@Aurelija's

After a rather uneventful week came Friday 13th. And right in the middle of the day the rumor hit the market on that S&P is about to downgrade a bunch of European sovereigns. Needless to say, the markets switched to the "risk off" mode in no time. Despite of the fact that the downgrade of the euro area economies was far from a "black swan", the EURUSD took a nearly 2-figure hit...


S&P later sent out an official statement:

...Standard & Poor's Ratings Services today completed its review of its ratings on 16 eurozone sovereigns, resulting in downgrades for nine eurozone sovereigns and affirmations of the ratings on seven others.

We have lowered the long-term ratings on Cyprus, Italy, Portugal, and Spain by two notches; lowered the long-term ratings on Austria, France, Malta, the Slovak Republic, and Slovenia, by one notch...

I've never been fond of the rating agencies - they act downright pro-cyclically, always behind the curve, and always come out in the wrong time...But, that aside, I am actually somewhat surprised by their official statement on the action, seeing in it, no less, no more, but an indirect claim that the situation in the euro area is hopeless, and that the only way out is the euro area's breakdown.

Just read the excerpt from their long explanation as to why the ratings were cut:

Today's rating actions are primarily driven by our assessment that the policy initiatives that have been taken by European policymakers in recent weeks may be insufficient to fully address ongoing systemic stresses in the eurozone. In our view, these stresses include: (1) tightening credit conditions, (2) an increase in risk premiums for a widening group of eurozone issuers, (3) a simultaneous attempt to delever by governments and households, (4) weakening economic growth prospects, and (5) an open and prolonged dispute among European policymakers over the proper approach to address challenges.

So, basically, the S&P claims that the whole thing is systemic, and all what Merkozi have been doing recently - all the discussion on fiscal austerity - is the road to nowhere. Interestingly, S&P even states that deleveraging is bad (given the current debt/GDP ratios in the euro zone, huh?!).

I thought I got the point with those 5 points already. But then the S&P made it easier with this much more explicit paragraph below:

We also believe that the agreement is predicated on only a partial recognition of the source of the crisis: that the current financial turmoil stems primarily from fiscal profligacy at the periphery of the eurozone. In our view, however, the financial problems facing the eurozone are as much a consequence of rising external imbalances and divergences in competitiveness between the EMU's core and the so-called "periphery". As such, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers' rising concerns about job security and disposable incomes, eroding national tax revenues.

In this, S&P, sadly but true, gets the core of the problem out - the euro zone is doomed to failure. It is a wrong construct.

I have myself been thinking a lot about the euro zone's past and future, and the more I do the more convinced I get that the overall idea was wrong. It merged too divergent economies, where Germany served as euro zone's "China" and the southern periphery acted as the euro zone's "US". By "China" and "US" I mean the differences in propensity to save/consume. That is, Germany has been the over-saver economy, channeling its savings to Greece &co which have been willing to use the money to consume beyond their means. And since the big chunk of extra consumption came, guess where from, the over-saver Germany, everyone was happy, enjoying the "gains from trade". Germany grew on exports, Greece&co grew on domestic consumption. Statistics showed nice growth for both.

Yet, as it now turns out, this inter-temporal transfer of wealth was not pure "gains from trade". In fact, it was all illusional gains - as during the past couple of years they have, and for the next several years will be repaying back their "gains from trade". This comes in many formats: higher borrowing costs, recession, lower wages, equity losses in the financial system, no pensions for newer generations... I would not be surprised if eventually the "cost from trade" turns out to be larger than the "gains of trade" we were after when the euro zone was being created.

All in all, my mind has started to question the benefits of free trade which is so well established in our modern academia. All this is just distribution of wealth in time which, when added together, is just a zero sum game.

Apart from the economic wealth, unfortunately, there is also social wealth involved, and this in the coming years will remain a huge problem involving a lot of loss in human capital. This huge youth unemployment we are seeing in the euro zone today is nothing but a result of inter-generational wealth distribution which was, as many people would agree today, not fair. But, unfortunately, when wealth is transferred in time, only those reaping the gains are the actual decision makers.

We are all in this together.