Italian populists will find it easier to complain than to govern

Well one of my 2018 New Year predictions is bearing fruit. I predicted that the big issue in 2018 for the EU would be Italy, and its push back on how the Euro is run. Just how this will play out is very hard to judge, but it is now centre stage. Most of the coverage centres on threats by Italy’s Five Star Movement (M5S) and the Northern League to take Italy out of the Euro. But the politics of that is much trickier than many give credit for.

It is, of course, too easy for liberals like me to sneer as the disparate group of politicians we refer to as “populists”. The popular frustration they play on is real enough, and liberals are very reluctant to engage with it. We seek for ways round it and dismiss it. But for all the weakness of established political movements, populism does represent a threat to European (and American) society. What populists aim to do is stoke up a sense of grievance and victimhood to secure power for themselves, which they then proceed to use to for the purposes of self-enrichment and cronyism. Nobody should be surprised that a movement built on resentment at elitism and cronyism should, in practice, be much worse than the system it is replacing. Donald Trump made hay from Hillary Clinton’s minor lapses in data security, and talked of “draining the swamp” in Washington. And yet the new governing elite plays fast and loose with security and thinks nothing of placing its own friends and relatives in positions of influence. Its supporters don’t seem to mind.

The populist system in Europe is most advanced in Hungary, where under Victor Orban’s Fidesz a crony state is becoming deeply entrenched. It is worth noting that when Fidesz first emerged from the post-Communist gloom it seemed fresh, modern and innovative. It has been corrupted by power. But Hungary does have some advantages. First it can claim subsidies from the European Union because of its relative lack of development. Second it has its own currency, so it is not beholden to the system of Euro governance. But note a key element of the system: it requires EU subsidies to keep going, and anti-EU resentment is one of its key themes. Staying within the system while complaining about it ever more loudly is Fidesz’s central political strategy.

The Italian populists are embarking on a similar strategy. I am perhaps being a little harsh on M5S. Its hatred of the old establishment cronyism is genuine and it does seem to want to move to something better. It refused to deal with Silvio Berlusconi, one of the pioneers of populist cronyism, for example – though its more cynical Northern League allies had long been associated with him. And yet Italy’s economic predicament makes something like the classic populist trajectory almost inevitable.

The central issue for Italy is the Euro. Both M5S and the League make this a central complaint. They complain that the Euro’s budget rules are too tight and prevent sensible fiscal policies from being implemented that might help lift Italy’s dismal economic growth rate. Plenty of economists from across the world agree with them. How much substance there is to these complaints is a complex topic for another time (my answer: yes some, but nearly as much as many make out). The real question for populists is just how serious about this do they want to be. Do they want to make genuine, credible threats to leave the Euro? The answer is surely not.

It is, in fact, institutionally and practically very hard to leave the Euro once you are in it. For all its extreme problems, Greece never seriously contemplated it. But there is a political problem too, which, for example, cost Marine Le Pen in France dear when she seemed to be on the threshold of power. That problem revolves around two things: interest rates and savings. One of the main reasons Italy joined the Euro was to reduce interest rates, especially on government debt. It should be remembered that, contrary to the populist narrative, Italy was not bullied and cajoled into joining the Euro by the Germans. The Germans never wanted them in, but Italy made it in thanks to both some fairly hefty austerity economics and diplomatic skill. This proved very successful. If Italy left the Euro, the country would surely have to raise interest rates on its debts and government finance, including a looser fiscal policy, would in fact be much harder. That is exactly why Italy joined the Euro and the basic dynamics haven’t changed. And this would not be some future prospect (like the dire predictions made about the British economy after Brexit), but would be immediately apparent should the prospect of Italy leaving the Euro look real. The rise in Italian government bond prices after the populist victory at the polls shows this.

The economics may not be quite as simple as I have made it sound. The Italian economy, for all its weakness, is roughly in balance on trade, which makes looser fiscal policy and monetary policy much easier – but that was true before. The real problem is that successive Italian governments have been unwilling to take on the economic reforms that might make the economy more productive, and a looser fiscal policy more sustainable. It is a popular misconception on the left that “Keynesian” loose fiscal policy can drive growth and pay for itself. That is only true of there is spare productive capacity, such as in a recession, or if productivity reforms form part of the government programme. In fact the left usually see “Keynesian” policy as an alternative to “neoliberal” reforms rather than a complement to them. I have written often that neoliberal reforms are played out – but that is not true of Italy, which used the gains made from joining the Euro to put off the evil day. The populist movement draws much of its strength from resistance to such reforms when they were belatedly embarked on by the Socialist government of Matteo Renzi – so embarking on a reform programme looks out of the question.

Still, politically, the interest rate problem is not the most serious. That is that leaving the euro would be seen as a threat to many Italians to the value of their savings. Economists talk about currency as a means to an end – a sort lubricant to help achieve real economic gains through higher levels of investment and consumption. Money means nothing in itself. But most people outside the elites have a different view. To them money is a sacred promise made by the government to the people that they can save now to spend later. Politicians forget that at their peril. If Italian savers start to think that threats to leave the Euro are serious, they will see a threat to their savings and support will drain away from M5S and the League faster than most people think is possible.

And so the populists need to maintain that balance: whinging about victimisation within the Euro straitjacket, while making no serious attempt to leave the system. This sort of have-your-cake-and-eat-it politics is, as it were, bread and butter to populist politicians. But it will surely be harder inside the Euro than out.

This is doubtless behind the Italian President Sergio Matterella’s rejection of the coalition’s proposed finance minister. What looked like a clumsy denial of democracy could in the longer term be part of a challenge to the populist parties to put up or shut up about the Euro. That could pay dividends if only the established political parties to put up a credible alternative government.

27 thoughts on “Italian populists will find it easier to complain than to govern”

  1. From what I have read on these issues, an Italian exit from the Euro looks to me difficult but probably not impossible. The ploy would be to introduce the start of a parallel currency as a second medium of exchange, without calling it that to avoid breaching Single Currency rules. If then a run on the weak Italian Bank system developed as a result of a collision between the 5-star movement’s desires to spend a lot more (e.g. on a minimum income for all) and the Eurozone authorities, the Italian Government could claim that it was being forced to make use of the parallel currency as its main currency, in order to enable Italian citizens to go on spending. This idea is reported to have been present during the Greek crisis, but not to have been sufficiently developed to try it. Given that the 5 star movement’s electoral base is in the poor communities of the South who would benefit from a minimum income and do not have much by way of savings to protect, I don’t completely discount an accident along these lines – and suspect that the reason why the proposed Italian coalition of the 5-star movement and the Northern League party want Savona in their Government is to have his advice on how to do it if that were to become necessary.

    1. Indeed, I think they have already started on something like this (or it was a proposal and I jumped the gun). That eases some of the transition issues, but the new money will trade at a discount to the old (unless the effective interest rate is much higher), so this doesn’t really change the political dynamics.

  2. That is that leaving the euro would be seen as a threat to many Italians to the value of their savings.

    This problem is easily avoided if the Italian Govt allows Italian citizens to hold euro accounts in either Italy, with any Italian bank that would offer them, or in other euro using countries. There’s no reason why that would be a problem for the Italian govt. It probably would be more of a problem for the German govt.

    “If Italy left the Euro, the country would surely have to raise interest rates on its debts and government finance, including a looser fiscal policy, would in fact be much harder.”

    If Italy left the eurozone, and re-introduced its own currency, it could choose to have whatever short term interest rates it deemed appropriate. Just like the “monetary committee” of the BoE makes that choice. It would also have the same ability to manipulate longer term rates through the same process of QE as used by the BoE and the ECB.

    It’s fiscal policies and monetary policies combined, if it allowed its currency to float, would be a matter of steering a sensible middle course between having too much inflation and too much recession.

    1. This problem is easily avoided if the Italian Govt allows Italian citizens to hold euro accounts in either Italy, with any Italian bank that would offer them, or in other euro using countries. There’s no reason why that would be a problem for the Italian govt.

      Hmm. A very large part of the assets backing those savings is in the form of Italian government debt, which amounts to 130% of GDP. If the government can’t switch that to the new currency because it is needed for the stability of the Italian banking system I think that might be a problem for the Italian government. The Italian banking system is quite diverse, but not necessarily that strong. Forcing it to manage a dual currency system would just about kill I would think.

      If Italy left the eurozone, and re-introduced its own currency, it could choose to have whatever short term interest rates it deemed appropriate.

      There are two problems. First, without capital controls in practice central banks have to hue to a world rate of interest. Unless they are in some sort of trouble when they are forced to jack it up to something much higher than is comfortable. Second, the short term interest rate set by the banks is not the rate paid by businesses or the the public. It only approximates when the system is not under undue stress. In the great financial crisis central banks cut rates, but everybody taking out a new loan or overdraft had to pay much higher effective rates.

      It’s fiscal policies and monetary policies combined, if it allowed its currency to float, would be a matter of steering a sensible middle course between having too much inflation and too much recession.

      Or, to put it less kindly, use inflation to rob the saving middle classes to pay for spending by a government that few people trust, and whose members increasingly succumb to the temptations that close government control of finances puts their way. This is Italy, not Denmark. Any higher rate inflation at all would be very unpopular. What I will grant is that it could be good for Italy in the long run, if it forced the government to face up to the reasons for poor Italian productivity and address them, rather than just blaming the Euro. But it would be a very painful journey. But changing the management of fiscal and monetary policy does not change economic fundamentals to any great degree – it helps smooth out the bumps.

      1. You don’t seem to be clear whether its Italian Govt Debt backing the saving or Italian Govt assets. But if there is free movement of capital in Europe then it really doesn’t matter either way.

        Everyone who wishes to shifts their money to Germany in German euros. It then becomes a German liability to pay out on these accounts. Next the Italian Govt redesignates its debt in Italian euros (or whatever it wants to call them) and it will have full control over them.

        The problem is that the Target2 imbalances will build up as everyone moves their money. But these debts are unpayable in any case. Already over 400 billion. Italy may as well owe a twice as much as it already does. It won’t be able to repay anyway even if it stays in the EZ.

        1. My understanding is that Italian banks hold large quantities of Italian government debt, so in effect this is backing most of the savings of ordinary Italians. No doubt the same is true for insurance policies. The problem is that if Italians shift their savings to foreign banks, Italian banks will collapse. That’s a problem because the payment systems of the various Eurozone countries aren’t properly integrated. It is actually quite hard to use an account set up in one country to make payments in another. There are few if any genuinely cross-border banks (as opposed to those with ring-fenced subsidiaries), and setting these up has been made much harder since the crises in Greece and especially Cyprus. Now in principle the government could save the banks by pumping in New Lira – but this is likely to be extremely messy and cause huge economic dislocation. Why would an Italian government take on such a risk when there is, in fact, very little public support for it?

          1. If there is just a possibility that Italy will exit the euro the wealthy will move their money to German banks. If the euro is a genuine common currency that shouldn’t matter in the slightest. It would be just the same as someone in the USA moving their money, in US dollars, from Florida to California. If there are local banks in Florida that had liquidity problems as a consequence the US Fed would step in to provide assistance.

            That’s what happened in Greece during the 2015 crisis. The banks didn’t collapse because the ECB supported them. They’ve no choice but to do that. The Bank of Greece didn’t have the ability any longer. There was plenty of euros in the cash machines for everyone else but Greek people. The decision to limit their withdrawals was purely political. Since then Greek people no longer trust their banks and keep most of their cash abroad or in 500 euro notes in safes. I’m told that they are very aware of the country codes on their bank notes and avoid the high denomination Greek ones for storage purposes!

            So IF the Italian govt wants to exit the euro the smart thing to do would be to say as little as possible, say nothing to dispel any rumours, and let as many people as possible make similar arrangements. Then when they are good and ready they either pick fight with the EU/ECB and get themselves thrown out of the EZ (that’s what I’d do!) and/or they close the banks for a week or so to make the switch to the New Lira and then the Bank of Italy will have all the powers it needs to support the Italian banking system itself.

          2. Hmm. The better off will always find ways to protect their interests, but the populist hinterland is amongst the less well off. And the way the ECB approaches “helping” banks has changed since the Greek crisis: look at Cyprus. Remember the crisis over bank preference shares. A lot of the non-deposit finance of Italian banks comes from a wide spread of retail savers – a bail-in would hit these hard. Besides the Italian government needs a solid base of depositors in local banks to buy their bonds. Foreign banks and other foreigners have been quietly divesting themselves of Italian government stock. That’s not caused a crisis because the ECB has taken up the slack through QE; that will end at some point. Engineering a run on Italian banks just looks too politically risky to me. Polls show that the Euro remains very popular. Unsurprisingly.

          3. Try an experiment. Go to Palermo and into a restaurant, and try to pay for your meal with your Paypal account. If that doesn’t work, then go to the local bank to try and get some cash. You may be able to make it work in theory, but the payment systems aren’t integrated and the bastards grab a slice of your hard earned funds every time you try to move it. And remember, the politics is no about the rich and sophisticated. And anyway, if the public withdraw funds on masse from Italy’s banks the Italian government has a big problem.
            The Italian government is not strong on tax collection in any currency, and the league is not going make that any better. It could be Argentina all over again.

  3. Surely Italy or Greece or any country in the Eurozone for that matter could only “leave the Eurozone ” if the Government of the country concerned forbids the use of the Euro for both internal barter and for buying goods in from abroad. For the Euro will still exist and be the preferred choice of most citizens when buying goods and property’
    An example would be Western Germany post war where the US Dollar, as well as bottles of whisky and cigarettes were the preferred currency, and it was only in June 1948 when the Reich mark was replaced by the Deutschmark at a ratio of 15 to 1, and that the new currency was supported by the occupying powers that people were willing to save and invest
    If the two currencies were run in tandem The new by the Government to pay wages and pension and second the Euro -acceptable in every country of the world, it would only be a matter of minutes before every wage earner was down at the currency exchange with his pay packet And if Euro notes were banned then conversion to sterling or dollars and then to Euros.
    This could not be stopped No government should underestimate people’s ability to get round obstacles placed in their way
    This is not to say that such an attempt will not be tried. Just because an action would be incredibly harmful doesn’t mean that it won’t be attempted. Our government’s efforts to pull us out of the single market is an example

    1. The eurozone is essentially defined as those countries with governments which will accept only euros as payment in taxation, are a part of the EU and accept the authority of the ECB as their central bank. The ECB in turn accepts them as part of the ‘club’.

      If Italy starts up its own parallel currency and accepts that as taxation payments it will effectively leave the eurozone, and if people like Juncker are to be believed, the EU too.

      Of course the euro can still be used by anyone else too. I believe Kosovo uses it but that doesn’t make it part of the eurozone.

      1. It that’s an important point. Any country can use the Euro as Ecuador uses the USD, though it does need to obtain a regular inward flow of the currency. But being part of the club is vital, especially for a country the size of Italy. Italy does have the capacity to create chaos in the zone, so that gives it a bit of leverage (much more than Greece) – but being kicked out would be a disaster for it.

    2. I think you are right. People tend to gravitate towards the currency they see as being most useful. And even if the new official currency can be used to pay taxes, that won’t be enough (especially in a tax-shy country like Italy). Something like this is happening in Zimbabwe. The problem in Italy will be finding enough Euros to meet demand. But the country exports a lot so this might not be that hard.

  4. As some of these comments imply, Italy does not appear to have any good economic options, given the social constraints. As you say Matthew, if it exits the Eurozone, it faces higher interest payments on its large Government debts, a loss of investor confidence and inflation leading to disillusion amongst its middle classes. But it is in a position that, according to IMF estimates, its unit labour costs have increase by 10% compared with the Eurozone average (and by 20% compared with Germany’s unit labour costs) since the inception of the Euro in 1999; its unemployment is still above the levels of before the financial crash, despite the current general EU recovery; the effort at structural reform by Renzi has failed; and the poorest section of its community – in its underdeveloped South – have revolted, with the 5 star movement as their chosen instrument.

    In these circumstances, should not Europe’s prime aim be the political one of eliminating the conditions in which Italian populism can flourish? What seems to be common to all forms of populism is a ‘them and us’ attitude in which the less advantaged sections of the population see an evil and self-serving elite as thwarting the real will of the people. To my mind, the disciplines of Euro membership imposed on countries which should not have joined it in the first place, such as Italy, can only serve to feed such attitudes. So why does not Germany and co offer Italy a managed departure from the Euro on conditions that guard as much as it possible against inflation taking off? The Greek experience illustrates the medium term problems of trying to muddle through.

    1. The trouble is that the Euro is quite popular amongst the ordinary people. Even in the south, it is not that poor, and with a weak social security system there is probably a greater reliance on savings than you might think. So having a stable currency with low inflation is a popular idea. Pushing the country out would make the public even angrier. And it is perfectly possible for poorer countries to live within the Euro. The problems of low productivity and high unemployment predate the Euro, and leaving the Euro is at best only a partial solution. It needs deeper reforms which would be very unpopular in the short term.

      1. ” And it is perfectly possible for poorer countries to live within the Euro.”

        Yep that’s true. Germany does OK with the euro because it is a net exporter, not because it is wealthy. There’s always enough euros coming into the country to avoid Germany, as whole, having to borrow. In the UK, as we are a net importer, someone has to do the borrowing to enable import bills to be paid. I’d argue that shouldn’t be just pushed on to the private sector, creating asset bubbles etc but that’s another story.

        The EZ did OK before the crash when the private sector was borrowing like crazy, but afterwards, when the responsibility fell to Govts they fell foul of austerity laws and the problems began.

        So, that’s the obvious solution! Just make it compulsory for everyone everywhere to run an export surplus! 🙂

  5. Yes, point taken, the Eurozone authorities would have to wait to be asked – which could mean that we are in for a protracted period of tension between the Eurozone authorities and a populist Italian Government. For my part, I would rather that fiscal discipline were enforced on the Italians by a combination of the capital markets and the IMF – but, not being Italian, perhaps I had better not presume to judge their priorities!

  6. I still don’t quite understand what you’re saying. In the age of the internet it’s quite straightforward for anyone to open an account anywhere in the world, in any currency they like. I already do that to some albeit small extent using Paypal. I have a mixture of US dollars, Aus dollars, and pounds. It’s not something that is confined to the rich.

    So it would be open to anyone in Italy to keep their savings in euros if they wish. The Italian govt leaves them as IOUs of euro using countries. Or people could buy gold certificates. Whatever they like.

    However the Italian Govt does it own spending in new Lira and imposes taxes in new Lira. In the unlikely event of no-one wanting to save in new Lira, either at home or abroad, the government’s budget will naturally balance and there will be no need to issue bonds.

    1. Just thinking about it a bit more, it’s just occurred to me that the sort of model I’m advocating for the EU is similar to Keynes’ Bancor suggestion for international trade after WW2.

      So primarily countries use their own currencies but have the euro too as an EU currency. So everyone can keep their euro savings but use local currencies for future earnings and pensions

      The big problem will be euro denominated private sector debts which will increase in real terms in those countries which end up with a lower currency and decrease in those which have a higher currency. .There’s no chance of this happening though. The politics of the EU are against it.

      From the perspective of a single country like Italy leaving the EZ it would be better to just decree that they are all existing debts are redenominated in the local currency.

      1. I’m sure redenomination is what the Italians would have to do, but that only highlights the practical obstacles. I think Wolfgang Munchau in today’s FT has it right: the Italian government should add to the pressure on Germany to reform the Euro, rather than just keeping a low profile, as they have to date, or throwing in extreme demands as the y did during the election. That way it will start to look as if it is Germany that is the problem, not Italy. And while I do have some sympathy with the German point of view, I do agree that they are at least as much a problem for the zone as Italy.

        The dual currency idea is an interesting one. But I remember in one of the videos on new monetarism you sent me the speaker said that one currency always tends to dominate – whichever turns out to be the most useful. If in Italy it became to easy too use the Euro after Italy left, a new Lira would struggle. But I don’t think that the local banking system would cope with a dual currency arrangement anyway…

        1. I’m not sure why a dual or multiple currency would be a problem. We have that now in the UK. We use the pound for everyday transactions, but if we don’t trust the pound for our savings there are other currencies. We can buy dollar or euro securities or shares in US or European companies. There is gold and there is Bitcoin. The government doesn’t need to take on debt so we can have assets.

          1. It comes from my experience as an accountant. Very few firms operate true multi currency accounting systems. Such systems are much more complicated than single currency ones, and more expensive to acquire and run. That does not stop most firms using different currencies but it is a problem for banks, who must manage their currency exposures with a great deal of care. And switching systems is the sort of high risk venture that has caused huge grief to banks. It’s why so many banks run antiquated accounting systems. Italy’s banks don’t strike me as being all that sophisticated so the chances of one of them messing things up, going bust and setting off a chain reaction is probably higher than normal.

  7. Matthew,

    I would still argue that your thinking is based on a “gold standard” currency theory. If currency has a value because it is backed up by an amount of gold in the vaults of the central bank then “investor confidence” is an important consideration. If the central bank hasn’t got enough gold or is creating too many bonds to fund government spending then the currency may not really be worth what the Govt claim it is worth.

    But, it’s been a long time since currencies have been run like this. Now they are purely fiat. Currency issued by the central bank is effectively just a tax voucher. They have a value because the govt will accept them in payment of tax. This is the main reason why any Govt needs to develop an equitable and efficient tax system.
    There are those who share my general line who say “ah but the Govt doesn’t need tax revenue to spend, so there’s no need to target the wealthy for tax”. This is, in my opinion, missing the point.

    If the tax system is considered to favour the wealthy who can get away without paying their tax the system falls into disrepute. Everyone dodges whatever they can. That’s possibly what’s happened in Italy and Greece and I would agree that should be fixed. And corruption should be stamped out. Especially once they have their own currencies again! But that’s not to maintain “investor confidence”. That really doesn’t matter. It isn’t a factor. What matters is to keep the economy working properly and inflation under control.

    And it doesn’t matter if Italian banks can’t cope with a dual currency. We live in the age of the internet. It’s just as easy to manage a bank account, anywhere in the world, in any of the currencies of the world as it is a local account with a local bank.

    These bank accounts aren’t for paying the gas bill. They are simply to store savings. There’s no reason why Italian people shouldn’t buy UK premium bonds – if that’s what they want to do. It’s not going to affect the Italian economy. It actually creates a debt for the UK govt so, arguably, it’s more of a problem for the UK than Italy when this happens.

    1. I get your point about fiat money. But I think you have to deal with where people are rather than where you think they should be. For two reasons. First that’s what guides people’s votes in a democracy. Secondly because financial systems are more fragile than you think. The 2008 crash happened because interbank admin systems failed in 2007. I have that insight to thank for the size of my current pension fund. I switched to IL gilts when got an inkling of the size of the mess.
      And as in this context we have to reckon with what I’ve called the sacred promise which forms part of the core social contract. Money isn’t just a voucher to pay taxes with, governments have a duty to preserve it as a store of value. This isn’t what the elite (you and me in this context) think. It goes to the heart of what most people think government is actually about. Fascism and nazism came about because of the collapse of currencies post WW1. German obstinacy about monetary policy isn’t a product of a few mistaken intellectuals. It’s what most Germans really think, given a bit of post hoc rationisation by German economists. Politicians know it’s instant death to challenge that notion.
      Which leads me to Italy. Most Italians have a big stake in the Italian banking system, which is a network of not very big and not very international banks. When the EU tried to bail in Italian bank preference share holders in dodgy banks, it caused a major political crisis. It is probably why so many people are fed up with the EU and established political parties. So that sweeps the League and M5S to power. But you mess with the solvency of Italian banks and the value of your currency at your peril. Telling them that they can invest in UK premium bonds rather than the local bank that they and their communities have come to trust wont cut it. So there will be a lot of sound and fury from the Italian govt but they wont make any serious challenge on the currency. Anyway. Let’s just see!

  8. There’s no fundamental disagreement on the point you make that governments have a duty to preserve it [money] as a store of value. There are some provisos that we both would make though.

    Firstly, the currency should be allowed to float. That means it can go down as well as up.

    Secondly, we both agree (I think!) with the idea of inflation targets. That’s currently 2% for the UK. It is a target and not an upper limit. That’s a point worth emphasising.

    There’s no inconsistency between acknowledging all this and saying that the pound is just a tax voucher. If the Treasury were to actually issue paper vouchers, redeemable against tax then they would be functionally equivalent to BoE notes. The Treasury did just this with so-called Bradbury pounds during WW1.

    1. And the Zimbabwe government with its dollar denominated notes. So far as floating currencies and inflation targets are concerned what you say is standard Anglo Saxon liberal economics. I feel the need to be sceptical of both. It’s hard to justify that the pound shouldn’t float freely. Less easy to say the same of the Danish krona. To me the decision to float depends on the context. Fixed exchange rates are often popular with savers. And as for inflation targeting I think liberal economists are too free and easy with what I call the sacred promise. 2% inflation doesn’t seem to cause much stress. It alarms me when economists suggest flexing it upwards, as many do these days.

  9. 2% inflation is what we target in the UK. We aren’t Zimbabwe. We aren’t in a post war situation. So let’s try to understand our own economy first. Why not 0%? Even “standard Anglo Saxon” economists accept there has to be an element of use-it-or-lose-it about currencies. We aren’t worlds apart. Whether that figure should be 2% or some other figure is subjective. The more conservative of us would perhaps choose a lower figure.

    Currencies all have a value relative to each other. We can’t all choose to peg our currencies at whatever we like. Say, we have just three countries A, B and C in a closed economy. Say country B wants 2B=A. (A and B are now the currency units). Then country C wants 2C =B.

    So now we have to have 4C= A and, therefore, country A has no choice in its currency value. Country A may be the biggest of the three economies and may be happy to let everyone else decide. Or it may not and there will have to be conflict. There’ll be currency wars, leading to trade wars and possibly even real wars too.

    So, IMO, currency pegging, or currency manipulation, should be outlawed by the IMF, or at the very least it should be done under licence with the agreement of other IMF members to perhaps allow developing countries accumulate some foreign currency reserves. Denmark is in no way a developing country. Denmark is a currency miscreant! Germany too. But Germany is hiding its misdemeanours behind the euro. If we pushed Denmark they’d just adopt the euro too and nothing would change from their POV. They’d be playing the same game as Germany.

    When countries manipulate their currencies downwards it is always to produce a ‘better’ trading balance. So someone else has to have a ‘worse’ balance. This creates debts for the non-manipulators. Both Govt and Private sector. Someone in the UK has to do the borrowing to support our current account deficit. Govt can only cut its share by slowing the economy (austerity) or pushing the debt burden on to the private sector.

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