The French Disconnection

Today, Christian Noyer, the chairman of the French Central Bank called for the credit rating agencies to focus on downgrading the UK before looking at France. His comments came in response to S&P placing France on “CreditWatch” – essentially monitoring it closely and considering an imminent downgrade.

The UK, Noyer argued, should be ahead of France in the queue for downgrades because it has:

  • a higher deficit
  • higher inflation
  • lower growth

Now, I have no love for rating agencies but he has missed the point a bit. If the factors he mentioned were the only factors then fine but he forgot to mention anything to do with the reasons S&P gave for putting France on CreditWatch, namely that the countries using the Euro are in a massive pickle and their politicians have proved unable to decide upon a way to depickle themselves.

I understand why he’s upset with the UK. David Cameron’s performance last week of refusing any attempt of negotiation in favour of showing his backbenchers that he is tough on Europe and tough on the causes of Europe was probably not our proudest moment.

Even so, Noyer should have a bit more compassion. He might have to deal with Cameron every now and then but in the UK we have to deal with the guy every day, and it’s hard enough without foreign central banks petitioning the rating agencies for a UK downgrade.

Yes, our finances are in bad shape but we are a long way from risking default. How he could compare the UK’s credit worthiness with France’s without mentioning the Euro-shaped elephant in the room shows he is either clouding his judgment because he is in a big huff with David Cameron or he is simply disconnected with reality.

We might have equally incompetent politicians running our country but while we are not using the same currency as Greece or Italy and while we have the ability to determine our own monetary policy, it should be no surprise to Noyer or anyone else that when it comes to worries about debt repayments, all eyes are on Europe.

RedEaredRabbit

We need to talk about Europe

In the run-up to the last election, much was made of the UK’s poor financial situation. We were told repeatedly  by the Conservatives that after years of irresponsible borrowing, our finances were the worst in the developed world, that we were on the point of bankruptcy and that if we didn’t immediately reduce the deficit then no one would lend to us.

18 months on, we’ve achieved nigh on no economic growth and despite the government’s cuts have continued to increase our debt at more or less the same rate.

This leads me to wonder – if our finances were so bad then and have got worse since, why is it that we can continue to borrow money so cheaply when no one will lend two Drachmas to all of those struggling economies in the Eurozone? Something doesn’t add up.

First, let’s look at whether our finances were really the worst in the developed world. This is a graph of government debt as a percentage of GDP for each country in the G7. The data is taken from the IMF website.

Government Debt as a Percentage of GDP (source IMF)

Government Debt as a Percentage of GDP (source IMF)

You see that orange line at the bottom? That’s the UK. Were we really borrowing so irresponsibly for all of those years under Labour? That’s a matter of opinion but if we’re on the naughty step then it’s pretty crowded.

On a side-note, Japan’s is quite impressive, isn’t it? They seem to be in a Ponzi scheme with their own public but Japan could be a million blog posts on its own so I’m not going down that avenue.

Turning our attention to the Eurozone, you will have noticed in recent weeks that Angela Merkel has blamed the current crisis on the irresponsible fiscal policy of certain member nations – i.e. that they have screwed the Euro by living beyond their means.

Here’s some more data from the IMF website showing some Eurozone economies’ borrowing as a proportion of GDP from the adoption of the Euro up until 2007, the year before the financial crisis.

Government debt as a percentage of GDP (Source IMF)

Government debt as a percentage of GDP (Source IMF)

Ireland and Spain reduced their debt significantly in this period. Italy reduced theirs a bit and although it was pretty awful in 2007, it was even worse when they joined the Euro so I don’t understand the sudden surprise now.

Anyway, it’s fairly clear that while Italy and Greece maintained high levels of borrowing throughout this period, Ireland and Spain did not. Merkel’s claim that each of these nations brought it on themselves purely through their government borrowing is not backed up by the figures. Ireland arrived on the eve of the financial crisis with much lower borrowing rates than they’d had historically but their economy imploded spectacularly nonetheless. Saying that the problems are purely down to fiscal policy is quite bizarre.

Another factor, which Merkel hasn’t wanted to mention, is monetary policy. In the UK when our economy got into difficulty the Bank of England cut interest rates and they have been sitting at a tiny 0.5% for the last two and a half years. Conversely, in April, egged on by Germany, the European Central Bank started to increase interest rates in the Eurozone and perhaps it should not come as a surprise that this coincided with the start of the current crisis.

The fragile Eurozone economies didn’t want higher interest rates but they could do nothing about it. Germany wanted higher interest rates because they were worried about inflation and so the weaker economies had to pay for this through lower growth and higher unemployment.

When the fragile Eurozone economies want to borrow money, lenders look at them and see that they are powerless to control this basic facet of monetary policy and therefore have lower confidence in their ability to respond to changes in their economies. If I want to invest some money shall I do it with a country who can respond to economic problems or one who can’t? Not a difficult decision.

There is though, another branch of monetary policy that is perhaps even more concerning. There is a reason that no one in the market really worries about the UK or the US being able to repay its debt but do worry about the economies in the Eurozone.

If the UK ever gets into a real pickle and needs some more Pounds to repay a loan they always have the option of going to the printer and just printing it. The UK controls its own currency. Ireland doesn’t. Italy doesn’t. Spain doesn’t. If they run out of money they go bust.

In the first recession they have faced, the Eurozone members’ lack of control over their own monetary policy has been a key factor in the crippling of several economies. Angela Merkel now wants to take things further and take away their control over their fiscal policy. Forcing the weak economies into crazy austerity measures will simply lead to many more years of high unemployment and no economic growth.

If it’s that simple though, why would Merkel be advocating a clearly bad policy? The problem Merkel has is that if she did the sensible thing and told the ECB to cut interest rates and buy up lots of government bonds from the weak economies, the German people would get cross and she would not be re-elected. Sadly, these are the things that matter most to politicians.

So what will actually happen? This is my prediction:

  • Germany will implement some rules to restrict fiscal policy of the Euro member states which will keep German voters happy but screw up the weak economies for years to come
  • Having done this Germany will then, finally, allow the ECB to buy up some government bonds, allowing the fragile economies breathing space to avoid short term default
  • The underlying problems will remain

Do you remember when William Hague fought his 2001 election campaign with pretty much one policy? “Keep the Pound,” he bleated incessantly for several months before losing in a landslide against a government who, err, kept the Pound.

He was right to want to keep the Pound though. Ok, he was right for the wrong reasons – nationalism and xenophobia have little place in macroeconomics but in hindsight, I shudder at the thought of where we would be now if we’d adopted the Euro too.

There is a certain romance in the single currency. It feels like it brings us all closer together, working with our neighbours in one financial union and it’s a marvellous two-fingered salute to the sickening xenophobia peddled by Nigel Farage and The Daily Mail.

Sadly, romance and economics don’t mix either and whatever transpires, one thing is abundantly clear – in an era of many bad ideas, the worst one of all was the Euro itself.

RedEaredRabbit