Friday, March 29, 2013

Francois Hollande lurches Right in historic U-Turn to save French economy

The U.S. Democrats have a love affair with Europe in general and France in particular. Will they absorb the French lesson below?

French president François Hollande has bowed to massive pressure for business tax cuts to pull France’s economy out of slump and stave off industrial decline, ditching a core element of his socialist platform.

Company taxes will fall by €20bn a year equal to 1pc of GDP, to be phased in gradually by 2015 under a convoluted system of rebates.

Premier Jean-Marc Ayrault said it amounted to a 6pc cut in unit labour costs, enough to close the gap with eurozone rivals. "France is not condemned to a spiral of decline, but we need a national jolt to regain control of our destiny," he said.

The mid-rate of VAT for restaurants and services will jump from 7pc to 10pc. The top rate will rise slightly to 20pc. Spending cuts will plug the revenue gap in order to meet the EU’s 3pc deficit target.

Critics call it the most humiliating U-turn in French politics since François Mitterrand abandoned his disastrous experiment of "Socialism in one country" under a D-Mark currency peg in 1983.

Mr Hollande came to office vowing lower VAT rates to protect the buying power of workers, and called business tax cuts a "gift to the rich". He imposed €10bn of fresh taxes on firms just weeks ago in his 2013 budget, a move that set off a revolt by business leaders.

The French National Assembly was in uproar on Tuesday as Gaulliste deputies derided the volte-face as a confession of misrule for the past six months.

His plan comes a day after French industrialist Louis Gallois delivered a report calling for "shock therapy" to halt the relentless decline of France’s eurozone export share, and the loss of 60,000 industrial jobs each year. He recommended deep cuts in payroll levies to bridge the gap in labour costs with Germany.

"President Hollande is finally starting to back away from some of his economically dangerous campaign promises," said Christian Schulz from Berenberg Bank.

Mr Schulz said the French leader has faced his "Schröder moment", reaching out like Germany’s Social Democrat Chancellor Gerhard Schröder a decade ago to a respected businessman to provide cover for reform.

Less clear is whether Mr Hollande will try to tame the Leviathan state, now Euroland’s biggest at 56pc of GDP. Such a move would entail a head-on clash with the socialist party base. "The new measures do not come anywhere close to what France would need to do to arrest its trend decline. He will need to go much further to end the maladie française," said Mr Schulz.

Pressure is mounting from all sides. The International Monetary Fund warned this week that France risked being left behind by Italy and Spain as they embrace root-and-branch reforms.

Mr Hollande appears to have been stung by accusations that his government is "anti-enterprise". The corporate lobby MEDEF said last month that investment was collapsing, and warned of capital flight in tones reminiscent of attacks on Leon Blum’s leftist Popular Front in 1936.

The new plan adopts most of the 22 proposals in the Gallois Report, including a state bank to steer cheap credit to exporters, though it falls short of Mr Gallois’ call for a €30bn cut in payroll levies.

Jean-François Copé, the Gaulliste leader, said the Hollande package was "hyper-complex, bureaucratic, and wholly inadaquate". Business leaders said it helps but comes too late reverse a collapse in profit margins as recession looms.

The tax reform aims to switch the burden from wealth creation to consumption, a trick used by Germany to carry out its "internal devaluation" within EMU. The policy was pioneered by Margaret Thatcher, a detail that France’s socialists prefer to keep quiet.

For Mr Hollande, it has been a painful wake-up from the utopian reverie of his first months in office. "Exercising power today is very hard. You don’t get any breaks, of any kind," he confessed.



Cyprus has finally killed myth that European Monetary Union is benign

The punishment regime imposed on Cyprus is a trick against everybody involved in this squalid saga, against the Cypriot people and the German people, against savers and creditors. All are being deceived.

It is not a bail-out. There is no debt relief for the state of Cyprus. The Diktat will push the island’s debt ratio to 120pc in short order, with a high risk of an economic death spiral, a la Grecque.

Capital controls have shattered the monetary unity of EMU. A Cypriot euro is no longer a core euro. We wait to hear the first stories of shops across Europe refusing to accept euro notes issued by Cyprus, with a G in the serial number.

The curbs are draconian. There will be a forced rollover of debt. Cheques may not be cashed. Basic cross-border trade is severely curtailed. Credit card use abroad will be limited to €5,000 (£4,200) a month. “We wonder how such capital controls could eventually be lifted with no obvious cure of the underlying problem,” said Credit Suisse.

The complicity of EU authorities in the original plan to violate insured bank savings – halted only by the revolt of the Cypriot parliament – leaves the suspicion that they will steal anybody’s money if leaders of the creditor states think it is in their immediate interest to do so. Monetary union has become a danger to property.

One can only smile at the denunciations of Eurogroup chief Jeroen Dijsselbloem for letting slip that the Cypriot package is a template for future EMU rescues, with further haircuts for “uninsured deposit holders”.

That is not the script. Cyprus is supposed to be a special case. Yet the “Dijssel Bomb” merely confirms that the creditor powers – the people who run EMU at the moment – will impose just such a policy on the rest of Club Med if push ever comes to shove. At the same time, the German bloc is lying to its own people about the real costs of holding the euro together. The accord pretends to shield the taxpayers of EMU creditor states from future losses. By seizing €5.8bn from savings accounts, it has reduced the headline figure on the EU-IMF Troika rescue to €10bn.

This is legerdemain. They have simply switched the cost of the new credit line for Cyprus to the European Central Bank. The ECB will have to offset the slow-motion bank run in Cyprus with its Emergency Liquidity Assistance (ELA), and this is likely to be a big chunk of the remaining €68bn in deposits after what has happened over the past two weeks.

Much of this will show up on the balance sheet of the Bundesbank and its peers through the ECB’s Target2 payment nexus. The money will leak out of Cyprus unless the Troika tries to encircle the island with razor wire.

“In saving €5.8bn in bail-out money, the other euro area countries will likely be on the hook for four to five times more in contingent liabilities. But, of course, the former represents real money that gives politicians a headache; the latter is monopoly central bank money,” said Marchel Alexandrovich, from Jefferies.

Chancellor Angela Merkel will do anything before the elections in September to disguise the true cost of the EMU project. It has been clear since August 2012 that she is willing let the ECB carry out bail-outs by stealth, as the lesser of evils. Such action is invisible to the German public. It does not require a vote in the Bundestag. It circumvents democracy.

Mrs Merkel can get away with this, provided Cyprus does not leave EMU and default on the Bundesbank’s Target2 claims, yet that may well happen.

“I wouldn’t be surprised to see a 20pc fall in real GDP,” said Nobel economist Paul Krugman. “Cyprus should leave the euro. Staying in means an incredibly severe depression.”

“Nobody knows what is going to happen. The economy could go into a free fall,” said Dimitris Drakopoulos, from Nomura.

The country has just lost its core industry, a banking system with assets equal to eight times GDP, and has little to replace it with. Cyprus cannot hope to claw its way back to viability with a tourist boom because EMU membership has made it shockingly expensive. Turkey, Croatia or Egypt are all much cheaper. Manufacturing is just 7pc of GDP. The IMF says the labour cost index has risen even faster than in Greece, Spain or Italy since the late 1990s.

What saved Iceland from mass unemployment after its banks blew up – or saved Sweden and Finland in the early 1990s – was a currency devaluation that brought industries back from the dead. Iceland’s krona has fallen low enough to make it worthwhile growing tomatoes for sale in greenhouses near the Arctic Circle.

If Cyprus tries to claw back competitiveness with an “internal devaluation”, it will drive unemployment to Greek levels (27pc) and cause the economy to contract so fast that the debt ratio explodes.

The IMF’s Christine Lagarde has given her blessing to the Troika deal, claiming that the package will restore Cyprus to full health, with public debt below 100pc of GDP by 2020.

Yet the Fund has already been through this charade in Greece, and her own staff discredited the doctrine behind EMU crisis measures. It has shown that the “fiscal multiplier” is three times higher than thought for the Club Med bloc. Austerity beyond the therapeutic dose is self-defeating.

Some in Nicosia cling to the hope that Cyprus can carry on as a financial gateway for Russians and Kazakhs, as if nothing has happened. RBS says the Russians will pull what remains of their money out of Cyprus “as soon as the capital controls are lifted”.

The willingness of the Cypriot authorities last week to seize money from anybody in any bank in Cyprus – even healthy banks – was an act of state madness. We will find out over time whether this epic blunder has destroyed confidence in the country as a financial centre, or whether parts of the financial and legal services sector can rebound.

Yet surely there is no going back to the old model, even though the final package restricts the losses to the two banks that are actually in trouble. Savers above €100,000 at Laiki will lose 80pc of their money, if they get anything back. Those at the Bank of Cyprus will lose 40pc.

Thousands of small firms trying to hang on face seizure of their operating funds. One Cypriot told me that the €400,000 trading account of his father at Laiki had just been frozen, leaving him unable to pay an Egyptian firm for a consignment of shoes.

The Cyprus debacle has taught us yet again that EMU has gone off the rails, is a danger to stability, and should be dismantled before it destroys Europe’s post-War order.



Repeal Obamacare

Liberals had hoped, and some conservatives had feared, that the legislative Frankenstein’s monster known as Obamacare would become more popular as its sundry measures were implemented. But the Patient Protection and Affordable Care Act is no more popular now than when it was passed, as Americans have come to realize that it will neither protect patients nor provide for affordable care. While full repeal of the law is not within the realm of short-term political reality — the presence of Barack Obama in the White House and a Democratic majority in the Senate ensures that — repeal should nonetheless remain the end goal, either one piece at a time for now or root and branch.

The price tag for Obamacare has gone from shocking to preposterous. In March 2010, the Congressional Budget Office estimated the ten-year cost of the law at $898 billion; by February 2013, that number had climbed to $1.6 trillion, and it is likely that further revisions will be in the upward direction. That is a very high price to pay for a system that will, by the admission of its own supporters, leave some 30 million Americans uninsured. Long gone is the fiction pronounced by President Obama and repeated by his media enablers that the law will not add “one dime” to the deficit; the latest estimate is that Obamacare will add as much as $6.2 trillion to the long-term national debt, according to the Government Accountability Office. No thinking person takes President Obama seriously on fiscal questions, but those alleged experts and pundits who argued for Obamacare on fiscal grounds should be regarded as thoroughly discredited.

As mind-boggling as its price tag is, expense is not the main reason to repeal Obamacare. What is not sufficiently understood is that Obamacare does not reform or regulate health insurance: It effectively abolishes health insurance. Health insurance functions by creating pools of beneficiaries large enough that the incidence of particular health-care expenses — for everything from heart attacks to injuries in car accidents — can be predicted by actuaries with some statistical reliability, thus enabling costs to be distributed among beneficiaries over time. Obamacare demands that all insurance beneficiaries be offered identical rates regardless of health-related variables, and severely restricts the kinds of plans that may be offered. The most important variable is, of course, the question of whether somebody already is sick. Under Obamacare, an uninsured person who develops a serious illness can demand that he be insured at a rate no different from that of a person who had been purchasing insurance for decades before he became ill.

The “individual mandate” was supposed to prevent that problem by requiring all Americans to purchase health insurance, but it is a mandate that manages to be both too invasive and too lax at the same time: The mandate will invite the micromanagement of individuals and businesses by the federal government, but Americans will in many cases find themselves financially better off paying the tax for not getting insurance (as Chief Justice Roberts has reformulated the mandate) until they become sick and need insurance. Because of that defect, the main rationale for Obamacare — bringing all Americans into a large insurance market that can then be regulated and subsidized to bring it into accord with the tastes of the central planners in Washington — will prove impossible to realize.

Obamacare proposes to control health-care costs by empowering a small panel of unaccountable political appointees — the Independent Payment Advisory Board (IPAB) — to keep a lid on medical costs by imposing price controls. We have two relevant bodies of experience from which to draw insight on how this is likely to play out: Medicaid payments are subject to similar price controls, and doctors have responded to low rates of reimbursement by refusing to see Medicaid patients. Medicare is supposed to be subject to similar price controls, but, because the elderly are more politically influential than the poor, Congress has declined to actually cut payments to Medicare doctors, year after year after year, knowing that doing so would make doctors just as unwilling to take Medicare patients as they are to take Medicaid patients. The result in the former case is price controls that work by hurting Medicaid’s intended beneficiaries, who often have worse health-care outcomes than those with no coverage at all; the result in the latter case is price controls that do not work, period.

During the debate over Obamacare, the president and his supporters promised that enacting the law would cause insurance premiums for the typical family to decline by some $2,500 a year. In fact, premiums have continued to go up, now at an accelerated pace. In 2008, the year Barack Obama was elected president, health-insurance premiums rose by 0.6 percent. In 2009, the year Obamacare was passed, they rose by 1.3 percent. In 2011, they rose by 9.6 percent, or 16 times as quickly as they did the year before the law was passed. Expenses are expected to rise the most severely for young and healthy people. Because of the perverse incentives the law creates, the CBO estimates that the number of people insured through the subsidized health-insurance exchanges will begin to decline quickly after 2018 as the young and healthy realize that paying the fine is more economical than paying ever-higher insurance premiums. That means that those remaining in the insurance pool will be on average older and sicker, which is why the CBO estimates that the cost of subsidizing them will grow by almost 6 percent a year. Put another way, the cost of subsidizing the exchanges is expected to double every twelve years.

In short, the system created by this ill-advised law would prevent the emergence of normally functioning markets in medical services and health insurance. Instead, it establishes a top-down system of price controls and subsidies that will discourage healthy people from buying insurance in the first place, reward those who exploit the system’s defects, and discourage doctors and other health-care providers from extending their care to those who most need it.

Obamacare is too flawed in in its basic conception to be improved through reform. It must be replaced, either all at once or step by step. Replacement remains a viable option because the law is still unpopular and still unlikely to work. Indeed, the next phase of its implementation promises to be a chaotic enterprise that will further undermine the standing and credibility of the law and its architects. Republicans can and should begin taking it apart and building something better on the ruins.




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