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UK Relations with the EU & the Coalition in 2012

February 1, 2012

How the City  can Play a Future Global Role

Mark made the following speech at a breakfast meeting on UK relations with the EU and the Coalition in 2012:

1. Now one-twelfth of the ‘New’ Year is already behind us, but the Eurozone saga continues unabated.

I have frequently observed that it is a victory for politics over economics, but it also reflects a victory for sheer human nature. Too often when we are confronted with painful choices, we as humans default into denial. Perhaps politicians across our continent are not such a bizarre breed or law unto themselves as we all thought!

2. It is well worth remembering that the unresolved crisis in the Eurozone, in its very earliest incarnation on the streets of Athens, was the official raison d’être for the rush into stable coalition government given by David Cameron and Nick Clegg in May 2010.

Even this pair of political pragmatists must have assumed there would have been political leadership capable of sorting out the single currency crisis by now. My view is that we should not blame Eurozone economists for a lack of understanding of the dismal science; indeed some of the brightest European economists are in places like Spain and Italy.

There is by contrast a paralysing sense of fear amongst many frontline politicians in Europe as a whole (and indeed in the United States) – fear that this crisis is a threat to their established way of doing things and way of life. Naturally for incumbent governments that is a fear that extends to their very existence – a concern close to the hearts of any democratically elected leaders.

Couple this lack of a vision as to how a better, more prosperous world can emerge with another typical human emotion, ‘something may turn up’. Well, I fear that the Micawber principle this time at least will not bear much fruit. As far as the Eurozone, and by extension EU, crisis goes something will NOT mysteriously turn up to get us all collectively off the hook.

3. The road to David Cameron’s December veto or, more accurately, his unilateral walkout. The outcome of the Brussels summit just before Christmas came as a complete surprise to all commentators and so-called EU experts. As I was not there, I can only give my personal version of what happened, so take it or leave it!

The backdrop to the conference, it is important to recall, was the unexpectedly large ‘rebellion’ on the Commons vote over the EU referendum. Cameron and Osborne felt that by slapping a three line whip and taking control of the whipping operation to make it seem, especially to new MPs, as a vote of confidence would smoke out around 35 or 40 irreconcilable eurosceptics. Even on the afternoon of the vote, Downing Street was spinning the line that there would be 65 or 70 Tories supporting a referendum and it is always a classic damage-limitation tactic to overstate substantially in order to grasp victory from the flames. Once 81 of his backbenchers (essentially a majority once parliamentary aides or PPSs were excluded from that category) had made clear their views, Cameron realised the acute danger he faced. He could not allow himself to become too detached from such a large grouping in his own party.

By the same token, David Cameron recognised that a new treaty would indeed potentially trigger a referendum, and nothing is more likely to see the coalition fall than a formal referendum on Europe. Imagine…day in, day out, over a three or four month campaign leading Liberal Democrats and leading Conservatives on national TV and radio taking diametrically opposing views on the issues. Cameron certainly could not stand on the sidelines here without being accused of betrayal by his own Tory troops. Preserving the coalition and his place at Downing Street necessitated killing off the prospect of an EU Treaty. So the ‘veto’ strategy was adopted.

This was made all the easier by President Sarkozy’s stance – he too has to worry about his supporters, not the parliamentary ones but the French voters – the Presidential election takes place at the end of April.

Perhaps we all spend a little too much time speaking with Parisians, who have all written off M. Sarkozy’s chances of re-election. However, we should not forget that his Brit-bashing, his critique of ‘Anglo-Saxon’ economics and defence of the French way of life goes down pretty well in ‘Middle France’ and that is the gallery to which he will continue to play in the run-up to the domestic election.

In truth Sarkozy succeeded in outmanoeuvring our PM at the Brussels summit. More quietly but with ruthless efficiency, so too did Angela Merkel. One of the minor tragedies of UK/EU relations in recent times has been the failure of the UK to engage more closely with Germany. Tony Blair and Gordon Brown were ideologically better aligned to Gerhard Schroder, so Merkel’s election in 2005 came as a blow. She is a much underrated figure in European politics – and having spent the first three decades of her life living under Communism in the old East Germany, increasingly as an economic dissident, she fully takes on board the low tax, light regulatory message embraced by British Conservatives. In truth she should be a political soul mate to David Cameron. However, she has never understood (nor forgiven) his decision on becoming leader of the Conservative Party to withdraw our MEPs from the largest, and most influential, centre-right grouping in the European Parliament, the EPP.

Two months ago back in Brussels Merkel in the run-up to the summit was methodically working the phones getting the non-Eurozone leaders on board. For the Poles, Czechs and Hungarians there was a further complication. The unexpected problems facing Putin in Russia have convinced many former communist states in Eastern Europe that Putin could only be replaced by a more nationalistic Russian figure, likely to be even less amenable to their domestic interests. Better at this juncture to hold close to the EU ideal and how better to show this than by taking the German line on what needed to be done.

4. As a result, Cameron was outnumbered 26 to one and walked. The trouble he now faces, especially in view of the poll boost he has received, is that Eurosceptic Conservatives have concluded that ‘banging on about Europe’ is a vote winner. If Cameron goes back on his veto in the months ahead, I fear he will face plenty of internal Conservative criticism – and this at a time when the domestic economy is likely to be struggling. Meanwhile isolation in the EU for any length of time will prove problematic, both to his Lib Dem coalition partners but also within Europe where the economic patient remains on the critical list.

5. In spite of everything, the conventional wisdom dictates that we are imminently reaching high noon for the Euro. The assumption then is that the single currency will either collapse or the Eurozone will be forced to move rapidly towards full fiscal union.

Experience suggests the road ahead may not be so straightforward, whatever assurances we have heard about sorting things out ‘within six weeks’. That was promised about four months ago! It is quite feasible that we shall spend the whole of 2012 tottering along from market crisis to emergency meeting to fully-fledged conference and half-hearted bailouts to weaker Euro economies. Indeed, provided – and it is becoming the overwhelmingly big ‘if’ in this whole saga – the global bond market remains stable then the cheap price of government debt provides little incentive to create a viable long-term structure for our ailing continent’s economies. With the cost of borrowing this cheap why not continue to appease the Greeks, Portuguese et al? Let’s just avoid the day of reckoning with yet another quarterly elastoplast ‘solution’.

Purists may (rightly) bemoan that politics is being allowed to outweigh economic realities…for now. What is so dangerous about the utter lack of leadership or vision amongst Europe’s leading politicians is that the longer this crisis continues the more private sector confidence drains away and global markets discount the entire region. More crucial still is the risk that the two distinct problems that face struggling European economies, solvency and liquidity, become conflated. The Greek issue is simply one of solvency – or more accurately insolvency. It must be allowed to default, from within the Eurozone. Their creditors (predominantly EU banks) will need to take a substantial haircut. They lent the money at attractive interest rates (implicitly recognising the risks) and must now take the consequences. Although perhaps having hedged their position, the banking fraternity can spread the burden by triggering the exercise of those notorious credit default swaps. The IMF (of which more in a moment) will need to take control of the Greek economy and in all probability we shall need to be on alert if order breaks down as the pain of extreme economic austerity takes effect.

The prospects for other struggling Euro economies are not, at the moment, so bleak. However, for so long as the nettle is not grasped by European leaders and finance ministers there is a real risk that the liquidity problems faced by Portugal, Ireland, Spain, and Italy, will become more deep seated. Difficult as it is for Angela Merkel in Germany, whose domestic political position appears ever more precarious, the EU’s economic powerhouse needs to cede control of this deepening crisis to the European Central Bank. The ECB’s mandate must now be to provide market intervention to maintain and restore confidence on behalf of all solvent Eurozone economies. Make no mistake, the politics of this will not be easy. It requires – as ever within the EU – bypassing democratic safeguards and potentially involves unfathomably vast quantities of central bank support with potentially hazardous medium-term economic consequences.

However, the twin lessons of the 1930s economic depression are that avoiding catastrophe requires swift action and once a process is underway not to worry unduly about overkill: better to pump too much, rather than inadequate amounts, of liquidity into the system. A financial system in freefall requires active central bank intervention, however irrational the collapse of market confidence. For all their faults Gordon Brown and Alistair Darling understood this three autumns ago.

Late last summer, the UK government became rather too enthusiastic in its promotion of a headlong move towards fiscal union in the Eurozone but the veto shows that it needs to be careful what it wishes for. Such a development would inevitably embolden the Eurozone to embark upon a rapid and radical political power-grab throughout the EU. Alarm bells should be ringing in the City of London, for whom this almost certainly spells bad news.

The complacent view from Whitehall is that any such emergency development in the Eurozone borne out of necessity would act to ringfence its weaknesses. History teaches us that an economic crisis is often regarded as too good an opportunity to waste for ambitious statesmen and bureaucrats who then impose a far-reaching political agenda. Recent talk of a transaction (Tobin) tax to be imposed throughout the EU to help underpin the Eurozone’s finance will only be the first such salvo.

As we are well aware dark economic clouds now hang over the EU and the Eurozone. For those of us whose instincts support the invisible hand of the market, there must also be recognition that financial markets are peculiarly prone to irrational panic. It is for this very reason that we have central banks, whose remit transcends party politicking. However, the onus must now be with politicians, from whom the vision and decisive leadership we have found to be lacking remains so sorely required.

For without stable financial markets there is little hope for the sustained growth so essential for economic recovery. The UK economy is a global leader in the financial services sector but as a consequence finds itself especially prone to the adverse impact of uncertainty on worldwide financial markets.

No UK taxpayer stands by and watches unimaginably large sums of money or guarantees in order to bailout the banking system with any sense of satisfaction. Indeed our own Prime Minister and Chancellor have repeatedly pledged that there will be ‘no further bailouts of the Eurozone’.

Regrettably, however, the seventeen-nation Eurozone lacks a central bank with the political clout – or, more important still, sufficient funds – to provide comprehensive cover in the event of a liquidity crisis of similar severity to the credit crunch of 2008. This is partly an issue of design when the Euro was set up as well as a reflection of the historical reluctance of Europe’s economic powerhouse, Germany, to surrender control of its financial destiny.

In short, whilst the ECB and EFSF (the dedicated fund set up to rescue struggling economies in the Eurozone) is sufficiently capitalised to keep smaller Eurozone economies such as Greece, Portugal and Ireland afloat, it is woefully inadequate to provide the same security in the event of a market run on economies the size of Italy and Spain. This is the problem that will imminently confront the Eurozone, the EU and the global economic system. If Italy is close to default the only institution capable of bailing it out is the IMF.

In the event of such a collapse in market confidence for Italy or Spain, the UK as a founder member of the IMF will almost certainly need to increase both its absolute funding and its guarantee facilities to the fund. This is an extremely unpalatable prospect. Nevertheless a failure to act by the UK would not only have immediate serious consequences to the financial services sector globally, but would amount to abdication of our responsibilities as a mercantile nation in the international field of trade and commerce.

As MP for the City of London I accept reluctantly, in the absence of German backing of the ECB, that I have little choice but to support a proposal by the UK government to underwrite further funds in this way to the IMF. I must confess many of my Conservative colleagues are both less sanguine but not as compromised as I am as a constituency MP. They would vote down any such plan and the danger for the coalition arises if the Labour Party opportunistically chose to join them in the lobbies.

A parliamentary debate and vote on the UK contribution to the IMF, indirectly bailing out the Eurozone, would be critical to the government. More important still it might prove endlessly divisive within the coalition.

The increasingly strong line from Eurosceptics is that the IMF would no longer be following its constitutional role as an organisation designed to get distressed sovereign economic nations back on their feet. Instead – so the story would go (a story, I suspect, supported by the Daily Mail and Daily Telegraph) our latest contribution to the IMF would be used (or misused, according to taste) to protect the Euro and the wealthier nations of the Euro, who would otherwise be facing colossal losses.

The question for many Conservative colleagues would then be – what is in it for us? You see for all the feverish telephone activity that we have been told that has taken place between David Cameron and Angela Merkel over the past couple of weeks over the operation of the Single Market (just about the only thing European that is close to Eurosceptics’ hearts) we need to face facts: given a choice of prioritising between the two for active attention in these difficult times, I fear Germany and the rest of the Eurozone would sooner ensure the single currency takes prime place even if Single Market development stalls.