Friday’s actions from Standard and Poor’s were hardly the biggest surprise in the financial universe: the ratings agency warned in December that eurozone nations were in danger of being downgraded.
Germany is, in effect, the last man standing. Others have succumbed to a mixture of three deadly sins: optimism, inaction and omission.
Too many countries are too optimistic about recovery when all the evidence is now pointing towards a eurozone-wide recession. Contracting output will only exacerbate the revenue shortfalls which have already placed countries on unsustainable fiscal paths.
Inaction is, perhaps, inevitable for politicians faced with a difficult trade-off between political expediency and fiscal reality. France, for example, needs to deliver austerity to bring its primary deficit back under control – and also to persuade its eurozone colleagues that Paris is serious about fiscal discipline – yet Nicolas Sarkozy hopes also to win the presidential election this spring.
As for omission, the idea of a fiscal pact is all very well but it doesn’t deal with the shortfall of income which led to today’s crisis. Until the 2008 economic collapse, many countries in Europe had good fiscal records. They would surely have met many of the conditions associated with the proposed fiscal pact.
Fiscal conservatives in the eurozone have, up until now, argued that austerity will bring its own rewards: tighter fiscal policy will lead to lower deficits and lower deficits, in turn, will lead to lower interest rates and, hence, faster economic growth. Throw into the mix the gains to competitiveness of lower labour costs associated with austerity and it suddenly looks like austerity really can pay off.
Within the eurozone, however, the argument hasn’t worked. Greece has its own problems which, if Friday’s breakdown of restructuring talks are anything to go by, are set to get worse. Even those who have been fiscally-conservative, however, have not been rewarded. Irish 10-year government bond yields are still up at 7.8 per cent, a ludicrously high level given the weakness of economic activity.
In the months ahead, the eurozone’s difficulties are likely to mount. As the contagion spreads, and as investors lose confidence in the ability of countries to deliver lasting fiscal austerity, countries which, to date, have benefited from immunity will also begin to suffer.
Next in the firing line may be Germany, not so much because its bond yields are about to spike higher but, instead, because its exporters are hugely exposed to trade with the rest of the eurozone and its financial institutions are groaning under the weight of the region’s financial disorder.
The narrative may then change. Until recently, the orthodox German take on the crisis was simply to argue that other countries should be more like Germany delivering fiscal conservatism, hard work and a current account surplus. But Germany may end up more like the others, unable to avoid a descent into recession.
That, in turn, could provide the eurozone with an unexpected lifeline. Faced with recession in both the periphery and the core, and with interest rates already close to zero, the European Central Bank may have to bite the bullet and begin a programme of quantitative easing, using newly-created money to buy government bonds. It won’t solve the crisis – that requires a leap of political imagination – but it would at least make the crisis easier to solve.