Another nerve-shredding week for the global economy lies in store. Last Friday's downgrade of US government debt by the Standard & Poor's (S&P) credit-rating agency felt like a gratuitous punishment after five days of unremitting agony.
The announcement came after the markets had closed. Today we will witness the reaction of investors.
The agency is partly right and partly wrong in its judgment on the soundness of US debt. It is justified in concluding that US politicians have damaged the confidence of investors with their reckless behaviour over the raising of the US borrowing ceiling. If the Republicans continue to negotiate in that manner – namely holding a gun to the head of America's credit in order to achieve their political goals – the downgrade might prove prescient. Yet on the broader question about the sustainability of US borrowing levels (bar any further lunacy from the Tea Party) S&P is wrong. The dollar is the world's reserve currency. Regardless of the debates about projected spending levels, the simple fact is that US bonds are still regarded by investors as the ultimate safe harbour. We know this because American borrowing rates have been driven down during the recent market turmoil. If global investors continue to seek out American debt this week, despite S&P's downgrade, the credit-rating agency will turn out to have merely downgraded its own reputation.
But the US downgrade is merely one potential source of panic. Investors will be looking with trepidation to the other side of the Atlantic too. Yesterday there was an emergency meeting of the European Central Bank (ECB), which has been split on the question of whether to buy Italian sovereign debt in order to ease the pressure on that nation's borrowing costs. If the ECB fails to stand behind Italy today in the face of market attack, it will prove itself to be as reckless as the US Republicans. But it is not only the ECB which needs to wake up to the scale of this problem. Parliamentarians from eurozone nations need to return from their holidays and ratify last month's bailout deal without delay. And the size of the European Stability Fund needs to be increased significantly.
We should be under no illusions here in Britain about how exposed we are to these raging storms in global capital markets. There have been reports of ministers privately arguing that the UK has been effectively "upgraded" thanks to S&P's US downgrade. There have been some hints of Schadenfreude from Tories over the strains on the single currency too. But this Government is inhabiting a fool's paradise if it imagines that the UK economy can stage a recovery if the US and eurozone governments cannot staunch the bleeding of confidence which we have seen in recent weeks. Our banks are hugely exposed to the risk of default in Italy and Spain. As Coalition ministers were once fond of arguing, when it comes to the global economy, we are truly all in it together. And the fates of our political leaders will depend on them getting their act together.
Leaders and policymakers in America and Europe need to be working with a common purpose and an intense focus over the coming weeks on solving this crisis of confidence. The stakes could not be higher.