It's Still Hailing Downgrades

Tuesday saw Europe hit by another slew of downgrades. Moody's followed Fitch and S&P and downgraded Spain – by two notches. As reported by DailyFX:

„In its rationale for the downgrade and negative outlook, Moody’s cited the absence of a solution for the European debt crisis and the worsening economic outlook for Spain. The agency lowered its forecast of 2012 GDP growth from 1.8 percent to 1 percent on continued softness in the labor market and “the difficult funding situation for the banking sector.” While acknowledging Madrid’s efforts to reform the labor market and introduce a balanced-budget constitutional amendment, Moody’s expressed “serious concerns” about regional government deficits and voiced doubt about the general government sector’s ability to meet “ambitious” fiscal targets.“


(emphasis added)


We have previously mentioned that we think that Spain's central government deficit has been prettified with a simple accounting trick – the government cut remittances to the regions by 16%, which means that deficit growth has been shifted to them – but it has not disappeared. We moreover continue to believe that after the inevitable Greek default, Portugal will be the next country to come to the market's attention. It is inconceivable to us that Portugal's growing problems won't have an effect on neighboring Spain and we expect the downward spiral to accelerate once Portugal becomes a market focus.

Meanwhile, S&P also continued to hand out downgrades, this time to 24 Italian banks. Here is the summary of S&P's statement:

Renewed market tensions in the eurozone's periphery, particularly in Italy, and dimming growth prospects have in our view led to further  deterioration in the operating environment for Italy's banks. We think funding costs for the banks will increase noticeably because of  higher yields on Italian sovereign debt. Furthermore, higher funding  costs for both the banking and corporate sectors are likely to result in  tighter credit conditions and weaker economic activity in the  short-to-medium term. We are revising downward our Banking Industry Country Risk Assessment (BICRA) on the Republic of Italy (unsolicited ratings, A/Negative/A-1) to  Group 3 from Group 2, and lowering the economic risk score, a  subcomponent of the BICRA, to 3 from 2. We are taking negative rating actions on 24 banks and financial  institutions and affirming our ratings on 19 banks.”


(emphasis added)

Once again we see here how the problems of the euro area's sovereign debtors continue to redound on the banking system in a vicious spiral.


UK Inflation – Time for the Next 'Dear Chancellor' Letter

Mervyn King must get his letter writing equipment out again. UK CPI 'inflation' was reported to have hit a new high of 5.2% in September – the very month when the Bank of England announced an additional 75 billion pounds in 'quantitative easing', better known as 'money printing'. Apparently, QE isn't really the appropriate method for achieving the BoE's 'inflation target in the medium term' as chancellor of the exchequer George Osborn opined in his recent hilarious and rather Orwellian letter to Mervyn King in which he assented to the latest iteration of 'QE' (see our previous report on this, 'The ECB and BoE Decisions, Monetary Pumping Resumes'). 

After the recent CPI report, it is time for King to once again write a letter to Osborn to 'explain' why a 0.5% interest rate and a vast money printing operation are not to blame for the outbreak of stagflation in the UK.

As the WSJ reports, the higher rate of CPI will impact government spending considerably as well – luckily for retirees,  widows and orphans it came at the 'worst possible time' for the government:

The surge in the U.K.’s consumer price index to 5.2% in September may be painful for squeezed Britons, but it’s also galling news for Chancellor of the Exchequer George Osborne, who is battling to bring down the country’s budget deficit.

The record acceleration in the CPI rate could not have happened in a worse month because September’s inflation numbers are used to set the increase in social security benefits and the state pension for the 2012/2013 financial year.

Back in March when official budget watchdog the Office for Budget Responsibility set its forecasts for the U.K.’s public finances, it used the projection that inflation would be 4.3% in September. With inflation now running at almost a percentage point higher, it means that Mr Osborne’s task of hitting his fiscal targets just got harder.

The Institute for Public Policy Research estimates the government’s spending on pensions and other benefits will now be £1.2 billion higher in the 2012/13 financial year than the OBR estimated in March.

The think-tank’s senior economist Tony Dolphin says adding to the higher-than-expected social security bill is the recent rise in unemployment. The Institute for Fiscal Studies, an economics research institute, estimates the bill could be as high as £1.8 billion.”

This could never happen in the US by the way, where manipulation of CPI by government statisticians in order to keep down 'COLA' expenses has been honed to a fine art.

The Telegraph meanwhile reminds Mervyn King of a warning recently uttered by Paul Volcker regarding tolerating rising prices for too long:

“Ouch! It's even worse than we thought – or perhaps that should read what forecasters thought. For most of us, news that CPI inflation last month reached 5.2pc won't come as much of a surprise; it's been obvious from our utility bills and shopping baskets for some time now. The older, RPI measure of inflation is worse still, at 5.6pc.

And still the Bank of England likes to pretend it's trying to meet the inflation target. More monetary stimulus in the form of a further £75bn of "quantitative easing", with the inflation rate at 5.6pc? If the economic bind the country finds itself in were not so serious, it would be almost laughable.

Everyone expects inflation to come down sharply over the next year, as the current round of fuel price increases and the January hike in VAT work their way out of the index, but then the Bank, the Government and most City analysts have consistently underestimated inflation for the best past of the last three years. What reason do we have to believe them now?


“Here's Paul Volcker, the Federal Reserve chairman credited with finally exorcising the inflation of the 1970s and early 80s from the US economy, writing recently in the New York Times.

My point is not that we are on the edge today of serious inflation, which is unlikely if the Fed remains vigilant. Rather, the danger is that if, in desperation, we turn to deliberately seeking inflation to solve real problems — our economic imbalances, sluggish productivity, and excessive leverage — we would soon find that a little inflation doesn’t work. Then the instinct will be to do a little more — a seemingly temporary and “reasonable” 4 percent becomes 5, and then 6 and so on.

No, inflation is never an economic panacea. Nor does it even help with the debt burden. If wages aren't matching inflation, then it is of no help in eroding the nominal value of household debt, and if taxes aren't keeping pace with inflation, then the same goes for government debt. Worse, many forms of government spending, most notably the bulk of benefit entitlements, are linked to inflation, so that we now have the absurdity of benefit claimants being better protected against price increases than wage earners.

These figures are not just uncomfortable for the Bank of England and the Government. They are a disaster.”


(emphasis added)


King's constant assertions that the BoE's easy money policies cannot possibly be held responsible for this outbreak of 'stagflation' are indeed ridiculous. Does he really believe that if the BoE stopped expanding the money supply prices would still rise anyway? This is actually a mathematical impossibility. There can not be a rise in the 'general price level'  if the money supply is held constant. If some prices rise, others will have to come down.  It should be obvious that the central bank's policies are the main factor behind the price increases over the past two to three years.

However, worse even than the rise in consumer prices is the fact that relative prices in the UK economy keep being distorted by these monetary interventions. Instead of 'helping' the economy as King continually avers, the BoE's policy is helping to destroy even more scarce capital.

Living standards in the UK are thus set to continue their decline – and no-one should be surprised that there is the occasional riot breaking out lately. This is what welfare statism based on a fiat money system inexorably leads to – it not only destroys the economy, it also undermines people's morale and morals.


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One Response to “More Euro Area Downgrades and Another Spike In UK CPI”

  • roger:

    Maybe slightly off topic, but as you mentioned morals at the end, I might as take a closer look into the aspect of morals. It has been one of the questions lingering in my head for long. My question is: in economics, where is moral’s place? Is it a mere byproduct of how well the society is doing or is it a type of wealth as well? Or is it something else entirely different that does not have a definite place?

    Superficially, it does appear as a byproduct/symptom of how well economically the society is. Riots tend to happen when there’s economic deterioration. The more deterioration, the more violent the riot and the lower the morals of the people involved in. That is what generally happens, although there are exceptions, such as Japan.

    But if we look at it from another perspective, moral is also a component of the well-being of the society. Provided 2 societies w/ the same material wealth, one society whose morals are higher is the more well-off from the 2. And there will indeed be a difference (no 2 societies have the exact same moral values) because cultural differences is a significant factor in determining the morality of a society. Viewed from this angle, moral is also a type of wealth.

    From the perspectives I have presented, which is the more correct? To this, I would like to bring out a post Mish had yesterday:

    Is this only a symptom of economic deterioration or does it also tell us that this is one type of wealth that China lacks?

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