Cause and Effect in European Politics and Law

Creditors and debtors of all countries - unite!

Adelina Marini, August 12, 2011

Now it is absolutely clear - a new global crisis is inevitable. It is also clear that not everyone understands this, so we can hardly expect concerted efforts or at least an attempt to soften the crash. In the past few weeks market tension has increased to an extent indicating that hysteria is under way. To the deepening crisis int he euro area the debt conflict in the US was added and while politicians and decision-makers are still struggling to find out what is going on, the next tile of the domino began to falter - France. The only one who seems to be understanding or at least uttering out loud the essence of the problem and how it can be solved is the governor of the British central bank - Bank of England - Sir Mervin King, who is also a head of the European Systemic Risk Board (ESRB).

"It is almost exactly four years since the start of the financial crisis. The origins of the crisis lie in the large stocks of indebtedness that resulted from the widening imbalances in the world economy, about which nothing was done for so long. One way or another, the losses that were built up in recent years will have to be shared between creditors and debtors; in the world economy between creditors in the East and debtors in the West, and within the Euro-area between creditors in the North and debtors in the South. The key question is whether that burden sharing will take place in the context of a downturn in the world economy, or whether it will take place in the context of a rebalancing of overall demand".

The problem with global imbalances was articulated yet last year by the G20 leaders. And in February the G20 ministers of finance and central bank governors stated that it was necessary specific indicators to be developed that would be able to detect significant imbalances. The analysts from the Carnegie Endowment for International Peace, Uri Dadush and Bennett Stancil, also think that the G20 is a solution. They recommend, although only in the context of Italy's rescue, the problem to be solved at the G20 level. Italy, they say, is too big to be saved with the new mechanisms being developed for a year now in the eurozone, which is why they recommend a globally coordinated rescue plan under the leadership of the IMF and including bilateral assistance from the US, Japan, China, Britain and other countries - assistance that could reach 5% of the rest of the G20’s GDP.

This proposal would have sounded wonderfully maybe before Mervin King downsized the forecast for Britain's growth and before the credit rating agencies to have downgraded the credit rating of the United States. It would have also been very nice if this proposal was taken into account and possibly moved forward before France was targeted.

And France is an interesting case. The shares of French financial institutions suffered on the Paris stock exchange for fears that France's credit rating could be downgraded if the price of the clean-up of the European debt crisis proved to be a heavy burden for the state and its banks, the New York Times reports. As euinside wrote many times, French banks are most loaded up with Italian and Greek debt compared with the other countries in the euro area.

And if you think that simply credit rating agencies' appetite just got enhanced with the US's downgrade, you are wrong - this time they are not the culprit. The newspaper writes that the French government, together with the three biggest credit rating agencies - Standard & Poor’s, Moody’s and Fitch came up on Wednesday (August 10) with a statement, saying that France's rating was not at risk. Market's anxiety, however, spread quickly and led to a serious drop of the shares of the second largest French bank Société Générale, considered by Paris too big to fail.

French President Nicolas Sarkozy was forced to interrupt his summer break and to call an urgent meeting of the government, but these actions did not influence the market. And Société Générale even asked the French regulator to investigate the rumours that led to the significant drop of the banks' shares.

The French situation is very unpleasant because the real indicators that were until recently valid to assess stability still are in good shape in terms of eurozone's standards - the economy is expected to grow by 2% this year; the budget deficit is 5.7% and unemployment - 9%; France's debt level is expected to reach 85.3%. These data in no way are sufficient to lead to a credit rating downgrade, which obviously the agencies admit.

Markets' fears, though, the way they are interpreted by the New York Times, stem from the fact that if Société Générale gets into trouble, given its huge exposure to Italian and Greek debt, its rescue would not be possible. Besides, it is still not clear what the size of the assistance for the "sick" countries in the euro area will be and how it will impact the overall financial situation of France.

One of the conclusions that forces its way from the situation is that the market started to emancipate itself from the opinion of the credit rating agencies and is more and more inclined to act alone, based on who knows what criteria. Another conclusion is that size no longer matters - no matter how big you are you have to be bigger than your indebtedness and economic perspectives. And this is not the case of the US, for example.

"Markets will rise and fall, but this is the United States of America. No matter what some agency may say, we’ve always been and always will be a AAA country. For all of the challenges we face, we continue to have the best universities, some of the most productive workers, the most innovative companies, the most adventurous entrepreneurs on Earth. What sets us apart is that we’ve always not just had the capacity, but also the will to act -- the determination to shape our future; the willingness in our democracy to work out our differences in a sensible way and to move forward, not just for this generation but for the next generation".

This is what President Barack Obama said on Monday, responding to Standard & Poor's decision from Friday (August 5th) to downgrade the country. Alas, no matter that everything he said is absolutely true it is hardly enough to reduce the budget deficit of the country or the huge debt.

The American President's statement directs the thought to the third conclusion - the current situation is a result of the fact that yet with the first signs of economic growth after the global recession, the efforts for more active and tight measures to overcome major problems sharply fell. Something for which there were enough warnings in the past few years. For now an extraordinary summit of the G20 is not planned which confirms the fact that there is a misunderstanding of the processes that are unfolding right now, and most of all - of their speed. So, there will be a crisis for sure - the question is what kind of a crisis.