Standard & Poor’s was correct to downgrade France and seven other Eurozone governments, but wrong to affirm Germany’s AAA rating. The euro will inevitably collapse and chaos will follow, endangering even the strongest governments.
Profligate government spending surely caused many problems now besieging Mediterranean and French governments, but investors understand austerity alone won’t save them from default and the costs of refinancing and insuring sovereign debt have risen significantly.
Slashing government spending and raising taxes are pushing the Club Med and French economies into deep recessions, and tax revenues will not be enough to meet deficit reduction goals. Only rapid improvements in exports could get those economies going, but proposed labor market reforms will not improve competitiveness quickly enough. And those reforms will be tough to implement with unemployment above 10 or 20 percent.
Sooner or later, Greeks, Spaniards, and Italians will ask, if the euro is supposed to boost prosperity why are wages falling, taxes rising and unemployment so high? Political upheavals will usher in governments promising to quit the euro and remark sovereign debt to reinstituted national currencies. Capital flight and exchange rate depreciation will follow, imposing huge losses on creditors—European sovereign bonds, as valued in dollar or yen, will fall dramatically.
Once Italy quits the euro, others will follow, investors holding bonds issued by the European Financial Stability Facility likely will get stiffed. They would have been smarter to purchase Confederate currency for its collector value.
In 1999, the euro’s value against the dollar was initially set at the average for the currencies of participating nations and left to float in currency markets, but European leaders failed to reckon with a changing world.
Rapid growth in China, India and Brazil, and even Poland opened vast opportunities for German and smaller northern states’ technology-intensive exports and financial services, but imposed new competition on less innovative, more-labor-intensive industries concentrated in France, Italy and other southern economies.
Over time, the euro became undervalued for Germany and other northern states and overvalued for the Mediterranean economies and France. This permitted German industrialists to export like supermen, while unemployment rose and became more permanent in the South and France.
With national currencies, exchange rate depreciation would make the South and France more competitive—it would make imports more expensive, boost exports and create jobs. However, sharing a common currency with most of Europe, German and other northern economies export strength kept exchange-rate adjustments from happening. In the South and France, governments stepped in to shore up employment and incomes, spent and borrowed too much, and now sovereign debt burdens are impossible.
Also, when the European leaders created the euro, they did not reckon with the fact that Mediterranean and French voters see social democracy through different lenses than their northern brethren.
In varying measures, voters in Germany and other northern states more greatly value a robust private sector and expect governments to maintain a strong safety net. Whereas voters in France and the South value a robust government and expect the private sector to pay for it.
As President Obama’s tenure demonstrates, the latter view is a prescription for slow growth, job flight and high unemployment, and inevitably requires huge government deficits to keep the whole system from coming unglued. And as Mediterranean states show, and France is about to exhibit, the whole system becomes unglued anyway when investors start demanding much higher interest rates on government bonds.
Without a euro, Mediterranean and French governments would be able issue debt denominated in their domestic currencies, rely more on domestic banks, and print money. The combination of inflation and exchange rate depreciation would lower living standards but nothing like the draconian conditions now being imposed by German mandated austerity and bailouts.
In the end, a common currency is just paper and can’t compel changes in culture that cause the French, Italians and others to value security and early retirement over German prosperity.
Under these conditions, the euro can’t work, and German and French government resistance to an orderly return to national currencies requires that instability and huge investor losses follow the collapse of the common currency. In that chaos, not even Germany, Holland and other northern states are certain to prosper, and their ability to avoid huge deficits and default is hardly certain.
These systemic risks require that no Eurozone state is worthy of a triple A rating.
Peter Morici served as Chief Economist at the U.S. International Trade Commission from 1993 to 1995. He is an economist and professor at the Smith School of Business, University of Maryland.