France lost its prized triple-A badge from the Standard & Poor's in January and so Monday's move by Moody's was not surprising but it underlined doubts about Socialist President Francois Hollande's ability to fix France's public finances.This is a commentary from the same article:
"I don't expect it (the downgrade) to have an immediate knock-on impact today on access to and cost of funding," said Espirito Santo analyst Andrew Lim of the possible impact on the banking sector. "But it's symptomatic of the wider concerns of a plain-vanilla negative impact on the economy being suffered in the next few months and quarters. Spain, Italy and peripheral Europe are weakening and France's exposure to them is something to be aware of."Whilst the Euro sank a little, it is not seen as a harbinger of crisis, or at least not yet. Another article notes some of the upcoming risks:
The stronger news is that the EFSF and ESM ratings may suffer with the French downgrade. Also, French corporates and banks may be subject to downgrades following the sovereign action as well.It is a very good point. When those doing the bailouts look less creditworthy, there are the makings of a future crisis. This from the Wall Street Journal:
"We do note that downgrades are warranted as our own sovereign ratings model shows France's implied ratings at AA/Aa2/AA, which remain below actual ratings of AA+/Aa1/AAA", wrote the BBH team of analysts, seeing scope for more downgrades given what we see as major misalignments in its ratings, especially with Fitch now.
The European Financial Stability Facility is widely expected to receive a credit rating downgrade within the week, allowing it to resurrect plans to issue bonds after the rescue fund's second-biggest backer--France--saw its rating trimmed.A piece in the Australian is highly critical of the (relatively) new French President, Francois Hollande (in some respects, a rather silly piece describing how he is enjoying the perks of power, but also with some more serious material):
A downgrade could marginally curb demand for EFSF debt. It would normally make it harder for borrowers to raise funds. But for the EFSF, it would help resume plans to finish its 2012 funding program after it was forced to shelve a three-year bond sale Tuesday due to the rating discrepancy between the EFSF and France.
The EFSF--Europe's short-term bailout fund that has helped raise cash for Greece, Ireland and Portugal--said Monday that it planned to sell three-year bonds denominated in euros.But the decision later in the day from Moody's Investors Service Inc. to strip France of its triple-A rating complicated the proposed EFSF deal, as it left the rescue fund's rating standing above that of one of its key backers. The EFSF described the decision to shelve the deal as "technical." Under its so-called Deeds of Guarantee rules, it was forced to pull it despite having attracted more than 3 billion euros ($3.8 billion) in investor demand.
This story has a particularly interesting aspect. Hollande campaigned on an anti-austerity ticket, and is now confronted with the power of the bond markets to discipline perceived high risk states. I found this an interesting story in light of a very thoughtful piece in Spiegel recently (I have growing respect for this publication, as one of the few outlets that offers real depth of analysis). This particular point came to mind when seeing the French downgrade:
Unfortunately, economic indicators suggest otherwise: unless it acts fast, "la belle France", for all its fine talk could become the latest and most significant victim of the eurozone debt crisis.
Economist Nicolas Baverez was one of the first to predict France's downfall a decade ago. He argued last week that the President, whose popularity has plummeted faster than that of any of his predecessors since his election in May, is in denial of the financial tsunami that could batter his palace walls by next year.
"He has missed at least three opportunities to begin a recovery," said Mr Baverez, warning that unless Mr Hollande quickly implemented reforms, the country would face the humiliation of being forced to go cap in hand to the eurozone and the International Monetary Fund for a bailout.
"In 2013 our country will be the world's biggest borrower of euros, bringing recession, soaring unemployment and an inevitable financial crisis," said Mr Baverez. "Germany will make France pay dearly for its backing."
[and later]
As thousands of people marched through the streets of Paris last week as part of a pan-European protest against austerity, student Laurent Botti, 21, handed out leaflets accusing Mr Hollande of being a "clone" of the conservative Mr Sarkozy.
"He has betrayed us," Mr Botti said, complaining that Mr Hollande had presented himself in the election as Europe's anti-austerity champion but had ended up siding with "big business".
Whatever the case, something has to be done, quickly: public spending accounts for more than half of French GDP, the highest share in the eurozone. No government has balanced the budget since 1981, thus public debt has risen from 22 per cent in those days to more than 90 per cent. The economy is stagnant and will hardly grow next year. More than 10 per cent of the workforce - and close to a quarter of the young - are without work.
The attempt by countries to bolster the faltering financial system has in fact increased their dependency on the financial markets to such an extent that their policies are now shaped by two sovereigns: the people and creditors. Creditors and investors demand debt reduction and the prospect of growth, while the people, who want work and prosperity, are noticing that their politicians are now paying more attention to creditors. The power of the street is no match for the power of interest. As a result, the financial crisis has turned into a crisis of democracy, one that can become much more existential than any financial crisis.I have long railed against government debt, and continue to wonder why governments in mature economies need to borrow at all. The Spiegel analysis is quite correct. Democracy, and the belief in democracy is now on the chopping block. We can see this most clearly in the countries that are already going through the most severe crises, such as Greece.
The problem that we, meaning all of the electorates of the Western democracies (to varying degrees) face, is our own immaturity. Whilst some of the democracies are very mature in terms of age, the behaviour of the electorate remains immature. When we see protesters on the streets of Europe, protesting against austerity, we have a picture that is analogous to the teenager having a tantrum and demanding a new iPad. The fact that his parents are already in debt, and cannot afford the iPad is entirely absent from his thoughts.
In the case of Francois Hollande, he promised the goods and the French electorate duly elected him. However, when coming to power and facing the reality of France's economic situation, he is now being forced to backtrack. The result is that his popularity is plummeting (sorry, cannot find the link for this). The problem faced by Francois Hollande is the problem faced in so many countries. The electorate demand a standard of living that is higher than can be funded from the output of the economy. To return to the article in the Australian:
The figures tell only part of the story. A report commissioned by Mr Hollande from Louis Gallois, a respected business leader, blamed the eurozone's heaviest social charges on payrolls, over-regulation and exceptionally high taxes for undermining France's competitiveness.It is a crude piece of commentary, but nevertheless captures some of the problems being faced by France. As France has lost competitiveness, the debt has been increasing. This is the story that sits underneath the economic crisis. The immaturity of demanding 'x' standard of living in economies that can only really afford 'x-' standard of living. Even as the emerging economies were rising in competition with the mature economies, the demands for ever higher standards of living increased. It was the role of governments, whatever it might take, to deliver these ever higher standards. This from the Spiegel article:
Genevieve Forestier, who abandoned her dream to set up a fashion label last year to take a job in a lawyer's office instead, could not agree more. "All the social charges and taxes are enough to put off even the most enthusiastic of entrepreneurs," she said. "The worst thing, though, about running your own business in France is that once you've hired someone it is virtually impossible to fire them. I've heard of a case where an employer had to continue paying a worker's salary even though he was in prison."
Not surprisingly, new firms seldom get off the ground and France has fewer small and medium-sized companies than Germany, Italy or Britain. At the same time the government continues living beyond its means. Mr Hollande agrees that the state should spend less, but some of the cuts thus far seem cosmetic.
The prospect of France losing market confidence terrifies European Union officials. It might need a bailout on such a scale that the mechanism to preserve the euro would be overwhelmed.
When the debts of companies and private households are added to the public debt, the sum of all debt has grown at twice the rate of economic output since 1985, and it is now three times the size of the gross world product. Economies in the developed world would appear to require credit-financed demand in order to continue growing -- they need consumers, companies and governments to go into debt and to put off paying for their demand until some unspecified point in the future. Of its own accord, this economic system produces the compulsion to drive up the debt of public and private households.One of the notable points is about household debt. We can see the mentality that is driving the electorate, which is in turn driving the politicians, by visiting an electrical store. Why pay now when you can pay later? We know that the people who enter the store, with a tight household budget already, deep down know that the purchase of the latest shiny good is going to put their overall budget at risk. However, they still buy. They just want that shiny new good. This is the mentality of the electorate, and it is no surprise that we get politicians who pander to this immaturity. There is a fundamental lack of maturity, and self-justification is given for poor budget choices.
Governments delegate power and creative force to the markets, in the hope of reaping growth and employment, thereby expanding the financial latitude of policymakers. Government budgets that were built on debt continued to create the illusion of power, until the markets exerted their power through interest.
Interest spending is now the third-largest item in Germany's federal budget, and one in three German municipalities is no longer able to amortize its debt on its own. In the United States, the national debt has grown in the last four years from $10 trillion to more than $16 trillion, as more and more municipalities file for bankruptcy. In Greece, Spain and Italy, the bond markets now indirectly affect pensions, positions provided for in budgets and wages.
As such, when the politicians, economists, and policy makers seek to justify yet further increases in debt, they are pushing at open doors of an immature electorate. We, the electorate grasp at their justifications willingly, as they are telling us that they can 'magic' into existence the shiny goods that we desire. And, as if by magic, they seem to keep on making them appear. However, it is just another variant of the electrical store offering 'buy now, pay later'. The Spiegel article understands the point. It subtitles the article 'betting with trillions'. The principle is this; increase the borrowing to solve the problem of previous borrowing. It is perhaps the greatest wager ever made. It is a wager that might collapse the global economy. We, the electorate, are collectively urging them to raise the stakes.
The word 'borrowing' does indeed apply to France, since whoever holds euros ultimately has the choice of 'lending' them to the germans or norwegians or whoever else.
ReplyDeleteBut i am starting to feel that the word 'borrowing' is the wrong word to apply to a sovereign issuer of it's own currency ( such as the UK) because it's hard to see why anyone really needs so desperately to 'borrow' anything they can produce themselves in potentially infinite amounts.
The interest rate charged on UK bonds ( ok 'gilts') is really just the bribe that has to be paid to stop the holder doing something else with his GBP. It's how much has to be paid in interest to suck those £££ out of the economy. It's a measure of how much else there is to do with them. And at the moment, there really isn't much. It's not as if the economy is awash with great business opportunities.
Taxation removes ££ from the economy, govt spending inserts them. If there's one thing we need at the moment it's more ££ circulating round the old place. So the govt should cut taxes ( on those who will spend) & *increase* govt spending , both in order to get the blood supply circulating, & damn the 'deficit', which is ( in our case, not the french) nothing more profound than a scorecard. How will the 'deficit' ever be paid back ? This is like asking "OMG ! The Rovers are up 12 nil ! Where are they going to get any more goals from ? Surely they will run out of goals & then where will we be ? "
Your prescription, Dr Cynicus, seems to me to be basically "hey! great idea ! let's follow greece & spain down the great austerity toilet! that will be ... bracing !"
It might be, but it won't acheive anything except untold grinding endless misery for thousands / millions. ( Check spain, check greece).
A very good, thought-provoking comment, even though I don't agree with its final conclusion.
DeleteWith Mervyn King buying up a huge amount of the Gilts in existence the interest rate that the market would normally set is totally distorted.
DeleteA lot of large institutions have no alternative but to invest GBP in Gilts, where else can they deposit the money with some sort of guarantee? The banks can dump it into the BoE with 100% safety. A pension scheme does not have this option. This knowledge is IMO being abused by the BoE, forcing the interest rates down to a level where money is, if valued by the cost of borrowing it, free, at least for the bankers.
I do not think this is a very good situation. And I also do not know how Mervyn King can raise the interest rates, as it would collapse the Gilts.
One issue you raise is that government spending inserts money (be it tax or deficits) into the economy. The big questions are whether the current level of the government spending making up roughly 50% of GDP is healthy, and whether the money is being spent more wisely than the original tax payer would spend it himself.
I understand the MMT arguments, but I think that this can only be applied in a closed self-sufficient economy. The UK is not self-sufficient and has been making a current account deficit for some 25 years. At some point the foreign acceptance of the GBP tokens will fall, causing the currency to lose value. At the moment the UK seems to be still supported by its historic laurels.
I wonder just how much longer this can go on?
Another part of the issue is that all the wealth seems to be migrating to the wealthy. The skewed distribution means that the spending power of the poorer and middle classes is depressed, further adding to the economic distress.
QE and ZIRP were introduced as temporary measures. They are now firmly implanted into the fiscal structure of the UK and I believe the UK is living on borrowed time.
(Sorry about that, couldn't resist it, wonder how time debt can be repaid?)
"Taxation removes ££ from the economy, govt spending inserts them"
ReplyDeleteNot true. Taxation takes money from the private sector and puts it in to the treasury. Only payment of debt reduces the money supply. Too much debt chasing too few goods creates an increase in prices. That lowers the standard of living. The only way people can achieve a rise in the standard of living is by lower consumption by both the pubic sector and private sector, and an increase in saving and investment in the private sector. That will mean a reallocation of resources and a lower wages. The longer the government and BOE increases the public debt, the stronger the pain will be when it all collapses.