Greece, the Eurozone and World Trade

It would be easy and tempting for UKIP’ers to look smugly at the renewed chaos unfolding in Greece and say ‘I told you so’. Easy but unhelpful. Although small, Greece is still an export market for us, and if Greece crashes out of the Eurozone that would create massive contagion which would badly affect the whole of Europe including the UK. In any case I am sure we all wish the Greeks greater success for the future.

So what would we do in their situation? To answer that we must first remind ourselves of why all the Mediterranean Eurozone countries are so determined to keep using the euro. It’s not just the War and history of invasion, it is also that all of these countries are incorrigibly corrupt. Their citizens no longer trust their own politicians and so turn to the European Union as a mechanism to counter this. So it’s no use telling them to ditch the euro. They might still do that, but only out of sheer desperation.

There are two quite separate parts to the Greek, and other Mediterranean country, economic crises: they have a fiscal deficit on government taxes and expenditure, and they have a balance of payments deficit on external trade . The former causes the more immediate challenge, and hence gets the attention of the EU, ECB and IMF ‘troika’, but the external trade deficit is just as, if not more, debilitating in the long run. It is the external deficit I want to examine in this article, as we have a very similar problem.

The UK’s balance of external payments is now running at a deficit of over 5% GDP and getting worse. And that during a recession! You would normally expect your external payments to move into surplus during a recession as imports fall. In theory if you have a deficit the need to fund that deficit creates a need to purchase foreign currency, which in turn devalues sterling. That in turn makes our currency more competitive and so help to boost exports and reduce imports, thereby re-balancing our external trade automatically. In theory. In practice capital flows have grown and overwhelmed trading flows, and as the French economist, Thomas Piketty, pointed out recently, capital to GDP ratios continue to increase across the world.

Greece of course can’t do this anyway as they have in effect a fixed exchange rate by using the euro. Part of the idea behind austerity was that costs would fall thereby achieving an ‘internal devaluation’, but whilst costs in Greece have fallen substantially over the past five years it has not led to any regeneration in the economy. In fact perversely it has simply led to Greece’s debts becoming a higher proportion of GDP as GDP has fallen, whilst unemployment has continued to rise.

It was Adam Smith who originally observed that the wealth of a nation is the product of its labour. So if you want your country to get richer (and generate higher tax revenues) you must get unemployment down as low as possible without triggering inflation. Yanis Varoufakis, the new Greek finance minister seems to have remembered this whereas the troika have not, and is now coming up against the sort of block-headed intransigence from the European Union we in the UK know so well. Even under the most primitive of jurisdictions, if new evidence comes to light you reopen the case. The failure of austerity clearly constitutes new evidence, yet Wolfgang Schrauble, Germany’s finance minister has simply said that the new Syriza government is bound by the contractual terms of Greece’s E245bn bail-in, and that “Elections change nothing. There are rules”. We can only wish Mr. Varoufakis the best of luck with that one.

But even suppose Greece does manage to secure terms for a debt restructuring and recovery, that is not going to change their external imbalance. Indeed it will make it worse as more imports are sucked in. So we need to look for a new solution to the problem of trade imbalances both for within the Eurozone and across the rest of the world as well. There are now massive trade imbalances around the whole world, not least between China and the United States. Further the old GATT/WTO rounds of trade talks aimed at reducing trading tariffs so as to promote world trade generally have ground to a halt for some time now, since such talks have little chance of success if they start from a position of imbalance.

The Bretton Woods conference, master-minded by John Maynard Keynes after the second world war, aimed at creating stability in world trade through a system of fixed exchange rates. It held for a couple of decades before collapsing because different countries experienced different rates of inflation. Britain in particular, due to a succession of weak Labour governments and the Heath government pursuing inflationary policies for political reasons, experienced a whole series of ‘runs on the pound’, and made the collapse of manufacturing in this country inevitable. Eventually we floated the pound in 1971 and a new international regime of floating exchange rates followed, with mixed success. However it can undoubtedly be said that Britain’s exit from the ERM in 1992, coinciding as it did with a time of high unemployment, which meant that the inflationary effects of devaluation were absorbed, laid the foundation for ten years of solid economic growth. So strong in fact that it took Gordon Brown quite a while to ruin it!

Thomas Piketty’s research is very relevant here, and while in my opinion he rather loses the plot when drawing conclusions from it, the value of his book, Capital in the 21st Century, lies in that research. The continued increase in capital to GDP ratios means that we cannot allow things to continue unchanged. The imbalances will only get worse as international capital flows increase. The irony is that the solution lies in precisely the very thing that successive rounds of GATT/WTO talks have been trying to reduce; import tariffs.

It has always been recognised that the danger of import tariffs lies in the fact that they can become competitive and create trade wars. However if you set up a successor Bretton Woods regime under which only deficit countries were allowed to set import tariffs, and the IMF were to set limits for each country according to the size of their deficit, then that would not happen. It could be applied separately to Greece as the new regime would be currency-independent. That would create a partial devaluation for Greece in that it would promote import substitution, though of course it would do nothing for exports. But it would also provide an additional fiscal revenue stream which can be used to stimulate the economy and reduce unemployment.

In a world where the environment is under threat, the continued expansion of world trade in itself must be questioned. I would venture that it is the balance of trade that matters far more than the volume of it. Of course world trade gives consumers much greater choice, and it allows small countries with limited resources of their own to join in. But ultimately Adam Smith was right. It is the product of your labour that makes you rich, what today we call ‘adding value’, and a country that only exports natural resources will return to poverty when those resources run out.

In Britain however there is a further way we can improve our competitiveness. By setting up a Sovereign Wealth Fund to hedge the National Debt. As you may have seen in my election address, I have castigated the Coalition for overlooking this. But what I did not say there is that funds nowadays are invested globally. It follows that a substantial proportion of the wealth fund would be invested overseas, which would involve the selling of sterling, which in turn would make it more competitive. The Chinese have always had a high propensity to save, and it was by investing in US Treasury bonds that their export boom and consequent high rate of economic growth was created. We can do the same.


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