France AAA Rating on the Line; SP Says 1 in 3 Chance of Further US Downgrades; Contagion in Downgrades? Currency Crisis Escalates; Euro Endgame
With the US AAA rating gone, how long can France hold its AAA rating? I suspect not long. So where will that leave the ECB attempting to put a circle around Italy? Will Germany have to backstop all of Europe?
Those are the new key questions and notice how the key question list keeps growing larger in size and significance.
France Vulnerable to Rating Cuts
Bloomberg reports AAA France May Be Vulnerable After U.S. Cut
The decision by Standard & Poor's to downgrade the U.S. credit rating leaves France as the AAA country most likely to lose its top grade, some investors and economists say.
France is more expensive to insure against default than lower-rated governments including Malaysia, Thailand, Japan, Mexico, Czech Republic, the State of Texas and the U.S.
"France is not, in my view, a AAA country," said Paul Donovan, London-based deputy head of global economics at UBS AG. "France can't print its own money, a critical distinction from the U.S. It is not treated as AAA by the markets."
"If Italy and Spain have difficulties, are we sure that, for instance, France can still be considered a 'core' country?" said Marco Valli, chief euro-area economist at UniCredit Global 'Core' is becoming a narrower group of countries."
While France's debt of 84.7 percent of gross domestic product is less than Italy's 120.3 percent, as a percentage of economic output it has risen twice as fast as Italy's since 2007. French government debt totaled 1.59 trillion euros ($2.3 trillion) at the end of 2010, according to the European Union; Italy's was about 1.8 trillion euros. France has had a larger budget deficit than Italy every year since 2006. S&P rates Italy A+, four levels below France.
"If French authorities do not follow through with their reform of the pension system, make additional changes to the social-security system and consolidate the current budgetary position in the face of rising spending pressure on health care and pensions, Standard & Poor's will unlikely maintain its AAA rating," S&P said in a June 10 report.
The S&P warned the US, now it has warned France. Notice how the rating agencies want austerity. I asked some tough questions above, here is a cream-puff question: Short-term, what will all these austerity measures do to global growth?
Japan Threatens More Yen Intervention
Adding to the global tension, Japan Official Warns of More Yen Selling
A Japanese Finance Ministry official said the government is ready to sell yen again following last week's move if it sees speculative trades driving the currency higher.
Further intervention would "maintain the effect and warn those who make unusual moves" in the currency market, Vice Finance Minister Fumihiko Igarashi said on a television program of public broadcaster NHK yesterday.
Japan acted alone in selling the yen last week, in contrast with a previous intervention in March that was coordinated among the G-7. The Bank of Japan added 10 trillion yen of monetary stimulus on Aug. 4, hours after the Finance Ministry's move.
Baba and Lee at Goldman Sachs said that Japan has been buying U.S. Treasuries when it sells yen, leaving it with more than 30 trillion yen in unrealized losses that will test the government's "true determination" to combat the currency's rise.
Japan maintains its trust in the ability of the U.S. to pay its debts and expects Treasuries to remain an attractive investment, a government official from the Asian nation said yesterday on condition of anonymity. Japan is the second-largest international investor in Treasuries, behind China.
Countries do not care much about losses on treasury holdings. They care about exports. Notice how even amidst the S&P downgrade of US debt Japan's reaction is to buy more.
I covered this topic at length on Friday in Reserve Currency Curse: Idea China to Stop Buying Treasuries After S&P Downgrade is Fallacious; US Would Welcome China Not Buying US Treasuries!.
Global Currency Wars
In spite of its stated "strong dollar" policy, clearly the US wants a lower dollar. It is equally clear (and stated) that Japan wants a lower Yen, Brazil wants a lower Real, Switzerland wants a lower Swiss Franc, and China does not want the Yuan to rise.
Yet every month, someone talks about China or Japan or some other country dumping treasuries or dumping the dollar.
In case you missed it, please consider Global Currency Wars Enter New Stage; Brazil Calls Off Truce, South Korea Reviews "All Possibilities", Philippines Threatens "Prudential Limits".
When does this madness blow sky high in a global currency crisis? I will tell you it is going to happen, I just cannot tell you when.
Europe's Structural Problems
Structurally the only way to resolve the European mess is
- Adoption of a European nanny state complete with common bonds and common fiscal policies
- Partial breakup of the Eurozone
Would Germany go along with the former? How difficult is the latter?
I cannot answer the former but the latter is easier said than done. Greece for example would immediately blow up in hyperinflation if it was forced to immediately go back on the Drachma. No one would want that. Capital and human capital would both flee Greece. The same might apply to Portugal and Spain.
Germany could leave. Otherwise, slowly but surely the European Nanny State solution will be forced down the throats of screaming German taxpayers.
The endgame is not clear, and both option 1 and 2 involve huge unresolved issues with global consequences. What is clear is the current path is unsustainable. There has never been a successful currency union in history that did not also involve a fiscal union as well. This time will not be different.