FIRST IT WAS THE AGENCIES, NOW ITS THE FORECASTERS’ FAULT, by François Leclerc

Guest post. Translated from the French by Tim Gupwell

“I can’t see any time soon when…the pressure will be off” replied David Cameron, the British Prime-Minister, in an interview with The Daily Telegraph. He continued, “this is a period for all countries, not just in Europe but I think you will see it in America too, where we have to deal with our deficits and we have to have sustainable debts”. In conclusion, his austerity policies are likely to continue beyond 2020, as the situation is “a lot tougher than the forecasters were expecting”. Georges Osborne, the Chancellor of the Exchequer, has already extended to 2017 the austerity plan of 2010, which was initially intended to last five years.

The prolongation of the schedule which is taking shape is now being referred to, in veiled terms, within the Eurozone, a good example being Jérôme Cahuzac, the French Budget Minister, when he announced that “ I’m afraid that reducing the debt may take a little longer” in reply to a journalist who was talking of one, two or three years.

In its annual report, the IMF has just outlined a road map for the Eurozone, advocating – when it actually makes any concrete proposals – measures which focus on pooling the debt, an issue which radically divides politicians. The continuing crisis, it now says, is raising questions about the viability of the monetary union because “its root causes remain unaddressed” and “the adverse links between sovereigns, banks, and the real economy are stronger than ever”.

Following the same logic, the IMF recommends urgently putting into place the banking union broadly decided upon at the last European Summit. It adds, however, an additional detail which sheds some new light on the project and contradicts the way it was presented: namely that the deposit guarantee intended to prevent capital flight and the bank resolution mechanism for the winding down of banks “would need ready recourse to additional funding in times of stress, from a common pool of government-provided resources or – for the euro area – an ECB credit line”, and cannot be entirely funded by the banking sector. In other words, the States are once again going to have to bail out the banks. Indeed, the current debate over whether the aid should be direct or indirect masks the fact that it is in fact the States who will end up financing the operation via the ESM…. Another important detail is that the IMF envisages the possibility that inflation could “fall significantly and even turn negative”, meaning what is commonly known as deflation, the worst of ailments.

In the chapter dedicated to growth-boosting measures, the IMF unsurprisingly reaffirms its belief in « structural reforms », predicting without ever revealing its calculations, an astounding rise over five years of 5% in the GDP as a result of a profound reform of labour markets, pension regimes and taxation…..In the unlikely event that this does not work, and preparing itself to be on the receiving end of some gnashing of teeth, the IMF adds in the entire range of ECB instruments: restarting sovereign bond purchases, massive loans to banks and further cuts in the base rate. For, as far as the Bundesbank and its president Jans Weidmann are concerned, nothing whatsoever has changed. It remains steadfast in its opposition to the ECB recommencing Spanish and Italian bond purchases on the secondary market, as well as to the issue of Eurobills, the latest attempt to kick start the project of issuing European bond, on a short-term basis.

As for the countries benefitting from a rescue package, whether the older model or the new-fangled version like Spain’s, it is now widely accepted, and the facts are there to prove it, that when one enters into their logic, there is no way out! The IMF has just recommended a financial extension for Ireland, the European Commission has just expressed its anxieties on the subject of “budgetary risks” for Portugal which are going to lead to the same conclusion, while the Greek Government is looking for 11.5 billion euros for 2012 and 2014, to get back on track and to be able to start a review of its second rescue package. Bravo, once again!

Deep down, the crisis is no nearer to an outcome. The links between public and private debt are growing stronger, as is their systemic nature – which needs no demonstration. The average maturity of the debt of the countries attacked by the markets is reducing, making them even more vulnerable to an increase in rates. The banking system is offloading whatever it can to the ECB but is now cut off from American Monetary Funds over the short term and has to agree to high rates itself in order to reinforce its capital reserves and meets its liquidity requirements. The reduction in the main ECB rate has, therefore, the consequence of affecting the core business of these funds, whose returns depend on it. You can’t make an omelette without breaking a few eggs, but with an increasing shortage of presentable collateral, another profound breakdown in the financial system is looming on the horizon. Each time an attempt is made to solve the problem, another new one is created. Far more than the danger of bankruptcy, it is this problem that the central banks are coming up against in the last resort and which is paralyzing them.