Marcus Evans Group | Worldwide Headquarters | American Offices | Latin America | European Offices | African / Asian Offices

Eurozone credit crisis: the parties of ‘austerity’ are downgrading us all

It is the state which has had the capacity and resources to support or even absorb the failing private sector, not vice versa

The news that the credit ratings agency Standard & Poor’s has downgraded nine of the eurozone area governments’ debt is another pyrrhic victory for the “austerity” party and another defeat for economic logic.

S&P cites reduced bank lending, higher government yields, lower spending by governments and households, weaker growth and political infighting and paralysis for its decisions.

Clearly, lower government spending exacerbates the current crisis. But the crisis is driven by the one sector that S&P strangely overlooked. The eurozone economy is still €73bn (£60bn) below its pre-recession peak. But the investment strike by businesses accounts for all of this decline and much more. Gross fixed capital formation in the area has fallen by €240bn.

As usual, the credit ratings agencies actions lag the market verdict. The prized AAA credit rating is more of a political virility symbol than anything that determines market interest rates paid by government borrowers. As such, in a presidential election year its loss will be felt more keenly by President Nicolas Sarkozy than by the French or other finance ministries.

In fact, S&P may be so far behind market developments that they have missed a turn in the market completely. Aside from Greece, bond yields in other EU countries have been falling sharply in recent sessions.

The reason for the fall in yields is not because either the economic outlook or fiscal position is improving. Interest rates have fallen because of the decision of the European Central Bank (ECB) to provide unlimited loans to Europe’s beleaguered banks. Mostly, this increased liquidity has been hoarded by what are increasingly zombie banks. But some of the money has found its way into European government bonds as banks receive much higher yields from governments than the 1% they must pay to the ECB. They make money by borrowing from the ECB and lending to EU governments.

Of course, it would have been much more effective if the ECB had bought the government bonds itself outright as has happened in Britain and the US. But it is determined to maintain the disastrous divergence in Europe of national fiscal policies and a supranational monetary policy.

It is also unclear that the ECB can or will continue to provide enough liquidity to the banks to keep the downward pressure on government yields, especially as much of what it can provide is simply wasted, is idling in the balance sheets of the distressed banks.

This indirect approach repeats the pattern that the private sector is being bailed out by the state. It should be clear from this where the source of economic strength lies. All the exhortations and demands to increase the reliance on private sector misses a central theme of the entire crisis. It is the state which has had the capacity and resources to support or even absorb the failing private sector, not vice versa. Across Europe, governments have provided direct funds and subsidies to banks, taken equity stakes in them and even nationalised them. The central bank is also a public body and it is cackhandedly coming to the rescue.

But Europe’s politicians as well as the EU commission and IMF are determined to compensate the private sector for this unspeakable incursion in their domain. While the losses of the private sector are absorbed, the successful public sector is being stripped of assets in health, energy, transport and other sectors and handed over to the inherently unstable private sector.

In Britain, there will no doubt be crowing that it has maintained its AAA rating while so many countries in Europe are being downgraded. It will be claimed that this marks the better economic or fiscal outlook of the British economy. This is nonsense. The British economy is still benefiting from strong export growth to the EU and its weakness is actually a drag on European growth. Britain also has a higher deficit and no better growth prospects than France

The French deficit is estimated to have been 5.8% of GDP in 2011 compared with 9.4% for Britain. The reason British yields are at rock bottom is the same as for the US and Japan, who have both been downgraded yet have even lower bond yields. In all cases, risk averse domestic investors shun both domestic stock markets and the bonds of other countries which contain currency risks.

“Austerity” is the transfer by the government of household incomes to the business sector. It is not working in any part of Europe, in or out of the eurozone area. It prolongs the investment strike rather than ending it. The whole of Europe needs investment, not cuts. © 2012 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds