The European Union. Love it? Loathe it? All of the above?

The Wall Street Journal writes that Euro chic is back in fashion. EU chic — to be precise.

The 12 gold stars that form the EU flag are not exactly selling clothing lines like hotcakes. But a Brussels PR firm plans to introduce T-shirts and a whole range of Euro clothing extolling historical EU figures, like Robert Schuman, the French foreign minister in 1950, who was one of the “fathers” of EU integration.

How über-cool. This really captures the zeitgeist. A certain je ne sais WTF croix. Like, yo. Dudette.

PR firms — well, they’re paid to lie. But history tells a very different (and rather less auspicious) story of European integration.

So I thought we’d focus upon Five Epic EU Fails. Drum roll, Maestro. The envelope, please. The nominations are …

5. Going bananas

So you thought that tale about the EU regulating the shape of bananas was an urban legend? Think again.

The 1994 regulation (you can read the full enchilada here) stated that bananas could have “slight defects in shape”. This gave rise to the “bendy banana” legend, as the EU Commission regulation referred to “abnormal curvature”.

Moving from crescent-shaped fruit to cucumbers, the 1998 rule (Regulation 1677/1988) on the concombre stated that they must be “well-shaped and practically straight (maximum height of the arc 10mm per 10cm of length)”.

In 2008, the Commission tacitly recognised how stringent food regulations were becoming, as shops were apparently refusing to stock up to 20% of food and vegetables, because they didn’t meet EU regulations. Consequently, the Commission noted that it was wasteful to simply throw the food away. Sanity prevails.

4. The farmers are revolting

Staying with foodstuffs, the three favourite swear words of the Australian farmer are Common – Agricultural – Policy (CAP). Established in 1962, this complex mechanism of farm production supports and export subsidies was implemented fully in 1967–68. By 1969, the CAP budget blew out 800%.

In fairness, the CAP is about ensuring that strategic food supplies are maintained and raising farm incomes. In practice, it led to massive over-production: wine lakes and butter mountains. It made food more expensive, imports prohibitive and ruined crop production in the Third World, as excess EU produce was dumped on developing countries. It also produced billions of dollars' worth of US Farm Bills as Washington responded with its own subsidies. Meanwhile, the long-suffering, efficient Australian farmer got crushed in the middle of the CAP sandwich. Go figure.

Oh yes, and some wag once worked out that if you sent every single cow in Europe on a first-class around-the-world air trip, it would still cost less than subsidising the cattle under the CAP. Moo to you too.

3. ERM II

Exchange-Rate Mechanism II was part of Phase II of the Euro’s introduction. Following the horrendous currency crashes of 1992 and 1993, Italy’s lira collapsed and withdrew from the basket of currencies that formed the embryonic Eurozone. Under “ERM I”, the lira could appreciate or depreciate a maximum of 6% within the currency’s band of adjustment.

ERM II, by contrast, was introduced in 1995 to accommodate weak currencies, so they could (re)join the transition to the euro, scheduled for 1999. ERM II introduced a much wider band of adjustment for currencies: +/– 15%. A 30% band, in effect, was close to a free float. It worked. The lira joined ERM II in 1996. The rest is, er, history. Well, the Italian economy is, anyway.

2. Britain’s entry into the EC (1973)

Britain had missed the boat. Twice. In 1951, the British were invited to join the European Coal and Steel Community. They declined. In 1955-56, at the Messina Conference, London could have opted to sign up for the 1957 Rome Treaty, which established the European Community. Harold Macmillan’s government said “no” once more. But Harold Mac was to regret this, as the UK economy declined to such an extent that he launched Britain’s first bid for membership in 1961.

Without consulting his partners, the French President, Charles de Gaulle, called a press conference in January 1963 and famously said “non.” Britain was “not ready” for EC membership.

In 1967, Britain, this time under Harold Wilson, tried again. De Gaulle exercised a veto once again.

Finally, in 1970-72, with de Gaulle dead and gone, Edward Heath’s (does anyone remember him?) government secured UK membership, but at a price: Macmillan and Wilson had demanded associate membership of the EC, or at least special trade access privileges, for the British Commonwealth.

Not Heath. Desperately, he gave up all claims and left the Commonwealth out in the cold. In Australia, this was known as the “British betrayal”. Britain finally entered the EC on 1 January, 1973. The EU has been regretting this ever since.

Fun fact: Princeton’s Professor Andrew Moravcsik in his book The Choice for Europe (1998) found in his archival research that de Gaulle named-checked Australia among his private reasons for vetoing British EC membership in 1963. Australia’s farm sector, de Gaulle opined, was so deadly efficient it could ruin the nascent Common Agricultural Policy, if Britain were permitted to bring the Commonwealth in.

So it’s all our fault.

I suppose a Brussels PR firm could put Ted Heath’s beaming visage on a hoodie. But I bet it would sell about as well as a Paris 2012 Olympics T-shirt.

And the winner is…

1. Greece’s admission to the Eurozone

Beware of Greeks bearing false national accounts. Athens didn’t make the cut in 1999, when the original Eurozone was established with 11 members.

But some creative accounting, most likely recommended by Goldman Sachs, led Greece to understate its fiscal deficit in 1999, the reference year for its eventual admission in 2001. The revisions helpfully left some defence expenditures accounted for inaccurately, while the EU Commission adopted a “don’t-ask-don’t-tell” policy by failing to question either the methodology or the data set provided by the government.

It gets worse, of course. In 2004, the new government at least revealed the earlier anomaly. The EU Commission admonished Greece. Not for the cover-up, but for being too honest. Fortunately, financial markets, who were busily watching Iraq and the Brent crude index hit stratospheric heights, looked askance.

But wait — there’s more. In 2009, the Greek government announced a revision to the 2008 fiscal deficit figure, raising it from 5% to 5.6%.

Then they decided the budget deficit in 2009 would not be 3.7% after all. No. Or Oxi, if you prefer. It would be 12.5%.

Oops.

“I’d love to have the German army in Australia,” Hugh White said wistfully.

The date was July 2004. The place was the bar on the fourth floor at the Department of International Relations, London School of Economics and Political Science, Houghton Street.

I was intrigued. “Why, Hugh?” I asked.

“250,000 troops,” White mused. “We could do a lot with a quarter of a million troops.”

“Not with 250,000 German ones,” I countered. “This is not your grand-daddy’s German army. Only 5,000 are combat-ready and the rest are polishing the wheels on tanks. It’s not like you can just drop them in a Vietnamese jungle. They’d die.”

“I’d love to write a book,” White beamed. “I really want to write a book.”

Well, he has. And he did.

At the risk of revealing a private conversation (but I doubt it; there were about 24 people present), the exchange above gives us at least some insight into the mind that produced The China Choice: Why America Should Share Power.

The China Choice’s thesis is straightforward: rather than engage in competition and conflict with China, Washington should share power with Beijing by forming a “Concert of Asia”, comprising the major powers of the Asia-Pacific.

White’s book expands upon the thesis he propounded in 2010. In an earlier article in The Conversation, I canvassed the debates White raised in his original Quarterly Essay.

Beijing: partner or competitor?

During the 2000 US presidential election, Al Gore and Bill Clinton campaigned on the theme of China as a “strategic partner” of the US. By contrast, George W. Bush argued that China could never be a partner of Washington; it would always be a “strategic competitor”.

As Bush’s future National Security Advisor and Secretary of State Condoleezza Rice asserted in Foreign Affairs in 2000:

“China is not a ‘status quo’ power but one that would like to alter Asia’s balance of power in its own favour. That alone makes it a strategic competitor, not the ‘strategic partner’ the Clinton administration once called it.”

Despite this inauspicious start, US-China relations under Bush were stable, following a terse exchange over the Hainan Island affair. The central point of friction between the Beijing and Washington during the Bush administration remained Taiwan.

Since 2003, the PRC leadership under Hu Jintao has vacillated between closer integration and hard-line opposition to any semblance of independence from Taipei. Further complicating the situation are occasional faux pas, such as Major-General Zhu Chenghu’s threat to strike “hundreds of American cities” with nuclear weapons, in the event of Sino-US conflict over Taiwan.

The US foreign policy debate on China-as-partner-or-rival was given a provocative twist in 2005 in Robert Kaplan’s ‘How We Would Fight China’. Kaplan, who writes an approving blurb for White’s book, is rather more hawkish than his antipodean colleague, although it is clear that White was influenced deeply by Kaplan’s ideas.

Taiwan is merely one of the strategic issues in Asia with which policy makers need grapple. As one leading US realist, John Mearsheimer, argued, China will attempt to push the US out of Asia. But it will fail, Mearsheimer asserts. How does White envisage the outcome in an Asia-Pacific where a declining US persisted in its military aggrandisement in the region? What if the future Chinese leadership becomes more hawkish and attempts to transform the South China Sea into a Chinese lake?

We won’t need to wait long to find out. In the last six weeks, China and the Philippines have come close to confrontation over the Scarborough Shoal in the South China Sea (SCS); the July ASEAN summit in Phnom Penh saw Southeast Asian states in furious disagreement over rival maritime claims in the SCS, even as Beijing sent a thinly-veiled warning to Manila to back off. The Philippines wants the dispute arbitrated by the International Tribunal on the Law of the Sea (ITLOS).

In response, a Chinese Foreign Ministry spokesperson said, “Isn’t it a weird thing in international affairs to submit a sovereign country’s territory to international arbitration? What a chaos the world will be in if this happens?"

Yes, quite weird. The rule of law, and an independent judiciary in the form of the International Tribunal for the Law of the Sea (ITLOS), under the auspices of the UN taking an impartial decision within the ambit of a multilateral treaty is very weird indeed. If you’re Beijing. If you believe in “sharing power” with Beijing.

If you’re Hugh White.

China has ratified the Third UN Convention on the Law of the Sea (UNCLOS III). The US hasn’t (to save you looking it up). However, like the NPT, UNCLOS III is merely another convention that Beijing signs without the slightest intention of adherence. In 2001, China also joined the World Trade Organisation and duly ratified its attendant Trade in Intellectual Property Services (TRIPS) agreement. Yet, anyone who has ever visited China knows of the sheer scale of knock-offs, replicas, fakes and blatant product piracy. Beijing makes sporadic, insincere attempts at enforcing IP rights; but these efforts fool no one.

Readers will find none of this in The China Choice. Nevertheless, White feels comfortable enough to advocate “concert diplomacy” with Beijing. Nor will you find any mention of cyber-espionage. In April this year, the US’s former counter-terrorism chief, Richard Clarke, warned, in a grossly under-reported story: “Every major company in the United States has already been penetrated by China.” For Clark, this represents not only a commercial threat to the US economy, but also a military threat.

Labor pains

In his review of The China Choice, Paul Keating wrote, somewhat oddly, “I have long held the view that the future of Asian stability cannot be cast by a non-Asian power.”

Why is Asia different from Europe or the Middle East? The answer: it isn’t. None of these regions possesses a regional state with the capability to ensure either security or stability. In any case, Beijing has demonstrated absolutely no interest in “Asian security”. Beijing describes itself as a “participant” in the ASEAN Regional Forum (ARF) process, not a ‘member’, thus avoiding any binding regional security commitments.

Consequently, anyone who argues that the world’s biggest non-democracy is interested in “Asian security”, as that country steadily continues to militarize the South China Sea, has an exceptionally perverse view of “Asian security”.

The ALP has never been entirely comfortable with the US alliance. Curtin called upon the Americans in desperation only after it was clear that Churchill had abandoned Australia and the Japanese invasion threat was real; Evatt opposed Washington’s plans to revive the Japanese economy after 1947; Cairns led Labor’s anti-Vietnam war crusade; Whitlam labelled Nixon’s bombing of Cambodia “criminal”, and called for the disbanding of SEATO – the US’s first attempt to contain China. In 1985, the ALP Left compelled Hawke to perform a volte-face on the MX missile tests.

Keating, while in office, kept his powder dry, although he and Hawke attempted to establish APEC without US participation (the Japanese refused to countenance this). But Keating emptied both barrels into Obama following the US president’s visit in November 2011, arguing that Obama should not have been permitted to deliver an anti-China speech in Federal Parliament. Simon Crean, Mark Latham and Kim Beazley lambasted the US publicly on the Iraq invasion (albeit from the safe distance of opposition) and pledged Australian withdrawal.

Kevin Rudd, like Keating, attempted to dilute US power in the Asia-Pacific, proposing a concert of powers, comprising China, the US, Japan, Indonesia and India, among others, under the rubric of an “Asia-Pacific Community”. However, no leaders in Asia or North America treated Rudd’s initiative with any seriousness. Nevertheless, Rudd’s views have found some resonance in White’s book, as White himself proposes a “concert of great powers”.

Two generations of Australian politicians and policy makers have proven perfectly content to accommodate China, as its wealth pours into Treasury’s coffers. Consequently, White’s book is likely to become the bible of the Beijing Lobby; its apostles traverse the political spectrum of China apologists and appeasers, including, but not limited to, Paul Keating, Bob Hawke, Malcolm Turnbull, Kevin Rudd, Ross Garnaut and Gareth Evans.

But putting aside this coterie, one is left wondering at whom White’s book is directed. The Australian defence and foreign policy establishments? The Pentagon? The US State Department? Surely not the Beijing lobby of former Australian prime ministers, foreign ministers and sundry acolytes? The slow boat to China they boarded sailed long ago.

The Concert dances… but it isn’t going anywhere*

Asia does not need great-power concerts which, White admits, are difficult to construct and potentially unstable once they are in effect. And, ominously, White further admits that a sphere of influence would need to be conceded to China: “Obviously not over the entire East Asian region… China might be conceded a sphere of influence – in Indochina, for example.” (p. 150). This may be news to Hanoi.

Spheres of influence are what landed Churchill, Roosevelt and Truman in such hot water. The notorious “percentages agreement”, negotiated by an inebriated Churchill over several hours with Stalin, allowed Moscow a free hand in virtually all of Eastern Europe; it forced Truman to adopt a policy of unlimited containment from 1948, embroiling Washington in wars, not only in Korea, but also, ultimately, in Vietnam. It left millions of Poles, Hungarians, Germans, Romanians, Bulgarians and Czechoslovaks under the yoke of Soviet imperialism for 40 years. And it left all of Europe confronting the threat of nuclear annihilation until 1989.

Instead of spheres of influence, what Asia needs is pluri-lateral commitments from the region’s major powers to limit their conventional and nuclear forces. This does not mean conceding China a “sphere of influence” where it can simply throw its weight around in Asia to the detriment of its neighbours; it means sound, negotiated limits upon the weaponization of the Asia-Pacific.

According to White’s strategic conspectus, this particular concert would comprise a “party of four” (p. 144): the US, China, India and Japan. The latter two countries are included – reluctantly. Meanwhile, Indonesia has potential concert status, but not until mid-century. White decides Russia is out. This might be news to Moscow; after all, where would Beijing and New Delhi – the world’s biggest arms importers – get their weapons from then?

It may well be that White has been seduced by the Pax Britannica – the high-tide mark of great-power concert diplomacy under the auspices of the Concert of Europe that shaped the 1815–1914 period (which the author cites approvingly on pp. 133–7). However, the circumstances were decidedly different. Britain was the balancing power that often determined whether or not a conflict took place; and, if it did, it played a decisive role (the Crimean conflict; the Opium Wars).

But White’s rose-coloured and fleeting appraisal of the Concert ignores the fact that British diplomats made a catastrophic error by allowing Bismarck’s emergent Prussia to fight three decisive wars (1864–70), giving the embryonic German empire mastery over continental Europe. By the 1890s, Bismarck was gone, and Britain was mired in a deadly, unlimited arms race with Germany; in 1914, the guns of August compelled Britain to fight beside France and Russia to counter the German threat once and for all.

Trust – but verify

White cites Bill Clinton’s declaration of a “strategic partnership” with Beijing approvingly; yet, he fails to note that it was Clinton who revitalised the US-Japan strategic partnership, so clearly directed at containing China, under the rubric of the Nye Plan. Clinton also signed National Missile Defence (NMD) – and its sibling, Theatre Missile Defence – into existence. Clinton left Bush to activate NMD, opening technologies such as Aegis to the Japanese and Australian navies. Subsequently, both Bush and Obama left open the possibility of supplying Taiwan with Aegis air-sea warfare capabilities as a means of dissuading Beijing from increasing its force projection across the Taiwan Strait.

Yet, ‘strategic ambiguity’ over Taiwan – a concept that invites uncertainty as to the US’s reactions and acts as a deterrent to both Beijing and Taipei – is dismissed summarily by White. Instead, White proposes a power-sharing arrangement:

“Washington has long claimed and exercised a unique military posture in Asia … This would have to change under a Concert of Asia. Treating China as an equal would mean accepting that America would not seek to impose limits on China’s military capability that it would not accept on its own.” (p. 151).

Why should Washington accept this? Why should the US retreat from its preponderant position in the face of growing Chinese military power? Instead, why not work to demilitarise Asia via sensible, verifiable disarmament measures, placing ceilings upon weapons stockpiles and deployments?

This was at the crux of the Reagan-Gorbachev disarmament initiatives. In December 1987, the US and USSR signed the Intermediate Nuclear Forces (INF) Treaty, which eliminated 9% of the world’s nuclear missiles (not warheads, mind) and removed short and medium-range missiles from the East and West European theatres.

The Soviets gave up more than twice as many missiles as the US. Similarly, the Conventional Forces Europe (CFE) Treaty (1990) saw Moscow surrender voluntarily the better than 2:1 advantage that the Warsaw Pact held over NATO in troops and armour.

In both cases, admittedly, the US “negotiated from strength”, as Reagan put it; throughout 1981–86, Washington spent $US2 trillion on rearmament and became the world’s largest debtor; by 1991, the USSR had collapsed. Nevertheless, in the interim, Reagan and Gorbachev concluded major arms reductions treaties that still define Russo-American strategic relations; these treaties were concluded bilaterally without the need for ‘concert diplomacy’. Instead, the watchwords of the new détente in Soviet-US relations were “trust – but verify.”

White says little about arms reductions; the chapter devoted to the military balance merely extemporises upon the implausibility of success of the Pentagon’s Air-Sea Battle concept and the emerging strategic stalemate between Sino-US maritime forces.

Bilateral and plurilateral arms reduction initiatives are more likely to come to fruition when the US directs its diplomatic efforts towards verifiable disarmament, as Moscow and Washington’s efforts since 1987 demonstrate. Verifiable disarmament has already proven effective in the case of India, which was brought within the ambit of a nuclear materials code of conduct by the US-India Civil Nuclear Agreement (2006), after decades of failed efforts to persuade New Delhi to adhere to the 1968 Nuclear Non-Proliferation Treaty (NPT).

By contrast, NPT signatory China has assisted Pakistan (and, possibly, Iran) by proliferating nuclear technologies; protected Tehran from sanctions; shielded and supplied nuclear North Korea; vetoed Security Council efforts to sanction Assad’s regime in Syria; and kept supplying Mugabe’s Zimbabwe with weapons until 2008.

Given that China’s major strategic successes have been assisting the nuclear weaponisation of both Pakistan and North Korea, one assumes that a veteran of security policy like White would not be so placid, nor so benign, about the prospect of granting Beijing anything resembling a regional sphere of influence on the basis of its track record.

The fact that Iran has Shahab missiles, courtesy of China, means Tehran also has the capability to launch strikes against any country in the Middle East. Moreover, as defence analyst Mark Schneider notes, “Even a thousand weapons may underestimate the scope of the Chinese nuclear force 10 or 20 years from now.” As Schneider also asserts, Beijing is reportedly working upon multiple independently-targeted re-entry vehicles (MIRVs, which permit 10-12 nuclear warheads on a single missile). Yet, this same China is the country with which White proposes the US “share power”?

This is akin to rewarding bad behaviour. Within the type of concert system that White proposes, a China that had already been granted a sphere of influence would have little incentive to move towards disarmament, as its extant security policies have already delivered Beijing advantages at no cost. Instead, China could deploy the threat of further weaponisation as a means of obtaining increased strategic advantages to the detriment of both the US and its allies in the Asia-Pacific region. Frankly, this is the type of thinking that leads to dangerous, unpredictable arms races.

Although both the Soviets and the Americans committed grave diplomatic and military blunders throughout the Cold War, they nevertheless reached the same, correct conclusion: it was imperative to retreat from arms races with no ceilings. This became the defining logic of the Strategic Arms Limitation Treaties in 1972 and 1979, through the INF and CFE Treaties, to the Strategic Arms Limitations Treaties (I-III) and New START (2010).

The China Choice lacks the intellectual perspicacity and, indeed, the literary panache that renders books like Robert Kagan’s Of Paradise and Power such compulsive reading. White is right to argue that Australia cannot have its cake and hope that the current US-China status quo will persist indefinitely; but the vigilant do not invite vampires inside their houses either.

White believes a Concert of Asia may mean peace in our time. The more sober Mark Schneider thinks not: “No other country has increased its military spending by double digits for twenty years with the intent of a ‘peaceful rise’”.

*The Comte de Ligne said this of the Congress of Vienna in 1814, the forerunner of the Concert of Europe, in case you’re wondering.

Think Australia is immune to global downturn, depression and despair? Think again.

One would be plundering the depths of naïveté to believe that Australia can continue to exist in an oasis of economic tranquility, while the global economy plunges into turmoil.

If you don’t believe me, then perhaps you’ll believe the chief economist of Deutsche Bank Australia? Or JP Morgan research? Maybe the Housing Industry Association? (Admittedly, HIA spruik for their own cause; but you can’t deny the figures.)

Commentators recognise that constant conjecture about recession can become a self-fulfilling prophecy. However, for most analysts, the objective is to examine the economic data dispassionately and base predictions upon a reasonable interpretation of the available evidence.

If certain data point to a Australian recession, potentially, this in itself raises important public policy issues:

1. How well prepared is Canberra for a major downturn in taxation revenues?

2. What budgetary scenarios are being modelled by Treasury in the event of a significant downturn in Australia’s growth?

3. What strategies does the Commonwealth government have in place to deal with the impact of a (worst-case scenario) “GFC II”, or a longer-term global recession followed by a slow, weak recovery? (the likely scenario).

4. How does the federal government plan to deal in the longer term with the emerging “multi-track” economy, characterised by a booming resources sector (WA and Queensland), a white-collar recession (scroll down to Macquarie’s research report on pages 3–4), a declining and hollowed-out manufacturing sector (Victoria and South Australia), and a declining housing market (national).

What are the key indicators suggesting Australia is destined for recession? Here’s the case for the prosecution.

Shares

Stock exchanges are not only a real-time measure of market confidence, but they also have a delayed-reaction impact upon the real economy. It’s axiomatic that business investment, private-sector job creation and the profitability of the retail sector, personal investment incomes and superannuation industry dividends are ultimately determined by the relative performance of local and global stock markets.

In early June, $20 billion was rudely wiped off the Australian stock market, on the back of another $35 billion lost in August 2011. The falls continued in September-October, as the ASX200 dipped below 3900 points.

The fall wasn’t as severe in June, but it was still coming off a 2012 high of over 4400. But it was the deepest trough since the market collapse of August 2008 and January 2009 – the apex of the GFC.

The market ebbed and flowed, but recovered for about 18 months from early 2010 until August 2011. Monthly market volumes were reasonably steady, and the market did not dip below 4400 until August 2011, losing 5.5% on August 8.

Reflective of weak global demand, the Tokyo stock exchange hit a 28-year low in early June. This was largely a consequence of slowing Chinese manufacturing output and weak US jobs growth – only 69,000 jobs added – in May.

The China Syndrome

Reality is about to bite Beijing: China sent a fraction under 20% of its exports to the EU and the US in 2009. So approximately 40% of all of China’s exports went to the world’s biggest markets. And that is mainland China alone.

Factor in Taiwanese figures (firms like Foxconn and Hon Hai build your iPhone and iPad in southern Chinese mainland factories, like Huizhou), plus the entrepôt port known as Hong Kong, and the figures rise appreciably. (However, hard statistics are difficult to come by, given the level of intra-Chinese imports and re-exportation.)

But in 2011, Chinese export unit shipment growth slumped by 60% year-on-year in the September quarter of 2011.

The entire model of the PRC’s economic growth and development is premised upon export-oriented industrialisation (EOI). Put simply, this means that the economy is export-geared predominantly to produce value-added consumer durables at low prices in sufficient volume to be sold-on in more affluent markets.

But when those affluent markets deflate rapidly in the wake of unsustainable debt positions, foreign direct investment (FDI) dries up, export orders decline significantly, and Chinese firms are compelled to confront the international politics of surplus capacity.

Surplus capacity is the problem that two of the most eminent political economists, Roger Tooze and Susan Strange, analysed in 1981. This book proved to have such longevity, it was republished in 2010, as the problems it studied from the era of stagflation in the 1970s, remain pertinent, eerily, today.

Meanwhile, China’s central bank has a currency problem. The yuan renminbi (RMB) retains a crawling peg, meaning it tracks US dollar movements within a certain band of adjustment. But US borrowing, particularly since 2008, combined with a “near zero” target range in the US Fed’s funds rate, has seen the yuan appreciate slowly by around 7.5% (or 10%, factoring-in inflation), although the RMB remains vastly undervalued. But every time the US Fed engages in quantitative easing (QE), yuan appreciation costs China – a lot.

Follow the money

The Reserve Bank knows recession is coming. That is why the RBA has cut official rates by 75 basis points in the last two months, in the hope of engineering a soft landing. The legacy of Bernie Fraser’s dithering in 1989-90, while Australia burned to the ground, lingers long in the memory of Martin Place, the RBA’s HQ.

But the blunt instrument of monetary policy is an insufficient and inefficient policy tool to induce adequate demand, investment and consumption growth in the face of tripartite pressures comprising Chinese economic slowdown, European austerity and American deficit reductions.

The US Fed is reportedly considering QE3 – a third round of quantitative easing – as a stimulus to the US economy, which produced weak growth and jobs figures in May, after posting positive results in the first quarter of 2012.

Beijing is watching the Fed carefully, as another stimulus would result in further US dollar depreciation and potentially harm the Chinese economy. The Beijing leadership is also reportedly considering an additional stimulus.

Over in Washington, Obama is in a quandary. Another US stimulus could be damaging politically in an election year, and positive economic outcomes arising from QE may not be clearly evident by November. For example, when George H.W. Bush went to the polls in November 1992, the recessed US economy was already recovering, but the results were not manifest, and Bush lost. Badly.

Economic forces beyond our control

What does all of this mean for Australia? The fact is that Australia’s economic fate will not be decided in Canberra; it will be determined in Washington, Beijing and Berlin. The future of car manufacturing in Victoria and South Australia will be the subject of executive decisions in Tokyo, Dearborn and Detroit, just as the decision to close Mitsubishi’s plant in Tonsley Park in 2008 was made in Stuttgart by Daimler Chrysler.

Mining tax or not, BHP, Rio and other resources firms are likely to scale back their investments and output in the short-to-medium term. Even with major resource projects in the pipeline, there are tonnes of stockpiled iron ore sitting in Chinese granaries, as warehouses bulge. Copper prices are falling, and this is never a good sign: copper always has an inverse price relationship with gold, which is what investors flee to when stockmarkets plummet.

Even China runs up against the brick wall of international surplus capacity. In a global economy characterised by continuous competition and super-saturated markets (how many flat screens can you really buy?), not every country can grow at the same time – plain and simple.

There are high-growth and low or negative-growth economies; there are surplus and deficit economies. At present, China and Australia are in a mutually-complementary growth cycle, while the US, Japan and the EU (except Germany) are deeply in deficit and in low (US) or negative (UK) growth cycles.

Do not believe the snake-oil salespeople (some of whom reside in Treasury and DFAT), who argue that the Australian economy is delinked from the US economy; it is not. As the 2008–current GFC proved beyond reasonable doubt, the global tsunami that emerged from the wreckage of the US sub-prime mortgage crisis created a ripple effect that extended far beyond the North Atlantic. Had China not injected 3 trillion yuan into the PRC economy, Australia would have drowned with the rest of the PIIGS.

There is No Plan B

Now is not the time for Canberra to gloat complacently to the rest of the G20 that its economy is the envy of the world because someone will have to eat crow, eventually. Certainly, the rest of the world envies Australia’s abundance of mineral resources and the efficiency with which it extracts them.

But the rest of the world does not admire the Dutch disease that afflicts Australia’s government and business elites, and leaves them in a state of suspended delusion, transfixed by the belief that the resources boom can never end.

The commodities bubble of the late 1970s and early 1980s ended in 1982, forcing the Hawke government to address the drastic deterioration in Australia’s terms of trade. Australia’s share of world trade halved between 1973 and 1983. Hawke and Keating regarded the Australian dollar float (1983), financial market deregulation (1984), industrial restructuring (from 1987) and East Asian market integration (APEC, 1989) as the only means by which Australia could escape banana republic status.

None of these initiatives prevented the Australian economy from relapsing into recession in 1990. Why? Because the global recession – not the domestically-induced high interest-rate regime – did the damage. Certainly, domestic monetary policy caused the recession to be longer and deeper, but, fundamentally, it did not cause the recession; the complex economic interdependence ingrained in the global financial system caused it.

What strategies would the federal ALP government, or prospectively, a Coalition government, implement in the event of GFC II and a significant fall in Chinese growth and demand? Neither side of politics wants to address this thorny issue, as tax cuts and middle-class welfare dominate a poll-driven agenda and will continue to do so for the next 12 months.

Foreign borrowing aside, to which strategies could a Commonwealth government resort in the event of financial crisis?

Former Prime Minister Paul Keating weighed into this debate recently, arguing that federal governments could utilise Australia’s $AUD1.3 trillion pool of superannuation funds, rather than offshore borrowing.

We don’t have the space here to discuss the lunacy of this proposal: allowing profligate and irresponsible federal governments, irrespective of their political flavour, to get their hands on the superannuation cash register?

Keating clearly isn’t in Kansas anymore. Loading up the banks with hard-earned pension funds truly is the road to serfdom, as super funds have scarcely been superior performers of late. Anyone from the tertiary education sector in the Defined Benefit Scheme will understand that only too well. Superannuation funds crises are an accident waiting to happen, but that’s a story for another time.

In the “dismal science” of economics, there is only one joke and one joke only: economists have successfully predicted 13 out of the last 2 recessions.

I, for one, would be perfectly happy to be proven completely wrong on this occasion.

In a widely reported speech on June 2nd, financial baron George Soros gave the European Union 90 days to address the debt crisis engulfing the continent.

The man who “broke the Bank of England” in 1992 said that the German government had a three-month window to resolve the Eurozone debt crisis.

By this, Soros means that the credit the German central bank, the Bundesbank, has extended to debt-plagued Europe will reach its limits within 90 days. His reasoning is that both German public opinion and the markets will drive Chancellor Angela Merkel to limit the ECB’s “indefinite expansion of the money supply.”

But to return to Soros. The centrepiece of his speech was the EU’s interbank clearing system.

Yawn. I hear you. We’ll try to make it interesting. Stay awake there at the back.

Hard Target

Today, we’re looking at Target2. This is the European Central Bank’s (ECB) Trans-European Automated Real-time Gross Settlement Express Transfer System.

With interbank transfers of up to €2.5 trillion per day, Target2 allows the ECB to provide the necessary liquidity to European central banks throughout the 16-member Eurozone area. Commercial banks maintain their accounts with their national central banks and are able to access and transfer debits and credits on a daily basis to settle their accounts.

Target2 is the ECB’s interbank settlements system. In the 1980s, this required entire bank settlements desks, with dozens of people working from print-outs or (too often) numbers scrawled on slips of paper.

The IT revolution of the 1990s and 2000s changed all that. In the Eurozone, the second iteration of Target was introduced in late 2007. As the name suggests, Target2 allows the ECB to lend to Eurozone central banks in real time at very low cost.

Since 2007, under Target2, the ECB has generated liabilities of over €800 billion, and this figure expected to reach €1 trillion by the end of 2012.

Not surprisingly, the central banks that have drawn most heavily upon the ECB’s lending facility come from the EU’s periphery: the PIIGS (Portugal, Ireland, Italy, Greece, Spain) – or GIPS, in more polite Euro-parlance – but even France and Belgium have accumulated significant liabilities under Target2. But I wouldn’t worry too much about Belgium: it’s not a country; it’s a bank.

In fact, only Germany, the Netherlands and Luxembourg have a net surplus position within Target2 (see Figure 1 below).

Now, Target2 has been the, er, target of acrimonius debate among economists in Germany and throughout Europe. Read both sides of the debate here and here. Its most vociferous opponent has been the man dubbed Germany’s leading economist, Hans-Werner Sinn.

Let he who is without Sinn…

Neoclassical economist Hans-Werner Sinn has argued that, first, Target2 credit is allowing peripheral Eurozone economies (the PIIGS) to finance their significant current account deficits. Second, Sinn posits – and Soros repeats the claim – that the German Bundesbank, has claims exceeding €600 billion on central banks in the periphery. Third, if a central bank defaults on its repayments, Sinn argues that the Bundesbank, German banks and, ultimately, the German taxpayer, will be compelled to absorb the consequent losses.

But these numbers do appear on the Bundesbank’s account, as the ECB owes the German central bank over €660 billion. Thus, German banks are financing Eurozone credit. So now you know – where the money’s coming from, that is.

Lender of Last Resort?

“Lend freely at a high rate, on good collateral,” wrote English essayist Walter Bagehot. His dictum developed into the ‘lender of last resort’ thesis, now the modus operandi of all central banks, as well as the International Monetary Fund.

So: upon what basis does the ECB lend so freely? In this case, bad collateral.

This is where the ‘2’ in ‘Target2’ comes in. In November 2007, the ECB under Target2 lowered the quality threshold of collateralized assets significantly. This is despite the fact that the EU’s own studies assert that there is at least €14 trillion in high-grade financial assets owned by EU governments and private banks. The figure is higher if you include lower asset classes.

The ECB has fuelled this expansionary credit binge by accepting the sovereign debt bonds of Europe’s indebted governments as collateral. Or, in fact, any asset as collateral rated above ’D'. A ‘C’-rated mortgage-backed security, for example, would be relatively risky commercial paper.

Thus, the ECB is facilitating liquidity throughout the Eurozone central and commercial banks by buying junk bonds, in effect. By doing so, the ECB can also control, within limits, the market yield on sovereign debt bonds.

Naturally, not all of the collateral is junk. ‘A’ and ‘B’-class assets also form part of the collateralized debt. And it’s not as if French or Belgian banks don’t have the ability to repay tranches of debt, albeit over a considerable period.

But, as Greece has proven – and Cyprus is about to – some countries simply do not have the financial capacity to meet their debt obligations. As Soros notes, the peripheral EU countries – parts of southern and eastern Europe – are heavily indebted to the ‘core’ or ‘centre’, and the quality of their collateral varies markedly, although much, such as sovereign debt issues, may be classed as junk.

In case you think we’re exaggerating the risk associated with lower classes of debt securities, consider the fact that Jens Weidmann, President of the Bundesbank, has himself expressed concern about the declining asset quality of collateral for loans undertaken by Eurozone national central banks.

Come fly with me

What’s more, all this liquidity that has been created to shore up the EU banks is pumping through the arteries of the Eurozone financial system. In combination with the fragility of the banks – and the EU economy in general – this has led to massive capital outflows.

Spain saw over €66 billion net in capital flight in March 2012 alone, comprising foreign investment outflows and investors liquidating positions and assets and fleeing Espana for safer havens.

Greece is no better. Actually, it’s worse, proportionally. In the last 24 months, Greeks have withdrawn fully one third of deposits from Greece’s banks.

But that didn’t stop the Greek government from injecting another €18 billion into the banks in May.

As Soros notes, there is likely a perverse proportionality between capital outflows from peripheral countries, high bond yields in the PIIGS, and historically-low bond yields in Germany and the UK. Actually, this week, German 2-year notes fell into negative yield territory, as investors fled to the Bundesbond and Bundesobligationen (German federal 10 and 5-year notes). They’re not making their buyers much either, at 1.18% and 0.75%, respectively.

What will Germany do? Enough to save the euro and nothing more to prevent a disorderly breakup, Soros opines.

He is right on that count. But the ECB, like the US Fed and the Bank of Japan, does have some latitude in that it is to a certain extent a self-contained ecosystem (the majority of European trade and investment is within the EU itself).

Tha means the ECB can continue to lend, provide liquidity and print fiat currency, just as the US and Japan do (the US has the advantage of printing the world’s reserve currency, while Japan lends money to itself). Theoretically, the ECB can print as many euros as it wants, albeit at the risk of inflation (which would help inflate away Eurozone debt in any case). A depreciated euro also advantages those all-important German exports.

Depreciation, by the way, has nearly always worked for the US; you don’t have to realise a single percentage point in productivity to gain a competitive advantage over your trade partners. For the same reason, the Bank of Japan is always desperately trying to sell the yen down to reap the same rewards.

Of sages and false prophets

Speaking of false ‘profits’, we wouldn’t be performing due diligence if we didn’t check Soros' ability to read a crystal ball.

Now, you do have to admire a guy who nets one billion dollars inside a week by betting against central banks, while the rest of us were probably doing worthless things, like volunteering for charity.

In his speech, Soros directs most of his vitriol at professional economists, castigating the notion of ‘economics-as-science’. I do have a certain sympathy with his argument; economists have a dismal record of forecasting.

Which brings me to George’s dismal record of forecasting. In his 1994 book, The Alchemy of Finance, Soros predicted:

1. The Japanese economy would surpass the US economy.
2. The dollar would depreciate markedly in the 1990s (it didn’t; it appreciated strongly between 1996 and 2002).

So if you took George’s sage advice in the 1990s, you would have bought Nissan shares and sold US dollars. Then you’d be…well…

You’d be Greece. Holding junk bonds.

At least one legacy of Kevin Rudd’s prime ministerial career has survived: his campaign to obtain a temporary seat for Australia on the UN Security Council (UNSC).

Elections for the two-year position take place in October this year, when the UN General Assembly (UNGA) will elect five new non-permanent members to the 15-seat Security Council. Five seats, of course, are permanent. The ‘P5’, or ‘Permanent 5’. Those belong to the US, China, Russia, Britain and France. Or, as some have put it unkindly, a Council of former great powers.

How does it work? Well, the UNGA votes in blocs. In this instance, we’re talking about regions. Currently, we have five of the ten non-permanent seats occupied by Morocco (Africa and Arab regions representative)Togo (Africa); Guatemala (representing Latin America and the Caribbean); Pakistan (Asia) and Azerbaijan(Eastern Europe).

You’ll be astonished to know that Australia falls into the ‘Western European and Others’ Group, better known as WEOG.

Yes, you read that correctly: not ‘We Are The World’, but ‘We Are The WEOGs’.

We’re a bunch of WEOGs, actually, along with Turkey, New Zealand and Canada. Come to think of it, that’s virtually a re-enactment of the Gallipoli campaign. Let’s hope we win this time.

Which segues nicely into my next point: Why The Hell Are We Running For A UN Security Council Seat?

Frivolity aside, there is actually a serious side to all of this: the Mandarins in Canberra (bad pun intended) are spending $55 million (a far cry from the original $15 million estimate) of the over-burdened Australian taxpayers' money on this vainglorious project.

Not that the Department of Foreign Affairs and Trade (DFAT) wanted to make this Olympian bid for Security Council gold in the first place. As former foreign minister Alexander Downer noted on the ABC recently, DFAT has better things to spend its parlous finances on.

This week, DFAT will shed 100-150 jobs in order to implement $25-30 million in budget cuts.

Meanwhile, in their conversation on the ABC this week, former foreign ministers Gareth Evans and Alexander Downer found common ground on at least one issue: Australia needs more foreign missions. Their argument is that Australia is a laggard amongst developed countries, possessing a mere 100 missions worldwide.

In 2011, for instance, Australia shut down the Harare mission, which used to boast Australia’s best-paid ambassador in the 1990s. It’s probably just as well, as, in return, the Zimbabwean mission in Canberra has apparently been up to all sorts of shenanigans.

A seat at the round table

Evans argued recently that it was in the ‘national interest’ to pursue a temporary UNSC seat. To be fair, we’ll quote him at length:

“There is not just sentiment involved here, but hard-headed calculation. Being, and being seen to be, an active player in pursuing co-operative global solutions to issues such as mass atrocity crimes, terrorism, trafficking in drugs, arms and people, and cross-border aggression both confers a general reputational benefit (gold in the currency of international affairs, as the Scandinavians have long understood) and significantly increases the chances of direct reciprocal support on issues of immediate concern to us, such as refugee flows.”

Fine words, to be sure. What is this ‘reputational benefit’ of which Evans writes? Good international citizenship? Hardly. As my colleague Michael Connors of La Trobe University writes aptly, “Australia, for the most part, is invisible in international politics.”

No power. No influence

Irrespective of whether Australia has a temporary UNSC seat or not makes no difference to Canberra’s ability to pursue these issues assiduously within the fora Australia occupies currently.

Let me be straight with you, dear reader: Australia can waste as much money as it likes on foreign missions. They do nothing for business and trade (AUSTRADE comprises an overpaid, cocktail circuit); DFAT and AUSTRADE are not the first port of call for Australian enterprises wanting to do business in Asia, Europe or the US.

There are plenty of fora where Australia is already a member and has no influence: it is an Executive Director at the International Monetary Fund; it is a member of the ASEAN Regional Forum; and it is a foundation member of APEC.

Australia is also a NATO Global Partner. At a conference back in 2008, I was surprised to learn, from some eminent American political science professors, that they had no idea Australia had troops in Afghanistan.

I duly informed them that Australia had over 1,400 troops in combat areas in Afghanistan. Australia was, in fact, breathless patriotism coming to the fore, the largest non-NATO contributor to Afghanistan.

“Really?” they chorused disbelievingly, reaching for another Veuve Cliquot. Well – we were in Paris, after all. Which is where you find Americans.

Australia’s embassies: God’s waiting room

Australian overseas missions, aside from being glorified passport stamping booths, are merely repositories for the corpses of failed politicians, careerist bureaucrats and irritating former cabinet ministers.

You want proof? Firmly ensconced in Washington is former defence minister and opposition leader Kim Beazley, whose claim to the position rests solely on his being an American Civil War buff. Beazley’s other legacies are three Federal election losses (one in 1996 as Deputy Prime Minister) and that white elephant, the Collins-class submarine, a device so obsolete it makes the German U-20 that sank the Lusitania look cutting edge.

To be fair, some of his predecessors have not been particularly illustrious either. Paul Keating appointed Don Russell, his closest advisor, to Washington in 1993 as a reward. Russell, a finance analyst, had no previous experience in diplomacy or trade.

Malcolm Fraser made Andrew Peacock his foreign minister, mostly to prevent him from challenging his leadership. Later, Peacock’s reward for retiring from the Howard-Peacock wars was being sent to D.C. as ambassador. Very little of substance took place throughout his tenure there.

In 2007, John Howard, against the wishes of Downer, appointed Amanda Vanstone as Australian ambassador to Italy.

“Terrorists don’t strike between 9 and 5 from Monday to Friday,” Vanstone said, to the Adelaide Advertiser in 2009, in defence of her appointment, citing the 24/7 nature of ambassadorial work.

More to the point, we can’t recall terrorists striking at all in Italy. Not since Amanda was in town, anyway.

Yet another political appointee, Richard Alston, was made Australian High Commissioner to the United Kingdom in 2005 (I could tell you some stories…but apparently we’re not supposed to defame people here at The Conversation. So I won’t).

So, you will have gathered I am not in favour of this particular fishing expedition where Australia attempts to bribe – yes, bribe a bunch of other countries to vote for its candidacy for a UNSC seat (yes, I know the link is to the Herald Sun but that doesn’t alter the basis of the story, the facts of which were obtained only after a Freedom of Information application to see how much DFAT were spending of our hard-earned on this glory trip).

One should not be surprised when former ministers Downer and Evans support Rudd and Gillard’s bid to obtain a UNSC seat either. Relevance Deprivation Syndrome is tough medicine for a former foreign minister to swallow, particularly when they are accustomed to being feted by acolytes and sycophants while overseas for much of their tenure.

Moreover, a successful Australian bid would open up all sorts of job opportunities: like becoming Australia’s ambassador to the UN, with the Security Council as a stage, instead of an irrelevant seat in the General Assembly. And Gareth, for whom I have a quite a soft spot, bless him, always wanted to be a UN Secretary-General.

But alas, like an ageing Laurence Olivier, Gareth “will never again play the Dane.”

Egads! Foiled again

One more thing: I will bet quite a few orange notes with a 20 on them that Australia fails to get the UN seat.

Why? Because Finland and Luxembourg, our WEOG rivals, will be backed by the European Union. And the EU also spends quite a lot of its time bribing African countries, and they bid a lot higher than we do. The EU is also the world’s largest aid donor, one of the biggest arms suppliers to Africa…well, you get the idea.

Like a superannuated, cashed-up baby-boomer versus a first-home buyer, Australia is not going to win this particular Dutch auction.

Last time we tried, in 1995, the French were doing nuclear tests in the Pacific, leading to much – pardon my français, mon vieux fruity vernacular on the floor of Parliament House in Canberra.

Former Deputy PM Tim Fischer (does anyone remember him?) even managed to call the French president “Black Jacques Chirac” (in rather broken English, as I recall).

Frère Jacques was not amused. That caused enough of a merde storm in Paris for France to block Australia’s bid for a UN Security Council seat by rallying votes against Canberra from the EU and France’s (many and varied) African, Pacific and Caribbean satellites.

How? Money. Arms. Aid. Euros may not buy much anymore, but they still buy more votes than orange plastic with 20s on them.

Australian foreign minister Bob Carr was interrogated about Australia’s alliance with the US in three separate meetings with Beijing’s leaders last week.

“Make no mistake, the re-emergence of China, and the rise of India and others is desirable,” Carr said.

But what caught the media’s attention was a statement by Song Xiaojun, a former People’s Liberation Army senior officer.

“Australia has to find a godfather sooner or later,” Mr Song was quoted in an interview with the Sydney Morning Herald. “Australia always has to depend on somebody else, whether it is to be the ‘son’ of the US or ‘son’ of China.”

True, Song is merely an analyst always willing to provide the media with a controversial quotation. He has no power or influence within the Chinese Community Party leadership. Nevertheless, his statements raise important issues for Australia’s future relationships with both the US and China.

More than a decade ago, at a round table discussion with some Department of Foreign Affairs and Trade (DFAT) officials, I argued that Australia would eventually need to make some hard choices about its relations with Washington and Beijing. Canberra, I posited, could not continue to maintain a close defence alliance with Washington, while continuing to enjoy the enormous economic benefits that flowed from the Sino-Australian economic partnership. Sooner or later, hot economics would spill over into cold politics. Beijing would start pressing Canberra to choose sides.

The DFAT officials were horrified by the suggestion. The US was our friend and ally. China was our economic partner. There was no inherent contradiction in this position.

But in the second decade of the 21st century, we have an emergent, more confident and more demanding Beijing leadership. For now, Australia counts Washington, Tokyo and Seoul as its most important regional allies. But China’s rise means Australia’s policy elites are beginning to view the strategic landscape differently. The emerging ‘Beijing consensus’ – comprising soft power diplomacy and market power, combined with the concept of China’s “peaceful rise” – has influenced Australia’s political and business decision makers that a ‘tilt’ towards Beijing is in the national interest.

But this not the first time that Canberra’s policy elites misjudged Australia’s national interests so badly.

Appeasement: Phase One (1967–1999?)

In the 1990s, Professor Allan Patience of Victoria University mounted a persuasive thesis: that for 30 years, Australian governments, from Harold Holt to Paul Keating, had devoted a considerable proportion of their foreign policy resources to appeasing Suharto’s Indonesia.

Appeasing Indonesia was the dual product of the US-Australian ANZUS alliance, and the escalating presence of US and Australian forces in Vietnam. Suharto’s New Order regime was viewed in both Washington and Canberra as a critical bulwark against the tide of communism that the domino theory predicted would sweep through Southeast Asia.

Deakin University’s Scott Burchill has written extensively on the Jakarta lobby from the perpective of a former insider. As Burchill has long held, in exchange for Suharto’s support, successive Australian governments delivered significant economic aid, light arms and military training, which lasted far beyond the Cold War requisites of the Vietnam war.

For his part, Suharto returned Australian largesse by maintaining a repressive regime in Irian Jaya (West Papua), invading East Timor in 1975 – infamously killing five Australian journalists at Balibo in the process – and employing heavy-handed suppression of the independence movement in Aceh.

Canberra’s unrestricted support for Suharto led to the development of an insidious coterie of unlikely collaborationists: Foreign Affairs and Defence officials; self-interested Asian studies academics; and sympathetic journalists, known unofficially as the ‘Jakata lobby’.

Even former foreign minister Gareth Evans, himself an unwilling hostage to the Jakarta lobby, was to express his dissatisfaction publicly on more than one occasion with an Australian foreign policy that left Suharto with a free hand to engage in systematic repression, while Canberra merely looked askance and handed him everything he wanted.

The well-meaning – but naive – Paul Keating even brokered the Australian-Indonesian Security Agreement in 1995. It was torn up contemptuously by Suharto’s successor, Habibe, following Australia’s intervention in East TImor as the leader of the UN security force in 1999.

For the historical record, make no mistake: neither John Howard nor Alexander Downer had any intention of disrupting the now-institutionalised status quo of appeasement towards Indonesia when they came to office in 1996. More accurately, as the US and the UN backed East Timor’s independence ballot, Howard and Downer lobbied furiously against the ballot. Precisely what you might expect of the Jakarta lobby.

Moreover, it was only in the context of an economically-ruined, IMF-controlled and dramatically-weakened Indonesia in the wake of the 1997 Asian Financial Crisis that Howard and Downer made their reluctant turn towards support for East Timorese autonomy and, ultimately, independence.

Even so, the Howard government had so calamitously run down the Australian Defence Force (ADF), via a combination of budget cuts and accrual cost accounting, that the ADF found that resources to run even the small East Timorese operation stretched the Australian military to its limits, requiring logistics support from New Zealand.

So hastily did Howard and Downer perform their volte-face, that the ADF could not have prevented the Indonesian military from re-occupying East Timor without US assistance, as some ADF officers later revealed publicly.

The road to Beijing

At present, China is clearly Australia’s most important trading partner. Almost 25% of Australia’s exports go to the PRC, with two-way trade totalling over $AUD120 billion in 2011 alone.

Australia is also the largest destination for Chinese investment, with over $AUD38 billion in inward foreign direct investment (FDI) over the last six years. The PRC’s net stock of FDI in Australia is, of course, lower than that of the US, EU and Japan, but the relative share of Australian FDI by Chinese enterprises has grown rapidly and will rival or eclipse other investors over the next two decades.

No one disputes China’s contribution to Australia’s fiscal stability, economic dynamism, and financial prosperity. Equally, Australian outward FDI and portfolio investment in the PRC is also expected to increase significantly as China gradually opens its state-owned enterprises to further foreign participation.

Peace in our time?

In 2010, defence analyst Hugh White published a provocative article as both a Quarterly Essay and in the Australian Journal of International Affairs.

White argued that ‘A Concert of Asia could be built between Asia’s great powers – America, China, Japan and India.’

If it sounds like White is endorsing some form of appeasement – well, he admits it himself:

“Many people will still see this as conceding too much to China. It will seem like appeasement…Perhaps Chamberlain’s mistake was not to accommodate Hitler over Czechoslovakia, but failing to make it absolutely clear that there would be no accommodation over Poland.”

Thus, for White, letting Czechoslovakia get wiped off the map and absorbed into the Third Reich was not a crime; the mistake was to let Hitler think he could annex Poland and get away with it.

(It might be worth footnoting here that the Czech armoured divisions were so competent that they made up 25% of the German Panzer divisions that defeated Poland and France so decisively in 1939–40. But that would be pedantic).

For White, “the best outcome for Australia would be a Concert of Asia,” as it would maintain Sino-US peace and preserve the US-Australia alliance.

In a public riposte, Michael Danby, Carl Ungerer and Peter Khalil excoriated White for his “Canberra Munich moment”. The three analysts note, correctly, that the contemporary PRC, although all-too-frequently brutally oppressive, is not directly comparable wih the regimes of terror operated by Hitler and Stalin.

Rather than caving in to Beijing, Danby, Ungerer and Khalil argue forcefully that Australia’s security cannot be guaranteed by a concert of powers where a fundamentally anti-democratic Chinese state is accepted as an equal partner in the governance of Asia-Pacific security.

Let’s be frank here: China is a state that drastically understates its defence spending; it has frequently resorted to violence to crush dissent in Tibet and in Xinjiang province to quash the Uigars.

In the South China Sea, which China claims in its entirety as its ‘historic waters’, Beijing killed Vietnamese fishermen in January 2005 in the Gulf of Tonkin. China refuses to allow the International Tribunal on the Law of the Sea (ITLOS) to arbitrate rival claims between Southeast Asian states and the PRC.

This is the China that White and the ‘Beijing Lobby’ want to appease. Whereas Jakarta was the target of appeasers until the 1990s, Beijing is now the centripetal force that drives elites to placate China at every turn.

Follow the money

Few groups are left untainted by Beijing’s influence. Australia’s universities are increasingly addicted to the cashflows generated by Chinese students, a situation that will culminate in dependency. Overseas students heavily subsidise domestic students' places to the tune of $1,200 per place.

Australia’s political and business elites are also heavily dependent upon the continued flow of Chinese capital to Australia’s resources, food, tourism and real estate sectors. Even a momentary pause in China’s growth plunged the Commonwealth budget into crisis, evidenced by the deep fiscal deficits that emerged from 2009.

Even John Howard and Alexander Downer were flummoxed by the question of who to support in the event of conflict between China and the US over Taiwan. But the question neatly illustrated the strategic quandary Canberra found itself in with its dual loyalties to the US alliance and Chinese commerce.

The view from the Ivory Tower

In the wide-ranging 2008 TRIP survey, which asks International Relations (IR) scholars in 10 countries for their views on a range of issues, 121 IR Australian academics [are there really that many?] responded (yours truly included). Asked the question, “Which entity would you like to see surpass the United States?”, 11 Australians responded “China.” 71 responded “The European Union.” And fans of Vladimir Putin will be pleased to note that he has at least 8 admirers in the Antipodes, as these 8 replied “Russia.”

Granted, only 11 wrote “China”, but more than 50% of Australian IR academics want to see a country other than the US become the most powerful country in the world (Question 79, page 86).

Perhaps we shouldn’t read too much into this survey. But anti-US sentiment, particularly as Bush was president and US forces were still in Baghdad, was clearly on display in Australia’s IR ‘academy’ in 2008 (the 2012 edition is on its way).

The cultural revolution

The emergence of a ‘Beijing lobby’ is a not a ‘reds-under-the-beds’ conspiracy. It is a quiet, cultural revolution that will infiltrate policy communities throughout Australia. But slowly, surely, they will determine whether Australia makes a strategic decision to pivot towards Beijing and, by logical extension, how far and how fast Canberra may loosen its ties with Washington.

It’s already too late to stop the Beijing lobby; Appeasement Phase II has already commenced.

“I don’t envisage, not even for one second, Greece leaving the euro area. This is nonsense; this is propaganda.”

That’s Jean-Claude Juncker, Prime Minister of Luxembourg, chairman of the Eurogroup, speaking after Wednesday’s EU finance ministers' meeting. Not given to half-measures, Juncker added:

“The exit of Greece out of the euro was not the subject of our debate today. Absolutely no one, absolutely no one, argued in that sense.”

The global media is agog with speculation about what appears to be Greece’s Eurozone death throes. Like a car crash about to happen, one can’t quite look away from the chaos that has come to characterise Greece.

Greek voters will also go back to the polls after President Karolos Papoulias failed to find a way through the impasse gripping Greek political elites.

The left’s Alexis Tsipras, leader of Syriza, refused to negotiate with potential coalition partners, arguing against the terms of the EU-IMF austerity regime.

The centre-left and centre-right parties, PASOK and New Democracy, remain committed to the bailout conditions, despite the fact it cost both parties dearly in the election.

Ironically, Tsipras' Syriza bloc finds itself in the same camp as far-right parties, such as Golden Dawn, who also oppose the bailout conditions vociferously.

The Good

Greece actually beat its primary fiscal deficit (i.e., budget deficit minus interest payments) targets in calendar Q1 2012, and through April as well. IMF and EU forecasts estimate that the primary deficit will be 1% this year, which is not as optimistic as the 1% primary surplus predicted in late 2011. But, as the late Christopher Hitchens would say, “It’s progress. Of a kind.”

The bad

Not a beautiful set of numbers, to be sure. And government revenues are down slightly (quelle surprise), while spending is down a little as well.

The ugly

But Athens also has to come up with a cool $US500 million plus today to pay 10-year bond issues, although indications are that government-less Greece will stump up the cash.

Dumb and dumber

Not to put too fine a point on it, the anti-bailout parties in Greece are behaving foolishly. It may well be that Tsipras is bluffing the Germans to see whether they will soften the austerity regime, but this is a dangerous and unpredictable game.

So, how might it turn out?

Call the bluff

The Germans may well call this bluff, leaving Athens with no option but to exit the Eurozone and the EU. German finance minister Wolfgang Schäuble has stated he “hopes” Greece will remain in the Eurozone. But he’s implaccable about conditionality, although there are two things Schäuble appears to have forgotten: he’s not Chancellor Angela Merkel; and he doesn’t make the decisions.

Syriza wins the second election

All right, Alexis: you wanted this job; are you defaulting now? If so, you’ll need a copy of the Lisbon Treaty. Fortunately, they’re a free 1.2MB download. Got it? Good. Turn to Article 50.

Yes, that’s the one that says member countries can exit the EU. Not the Eurozone, mind; there’s no mechanism for that.

Would you like capital controls with that?

Right, Alexis. You are now Prime Minister of Greece. You’ve defaulted, left the EU, introduced the ‘New Drachma’ and exited the Eurozone. You’ll be wanting some capital controls with that to prevent capital flight.

Who are they? Over in the corner? Just a bunch of lawyers here to enforce your euro-denominated bond contracts. And every other Greek contract denominated in Euro since 2002.

No, they are not accepting drachma, although US dollars will be fine, coupled with an appropriate forex fee, of course. Now, Prime Minister, here’s the fax from Brussels:

1. You will no longer receive any bailout funding.
2. All fiscal transfers from the EU Common Agricultural Policy cease forthwith (yes, Greece is a net beneficiary).
3. All EU structural funding is halted. Permanently.
4. All tariffs, quotas and other barriers to trade in goods and services with non-EU members now apply to Greece.
5. Greeks no longer possess EU citizenship or passports. Greeks are not free to work in, or emigrate to, any other EU member country, except for strictly limited periods under tourist or work visas.
6. The EU customs union with Turkey no longer applies to Greece.
7. All EU Framework funding to Greece ceases forthwith.
8. The Greek government no longer has any recourse to commercial legal arbitration within the ambit of the European Court of Justice.
9. Your 114 tonnes of gold reserves are hereby forfeited to bank creditors. Read the fine print.
10. The EU may negotiate an exchange rate between the euro and the ‘New Drachma’ (see Lisbon Treaty, Protocols 4–14). But probably not.
11. Countries may apply for re-admission to the EU. Let me know how you go with that one.

Greece. Is. Not. Argentina.

No, it’s not; it’s much worse. Argentina only had $US97 billion in debt when it went to the IMF in 1997, and defaulted with $US132 billion in 2001–02. It tried IMF prescriptions and dollarization (a currency board where the Argentine peso was fixed 1:1 with the US dollar).

By late 2001, following announcement of the default, Argentine inflation was running at 10% per month. By the end of 2002, the peso depreciated to around 30% of the value of the US dollar. Annualized inflation reached 80%.

This was not a victimless default: the Argentinian middle class was effectively wiped out; violence erupted in the streets; homelessness and prostitution became endemic; and unemployment hit 25% (yes, Great Depression levels).

Argentina undertook successful debt restructuring in 2005, wiping out 60% of the red ink. Despite paying the IMF back nearly $US10 billion (in order to remove Fund conditionalities), US and other jurisdictions have frozen Argentinian assets, and Buenos Aires still has tremendous difficulty raising credit in international markets.

Why Greece could not ‘do an Argentina’

The Argentinian industrial and resource base is vastly different from Greece’s. Argentina is a highly diversified economy, with a large-scale, and export-oriented agricultural sector, significant chemicals and automotive industries, a solid taxation base [no comparison to Greece there], and is a net exporter of oil with proven reserves of 2.5 billion barrels. It’s also a net exporter of natural gas.

And Argentina also has relatively-low per capita labour costs.

Ah, there’s the rub: It also has 30% of the population living below the poverty line. Would the Greek electorate accept significantly-reduced standards of living of this magnitude under the terms of a default?

The staggering number of crass commentators and junk analysts suggesting with apparent seriousness that Greece should follow Argentina’s example suggests complete ignorance of the facts and a disturbing distortion of the realities of Greece’s economic predicament.

But if you really want to, Alexis, pull the trigger. Go on – pull it. I dare you.

The democratic executions of Nicolas Sarkozy in France and Lucas Papademos in Greece means the body count of European leaders guillotined by angry electorates has risen to 12.

Sarkozy and Papademos join the political corpses of Gordon Brown (UK), Jose Zapateros (Spain), Silvio Berlusconi (Italy) and George Papandreou (Greece) on the dustheap of history. Voters in Finland, Ireland, the Netherlands, Portugal, Slovenia and Slovakia have also terminated governments with maximum prejudice since 2008.

That must leave leaders like Germany’s Angela Merkel, who faces the electorate in 2013, feeling extremely nervous.

Politics in hard times

Voters have not discriminated as they have deposed both centre-left and centre-right parties throughout Europe. For example, Ireland elected Enda Kenny’s conservative Fine Gael party to office, while Britons replaced Gordon Brown with the Cameron-Clegg Conservative-Liberal Democratic coalition government.

Across the English Channel, Spain rejected José Zapatero’s socialist government, which acceded to power following the 2004 Madrid bombings, and elected Mariano Rajoy, the leader of the conservative-liberal People’s Party.

But France last Sunday swept aside 17 years of conservative rule and elected an untested Socialist, François Hollande.

Meanwhile, Greece has no government, such is the public’s antipathy for its mainstream political parties. Another election, tentatively planned for July, is likely.

Paris in the spring

François Hollande tried to inject the spirit of the Revolution into his campaign, although the Parti Socialiste’s victory ended with Moet et Chandon, rather than rivers of blood.

Hollande may present himself as a cleanskin, but he is simply another member of the old guard, who entered government as an adviser in Mitterrand’s presidency in 1981. If Hollande has one thing in common with Sarkozy, it’s the fact that he’s done absolutely nothing but politics for his entire life.

Like Jacques Chirac and virtually all previous French cabinet ministers, Hollande is an énarque, a graduate of that training ground for politicians and bureaucrats, the École National d'Administration (ENA).

Chirac is an énarque. So is Hollande’s former partner and 2007 Socialist presidential candidate Ségolène Royal. And so is the new President’s likely foreign minister, Laurent Fabius.

Laurent who? Glad you asked. Fabius is part of the French gerontocracy (he is over 65, after all) that will head up Hollande’s distinctly old-hat cabinet. One of Hollande’s key election platforms is to reduce the retirement age from 62 to 60. So good old Laurent should be getting his Métro pass in the post any day now.

Most French voters probably thought Fabius was dead, if they’d even heard of him in the first place. He wasn’t dead; he was merely waiting for someone to return his phone calls.

As prime minister (1984-86), Fabius was one of several centre-left leaders who climbed on the liberal market reform bandwagon, a posture dutifully duplicated by more successful centre-left leaders in the 1990s, such as Tony Blair and Bill Clinton.

It wasn’t difficult for Fabius to make the switch. At 37, he was France’s youngest prime minister to date, and President Mitterrand was in the throes of abandoning his disastrous experiment with nationalization, which had been the price of the 1981 coalition between the Socialists and the Parti Communiste.

While Margaret Thatcher refused to U-turn in the face of austerity, strikes and millions unemployed, Fabius turned and fled from nationalization.

But unlike Blair and centre-left leaders in Australia and New Zealand in the 1980s, Fabius did not view markets as the solution to French economic problems.

The result: Fabius left the French economy in 1986 exactly how he found it in 1981: in recession. Previously, from 1981 until 1983, Fabius had been Budget Minister. Not a very successful one.

It would be his successor as prime minister, Jacques Chirac (1986-88), who would undertake a wave of deregulation and privatization. It cost Chirac the presidency as well; the unpopularity of market reforms killed his chances in the 1988 election. Chirac would have to wait until 1995 to get the keys to the Elysée Palace.

The Socialist Party veterans – known disparagingly as the ‘elephants’ – are stampeding to Paris to make their claims on the seats of power.

The latest rumour is that Martine Aubrey will be appointed premier. Like Marine Le Pen of the Front National, Aubrey, 61, is yet another member of a political dynasty. She is the daughter of Jacques Delors, former finance minister in the Mitterrand administration. Delors was also the powerful EU Commission President (1985–94). However, publically, Aubrey tends not to use the Delors name.

Expect to see more 1980s job-seekers in Hollande’s administration shortly.

And this just in: Hollande has used his first real speech as president-elect to attack Britain. Hollande said that Britain is “indifferent to the fate of the euro area” and “attentive only to the interests of the City.” (yes, I know it’s the Daily Mail, but he did say it).

Meanwhile, in Athens…

The news is not good: the Freedom Party might be able to cobble together some kind of provisional coalition until another election can be help, probably in July. But a second election might not resolve anything either.

In an ominous development, Syriza leader Alexis Tsipras, who is expected to be asked to form a government by the Greek president, has declared the previous government’s bailout commitments, “null and void.”

Even less edifying is the sight of the Greece’s Golden Dawn, an anti-immigration party that wants to install landmines on Greece’s borders (yes).

Golden Dawn has obtained nearly 7% of the vote and have gained parliamentary representation for the first time.

Centrist parties, long dominant in the European political mainstream, were hit hard in Greece, just as Golden Dawn, the Front National in France and the UK Independence Party (UKIP) have ridden the dual tides of anti-immigration sentiment and the rejection of austerity regimes.

Berlin: Resistance is futile

Angela Merkel has responded to the vociferous anti-austerity votes in Greece and France by declaring her hand early: there will be no renegotiation of the fiscal compact, formalized in March this year.

The French Parliament, along with most of the 27 EU legislatures, is yet to ratify the EU fiscal compact. Hollande’s Socialists hold almost 58% of the National Assembly lower house seats in the new Parliament.

Greece’s parliament passed the fiscal compact in March this year. But it is unlikely that an unstable government with an uncooperative civil service will be able to meet the stringent budget cuts demanded under the new EU regime.

Politics and the Franco-German entente will force Merkel and Hollande to come up with a compromise, as Hollande’s economic policy cannot simply be ‘Sarkozyism without Sarkozy’.

Instead, look for a European ‘growth pact’ in the near future; this is likely to be Merkel’s only concession as Germany demands fiscal discipline.

How would a growth pact be financed?

Cash-strapped EU governments are unlikely to dig deeper, so the money will come from forward commitments: the EU has already raised its revenue requests for the 2014–20 financial framework. Expect EU regional and structural funds to shift finances around so that labour-intensive projects throughout the EU are prioritized.

Don’t expect Merkel to acquiesce to Hollande’s demands easily though; as Volker Kauder, parliamentary leader of Merkel’s Christian Democratic Union said Tuesday, “Germany is not here to finance French election promises.”

Even in prosperous Germany, Angela Merkel understands political reality: with 12 European leaders gone, no government is safe.

Bank of England (BoE) Governor Sir Mervyn King today courted controversy by stating the Bank “should have” done more to prevent the UK’s banking disaster.

In an uncharacteristically blunt assessment of the Bank’s role in the financial crisis, King said that the bank should have “shouted from the rooftops” the perils Gordon Brown’s govermment faced in 2007–08.

Blame game

Nevertheless, King was careful to deflect blame from both the BoE and himself. He argued that because the Bank was stripped of its power of financial regulation by the Blair government in 1997, it lost the role of supervision to the UK Financial Services Authority (FSA).

Last week, FSA chief Hector Sants burnt several bridges by lambasting the City’s “incompetent” executives in his departure speech.

What Tony and Gordon did at school

Upon accession to office, Prime Minister Tony Blair and Chancellor Brown granted the BoE formal independence, something Margaret Thatcher, despite her attachment to deregulated markets, could not quite bring herself to do. Nor could her successor, John Major.

The trade-off in 2001 was the role the Labour government handed to the FSA, which oversaw financial services regulation and coordinates anti-money laundering (AML) programs as well as combating other financial crime.

The reasons Blair and Brown had for transferring competences to the FSA and diluting the BoE’s power were clear: Labour had regarded the Bank as being too close to the banking fraternity for too long in the financial centre that is the City of London.

Moreover, in the mid-1990s, the BoE, long the Treasury’s rival, had been much more inclined under governors Robin Leigh-Pemberton and Sir Eddie George to join the embryonic Eurozone. The BoE had prepared papers for the abolition of the pound sterling and Britain’s entry into Economic and Monetary Union, despite the Major government’s antipathy towards the euro project.

But the 2007–08 global financial crisis was not the first time the BoE had blundered so badly.

On 16th September 1992, during the 1992–93 European currency crisis, the BoE spent £3.3 billion defending the pound against forex speculation, leading to Black Wednesday, when the sterling dramatically departed the EU Exchange-Rate Mechanism (ERM) after only 18 months.

Speculator George Soros netted £1 billion for betting against the sterling. The BoE dumped financial reserves – taxpayers' money – into Soros' coffers. The pound has never returned to the ERM.

On 5th July 1991, police raided the offices of the Bank of Credit and Commerce International (BCCI), a Luxembourg-registered, London-based and Bank of England-supervised gaggle of fraudsters, racketeers, money-launderers and arms dealers masquerading as a financial institution. The BoE was sued for £1 billion in a lawsuit that ended only in 2005.

The BoE, charged with BCCI’s supervision, could not have acted more incompetently. The depth and breadth of BCCI’s unlawful activities over almost 20 years were so extensive that the EU was forced to issue the Second Banking Directive (the so-called ‘post-BCCI’ Directive); Luxembourg was compelled to reform its “bank secrecy” legislation (which required further action on the part of the G8’s Financial Action Task Force, as Luxembourg didn’t bother complying fully); and US Congress was forced to act, introducing the US Bank Bill Amendments of 1992–93.

February 23–26, 1995: Nick Leeson has fled, leaving behind the wreck of Barings Bank, the oldest merchant bank – the Queen’s bank – in England. The BoE belatedly attempts a rescue, but ultimately turns Barings over to administrators. Not entirely the BoE’s fault, but they did have responsibility for prudential supervision – which was sorely deficient.

But wait – there’s more.

This is hardly inspiring stuff from the BoE. More alarming is the fact that in 2010 the British Chancellor, George Osborne, decided to abolish the FSA and hand regulation back to the BoE.

For Governor Mervyn ‘Too Big to Fail’ King, these post-hoc admissions look far too much like a political shot at the Blair-Brown governments which, admittedly, bear enormous responsibility for the financial mess. Meanwhile, the BoE itself benefits from the aboltion of the FSA by the Conservative-Liberal Democratic coalition government and finds itself back in its ‘rightful’ position of King of the City of London.

In addition,the BoE might not have a lot of financial re-regulation to do until 2019: the Vickers Report doesn’t recommend implementation of a raft of reforms until then. And even so, Vickers is no Glass-Steagall Act.

One more thing: if you think the UK banking sector is separated from the Eurozone crisis, think again. Indeed, UK banks are inhaling European Central Bank funds as fast as they can draw breath. Some €37 billion breaths, to be precise.

But at least Chancellor George Osborne is fighting to stop France and Germany from watering down Basel III.

The last thing the post-2008 global financial sector needs is banks with even more lax minimum capital requirements.

Disclosure: Remy Davison is a Director of a Centre that receives funding from the EU Commission.

Even as Rafael Nadal gracefully accepted his cheque for €300,000 for winning the Barcelona tennis championship for a seventh time, the Spanish economy relapsed into recession.

In response, markets savaged the IBEX stock index, while ratings agency Standard & Poors last Thursday downgraded the credit rating of 16 Spanish banks to BBB+/A-2.

For the second time since 2009, Spain recorded negative growth. On this occasion, the economy shrank 0.3% in the March quarter, hard on the heels of last week’s news of Britain’s double-dip recession.

Given the Madrid government’s parlous finances, they might want a piece of Nadal’s cake, as the Spanish tax office launched an investigation of Nadal’s companies in the Basque region in February.

Spain’s austerity measures have produced almost 25% unemployment, although the large number people working in the informal economy exaggerates these figures somewhat. The Spanish finance ministry estimates that the 365,000 lost jobs in March quarter means almost €1 billion in lost tax revenues for Mariano Rajoy’s government.

These unemployment figures put Espana squarely back in 1985. Right before Madrid joined the European Union, to be precise. Back then, Spanish living standards were around 62% of the EU average.

The Spanish Apartment

Why did the Spanish economy collapse following the global financial crisis? One reason is the popping of the property bubble: between 2007 and 2011, property prices officially fell 17%, but some regions saw price collapses of up to 50%. Parts of Spain now look suspiciously like Ireland: hundreds of thousands of apartments and houses stand derelict, literally abandoned by their bankrupt developers.

So, superannuated Brits (if there are any left) and cashed-up Australians can pick up potential bargains, although Spanish banks aren’t too keen to lend on property.

Moreover, the Spanish government has scrapped the tax incentives that prodded people to invest in property.

¿Qué Pasa

Let’s get Real, Madrid: when Spain joined the EU in 1986, it sold off its manufacturing industries – mostly to the Germans – lock, stock and barrel.

That left property and tourism to fuel Spain’s largely services-oriented economy. Sure, there are major, majority-Spanish-owned energy players like Repsol, and some enviable green-tech exporters, but Spain is horribly vulnerable to regional and global financial shocks. Adoption of the euro from 1999, which replaced the weak peseta, meant Spanish multinationals spread their wings worldwide, investing in Latin America in particular.

But this also meant that Spanish business didn’t invest in Spain. Yes, Spain is a net exporter of investment (and let’s not get started on how Argentina is rapidly nationalizing Spanish-owned assets). Its largest source of FDI is France (over 40%), although this largely comprises French firms funnelling resources into their Spanish subsidiaries. The UK is the second-largest investor in Spain, although property and investment incentives have driven British cash to Spain

The rain in Spain turns quickly into pain

Property investment and home ownership is just great – when it’s bubbling. But it’s also dead capital subsidized by government tax incentives (much like negative gearing in Australia). As The Economist reported in 2011, Spain emerged as one of the most overvalued property markets in the world by 2011.

Four years ago, many Spaniards were considering a second (holiday) home. Now, some are wondering whether they will soon be homeless – if they aren’t already.

Meanwhile, in Gay Paree…

Super Sarko, aka President Nicolas Sarkozy, is just days away from having his swashbuckling career cut short.

His opponent, the bookish Socialist, François Hollande, appears too far ahead – 10%, according to some polls, 6% in others – for Sarkozy to catch him, even if the President’s Union pour un Mouvement Populaire (UMP) party were to obtain most of the support gained by the Front National’s Marine Le Pen in the first round.

Now Hollande’s prospective election poses new challenges for the beleaguered Eurozone. German Chancellor Angela Merkel hasn’t even bothered awaiting the French election result, deriding Hollande’s calls to renegotiate the fiscal compact crafted by Sarkozy and Merkel in 2011–12, and formalized in March this year.

Hollande may talk tough, but his options are limited, as the more disciplined fiscal regime implemented under the Berlin-Paris axis since March 2012 is now carved in hard EU law (even if Ireland knocks the compact back, the EU will simply proceed without Dublin).

Hollande wants to spend his way out of trouble, and this would involve mutualizing Eurozone debt by employing the (theoretically unlimited) resources of the European Central Bank and issuing EU-backed debt bonds (not to be confused with ‘eurobonds’ which have been around since 1960).

Hollande does hold one ace in his hand: if the Socialist Party (PS) wins a parliamentary majority, as well as the keys to the Elysée Palace, then the PS can block ratification of the Eurozone compact, until Hollande extracts some compromises from Berlin.

The PS’s official platform is to renegotiate the fiscal compact, but the realities of office, the resolution of Merkel (who declared reopening debate on the matter “futile”), combined with the Bundesbank’s refusal to countenance anything but austerity measures to rein in Europe’s chronic deficits.

A Holland victory would see the Socialists in the Elysée for only the second time since World War II. In 1981, François Mitterrand won an historic victory in coalition with the Communist Party, which resulted in a series of disastrous nationalizations, followed by a dramatic volte-face in 1983. Mitterrand abandoned nationalization and, ultimately, turned to deregulation and privatization, championed largely by his Gaullist Prime Minister (and future president), Jacques Chirac.

France and Hollande no longer have these policy options on the table. France and Germany have run the EU for so long, a fracturing of the relationship would have dire consequences for Eurozone policy. But Hollande has some unlikely allies in the Netherlands and ECB President Mario Draghi, who has called for a ‘growth pact’ to offset the austerity measures.

For Merkel, ‘growth pacts’ are code for financial indiscipline and fiscal laxity. But Europeans have tried austerity for four years; the votes are in, and they don’t like the results.

Frankly, Europeans can vote out every conservative/centrist/socialist government they like and replace them with the opposition, but it won’t make a jot of difference to either the EU’s financial instability or fiscal austerity.

If you believe David Cameron, Europeans are only half-way through the Eurozone crisis. Politicians better buckle up: there are many more winters of voter discontent to come. As wise old Rene Descartes was wont to say, “it is a mark of prudence never to place our complete trust in those who have deceived us even once.”

You know the old three-card trick: pick a card. Any card. But, inevitably, it’s the card the magician wants you to choose.

Jim Yong Kim, now the newly-annointed World Bank president, was the only possible choice in a stacked deck of only three cards. And the other two candidates were jokers.

Why? Because Kim’s appointment was a lay-down misère the minute Barack Obama paraded the anti-HIV campaigner on the White House Lawn and declared he was the US candidate for the Bank job.

Kim was always going to win the majority of votes from the Bank’s 25 Directors, despite serious competition from Nigerian finance minister Ngozi Iweala, 57, who has had a 25-year career at the World Bank.

Another candidate, Colombia’s former finance minister Jose Antonio Ocampo, formally withdrew his bid for the job last Friday. But in a parting shot at the US, EU, Japan and Russia, Ocampo backed Ngozi Iweala, labelling the selection process “a political exercise.”

Fleetingly, Iweala made the World Bank presidency a genuine – if illusory – contest, as she campaigned publicly and vocally for the position.

In her interview, Iweala canvassed World Bank challenges, listing 11 major issue areas in the developing world including job creation, infrastructure building and education, health and gender issues.

In the last few hours before the decision was announced, Iweala appeared to have accepted defeat. However, she declared her campaign for transparency a success.

Despite the World Bank selection panel’s claim that this would be a “merit-based” selection process, early news reports suggest US representatives at the Bank did not allow the merit discussion to proceed following the candidate interviews.

Nigerian news site, The Nation, reports that outgoing Bank President Robert Zoellick disclosed that “the next election will be merit-based but not this one.”

The Nation’s other claim – that Washington secured the EU’s support with the US backing Christine Lagarde’s elevation to the position of Managing Director of the IMF in 2011 – certainly rings true.

Clearly, as the IMF job has been a European appointment since 1944, neither the US nor the EU want to create a precedent where the world’s international financial organizations are run by outsiders. Traditionally, of the major international organizations, only the UN Secretary-General’s post is relatively open. It is usually awarded to a national of a non-aligned or neutral country. But there are exceptions, such as current UN Secretary General, Ban Ki Moon (South Korea).

Nevertheless, Washington has a history of getting rid of chiefs of international organizations who don’t do its bidding. Bill Clinton canned Boutros-Boutros Ghali (Egypt), favouring his preferred Manchurian candidate, Kofi Annan (Ghana).

At least if you campaign for the Director-Generalship of the World Trade Organization (WTO), you may stand half a chance of success. Of course, you’re forced to log about half a trillion frequent flier miles drumming up support from Trinidad and Tobago to Tonga. But this will all be pointless unless Washington supports your candidacy.

And, in the rare event that, say, Washington, Tokyo and Brussels disagree, then a compromise candidate can be found that they’re mutually disappointed with: how about Dominique Strauss-Kahn’s appointment to the IMF, for instance? Nobody was happy to see DSK coming. Or going.

Mind you, few can match the mind-boggling machinations that saw Gaddfi’s Libya elected by African countries to head up the UN’s Human Rights Commission in 2003. In second place is – yes, you guessed it – Libya’s election to the HR Commission’s successor body, the UN Human Rights Council in 2010. By early 2011, Libya was belatedly expelled from the Council. Gaddafi was expelled from his bunker a few months later.

The controversy surrounding this World Bank selection process will be rapidly forgotten by the global media. But the whole merry-go-round will start up again in 5 years' time when a new Bank president will be appointed.

Who will that be? Well, if Dominique Strauss-Kahn’s still looking for gainful employment in 2017…

(You can take that to the Bank).

Lord Wolfson’s vainglorious economics prize for 2012 will be awarded to the best solution for an orderly exit from the Eurozone.

The five finalists are:

1. Roger Bootle from Capital Economics;
2. Cathy Dodds, engineering graduate from Oxford University;
3. Jens Nordvig and Nick Firoozye from Nomura Securities;
4. Neil Record of Record Currency Management; and,
5. Jonathan Tepper, chief editor of Variant Perception.

All five get a guaranteed £10,000 share of the prize money, with the winner receiving £25,000.

Quiet please. We’re grading papers here. Remember, the decision is final and no judge shall be entered into.

What do they argue?

For Roger Bootle from Capital Economics, “The euro is a malfunctioning monetary union that was put together for political reasons”. He posits that monetary union should be undone, and Germany should leave the Eurozone with what used to be called the Deutschmark Zone. Not very likely, he concedes. Bootle says this that defaulting countries (like Greece) could effect temporary capital controls and redenominate national debt in a new currency (like a neo-drachma), boosting exports when it falls, inevitably, by 50% against the euro.

Verdict: Old hat. The usual catch-cry of ‘weaker-currency-cheaper-exports’. Exports of what? Greece doesn’t manufacture BMWs, Bosch appliances or engage in Airbus aeronautics. And who the hell would trust a ‘new’ drachma? No one even wanted the old one. Capital controls? How? Greek residents have been sending their euro out of the country ever since this crisis began. They’ve withdrawn at least €75 billion from the Greek banking system in recent months. That money is either stuffed in the mattress, studiously avoiding tax, or in Switzerland. Grade: C–

Cathy Dodds: Complicates the situation by dividing the Eurozone into two – or possibly more – regions (broadly speaking, ‘core’ Northern Europe and the ‘peripheral’ south, each with its own central bank, currency and monetary policy. The Euro would be abolished, ultimately, with a new currency unit based on a basket comprising the regional currencies.

Verdict: Mind-boggling complexity. More new currencies? More central banks? More monetary policies? If you want to see how this works, take a glance at eastern Europe’s non-members of the Eurozone. Last time I looked, Hungary, Poland and the Czech Republic were not travelling at all well. In March, the EU froze almost half a billion euro in funds payable to Budapest due to Hungary’s chronic budget deficit. And Budapest isn’t even in the Eurozone. Quite apart from this, German, French and Italian business own most of eastern Europe’s industrial productive capacity. Moreover, as long as you have an EU, you have to have a general unit of account for the EU General Budget and Common Agricultural Policy transfer payments. From 1950 until 1971, this was the European Payments Union, that introduced the European Unit of Account (EUA). This was replaced by the European Currency Unit (ECU) until 1999, which saw the introduction of the Euro. The point here is that the euro gives the ‘core’ EU greater purchasing power in the ‘peripheral’ EU. And that keeps peripheral Europe peripheral. Which is how western Europe likes it. Grade: D. Must. Try. Harder.

Jens Nordvig and Nick Firoozye: A country departing the Eurozone would still find itself laden with contracts denominated in euro. There are extant EU foreign debt contracts (i.e., contracts that are not written within the legal jurisdiction of the debt-issuing country) that total over €10 trillion. Nordvig and Firoozye recommend that Eurozone defectors redenominate debt that falls within the jurisdiction of national law in a new currency. In a less complicated version of Dodds’ solution, the Nomura Securities analysts suggest that debt under foreign law contracts should be reissued in European Currency Units (ECUs), based upon a country’s share of a weighted basket of currencies.

Verdict: Slightly better, but still riddled with problems. Banks with euro contracts would invariably get all lawyered-up and sue within their domiciles, arguing that the debt must be repaid in euro, and they would likely win in court. In addition, neither Dodds nor the Nomura analysts address the question of the 25% of all global foreign exchange reserves that are held in euro. What happens to offshore euro once you abolish the currency? Don’t even get me started on currency runs once the markets get wind of the abolition plan. And they will. Grade: B-

Neil Record of Record Currency Management writes of the need for Germany and France to form a “secret task force”, abolish the euro currency and replace it with new national currencies. Germany, Record argues, “must propose that it unilaterally breaks away from the euro, establishes its own national currency, severs its links with the ECB and takes no further part in the resolution of the euro crisis.”

Verdict: Sorry Neil, but I’m not putting my money in your Currency Management. First, Germany is a free rider on the euro: it’s undervalued, while the pre-2002 DM was overvalued, hurting German business and exports. Why in the world would Berlin want to abandon the euro? There are reasons why Frau Merkel is prepared to bankroll this project. Second, I don’t know whose thumbs Neil was twidling during the 1992 and 1993 EU currency crises, but he is clearly clueless about what happened when a bunch of forex speculators dramatically ‘broke the Bank of England’. Two words, Neil: George. Soros. Grade: F.

Jonathan Tepper looks at previous currency breakups. Like Czechoslovakia, the USSR, Pakistan-Bangladesh and the Austrian Empire. Plus a whole bunch of countries in Africa and elsewhere that became independent of their colonial masters after World War II. These all went smoothly, according to Tepper. So if Greece, Portugal and Spain exit the Eurozone, they would default and become more competitive by introducing a new currency.

Verdict: Hmm, Czechoslovakia, USSR: non-convertible currencies. And when the Czech and Slovak Republics split, two-way trade fell and they both ran down their foreign reserves. Slovakia is in the Eurozone (since 2009); the Czech Republic is still slated to join in 2013. Pakistan-Bangladesh? Smooth split? If that’s what you call a civil war with over a million dead. Austrian Empire? World War I. Then Austria went bust in 1931 and Nazism gained popularity. In 1938, Austria ceased to exist. Very smooth. African colonies? The former French colonies’ currencies would be worthless if they weren’t backed by the CFA franc zone. Yes, and the euro is being used in the Caribbean as we speak. Do we really have to grade this? OK, E-

None of these solutions can be achieved quickly and with the minimum of economic and monetary dislocation. Most of them are also centred around some type of currency manipulation scheme, like the one Washington so deplores about Beijing. When West Germany underwent currency reform in 1949, it swapped the old Reichsmark 10:1 for the new Deutschmark (DM). In 1990, when East and West Germany unified, the Bundesbank accepted up to 4,000 East German marks at 1:1 exchange and 2:1 for larger sums. Yes, the German central bank exchanged the strong DM for essentially worthless paper from a socialist state that had just been abolished.

The point here is that 1949 and 1990 were both clean-sheet operations. The Eurozone itself took almost 10 years to construct (although it really started to evolve in 1972). Currency unions are not made and broken overnight. Not without castastrophic consequences they aren’t.

And the winner is … None of them. And these sundry economists and consultants have too much time on their hands if they can waste it writing essays on a hypothetical scenario for Lord Wolfson’s vanity project. Frankly, Edward Hugh’s post is better (scroll down for Athens University’s Yiannis Varoufakis’ opinion, which is the most sane piece of analysis out there). Varoufakis argues,

“All that it would take to allow Greece to stay in the eurozone, in a better state than it is today (and less austerity for that matter), is the continuation of the present ECB policy toward Greek banks…As for those who argue that the ECB will take an aggressive stance, think again: The ECB will not knowingly take steps which will destroy the eurozone.”

Damn straight. The envelope, please. Congratulations, Yiannis. You are our 2012 Wolfson Winner. Here’s your 25,000 drachma prize…

P.S. If you’ve read this far, you’re probably interested enough to read a book on how the euro got started. For an insider’s account, see Bernard Connolly’s The Rotten Heart of Europe (1995).

Disclosure: Remy Davison is a Director of a Centre that receives funding from the European Commission.

Last week’s story on The Conversation saw HECS architect Bruce Chapman bemoaning lost tax revenue from graduates who flee overseas away from the clutches of the Australian Tax Office (ATO).

Here’s an idea: how about deregulating HECS loan repayments?

After all, utilities have already been deregulated, resulting in the emergence of private markets for gas and electricity retailing throughout Australia. Utilities retailers obtain energy supplies from wholesalers. Consumers simply choose their retailer according to price and service. If you want a better deal, dump the retailer at no cost and sign a contract with a new one.

Credit cards work in a similar fashion. Vendors offer products differentiated via incentive schemes (interest rates; balance transfers; interest-free periods; reward points; annual fees).

HECS could operate in a similar fashion, and there would be benefits for all arising from market deregulation.

Instead, the Federal Treasury and ATO (as debt collector) operate an inflexible, virtually-integrated upstream monopoly, where the Commonwealth owns virtually all of the suppliers and sets all prices.

The Commonwealth government already does it

Remember when David Kemp privatised the employment agency functions of Centrelink? A certain T. Rein made a fortune out of it, just in case you’ve forgotten. I haven’t come across anyone arguing that Centrelink should re-assume this responsibility because they did such a great job.

And while the Commonwealth delivers Medicare, it also co-exists alongside a subsidised, profitable private health insurance industry. And no one’s arguing that the Feds should re-regulate health insurance, abolish private providers and assume full responsibility for all health care, are they?

What’s the business model?

Clearly, the ATO would have to wholesale HECS to the retail sector at a price that is lower than the current market rate, so that HECS providers could operate profitably. So the wholesale floor price for HECS debt would need to be x per cent below the retail price.

But the ATO benefits. Why? Because HECS retailers will buy debt wholesale and pay up- front to the ATO.

And if HECS providers want to charge higher prices by partnering with corporations to sell ‘beyond-the-box’ products, that could deliver real value to students, good. Like phones, car loan discounts or bundled (very pricey) chemistry or law textbooks. The sky is literally the limit. And the ATO can deliver none of these things, partly because it lacks the imagination.

Students benefit

How? By having the right to choose the most competitive and attractive HECS provider for their course. To protect students, the Federal Government would need to regulate maximum prices (just as it does now by setting the cost of subjects and courses) to prevent retailers from price gouging, collusion or cartelisation. Regulation would fall within the ACCC’s purview. That’s what they’re paid for.

University admissions criteria remain the same

This is not a cunning scheme so students can obtain back-door admission to medicine or law without gaining the ENTER score. Students will still need to gain admission to their course of choice and then choose a HECS provider.

The ATO can still play

If students choose to go with the ATO as their HECS provider, fine. That’s what it’s all about: choice. And choice is good, wouldn’t you say?

Incentives plus

Assume the HECS retailer wants to build market share and customer loyalty. What better way than to give discounts, or even free subjects? Full time students might take 8 subjects per annum. Sign up for 16 subjects (2 years) and receive the cost of the 16th subject free. Or at a discount for paying up front (just as HECS operates right now).

Make it flexible

Do you want to make extra repayments of your HECS debt at any stage? Go right ahead. And firms can introduce incentives to encourage voluntary additional or early repayments. This is a lot better than the route the Commonwealth is travelling: HECS bonuses for voluntary repayments over $500 were reduced from 10% to 5% on January 1st, while HEC price discounting has decreased from 20% to 10%. Typical market behaviour of…monopolists.

What if HECS retailers go bust?

Happens all the time in the retail sector. The natural tendency of firms under imperfect market conditions is to gravitate towards an oligopolistic market, with only 3 or 4 players left after a few years. More successful retailers would take over business failures. If no firm is willing to merge or take over a failed retailer, then the ATO could simply assume responsibility for the HECS contracts. After all, they’ve already got that firm’s money.

But…but…it’s inequitable

No, it’s not. Until 2012, wealthy people got a steep 20% discount if they covered their kids’ tuition costs. They still get 10% off. Deferred repayments would kick in when taxable income reaches $47,196 per annum. Just like it does currently.

Critics of inequity should target the ATO, which also king-hits graduates who choose careers in the non-profit sector: charities and the Red Cross, for instance. To attract qualified graduates, non-profits pay lower-than-industry salaries, but offset this utilising salary packaging, meaning a portion of an employee’s income is taxed at a lower rate. But the ATO creates an entirely illusory world where it calculates HECS repayments on the basis of the employee’s ‘purported’ salary. And they also hit these employees with FBT. Touché.

Tertiary education should be free

Sorry, but we are not living in the People’s Republic of Brown, despite widespread evidence to the contrary. Education costs real money and the Commonwealth subsidises the real cost of tertiary education anyway.

That said, the Commonwealth only pays approximately 40% of the recurrent funds going to universities. The rest comprises fees, research grants and consultancies. Don’t kid yourself that the Feds are still living in the Whitlam era. They’re not. And your HECS repayments go directly into consolidated revenue.

The transaction costs

Treasury may need to take a financial hit in the longer term, as the cost of HECS retailers buying blocks of debt today (at current prices) may impact Treasury’s longer –term revenue stream, bearing in mind the rate of CPI indexation, which currently applies to HECS debt. HECS is 100% interest-free.

The upside for Treasury is that it gets the revenue now in current dollars from the HECS retailers, not 5 or 10 years down the track (ergo, dollar depreciation, which almost always outpaces CPI). Grads who head overseas have already signed up with a HECS provider (sure, they may opt to sign with the ATO, but that’s Treasury’s problem).

Think big

And, while we’re on this, why not a deregulated market in overseas student fees? Over 430,000 international students were enrolled in Australia in 2010. They’re worth $18 billion to the Australian economy in a good year, and education is by far our largest services export. What could be better than firms marketing Australia’s education system globally (and I don’t mean the bored, subcontracted Oz uni spruikers at international education expos), particularly as this market has become especially cut-throat since 2008, as the US and UK ramp up their product marketing ever more aggressively.

It will never happen

Possibly true. The ATO has its fat fingers so deep in the till that it’s impossible to extricate them. But as virtually every state and Commonwealth government has dealt itself out of ownership of everything from airlines to banks to utilities, it’s difficult to defend the proposition that the Commonwealth needs to play monopolist with HECS.

Now taking bets on whether the ATO audits me this year…

Quite a surprise. Jim Yong Kim, former World Health Organisation (WHO) chief, is Barack Obama’s nominee for the presidency of the World Bank. The White House announced Obama’s support for Kim, currently president of Dartmouth College, earlier this week.

None of the widely-touted names – Hillary Clinton, Tim Geithner and Larry Summers – made the final cut. Apparently, none of them wanted the job. Moreover, neither Clinton nor Geithner finish their term with the Obama administration until January 2013, meaning a messy interim appointment would have been required, as the World Bank post needs to be filled by July, when serving president Robert Zoellick hangs up his hat.

The developing world’s favourite choice (probably), Jeff Sachs, declared his support for Jim Kim once Obama made his preferred candidate known. However, there are a still a couple of outside chances.

There are long odds on Ngozi Okonjo-Iweala, Nigeria’s finance minister, who is a well-regarded economist, and has already served as the World Bank’s managing director.

But the World Bank job has always been a US appointment since 1944 and the likelihood of a non-American getting the job is virtually zero. For one thing, the US, European Union and Japan control most of the votes at the World Bank; the BRIC countries – Brazil, Russia, India and China – have little influence at the Bank, and the sum total of the developing world’s votes amounts to a paltry 6%. The BRICS control around 30%, while the OECD plus Saudi Arabia have an overwhelming 60%. That’s a majority shareholding in anyone’s language.

Moreover, the EU, Japan and Canada have already indicated support Obama’s candidate. In addition, everyone realizes that a non-American World Bank president would make getting Bank funding through US Congress a veritable minefield. Traditionally, Congress isn’t favourably disposed towards UN agencies in any case, and sending hard-earned US taxpayers’ cash in an age of austerity to countries senators have never heard of isn’t a recipe for success. And if an American isn’t running the World Bank, then why-are-we-doing-this-anyway-goddamit?

Obamaphiles have praised his choice of a Korean-American who has the reputation as the man who ensured millions of HIV sufferers in the developing world received treatment. But not everybody’s happy.

Critics like William Easterley point to Kim’s 2000 book critiquing neoliberalism and its focus upon growth. Over at Reuters, Christopher Swann complains about Jim Kim’s lack of finance and banking credentials – after all, the guy would be running a development bank. Bob Zoellick, although a lawyer by training, did do time as an executive VP of Fannie Mae (not the world’s best-run mortage finance enterprise, admittedly). One long-serving president of the Bank, former US defence secretary Robert McNamara, was a bean-counter before he became President of Ford.

Academics haven’t been kind to Kim either, suggesting he hasn’t even run Dartmouth College particularly well.

But I’m betting it’s a lay-down misère he’ll get the job. Anyone care to wager a fiver?