The Markets, The Euro and Faith

[rabbitstew]

Does anyone else find it frightening how much the strength of the European Economies (starting with the Eurozone and spreading to everyone outside it who trades with it...) now seems to be based on faith? (faith that they are worth anything in monetary terms, that is). It seems to be a constant struggle for Governments to prove to the markets that their economies are worth something, and everyone seems to have lost faith in the idea that there is any mathematics or science behind it. Or am I not understanding something? Is the Euro the problem, or are the markets the problem?

What does everyone else think? (And I won't post again on here, as I don't think I'm very good at being constructive, beyond this question, at the moment - plus I have no idea what I think!).

In a sense, modern economies (particularly banking and stock markets) are always based on faith. Once people lose faith that, for example, the bank has the ability to pay out, or that the company will remain solvent, then it becomes a self-fulfilling prophecy.

I don't know how much economics you know, so forgive me if this is coals/newcastle, but if not much you might find the articles on fractional reserve banking, Keynes description of the stock market 'beauty contest' and fiat currency interesting.

In terms of where the problem started, it is complicated and quite hard to summarise, but basically IMO the bottom line was the housing market bubble in many countries (US, UK, Spain in particular) and associated consumer lending boom. The interlinking of banks then meant that defaults in one country affected banks in most other countries because they also owned the bad debts.

The Euro makes things worse, because it restricts the things that member countries can do to deal with economic problems.

The basic 'toolkit' that the government has to manage the economy are:

Monetary policy - Interest rates / Currency value (linked to interest rates - all other things being equal, if your interest rate is low, people won't want to hold your currency and its value will fall) / money supply
Fiscal policy - ie taxes / public spending

Once locked into the Euro, the member countries could no longer set interest rates independently. Germany has a strong economy, and values low inflation very highly. When, for example, the Spanish economy slowed, the Spanish govt were not able to do what would in normal times be expected - lower interest rates, let the currency fall, and if necessary live with a bit more inflation.

I'm hoping all this makes sense, its very hard to explain coherently and briefly with a very small box to type in!

No, thanks very much, Takver, it does make sense and is very interesting. (Breaking my rule not to post on here).

I think I've realised that, whilst I played lipservice to understanding it, economic theory has always been one of my false Gods. So, when the bankers in the City messed up, I felt like shouting out, "I told you so!" because I'd never truly believed in it in the first place (ie didn't believe the market was very clever). So maybe faith can be recovered by greater understanding (she said optimistically!!!!!!!!). Maybe we really do need to navel gaze obsessively, ala rabbitstew after all... (please, no...). Then, when we understand we've all got a point, we won't be quite so malicious when we disagree with each other.

Good summary, Takver.

And now we find the false god has feet of clay, WTF can be done about it?

If Ireland/Spain etc can't devalue their currency, surely about the only thing they can do is austerity measures - cutting salaries etc. But it doesn't seem to be working for Ireland so far and of course it means there's even less money in their economy.

Well, there were a fair few economists saying 'I told you so' too.

Believe me, the old joke about economists (you ask three economists a question, you'll get four different opinions) is very true.

And the other joke - an engineer, an electrician and an economist, in a railway carriage, arguing whose is the oldest profession. The engineer argues, god created the world in 7 days - obviously an engineering feat. The electrician says - out of the chaos, came light, so electricians were first. Ah, says the economist, but who do you think created the chaos?

Sorry, Grimma, that rather unhelpful post crossed with your far more sensible one

Yes, I've always liked that joke! I think maybe that's the problem...

Maybe we've all realised that in terms of making money, we cannot rely solely on the financial markets and that within one country we do need a balance between manufacturing, financial and other services, and agriculture, so that if one messes up, we can rely on the other/s? Or did we become too global, so that if one big country falls, we all fall, and we can no longer be self sufficient, even if we want to be? (Or is it actually better that the whole world to a certain extent is suffering together, even if it is not better for us?...).

Well, as someone who is firmly convinced that both climate change and energy security are big issues for the future, my personal opinion is that we really do need a fundamental change in the way our economy is run. So more local manufacturing and agriculture, combined with a change of attitudes such that we are not expecting continual economic growth.

The implications of that for me would be that we need greater economic equality, because we can't rely on growth to increase the incomes of the poorest (of course in recent years it has mainly increased the incomes of the richest).

I suppose the only era in recent history where a fundamental shift in the economy has combined with increased equality of outcome was the second world war, where I believe there genuinely was a sense of 'all in this together'. Largely I imagine because if it had not been clear that the rich were losing as well as the poor, there was a real belief that revolution was possible. (I find George Orwell's essays of the time fascinating.)

So, do we now rely on the current Government to concentrate on rebuilding the financial markets, now, on the basis that will be the quickest way to create the money needed to rebuild our economy properly - or is this a false argument, because the World's population is now so big and resources getting so scarce that there isn't actually much money to be made from the City any more? (ps sorry if this sounds naive, Takver, I confess to not having read the articles you referred to in your earlier post, yet).

Doesn't sound like a naive question at all. My personal opinion, is that we would be far better to concentrate on rebalancing our economy for a no growth / high citizen welfare / high equality state. So lots of investment into renewable energy, agriculture, education, training.

Unfortunately it seems like what the political parties of both sides want is to get back to business as usual as soon as possible, with (from the right) a once and for all downward shift in levels of public spending.

The City can't 'make money'. It can generate some real income for our country only at the expense of others, ultimately, if its selling some 'service' particularly well.

The markets appeared to be 'making money' largely because of house price inflation.

A house is a thing to live in that realistically has to be tied to earnings. Unfortunately they are seen as 'investments' and then the price of houses controls the price of houses, lenders lend too much ... till the bubble bursts.

That is so true, Grimma. I always think it is interesting to think about any given issue in economics in terms of real concrete items - so the goods and services that people actually want to consume, and how those are being provided.

Obviously, some quantity of financial services is useful within that package to oil the wheels as it were, but my feeling is that we have passed far beyond that point and off into the stratosphere.

The same way of looking at things is always useful I find when someone (politician or whoever) says 'we can't afford to fund that from public spending'.

Either as a country, we have sufficient resources to provide a certain service / a certain level of material goods to particular people, or we don't. Whether that service/goods are paid for centrally through taxes (meaning that they are likely to be rationed by queue, means test or something similar) or paid for privately by individuals (meaning that they will be rationed by income) is a choice that we can make as a society.

So, should we be balancing the recovery with a mix of increased taxes and money spent on investing in profit-making activities (financial markets, manufacturing, agriculture, services), and possibly some decrease in spending on the Welfare State, but not as much as now? Can this work, economically, or would taxes have to increase "too much" in order to get sufficient investment to rebuild our ailing agriculture and manufacturing industries????

What is too much tax? How do we get the extremely wealthy to see that a large percentage of a colossal amount still leaves them with a colossal amount and that a fair proportion of their gain is more at others' expense than as a result of their own merits (ie their benefit to society by having lots of money to spend only stretches so far, particularly when lots of their money is in overseas investments)? (In other words that it is fair to tax them like this and unfair of them to get their money out of the country to avoid it?????). Or is this failing to understand how globalisation works?

And as for those who are less extremely wealthy... what is fair for them? And the really not very well off at all?

Oh, and should taxes on the businesses stay low to encourage their growth at the same time as raising tax on some individuals? Is this fair but impossible to sell to the public, or just silly?

Oh, and should taxes on the businesses stay low to encourage their growth at the same time as raising tax on some individuals? Is this fair but impossible to sell to the public, or just silly?

Its not silly at all, and I don't think it needs 'selling' to the public if they've any sense. The taxes on businesses should be pitched low enough that (a) they can succeed (b) stay in the UK.

The sort of people who may have higher taxes imposed may well include owners of businesses when they take money out of them.

Rabbitstew - Could you please explain the statement "a fair proportion of their gain is more at others expense than as a result of their own merits"?

PelvicFloorTrauma - I mean that I believe no-one is worth millions, because their profits are to a certain extent illusory. They don't KNOW they are worth that much, they just think they are - next year it may turn out they were wrong and will find out they have actually lost billions.

Oh, and in the case of industries where something tangible is made (eg manufacturing), then I mean that the bosses at the top who make huge profits for the company may occasionally be doing so at the expense of their employees (NOT always, of course and what is fair is a matter of opinion), by underpaying them in order to make greater profits for shareholders. They are then rewarded by the shareholders and the employees don't get much of a say in it. ie it's the age old "class war" problem - both sides genuinely have a point, so you have to find a fair balance between the two arguments. I just believe that balance is not being struck at the moment and that there is too much inequality in society, which has the potential to cause a lot of unpleasant discord.