Bob Lyddon said there was a risk of the European Stability Mechanism’s spending power “falling off a cliff” – severely curtailing its ability to lend money to members of the EU27.
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The possible downgrading of France’s credit rating would have a catastrophic impact on the “firewall” relied upon by the Eurozone to safeguard the single European currency, a UK-based economist has claimed.
The European Stability Mechanism (ESM), an intergovernmental organisation based in Luxembourg, was established in 2012 with the intention of providing instant access to financial assistance programmes for member states of the eurozone in the event of emergencies.
He wrote: “The European Stability Mechanism (ESM) backstops the euro.”
Its nominal size was £605billion (€705billion) but its lending capacity is lower at £430billion (€500billion), with the main condition being that the EU27’s guarantees of the ESM’s solvency need to be good enough to convince credit rating agencies to assign the ESM a AAA rating, Mr Lyddon explained.
The difference between the ESM’s nominal size and its lending capacity acknowledged that the guarantees of some member states were not good enough, he added.
Mr Lyddon continued: “This structure is hanging by a thread. Standard & Poor’s Global Ratings attached a ‘Negative Outlook’ to France’s AA rating on June 2, 2023. If at any point France’s rating drops to AA-, the ESM’s roof falls in.”
The ESM was now the Eurozone’s “only significant bailout mechanism”, Mr Lyddon, founder of Lyddon Consulting, stressed, with the European Financial Stabilisation Mechanism (EFSM) possibly being able to lend as much as £25billion (€30billion) and the European Financial Stability Facility (EFSF) closed to further lending, with £164billion (€191billion) of loans outstanding.
Mr Lyddon said: “The ESM is the Eurozone’s alternative to having genuine central bank money.”
Britain has never been a member of the monetary union, having opted instead to retain the pound.
Mr Lyddon said: “If a Eurozone member state is unable to pay its debts as they fall due, it cannot instruct its central bank to issue more currency, as a genuine sovereign with its own currency like the UK can do.
“Instead the member state issues new debt that is bought by the ESM, and it uses the proceeds to pay the pre-existing debts it could not either service or refinance off its own bat.”
The ESM has so far loaned £74.1billion (€86.2billion) lent out, to Spain (£17.26billion, or €20.1billion), Cyprus (£5.41billion or €6.3billion) and Greece (£51.35billion or €59.8billion), leaving £355.48bilion (€414billion) up its sleeve, Mr Lyddon explained.
At present, the ESM’s credit rating was AAA, because enough large members – for example, Germany and the Netherlands – have high credit ratings themselves.
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Mr Lyddon added: “France’s position is critical, because it is big with a callable capital of €126billion (£108.19billion), and it is on the edge of losing its AA rating and dropping out of the group of member states whose guarantees are good enough.
“If France’s callable capital is deemed unreliable, the ESM’s firepower drops off a cliff, to €182billion (£156.27billion).
“The ESM cannot then discharge its purpose: providing debt relief to member states, regardless of their size.
“Put differently, a drop-out of France would bring the house down, exposing the circularity of this ‘auction of promises’ and the vacuum in the middle: the lack of genuine euro central bank money.”
