About That Downgrade

by Andrew Stuttaford

The overdue decision by Standard & Poor’s to strip France and Austria of their triple-A ratings and downgrade seven other Eurozone countries is yet another hit to confidence in the sustainability of the EU’s embattled currency union, but should not have come as too great a surprise. Nevertheless it was (as Paul Krugman noted) good to see S&P acknowledge this (my emphasis added):

We also believe that the agreement [the latest euro rescue plan] is predicated on only a partial recognition of the source of the crisis: that the current financial turmoil stems primarily from fiscal profligacy at the periphery of the eurozone. In our view, however, the financial problems facing the eurozone are as much a consequence of rising external imbalances and divergences in competitiveness between the EMU’s core and the so-called “periphery”. As such, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers’ rising concerns about job security and disposable incomes, eroding national tax revenues.

S&P accepts the reality that the Eurozone’s leadership will not and (possibly) cannot face: one size does not fit all. Instead Merkozy & Co. persist with attempting to enforce a procrustean economic policy that may buy some time, but will not,  by itself, stave off the disaster that it may, in the end, make even worse.

Elsewhere S&P makes clear that, by throwing a lifeline to Europe’s flailing banks, the European Central Bank has provided a breathing space, but the rating agency is clearly (and correctly) skeptical whether financial institutions on life support will be very enthusiastic about providing cash infusions to countries that are themselves in the ER.

Recent Italian and other primary auctions suggest to us, however, that banks and other investors may still only be willing to lend longer term to governments facing market pressure if they are offered interest rates that, all other things being equal, will make fiscal consolidation harder to achieve.

Reading what S&P has to say leaves little doubt that it believes that a German-underwritten bazooka (euphemistically: “a greater pooling of fiscal resources and obligations”) remains the way to go.

Then again, S&P doesn’t have to answer to Germany’s voters.