Mike Curtiss (16
Comes the Downward Spiral"
At the end of a briefly euphoric week, reality caught up.
On one level, Friday’s news was not really surprising. The
French rating downgrade was a shock foretold. As was the
breakdown in talks between private investors and the Greek
government about a voluntary participation in a debt writedown.
A proposition that was unrealistic to start with has been
rejected. We should not feign surprise.
And yet both events are important because they show us the
mechanism behind this year’s likely unfolding of events. The
eurozone has fallen into a spiral of downgrades, falling
economic output, rising debt and further downgrades. A recession
has just started. Greece is now likely to default on most of its
debts and may even have to leave the eurozone. When that
happens, the spotlight will fall immediately on Portugal, and
the next contagious round of downgrades will begin.
Europe’s insufficient rescue fund, the European Financial
Stability Facility, now also faces a downgrade because it had
borrowed its ratings from its members. The way the EFSF is
constructed means that its effective lending capacity will thus
be reduced. Even though the French downgrade did not come as a
surprise, the eurozone member states have no plan B for this,
just a few stopgap emergency scenarios. They may decide to run
the EFSF and its permanent successor concurrently. They may also
provide the latter with a full immediate allotment of its
capital. But this will create gaps in national budgets in a bad
By downgrading France and Austria but not Germany and the
Netherlands, Standard & Poor’s also managed to shape
expectations of the economic geography of an eventual break-up.
A downgrading of all triple A rated members would have been much
easier to deal with politically. Germany is now the only large
country left with a triple A rating. The decision will make it
harder for Germany to accept eurozone bonds. The ratings wedge
between France and Germany will make the relationship even more
The immediate gut reaction to Friday’s news is also a reminder
that the crisis and its resolution are taking place in parallel
universes. Angela Merkel’s comment that the EU should now
quickly complete the fiscal treaty is a typical example of that
disconnect. No matter what happens, fiscal discipline is their
answer. The crisis response fails to recognise the overarching
role of the private sector in the eurozone’s internal
imbalances. The conclusion of the fiscal treaty, which is the
top priority of EU politics right now, is at best an irrelevant
distraction. Most likely, it will enhance the trend towards
pro-cyclical austerity of the kind we have seen in Greece. I
also expect to see the EU administer a dose of regulatory
revenge against the rating agencies. Justified or not, this too
is a distraction.
I argued a while ago that the December summit was the last
chance for a comprehensive systems reboot. Back then, one could
have envisaged a grand bargain that combined a joint
eurozone-level budget, a eurobond, a policy regime to address
intra-eurozone imbalances and, in this context, also hard
national budget constraints. Ms Merkel and her acolytes in
Berlin and Brussels celebrated the outcome of the December 8-9
summit as a victory because it included none of the above,
except the budget balancing component.
Now that she has got everything she wanted, the system continues
to unravel. With each turn of the spiral, the financial and
political costs of an effective resolution increase. We have
moved past the point where electorates and their representatives
are willing to pay the ever-rising costs of repairing the
system. Last week a couple of senior parliamentarians from the
ruling CDU party, whom I had previously considered voices of
moderation, argued that a Greek exit from the eurozone would not
be such a big deal. Expectations are changing quickly, and so is
the acceptance of a violent ending.
And no, the European Central Bank’s huge liquidity boost is not
going to fix the problem either. I do not want to underestimate
the importance of that decision. The ECB prevented a credit
crunch and deserves credit for that. The return of unlimited
long-term money might even have a marginal impact on banks’
willingness to take part in government debt auctions. If we are
lucky it might get us through the intense debt rollover period
this spring. But a liquidity shower cannot address the
underlying problem of a lack of macroeconomic adjustment.
Even economic reforms, necessary as they may be for other
reasons, cannot solve this problem. This is another European
illusion. We are now at a point where effective crisis
resolution would require a strong central fiscal authority, with
the power to tax and allocate resources across the eurozone. Of
course, it will not happen.
This is the ultimate implication of last week’s ratings
downgrades. We have moved beyond the point where a technical fix
would work. The toolkit is exhausted.