Financial crisis? It\’s the politics, stupid!

When Bill Clinton ran for US President in 1992, his campaign theme was \”It\’s the economy, stupid.\” His opponent, George H W Bush, sought to focus the election on his crushing victory over Saddam Hussein in the 1991 Gulf War. But Clinton avoided foreign affairs and politics, and focused instead on the ongoing recession and its attendant unemployment. One Democratic car sticker said, \”Saddam has kept his job. Have you?\”

We saw the obverse of this in the economic panic and stock market crash that swept across the globe last week. Many analysts called it a financial crisis. In fact it is a political crisis. The economic issues are solvable, but investors no longer trust politicians in the US or Europe to do what is required.

This cost the US its AAA credit rating from S&P, a top credit rating agency. Raising the US government debt ceiling-the amount the US can borrow to make payments-used to be a routine matter. But this year the Republicans, who control one House of Congress, threatened deadlock on the debt ceiling, which was due to be breached on August 2, making further government payments impossible.

Obama blew hot and cold, and ultimately half-surrendered. The two sides agreed on a temporary quick-fix. The debt ceiling was raised by $900 billion, barely enough to accommodate one year\’s fiscal deficit, subject to a new committee devising meaningful debt reduction a few months hence. This stoked investor fears that the debt ceiling drama would be repeated every few months.

A dismayed S&P downgraded US bonds to AA+. In its downgrade explanation, S&P made an error of $2 trillion in projecting US debt a decade hence. Obama and other government spokesmen gleefully castigated S&P for this.

Yet 71% of Americans in a Washington Post survey said S&P\’s rating was fair. S&P said its downgrade was based not on precise calculations of future US debt but on a flawed political process. Some Republicans want to keep the debt ceiling simmering till the next Presidential election in November 2012, constantly threatening a US government shutdown. Such dirty politics might make Obama unelectable by causing economic distress, maybe even another recession. Investors worry that such crass political opportunism will lead to gross economic mismanagement.

The same lack of trust explains the financial panic in Europe. The solvency of Greece and other weak European countries has long been in doubt, but last week doubts increased about Spain and Italy too. Rumours spread that even France might lose its AAA rating.

In most countries, the government controls both fiscal and monetary policy, and so can always print enough currency to pay its debts. But in political pursuit of European unity, 17 European countries have given up their currencies in favour of the euro, managed by the European Central Bank. It was always a mistake to create a monetary union of such disparate countries.

Earlier, Greece could have overcome its lack of competitiveness by devaluing. But once it adopted the euro, devaluation ceased to be an option. Today Greece is not competitive, cannot grow, and so is increasingly unable to repay its debts. Portugal and Ireland are in similar difficulties. Germany, Holland and the Scandinavians are increasingly resentful of being asked time and again to bail out the laggards.

Clearly, the Eurozone will not work without a permanent fiscal arrangement that obliges stronger regions to subsidize weaker ones. One option is for Greece and other weak Europeans to abandon the euro and revert to their old currencies after massive devaluation. The second is for the 17 Eurozone countries to invent a partial fiscal union in which the rich areas guarantee support to the weaker areas. Alas, politicians view both options as unthinkable today.

To gain time, politicians have mounted repeated rescues seeking to keep alive the fiction that Greece and other weak countries can be made solvent. This simply postpones any solution. Investors are getting disillusioned with the vacillation and ostrich-like denial of European politicians. This vacillation is now affecting the bond prices of all European countries save Germany and a couple of others.

This poses a threat to big European banks holding massive government bonds. These banks might survive partial default by Greece, Portugal and Ireland. But a Spanish default would be crippling, and an Italian one would be fatal. This fear sparked last week\’s panic selling in stock markets. If the panic spreads, a double-dip recession will follow.

This is not a mere economic or financial crisis. It is a much deeper crisis of state management. Clinton would have said, \”It\’s the politics, stupid.\”

1 thought on “Financial crisis? It\’s the politics, stupid!”

  1. Yes, this might be the unnoticed part of the picture. Usually, the crisis in Western countries come out at last to be the platform or aftermath of dirty political motives. I agree with it.

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