December 16, 2024 - 7:00am
Over the weekend, Moody’s downgraded French government bonds from Aa2 to Aa3, after the agency expressed doubts that the incoming government of Francois Bayrou could get a handle on the country’s deficit. To which investors in bond markets will probably respond: tell us what we don’t know.
Although European Union rules require France to bring its fiscal deficit below 3% of GDP, the country is moving in the opposite direction, and will probably top 6% next year. The deep divisions in the country’s legislature, which is making it all but impossible to form a stable government, also make it highly unlikely that any tough decisions can be taken on budget cuts or tax rises. There is a constituency in the parliament to oppose just about any and every change, so the country will probably muddle through, directionless at a difficult time.
This problem is hardly peculiar to France, though. The other European powerhouse, Germany, is grappling with similar divisions, and there is little faith that elections in February are going to return a government with a clear mandate one way or the other. Although several other European countries are similarly fragmented, the biggest story of all, when it comes to internal divisions, may actually lie across the Atlantic.
Although Republicans won a “trifecta” in the US’s November elections, their hold on the House is so slender that it appears unlikely major budget reductions will accompany the sweeping tax cuts the party wants to implement. Once again, every programme has someone to defend it. Moreover, the likelihood of Republicans losing the House in the 2026 mid-term elections will further make them reluctant to get bold about belt-tightening.
That’s why bond investors have for months been signalling their loss of faith in the fiscal rectitude of many western governments. Yields on long-term government bonds have been rising in all the major northern economies — none more than the US, whose 10-year bond is up nearly three-fourths of a percent since September. European interest rates are actually moving more slowly — up about a tenth of a percent in Germany and two-tenths in France. Britain, though, where inflation has proved more stubborn, is tracking the US more closely.
But everywhere, rising interest rates are only worsening government attempts to get their deficits under control, since governments must pay more in interest. The US has spent $300 billion more this past year alone, with annual interest payments now exceeding the budgets for both Medicaid and the Pentagon.
There are a couple of sub-plots to this drama — one intriguing, one potentially alarming. The intriguing storyline is that while bond yields are rising in northern Europe, in Portugal, Greece, Italy and Spain, the so-called “PIGS” that once carried that derisive moniker for their profligacy, they’ve actually trended downwards this year. This flips the long-standing script of the prudent north and spendthrift south, and may augur interesting changes for the future development of the European Union.
The alarming plot is that this rise in bond yields is occurring while central banks are cutting interest rates. Normally, this shouldn’t happen. Lower rates on short-term credit should pull down interest rates across the board. The fact that investors are demanding more, not less, interest on their long-term loans suggests they don’t trust central banks when they say they’ve won the war on inflation.
In short, central banks appear to be losing control of the market narrative. Given the degree to which economic stability depends on faith that the authorities “have got this”, that could become a major problem should any of these political divides metastasise into a proper crisis.
John Rapley is an author and academic who divides his time between London, Johannesburg and Ottawa. His books include Why Empires Fall: Rome, America and the Future of the West (with Peter Heather, Penguin, 2023) and Twilight of the Money Gods: Economics as a religion (Simon & Schuster, 2017).
jarapley
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SubscribeIt is already a proper crisis. The state’s misallocation of resources, of which huge deficits and massive debt burdens are just two symptoms, has devastated the European economy.
In 1992 Europe constituted 28% of global GDP and the USA 26%. In 2024 Europe now constitutes just 17% while the USA has maintained its share at 26%. The trajectory is awful. In just one generation Europe has thrown away its economic hegemon. Europe’s relative global economic heft hasn’t been this small since Napoleon was knocking about. It’s that heft that paid for our superior welfare states, our first class militaries, and our international influence.
The problems of the USA and Europe simply cannot be compared. The USA continues to command a dominant share of the global economy. The USA continues to incubate new technologies. The USA continues to create new industries. The USA continues to grow. This all creates a fundamental demand for dollars no matter what the US government does. By contrast, Europe hasn’t had a globally significant innovation in 2 decades. All Europe offers investors is government debt, and in a vicious cycle that’s where a lot of European capital ends up, perpetuating the cycle of economic sclerosis.
Whether measured by births, by innovation, by economic growth, Europe is fading away. Unfortunately for Europe, history didn’t die. Europe isn’t divinely protected from the tempests that ravage middling states. We are now middling states and history will come calling soon enough to upend our complacency.
…. and people somehow still wonder why Europeans are moving most of their investment money from Europe into the US economy. While the EU and the Labour government continue to make growing a company extremely difficult, this situation will deteriorate even more quickly. Very depressing.
Does the US dominate because its economy creates a demand for dollars or does the reserve currency status of the dollar simply produce demand by itself?
Of course the US has many interesting companies, especially in the big tech sector. Now with the spectacular achievements of AI that is certainly the case. On the other hand, many of these companies are based on speculation. They have yet to prove their relavance in terms of actual production and profits. In fact, when it comes to physical products, such as cars or solar panels, the US has a hard time competing with China as well. No longer just in terms of affordability, increasingly also in terms of quality and performance.
Another US sector that dominates is its financial sector. Private equity firms such as BlackRock offer easy and huge returns, and so this also suck investment out of Europe and the real economy in general. But again we have to wonder how much of this is can be attributed to competitiveness of the US economy and how much to the ability of the US to print more money than anyone since the dollar is the reserve currency. It also produces a vicious circle; everyone invests in certain parts of the US economy because it offers big returns and for that reason alone it keeps offering those big returns.
You are comparing the 20th century industrial economy that Germany conquered and is now losing to an Tech centered innovative economic system. The Chinese are impacting them more than the USA. Some speculation in the USA but Silicon Valley has produced many Tech stalwarts that continue to innovate, and our capital markets more efficiently allocate capital than the bank center system in the EU. I’ll take our economy over the EU’s any day. And BlackRock is an Asset Mgr while Blackstone (different company) is the PE firm
There’s not much speculation involved where the economic impact of AI is concerned. It’s going to be devastating.
Not true generally. If you just look at the P/E of many big tech stocks it is simply intrinsically speculative, i.e. far from generation a return on investment so far.
AI increases the productivity of coders by as much as 80%. Most industries have only so far been automated to a fraction of the potential – around 15% I reckon. The impact on the acceleration of business automation alone – forget about all the other stuff – is going to be massive.
I fear you are right. Instead of being a tool to enhance human performance, it seems the goal is human replacement. And if people lose their jobs, what will happen to the income flows that sustain the consumer economy? The rich will continue to exchange wealth among themselves, using the multiplier effect. But what about the rest of us?
Tell your kids not to go to university, but learn manual skills instead. It will be a while before plumbers or paramedics become redundant, but the middle class professions are done (except maybe the Civil Service).
This is pure speculation on my part, but the sector that yields the highest ROI nowadays is organized crime, in its various visages. How much of investor money – especially from offshore accounts – is funding the proliferation of organized crime across the developing world (with so many customers in the developed world, don’t forget). For me the strongest argument against the drug trade isn’t harmful physical effects but the deadly social ones caused by proliferating organized crime (which runs Venezuela and Brazil nowadays).
You seem to share a peculiarly British satisfaction from self-flagelation. I don’t question your interpretations, but the apparent ‘just desserts’ attitude regarding potential disaster for the place you live and where your family’s future is presumably invested.
Furthermore, to place this in context, remember who controls the rating agencies (that have let people down so badly during a series of financial crises). They’re just another Wall St political tool.
It isn’t self-flagellation to note that in 30 years Europe has declined 35% relative to the USA, my child has been waiting 24 months to see a Consultant at home, the infrastructure my family rely on is quite literally collapsing, the tax burden is even higher than it was after the nation fought the largest ever global war for 5 years, and technological backwardness now afflicts nearly every sector of the economy. For those of us who sometimes work internationally, coming home to the UK is a shock and yet it seems, like boiling frogs, no one at home can see the desperateness of the situation.
Memo to all those who want Britain to adopt a PR system of electing MPs: This is what it looks like.
Totally agree. For all its faults, FPP produces govts that can actually govern
Have you been awake for the last 16 years?
Indeed, Two teir Kier is far move effective than Maricon
You might not like him, but at least he has a majority and can do things.
Your statement is true. Decisions can be made when PR produces dithering. But if those decisions are stupid……….
…then put the other lot in at the next election.
Of course it is the credit rating agencies themselves that should have lost credit after 2008. When are we finally going to decide this entire financial system needs to be reformed? Probably not in time.
The fiscal rules under the Maastricht treaty have been broken so many times by EU member states like France that one has to wonder why it even still exists. When other north/western EU states do abide by these rules it completely undermines the euro and EU, especially if those countries could really use some extra deficits for once. For example, the Netherlands – which has half of France’s debt – just had their budget rejected while they have one of the worst housing crises in its history. Full-time working people with normal jobs are literally left homeless in Amsterdam. Also there is a lot of discrepancy in inflation between member states. Some countries still experience high inflation while the ECB is rapidly reducing interest rates.
All of this happens in a context of years of loose monetary policy. While we are supposed to focus on fiscal responsibility and austerity central banks pumped billions into assets producing enormous unearned inequality. We forget that central banks can and do just buy the bonds themselves, pushing down their interest rates artificially. But this type of money printing after 2008 and 2020 incentivized endless rent seeking and speculation. Meanwhile deficits never really seem to result in the problems we are constantly warned about. In fact, they seem to be misunderstood.
So that central banks are losing control of the market narrative is not so strange. In 2008 we found out it simply does not make sense but we failed to seriously push for reforms and hold bad actors accountable.
There is approximately zero discussion of this by the public or mainstream media. Most people just want to shout at each other about which political party is best while the central banks pump asset prices.
Sadly, in the wake of the Condemic, most people just wanted to get back to a normal life, not realising that was never going to happen – partly because of the vast new government power attained and partly because of the changing attitudes among the population, who are no longer willing to be cast as consumers with the obligation to sustain the economy and were able to perceive during lockdown other more important values in life.
It’s has been going on for far longer than since the pandemic. In the UK, back to 97.
Financial models assume that the possibility of a G7 country defaulting is zero. Questioning this assumption is too horrific to contemplate. That is why no financial insitution will do so until it is too late.
Too many models fail to take real world factors and possibilities into account. That has always been my beef with economics – there is no such thing as a perfect market, because insider knowledge differs so considerably and all companies naturally trend towards a monopoly.
I have a tangential question if anyone can answer it. How much of the UK income tax and National Insurance revenue comes from public sector jobs?
The public sector workforce is about 6M, total workforce about 33M, so as a first approximation about 18%.
So that makes the tax take 18% lower than reported, since it was taxpayers money to begin with? Does that 6m include quangos and their taxpayer funded jobs?
Makes sense for the USA to move from the dollar to bitcoin,basically bankrupts everyone else.
Europe needs to decouple from the U.S. It has put itself in a position of dependency and US crippled them under the disguise of “friendship”.
Europe needs to recognize that while it was great that America saved them from the Nazis, it’s now time to think for itself. Having wars in Europe today is a sign of demise, not growth. Wars, politics, and immigration overflow – is like Europe is regressing.
Investors don’t believe that central banks in certain countries are getting debt under control because they’re not. It’s not about inflation. It’s about debt.