By now, everyone knows that S&P downgraded 9 eurozone countries on Friday, including France and Austria who were stripped of their coveted AAA ratings. But many, like Goldman Sachs Asset Management Chairman Jim O’Neill, have noted that everyone saw this coming.From O’Neill’s latest Viewpoints From The Chairman note:
Given that the downgrades were highly signposted, it has to be one of the most widely anticipated moves of all time. Putting this together with the fact that when both Japan and the US lost their AAA credit ratings a long time ago and there were no discernable negative market consequences, I am not sure this news is that interesting. It will certainly be a source of political fun and games especially in France, but whether it is relevant for the markets remains to be seen.
His last point is certainly a notable one. Europe hasn’t made a major headline in weeks, yet the continents debt woes continue to deteriorate. If anything, S&P has reinvigorated the conversation.
Having said that, he notes that S&P doesn’t seem to believe austerity is the right way to fix Europe.
What is more interesting to me as I read the S&P statement and the brief comment from John Chambers is the rationale used. S&P appear to doubt the likelihood that the fiscal compact will be successful in contributing to a framework for stronger growth, implying that fiscal tightening leads to weaker growth which then leads to bigger deficits. In that regard, their decision endorses the views of many observers that the German-inspired fiscal compact is not really the right path.
O’Neill’s prescription for fixing Europe is economic growth. He notes that many argue that Europe should fix the competitive imbalances within the eurozone. But for one country to become more competitive (eg Greece, Portugal), another must become less competitive (ie Germany).
Rather, O’Neill argues that the eurozone as a whole needs to think about becoming more competitive with the rest of the world. And the only significant force that can help on this front is the ECB.
Where the Euro Area can achieve more competitiveness is against the rest of the world, and this links to the broader required response to the S&P verdict this weekend, an easier monetary policy from the ECB, and stepped up efforts to reduce long term interest rates in the troubled Club Med countries. A further significant easing in Euro-wide financial conditions is the appropriate response to the fiscal compact, as it will be this that will help soften the cyclical blow from tightening. Whether the Euro Area can achieve this at a time when Japan, the UK and the US are all eager to maintain their own easy financial conditions, if not strive for even easier ones, is amongst further challenges, but at least the ECB needs to try.