Sunday, bloody Sunday! And then what?

Reports indicate that this Sunday afternoon euro area central bank presidents have been dragged away from their Kaffee und Kuchen, fishing stools, family dinners and… but I shouldn’t speculate further on what European central bankers normally do on a Sunday afternoon. Their task is to decide whether to act to arrest market panic and, specifically, whether to buy Spanish and Italian bonds in order to prevent spreads over German paper rising yet further, threatening a re-run of Greece, Ireland and Portugal. And then there were four, or five.

Obviously they should decide to do so. The ECB’s failure to offer clear support to Spain and Italy last week, unsurprisingly largely reflecting Bundesbank intransigence, was one of the main reasons, at least in the ‘European theatre’, for the panic. The unwillingness to provide support was ‘justifed’ by a supposed need to keep up the pressure on the governments of the two countries to announce even tougher austerity measures. This is the kind of stand-off between monetary and fiscal policy that was at the heart of Japan’s lost decade in the 1990s.

Let us hope that, faced with the clear evidence of the lunacy of such politicking (by ‘independent’ central bankers!) they will do the right thing. They probably will. Time and again in this crisis policymakers have drawn lines in the sand only to be forced to cross them the next day. Better late than never.

But don’t expect any sympathy for the foregone pleasures of a summer Sunday afternoon.

Even as it is, the risk of large losses when markets open on Monday is high. Not only are European policymakers clearly not up to the challenges of mastering the crisis, obsessed by the irrelevant (inflation),  pushing their own agendas (downsizing government) or indulging small-minded nationalistic views (too many examples to mention). The problems in that other pillar of the West, the United States, are no less severe.

Standard and Poor’s has just downgraded US sovereign debt for the first time ever. It is not clear whether markets will shrug that this is merely a reflection of what everybody knows -  US policymaking is in a total mess, nowhere more so than on budget policies – or whether they will see it as a sign that some fundamental lynch-pin of the global financial order is coming loose. Or anything in between. Whether the view that prevails is rational is entirely another question, but, sadly, irrelevant.

I myself am still undecided on this (and not just because I don’t follow the US fiscal numbers so closely). On the one hand, I think that the rating agencies, which were something between inept and downright corrupt in the case of rating issuer-paid securities, have not deserved a lot of the flak they have received during the sovereign debt crisis on both sides of the Atlantic. It is too cheap to say: you were corrupt then, so shut up now. Here the ratings are unsolicited. The agencies’ job is too assess whether bondholders will be repaid in full. In my view the downgrades that we have seen broadly (I won’t say that no misjudgements were made and in the US case some facts are disputed) reflected the fact that, indeed, bondholders were at risk of losing money. Why otherwise was debt trading on secondary markets at a 40% discount? How was this risk of losses not increasing when politicians, cheered on by commentators  on both left and right, were insisting precisely that the private sector must make a ‘contribution’?

And in the specific case at hand, who would deny that American policymaking is dysfunctional? Put most simply, resolving the fiscal issues, at least with standard policies, relies on some combination of tax increases and spending cuts. In the US political system cross-party support is needed for that to happen. But one side doesnt want the former and the other opposes the latter.

On the other hand, what does the idea of the US government defaulting on its debt even mean? The debt is issued in US-dollars. At the risk of sounding obtuse, they are called US dollars because they are issued by the US government. I would say that the US government cannot default on its debt as long as it has printing machines and enough paper and ink, but even that is too restrictive. The government or its agent, the Federal Reserve, can simply credit the relevant accounts with the required sums. Unconventional? Sure. Inflationary? Possibly. Not an option for a euro area county? That’s exactly the point.

So there is no scenario short of something approximating to ‘the end of the world as we know it’ in which Uncle Sam would be unable to satisfy, in a legal sense, its creditors. In such a case we would have other things to worry about than bond ratings. This is precisely why currently interest rates on Treasuries are at historical lows. In these terms the idea of a downgrade seems rediculous.

So much for dispassionate argument. In four hours or so markets in Asia will open. And I am not the only one sceptical of the collective wisdom of the markets. We will see. European central bankers, for one, won’t be as relaxed as usual on a Monday morning, but let’s hope they are focused on the immediate task at hand. And who knows, maybe the threat of future curtailed weekends might encourage them to think about a more fundamental change of course.

Update: As expected the ECB has moved. (The G7 has also announced (vague) intervention plans.) As ever, when there was no other alternative. When will policymakers get ahead of the curve, do the right thing before exhausting all the other possibilities?

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