European governments had given a sigh of relief afterSpainandItalysuccessfully auctioned off large bond packages at much lower interest rates onJanuary 12, 2012. One day later, S&P caused shockwaves when 9 Eurozone countries, among them France and Austria, were downgraded by one notch.
This move had not come unannounced, since already in December the rating agencies had issued warnings. It is the result of a lack of confidence in the problem solving capacity of the Eurozone, despite the summit attempts of December 9. A number of additional issues seem to have played a role in this decision:
a) A solution toGreece’s debt crisis seems to become ever more elusive. The “Troika” (IMF, EC, ECB) were sceptical after their last visit toGreecewhether its consolidation measures were sufficient.
b) Suddenly also the rating agencies come to the realization that the whole zone engaging in drastic public budget consolidation will drive the EU into a deep recession, lower tax revenue and threaten debt servicing.
c) A few days ago it transpired that the EU Commission had produced yet another draft agreement for the EU countries (minusUK) which was less stringent than previous attempts. This refers specifically to a reduced European Court of Justice role in consolidation and to the escape clauses in case of natural catastrophies and deep recessions (clauses which exist already in the present Stability and Growth Pact).
d) The agencies argue that the Eurozone has neither the political will nor the institutional structures to tackle the crisis decisively; too many competing voices are heard, to little common direction visible.
e) For a number of countries special factors are mentioned. ForAustria, its bank’ exposure toEastern Europeand toHungaryspecifically are seen as increasing sovereign risk. I see problems withHungary, but do not think that they will affectAustria’s situation.
I have shown in a number of previous postings that I am extremely critical about the role of rating agencies. I still think that sovereign financing should be taken away from private investors and put in the hands of public institutions (ECB). This would also reduce the role of rating agencies, since I have argued for public bodies (OECD, IMF, EC) to conduct their assessments of the economic policy stance and the debt servicing capacity of sovereigns. Still, I agree with some of the above assessments, albeit with important exceptions.
It can be assumed that the timing of the downgrading – which certainly is not helpful – has been chosen as a warning to EU bodies before upcoming meetings of finance ministers and heads of state to finally come to grips with the crisis. The timing becomes especially detrimental if as a result of the sovereign downgradings also banks active or at home in these countries will be downgraded, as well. It is against all logic and empirical evidence, if rating agencies expect immediately visible success stories from measures taken. To solve a deep crisis always takes time, economic policy measures have decision and implementation lags of significant size. But still, all EU citizens can expect of their policymakers to finally come up with a comprehensive and effective package design – which then will be implemented over as short a time as is feasible.
- Greece does need a reduction in its debt burden: if – contrary to the 50% commitments made by CEO Ackermann on behalf of the International Institute of Finance earlier – banks and hedge funds now renege on this promise, Greece will need to legislate this debt reduction; simultaneously the Troika must disburse the at least 130 bn which they have promised and agree with Greece on a joint consolidation and growth package which contains effective measures against capital and tax flight, as well as credible attempts to broaden Greece’s economic base in order to make the country competitive. Without the prospect of innovation-driven growth Greecewill never be able to repay its (reduced) debts. If Greececannot provide its citizens with a prospective positive future for their children, the exodus fromGreecewill continue and hurt the growth prospects even more.
- The AAA-rating of the rescue funds (EFSF, SFM) needs to be safeguarded, in spite of the recent downgrades. This is, however, important only, if these funds keep nurturing the hopes of attracting outside investors into contributing to them, thus leveraging the EU means by a factor of 3-4. This hope should be abandoned quickly: the second richest economic bloc of the world must be able to solve its own crisis with its own means. Rather, the EU should decisively put confidence-building measures in place, based on the undisputable strengths of the EU economy.
- It is absolutely necessary to overcome the fragmentation of the EU banking system by means of a European Banking Fund. The interconnection of European banks has once more become very clear. The result can only be to create a centralized financial supervision system and a joint fund for refinancing banks, plus a joint effort to downsize the banks in such a way that they can once more finance the real economy.
- As a result of this, banks outdo each other in distrust and deposit each night more than 500 billion € with the ECB instead of lending to each other and the real economy.
- The success of the recent Spain and Italyauctions is attributed mainly to the previous flooding of the markets with cheap three-year money from the ECB. But the overall ECB strategy to attempt to help stem the credit crunch not by extending money to the economy and households directly, but via the banks, has been unsuccessful: banks receive cheap money in order to purchase high-interest government bonds in order to drive their interest rates down and in order to provide the banks with first-rate collateral. This has resulted in a massive carry-trade and subsidization of the banking sector, without solving the credit crunch: banks rather deposit their cash with the ECB – a definite failure. The ECB must be put in a (statutory) position to finance governments directly, but also – in case of a failure of the banking system – the private sector, of course, against economically appropriate safeguards and conditions.
- The fetishization of sovereign budget consolidation as the major instrument of European and Eurozone economic policy making and anti-crisis policy must be overcome. This focus neglects – against all economic thinking – the debt situation of the private sector and assumes that a solution to the sovereign debt crisis would solve the whole problem. It is however the total (private and public) debt situation – visible in the balance-of-payments imbalances – which needs to be solved. Frequently, public indebtedness is a (necessary) reaction to private-sector surpluses. It takes a joint European investment and growth strategy, jointly with consolidation packages to improveEurope’s long-term competitiveness.
As long as we have the present system (i.e. pay attention to the rating agencies), the downgrading of the 9 Eurozone countries must be taken as a warning signal by the European policymakers. It is high time (“high noon”) that in the forthcoming finance ministers’ and heads of state meetings outdated ideologies and nationalistic thinking are abandoned and that a joint crisis solution strategy is finally developed. Calls from the sidelines, be they from non-Eurozone countries or from bank CEO, how to deal with the crisis and how to excludeGreecefrom the Eurozone, are completely superfluous. We are in the middle of a European crisis. Only a joint European effort by everybody will be able to solve it.