Saturday, January 14, 2012

S&P downgrades will haunt e-Zone and divide it

S&P depreciates much of old Europe: too much or not enough?

The ‘what’ of it all
Standard & Poor's Ratings Services stripped triple-A ratings from France and Austria and downgraded seven others, including Spain, Italy, Portugal, Malta, Slovakia, Cyprus and Slovenia. It retained the triple-A rating on Europe's No. 1 economy, Germany. France and Austria were downgraded by one notch from AAA to AA+; Malta, Slovakia and Slovenia were also downgraded by one notch. S&P lowered the ratings of Italy, Spain, Portugal and Cyprus by two notches. When you have to move your belt over more than one notch at a time it’s a big deal, so too with ratings.

Downgraded for ‘inadequate action’
In December S&P had placed 15 of the 17 euro-zone countries on watch for possible downgrades It said Friday it had decided to lower the debt ratings of nine of them because it felt the currency bloc has so far failed to take adequate action. But does that make sense? In what context are the ratings made? The current Zone? The prospective Zone? Until you know the context ratings are not really possible but S&P has plowed ahead.

Rating upheld for ‘inadequate action?’
I guess Germany retained its ‘AAA’ for the same reason: the Zone has done so little.  Had it done more, it certainly would have taken more of Germany’s resources. So in some sense the S&P is rating Germany as if it will stay on the sidelines. In that it is endorsing a certain form of the Zone with Germany's rating. The Zone is left with an EFSF (Europeans Finding Safety For-now) floundering. A fund has a hard-time getting a rating better than those that back it. And the bulk of the backing for the still AAA rated EFSF is from less than AAA-rated countries in the aftermath of the S&P downgrades.  How long can that last? If it lasts surely it limits any gain in size if the rating is to be upheld. Bye-bye fund flexibility.

Euro takes a hit
The euro fell sharply, hitting an intraday low of $1.2623, its weakest level since late August 2010. The euro has lost more than 10% against the dollar since late October. It is one of the main casualties of the downgrade process though it’s a casualty that will help to boost growth.

You can’t shrink yourself to prosperity
S&P did have the insight to see the limits to the ‘Germanization’ of EMU policy, saying. "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."

2-Tonic is wrong elixir?
EMU’s policy thrust has been Teutonic, well too-Teutonic throughout the Obama Presidency. Even the UK adopted it as part of some pied piper progression (although Wagner does not usually have that effect on people) in the wake of Obama’s first G-20 summit.  Had Europe and the G-20 instead accepted the Obama plan for stimulus at Obama’s first summit, global growth would be better now and government revenues would be higher. Unemployment would be lower and yes debt levels higher but debt ratios would probably not be as bad as they are now. And all this angst about it, in all probability, never would have arisen. Countries would not be like a wolf caught in a trap pondering gnawing off one foot to go free. But that is what has become of Europe.

The easy way out
We see this on Wall Street a lot. When a firm gets in trouble and starts missing its earnings it starts cutting expenses. In the financial industry and many others it is the easiest thing to do. But the trick is to cut in a way that does not harm revenue growth. The real trick when earnings miss is to expand sales but few firms have that acumen. Cutting is easier and that is true for countries too. Got a budget problems Raise taxes! Cut some expenses! Does that hurt growth? Probably but you get some kudos for taking a tough step even if it is in the wrong direction. European taxes already are so high they among the eight wonders of the world. They are about to get ‘K’ status as a new peak. But don’t try to climb them.

S&P does Zone disservice
In the END S&P has executed a bunch of downgrades that do not add up to much. The real issue is not that the EMU has not done enough but that it has no sense of what it is doing and where it is going. Until the Zone has a sense of common purpose (other than not drowning and not letting the weak drag down the strong) it cannot be successful and there will be more downgrades to come. Germany should not be rewarded for sitting on the sidelines. Keeping its AAA just gives it something to defend and makes it less likely to throw its lot in with the rest. Germans are going to think that staying on the sidelines is a good policy. It is not. Or to put it another way, it is not, if the e-Zone wants to survive intact. But what does that mean? Who or what is the ‘e-Zone’ and, in that sentence, what DOES it WANT? The Zone is not a thing. It is a concept. And each member has in its mind a different concept. And that is why in the end it fails. S&P has done EMU no favors especially not by playing favorites with the downgrades.



The euro zone is in terrible terrible shape their is one thing thats certain. More downgrades are coming.


Downgrades will come and go.