would be the end and a collapse of the system. Therefore they will print money. They will raise inflation targets. They won't even tell people they are doing this. Oil is at record high once more. Just like with any unwarranted inflation, peoples living standards are falling. Prices rise and real wages don't keep pace. 

Through all the bailouts and enlightened interventions, nothing has been solved. Its worse than before the crunch. Its the quiet before the storm, just like prior to the market collapse of 2008. Everything was fine until it happened. That's the problem with economic collapse caused by government mismanagement. You can't predict it, you just know it will come. And when it comes its always too late to act. We won't hit bottom until the market is allowed to cleanse itself, but that isn't going to occur. Until then, just know that inflation will always be there, always rising, even when it may seem its not. Deflation is just the Governments smoke screen.

China Hedge Part II

Earlier last year I wrote a post about the China Hedge and there's further activity as the video shows.

Click here to view Video.

Is Gold in a mania? Is this the end of the bubble? Or are the Chinese ahead of the game yet again? The clip mentioned that China has now become the largest Gold producer in the world, surpassing South Africa (which incidentally has been in decline for a while now). The Chinese are digging like crazy for the stuff, they have been for years as the Government knows the yellow stuff is the key to their economic well being during the next 10-20 years. We don't have a bubble, but the Central Banks and Governments will create one here. George Soros aptly called it the 'ultimate bubble' and I agree. When he said this many looked at his comments and concluded that this meant gold was already in a bubble, but I never drew that conclusion, he's a smart guy. As it transpired later Soros actually added gold to his fund. Funds all around the world are increasing their holdings. But we are way off the bubble top, years away. 

The fundamentals for the bull market just keep getting better and the authorities apostles, such as Paul Krugman, keep telling us Gold bugs what we want to hear. Apparently we aren't doing enough. Right? We've been here before Mr Krugman. You've been telling that gruff to Japan for 20 years now and what have they got? Huge debts and a basket case economy. Get those interest rates lower, increase spending and get more money into the pockets of people. I forgot that prosperity was that easy.

China has also become the largest Gold consumer, which is another huge shift in the world. Ten years ago their citizens couldn't buy it, now the Government actively encourages purchases. You can't eat gold? You can't use gold? But you can't use or eat worthless paper tickets, promises of payment, that we call money. Bonds are a disaster. Housing is going to be a terrible way to hedge going forward and stocks, dear me, companies have that much state intervention Karl Marx would be proud. Only Cash is going to do worse than the list above. However Gold is outside the system. It's no ones liability. However stupid, despotic or mad our leaders become, it won't affect gold. 

We all await the China crash. Marc Faber seems to suggest sometime in the next 9-12 months. More market commentators have noticed. Hugh Hendry, Jim Chanos, Mish Shedlock with many of the underground economics forums also beginning to discuss the events that are happening. Evey Credit boom ends, and there is never the 'soft landing' that is always told, it always gets messy. However when China does run into difficulties don't think this is it. It will just be a setback, many of the above also agree with that concept. Unlike the West, China is starting from a very low industrial base, meaning there is still huge potential to grow. She will just grow her way out of problems eventually. Remember the US had huge issues as it rose to become the superpower. The Great Depression, the panic of 1907 and many financial storms throughout the nineteenth century. She overcame them all as it was from a lower industrial base and she borrowed money to produce not consume, similar to China. Of course when China stumbles what will happen to Australia in the short term? Many Asian nations - Japan, Malaysia, Vietnam? African nations such as oil rich Angola or Nigeria? South America, with Chile and Venezuela? Not only are the Chinese buying gold but they are forming huge trade links around the world and also practice a form of check book diplomacy. They use their monetary reserves and labour to build infrastructure for such countries to access the natural resources they need and buy some friends while they are at it. 

The Eurozone, Chinas biggest importer won't be doing the country any good with what's happening there. Previously I contemplated that Euro members could leave as they can't adapt to the Germans mentality. However I now think its the Germans, the strong rather than the weak, who will leave! I mean the recent bailout is a complete disaster - no one has the funds to pay for it. This will just further undermine the Euro in the long run. I think it may now be more likely that Germany will leave as there are more mutterings from their public that they've already had enough and want a return to the sound Mark. If that happens you can kiss the Euro goodbye. The Germans are the only ones disciplined enough to run a relatively sound currency (perhaps Finland, Holland and France also). The Euro needs the Germans. Again all this just puts further gloss to the gold bull run. You can't even turn to the Germans for sound money any more.

We are witnessing the breakdown of the welfare experiment since Nazi and Japanese expansion created the Western promises 'a society fit for their war hero's'. The social ratchet kept tightening, with no politician loosening the grip. Just like the collapse of communism it will be the free market that defeats statist policies. It always does. While we transition there's going to be some pain along the way. Chinas Hedge continues....

It's not a Greek Crisis

"There is no money. There is no one else’s pocket left to pick. You can’t borrow anymore, you can’t print anymore, and you can’t steal anymore from anyone else....You object to the bond market, but the bond market is just the voice of reality calling. It’s telling you that 2 plus 2 is still 4, no matter what your union bosses would have you believe. Your bosses tell you that ‘the people’ didn’t spend the money, but it’s not true. That’s exactly who has wasted the money, and now the bill is coming due....You’ve thrown your bottles, burned your flags, waved your signs and had your fun. Now it’s time for you to learn the lessons of history and abandon this idiocy before we finally lose our patience with you. Grow up – and get back to work."
Daily rant directed towards the recent Greek Protesters

It may be all Greek to you, but the effects of the bond bubble is here for all to view (already a wiki page has formed). As soon as the so called economic professors proclaimed the financial crisis to be over (the very same individuals who said 'What housing bubble?') another one has begun to erupt and its only just begun. The location or nation doesn't matter, the important point is no politician, government official or prominent academic has a clue what to do next. A 'bailout' is required to avoid financial contagion, horror stories of Lehman are retold. It doesn't matter that no one in the West can cope with their own domestic liabilities never mind take on others, instead a short term fix is proposed as the solution. In reality it can only exacerbate the problems down the line.

Euro bashing has taken center stage. All the Euro sceptics have suddenly come out of the closet. They never knew in the first place why the UK shouldn't join the Euro but recent events have given them the confidence to speak out once more. Is the Euro doomed? Wrong question. All fiat money is doomed. Despite what has been said regarding the Euro, the Germans hold the key to it. Their Deutschtum regarding sound monetary policy does not bode well for future bailouts towards the more irresponsible European nations. Germany should have got rid of Greece and let them fail. But politicians prefer short term fixes rather than the tough long term ones - they won't be around when they break again. Our old PM Tony Blair can attest to that.

Many falsely believe that Greece is the Canary down the coal mine. Put it this way, did we expect better of the Southern Mediterranean nations? We could list the historical facts, the Inquisition, Catholicism focus on the collective rather than the individual, corruption, even the hot weather but that's what history teaches you - what to expect. Greece isn't the canary down the coal mine, the drachma when it existed was very weak, and the Greeks vigilance at the printing press had a terrible history. Britain, as I have mentioned, is the canary down the coal mine from what I can gather. It is a member of the monetary core - nations such as Germany, Switzerland, the Scandinavian countries, the US - these countries have historically had relative sound money (a few periods of exception can be noted) and have respected individual liberties as early leaders of free markets. When the crisis spreads to the core then we will see real problems. Who will bailout the last resort? There is only one tool. A printing press, others such as China wait to see what destruction we can inflict on ourselves. They gave us cheep goods, gave us their savings to buy more of their goods and saturated us with consumption based debt as we have already struggled to grow our economies over the past decade. If you can't beat them militarily then use economics as a weapon, as Sun Tzu said, '...one hundred victories in one hundred battles is not the most skillful. Seizing the enemy without fighting is the most skillful'.

Portugal and Spain are showing signs of stress also, how long it takes to spread northwards remains to be seen. Eastwards Dr Faber says bubbles are forming in China, nothing I haven't observed but good to hear from the doom prophet whose practically called every bearish situation before it happened for the past 25 years. Where can an investor turn in times like these? The answer should now become obvious to anyone who is following such events closely.

Tonight we have the election here in the UK. Will we have a hung parliament? I hope it lives up to its promises as the most exciting election in a generation. The last two were very boring for a neutral like me, I was too young for the elections previous to these. On that note its time to go watch what Government will 'solve' our domestic crisis. Unfortunately as the quote hints at the start, no politician or bailout offers a cure. Only ourselves as individuals can put things right. Politicians will just keep putting our problems back for the next guy to solve.

A Budget to Forget

"If we subtract spending on welfare and debt interest then we estimate that the rest of public spending would be cut in real terms by an average of 1.4% a year compared to an average increase of 0.7% in the Thatcher era."
Institute of Fiscal Studies

It was a budget we all expected just before a General Election, a budget aimed at claiming maximum votes. It was quite simply a farce. No real change anywhere, savings cancelled by further spending promises, it felt like a budget for an era gone by where the economy was once perceived to be humming along. Mentions of cuts were detailed after the actual event, with yet more 'efficiency savings'. Call me sceptical but surely if it was that easy to cut billions in Government spending, then why aren't they doing this already? Never in history have I seen a Government be able to bring down a budget deficit like ours with 'efficiency savings', only real cuts can carry out the required correction. Of course the truth eventually came out. The press picked up on the fact that Chief secretary to the Treasury Liam Byrne confirmed that the Labour Government would have to make larger cuts than Thatcher did back in the 80's. However I still don't believe Labour would do this. It stinks of Jim Callaghan who took over the mess Harold Wilson left him, talked tough, but never had the conviction to administer the cure.

What's amusing in all this is people's shock to it all, 'Tougher cuts than Thatcher, well I didn't think it was that bad', well think again, you won't get common sense from the media. Thatcher never had a deficit like this. She came in when interest rates had peaked. She came in when Unions were Striking everywhere, North Sea Oil production was on its way up and private debt was no where near what is today. Thatcher had it easy! We have everything in reverse at this current point in time. Still it will work itself out, won't it?

Growth is what we need or what we are told. We need to ensure a return to growth and this will solve everything, right? Communist Russia grew for years during Stalin's reign of terror, but it wasn't the paradise that the propaganda portrayed. Governments can grow an economy like now by borrowing from future generations but the bill has to be paid at some point. Communist economic systems recorded growth but this growth included people never having goods they wanted. Governments made Steel, Cement, machines that no one used but at the same time people in these countries couldn't get basics such as bread or clothes, items we now take for granted. They couldn't get homes. Russia has historically been one of the largest Oil producers in the world but its people couldn't even buy the stuff as it was rationed during Communism. The state needed the oil to to pay for imports as natural resources were the only exports the central planned system could sell to the West. They had growth but people weren't satisfied, peoples lives didn't get better. Governments can grow economies but they can't meet peoples individual needs, innovate and create like a free market can.

When you hear a politician saying we need 'to lock in growth' its just political engineering, telling people we need growth rather than letting people, as individuals, determine what they want to do, what they want to consume and produce. It's time to let our economy shrink if need be and put it on a more sustainable long term path.

IMF Greek Bailout

Well not quite a bailout, but it stinks of another 'Greenspan put'. If the market won't lend to you, we will. The market now knows there will always be a lender of last resort, again another moral hazard. I'm sure the Greeks will now be able to sell their bonds, in fact rates may even come down again as the market can rely on the IMF to buy if Greece gets in real trouble. A further inflationary wave among the existing ocean of expansive monetary policy. Problem is, the plaster doesn't cure the Cancer patient. They can get lazy once more. Why train as hard as the other sprinter to compete when they keep making the race shorter for you.

The Eurozone should have let the Greek Government fail. People may look at this stance as uncompromising but this is how free markets work. No one objects to small companies failing, indeed it frees up societies resources, labour, land and capital for others to use in a more productive manor that satisfies peoples needs. When it comes to Governments, people rationalise that they should print, get bailed out etc, but if Greece was allowed to fail this would be beneficial to the Euro and also for the Greek people.

It would have sent a signal that the EU is serious in maintaining discipline on Governments. Either Greece's Government would have been forced to shrink by market forces and the Greek people would have got more competitive or what I feel would happen is the Greek people would have just left the Euro, thus leaving the nations that are serious about trying to have a sound economy under the Euro.

Greece should have left. I can't see their culture getting real. They blame international 'speculators', the Germans, the Euro anyone but never themselves. They are not man enough to admit to the error of their ways and if you can't do this then you can never learn from your mistakes and improve. Let them have their drachma, they would probably encounter a short term inflationary bounce as they regained monetary autonomy once more. So called economic commentators would use this as evidence to support their theory that the Euro is a straitjacket. The bounce wouldn't last and their economy would tailspin into a basket case state once more over the long term.

Franc Fort

Back in the 50's, 60's and 70's the French Franc was like the British Pound - a basket case. For years the French had used the currency to try and solve the problems of the day but on all occasions it never worked. When the ERM was introduced throughout Europe its aim was to achieve currency stability between nations after Bretton Woods collapsed. It meant all Governments had to peg their currency to the German D-Mark, the cornerstone of the scheme in effect 'borrowing' anti-inflation credibility from the Bundesbank. The problem was other countries would always keep revaluing as they couldn't keep pace with the Germans uber-hard monetary stance. Ironically it was France's Socialist leader Mitterand who decided to get France serious and a policy known as the 'Franc Fort' was implemented. He liberalised markets, allowed unemployment to go where it had to, cut government spending and so forth. They didn't use the currency and allowed people to get competitive once more and in turn won the respect of the Germans who in effect exported their harder monetary stance to France. I'm not saying France is a free market utopia (far, far from it) but they are in a better shape now thanks to such policies. I also don't agree with currency pegs, but the peg meant the French had a commitment to track the Germans on monetary policy. The Euro of course removes the peg factor completely.

"As the chancellor made crystal clear, there is going to be no devaluation, no realignment...The soft option, the devaluer's option, the inflationary option would be a betrayal of our future, and it is not the government's policy."
John Major, days before the pound exited the ERM

Well the Conservatives tried but failed. The UK couldn't stand the heat or rather we are still stuck in a bygone age where we believe the pound to be still the best currency in the world, hence not for the first time we valued the pound way above market rates, in this case we overvalued it against the Mark. What a bunch of pansies we are! Speculators made great gains from the event at the time, many are critical of the money men for profiteering at a nations expense.

However what about the speculators that bet against the Franc at the time? No one tells that side of the story, where those speculators lost a bundle. Ten years prior the French wouldn't have stood the heat, their culture would have been too weak, but the Mitterand 'Franc Fort' meant they could maintain the peg, admittedly with great difficulty. The market still didn't believe the French, thats why they bet on a similar devaluation that had happened in Italy and the UK, but they underestimated the shift in French culture that had occured during the past decade and the determination of the Government not to bow to short term outlooks.

'Sound as a pound' is still a popular saying but its lost all meaning these days, referring to a time when the pound used to be sound compared with the worlds other currencies. A more fitting title going forward may be to replace the 'sound' with 'unsound'.

Market Prices need to be allowed to do their Job

Market Prices are there for a reason. Profit, Loss, Bond Yields, Currency Exchange rates - prices all directing economic activity in an uncertain world where we all have infinite desires and wants but limits in our productivity to meet them. Don't use a currency to solve your problems, it will just embed the rot further. Let prices do their job.

Keynes and Hayek (Accompanied by General Ramblings)

“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”
John Maynard Keynes
The General Theory of Employment, Interest and Money


“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”
F A Hayek
The Fatal Conceit

Both quotes above are taken from the recent econstories rap video that has been showing up all around the Internet which can be viewed here. A very lucid video crammed with factual information, so don't be put off by it's format as a rap song. As we start a new decade, more people will see the ill's of our economic system and formats such as this will help inform people on all levels, as I realise many people find history and economics a very dry and boring subject.

The video contains many subtle messages. The receptionist not recognising Hayek, Keynes book in place of the bible in the hotel room, a party at the FED - the old alcoholic analogy along with "Tim" and "Ben" as the bar tenders. It compares our current solutions to nothing more than the 'hair of the dog', painting a clear picture of what needs to be done. The video is not biased either, with a fair representation of Keynesian economics.

Back in the real world Greece finds itself on the ropes once more, the bond vigilante's are turning up the heat sending rates upwards meaning rollover default is becoming a real danger. As quick as the pansy states will be able to cut their budgets, the rates on their bonds will rise over the long term negating all of the spending cuts. Portugal was thrown in the same gladiatorial arena, as the med club cousin found it couldn't find buyers for some of its bonds. Who's next - Spain, Italy, Japan, the UK, the landscapes getting ugly as distress in the bond bubble is on display for all to see. The Euro fell, but the Germans seem to be having no Southern Shenanigans. Staunchly opposed to any bailouts instead demanding nations begin to get their house in order as their Bunds still look as solid as any other government debt instrument out there. Could the Chinese bail the Greeks out? Yu Yongding doesn't believe so declaring the assets as unsafe.

What seems to have surprised many is the speed of events and how the Greek economy has fallen into the abyss. Well this is what happens when a government runs out of bullets, the market always catches up with you. It took near 80 years for it to catch up with Communist Russia but when it did, it fell in spectacular fashion. The decades of decay are still there for all to see.

Pimcos Bill Gross has given a big no, no on UK Government Gilts as he sees not only real rates of return as an issue but the devaluation dilemma. When the UK politicians still have access to devalue, investors wisen up and realise its not just the interest rate you need to worry about, its a question of will the currency still be worth the same 10 years down the line? Italians used to perform this form of default when the basket case lira was around, nonetheless international money gets smart and knew not to trust an Italian Government. Similar to their driving, reckless.

In Britain it goes from bad to quite simply awful. Over in America Obama has felt the peoples backlash of late, with all the Wall Street bailouts and excessive government intervention coming back to bite him. Meanwhile the 'Great' British public reward Gordon Brown, increasing his bounce in the polls, even though the current Labour government are doing all they can to make the fundamentals worse. That's the British for you, we believe in the free lunch and that Government can solve the issues of the day. We like illusions, inflation, governments and think there's not enough spending on public services despite our gigantic deficit. Americans talk of dollar death, they should think about coming over to Europe and see how to really mess things up! Sorry Peter Schiff, its not just America that's the 'Caboose', its pretty much the whole of the West.

Japan has been in the news a fair amount lately, with many commentators declaring default could occur there first. While Japan is a basket case, their savings rate is not what it was and they are all getting a lot older, they still have a lot of currency reserves, second only to China. They will sell these first to pay for the latest Government who are following Keynes advice just like the previous Government did for the past 20 years. They will also stop buying US Treasuries at some point, which they still seem to have an appetite for, instead buying their domestic bonds. Of course they will go pop at some point. You don't build up 200% of government debt and not pay for it. Any slight move in rates would be fatal, therefore expect the above actions to be taken first.

Switching gears, Shells profits collapsed forcing the sale of its assets and job losses for the oil giant due to oils lower price. You always hear about price rises in the media, but never hear about the falls. When oil was around $148 a barrel, it was the 'evil' oil companies that was causing the price to rise, profiteering at the expense of the public. When it collapsed, the same reasoning didn't add up as the same companies were scrambling to mend their books. 'Why didn't the price of oil fall at the pump substantially when its price fell from $148 to $40' - simple its hedged. The free market insulates consumers from the volatility in the commodities markets by using futures contracts to hedge against price spikes and dips. Hence the price at the pump stays fairly stable in comparison. The only reason the price rises over the long term is from Government Monetary mismanagement. Of course the government likes to blame speculators, oil companies, Arabs and the public generally buys the lies. Against gold of course oils price doesn't really move anywhere over the long term, but enough on minor details such as these.

Reports again come out detailing inequality is larger than it was thirty years ago. As Milton Friedman once said "We all start the race from the same point, but each one of us has a different finishing line". Markets enable us all to prosper and follow our own goals, using our available talents. Governments are the ones who ensure further inequality. The monopoly on money ensures the currency is inflated, enriching the asset rich at the expense of the asset poor. Lower incomes are also crushed further as a larger chunk of money is used to buy everyday goods, food, energy and so forth. The Government welfare state has meant the 'why work?' culture further expands creating an increased disillusioned underclass stuck in a vicious circle. Charity starts at home and the only way to help people is to allow them to help themselves. Who says the free market can't run a social welfare system? They already exist in the form of voluntary organisations who gain donations or Church organisations. People are more reluctant to claim if they can see the people providing the handouts, rather than some faceless factory system, where the government churns out the public's money. Of course we only get widespread unemployment when the free market tries to correct the governments wrong doings. Otherwise shocks to the whole system wouldn't occur, outside of a natural disaster of course.

Coming full circle back to Hayek and Keynes, I always find history is full of interesting stories. One such story is before Keynes wrote his famous book in 1936 becoming the de-facto textbook in economics, Hayek had critiqued Keynes previous works. In Keynes previous work, Hayek had done such a good job that Keynes declared to him that he no longer believed in what he wrote and had gone back to the drawing board to write his famous general theories. When this later book was released Hayek decided not to critique it as he didn't wish to waste his time again and felt everyone would see it to be as flawed as his previous works. The rest, they say, is history.

The Euro, the Pseudo Gold Standard

The Euros showing signs of stress lately. The Dollar climbed to $1.43, its highest in three months as the fiat race to the bottom continues. Greece's sovereign debt was downgraded with the third generation of a Papandreou residing at the helm in what looks to be another Greek catastrophe. Spain somehow continues to mask the mess it finds itself in. At some point the poison will inevitably seep through. Meanwhile with regards to the other PIIGS (yes thats two i's, Ireland and Italy) we find Ireland have launched their second cost cutting budget in an attempt to appease the other 'sounder' Euro states. According to the governments figures they have come out of recession unlike here in the UK. Italy's leader Berlusconi took a beating, literally. Although the attack was appalling, its more disturbing to see such popular support for Massimo Tartaglia, the person who carried out the senseless assault. Austria's Government followed the new global trend by effectively nationalising the countries 6th largest bank, Carinthian Hypo Alpe Adria Bank AG, with the taxpayer now becoming it's largest shareholder. It's not the only bank in trouble with the countries 4th largest, Oesterreichische Volksbanken AG, also under the governments watch. Exposure in the Balkans and Eastern Europe, Austria's banking system is looking more insolvent as time goes on. Despite what Americans say about their banking losses at least their banks are declaring them. Europe's financial system is one monstrous black box, with everyone trying to call each others bluff. Even Germany seems to be throwing out the rule book announcing tax breaks despite a widening budget deficit, however compared with many other countries double digit percentage horror shows it won't sound an alarm with the bond vigilantes.

There's been many commentaries written in relation to the Euro the single currency that's used by 16 separate nations, usually critical toward the faceless bureaucrats who reside in Brussels. However its important to understand how the Euro came about. During Bretton Woods I, when the US was on it's quasi Gold Standard, they pegged the dollar to gold allowing only foreign central banks to redeem their dollars for gold. With increased deficits by Kennedy and then by Lyndon Johnson this spending had to be paid by someone, therefore the government does what it usually does, it printed money to pay the difference. When the Bretton Woods agreement was created the Keynesian's proclaimed that redeemability of the dollar for gold would cause no issues as institutions would never need to claim. Unfortunately for them they didn't count on Jacques Ruff advisor to former French president Charles De Gaulle. 'They run deficits without tears', thus Ruff advised De Gaulle to call the Americans bluff and trade in the paper promises for something that the American Administration couldn't create out of thin air. Others followed suit.

The rest as they say was history. Bretton Woods I was abandoned, in which we moved to the current global monetary system we still have now. The erratic fluctuations of the currency markets during the seventies accompanied with widespread financial turmoil prompted many European nations to look for solutions to stabilise trade, thus the chaos became one of the prime reasons for the single monetary currency created two decades later. There was an obvious issue from the start. Two distinct tribes existed within the union, the North dominated by Germans who had previously presided over the Mark, a currency as hard as any other in its day. The other faction, the Southern Mediterranean nations a historic bunch of pansies that would use their currency at the first instance of economic trouble to try and solve their problems. During its first 10 years all seemed well but when disorder came, the Mediterranean nations suddenly found themselves in a bind. They couldn't devalue or print as they had in the past, instead they were told by the Northern circle that they must cut their deficits along with reckless spending. Don't get me wrong, the ECB have dabbled in QE however in comparison to the Drachma, Lira, Escudo or Peseta if they still existed and were in the hands of the irresolute Southern Europeans, then things would be getting a whole lot worse for such countries as we tread into unknown waters.

The Euro is in effect a Pseudo Gold Standard for some. Similar to when the majority of nations had a fully convertible Gold Standard, there are checks on Government spending such that they can not rob the public through inflation, or sidestep genuine long term fixes with short term devaluations. This is not to say the rules can't be bent, the rules are always for bending when the government is solely in charge. For example the deficit limit for states that were to join the Euro was originally set at no more than 3% of GDP. Problem being that nations such as Portugal just moved some of their deficit from the official figures to assist in their entry into the Euro to meet the criteria. After the financial crisis fiscal restraint has been put on the back burner, another crisis will need to occur before anyone gets serious again.

Like a Gold Standard, the old bundesbanks dominance on the ECB acts as a check against others that are more willing to deploy looser monetary policy. It depends if you have the stomach for such medicine as to whether you believe it is beneficial.

Many commentators state that the Euro is the problem facing countries like Greece, the reasons given are usually the very same policies that got them in the hole in the first place, in this case excessive government involvement and monetary inflation. They are usually correct on one point, that it was the Euro that exacerbated the credit boom for many such nations. Generous subsidies to promote the Euro's launch created undeserved prosperity, accompanied with negative real interest rates in such countries, meant loose lending was endemic.

Ideas that increased inflation and spending can alleviate the problems we face are wrong. They instead increase the states control and crowd out private enterprise and initiative. Not only does it fail, but it becomes an immoral path as genuine savings are stolen from the people.

One of the questions people ask is what will become of the Euro? Will it survive? Will its members fragment? Will it gain in numbers and strengthen? I don't think we can arrive at a conclusive decision on any of the above as they are all legitimate possibilities.

Fragmentation could be possible. A number of nations could drown in their own debt but we have to realise governments always bend the rules. The ECB may show a tough hand for the moment but could ease if events got out of hand. If a nation did wish to exit then imagine the stigma attached to the politician in office at the time. It would take a brave politician to declare an exit from the Euro while others in the Balkan's, Baltic's and the East are clamouring for such prestige.

Would others join the Euro as a refuge? Possibly, however if the above were to occur we could see the emergence of a new strengthened Euro. Nations such as Norway or Switzerland could join, forming what would be one of the soundest currencies in the world. They didn't join in the beginning with the current members therefore , if the weakest were weeded out they could have a change of heart. This would be the only reason I could see them joining.

Survival? I'm bearish on all fiat money. Even the Euro. There are many problems contained in Europe. It could however emerge as a genuine contender to the Dollar if the harder money circles have their way.

So is the Euro a good or bad thing? Well I'd prefer the ECB administering my nations currency rather than the current set of inept individuals who are running riot with the UK's monetary policy. German jokes aside, you have to wonder how they do it. After a crippling war they arose as the dominant power of Europe once more, a dynamic economy that produced quality products, while other Western nations industries went into decline. It dealt with unification as Communism collapsed thus inheriting a nation with years of decay that required to be rectified. She then became one of the key participants to unify Europe under the single currency opting to bin their sound Mark. Subsidies were provided to Ireland and Spain to promote the Euro, subsidies paid for by the German taxpayer. She wasn't even resource rich, importing many commodities. There was however a culture of hard work, along with the abstinence of partaking in speculative activities such as Real Estate even as the 'Anglo-Saxon' economic models mocked the Germans for relative stagnant growth in comparison. Since the arrival of the crisis the jokes have stopped and once more the Germans hold the key to Europe, to the pseudo fiat Gold Standard known as the Euro. History leads me to the opinion that I'd prefer the Germans to manage my sovereign currency. Its the same story for many others who are current members of the Euro, it just depends if their culture can adapt to a different monetary way of thinking.

British Pound Devaluation Delusions

"It does not mean that the pound here in Britain, in your pocket or purse or in your bank, has been devalued."
Harold Wilson, British Prime Minister, after the Pounds devaluation in 1967

"A weak currency arises from a weak economy which in turn is the result of a weak Government."
Gordon Brown, During the Pounds devaluation after it was withdrawn from the ERM


Mervyn King the Bank of England's Governor has been causing a stir in the markets this week. Despite Sterling being a flawed currency it hasn't stopped Mervyn King from making comments that he feels a weaker currency is beneficial for the UK. Undeterred by the pound losing around a quarter of its value, it seems that the BoE still feel the need to send it lower. US-centric reporting has been emphasising the Federal Reserves draconian monetary actions, but yet it is the UK that leads the way in QE and the destruction of its currency. Labour Governments always seem to be in power when the pound gets a pounding. 1931, 1967, 1976 and recently 2008 and beyond. If Neil Kinnock had won the 1992 election like so many believed at the time, they would have got the whole set for the past one hundred years. So what does it matter that the pound has devalued of late? Is it as black and white as 'it will boost our exports', that the media and business pundits proclaim? I agree with the quote above, not Harold Wilson's, but Gordon Browns. Over the long term, Governments that use their currencies to try and solve their economic troubles are doomed to fail. If you try to alleviate trade deficits with this mechanism over the short term it may succeed, but eventually more devaluations will be required in order to 'boost' exports again.

Implications of Devaluations

An examination of the devaluation is required to understand what benefits/disadvantages it brings. Governments always claim that this will lower the cost of our exports, which it does, but no analysis is paid to what actually occurs. If we examine a factory that exports goods, they may be struggling to compete, say against similar German products. A devaluation would instantly lower the cost of the good on the export market. The German Government, for example, may hold steadfast and are not willing to allow their currency to depreciate by the same margin. The British company without doing anything have instantly gained a cost advantage, in effect a free handout. The German company on the other hand has to look for savings itself. Management immediately begin cost cutting, increase productivity or improving their processes. They look at their product, they start to innovate or add extra features or improve the quality to justify the short term price dynamic that has just occurred. The British management does not need to do the above. They can produce the exact same product, using the same processes as there is no immediate need to innovate.

Also something much worse occurs. For the sake of the example say the two products, German and British, now are priced at €500 and €400 respectively after the devaluation, whilst previously they were €500 and €550 respectively. The British management now can increase the price over the short term, to say €450 as they are still cheaper than the German products. This extra margin may go into inflating workers pay, or other company benefits. Not only have no product or business improvements happened, but the British company is also rewarding itself.

The Import Dynamic

Misreporting in the media leads us to believe that the cost of our overseas holiday is the biggest headache when the value of our currency goes down - if only. When the currency takes a fall the whole nation is immediately given a pay cut, all our imports now go up in price. If we have to buy raw materials or products produced abroad it now costs us more, our purchasing power has effectively fallen. In the example given above, if the British company has to import any materials to produce its end product these will drive up their costs. Also the public now have to pay more for the product in question. The cost may seem to have reduced to €450 but remember its all relative, the British people are still getting paid in pounds. People can't buy the same amount of products as imports go up. A price spiral starts. The mechanic who imports car parts from abroad must now charge the public more for car repair work. There are an infinite number of other business transactions that take the same format as the given example. All these costs eventually come back to the British company as their workers require higher wages to cope with the higher prices. This in turn keeps driving the cost of the product higher. Meanwhile in Germany, they have continued innovating lowering their costs through business improvements, driving costs down in order to compete and in turn producing a better end product. The end products cost after a year or two, could now be say €400 and €500, for the German and British companies respectively. The British company is back where it started but in a worse condition, as they have fallen further behind in terms of productivity and end product quality.

The above process can develop into a vicious spiral, with the British company loosing further export share and demanding further devaluation in order to 'boost' exports. There is no simple fix, if a currency goes down in value it doesn't help anyone.

What needs to occur is to let the market take the pain, not the currency. This may mean higher unemployment in the short term, but people and companies get competitive again. Any nation in history who has enjoyed an export boom has done so on the back of a strong domestic currency. Britain during the 19th Century, Germany and Japan through the second half of the 20th Century, the US when they rose as the global superpower. However times change. For the past 30 years or so US politicians have put forward the benefits of a lower Dollar for jobs and exports, but over the years it hasn't worked. Workers wages continue to decline, and US companies continue to disappear.

In Japan from the end of the second world war up until just before the lost two decades, the Yen dramatically appreciated against the US dollar. Yet Japanese exports during the same time frame also increased. Westerners used to joke that Japan only produced kimonos or tiny cheap ornaments. Japan subsequently underwent a huge economic development, beating the West on car manufacture and electronics to such a point that it has now become hard to name a handful of Western electronics companies. In 1970 the Yen was valued at around 357 to the US dollar. Within 20 years it was 146, more than doubling in value. During the lost two decades it hasn't moved much further, to around 90, however its worrying that its still appreciating despite the stagnation of the Japanese economy during this time.

Where does this leave the British Pound?

It's worrying when the people responsible for the defence of a currency welcome devaluation and even believe that this will solve the economic imbalances we face. You can't solve a domestic economies shortcomings by debasing the currency. The British Pound has resumed what it was prior to the late seventies and early eighties. It's once again the whipping boy in the currency markets. Investors beware, the British Pound will not be a place to be for the foreseeable future.