Europe Downgraded

And the European debt crisis rolls on

Standard&Poor’s, one of the leading US-based ratings agencies, on Friday (20 December) downgraded EU’s rating by one notch to AA+, citing concerns over how the bloc’s budget was funded. “In our opinion, the overall creditworthiness of the now 28 European Union member states has declined,” Standard&Poor’s said in a note to investors. Last month, it downgraded the Netherlands, one of the few remaining triple-A rated EU countries. In the eurozone, only Germany, Luxembourg and Finland have kept their top rating.

Not surprising. The Netherlands experienced a very tough budget fight in 2012, with a resigning prime minister, upsetting elections and, during 2013, a close encounter with harsh austerity policies. This was not exactly what the Dutch had expected that they would be subjected to. Or, as I explained the situation in March 2013:

The Dutch government, which has been clearly in favor of tough austerity measures on southern European economies where the deficit exceeds the three-percent limit, now suddenly recognizes that austerity is bad for GDP growth. To play on another American proverb, life is not as fun when the austerity chickens are coming home to roost.

Evidently, the Dutch austerity measures did not prevent a credit plunge. Back now to the EU Observer story about the Standard & Poor downgrading:

The agency noted that “EU budgetary negotiations have become more contentious, signalling what we consider to be rising risks to the support of the EU from some member states.” EU talks for the 2014-2020 budget took over a year as richer countries – notably the UK and Germany – insisted on a cut, while southern and eastern ones wanted more money.

And herein lies the gist of why S&P is worried. The EU budget fight is about countries with better government finances wanting to pay less to countries with troubled or outright catastrophic government finances. If there is a cut in EU funds to Spain, Portugal or Greece, those recipient countries will have to take even tougher measures to try to comply with the budget balance targets set by the EU and the ECB. Given that they are already chronically incapable of doing so, it is not hard to see why S&P is very concerned with cuts in the EU budget.

This message, though, seems lost on some Eurocrats:

The news struck just as EU leaders were gathering for their last day of a summit in Brussels. European Commission chief Jose Manuel Barroso dismissed the rating downgrade. “We have no deficit, no debt and also very strong budget revenues from our own resources. We disagree with this particular ratings agency,” the top official said in a press conference at the end of the EU summit. “We think the EU is a very credible institution when it comes to its financial obligations,” Barroso added. … EU Council chief Herman Van Rompuy downplayed the S&P decision. “The downgrade will not spoil our Christmas,” he said.

Perhaps we should not expect anything else from them. After all, the Eurocracy in Brussels has proven, over and over again, that it lacks insight, interest and intelligence to successfully deal with Europe’s perennial economic crisis. This is in itself a troubling fact, as the signs of a continuing crisis are everywhere for everyone to see. A good example, also from the EU Observer:

The number of people unemployed in France rose 0.5% to over 10.5% in November, figures released Thursday show. The statistics are a political blow for President Francois Hollande who had pledged to bring the rate down by the end of 2013. The figures for December will be released end January.

The Eurocracy’s refusal to see the big, macroeconomic picture is also revealed in their delusional attitude toward the EU’s crisis policy:

The EU says Spain’s banks are back on a “sound footing,” but one in four Spanish people are still unemployed. Klaus Regling, the director of the Luxembourg-based European Stability Mechanism (ESM), made the statement on Tuesday (31 December) to mark the expiry of Spain’s EU credit line. He described the rescue effort as “an impressive success story” and predicted the Spanish economy will “achieve stability and sustainable growth” in the near future.

The only problem is that the crisis in the Spanish banks was not the cause of the economic crisis. The welfare state was the cause. Europe’s banks actually suffered badly from the crisis by having exposed themselves heavily to euro-denoted Treasury bonds: when Greece, Italy, Portugal, Spain, Ireland and even countries like Belgium and Netherlands started having serious budget problems, Treasury bonds lost their status as minimum-risk anchors in bank asset portfolios.

With trillions of euros worth of exposure to government debt, Europe’s banks rightly began panicking when in 2012 Greece forced them to write off some of the country’s debt. The debt write-off was directly linked to a runaway welfare state, whose spending promises vastly exceeded what Greek taxpayers could ever afford. The same problem occurred in Spain where the government’s ability to pay its debt costs have been in serious question for almost two years now.

To highlight the Spanish situation, consider these numbers from Eurostat:

  • In 2007 the consolidated Spanish government debt was 382.3 billion euros, of which financial institutions owned 47 percent, or 179.7 billion euros;
  • In 2012 the consolidated Spanish government debt was 883.9 billion euros, of which financial institutions owned 57.5 percent, of 507.9 billion euros.

In five short years, Spanish banks bought 382.2 billion euros worth of government bonds. During that same time, the Spanish government plummeted from the comfortable lounges of good credit to the doorstep of the financial junkyard.

It was also during this period of credit downgrading that the Spanish government began subjecting the country to exceptionally hard austerity measures, the terrifying effects of which I have explained repeatedly. However, as today’s third EU Observer story reports, those effects are of no consequence to the Eurocracy, whose praise for austerity will soon know no limits:

He also praised the EU’s austerity policy more broadly, saying: “The people’s readiness to accept temporary hardship for the sake of a sustainable recovery are exemplary … The Spanish success shows that our strategy of providing temporary loans against strong conditionality is working.” Spain will officially exit its bailout later this month, after Ireland quit its programme in December. Unlike Cyprus, Greece, Ireland and Portugal, the Spanish rescue was limited to its banking sector instead of a full-blown state bailout. It saw the ESM put up a €100 billion credit line in July 2012. In the end, the ESM paid out €41.3 billion to a new Spanish body, the Fondo de Restructuracion Ordenado Bancaria (FROM), which channelled the loans, most of which mature in 2024 or 2025, to failing lenders.

So all that has happened is that European taxpayers have been put on the hook for failed Spanish bank loans – loan defaults that Spain’s banks could have dealt with had they not chosen to lend a total of half-a-trillion dollars to their failing government.

Nobody seems to ask how this debt restructuring will help the Spanish government end its austerity policies. Such an end is a must if the Spanish economy is ever to recover. That does not mean a return to “business as usual” under the welfare state – on the contrary, the welfare state must go – but what it does mean is some breathing room for the private sector to regain its regular, albeit slow, pace of business.

Instead of connecting the dots here, the Eurocracy continues to look at the European economic crisis through split-vision glasses, and Spain is no exception. The EU Observer again:

For its part, the European Commission last month warned that the Spanish economy is still in bad shape despite the good news. It noted that “lending to the economy, and in particular to the corporate sector, is still declining substantially, even if some bottoming out of that contraction process might be in sight.” Meanwhile, the latest commission statistics say 26.7 percent of the Spanish labour force and 57.4 percent of its under-25s are out of work. The labour force figure is second only to Greece (27.3%) and much higher than the EU’s third worst jobs performer, Croatia (17.6%). … A poll in the El Mundo newspaper published also on Wednesday showed that 71 percent of Spanish people do not believe they will see any real benefit from Spain’s recovery until 2015 at the earliest.

All this ties back to the Standard & Poor downgrading of the EU. There is, plain and simple, a lot of concern that nothing is going to get better in the EU. There are good reasons to believe this: the persistent message from Brussels over the past two years has been that the next austerity package will be the last, that it will turn things around and put depression-stricken economies back on track again. As we all know, that has not happened, which raises the question if the EU is going to have to actually increase its bailout efforts toward fiscally troubled member states.

This blog’s answer is “yes, very probably”. Europe’s only way back to prosperity and growth goes through the structural elimination of the welfare state.

2 comments

  1. anti-sharia

    Reg. Spain, yes little is improved when leverage (debt) is moved from the private balance sheets to the public one.

    However, on the cause and effect; you get it wrong again and again…. There has been no real Gov sector pain in Spain.

    No hospital is closed. No school is privatized. No bureaucrat has been removed. No red tape is cut. Waste from start to end continues. I visit Spain regularly, sell products to state healthcare. Its business as usual.

    The private sector suffers under lack of savings (inflation outruns saving premiums, yields). The Gov keeps the private sector locked out of health, education etc monopolies. The unemployment is bobble-popping related, and structual in a post fascist counrty (big Gov).

    Anti-sharia

    • S R Larson

      No austerity in Spain…? Try these three to begin with:
      http://libertybullhorn.com/2013/03/16/tax-hikes-drive-inflation-in-spain/
      http://libertybullhorn.com/2013/02/20/danish-banker-sees-end-of-euro/
      http://libertybullhorn.com/2012/11/01/bailouts-add-insult-to-europes-austerity-injury/
      Next, instead of telling anecdotes, try read some statistics. There was a major decline in Spanish government spending in 2011. The nominal uptick in 2012 was due entirely to the massive inflow of people on welfare and unemployment benefits. The central government continued to push spending cuts onto the provinces. Which brings us to the very point about government spending that theological Austrians like yourself always fail to recognize: when you raise taxes and cut government spending in general, you cause a rise in unemployment; since government promises to pay everyone unemployed a certain amount each month, the total cost of unemployment benefits rise. Together with all the other entitlements that the unemployed qualify for, this can cause a rise in spending that outpaces the original spending cuts.
      I realize that to understand this you need to think in several steps as well as possess a certain capacity for dynamic analysis. However, the mechanisms explained here – and the data that backs up the reasoning – should not be too complicated for you to grasp. Others get it…