It is a public holiday in NSW today – Labour Day – to celebrate the 8-hour day although for many workers that victory is now a thing of the past as labour market deregulation bites harder on the hard-won conditions that workers enjoyed during the full employment period. I am also ailing (with “the bug” that is “going around”) and I have two major pieces of work to finish (one completed this morning). There is also a birthday in my immediate family and so I am partying tonight (in relative terms). So all that means a shortish blog. I was giving a talk in Perth last week about the absurdity of state (non-currency issuing) governments running down public infrastructure because they refuse to borrow all in the name of preserving their AAA credit rating from the corrupt ratings agencies. The obvious question seems to evade people – why have AAA credit rating if you refuse to borrow. The ridiculousness of the ratings game raised its head again last week when one of the ratings agencies threatened to downgrade the British Government’s rating. It is clear that the agency is probably needing a revenue boost so tried to attract some publicity. If I was the Chancellor I would have told them to buzz off and to stress how irrelevant they really are. But the reaction was typical – angst and worry. For what? Nothing. The only thing it demonstrated was how mislead the public are and how mindless this “dark age” that we are living through at present really is.
On September 28, 2012, Fitch Ratings issued its latest attempt to remain important – Fitch Affirms United Kingdom at ‘AAA’; Maintains Negative Outlook – which really says it all.
In their press release on Britain’s “sovereign ratings” they noted that the:
–Long-term foreign currency Issuer Default Rating (IDR) affirmed at ‘AAA’
–Long-term local currency IDR affirmed at ‘AAA’
–Country Ceiling affirmed at ‘AAA’
–Short-term foreign currency rating affirmed at ‘F1+’
They also added that:
The Outlooks on the Long-term IDRs have been maintained at Negative.
Which you will conclude are mindless statements given the nature of the monetary system. They are claiming that there is a scale of possible ratings other than zero risk, but it is difficult to find any coherent reason for them denying the obvious.
Which is – Britain issues its own currency and that means it holds all the cards if it should choose to do so.
What we have in relation to these ratings agencies is an elaborate charade – a game of bluff. The British government has all the policy tools necessary at its disposable to render anything that Fitch and its ilk might say, yet plays along as if the boot is on the other foot.
In case you are in doubt, please read my blog – Who is in charge? – for more discussion on this point.
I was talking to a person in London recently who was a very influential economic policy advisor to the previous Labour Government. He said that they knew that the government had a currency issuing monopoly but worried that the consequences of the ratings agencies turning on the government would be severe so they just didn’t want to take a chance.
This is nothing more than a game of bluff and the government has the power but pretends it doesn’t. Ridiculous.
You get some spiel about the methodology in this Fitch document (undated) – Sovereign Ratings – although the document seems to be a picture parade of all the self-important staff with fancy titles that spend their time engaged in the ultimate unproductive, “make work scheme” that one could ever imagine.
We read that:
Fitch’s sovereign rating methodology draws on modern instances of default and near-default to establish key indicators of debt capacity – both quantitative and qualitative – changes in which may presage growing debt distress. Sovereign ratings assess debt capacity over the medium term and endeavour to look beyond cyclical and other short-term fluctuations. A risk model assures comparable treatment of countries and serves as a starting point for the rating process. The methodology is continually updated to incorporate experience acquired from crises such as in Mexico, Asia, Russia and more recently in Argentina and Turkey. Particular weight is attached to the analysis of debt structure – by debtor, creditor and maturity – public and external accounts, as well as the health of the financial sector in order to provide a comprehensive assessment of country risk.
Let’s state some basic principles that apply to any fiat-currency issuing nation:
1. The national government can never reach a situation where, on financial grounds, it is unable to honour all of its obligations denominated in the currency it issues. Read: Never!.
2. Such a government exposes itself to default risk if it chooses to create liabilities (borrow funds) in a currency that it does not issue. Which means that to remain risk free a national government should never borrow in foreign currencies. There is no need to borrow at all much less in foreign currencies.
3. There may be times when the polity becomes so dysfunctional that certain elements determine that it is best – as a political stunt – to default on its obligations. Or during times of war governments might default on its debt obligations (for example, Japan in the 1940s). None of these circumstances are amenable to “risk models” or “key indicators” that are based or constructed using economic and/or financial data.
4. It is totally inappropriate to make historical comparisons between nations that have pegged currencies, or which use foreign currencies and nations that issue their own floating currency. It is also inappropriate to historically compare monetary systems that were based on fixed exchange rate systems (such as the Bretton Woods arrangement) and fiat monetary systems where there is strict non-covertability (that is, the unit of currency is only able to be converted into itself).
And if you understand the economics underlying these principles, you will quickly realise what a charade the Fitch Ratings excercise the other day was.
Here is what they said about the UK.
First, they wrote in their press release that:
Fitch judges the risk of a fiscal financing crisis to be negligible.
That is, zero! Britain will always have people queuing up to buy the debt that it voluntarily (and unnecessarily) issues.
So if that is the case, how can we have a negative outlook on the debt that the British government is issuing?
… weaker than expected growth and fiscal outturns in 2012 have increased pressure on the UK’s ‘AAA’ rating, which has been on Negative Outlook since March 2012. With a structural budget deficit second in size within the ‘AAA’ category only to the US (‘AAA’/Negative), and general government gross debt (GGGD) approaching 100% of GDP in 2015-16 under Fitch’s revised baseline estimates – the upper limit of the level consistent with the UK retaining its ‘AAA’ status – the likelihood of a downgrade has therefore increased.
Why, if there is no risk of any “fiscal financing crisis”? Answer: no reason given other than their “risk model” must have some constraint built into it that says when this reaches this point we downgrade. There is no economic reason for this.
As an aside, there was some reportage last week (September 28, 2012) in Le Parisien – L’incroyable histoire de la naissance des 3% de déficit (The incredible story of the birth of the 3% deficit)
An English language report – The secret of 3% finally revealed – says that a “former senior Budget Ministry official” in the Mitterrand government was asked to come up with the fiscal rules that would become the Stability and Growth Pact (SGP).
He was quoted as being the “the inventor of the concept, endlessly repeated by all governments whether of the right or the left, that the public deficit should not exceed 3% of the national wealth”, although if we asked whether that statement was true or false we would all conclude it was false.
Why? Because wealth is a stock and GDP is a flow and the SGP budget deficit rule is specified in terms of 3 per cent of GDP (the size of the flow of national output and income in any given period). Whether he was actually the “inventor” of the rule is another matter.
Anyway, the official had this to say when asked about the origins of the 3 per cent rule:
We came up with the 3% figure in less than an hour. It was a back of an envelope calculation, without any theoretical reflection. Mitterrand needed an easy rule that he could deploy in his discussions with ministers who kept coming into his office to demand money … We needed something simple. 3%? It was a good number that had stood the test of time, somewhat reminiscent of the Trinity.
Which is another example of how arbitrary the neo-liberal period has been. Yet these arbitrary rules and assessments – all part of an elaborate smokescreen or charade – cause real damage to the lives of working people and rarely undermine the capacities of the elites. There are countless high paid officials in Brussels strutting around making all sorts of statements about the need for nations to cut welfare, wages, jobs and the like based on a rule that was just made up on the spot without any economic justification or authority.
If only the general populace could become familiar with this chicanery. That was one of the message I tried to impart in my talk in Perth last week. That citizens have to arm themselves with knowledge to challenge these crazy arbitrary rules and statements that our politicians emit as if they are venerable truths that have to be obeyed.
Anyway, back to Fitch.
First, they claim the currency issuing government has to reduce its budget deficit (engage in fiscal consolidation) or else it will lose its AAA rating.
Second, they acknowledge that the “private sector deleveraging and fiscal consolidation as well as from depressed business and consumer confidence, weak investment, and constrained credit growth” are undermining growth in the UK.
Which means they demanded that the UK economy grow more slowly than otherwise to hold the AAA rating.
Third, then they note that the “weaker than anticipated economy” is undermining tax revenue collections which is pushing up “public sector net borrowing” and blowing out the fiscal projections that they had previously formulated.
Why they thought that there would not be a increased deficit once the fiscal consolidation undermined growth is another matter that bears on their basic macroeconomic understanding in the first place. Like the IMF and the OECD, these agencies demand fiscal cuts, yet pretend that they will be offset by private sector spending growth. Even the most basic understanding of psychology tells us that confidence does not increase when sales are falling, jobs are being cut and unemployment is rising.
Fourth, in light of the weakening economy and the fact that the Government will not meet its deficit and debt reduction targets within the time frame specified in recent budget statements, Fitch decided to shift the AAA rating “to Negative from Stable”. As they say, this is because “Fitch’s Sovereign Rating Methodology” has a mindless rule that says with “general government gross debt to GDP ratio forecast to approach 100%, the likelihood of a rating downgrade has increased”.
What is the difference between 100 per cent, 110 per cent, 0 per cent or any other percent? A mindless and arbitrary rule drawn from analyses that breach the fundamental principles I outlined above.
But it is also moronic in the extreme – the logic being: Cut deficits to keep the AAA rating – which undermines growth and pushes up the deficit and debt – which undermines the AAA rating.
And the politicians and everyone else goes along with this nonsense. We really are not a very bright race of people.
Negative Outlook on the UK rating reflects the very limited fiscal space, at the ‘AAA’ level, to absorb further adverse economic shocks in light of the UK’s elevated debt levels and uncertain growth outlook.
Which means nothing at all. What fiscal space are we talking about? Earlier they admitted that the “risk of a fiscal financing crisis to be negligible”. That is, there is as much financial space for deficit spending as is required in the UK – as there is for any currency-issuing government.
There is near infinite financial space, which is the concept of “fiscal space” that they are referring to. There isn’t infinite real space – that is, the availability of real goods and services that can be purchased at any time with government spending.
But whatever is available for sale in UK Pounds – including all the unemployed and underemployed workers – can be purchased at any time by the national government. There is never an intrinsic financial constraint on that capacity.
Once again, we encounter lots of arbitrary (voluntary) constraints. When people say to me that the government has run out of money I just look at them (quickly recall which currency is being discussed) and say: What the Australian Government has run out of dollars?
The fact is that the British government can absorb any “adverse economic shock” at any time without exception. It might choose, as it is now, not to do so. But then the public debate would turn to examining why it was deliberately allowing unemployment to increase when it has all the means at its disposal not to have that happen.
Fitch also give us a guide to what would trigger a downgrade in Britain:
— General government gross debt failing to stabilise below 100% of GDP and on a firm downward path towards 90% of GDP over the medium-term.
— Discretionary fiscal easing that resulted in government debt peaking later and higher than currently forecast.
— A material downward revision of the assessment of the UK’s medium-term growth potential.
Which confirms that their entire business is conducted at a level which is moronic in the extreme.
The logic being: Cut deficits to keep the AAA rating – which undermines growth and pushes up the deficit and debt – which undermines the AAA rating.
Please read my blogs – Time to outlaw the credit rating agencies and Ratings agencies and higher interest rates and – Moodys and Japan – rating agency declares itself irrelevant – again – for more discussion on why the ratings agencies should be ignored and … outlawed.
Given their propensity to corrupt behaviour (as evidenced in the various hearings that have been conducted in the fallout of the financial crisis) I would outlaw the ratings agencies immediately.
But if I was in government I would also be engaging in a large education campaign trying to inform people about how moronic the logic used by these agencies is.
But I am not in government, so I am doing it anyway, except my reach is significantly more limited than if I was the Prime Minister of Britain.
That is enough for today!
(c) Copyright 2012 Bill Mitchell. All Rights Reserved.