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|US downgrading? The real worry is EU default|
The Times - August 8th 2011
It was a week on the wild side, and this week promises to be a tad tumultuous too, thanks to the first ever downgrading of
It is better in
Gnomic words, you may think, though no more gnomic, really, than the signals from markets during the past few days. In this supposedly disastrous week for the
It was, admittedly, a week when “safe havens” were popular with investors, which is why both gold and the Swiss Franc were among the winners. But it is government debt from which investors are said to be running for safety, and
A possible explanation is
As long as job creation remains weak and incomes are flat or falling, growth can come only from business investment or from exports, and neither is looking hale and hearty. The one good piece of news has been the price of oil, down about 5% in the past week and back roughly to where it was at the start of the year. This reflects slowing demand, but could also, if the fall is sustained, perk up western economies a little.
The downgrading by S&P is not surprising either. Apart from the brinkmanship over the debt ceiling,
That American picture is not pretty or politically responsible, and it leaves businesses in a fog about what will happen to taxes and public spending after 2012. Even so, the risk of any financial calamity there is small, for there is no prospect of government default and banks do not look exposed to any new dangers. It is rather rich of China (S&P rating AA-) to lecture America about the need to live within its means when it is that country’s unwillingness to allow its currency to join the modern world by being freely traded that has obliged it to buy $3 trillion worth of foreign securities, mainly US Treasuries, in order to suppress its currency’s rise.
Schadenfreude no doubt has a good Chinese equivalent, and
Why? Because in the western world it is only in the eurozone where there is a known, and plausible, risk both of government debt defaults and of big new losses by banks and other financial firms. Ironically, eurozone governments have increased this risk by doing the right thing—just not completely enough.
They did the right thing by acknowledging on July 21st that
This produced the entertaining spectacle in Rome of Silvio Berlusconi, Italy’s Bunga-Bunga prime minister, standing up in Parliament to say that his country was solid and faced no real crisis, and then announcing two days later a package of economic reforms intended to deal with that very crisis. If those reforms really happen, the euro will in one sense be working: it will have forced
Less entertaining, however, is the policy and political dilemma that explains why the eurozone debt crisis has not yet been resolved. Eurozone governments have a simple, but painful choice to make.
They must either decide that in a common currency, countries have to take collective responsibility for government debts issued in that currency, in which case the solution is the issuance of collectively guaranteed eurozone bonds to be swapped for Greek, Irish, Portuguese, Spanish and Italian bonds, as needed, rather as new lower-yielding “Brady bonds” were swapped for Latin American debts during the 1980s. Or, they must take the tough love route, decide that government debts remain national responsibilities, and that anyone defaulting will have to leave the eurozone.
There is no middle ground. The best bet is that the collective responsibility path will be chosen, that the euro will survive, and that the tussle will then be over what new rules and treaties are needed to stop German taxpayers’ worrying about their money being wasted by Greeks and Italians. The longer this choice is deferred, however, the greater the risk that before it is made some European bank, somewhere, will find itself unable to raise funds, and that a new chain of collapses occurs. A fresh financial crisis is not inevitable, but it is possible—unless the eurozone makes its mind up, soon.