UK debt downgrade represents opportunity to adopt policy that will benefit real economy

At the end of last week, Moody's downgraded the UK's debt.  Initial reaction to this was best summarized by the Guardian,

[from Ed Balls] "The downgrading of Britain's credit rating is, in the chancellor's own words, a 'humiliation' for this government … The first economic test he set himself has been failed by this downgraded chancellor. 

Yet, as we have seen today, he remains in complete denial, offering more of the same failing medicine, even though Moody's now agrees that 'sluggish' growth is the main problem."... 

"Over a weekend, he went from saying he must stick to his plan to avoid a downgrade to saying that the downgrade is the reason why he must stick to the plan. He used to say that a downgrade would be a disaster; today he says it does not matter. 

But he still warns that a downgrade in future might be a problem – until it comes along; then he will have the same excuses. It is utterly baffling and completely illogical. He is just making it up as he goes along."...

[From George Osborne] the downgrading was a "stark reminder" of the debt problems built up in Britain. ... 

"We can either abandon our efforts to deal with our debt problems, and make a difficult situation very much worse, or we can redouble our efforts to overcome our debts, make sure that this country can earn its way in the world, and provide for our children a very much brighter economic situation...

The debt downgrade was not a surprise.  As your humble blogger has been saying since the beginning of the financial crisis, so long as the burden of the excess debt in the financial system is placed on the real economy, the result will be a Japanese style economic slump.  The debt downgrade is simply confirmation of this.

What Moody's downgrading the UK debt did do is create an opportunity for UK policymakers to step back and evaluate the results of the policy of financial failure containment and the Japanese model for handling a bank solvency led financial crisis that was adopted in 2008.

An examination of the results would show that the financial crisis was a blip for the bankers who have continued to receive outsized pay packages and has been a disaster for the real economy with the elderly, the poor, savers and the under 30 year olds being particularly hard hit.

If a policymaker was not angling for a Tony Blair high paying advisory role with a bank, a policymaker might be tempted to look around and see if there was an alternative policy that might work better.

Finding this policy is not too hard as Iceland recently received an upgrade on its debt rating.

While not perfectly implemented, Iceland's policymakers understood that the policy of financial failure prevention and the Swedish model for handling a bank solvency led financial crisis was better for both the real economy and maintaining the social contract.

Under the Swedish model, banks are required to recognize upfront the losses on the excess public and private debt in the financial system.  This protects the real economy as capital that is needed for growth and reinvestment is not diverted to debt service on the excess debt.  This protect the social contract as the real economy continues to generate the funds need to pay for the social contract.

The Swedish model does have one significant downside.  It dramatically reduces cash payments to bankers or policymakers/senior advisors to the banks for a number of years - until such time as the banks have been able to retain sufficient earnings to rebuild their book capital levels.

As always, your humble blogger is hopeful that there exists a country whose policymakers but the citizens of the country ahead of the banks.  If the UK is that country, I expect that the policymakers will acknowledge what they are doing is not working and turn to the Swedish model.

If the UK were to do so, I confidently predict that the real economy will show significant improvement within 12 months.