Modestly positive trading on European stock markets Monday morning appeared to confirm what euro zone leaders had predicted for weeks: that the decision Friday by Standard & Poor’s to cut the credit rating of nine European economies had been so fully expected by investors that it was destined to be greeted as old news when it actually happened. Yet if the supposedly ho-hum downgrade didn’t provoke a plunge across European bourses, it’s because markets were already well aware of the deeper, far longer-term concerns S&P cited in announcing its move–and that the market was overlooking those for now to act on shorter-term outlooks. It probably means that worst difficulties probably await member governments in the weeks and months to come.
Probably the largest of those tests will be creating what markets and analysts demand most from the euro zone: true integration of the 17-member club into the united body it has long claimed it is. As my colleague Michael Schuman notes in his story today, “until the leaders of Europe find a way to share sacrifices and allocate losses, the debt crisis will continue to spiral downwards.” Only in that way, Michael stresses, can mutually binding policies and reforms—including sticks of deficit and debt reduction and carrots like competition and growth stimulus—be applied to what’s now a too radically diverse economic patchwork of strengths and weaknesses. Indeed, as the S&P downgrade both highlights and accentuates, the euro right now is a lot like a locomotive pulling a string of first-, second-, third- and fourth-class three cars advancing at different speeds and lurching in divergent directions—and which could cause the entire train to derail if they aren’t brought quickly into greater alignment.
Perhaps fittingly, European leaders responded to Friday’s S&P downgrade with contrasting degrees of consternation. Though French officials had long said that retaining France’s triple-A rating was virtually a life-and-death matter, their comments over the weekend echoed the more recent phlegmatic change of tone. Several French cabinet members noted, for example, that the AA+ note Paris now shares with the U.S. is the next best thing to the lost top mark—and a drop in status that hasn’t led to the American government’s borrowing costs rising significantly. Some German officials reacted sternly by urging euro partners to pick up the pace of cost-cutting and reform, while others went the other way by joining European Union authorities in darkly questioning S&P’s motives and bone fides to intervene as it did–and urging the EU to establish rating agencies of its own (and in so doing raising questions about the motives and bone fides of creating such outfits from the outset).
Similarly defensive and angry voices were heard elsewhere in Europe—some wondering why S&P cut France’s rating when rival Moody’s decided Monday to stand pat with its AAA grade. Others questioned how S&P could possibly downgrade French debt while preserving the UK’s triple-A rating. Some critics and pundits lashed out at S&P with the claim that agencies and their ratings—which failed to see most of the major crises, market melt-downs, or bankruptcies of the past 10 years coming—simply don’t matter, and should be ignored. (This isn’t one of those, but is interesting on the topic of whether downgrades matter.)
Though S&P’s decision Friday was in many ways debatable (as have been its actions or failure to act in the past), it can also be said to formalize something that already existed within the euro zone: a hierarchical ranking of supposed equals. The cuts left only Finland, Luxembourg, the Netherlands and Germany with triple-A status (with the first three of those on negative watch), while France, Belgium, Austria and Estonia were all assigned to a second tier of relatively stable yet nevertheless subaltern grades. Below them come somewhat risky Italy, Malta, Slovenia, Spain, Slovakia and Ireland, followed by the junk domain of Portugal, Cyprus, and Greece. Whether that will result in an immediate and significant increase in debt financing costs for most demoted nations—i.e., above the rising rates that some like France were already being forced to pay on new bonds ahead of the downgrade—remains to be seen. Initial impact on looming French debt issues suggests that, if a spike comes, it won’t be immediate. However, the risk of that eventually transpiring is significant, especially as euro zone governments seek to raise over $40 billion in new loans from markets in 2012 as they roll over $1 trillion of debt–much of it in the first half of the year.
And that’s only one example of how a bite to one part of the euro zone often causes teeth marks to appear elsewhere in it. As dangerously stalled negotiations between Greece and creditor banks indicates, difficulties experienced in a weak section of the euro neighborhood will eventually be felt in even the stronger sections. For example, as the only euro heavyweight with all its force intact, Germany–with France downgraded–is having to weigh-in even harder to get a deal cut between Athens and its creditors—knowing the risk of a technical (or actual) Greek default could blow the single currency apart (and along with it, billions in German funds already pumped in to keep Athens propped up). Meanwhile, in the wake of the S&P downgrade Berlin has also resigned itself to inject even more German money into the European Financial Stability Facility to compensate for what markets will now view as less stable funding pledged by downgraded partners.
Germany shouldn’t expect gratitude for its efforts. To the contrary, many euro countries that have applied drastic austerity measures imposed by Berlin in exchange for bail-out money are openly complaining that the German obsession with cost-cutting utterly forgets the equally important funding of economic growth—a lack of attention that’s speeding the march of many euro economies into recession. As such, some commentators—including Michael Shuman in his story today–warn the German emphasis on debt reduction without attention to growth stimulus is actually worsening Europe’s wider economic situation.
That kind of criticism of Germany’s leadership in the crisis is bound to grow as economic activity slows further, market demands on new bond issues push financing costs to downgraded states ever higher, and looming national elections cause incumbent leaders to look for scapegoats abroad to blame their troubles on. The atmosphere in Europe won’t grow any happier, either, when (not if) officials elsewhere in recessionary euro nations offer their own form of schadenfreude at Germany’s export-driven economy grinding to a halt as consumer spending in its largest clients—i.e., other euro countries—dries up.
That scenario is exactly the opposite of what investors are looking for. Yes, they want debt and spending brought under control; but they also want clear signs of cohesive, intelligent, and efficient planning and policies applied across the entire euro zone as a means of creating a terrain conducive to significant and sustained economic growth. (The dirty secret is, markets don’t even care that much about sovereign debt levels so long as growth—and with it income states can generate from it—remains robust, and with it the profit outlook for companies and investors.) That requires a leveling of the euro zone economic, fiscal and labor playing field across the board in a way that both reflects and enhances true unity between members.
S&P’s decision Friday is a reflection that such unity doesn’t exist. Now it’s up to euro zone states themselves to decide whether that humbling serves as an excuse for why their common currency effort failed, or spurs them towards the sweeping measures required to save it.