Eurozone Crisis

My Lords, like other noble Lords I am grateful to the noble Lord, Lord Lamont, for securing this debate, even though the topic has widened from that he initially intended. I also wish to congratulate the noble Lord, Lord Wolfson of Aspley Guise, on his witty maiden speech. Despite appearances to the contrary, the debate has not been about economics. Instead, as the noble Lord, Lord Ashdown, pointed out, it has been about politics—the political choices made by Governments in the eurozone, most notably the Government of Germany, and the choices made by Her Majesty’s Government. Indeed, the common theme that has run through much of the debate has been the severe austerity that Germany demands of the rest of the eurozone and the similar economic misery that the coalition is inflicting on Britain. It is now clear that the eurozone embodies fundamental design flaws. These have been addressed by the noble Lords, Lord Lamont, Lord Alderdice and Lord Higgins, my noble friend Lord Myners and the noble Baroness, Lady Wheatcroft. A successful monetary union requires a powerful and active central bank, an all-Union bond market managed by a central treasury function, some means of balancing the economic benefit between the most successful and least successful parts of the Union, easy migration and, it is hoped, some sort of all-Union employment policy. This is a reasonable description of the United States of America, with the employment policy being provided by the military. My noble friend Lord Desai was right to point to problems in the bond market as far as short-term financial stability is concerned, for it is the existence of an all-Union bond market that is crucial. Given that the eurozone economy is the largest in the world, any major bond fund must have significant exposure to the euro, just as it must have exposure to the US dollar and, to a lesser extent, to sterling. This can be obtained by holding any eurozone sovereign bond. Moreover, the exposure can be maintained by switching between different sovereign bonds with no foreign exchange risk whatever. Hence the huge flows between eurozone sovereigns that have produced wild gyrations in interest rates over the past few months as uncertainty and rumour have fuelled massive capital flight. The point was made by the noble Lords, Lord Wolfson and Lord Flight: it is like walking along a rocky path carrying a large amount of water in a shallow pan. Compare this with the situation in the US. The state of California, which represents 13 per cent of the US economy, is bankrupt. This has no impact on the US Treasury bond market at all. Similar problems in Greece, which represents 2 per cent of the eurozone economy, have produced a wave of destructive contagion. The creation of a eurobond market equivalent to the market of the US Treasury—no bailout, no austerity, no ECB as lender of last resort—will bring durable financial stability. Of course, creating a eurobond market is a formidable political problem, but it is not impossible to imagine that this could be solved. It is not necessary to have a United States of Europe, as the noble Lord, Lord Lawson, claims. It is conceivable to have a powerful central bank, a central bond market funding a monetary union with a centre that is still politically weak relative to powerful member states. Indeed, that is a description of the most stable monetary union in the world, the Confederation of Switzerland. Clear identification of the design flaws of the eurozone that have resulted in such appalling financial instability should finally dispose of the illiterate comparisons often made between Britain’s fiscal problems and those of the eurozone members. Are the Government right to argue, as they do over and over again, that their austerity policy is necessary to maintain the confidence of the bond markets and keep UK interest rates low? Perhaps it is, but only because of their own political folly. The Government have repeated this mantra so often that the markets probably believe it by now, and in believing the Government’s pro-cuts propaganda, they demand a redoubling of austerity. We have financial stability, but it is the stability of the grave. We are repeating Japan’s lost decade in an economy that is much poorer and much more unequal. I warned at the time of the Budget that the Government’s austerity policy risked creating a vicious cycle in which expenditure cuts and tax rises would lead to lower growth, which in turn would lead to falling tax revenues and rising costs of recession. This in turn has led to yet further higher deficits, and so on in a downward spiral. But there is another twist in the tail that I had not fully appreciated until I read the OBR report. The austerity programme also reduces the medium-term productive potential of the economy and hence reduces the possible future growth rate that is supposed to restore the nation’s finances, so now we have two mutually reinforcing engines of economic decline—the merry-go-round of cuts that do nothing to cut the deficit, and the recession-induced fall in growth potential that is making the deficit bigger too. And what is the Government's response? It is more of the same. That is not my verdict. As the noble Lord, Lord Hollick, pointed out, it is the verdict of the OBR. Reviewing the plethora of schemes to turn the economy around, the OBR concludes: "““We have not made any material adjustments to our economy forecast on the basis of these policy announcements””." In other words, the OBR concludes that the Government’s much spun ““growth strategy”” will achieve a net result of precisely nothing. However, I believe that the OBR is being overly optimistic. First, the OBR persists in being excessively optimistic about where future demand will come from. In March, it predicted that private sector investment would grow this year by 6.7 per cent. Now, eight months on, it admits that investment has fallen. In March, it predicted that investment next year would grow by 8.9 per cent, and it still thinks that that is almost achievable. It says that investment in 2015 will be roaring along at 12.6 per cent growth a year, up from the 8 per cent it predicted in March. Where do these fantasy figures come from? Where is the incentive to invest when household incomes are going to be as low in 2014 as they were in 2002? It does not matter if interest rates are low: if there is no demand, there is no reason to invest. Secondly, the other component of the rebalancing of the economy referred to by the OBR is supposed to be net trade. Again, the OBR is being excessively optimistic. It admits that most of the beneficial impact of the devaluation of sterling has now been exhausted, and recognises that markets in Europe will be depressed for some time, and yet somehow conjures up a significant improvement in trade performance, so overall the OBR is far too optimistic. The situation is much worse than it thinks. The people for whom matters are really worse are the poorer members of our society. If the OBR’s predictions are correct—I think that they are over-optimistic—household real disposable income will fall by 4.7 per cent over the next three years. However, that is an average figure and well over 60 per cent of the population have below-average incomes. If we examine the impact of the Government’s policies on median income—that is, the level of income in the middle of the income distribution—then the fall in disposable income will be 7.5 per cent. The cuts in real income are concentrated at the bottom end. Indeed, as the IFS analysis of the Autumn Statement has shown, the measures taken this week will lead to further cuts in the real income of the bottom 30 per cent and give benefits to the top 30 per cent. Nothing is more disgraceful and distasteful than the savage pleasure that Liberal Democrats and Conservatives take in cutting support for the poorest in Britain. There is one further chapter of this dreadful story that must be taken into account in any overall assessment of the state of the economy: that is the level of unemployment, particularly of youth unemployment. It is simply uncivilised to have more than a million young people unemployed and their lives blighted at just the time when they should be looking forward to building a future, careers, stable households and families. Yet the prolonged recession holds out that prospect not just for the 22 per cent of young people now unemployed but for thousands more. We can begin to solve these problems only if there is a return to significant rates of growth in the eurozone and in Britain. The austerity imposed on the eurozone by Mrs Merkel, and on Britain by the coalition Government, will achieve nothing but a lost decade, or more. Stable financial markets will not produce an automatic increase in business confidence. There is no confidence fairy; she was killed by the Government's austerity rhetoric. What is necessary is a radical rethink of economic policies and even economic institutions. We need a major increase in government investment to kick-start private sector investment. We need new funding for industry on a greatly enhanced scale—not just what the Financial Times called the ““gimmicks”” of the Autumn Statement. We need a realisation that demand can be boosted by redistributing income towards the poorest, because they spend every pound they get and their spending has a lower import content than that of the wealthier sections of the community. The Government must become an employer of last resort to tackle youth unemployment. How should we pay for all this? First, we should realise that unless something radical is done, the deficit will go on rising; we will go on borrowing more as we cut more. Secondly, if there is to be quantitative easing, it should be far better directed than it is under the shotgun approach used at the moment. Thirdly, even small amounts of redistribution could have a significant effect on the rate of growth of demand. It will be evident from what I have said that I am fearful for the prospects of the eurozone and of our economy. Of course our current economic circumstances are dreadful, but they are made by human hand and they can be unmade by human hand. The key is political: political will and political intelligence, allied to sound economic analysis. All three ingredients are notably absent from the Government’s policy.