Is it time for deep cuts or should the borrowing go on?
What Do Women Want? was the question feminist writer Erica Jong asked in 1998. Professionally, I would like an answer to another burning question: What do markets want?
That riddle deepened with a chilling comment from Francisco Gonzalez, chairman of one of Spain's biggest banks, BBVA. “For the majority of Spanish companies and financial firms, international capital markets are closed.
“If the Spanish state is having difficulty in financing itself outside Spain, then the difficulties will be even greater for those in the private sector.”
This remarkable statement prompted EU leaders to agree new EU surveillance of national budgets and the publication of stress tests on EU banks. The stress test decision was opposed by the banks and their lobby groups for being offensive to the secrecy of Irish officialdom and political life, but the objections melted like snow in an Irish June.
Gonzalez's comments spurred the Bank of Spain to publish the results of stress tests on Spanish banks and for EU leaders to promptly agree to follow suit at last week's summit but it’s clear markets are not willing to replace the debt of many European banks. In the case of Irish banks alone, €77bn of such debt must be repaid. Markets also appear increasingly reluctant to lend to Ireland. Yet, just when one thinks this may be the terminal crisis, a successful but puny €3bn bond auction by the Spaniards gives the euro its best day for a couple of years. After the stress test announcement the euro rose again, as did European shares. But why were we facing a lenders' strike in the first place? Because banks and investment funds simply want more information.
Inter-bank lending is shaky because banks don’t know what other banks hold in government bonds that might be at risk of default. Doubts also exist about the losses faced by European banks on the assets they still hold from the bubble days. Policymakers seem to have forgotten that markets are essentially exchanges of information rather than of actual products bought and sold. If markets knew enough, they would lend to countries at an appropriate interest rate and governments could choose between borrowing or cutting their budget deficits and risk further contraction in the economy.
Post Tuesday’s UK Budget, one can wonder if Chancellor Osborne is killing the recovery. Or would failure to act on the deficit risk lead to a punitive rise in long-term interest rates — or even a refusal to lend at all?
Here, some Irish economists have formed an unlikely alliance with the trade union movement in calling for a slower approach to reducing this country's yawning deficit. Others say the difficulties in the market show the Government is not cutting fast enough.
There are big guns ranged on both sides. In just the past seven days, Alan Greenspan warned that the market could yet treat the US like Greece if present deficits continued. Meanwhile, veteran UK analyst Samuel Brittan argues that an expanding economy will itself generate most of the savings required to finance budget deficits. Harvard Professor Paul Krugman brought in the Irish angle, pointing out that Ireland's budget correction has been much praised, and Spain's much criticised. Yet the interest rate demanded by markets for lending to Ireland is significantly higher than they will accept from Spain, proving his opinion that markets prefer growth to fiscal austerity.
If information is key, markets do know more about Irish banking than Spanish. It’s a pity that something so vital for economic policy making — how much borrowing lenders will tolerate — is subject to so much uncertainty.