DABERIAM LXXXIX

March 2015

Nothing has changed in my view of Europe since the pessimistic comments in January.  The EU’s fiscal regulatory regime and credibility continues to be undermined.  One of the primary objects of the European Commission, and indeed one of its claims to legitimacy, was the ability to discipline individual states and ensure their finances were properly run.

In February the deadline for France to bring its budget deficit under the EU limit of 3% was extended to 2017.  France has failed, in spite of earlier extensions, to implement the fiscal and structural reforms needed to keep its budgets under control.  Even after the extension was made, the Economic Minister indicated that it was unlikely that the targets would be met before 2018.

Italy has also been let off from complying with the budget rules and its debt level is only marginally behind Greece.  This brings us to the Greek government’s political strategy of publically defying EU rules. Greece was on the verge of default some two or three years ago and the problem was only postponed because the German Chancellor was worried that a Greek default would cause serious damage to the German banks.  More debt was piled on to service what was already effectively a bankrupt situation.  The latest twist in the Greek debt saga is the introduction of the game of Russian roulette! The new Greek government going into the negotiations has already indicated that it might not continue to support EU sanctions against Russia.  It has to be remembered that to continue this policy, the EU requires unanimity of Members’ votes.  The current state of play basically pushes the Greek debt issue down the road, while it is clear that the steadily increasing deficit is unsustainable, a restructuring – the polite word for default – is still not acceptable to the convoluted workings of the Commission.

The European Central Bank’s role in all this has become pivotal and we will know in the next week to what extent the QE card will be used to help finance the Greek government.  The muddle of Europe is dragging the Central Bank into the political arena and undermining its independence. 

The UK is suffering massive political instability.  Even before the election campaign gets fully under way, disinterest in the main parties is apparent.  The result of this disinterest is probably the major reason behind the proliferation and popularity of fringe parties.  The random announcements from both Conservative and Labour leaders add confusion.  House-building numbers are announced disregarding all logic or acknowledgement of the fact that probably the major headwind for housebuilding is incoherent planning departments at local authority level.  Industrial policy announcements are random, and devolution promises come out like confetti.

My nightmare scenario in January of a Scottish National/Labour coalition seems, unfortunately, to be gaining ground as a possibility.  It seems, however, that whichever government is formed it will be a coalition, which will increase the possibility of another election in the relatively near future.  While wages are rising, which is good for the economy, capital investment is still subdued.  Not, as is often publicised, because of lack of finance but mostly concern about the uncertain political outlook.

The US economy continues to run ahead of expectations, in spite of the decline in oil related capital expenditure owing to over-supply and the low price. Overall, industrial expenditure is rising satisfactorily. 

Consumer expenditure is also rising comfortably, mostly driven by wage increases rather than debt, which is all good news.  With wages rising and the cost of living index hovering at zero or marginally below, economic growth is set to accelerate.  There might be a small dent in this prognostication as a result of the severe weather and the west coast dock strikes in the first quarter.

The economic situation in China continues to deteriorate and is on course to come in well below the government’s 7% target.  China has experienced a generalised deflationary trend and there is already considerable capital outflow which is impacting foreign exchange reserves.  While it is apparent that the situation is deteriorating, there is no indication yet that the government will change policy.  In any event, it is difficult to see what they can do other than let the painful rebalancing take its course.

On a final note, Russia has to be considered to be at a crossroads.  The Kremlin’s propaganda against the West and internal dissidents is taking on a life of its own and it is difficult to see how Mr Putin, even if he wanted to, can roll this tide back.  The West will have to play a careful game, trying to avoid too much public rhetoric on the one hand but getting itself better situated with a big stick on the other.  A difficult balancing act for the EU where policy is hard to come by!