ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Finance in These Postmodern Times

Without a well-designed surplus recycling mechanism the eurozone will go from bad to worse.

Does the downgrading of the sovereign credit ratings of nine eurozone countries, including France, Austria, Italy and Spain, on Friday, 13 January by Standard and Poor’s (S&P) signal that the eurozone itself is fast approaching its end? Previously, when S&P had downgraded the sovereign debt ratings of the United States (US) and Japan, the bond markets did not take the cue – the downgrade had no appreciable effect on the yields of the government bonds of those countries. The various funds and financial institutions that buy government bonds, in effect, called S&P’s bluff. But this time around, has the US credit rating agency got it right? After all, it actually stated that “the financial problems facing the eurozone are as much a consequence of rising external imbalances and divergences in competitiveness between the eurozone’s core and the so-called ‘periphery’”. And, it went on to add, “a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers’ rising concerns about job security and disposable incomes, eroding national tax revenues”. Moreover, three days later, on Monday, 16 January, S&P downgraded the credit rating of the European Financial Stability Facility (EFSF), the eurozone’s rescue fund, by one notch from triple A to AA+, for, after all, France and Austria are among its main guarantors. The EFSF is expected to contribute to the second “bailout” of Greece, but that country’s negotiations with its creditors broke down on 13 January, as Greek government bondholders demanded a higher rate of return to compensate for the higher default risk.

Greece, Ireland and Portugal are now deemed to be not directly worthy of the bond markets and are now dependent on the EFSF; Spain and Italy may soon join those countries. But the downgrading of France and Austria is ominous, albeit they are still deemed creditworthy by the funds and financial institutions on the demand side of the bond markets. But what is now the worth of their guarantees for the financial health of the EFSF? As a eurozone country’s ratio of the public debt to gross domestic product (GDP) crosses 60% and its real GDP growth rate falls, the spread on its government’s bonds rises and eventually there is a run on those bonds. In the present context of extreme fiscal conservatism, the medicine of fiscal austerity only worsens the health of the patient, i e, pushes the economy’s growth rate into negative territory, and the country falls out of the bond markets, with the EFSF now having to bail it out. Indeed, the list of triple A guarantors of the EFSF is dwindling. Is a domino effect in motion, we might ask? Now only Germany, Luxembourg, Finland and the Netherlands are left on the list of triple A guarantors of the EFSF.

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