The Ratings Race
Last week’s announcement of downgrades for several European countries, as well as the European Financial Stability Facility (EFSF), produced an echo somewhat familiar to many Americans: resentment and a quick search for blame. Some even looked under the table for a conspiracy against the Euro, cooked up in either New York or London.
But the bottom line was in fact the bottom line – the arithmetic did not add up to a formula for economic stability or reliability when one took a hard and unvarnished look at the accounts. In laying out their analysis, Standard and Poor’s did not make public what was not already visible. “The policy response at the European level has not kept up with the rising challenges in the euro zone” as one S&P representative put it. “There appears to be only a partial recognition of the source of the crisis” added another.
What the main message seemed to be is that the response to the euro crisis remains muddled. The plan appears too focused on fiscal austerity as the main weapon – without adequate solidarity being generated to deal with the increasing divergences between the core of the euro zone and its peripheries. The efforts to achieve a consensus at the December 9th EU summit were deemed inadequate and “did not produce the breakthrough of sufficient size and scope to fully address the euro zone’s financial problems”
In some ways, this sounds similar to the last August downgrade of the U.S. Here, the verdict after the enactment of debt ceiling legislation is much harsher:
“The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy….the differences between political parties have proven to be extraordinarily difficult to bridge…the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envision….”
In both cases, there is an argument that the political will to deal with the real sources of what is at the core of fiscal and economic problems is missing.
Responses to the downgrade were reflective of the mix of domestic politics and the sluggish process of European consensus-building. French President Sarkozy is worried about what this will do to his campaign for re-election this spring. On the other hand, German Chancellor Merkel, who does not face an electoral race until next year, argued that Europe has to up its game in getting a grip on the tools needed to maintain confidence in the markets. For Merkel, this means implementing a fiscal compact to underline mechanisms of common fiscal rules, which are seen as a way to maintain a path toward reining in massive budget deficits.
Merkel has been able to sustain her popularity in the polls throughout this economic storm by arguing that she is standing up for the very rules that have helped Germany maintain its AAA rating. Yet the gap pointed out by the S&P downgrade between Northern and Southern Europe is seen as growing without a clear consensus on how to cap it.
The challenge facing both sides of the Atlantic is a political one. Forging a consensus around the debt and deficit issues in the U.S is going to be near impossible this year given the presidential and congressional campaigns. At best, the U.S. can hope for some ad hoc efforts – like the payroll tax agreement – to get us through this volatile year. That leaves a great deal of time and money wasting away until the dust settles after Nov 6th. Even then, whatever the results of the elections will be, the analysis of the American political system cited above may remain valid.
On the European side of the Atlantic, the forging of a political consensus will be made difficult by the presence of struggling national governments in every capital of Europe. The difficulty of even producing a national consensus within each member state will shape the parameters of an EU-wide formula for the future.
The downgrades were a snapshot of a race being run between governments and both the markets and the domestic political mood of countries facing serious choices. How that race turns out this year will determine which choices and which leaders are going to be winners and losers. The question is: how much time will be left on the clock before it runs out?