Finance Matters

The bank of England is expected to launch another round of quantitative easing (QE) this week, in the hope of preventing the UK falling into another recession, after the economy contracted by 0.2 per cent at the end of last year.

The bank is likely to pump at least £50 billion into the economy by purchasing government gilts from pension funds and insurers with electronically created money.

This round of QE, which is designed to bring down borrowing costs, follows a £75 billion injection into the economy last October.

Since the QE programme started in March 2009, the Bank has bought £275 billion in gilts.

A final decision on the latest round of QE will be made at this week’s Monetary Policy Committee (MPC) meeting.

Some economists believe that last week’s welcome news that the UK’s manufacturing and services sector has grown to its highest level for ten months may lead the MPC to review the scale of the latest round of QE.

Last week The National Institute of Economic and Social Research (Niesr) called for the government to ease back on spending cuts in order to encourage the economy to grow.

The think tank warned that the UK economy will enter recession in the first half of 2012 if households continue to cut back on their spending.

Niesr forecasts that the economy will shrink 0.1% in 2012, however if the eurozone debt crisis is resolved the UK economy could grow 2.3% in 2013, it said.

“We forecast a return to technical recession in the first half of this year, as households continue to retrench, credit conditions remain tight, and businesses are reluctant to invest given uncertainty about both domestic and foreign demand,” the think tank said in its UK and World Economy Forecast.

This post originally appeared at The Christian Science Monitor.

Making my way from Milan to Rome in recent days, I experienced firsthand the rancorous process under way to deleverage Italy’s sovereign debt and impose more competitive habits on the languorous rhythms of this Mediterranean culture.

Angry truckers blocked the main highways, drivers left their taxis standing, and most trains were canceled. Students scrawled anti-austerity slogans across peeling, ocher-colored walls. Surly shopkeepers only brightened at the sight of mid-winter gaggles of Chinese tourists.

All the strikes and animosity took aim at the reforms proposed by the “un-democratic” government of Italian Prime Minister Mario Monti and his so-called technocratic cabinet – even as he was hectoring German Chancellor Angela Merkel to loosen up Germany’s fiscal authoritarianism and allow some breathing room for growth in the eurozone. Because elected politicians couldn’t get their act together, Mr. Monti was appointed by President Giorgio Napolitano late last year to formulate and implement key structural reforms before a new election takes place in 2013.

Alas, the protesters have the wrong target in their sights. Italy got into its mess not because of too little democracy, but too much of a decayed form of governance. Italian electoral democracy – like that in the US – is so politicized along partisan lines that it became dysfunctional and wholly incapable of meeting the tough challenges facing the country.

Monti, whose fair-minded wisdom and long experience as a European commissioner make him more a meritocrat than a technocrat, is certainly right when he declares that “the absence of political personalities in the government will help rather than hinder a solid base of support” for reform. He understands that Italian democracy, like American democracy, has become a “vetocracy,” to use a phrase coined by American political scientistFrancis Fukuyama.

In a vetocracy, elected politicians are so captured by short-term populist sentiment and organized special interests that the mere formulation of a policy that seeks compromise for the long-term common good is eviscerated by the parties in play even before it can be put to a vote in parliament. Any bill that gets through is so shorn of substance as to be meaningless. So what remains is the status quo.

In his seminal “The Rise and Decline of Nations,” the social scientist Mancur Olson described how this powerful accretion of organized interests in democracies over time has dragged down states time and again because it inevitably produces unsustainable deficits and drains an economy of vigor by protecting “rent-seeking” cartels.

In Italy today, parties representing taxi driver unions or shopkeepers aren’t about to favor making their clients’ lives more difficult through open competition. Public employees will resist cuts in jobs and benefits. Bankers will use their influence with legislators to avoid regulation. The rich will block higher taxes.

Giving voters a bigger say through direct instead of representative democracy can’t be the answer either. If put to a popular vote, what pensioner would be in favor of trimming the generous social contract he or she has come to expect even if the collective Italian purse can’t afford it?

As can be seen in California, where the direct democracy of the initiative process dominates governance, rational self-interest expressed by voters at the ballot box can add up to the wholesale madness of unintended consequences. As the result of a series of initiatives over the years slashing property taxes and seeking to punish criminals, California now absurdly spends more on prisons than on higher education, undermining the building blocks of its future.

Direct democracy is an especially bad idea in America’s Diet Coke culture, where people seem to want consumption without savings and government without taxes just like they want sweetness without calories. To make the situation worse, special-interest money, sanctioned by the US Supreme Court as “free speech” (Citizens United v. Federal Election Commission) easily distorts and manipulates honest discourse in any political campaign.

As difficult to swallow as his dose of discipline may be, the depoliticized democracy being practiced by Prime Minister Monti is the only possible form of government that can move Italy forward. And we will see more and more of it in the West for the same reasons we’ve seen it in Italy.

The whole idea of the US congressional “supercommittee,” which unfortunately has so far failed, is to take the politics of gridlock out of formulating a fair and common-sense policy to reduce long-term deficits.

In California, an independent bipartisan group called the Think Long Committee, with members ranging from Google’s Eric Schmidt to the former chief justice of the state’s Supreme Court to former US Secretary of State Condoleezza Rice, has been more successful.

It left politics aside and was able to reach a bipartisan tax-reform plan bridging the ideological divide that has paralyzed the state legislature for years. It will offer that plan to the public for a vote in 2014. The group has further proposed a more formal nonpartisan body, appointed by elected officials but composed of prominent citizens with expertise and experience, to watch over California’s long-term interests.

In none of these instances is anyone suggesting doing away with one-person, one-vote democracy and transferring popular sovereignty to a meritocratic elite, as is the case, for example, with the demonstrably competent Communist Party mandarinate in China. In every case, the ultimate say still resides with the voting public.

But in each case the “vetocracy” aspect is stripped out of policymaking. Instead of only pulling the lever out of narrow self-interest or being called upon to sift through the spin of special interests at election time, the public would be able to decide on considered policies proposed to them by bodies entrusted to take into account the long-term common interest.

The current travails of governance in the West suggest that an evolution of democracy is necessary in which institutions with meritocratic elements are established as a way to counterbalance the short-term, special-interest political culture of electoral democracy.

Meritocratic institutions with delegated authority, after all, are not foreign to democracies. We have independent central banks, higher courts, and powerful regulatory bodies in areas ranging from food and drugs to the environment and health.

Even in California’s radical democracy, key powers have been granted to commissions appointed by the governor that regulate development along the coast, oversee the state’s energy and water supply, and administer the University of California. All are accountable to the public because they are appointed by democratically elected officials, yet they are all insulated from the electoral process itself.

Italy’s experiment with depoliticized democracy will be closely watched as an antidote to the paralysis and dysfunction that afflicts the West today. If political decay can yield to good governance in Italy, everyone will benefit from the path blazed by Mario Monti.

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The German Chancellor is visiting China where she is expected to discuss China’s currency policy and the eurozone debt crisis.

The Volcker Rule is starting to draw the public ire of officials from global economic superpowers as the end of the commenting period on the proposed rule nears and the July 21 implementation looms. The law itself is arguably one of the most controversial 

At the core of the countries’ worry is the fact that the proprietary trading ban—which prevents banks from making trading bets with their own money—in the Volcker Rule does not have an exemption for foreign sovereign bonds.

Officials from Japan, Canada, U.K. and the European Union have all expressed concerns that the lack of exemption could hinder the selling and buying of sovereign bonds, which could make the markets illiquid and volatile, and hinder countries’ borrowing abilities. That’s especially troubling for European nations at a time when many are struggling to raise money amid the effects of the debt crisis. 

The Volcker prop trading ban, as it is currently written, has exemptions for debts of the U.S. government and agencies, government-sponsored entities, and states and their subdivisions, according to a report from KBW Equity Research team. In addition, there is an exemption for market making—the selling and buying of assets for clients—that has become one of the most contentious points within Volcker as regulators are unsure where to draw the line between market making and prop trading, and how to define either terms.

Bear in mind that one of the biggest criticisms of Volcker has been its complexity, and that even federal regulators are unsure how to implement the rule.

The KBW report stated that the market making exemption is enough to allow banks to properly trade sovereign debts, and also pointed to Volcker allowing long-term investments in securities, which can include sovereign debts. But the fact that the Rule prohibits banks from keeping securities on their “trading book” to trade for short-term gain could also become problematic. (Andrew Ross Sorkin has a good explainer here applying a used car lot analogy onto trading sovereign bonds.)

The countries, themselves, have also tried to fight Volcker in different ways. Japan has sent several letters to U.S. regulators, Canadian officials have gone so far to say that the rule violates the North American Free Trade Agreement, and the EU commissioners said they are planning to meet with U.S. Treasury Secretary Timothy Geithner in the coming months. Some countries have also remarked that their foreign business will have to pull their U.S. operations if Volcker becomes too impactful.

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