French President Nicolas SarkozyYou probably heard that on Aug. 5 Standard & Poor's downgraded the United States one notch, from AAA to AA. You may not have heard that on Aug. 10 S&P said France's current AAA rating was "warranted" and "stable." S&P was saying that the United States is a bigger credit risk than France.
The market is behaving as though S&P had said the exact opposite. Treasuries rose in price, and the United States.was able to auction $72 billion of notes and bonds at 2.13 percent, the lowest average yield for a re-funding on record. Meanwhile, the difference between French and German yields on 10-year bonds rose to almost a full percentage point. That's the largest spread for France since the euro was established. The annual cost of insuring French debt against default for five years soared from about $75,000 in the earlier part of the summer to $175,000, compared with about $55,000 to insure the United States. (The cost of insuring French debt has since fallen back to about $150,000.) The market is saying that AAA France is a much bigger credit risk than the AA United States.
Qu'est-ce qui se passe?
One view of the market's reaction is that the downgrade of the U.S. raised fears that S&P would downgrade France, despite the agency's reassurances. Another (not necessarily contradictory) view is that the market has zero respect for S&P's judgment about the relative creditworthiness of the two countries. When I asked investors whether S&P's response made any sense, the reaction was uniform: Of course it doesn't!
Investors really don't have any respect for the agency's reasoning in downgrading the United States. The first thing S&P cited in announcing the downgrade was "political risks": its belief that "the effectiveness, stability and predictability of American policymaking and political institutions have weakened." To be sure, S&P also talked about the U.S.'s soaring debt-to-GDP ratio"”a key quantitative measure of a country's financial health"”but its concern was less about the number than about the possibility that we won't be able to tame the growth of our debt. The widespread feeling among most investors I spoke to was that regardless of whether S&P was right or wrong, it wasn't appropriate for the ratings agency to make so political a judgment. Nor, they said, was politics anything about which S&P has previously demonstrated any particular expertise. (You could even ask whether S&P has demonstrated any expertise about the Eurozone, given that the agency rated Ireland and Spain AAA in 2006.)
Based on many purely quantitative measures, France is actually in worse shape than the United States. John Chambers, the chairman of S&P's sovereign ratings committee, conceded the point in an Aug. 8 conference call. France's debt-to-GDP levels aren't significantly different from ours. Indeed, S&P has forecast that in 2015, France's debt will be 83 percent of GDP, higher than the 79 percent that it forecasts for the United States. But S&P thinks France has demonstrated a greater willingness to tackle its problems"”for instance, by reforming its pension system"”and that France's ratio will come down dans les années suivantes , whereas ours will increase. Maybe S&P is right, but there's enormous weight resting on that qualitative judgment, because France has several disadvantages relative to the United States. It will likely face more difficulty growing its way out of its debt problem because France's gross domestic product is growing even more slowly than ours is. (France logged a 0.9 percent increase during the first quarter and no increase at all during the second.) And France's currency, the euro, is not the reserve currency of the world, as the U.S.'s is. That status, according to Moody's, give the United States "unmatched access to financing."
In addition, there's this little matter of Europe being in the middle of a rather dire financial crisis. No one I spoke to thinks that you can view France's credit as being independent of the Eurozone. France has contingent liabilities to the European Financial Stability Fund, which is Europe's attempt at a bailout mechanism, meaning that France is partly on the hook for the EFSF's existing loans and may have to cough up more. One market observer told me that including those liabilities increases France's debt to GDP ratio by almost one-third.
Read Full Article »