HowWealthWorks.com

[Suresh]

You can see the Keynesian thinking here. If the private sector pulls in its horns, then the public sector must step up to maintain aggregate demand so that GDP doesn't fall. In stepping up, the public sector may have to run a deficit. But, see, here's the problem. Running a short-term deficit may only be possible if the government is starting from a low public debt level and there is sufficient global demand for the government's sovereign debt. This problem is why we keep the concept of exploding debt dynamics in the back of minds.
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Financial Times: The eurozone depends on a strong US recovery
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So what determines sovereign credit risk? The traditional European approach focuses only on visible fiscal deficits and debt. This is far too limited. That is not only because it ignores contingent public debt. It is even more because it ignores the national balance sheet and so the close links between private and public sector balance sheets. It also ignores the balance of payments. It is often said that the current account does not matter in a currency union. This is true: an exchange rate crisis is impossible. But it is also false: a credit crisis may happen instead.

If a country runs a current account deficit, residents must be selling financial claims to foreigners. If private parties are the sellers of claims, foreign suppliers of funds must believe in their solvency. If the public sector is the seller, suppliers must believe the same thing.

When the domestic counterpart of the external deficit is a private sector deficit, it is frequently a boom in the supply of non-tradeable services that drives the economy. Property bubbles are a part of this story – very much so in the recent cases of Ireland and Spain (and also in the US and UK).

So what happens if this boom collapses? The supply of creditworthy private issuers of financial claims shrinks and capital inflows become more expensive or more restricted. Three things will then happen: first, the economy will slow; second, the external deficit will shrink; and, third, the fiscal deficit will rise. The more determined any offsetting fiscal action, the smaller the shrinkage in the current account deficit and slow-down in the economy will be.

If a country has relatively weak international competitiveness, an inflexible labour market and an irrevocably fixed exchange rate, the end of the property boom will reduce domestic demand, without generating a significant offsetting expansion in net exports. The fiscal deterioration is then likely to be large and sustained.

Thus, as the private sector deficit moves into surplus, the public sector moves in the opposite direction. Ireland’s is a dramatic case: according to the Organisation for Economic Co-operation and Development’s latest Economic Outlook, the general government fiscal deficit will move from a surplus of 3 per cent of gross domestic product to a deficit of 7.1 per cent just between 2006 and 2009.

Spain’s fiscal deficit is forecast to move from a surplus of 2 per cent to a deficit of 2.9 per cent over the same period. Yet Spain still runs a large current account deficit (see chart). So the private sector also runs a sizeable deficit, forecast at 4.5 per cent of GDP in 2009. If that were to shrink faster than expected, very likely in today’s circumstances, the slowdown in the economy and jump in the fiscal deficit would be even bigger.



Other eurozone members running big current account and private sector financial deficits are Greece and Portugal. Meanwhile, Italy, Belgium and Greece have high public sector indebtedness. These six, then, are the vulnerable countries, with Greece much the most vulnerable.

So how likely is a fiscal crisis? The answer is that it depends on the length and depth of the eurozone’s recession, a member’s initial public debt position, the credibility of its fiscal authorities, its difficulty in achieving improvement in external competitiveness and, not least, on whether a crisis happens in any of these countries. Panic is contagious.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Financial Times: S&P cuts Greece’s credit rating
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Standard & Poor’s decision to cut its ratings sent Greek stocks plunging, saw the euro weaken, and heightened concerns across the eurozone over the public finances of the weaker economies as they take on record levels of debt.
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The downgrade of Greece’s sovereign credit ratings from A, which is five notches below the top triple A rating, to A minus comes only five days after the country was put on credit watch by S&P.

It turns the spotlight on Portugal and Spain, which were put on credit watch by the agency this week, and Ireland, which was put on a negative outlook last Friday.
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The vast amount of bonds due to be issued this year – more than €1,000bn is expected in Europe, nearly double that of last year – is also putting increasing pressure on governments as they try to issue debt.

On Wednesday, Italy was forced to pay much higher interest rates than it had bargained for to attract investors to sell five-year bonds. Last week, a German bond auction failed as it fell short of the amount of cash it had targeted to raise.
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Athens has seen its current account deficit soar above 14 per cent, the highest in the eurozone, while its debt to gross domestic product ratio has risen to 94 per cent – only Italy has higher debt levels.
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Financial Times: Spain loses triple A rating
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S&P lowered its rating to double A plus from triple A, arguing that the global economic crisis had highlighted “structural weaknesses” in the Spanish economy that were inconsistent with the highest rating.
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Spain has embarked on a heavy government spending programme to counter a deepening recession, and expects a budget deficit this year of 5.8 per cent of gross domestic product. But the European Commission predicts the deficit will reach 6.2 per cent of GDP and S&P made a deficit forecast of 6.6 per cent.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Bloomberg: France’s AAA Rating May Be at Risk on Debt, ING Says

France’s AAA rating may be at risk as the deepening economic slump erodes tax revenue and forces the country to raise borrowing, according to ING Groep NV.

“I’m not saying France is going to be downgraded, but the level of debt puts them in a spot of danger,” Padhraic Garvey, head of investment-grade debt strategy in Amsterdam at ING, said in an interview. “Their AAA rating is under stress.”

S&P affirmed France’s AAA rating last week, assigning it a “stable” outlook.
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The French government increased its 2009 budget-deficit forecast for the third time in 2 1/2 months on Jan. 20 to 4.4 percent of gross domestic product, the most since 1995. The European Commission forecast it will be 5.4 percent. Public debt will rise to as high as 70 percent of GDP this year, from 67 percent in 2008, Budget Minister Eric Woerth said Jan.20.

The extra yield investors demand to hold 10-year French bonds instead of benchmark German bunds widened to 57 basis points on Jan. 21, the most since the euro’s debut a decade ago. The average spread in the past 10 years is 8 basis points.
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France’s economy will contract 1.8 percent, the severest recession in six Decades, according to the commission.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Global Economy Matters: Banking Problems In Southern Europe Send The Whole World Running For Cover

Well that so called investor "risk appetite" took a surprise hit yesterday (and from an unexpected quarter). ...

As Izabella Kaminska notes, it is Southern Europe that is now getting all the attention.