Cameron's Veto: is this a Waterloo or an Arnhem?

Sometimes it is best to wait before blogging on events. I took this view on Friday before commenting on David Cameron's veto at the EU Summit. Better to wait and think through the implications before hitting the keyboard.

Depending on which newspaper you have read over the weekend, individual views on the veto will differ. If you are a Telegraph or Mail reader it is likely to be the greatest British victory on the Continent since Waterloo. Guardian and Independent readers will doubtless form the view that the UK is about to be thrown out into some sort of diplomatic nuclear winter. Readers of the Economist will probably conclude that the Prime Minister didn't really have a clue what was going on and hopelessly overplayed his hand!

So what is the truth of the matter? My own view, having given it much thought, is that the leaders of the UK, France and Germany are engaged in a game of high stakes poker with bluff and counter-bluff the order of the day.

Whilst this may seem like a European issue, national considerations are playing a key role. The French President, deeply unpopular at home, faces re-election on April 7th. He faces his electorate with an economy tanking, rising inflation (anybody who has been to France recently will notice how expensive it has become), a cut in his country's credit rating and his major banks all but bankrupt. Out of the fog, his election strategy is becoming clear. He intends to say: "It's not my fault, it's those Brit's and their dodgy banks who have infected all the rest. But don't worry, I've thrown them out of Europe, so vote for me!"

Chancellor Merkel does not face re-election until September 2013, but if she is to stand any hope she needs to whip the rest of Europe into shape double-quick. However, the German public is deeply unhappy with having to prop up other countries. They haven't gone through years of fiscal austerity only to go bust bailing out the Greeks and Italians.

Similarly, Frau Merkel's strategy is also becoming clear: "It's not my fault, we need much closer fiscal integration to make sure we, sorry I mean the EU, has oversight of other country's budgets so they can't do it again. Vote for me!"

Of course the irony is that European leaders still think they are in charge of events. The reality is that the bond markets will have as much, if not more, say in how events unfold. The key point of last week's summit is that it did absolutely nothing to solve the immediate liquidity crisis that is enveloping the Eurozone. The ECB still can't buy bonds, we have no Eurobond, yields are going through the roof (as I write Italian ten-year bond yields are up by 15 basis points and rising) and the ratings agencies are downgrading as fast as they can type.

So what is the PM's game? Like his European counterparts he is also looking over his shoulder at the Eurosceptics within his own party. My guess is that the PM has made the calculation to temporarily appease the Tory right in the hope that he sees the back of President Sarkozy in April. Alternatively, the whole Eurozone could go bust and break up at which point last week's veto won't make a blind bit of difference.

The nightmare scenario for the PM is that the French socialists fail to get their act together and split their vote, which last time let in Jean Marie Le Pen of the National Front. In 2007 the socialists had to swallow their pride in the second round of voting and get behind Sarkozy to keep Le Pen out.

We are therefore in the extraordinary situation that a British Conservative Prime Minister is hoping for a socialist victory in France so that he can get rid of his arch-enemy and, he hopes, break up the Merkel/Sarkozy relationship.

Today, the Prime Minister basks in the adoring headlines of the right wing media comparing his triumph to Waterloo. He must hope that the reality is not more like an Arnhem, where a flawed strategy and faulty intelligence led to annihilation.

Debt crisis solved (hopefully), now deal with the demand crisis please!

European leaders are busy slapping themselves on the back today, but they shouldn’t get too carried away – there is an even bigger job still to be done.

As ever the past can give us a clue to the future. When Franklin Delano Roosevelt FDR) became the 32nd President of the United States at the height of a banking panic in 1932 he dealt with the immediate problems with a torrent of legislation designed to stabilise the situation. The Emergency Banking Act gave banks vital breathing space against foreclosure. The Federal Deposit Insurance Corporation effectively guaranteed all deposits which stopped the run in its tracks. The Glass Steagall Act separated commercial and investment banking thereby controlling the rampant speculation which had undermined efforts to bring America out of the Great Depression.

All of this should sound familiar to European policymakers, but crucially Roosevelt did not stop there. In between his election victory in November 1931 and his inauguration in March 1932 he attended a meeting at the White House with outgoing President Herbert Hoover and the British economist John Maynard Keynes. Hoover talked passionately about why it was not the government’s place to stimulate demand. Keynes retorted with his belief that fiscal and monetary measures can mitigate the adverse effects of economic recessions . The story is that FDR did not understand a word that either said, but he instinctively knew that something had to be done, and if that didn’t work he’d “try something else.”

The result was a monumental kick-start to the American economy. He expanded a Hoover agency, the Reconstruction Finance Corporation, making it a major source of financing for railroads and industry. The National Industrial Recovery Act established rules of operation for all firms to stop cut-throat competition, such as predatory pricing, and also increased wages.

Crucially, the recovery was pursued via pump priming with Federal money. $3.3 billion of spending via the Public Works Administration for example created the largest government-owned industrial enterprise in American history, the Tennessee Valley Authority (TVA), which built dams and power stations, controlled floods, modernised agriculture and homes in the Tennessee Valley. In simple terms, FDR put people back to work and gave them money to spend which in turn created demand.

All of this is very much counter-intuitive. Our instincts in times of financial crisis are to retrench and hoard what we have got. In actual fact we need to be spending and Government has to give the lead, in order to rebuild confidence.

The sense I have is that our policymakers know what has to be done even though it goes against many of their instincts. Our current Chancellor of the Exchequer has talked in vague terms about “big capital projects”. This is going to need more than words though.