Turns out that Francois Baroin, the French Finance Minister, wasn't far wrong last week. The most hated man in the City of London said that Britain was in just as bad financial shape as eurozone countries like France, and that the rating agencies should be downgrading British debt. We have higher inflation, lower growth and larger debts than France which is currently on the downgrade 'list of shame'. Now Moodies has put the UK on credit death watch too.
Who are the rating agencies? Well, they are private firms that specialise in giving credit risk ratings to banks and countries. Triple AAA means that the country is a very safe bet. Both Britain and France have this top rating, which allows them to borrow cheaply. But when they get on credit default watch, and both countries now are, then private investors think twice about lending to them, which makes the cost of their borrowing increase. The cost of borrowing has ballooned recently for countries like Portugal and Greece which the credit rating agencies think will default on their debts.
Yes,I know it's complicated, and the fact that it's all couched in the impenetrable jargon of the financial industry makes it worse. Few people can be bothered to find out what is going on in the financial fortresses of Europe because it is so difficult to make any sense of it. Take the year end rally.
In the dying days of 2011, the European Central Bank did what it said it wouldn't do and threw 489 billion euros at the busted banks of Europe. What happens is this: the insolvent banks can't borrow at the moment because no one is prepared to risk lending to them. So, what does the ECB do? It offers them unlimited funds at a give-away interest rate of 1%. The idea is that they will then lend to countries like Spain and Italy who are currently (because they are busted) paying 5% for their loans.
The banks are suddenly keen to gobble up the debt of Spain because they get a guaranteed "spread" that means a profit, on the deal. They borrow from the ECB at 1% and then lend to Spain at 5% and get 4% profit for doing absolutely nothing at all. They also use the money to lend to businesses at similar rates, and get millions of pounds of effortless profit. This becomes the bankers bonuses at the end of the year. This nonsense is what passes for financial management in Europe.
Because of this free money, everyone is suddenly happy and the stock markets forget about the eurozone sovereign debt crisis and deliver a nice year end rally, so that the financial community get a nice Christmas bonus. The European Central Bank is effectively giving money away - to incompetent and insolvent banks who have ruined themselves through their irresponsible lending policies. But the ECB can think of nothing better to do than to pour money over them like custard over a christmas pudding.
So, where does the ECB money come from? And if they can suddenly invent £500bn why don't they give it direct to countries? Well, this is the ECB version of printing money. It's what the Bank of England has been doing for the last two years. It violates all the principles of sound finance, needless to say, and stores up trouble for the future. But the alternative was an epic credit crunch in the New Year which would have seen the collapse of several very big European banks and a couple of countries. So the system has been salvaged again by the policy of stuffing bankers mouths with gold.