by Peter Martino
January 17, 2012 at 4:30 am
Last Friday's downgrading of France and Austria by credit rating agency Standard & Poor's has left the eurozone, the group of 17 European countries using the euro as their currency, with just four countries with a triple A rating. Of these four Germany is the only one that was not given a negative outlook. Indeed, S&P thinks that the Netherlands, Finland and Luxemburg risk a further downgrade this year or next year.
This is bad news for the euro. The creditworthiness of the euro bailout fund, EFSF, depends on the ability of eurozone countries with the top rating to provide enough money to bail out eurozone countries in financial difficulties. With France, the eurozone's second largest economy, out of the top league the pressure on the four remaining countries rises. This explains why the Netherlands, Finland and Luxemburg were given a negative outlook. If these countries lose their ratings as well, even Germany, Europe's largest economy, risks losing its triple A rating. The euro is dragging all the eurozone countries down with it.
What Europe's politicians should do is draw up a contingency plan for a eurozone break-up, providing a blueprint for an exit of countries such as Greece and Portugal that urgently need to devaluate to save their economies. In last Friday's Financial Times, Nomura Bank's strategist Jens Nordvig gives a second reason why the eurozone needs such a plan, which must also offer guidance on orderly redenomination of euro-denominated assets and obligations in a break-up scenario. It would alleviate investor worries about such assets and improve the capital flow situation and funding costs. "Ironically," he points out, "spelling out guidelines for a eurozone break-up may -– at this stage in the crisis -– even help to reduce the risk of the break-up itself."
Unfortunately, it does not look as if such a plan is being considered. Instead of drawing up contingency plans, Europe's politicians continue their vain efforts to save the current European monetary union. When S&P announced the downgrading, angry European politicians, refusing to face economic reality, began to shoot the messenger. "It is not the rating agencies that dictate the policies of France," François Baroin, France's finance minister said defiantly. Austrian Chancellor Werner Faymann called S&P's decision "incomprehensible." German finance minister Wolfgang Schäuble warned against "overestimating the ratings agencies in their assessments."
EU monetary affairs commissioner Olli Rehn, a Finn, called S&P's decision "inconsistent" and said the agency had made mistakes in the past. Internal market commissioner Michel Barnier, a Frenchman, said S&P's evaluation did "not take into account recent progress."
Barnier is working on plans to establish a semi-official EU credit rating agency. Barnier has been castigating the three big agencies in the world -– S&P, Moody's and Fitch -– since the European sovereign debt crisis began. He argues that these three American agencies do not grasp Europe's economic realities.
The last thing Europe's politicians want to do is acknowledge that their own centralizing policy of imposing a common currency on such widely diverging economies and cultures as Greece and Finland, has caused Europe's current economic predicament. Instead, they blame capitalism, the financial sector and the "greed" of speculators and investors.
To "solve the debt crisis," French president Nicolas Sarkozy has launched a plan to introduce a eurozone financial transaction tax. Sarkozy is in the middle of a reelection campaign and has to convey the message to French voters that the banks, not he, is responsible for the current crisis, and that he will punish them for it. While investors need to be reassured and have their worries laid to rest, Sarkozy proposes to tax them.
Last week, Sarkozy received the support of German Chancellor Angela Merkel. Schäuble and Baroin have been asked to draft proposals for a financial transaction tax by March. Last September, the European Commission proposed a financial transaction tax of 0.1% on bond and share trades, and 0.01% on derivatives. The Commission expects that such a tax could raise €57bn a year in the EU -– about €10bn of which would be Germany.
Economists warn, however, that the tax will leave a big hole in Europe's public finances. France and Germany seem prepared to introduce the tax on their own. At best, the Franco-German alliance will be able to persuade the eurozone to go along, but Britain -– an EU member, although not a eurozone member -– will definitely not join. Hence, if the tax plans materialize, the financial centers of Frankfurt and Paris are likely to move their activities to London, as they did in the 1980s, after Sweden introduced the tax: over 90% of its traders in bonds, equities and derivatives moved from Stockholm to London.
The results could be devastating. Germany, whose economy slipped into reverse the last quarter of 2011, contracted by 0.25%. Prime Minister Mario Monti of Italy is prepared to support Sarkozy's proposed tax on financial transactions, but said it should apply to the whole 27-nation EU and not just the 17 eurozone nations. Merkel and Sarkozy will also have to persuade governments in the Netherlands and Ireland.
The Dutch federation of employers has calculated that the introduction of a financial transaction tax would cost the Dutch economy between €7.5bn and €24bn. The Dutch pension funds have warned that the tax would diminish Dutch pensions by 10%, as the tax would cost them €3bn a year. Unlike many other European countries' pension systems, which are pay-as-you-go -- in which the benefits of the pensioners are paid by the current workforce -- the Dutch pension system is largely financed from the contributions pensioners paid in the past and from the return on the investment of these contributions.
It remains to be seen whether the Dutch are willing to bring such a huge sacrifice. French President Sarkozy, however, has announced that France is willing to proceed unilaterally with the introduction of the tax.
Sarkozy's motives, however, are political rather than economic. As François Hollande, his Socialist challenger in the presidential elections, said after last Friday's downgrade: "It is not France that has been downgraded; it is Sarkozy's government." Sarkozy therefore feels compelled to levy a tax on the so-called greedy investors and capitalist speculators who, he claims, are responsible for the current crisis.
If Sarkozy loses the elections, Europe risks being saddled with a Socialist-governed France.
That is bad. If Sarkozy wins thanks to his financial transaction tax, that is bad, too. Either way, France will suffer. And with France, the euro and the whole European Union.
Brace yourselves: the eurocrisis has only just begun.