This is a link to a very succinct paper on the ‘impossible choices in a world depression‘ by Immanuel Wallerstein. It makes reference to a very interesting fact that has gone unnoticed over the past two weeks. The Spanish government introduced a significant austerity package on the 27th May amounting to €15bn. The deepest budget cuts in the country for 30 years. The following day the credit rating agency, Finch, along with others, downgraded its debt rating from AAA to AA+
If governments are cutting spending to reduce budget deficits, why are they being punished by the financial markets which they seek to borrow from and for whom they are cutting spending for? This is a serious question that has gone completely unnoticed in the current fetishisation of fiscal deficits. The reason is because cutting government spending will not improve economic performance, growth or recovery.
Brian Coulton, Fitch’s person in charge of ratings for Spain said these exact words in a press release following the downgrading: “The process of adjustment to a lower level of private sector and external indebtedness will materially reduce the rate of growth of the Spanish economy over the medium-term.” He then went on to argue, like the OECD, that the primary problem in Spain’s economy is an over regulated and inflexible labour market. There may be truth in this. But, either way, the following fact remains: cutting budget deficits will not reduce the premium governments have to pay for issuing bonds. Financial markets reward growth not fiscal austerity. Cutting deficits, by definition and in fact, reduces economic growth. Cogito, cutting deficits in the absence of a clear growth strategy increases the probability of a further down grading of public debt.
This fact becomes more truthful when one examines why the Greeks had their debt downgraded to junk status today. Despite a €110bn ‘pain for gain’ guarantee from the EMU/IMF recapitalisation package, Moody’s credit rating agency stated “Greece’s credit ratings will now depend on its future economic growth“. There it is in black and white.
Spain and Ireland will not return to growth because what was previously driving their economies has evaporated: real estate activity. Unless this collapse in private investment is replaced with something else quickly, the probability of a default and being priced out of financial markets increases. Budget cuts will make no difference to this scenario. The more important question therefore is what will create growth? Reliance upon the private market is an act of faith. Relying upon state or euro coordinated investment is a rational choice.