So that’s it, then. The veil has slipped. The only surprising aspect of the French sovereign debt downgrade is that it took so long. The eurozone’s second-largest economy has lost its AAA rating. Eight other single currency members were also downgraded. Given that Paris is bank-rolling no less than a fifth of the purported “big bazooka” bail-out fund – the so-called European Financial Stability Facility – monetary union is now on very thin ice.
That’s because, in the wake of S&P’s exocet, the EFSF also could be downgraded. So the fund, too would pay more to borrow, just as credit becomes more expensive for the newly-downgraded countries it might need to bail-out. The likelihood the EFSF can do its job will fall, then, as the chances it will be needed rise. The question of whether the fund can “lever-up” from its existing €440bn (public money pledged, not delivered) to the €1,000bn-plus that may be needed if Europe’s banks endure “another Lehman”, is now under serious scrutiny.
Just five eurozone countries – Italy, Spain, Ireland, Portugal and Greece – have around €200bn of debt maturing between now and April. Can they re-finance, pulling back from the brink of insolvency? Their chances just got worse.
Before we Brits gloat, let us remember that the main reason the UK remains triple-A is that we’re “printing money” and using it to roll-over our debts, the Bank of England creating new credits ex nihilo, then buying gilts from existing investors.
What Britain also has going for it, of course, is that the coalition has forged a “credible” deficit-reduction plan. What “credible” means in today’s whacky world of Western government finance is that the UK’s plan is more realistic than total fantasy. The question is how much more.
Messrs Cameron and Osborne deserve praise for putting “austerity” centre-stage. The fact that they’ve done so, and the Liberal Democrats have backed them, has bought Britain some temporary respite from reality. Well, that and QE. But ministers still talk of “paying-off the deficit” within five years as if that will solve our problems. It won’t. Because, at the risk of insulting some readers’ intelligence, you don’t “pay-off” a deficit.
A “deficit” means that, in a particular year, the government spends more than the economy generates in revenue. The resulting annual shortfall must then be borrowed, the related debt slice added to the overall national debt, so increasing the total that must be serviced by interest payments until maturity. On maturity, of course, the debt relating to yesteryear’s deficit is re-paid – often, by issuing more debt. And so we go on. Until the ponzi scheme folds.
Let’s say the coalition does achieve “zero deficit” by 2015/16. All that will mean is that the total debt stock has peaked – unless, that is, we slip back into deficit the following year. So, our “national debt”, already huge, is set to grow mightily between now and mid-decade – which is what happen when you run annual deficits that are double-digit percentages of GDP. So even amid “austerity”, the total amount of outstanding IOUs the UK must service gets ever bigger.
Some say that at £920bn, around 64pc of GDP, UK national debt is “rather low”. Using the same “Maastricht” definition applied to the likes of Greece and Ireland, British government debt is actually 75pc of GDP. Consider, also that Britain has public sector pension obligations of another £1,150bn – which need to be met only over time, of course, but the bulk of which will come directly from future tax receipts, rather than investment funds, hindering our ability to pay interest on other future debts. Then there are other multi-billion pound hidden government liabilities, not least those related to the disgraceful private finance initiative.
Even excluding these extra fiscal burdens, and sticking to the more flattering non-Maastricht methodology, UK debts soar between now and 2015. By the time we reach “zero deficit”, a moment when the coalition, if it still exists, will go into uber-spin mode, probably issuing a commemorative postage stamp, official estimates put government debt at more than £1,500bn – no less than five-times more than at the turn of the century and three-times more than in 2008. And that assumes the UK economy grows as planned and “austerity” is implement in-full.
That’s why I believe that, while the UK government is acting more responsibly than many others, something far more drastic is needed. With the state now accounting for around half of total GDP, the answer – at least the long-term answer – can’t be more taxation. The state must do less, much less, and do it better. There really is no alternative.
Some point to Canada’s fiscal consolidation as an example Britain may follow. A new pamphlet from the Centre for Policy Studies makes a compelling case. Between 1994 and 1996, Canada cut government spending by almost 10pc in nominal terms – an adjustment that makes the UK’s plan look like a picnic. Between 1997 and 2007, Canada grew by an annual average of 3.3pc, better than any other large Western economy, with business investment up 5.4pc a year. The national debt, in turn, dropped from 68pc of national income to 29pc – a big reason why Canada has weathered the sub-prime storm.
Some say this isn’t relevant to Britain. Canada’s fiscal recovery relied partly on commodity exports and happened when the global economy was in rude health. But that doesn’t mean “austerity” won’t now work in Britain, a net oil-importer, at a time of global economic turmoil. It means that we need to go even further, if we are to keep our creditors at bay. For we are only managing to do so, for now, as I said, by “printing money”. And QE simply can’t last.
Which brings us back to Europe. The eurozone is in trouble in part because statist governments have overspent for decades. Even before the credit crunch, government debts were large – not a good point from which to start.
The reason the eurozone is in extreme fiscal peril now, though, is that governments that were anyway financially weak are being dragged down by a slew of massively-bloated, insolvent “zombie” banks – commercially dead, but still operating in a kind of non-functioning twilight zone as a result of government finance. The trouble is that those governments simply can’t afford to go on.
The hoped-for solution – robust economic growth, generating the confidence and tax receipts needed to float the eurozone off the fiscal rocks – will remain elusive as long as the “zombies” refuse to lend, stock-piling cash in a desperate struggle to achieve new life. But, for many of them, new life will never happen. Their hidden liabilities are simply too large. Such banks must be taken-down, their retail depositors protected of course, and their debts written-off. Shareholder and creditors will suffer. But that’s what should happen when you make a bad investment.
The reality is that much of Britain’s banking sector is in a similar state. And while the UK government talks the talk when it comes to radical fiscal policy, it is even more squeamish than its friends in Europe when it comes to slaying the “zombie banks”.
The cost, so far, of Britain’s banks bail-outs, or “financial interventions” in the Whitehall vernacular? A cool £2,270bn, more than twice our on-the-books national debt. How much of that will the government recoup when, if at all, these bankrupt institutions are sold-off? Consider that, before getting smug about what’s happening in the eurozone.