Credit ratings agency Standard & Poor’s is really putting the boot into Europe.
Fresh from spooking investors with downgrades of Greece and Portugal, the agency decided to have a jab at Spain yesterday too.
The damage wasn’t quite as bad. Spain was only downgraded a notch, from AA-plus, to just AA. But it was more than enough to get the markets really fretting about “contagion”.
So what happens next?
Greece’s crisis has revealed the eurozone’s other sick countries
Analysts had a field day yesterday. The Greek crisis has been described as being ‘the next Lehman Brothers’ or even a form of financial ‘ebola’.
The problem is that, while Greece is in the worst position financially, its woes have reminded investors that lots of other countries are poorly too. And it doesn’t matter that Portugal has been more honest than Greece about its situation, or that its problems aren’t exactly the same as those of Greece – the market isn’t going to discriminate when it’s feeling panicky.
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As Jonathan Loynes of Capital Economics put it: “The crisis in Greece crystallises the worries about the dire state of the public finances in many countries in the same way that the collapse of Lehmans raised fears of a domino effect throughout the financial system.”
And S&P’s decision that Spain’s future looked dodgier than it had thought previously didn’t help matters. A highly inflexible labour market means that labour costs will remain high despite soaring unemployment. And the housing market bust threatens to act as a drag on the economy until at least 2016, reckons the ratings agency.
Currently, Europe’s politicians, alongside the International Monetary Fund, are debating bail-outs – for Greece now, perhaps for other countries later. The latest suggestion is that Greece might need €100bn to €120bn over three years, although details are not yet confirmed.
The markets have given up on Greece already
But there’s a much bigger issue here. The truth is that the markets have pretty much given up on Greece already. A default of some sort is being priced in. And that’s because this isn’t a problem of short-term liquidity. It all comes down to the fact that these countries’ economies are in dire need of fundamental reform.
The Portuguese have played honestly with their statistics. But their main problem, as one analyst put it, is that their economy basically doesn’t grow. That’s not something that can be rectified overnight with a little financial injection from the IMF. The same goes for Spain – the country has 20% unemployment partly because of its inflexible labour market, not just because of the recession.
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This is as much about politics as it is about economics. And that’s why it’s getting so messy.
Why should German voters agree to give the Greeks what amounts to a gift of taxpayers’ cash if there is no sign that Greece will change? That’s why German Chancellor Angela Merkel keeps hedging her bets – she can’t commit to an out-and-out no-strings-attached bailout until regional elections on 9 May are done.
But at the same time, the Germans can’t force Greece to be ‘more like Germany’. And how likely is it that Greek voters will accept a massive collapse in their living standards, simply to remain part of the eurozone? Particularly when, as they see it, they’ve been hung out to dry by their so-called partners? Unrest is already rife. The Greek air force has even gone on strike (or called in ‘sick’) now. No wonder Greek politicians are resisting calls for further wage cuts.
Why the euro is destined to crack up
The trouble is, politicians in both countries will keep following the path of least resistance. Up until now, that path has been to just talk about a rescue package and hope that the problem will go away. The problem hasn’t gone away.
So now they’ll try to come up with something, probably a short-term patch of some sort. But agreeing all that is going to be very difficult at a time when everyone involved has an eye on their own domestic voters.
And whatever comes out of it, markets will continue to believe that some form of debt ‘restructuring’ is the ultimate destination for Greece. And that means they’ll also remain very wary of buying into the debt of ‘Greece-type’ countries, which in turn makes it more likely that these countries will run into funding problems in the future. For example, Italy is trying to sell between €5.5bn and €8bn of two, five and ten-year bonds today. We’ll be watching to see how successful that is.
In short, there’s no easy answer here. The financial crisis has simply revealed all the problems and internal contradictions within the eurozone that were easy to ignore during the boom times. Now that everyone realises that Germany can’t dictate Greek economic policy, and Greece can’t depend on Germany to give it a loan, it’s surely only a matter of time (although it will take a long time – perhaps years) before one or other of them leaves the eurozone.
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