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Ratings Matter for the Euro Area

As you all have heard, Friday was (again) S&P’s day in the limelight. The rating agency downgraded over half of the 16 Euro area countries put on credit watch negative in December 2011. A quick look at my feed shows several takes on S&P’s action: the Economist’s Free Exchange comments on the now soft-core country, France; Michael Schuman hammers out the implications of the EA policy makers’ ‘misguided’ approach; Bruce Crumley (h/t Schuman) sees problems for Sarkozy; and as always, one of my favorite authors, Edward Hugh, eloquently characterizes the downgrades in the context of the real economy.

However, there’s one curt take on the downgrade that I disagree with. Barkley Rosser at EconoSpeak (h/t Angry Bear) compares the downgrade of France and Austria from AAA to AA+ as the same as a downgrade to the US or Japan. Furthermore, his title implies that these downgrades are irrelevant. I wholly disagree. There is one simple reason for this: France and Austria are subject to high rollover risk, while the US and Japan are not. Why? Because France and Austria do not have monetary autonomy over the currency in which their debt is issued (euros, to which the ECB holds the right to supply), so all debt issued can be treated as foreign-currency debt. Debt issued by the US and Japan is primarily local-currency debt.

A bit of background on ratings. When S&P, for example, changes its rating for a country, the rating that market participants (and the press) usually discuss is the foreign-currency rating. There’s another rating, the local-currency rating, that is used to quantify the risk associated with bonds denominated in the currency issued by the monetary authority. Now, for countries like the US and Japan, where the lion’s share of its debt issuance is denominated in its local currency, foreign-currency ratings are largely meaningless. The central banks in the US and Japan can always monetize debt issuance when needed. However, for any country in the Euro area (even Germany), debt is issued in a currency over which it has no effective control. Therefore, the foreign-currency rating is the one that matters.

For foreign-currency ratings, external indebtedness and leverage trajectories are key metrics. The next couple of quarters are likely to show either an improvement or deterioration in these metrics. If the real economy has not stabilized – the ECB desperately hopes it has – and turns downward in coming months and quarters, creditors in euros will favor the markets with the higher credit metrics, Germany, Netherlands, and Finland relative to those with lower metrics, France and Austria. Better put: if the growth trajectory is worse than expected – the 63 respondents to the ECB’s Q4 Survey of Professional Forecasters expect +0.8% GDP growth in 2012 – spreads to German bunds only remaining AAA with a stable outlook, as rated by S&P) will rise.

Ratings do matter for the EA countries. S&P’s action is a harbinger of bad economic and political things to come, not lower rates.

This post was originally published on my Roubini Global EconoMonitor blog, The Wilder View.

Fiction In the Washington Post

by Robert Waldmann

(lifted from Stochastic Thoughts)

Fiction In the Washington Post

I don’t want to make this a daily feature but Anthony Faiola and Michael Birnbaum made it hard for me to get past The Washington Post (my home page) without an angry blog post. In what is supposed to be a news article, they make a false claim of fact. They do not point to any supporting evidence (nor could they as their claim is plainly false) nor do they quote even a self appointed expert.

Their claim that “Europe‚Äôs crisis now is as much political as economic. It stems from a legacy of overspending and overborrowing, but …” is false. Spain and Ireland were running budget surpluses and had a debt to GDP ratio lower than Germany’s. Italy had a primary surplus and declining debt to GDP ratio. Germany happens to be the one and only country allowed to adopt the Euro in spite of not meeting the Maastricht conditions (which shows how stupid those rules were).

Now, I suppose that the claim is vague enough to be not proven false — they didn’t write public “overspending and over borrowing.” Indeed the root cause of most of the crisis, here in Europe as well as in the USA, ws a combination of banking deregulation and banker’s errors.
Here I think the problem is that they consider the sentence which I truncated to be a claim that the problem isn’t just over public spending and under taxing by Greece and Portugal. They go on to criticize Germany “but … it also reflects a lack of investor faith in the will of financially solid nations such as Germany to unite behind their troubled neighbors to shore up the currency union.” so they can’t say that the German position is total nonsense. That would be unBallancelicht.

But the German claims are false.

Wilder on ‘The euro area bond crisis in charts’

by Rebecca Wilder

Edward Harrison draws our attention to the euro area bond crisis: Spain, Italy, Belgium yields now under attack. I’d like to add to this thread by offering some illustrations of the polarizing of bond markets that’s coincident with the euro area bond crisis. (Notice I do not say currency crisis because it’s really the bond markets that are seething – the euro area, hence the currency, is thought to be relatively secure for now.)

(click to enlarge)

Spain, Italy, and Belgium are breaking away from the ‘core’, Germany, Austria, Netherlands, Finland, and France. But if you look really hard, France is showing a fair bit of stress too; it’s underperforming the other core countries.

This is ironic. By attempting to stem broader contagion by ring-fencing Greece, Ireland, and Italy, euro area policy makers focused market attention on those countries too big to quickly ring-fence, i.e., Italy and Spain.

(The complete post is at Newsneconomics)