Economics & Finance – Page 20

Inflation and the British economy

There is an excellent article in today’s FT by Chris Giles. Unfortunately this is behind the FT paywall so I don’t think clicking through will help most of my readers.

Mr Giles considers what has gone wrong with the British economy over the last year – since growth forecasts are being consistently revised downwards. Two explanations are often offered – “it’s the Euro crisis” or the government is cutting “too far, too fast”. In fact both are wide of the mark. The simple fact is that while rates of pay have stuck broadly on forecast (2% increase), consumer prices have increased by more (over 5% compared to just over 3%). The gap is plenty enough to explain the lowering of real terms growth.

Why have prices shot ahead of forecast? Mainly external factors to the British economy – oil prices, global prices for food and clothing and so on. I really don’t like calling these price rises “inflation”. Inflation suggests a degrading of money which, inter alia, makes debts easier to afford. But incomes aren’t keeping up, so debts aren’t eroding by more than the 2% a year or so that incomes are rising. Similar considerations apply to government debt – taxes largely depend on income. VAT is an exception – but many benefits (like pensions) are linked to the rate of increase of consumer prices – so the national debt doesn’t get any more affordable.

The economic pain of these external price rises is being spread widely. Surely the Bank of England is right not to tighten policy – which would only cause unemployment and concentrate the pain on an unlucky few. Our comparatively low rate of unemployment, compared to previous crises of this economic scale, is one of the wonders of the British economy.

Five Eurosceptic fallacies

I caught a bit of last night’s Radio 4 Analysis programme driving home from a meeting, on Euroscepticism in Britain. One speaker (I didn’t catch who) suggested that the case for Britain being in the EU was mainly economic – that we could put up with a bit of lost sovereignty because we were being hitched to an economic powerhouse that would do our economy good. This he said, was now clearly nonsense. In evidence he said that the EU used to be 26% on the world economy and now it is 18% (I may have misremembered the numbers). “We are being chained to a corpse.” I was apoplectic. But it is typical of the drivel that is being spread across our media. It’s worrying that so few people bother to argue back.

Let’s clear the decks with some points of general agreement. The Euro is in crisis, and this crisis could lead to an economic disaster. This in some measure results from severe mismanagement of the currency by the EU’s leaders, aided by the European Central Bank (ECB). The stock of European institutions is low in public eyes, not just in Britain, but across most of the continent. This has something to do with a democratic deficit – with the institutions wielding power with little apparent democratic consent.

But it is possible to accept all this, and to think that the EU, and even the Euro, is fundamentally a good idea, and that Britain would be mad to consider leaving it. The country may even be forced to join the Euro – though that event is surely a long way off.

Let me try to help the feeble defenders of British membership by elaborating four critical fallacies behind the Eurosceptics’ arguments, and fifth that is a bit more arguable.

First fallacy: there is such a thing as “just” a free trade area. It often said the the country joined something that was just a free trade area, but this has morphed into something else. But free trade across borders is a complicated business – and not just a matter of border controls and tariffs. Its implications quickly reach into vast swathes of ordinary life. Most of the US Federal government’s powers rest on its right to regulate interstate trade. And the unhappy experience of the North American Free Trade Area (NAFTA) shows how politics gradually undermines transnational free trade projects that do not involve a significant pooling of sovereignty.

Fallacy no 2. Britain is being ripped off by the rest of Europe because we have a trade deficit with them. This leads to the idea that outside Europe we would get a sweetheart deal (like Norway of Switzerland, or at least in popular myth) because they need us more than we need them. But the British trade deficit arises from the chronic mismanagement of the British economy, which led to a prolonged period (since the late 1990s) where the Pound was too high for many of our export businesses to be competitive. This uncompetitive exchange rate has now been reversed, and so our trade balance with the EU will correct. And as for bargaining power, there is a fatal flaw to this line of reasoning: the relative size of the UK against the rest of the EU. EU trade is a major part of our economy; UK trade is not a major part of the EU economy.

Fallacy no. 3. Being outside the EU means that we don’t have to comply with EU regulations. This is largely true of the labour market, it has to be said. But far from true of product markets – since we need to sell our products in the EU. Also, if foreign manufacturers are forced to comply with separate British product standards before they can export here, they will either charge us extra or not bother. If you are in any doubt about this ask a Norwegian or Swiss about how much better life is without the burden of EU regulations. You will get a lecture about how they have to comply anyway, without any input into how they are made. This is of particular relevance to one of the areas where Britain has a competitive edge: financial services. Our representatives in Europe are forever batting back ideas for new rules that would disadvantage the City; I wonder what would happen if they weren’t there any more?

Fallacy no 4. We would save money by leaving the EU, because we are a net contributor to the EU budget. This is an illusion. We may pay less in net contributions, but we would pay more in tariffs And if we charge more tariffs in return? Any economist will tell you that this is a road to nowhere. Our net contribution is a small price to pay for access, and, besides, some of it helps to develop new markets in the Union’s less developed countries.

Fallacy no 5. Britain would have been worse off by joining the Euro at the start. This contention is unprovable, as is the opposite: that we would have been better off in it. The Euro, of course was badly managed. But so was the Pound. While the Euro was going on, the pound shot up in value, destroying many of our exporters and creating a big trade deficit. Borrowing ran amok, as did, to a lesser degree, government expenditure. When it all blew up, it left the British economy in a terrible state, one that it will take many years to recover from. Won’t the devaluation of the pound help our recovery? Yes, but it should never have got that high in the first place. What would have happened if we were inside the Euro? Almost certainly no better – except that our problems would have been more transparent, so we might have started to fix them a more quickly. My point: an ugly mess either way. Look at our Eurozone colleagues and the British economic performance does not look stellar. A floating currency is no free lunch.

Of course there is a lot wrong with Europe and the Eurozone. That does not mean that this country is better off outside. The best case for a referendum in this country is that it would force supporters of the Union to make the case more forcefully, and expose the fraud behind the anti-EU case. But on their performance to date, who can be confident of that?

Lib Dems and the Quality of Life

One of the more entertaining episodes of the last Lib Dem conference was the debate on the party’s new Quality of Life policy paper. This paper had wended a long but largely uncontroversial path through the policy formation process, including extensive consultation, before reaching the conference – and I was a member of the working group – interest declared. And generally policy that has followed this path gets more or less nodded through. Not this time. The motion and paper got the backs up of many representatives, and there were a number of well-delivered and entertaining speeches against. For a flavour of this ire see Alex Wilcock’s blog – scroll down past the Dr Who stuff to 20 September. If you click through to the comments page, you will find Alex describing yours truly as “not so much a thinking liberal as a sneering one”! The paper was passed, but the margin was quite narrow by the usual standards of these things.

And that’s a bit of a problem. This is policy that stands behind other policy – important not so much for its direct recommendations as its influence on subsequent policy. I hesitate to call it philosophical – since it does not attempt to develop the core values of the party, but rather to apply them in a new way. But if it is considered contentious, it may get ignored. And for all that it is official policy, this would be quite easy.

What’s the fuss about? The starting point of the paper is that public policy is too dependent on “hard” economic statistics, such as income and economic growth, to measure success. But these are only intermediate measures – in other words we like them because they lead to good things, rather than being good of themselves. That is because of the difficulty of measuring success in itself – the hitherto rather woolly concepts of wellbeing and quality of life. But social science has been advancing rapidly and it is now possible to measure wellbeing in a rigorous way – mainly through asking people to make subjective judgements on their state of mind.

What the paper recommends is to make wellbeing an explicit policy goal, alongside the traditional economic measures. To ensure this is done rigorously, it recommended that a National Institute of Wellbeing is established to promote standards. Various other devices (a cabinet champion, for example) were recommended to get it embedded into the business of government.

So far, so good, perhaps – but for liberals some loud alarm bells should be ringing by now. This could be a charter for highly paternalistic government. And especially when you come up against the evidence that many people seem to have a poor understanding of what is good for their wellbeing. So the beating heart of this policy paper is the insight that individual autonomy (“agency” in wonks’ jargon) is central to wellbeing. The idea is to help people help themselves, and not bullying and cajoling them into making better choices.

Education is central. And, to make a small digression, this takes you in a very interesting direction. A lot more is understood about life skills – emotional intelligence, resilience, and such – and the wellbeing insight gives these a much higher priority at all levels of education.

Fortunately there is a wealth of evidence to support the liberal view. There one further thing – the measurement mechanism of choice for social sciencists, self-reported wellbeing, is a thoroughly liberal idea. Wellbeing is what the population says it is, and not an arbitrary idea imposed by policymakers. It’s like voting.

What were people objecting to? One faction distrusted anything with so little in the way of concrete recommendations – especially when those few recommendations sounded like more bureaucracy and a new quango. At best they interpreted it as harmless, and so a cost-free policy to rebel against; at worst they thought it was opening the party up to being criticised for being irrelevant in times of widespread economic hardship. Others, Alex was amongst these though he was not called to speak, understood how dangerous the the quality of life idea could be in the wrong hands, and felt that it was too toxic to touch. Or, possibly, that the detail of the policy paper did not live up to its liberal intent. At any rate that is my reading of what they were saying.

All this put the promoters of the motion in a bit of a difficulty – it is really quite difficult to push abstract ideas in this kind of debate. In a short speech you don’t really have much opportunity to say more than “I think this is a good idea” rather than why you think it is good – at least not in a way that will connect to more than a minority of the audience.

Does it matter? The problem is that the wellbeing agenda is slowly but surely infiltrating itself into the public policy process already. The word (or “well-being”, the spell-check compliant variant which I don’t like) and quality of life come up with increasing frequency in all kinds of public policy contexts, and especially in health. The concepts, if not the measurements, lay behind so much of the last government’s meddling in people’s lives. And David Cameron is an enthusiast too, though with an entirely different agenda -but no doubt paternalist in a different way. Liberals need to get into this debate and push back hard against paternalism – but using the language of wellbeing, and not just pronouncing the plague on all its works.

And there is something else, even more important in my view, which the paper doesn’t really touch. And this is the usefulness of the idea in promoting a more environmentally sustainable economy. It is important to break through the tyranny of current economic measurements to show that a more sustainable way of life does not equate to poverty – and indeed that it can be better for everybody. This is why the New Economics Foundation is so interested in wellbeing. I particularly like their paper on Measuring our Progress.

So we need to keep pushing. As one of the motion’s supporters said to me afterwards “Who remembers how close Nick Clegg’s margin of victory was for the party leadership?”. Still, we that understand and support the policy have a selling job on our hands.

Understanding the Euro Crisis

My favourite contemporary economist is UCL’s Professor Wendy Carlin. She was my tutor at UCL, and led my second year macroeconomics course, and a third year course on European institutions. Her patient, dispassionate analysis is worth so much more than all that shoot-from-the-hip banging on by celebrity economists, Nobel Laureates and all. It was her analysis, well before the current crisis broke, that demonstrated to me that the last government’s economic “miracle” was unsustainable (the combination of an appreciating real exchange rate and a trade deficit being the giveaways). She also helped me understand the Eurozone, and pointed out the trouble ahead, again well before it happened, arising from diverging real exchange rates within the currency bloc – in other words Germany was becoming more competitive while Italy, Spain and others were becoming less so.

So I was delighted to read her summary of the Eurozone crisis – 10 questions about the Eurozone crisis and whether it can be solved. The is a wonderfully clear summary of the whole situation, written in early September. Her central point is that the zone’s banking system is at the heart of the crisis, and tackling the banks will the heart of any solution. European politicians have been trying to avoid this, no doubt because it shows that Northern European countries have played an important role in creating the crisis. However, not least thanks to the new IMF chief Christine Lagarde, this is changing.

Of course Professor Carlin cannot point to an easy escape. She points to two alternatives paths, other than the breakup of the zone:

Scenario #1 – a more decisive approach based on current policy (bailouts)
Policy-makers need

the existing bailout schemes to be successful and to be seen to be working in the next year

to keep Italy out of the bailout regime

to develop a replacement for the high moral hazard regime for banks and for governments but to do this in a way that does not undermine the bailout regime in the meantime.

Scenario #2 – large-scale restructuring of bank and government debts (defaults)
Policy-makers need

to move decisively now to end the high moral hazard regime by accepting that default on bank and government bonds on a much larger scale than envisaged in Scenario #1 is necessary

to engage in restructuring sovereign debt and bank debt by, for example, forcing bond-holders to swap existing short-term bonds for long-term

European politicians are attempting the first path, but the problem is contained in Professor Carlin’s third bullet: devising a financial scheme that avoids moral hazard by banks and sovereign states – this reckless behaviour in the belief that it will be underwritten by everybody else. The favoured answer of many is a “Eurobond” – i.e. government borrowing underwritten collectively, combined with a toothier version of the failed Stability & Growth pact. But this decisive step towards a more federal Europe runs well beyond any democratic mandate. The German Chancellor, Angela Merkel, is rightly suspicious.

Which leaves the second scenario, which is favoured by American commentators, based on their experiences of Latin American debt crises. This is surely much more convincing, and I hope that the IMF will use its influence to push down this path. Bank regulation clearly needs to change, but beyond that it doesn’t need a more federal Europe. We can use bond spreads to act as a break on government profligacy – which is how the Eurozone should have been run from the start.

A final point worth making from Professor Carlin’s analysis is that dropping out of the Eurozone wouldn’t really help Greece or any other country that much. They would still have to run a government surplus, and so still have to go through a very painful reform programme sucking demand out of their economies. Of course the hope is that a rapid devaluation would kick start exports – but it does not stop the need for painful supply-side reforms if these countries are to recover anything like their former standards of living.

Time the British woke up to the crisis in Europe

It is a commonplace for Britain’s politicos to sadly shake their heads and complain that the Euro crisis demonstrates a woeful lack of political leadership. Regardless of the fairness of this charge in respect of Angela Merkel, say, it clearly has resonance for Britain’s own leaders. There seem to be two camps: ravingly impractical Eurosceptics, and sheer paralysis from everybody else. The mood amongst Europhiles (as I witnessed at fringe meeting at the Lib Dem conference) is akin to deep depression. It is time for this to change.

To be fair some key players have been showing something less than paralysis – George Osborne and Nick Clegg have both been conspicuous in raising the seriousness of the situation with their international colleagues – but their pronouncements are hardly more helpful than anybody else’s. They aren’t bringing anything to the party and they aren’t trying bring our own public alongside.

The first point is that the Euro crisis has serious implications for Britain, much though most people seem to think it is happening to somebody else. This is for two main reasons. First is that this country would be caught up in any financial disaster. Our oversized banks are deep in the mess; Euro zone countries are vital trading partners for a country very dependent on trade – especially given that international financial services are so important to us. Our fragile attempts at recovery risk being completely blown off course. Forget Plan B if this lot breaks.

The second reason it matters to Britain is that resolution of the crisis could take the European Union in a direction that is against our interests. Britain leads the single market wing of the union: the chief Euro zone countries are more protectionist in their instincts. We risk being shut out of the design of critical architecture – much as the Common Agriculture Policy was put together in our absence.

How to proceed? We need to tackle the dark spectre head on: the best resolution of the crisis involves changes to the European treaties. To change the treaties will require a referendum here (let’s not weasel out of it this time). If we face up to that challenge now, it will show real courage, and help get things moving.

But, of course, we would need to see something in return. Changes to the treaties that would further our interests. These need to be to promote the single market, to protect London (and Edinburgh) as centres for financial infrastructure, and to reduce unsightly bureaucracy and/or operating costs of the Union (the siting of the European Parliamnet at Strasbourg needs to go on the table, at least). Given our understanding of finance, we might well have useful things to say on the Eurozone architecture too – even though we clearly can’t be part of it.

To do this our leaders (the Prime Minister and the Deputy Prime Minister in the lead) need to build two sets of alliances. The first is within the British body politic, so that the referendum can be won. This needs to cover Tory pragmatists (David Cameron, George Osborne and William Hague), the Labour leadership and, preferably, the SNP. The Lib Dems have an important role in making this hold together since, by and large, they understand the Union the best. Mr Clegg’s experience of deal-making in the European parliament counts for a lot. The next set of alliances is within the Union itself, to create a Single Market bloc. The obvious candidates are the Nordic countries, Ireland and the Netherlands, together with many of the newer members in central and eastern Europe.

This will be very difficult. That’s the point, almost. The reward is a stabler EU, constructed more to our taste, even if we must concede some powers to an inner core of Euro area countries. Everybody wins. And by taking on the wilder Eurosceptic fringe, including their newspaper backers, it will cheer all right-thinking people up. It’s time we stopped being paralysed by fear and came out fighting.

Taming the banks: two views from the FT

Oh the shame of the FT’s paywall! Yesterday the paper presented a wonderful view of the debate on the UK banking reforms proposed by the Vickers Commission with two opinion pieces under the title Taming the banks, long overdue or utter folly? For the reforms was regular columnist John Kay. Mr Kay (though I’m sure he’s not really a mere Mr) is one of my favourite FT columnists. His articles do come out on his website in due course, but not this one yet, I’m afraid. It is a very lucid article, pointing out the massive size of UK banks balance sheets: at £6 trillion, four times the size of the country’s income. Of these but a tiny fraction is lending to industry, and a rather larger fraction is domestic lending such as mortgages. The bulk of it is to the finance industry pumping up the great game of leverage. The idea of ringfencing, the critical part of the proposed reforms, is to stop the small fraction of balance sheets that matters to individuals and “real” businesses from being poisoned by financial engineering gone wrong; or to put it another way, to stop the British state from having to underwrite the latter to protect the former. Mr Kay’s only criticism is that the reforms are being implemented too slowly.

The opposing article is from Sir Martin Jacomb. Sir Martin is no more a banker than Mr Kay, that is to say he’s done non-executive directorships but not much more; he’s a lawyer and chiefly famous for saying that universities should be independent of government, and that Oxford University should cut its ties with the state. The bankers are in fact rather quiet on the reforms, after some rather clumsy lobbying to get the implementation delayed, which appears to have been quite successful. The weakness of their case seems reinforced by Sir Martin’s article, which nearly nonsense. Is this really the best the FT could find?

Sir Martin reiterates a familiar litany:

The reforms advocate breaking up “universal banks”, but this model “can be perfectly safe”.
It will hurt the City’s international position. “There must be universal bankers in Frankfurt rubbing their hands.”
It will cause the loss of jobs and taxes.
the new banks will not able to offer helpful products to industry.
It does not address the immediate problems besetting European banking, “which result not from mistakes by bankers so much as blunders by European Union governments in the management of the euro.”

This lot is readily disposed of:

Universal banks did not come out the recent crisis well. It is true that some of the better managed ones did not need direct government rescue (Barclays and HSBC in the UK, BNP Paribas, JP Morgan), though still benefited from implicit and explicit guarantees. But far too many did, especially in America (notably Citigroup and Bank of America), here (Natwest and HBOS) and Switzerland (both UBS and SBC).
This is yet another cry of “Wolf!” from the City. I remember how us not joining the Euro was supposed to kill the City in favour of Frankfurt. The City’s standing is based on network effects of people, skills and time zones. Most of its activity is from foreign owned institutions already. If the UK owned activity shrinks, it is because the public liabilities that go with it are too large. It best that we adapt.
This sort of answers the jobs and taxes bit. As Mr Kay points out, lending to job-creating non-financial businesses should not be affected, and might even benefit if they do not have to compete for attention with gearing up of financial products. It is much healthier if our economy is less dependent on highly paid bankers’ jobs.
Sir Martin uses the example of a currency hedging, which might be useful for an exporter with a long term contract. But surely his ordinary banker can introduce him to an investment banker at little extra cost?
This is true; it’s a separate issue. But is quite astonishing for him to suggest that the Euro area problems are the fault of politicians rather than bankers. It was the bankers that bankrolled the Italian, Portuguese and Greek governments at absurdly cheap prices. It was its banking industry that laid the Irish government low. It was bankers from across the zone that pumped up the Spanish property bubble. This kind of “it wasn’t us” defence from bankers simply shows how little they have learned from the disaster.

Apart this whingeing, Sir Martin makes a more subtle point. We should be promoting more competent management amongst banks, and excessive regulation does the opposite. Well, we must ask what caused the rampant incompetence in the most of the world’s banks before the crisis. Surely it was the thought that if things went bad governments would come to the rescue, and it would all then be somebody else’s problem? This is exactly what the reform seeks to address. By separating the investment banking side out, it means that failure from that side will be easier to tolerate, and should not require the UK tax payer to stump up. The retail side would be bailed out in the event of a failure, true, but it will be more difficult for these banks to pump themselves up to create a massive hole.

There is an irony behind all this. The point about banking reform is to make banking more, not less risky, for bankers anyway. We need to see more bank failures, not less. The by-line to Sir Martin’s article is perhaps its most cogent bit: “Beware the paradox that a system to limit risk invariably increases it”. But risk to whom?

Time for Plan B?

Predictably, the heat is mounting on the British government to soften its fiscal policy in light of weak economic growth. Today the new IMF chief Christine Lagarde seems to be adding to the pressure, even if she wasn’t explicit. The code for changing this policy is referred to by political types as “Plan B”. I am now convinced that some sort of Plan B may now be a good idea – but it would not take the form that a lot of Plan B advocates, especially the Labour opposition propose.

First, why? I have been progressively convinced by the FT’s economics editor Martin Wolf. I have found him to be easily the most cogent commentator on the current economic situation, better than any number of economics Nobel Laureates or former members of the Bank of England monetary policy committee, who seem to think that their past glories can compensate for the shallowness of their analysis. Paul Krugman, Ken Rogoff, Joseph Stiglitz, to name a few, have disappointed somebody that has respected their weightier works; David Blanchflower has turned downright silly in order to widen his audience. Mr Wolf has been consistent, logical, and has gone further than most to try and understand all facets of the arguments.

The problem in the UK economy is not lack of consumer demand, since consumers are right to pay down debt as a priority right now. The problem is lack of business investment, and a weak world economy, and hence potential export markets. And excessively tight fiscal policy may send investment into a doom-loop, since so much depends on confidence. Add to that the fact that current levels of public expenditure are unsustainable, and the massive size of the public deficit, and you will understand that most versions of Plan B are unconvincing. Reducing the cuts simply creates problems for later, and builds up a false confidence in what this nation can afford. Cutting VAT temporarily, as advocated by Labour, addresses the wrong problem.

The answer must be to promote investment. As Mr Wolf points out (here but behind the FT paywall), there is a golden opportunity for the government to do so because its borrowing costs are so low. The trick is finding projects that deliver a convincing financial return; borrowing against such projects does not undermine the country’s finances. Unfortunately this is easier said than done. A lot of public projects make extravagant claims about their worth, but are in reality wasteful prestige initiatives – think of the Building Schools for the Future programme. Or else they turn out to be so badly managed that promised returns are never delivered – think of NHS IT, or Edinburgh trams, or anything undertaken by the Ministry of Defence.

There is no doubt some scope for increasing funding to standard public projects. But actually what needs to be done is to provide more support for medium sized and small businesses, especially growing ones. The banks are not stepping up to the plate, demanding ludicrous returns for their efforts. Surely there is scope for the government to beef up regional development funds and increase funding for institutions such as the Green Investment Bank. This will not open the floodgates to usher in an era of rapid growth. But surely it would help.

The Euro: Thatcherism by other means

It’s a grim time for supporters of the Euro project like me. Hardly a day goes by without hearing some highly patronizing person going on about how a country fixing its exchange rate is a terrible idea because it can’t then devalue when it hits trouble, and how the austerity policies in the Euro zone are doomed to fail. One irony is that many of these people are from the the political right; the sort of people who think that the Thatcher revolution of the 1980s was not just a good thing, but a turning point for the British economy. In fact the Euro advocates are proposing very similar medicine for southern Europe.

The UK economy inherited by Mrs Thatcher in 1979 was a mess. Both unemployment and inflation were persistent, and the country was referred to to as “the sick man of Europe”. Mrs Thatcher’s solution was to focus on the long or medium term drivers of success, with utter contempt for short-term palliatives. She progressively liberalised the economy, and in particular the labour market, then dominated by trade union power, and taxation, which had reached punitive levels on the rich (and not so rich, come to that). In macroeconomic policy she believed in squeezing down inflation through tough monetary and fiscal policies. Interest rates soared. Amongst other things, the pound rapidly appreciated. This was all part of the medicine.

The results were indeed dramatic. Unemployment got much worse, with devastation sweeping through great swathes of industry – all of which makes our current troubles look like small beer, even though, according to GDP statistics, we are supposed to be in a worse mess now. But in due course the economy prospered and reached undreamed of heights – though some parts of the country never recovered.

Back to the Euro zone. The underlying problem with all of the currently struggling economies, except Ireland maybe, is not entirely dissimilar to that faced by Britain in 1979. A host of product market, labour market and tax inefficiencies have conspired to make their economies relatively uncompetitive. The political will to tackle these problems has been lacking. Before the Euro they could simply let their currencies slide to offset this lack of competitiveness. But all this did was to ensure that the living standards of citizens stayed below their potential. And it was unsustainable in the long term; eventually you get to stagflation and even hyperinflation – a fate which Portugal in particular was reaching before the Euro project offered rescue. Once in the Euro devaluation is not an option, and so politicians have to focus on medium and long term reforms. This is what they are now doing, some with more enthusiasm (say Portugal) than others (say Italy).

Mrs Thatcher, of course, would never approve of a country joining the Euro – she treasured national sovereignty too much – but she would have approved of many of its consequences. Mrs Thatcher did not believe in devaluation.

But this is hardly an advertisement for the Euro for many. A lot of people still think that the Thatcher years were a period of gratuitous violence with adverse consequences that we are still suffering. It was she that was responsible for the trashing of so much British manufacturing, with the appreciating pound very much part of this. And the work she started was capably continued by Messrs Brown and Blair, since a high pound, together with aggressive exporting practices from China and India, had a similar effect in the 2000s – albeit compensated by unsustainable jobs in finance and building.

And there is no avoiding that the southern European economies need to go through a process of harsh economic reform, or else suffer a slow slide into poverty. Euro advocates had always foreseen this; what they had not foreseen was that reduced government borrowing costs once in the Euro would allow these countries to put off the evil day, only to make it infinitely worse when it arrived.

British banks shoot themselves in the foot.

Oh dear! The Vickers review on banking reform hasn’t been published yet, and the news is full of people taking positions and what it might or might not recommend. I have a lot of sympathy with our Prime Minister, who wants the blessed thing to be published before we have a row about it. What to make of it?

The reporting is a bit confusing. The Independent has hyped the thing up to be a war between the Vince Cable and George Osborne, not so much about the proposed reforms, but how quickly they will be implemented. Meanwhile somebody has briefed the FT that Cable has pretty much given way on timing so there is no real row at all.

The proximate cause of this flurry is a lobbying campaign by the banks. This campaign will do nothing to redress their general aura of incompetence. They are basically saying the reforms should be kicked into the long grass because they will interfere with their lending to British businesses, which is critical if business investment is going pull us out of the economic doldrums, as most people hope. There is some merit in this, because some of the reforms (on capital requirements and liquidity) could have just that effect. But the ineptitude of their stance is staggering.

Politics is built on simple messages, and the banks are offering the Liberal Democrats a very tempting proposition. This is a wonderful opportunity for them to show what they are doing in government by showing that they are resisting pressure from the banks. As the banks themselves continue to insist on paying large bonuses for reckless trading activities, this is a popular stand. Ed Miliband and Labour have not been slow to take up the anti-banker sentiment. The Tories, meanwhile, don’t seem to know what’s hit them, and none of their side are sticking their necks out on the banks’ behalf. Meanwhile John Cridland, the CBI director general, has weighed in on the banks’ behalf calling a rapid implementation of the reforms “barking mad”. It is difficult to understand what he thought he was doing; the CBI’s credibility has been badly damaged as a result.

There may not even have been much of a row in the coalition in the first place. There is consensus on the general thrust of the reforms; no doubt Vince Cable was quite flexible on the timings of some aspects, provided others proceed fairly quickly. Now it is important to him and the Lib Dem part of the coalition that they are seen to get results. A public row makes things worse for the banks. If ever there was a time for quiet lobbying based on dry details, this was it. Using the megaphone is totally counterproductive.

Not that I have much sympathy with the banks. They are making too much money, and any sensible reform would reduce their profits, both by taking away the implicit government subsidy and by increasing competition. It’s bound to hurt. If the banks want to take some of their activities, and even their HQs, elsewhere, then so be it. I’m not actually sure where they would go though. Switzerland has dramatically increased its capital requirements for banks, and the stratospheric Swiss franc doesn’t make operating there cheap. If they don’t have the implicit backing of a big government then their business model breaks down anyway – ruling out places like Ireland and Bermuda. Going into the Eurozone when its own banking system is under incredible stress hardly looks a good idea either. In America they have a habit of sending bankers to prison.

The central reform is to separate banks’ trading activities from their “ordinary” ones of taking deposits and lending to the public and non-financial businesses. This was quite contentious in the commentariat when it was first mooted a year or so ago. But there seems to be a much greater consensus behind it now. Who would have guessed it? A lot of people assumed the bankers would get away with it while politicians tried to make up their minds, and the disaster of 2007/08 faded into the memory. Not so. The banks’ inept PR machinery can take some of the credit.

When confidence is lost

A scary day. Here in London people are appalled by the looting and burning, and angry and panicked. Something analogous is going on in the world’s financial markets. At times like this we realise how much of a modern society is built on trust and confidence in strangers.

On the streets we hope that our well-ordered and safe lives are built on more solid foundations: law and the agencies that enforce it. But in fact it depends on almost everybody imposing voluntary boundaries on their behaviour. Even a tiny minority can create havoc. If it truly is a tiny minority then we can contain it, but at the cost of deadening society around us and reducing the level that different communities mix. It’s impossible to know where we will end up, but our town centres may never recover and the divisions in our society may simply grow.

The financial markets are likewise built on trust. We also like to think that it has more solid foundations, on decisions taken based on solid information, with effective regulation and security. Alas no. Decisions are taken in an instant, and often by computer algorithms with a limited digital input. A lot has to be taken for granted, so when confidence diminishes panic is likely to follow. One of the more irritating aspects of these markets is the way people jump to quick explanations as to why a market has moved in a particular direction. This week there was a lot of talk about the downgrading of US debt. But the causes are unknowable, the sum of many decisions based on partial information and individual circumstances.

The downgrading of US debt simply cannot be a rational explanation. It was based on no new knowledge; it directly affects investors only at the margins. US debt actually rose in price, while share markets tumbled. Share prices had in fact mostly lost touch with reality anyway, so a sharp fall in value should hardly have been a surprise. The ability of professional investors to accept clear nonsense as a basis for valuing shares is one of the remarkable features of modern finance.

The panic will subside. Life must go on. But the difficult times will continue, both in the economy and civic cohesion.