05/08/2011 Newsnight

Good evening and welcome to Good evening and welcome to

Newsnight, also being broadcast tonight on BBC world News. Five days

ago global investors were pondering the possibility that the US

government might default on its debt. Then they were told they could

relax but instead they started to worry about the American recovery

grinding to a halt and European governments hitting a brick wall

their efforts to fix the single currency. Tonight, after the

week for the Dow in more than two years, an US broadcaster is

reporting that the key ratings agency, Standard & Poor's, is about

to stop giving American government debt a Triple A rating.

the end of another hair-raising day, here is Andrew Verity to explain how

we all landed up in so much trouble again.

There's no time like August for an There's no time like August for an

There's no time like August for an international financial crisis. Two

international financial crisis. Two international financial crisis. Two

There's no time like weeks ago, markets across the

had enough confidence in Europe's institutions to be convinced by

leaders' assurances that they could deal and were dealing with the

crisis in sovereign debt. This was the week that that confidence

collapsed. Now it's as if Europe's leaders are giving up trying

reassure the markets; instead, have taken to attacking them. The

market unrest witnessed in the last few days is simply not justified

the grounds of economic fundamentals. Such dramatic changes

in the markets are from of view incomprehensible. On this,

the busiest trading day of the year, shares in London dropped again by

2.7%. Over the week the top companies have lost more than 10% of

their value, around �150 billion, with similar drops across Asia and

Europe. It has been the worst since the banking crisis. 2008,

almost exactly four years credit crunch which caused that.

What happened in the credit crunch of 2007 was that the banks became

reluctant to lend money to each other. It was as if all of the

here at Canary Wharf were looking each other, thinking:

how many billions of pounds you have lost on these bad assets, I don't

know even how many billions of pounds I've lost so I'm not sure I

want to lend to you when I know if I will get it back.

lend but only if you pay a fat rate of interest to compensate me for my

risk. The question now is: same phenomenon happening again?

What caused it back then was concern over the value of billions of

dollars of assets. The same concern; different assets. Those who have

lent money to eurozone countries by buying their government's bonds are

worried they won't get all their money back. Here is how worried. If

you bought a bond from the Spanish government the markets reckon

will get back only 96%. .

With that much uncertainty, there With that much uncertainty, there

isn't a credit crunch now, but there may be soon. Well, at the moment the

fundamental case is that a lot of European economies in common with

the UK and US borrow from overseas investors. At the moment, overseas

investors haven't got confidence in our domestic economy so they are

more likely to wait before putting more money in, and that's what

causes the shortage of funding which manifests itself as a credit crunch.

These foreign investors need austerity measures, a degree of

political consensus, and that will give them confidence

safe to lend to these again. The way the credit crunch

resolved four years ago was nanny came to the rescue in the

shape of the state. It was governments and Central Banks that

told the other banks: if you bad assets that no one else wants it

buy, we will buy them from you. They told them: if you can't get funds

from other banks, we to you. The question now is: who is

willing to play the role of nanny? Not Angela Merkel, who has been

very aware of just how far German voters aren't willing to go to

out member states who lack fiscal discipline. Today she spoke

telephone to Nicolas Sarkozy. They have to come up with

what? The first thing that needs be done is that the European Central

Bank should start buying Italian and Spanish bonds on the

secondary market and therefore bringing the yields down. It

to do that pretty quickly. yields have gone up significantly

and that means for that the debt - not all the debt -

portion of the debt, that has become very expensive. We are not

suggesting it will be hugely expensive for the whole lot, but

they need to calm markets nevertheless so that when countries

go back to the markets again they can borrow at lower rates. Claiming

Italy is under attack from speculators, Italian Prime Minister

Silvio Berlusconi has called an emergency meeting of G7 finance

ministers to take place within a few days. They must act or they will

have a hectic holiday season. I think there needs to be a political

consensus across Europe and that is nigh on impossible to

the moment. I think therefore we have to wait until the crisis

possibly looks worse and this game of brinkmanship comes to a head

whereby European politicians realise there is no alternative but to all

get together and act multilaterally. The banking system didn't stabilise

itself in 2009 until global governments made it clear they

defend the system no matter what. Now it's up to politicians to defend

The markets are telling Europe's top The markets are telling Europe's top

bankers and politicians that they are unconvinced by their assurances.

They don't really believe them. But perhaps Europe's leaders can agree

with the markets on one thing: they are not giving eurozone countries,

institutions nor leaders much credit.

Andrew Verity there. Anyone working Andrew Verity there. Anyone working

Andrew Verity there. Anyone working in the financial markets will

in the financial markets will in the financial markets will

Andrew Verity there. probably just be glad that the

weekend is final here. A huge of red ink has hit dealers' screens

over the last two days and they had another seesaw ride. We

asked three correspondents in key global financial centres to tell us

what it has been like for them. First Lucy William

First Lucy Williamson in Here in South Korea the sun has set

on a very dark day for the markets. The index fell 3.7% today, the

biggest in a series of losses over the past four days. It's now facing

its steepest decline in almost three years. Government officials held

emergency meeting today up to road - up the road here and are

insisting there's no reason to panic. Korea's economy is being

shaken but uncertainties in America and Europe but 70% of its trading

partners are emerging countries. There's not much comfort elsewhere

in Asia. The Nikkei fell 3.7%, Hang Seng in Hong Kong by more than

The main stock market index here in The main stock market index here in

Germany the Dax fell by 13% over the whole week. The main index in France

fell by 11%. In Italy it was 12%. It's all part of a relentless slide,

as stock markets start to realise that that deal apparently done less

than a month ago to stabilise the euro may not now be the last word on

the matter. At the Stock Exchange here you get the feeling activity

goes on. Angela Merkel is apparently relaxing in the Alps but there's no

doubt that that is short-lived. has been engaged in conference calls

with other leaders of eurozone countries. Her big constraint

public opinion here in Germany. The opinion polls indicate that people

by and large want the euro. There is no great yearning to go back to the

Deutschemark. But the polls also say that they are absolutely split down

the middle on whether to pay more of their money, taxpayers' money, to

keep that euro in its current form. .

Here in New York, it has been one of Here in New York, it has been one of

the more dramatic weeks for the the more dramatic weeks for the

Here in New York, it has stock markets. On Thursday, the Dow

Jones industrial suffered its worst one-day loss since 2008 falling 4%.

The Standard & Poor's index didn't do much better. So what's behind

this sea of red? Well, the is that the US economy is

back into recession, and here is why. The week started with a debt

deal that cut US government spending, putting the US on

austerity path just when recovery appears to be faltering.

Manufacturing and consumer spending data was also weaker than expected

and today's jobs report simply offered only a tiny amount of

relief, just showing that employment picture wasn't actually

getting worse. .

Well, all day we have been hearing Well, all day we have been hearing

the comparisons with the dark days of autumn 2008, the credit crunch

and the great banking crisis. say the parallels over the top, the

banks for starters, are different; others say it's worse. With

Baroness Vadera who had a ringside seat on the last crisis, working

with Gordon Brown in the Treasury. You played a big part in writing

that bank bail-out plan time many people credited with

turning the situation around and taking the markets out of the sort

of death spiral that they were in then. Does this feel similar to you,

the last few days? I think it has similar feel. It feels as scary

it is different and I am in the camp where I think it's

potentially worse. The reason potentially worse is the governments

stepped in all over the world saved the banking system in order to

save their economies and now who is going to step in to save

governments? Secondly, when we went into that crisis interest rates

quite high so we did have policy to use as a tool and now we

are at the outer limits of that. Lastly, we are currently facing

quite a lot of inflationary pressures, particularly coming from

commodities and emerging markets, so we've actually got a little bit of

pressure on the other side, so our room for manoeuvre is a lot more

limited. As someone who has been an insider for so long on

of crises and you played a big part in the G20 meetings as well, if you

were in the French Treasury tonight or if you were sitting at the ECB,

what are the calls that are being made? What are they going to be

thinking about over the next days? I think that the problem

they have currently is they don't have a functional system for making

decisions. They don't have institutional mechanism for making

decisions in the way they need to be made. The crisis in the last few

years has taught government some lessons. You have to act really

fast. You actually probably have to act without the market expecting

to. You have to overshoot market expectations. You have to be

comprehensive and see off all of the avenues of attack and most of

you have to communicate fighting with each other and so far

the eurozone has not managed to single one of those things. So I

think what they will be doing now is talking about liquidity for

Italy and for Spain, and the only source of liquidity - Liquidity,

giving them cash in some way or another? Giving them cash,

not the same thing as risking putting in a huge amount of risk,

the numbers are large, and the only source of ready cash is the ECB.

Because they haven't really pre-committed to the EFSF, so this

is the only source of funding and the ECB of course has a duty to

financial stability, so has a duty to act, but they will be very

reluctant to do so without reforms. But a lot of people

has been a talk in the last weeks and months, people

European leaders are kicking the down the road, even US governments

maybe have been putting off difficult decisions, but isn't there

an argument that says you guys put off all the difficult decisions

well? You were faced with a crisis, a lot of debt sitting on

balance sheets, ultimately a lot of the problematic debt in the bank

sector didn't get written off as maybe it should have done, it got

shifted on to the balance sheets governments and now we are dealing

with the second leg of a crisis that you sort of left us with? Actually

it's not true because the response at the time stopped essentially

position that would have been a lot, lot worse. We would have been in a

much worse position today if we hadn't done what we did all over the

world. We would have been in depression and deflation. We did not

assume the debts of the banking system. But a lot of these debts,

if they were not going to be repaid, why were they not written off

That is what people ask now. Yes, would have been difficult but aren't

we just now dealing with that has been passed along for

several years? I think that what did in the response in 2008 was to

stop that debt spite, but it was always going to take - always

to take a long period of time to deal with the overleveraging of

whole system, whether in banks, governments or in households and it

was always going to take a long time to deal with the level of toxic

assets. We didn't assume - for example Ireland - we did not

assume the debts of the sector. Briefly, you don't think

you should have been tougher and gone further in dealing with the

fundamental problem which is debt? I don't think it was

at that time without actually tipping us over the edge

gone further, but it was always going to be - some of these problems

now are self-inflicted. The cost of dealing with them has increased

because of the delays in dealing with them and that is the real

problem of the eurozone crisis and in of course the US has also been

self-inflicted. Baroness Vadera, thank you very much. Thank you. As

we have been discussing there are deep economic problems lying beneath

all of the yearses in the markets because - gyrations in the markets.

But most worrying for some has been the politicians' inability to

confront those issues. There is one big difference between now and

Back then, the worries centred on the banks. Today they are in the

frame, but the focus is on the paralysis of politicians on both

sides of the Atlantic, whether it's American budget policy or the

troubles of the eurozone, governments just don't

able to confront the problems they face, but perhaps we shouldn't

that so surprising. I think policy paralysis is actually a really big

difficulty because politicians have to assume, have to be optimistic

about the future. They assume that growth will somehow rebound. That's

the experience we've had for the last 40 or 50 years. When things go

wrong, they correct pretty quickly. This is really the

first time when we've seen things going badly wrong and they haven't

corrected particularly quickly. The consequence of that is that it

forces politicians to have to consider and contemplate really,

really tough decisions. Some say the problems go even deeper, that

integrated global markets and national democracies just don't mix.

To come together to fix global problems, countries need to

some national sovereignty and that's not something that democratic states

find easy to do. You see this in trouble the G20 leaders have had

resolving imbalances in the economy and you surely see it in

acute form in the struggles of eurozone. We have a policy crisis

worldwide. Policy is deliver vision. We want to see,

can America, how can euroland along with a perspective? How

able to get the economic the table? Now we are not ready and

not able obviously on a basis to solve these problems. The

moment of truth in financial crises comes not when governments run

of options but when they come out of politically possible ones, like when

Norman Lamont raised interest rates to 15% to defend Britain's place

the ERM in the middle of a recession. That was when the

knew the game was up. After the events of the past few weeks,

Europe's politicians must battle now to convince the doubters that they

haven't exhausted the realms of the politically possible.

With me now, Holger Schmeiding, With me now, Holger Schmeiding,

chief economist at Berenberg Bank in London; David Riley,

rating agency Fitch Fitch; the economist and author, Noreena Hertz,

and fund manager Joanna Kryklund from Schroders. David Riley, can

start with you, to pick up on something in my piece there,

a sense that there's now with the euro. If they are going

to hold it together, they have to take a big step towards fiscal union

and yet it doesn't seem like anyone in Germany or in a lot of

places is ready for that to Is that the basic fact that we are

facing? That seems to be really what the market has been now

concluding and demanding, which is either we have effectively a United

States of Europe or the not viable and the euro will

disappear, certainly in its form. I think what's

that increasingly the market is pushing policy makers and Germany

particular closer to the position where it's going to have to

some of the policies which it has not wanted to do, which will take it

closer to fiscal union, example I suspect they will start

dusting off plans for a common euro bond, which will issue for

everybody, will be joint and severally guaranteed. If

increase the size of the fangs stability facility,

essentially the rescue fund that, could ultimately become a sort of

debt management agency if you like for Europe, so I think they are

being pushed towards fiscal union but kicking and screaming

way. Holger Schmeiding, two weeks ago the

ago the Germans were not ready even for that kind of bond, does it just

take every few weeks another market crisis to push Germany down

road? There is something to that, yes. It takes one crisis sort of

after the other to push the Germans towards that, but the Germans will

always exact a price. What the Germans will always be asking for

each stage is, if we the Germans have to issue stronger guarantees

than you our partners, please subject yourselves to stronger

fiscal surveillance. So it's a mutual process. If Italy is ready to

put a balanced budget amendment into its constitution then the Germans

are ready to grant more. So it's a mutual process of the two

coming together. OK, but Noreena, we are talking about - when you talk

about surveillance, you are talking about Germany getting more and more

- in return for the money, Germany getting more and more control

other countries' policies. Mmm. you think that can happen? Do you

think that's something democratic that could happen? I think it's

very worrying and I think in Germany in particular Angela Merkel

having to walk a very tight line between what Europe needs and what

her domestic electorate are wanting. We've got to remember that she had

bad election in the federal elections, the CDU, and so for her

to sell to the German people this plan and Germany bailing out

essentially the rest of Europe is going to be problematic. Then,

imposing in return austerity programmes potentially on countries

that are barely coping is to be good for Europe. It's not

going to be good for any of us. But that's a good point, do you think

that countries are getting forced into policies that actually could be

counterproductive for growth, for their economy, or as far as you are

concerned you are managing billions of dollars worth of assets, you can

never have too much fiscal austerity? How does it work? Well,

no, unfortunately we do need the politicians to get ahead of the

curve, to some extent they have to shock and awe the markets. What if

they can't? The problem is the last few weeks we seem to be seeing

they can't. What they will continue doing, I think, is

buying themselves time so in short term the markets are going to

have to keep on focusing on sort of news flow and the

that we are not going to get sustained rise in equity prices

while this situation is ongoing, and that's particularly while economic

growth globally is weak. So I really for markets to enter

sustained uptrend we need to the one hand a credible solution out of

Europe. I think that will long time. On the other hand,

something that maybe will come sooner is some kind of improvement

in economic statistics which we not seeing at the moment. I am

interested to ask you, it has mildly nauseating the last few days

the way the Chancellor has sort of crowed here about how we

haven and no one is worried about our commitment to cutting the

deficit. I assume that you are piling into the UK in a big

way with your fund? I wouldn't say that, but I think that certainly the

UK has one major advantage relative to the eurozone and that

to weaken their currency relative to some of the member states within the

eurozone and I think that has huge advantage. I think that comes

back to the point that you were asking me about earlier which is

from the perspective of an is there any such thing as too

austerity? Well, actually there is. Ultimately we want to see growth,

especially if investing in the equity markets and the fact that

there's this fundamental rigidity the eurozone and the countries

are struggling can't devalue currencies, which is the way the

Asian economies for example got of their crises, is a concern. So

it's a careful line we are treading. On the one hand we want European

policy makers to show they of the curve but at the same time we

don't want measure measures that are too extreme because ultimately that

means a lost decade for growth in Europe. Exactly, like the problem

in Japan in 1996/97 when they did try and balance the budget far too

quickly and ended up with this decade which we are now potentially

facing in Europe. But there was political paralysis at the heart of

that as well. That is why it's an example of what I was talking

in the film, that the politicians were - but do we have the

capability, capacity and leadership here in Europe to move

out of a out of a state of paralysis? I'm not

sure. There's a big difference to that, namely when we look at what is

happening in Europe, look through the turmoil, we are actually

a wave of structural reforms. We are seeing the labour market reforms,

that is Europe beneath the surface, but Neath the noise is actually

delivering all the the end will make the place better,

which is if Europe manages to buy time, after that time is over,

Continental Europe will be in a much better shape than it is today. But

structural reforms, another way of putting it - And in that process, we

are going to have millions more people unemployed, we are going to

have consumer confidence David Riley, the point is, that is

a worry, isn't it, say we assume that there's just going to be slow

movements, Germany with a gun to its head, moving closer and closer to a

fiscal union; doesn't that, the best of all worlds, doesn't it

condemn large parts of Europe to very slow growth for years? It does

potentially, but I actually don't think that's going to be a viable

strategy. I think what actually needs to happen, the markets are not

going to wait for structural reforms to transform Italy into a dynamic

economy. Essentially, there was a real risk now of a self-fulfilling

not just a self-fulfilling liquidity crisis but a self-fulfilling

solvency crisis. Italy and Spain are solvent but if the market is saying

we are only willing to lend at 7 or 8% over the medium term then

will become insolvent so the ECB must intervene. But can the

European Central Bank be a stop-gap in this? It hasn't got any -

would say that was a fundamentally political act and it is

independent institution; it's not supposed to be just doing the job of

governments. The European Bank can do exactly what the Bank of

England does, what the Yes. The European Central Bank is

an extremely powerful institution. If they step up to the plate, which

they reluctantly will likely do, they can defuse the crisis and if we

again make these comparisons, always remember the eurozone has as a unit

a fiscal deficit much smaller than that of the US and the UK which

means if they want to they can get things under control. They just

to be pushed to do it. Actually, we haven't very much longer and

obviously this news about the US is quite important tonight, and I

we have been talking about of politicians and we started

week looking at rather paralysed American politicians. David,

should get your reaction to the about Standard & Poor and them

taking away the US Triple A rating. Yes, I think

Poor's signalled their intent to downgrade the US. I don't think it

will come as a surprise. Are we going to see a real market reaction

to that on Monday? Is this the end of the world? Yonks, no. I suspect

not. I think at the moment they care more about that than downgrades. I

think at the moment we need stabilisation in the economic data

because if growth improves that helps put some of the sovereign debt

concerns on the backburner. With respect to the potential

of the United States, the it is still one of the most highly

rated economies so it won't a sell-off in US bonds necessarily.

It might provoke a sell-off in lower rated bonds as people shuffle their

portfolios. So basically the US stays top dog and everybody else

loses their Triple A as well? don't know about that but it is

still favourable for the US Treasury at the moment despite the downgrade.

Do you see some of the same kind of paralysis in the US? Do you think we

are being too kind to American politicians? I think we

politicians? I think we actually are seeing worse paralysis in the

US. In the eurozone we experience over the last 18 months.

I disagree with that. There's a crisis, they always react and in the

end they manage to defuse the crisis. In the you had we have this

stupid situation, they cannot agree to borrow for a while so the

eurozone has problems but it's not that dysfunctional, it just is

rather noisy. You are saying noisy. I don't think anyone looking at the

eurozone in the last few weeks recognise your description of them

fixing the problem. No, not here, but once they react to problems

now they have one and we will see on Monday how they react. I think

that's a particularly toxic cocktail right now. On the one

the US, very flat growth, flatlining, we have unemployment

high there, yes the unemployment figures were a little better but

still high, and this potential downgrade, and on the other

have Europe with the eurozone now widening the crisis to Spain and

Italy. One on its own would have been worrying. Two together, can the

world cope? I'm not sure. I think double dip ahead. Is the answer,

you are an investor, just to get of America and the US? Go to

emerging markets? Certainly island avoid Europe for the time being,

yes, but in the meantime I there are opportunities

United States and emerging economies. Thank you very much to

all of you. I just want to look at tomorrow's front pages. The FT

predictably it's a big day: week echoes depths of 2008 crisis.

On the Independent: where are you, On the Independent: where are you,

EU? Britain takes �150 billion blow as debt chaos hits economy. So not

such a safe haven according Times. And that story we've had

today: the British team killed by polar bear in Norway. And the

going its own way: Eton pupil killed by polar bear.

That's all from Newsnight tonight, That's all from Newsnight tonight,

we will leave you with the site of Nasa's Juno spacecraft

Nasa's Juno spacecraft heading for Jupiter. It will fake five years to

get there by which time if you are an optimist you might say this

planet's economy might just have sorted itself out. Ignition, and

Apology for the loss of subtitles for 40 seconds

lift-off. MUSIC

you have outdoor plans. The weather will keep us on our toes. A

promising start for many. Showers will get going, and as you can see

by the afternoon they will be fairly widespread much pretty heavy

aisle-moving ones too - slow-moving ones.

Some brighter spells and a lucky few Some brighter spells and a lucky few

will stay dry through much of the day but showers never far away which

will keep temperatures down. Feeling breezy around southwestern coasts so

not ideal holiday making down Devon and Cornwall. Limited

brightness with showers coming in the breeze. A similar story across

Wales, a lot of cloud with from time to time. Northern Ireland

seeing some sunshine, I think, but even that will not help temperatures

much. 16C in Belfast and for Scotland some sunshine across more

northern areas but shower building up and turning pretty wet

into evening. and east of Scotland.