S&P Strikes at the Heart of the Eurozone

Standard & Poor’s slashed through Europe today, cutting the government debt rating of many of the Eurozone member countries, first among them in importance - France.

France lost its AAA rating and was placed at AA+ by S&P. The cut wasn’t a surprise because S&P warned as early as December that the cut was in the offing. But, the consequences will be felt across Europe and perhaps the world. Of course, it would be wise to remember that the same was said when America lost its AAA rating last summer, and not much has changed since, except that US debt has been bought in great quantities, driving the cost of borrowing in the US below 2% for many of its government bonds.

So, perhaps the French cut will have similar results, but I doubt it. For several reasons.

First, France and Germany are the two Eurozone countries that have formed a money wall to protect its weaker members, such as Greece, Ireland and Portugal. Italy is now in the cusp of an ongoing fiscal crisis that may see it dipping into both the International Monetary Fund (IMF) and the European Central Bank (ECB) for help with liquidity.

And, the Greek government announced today, before the downgrades occurred, that its negotiations with its lender banks had met a dead end and that perhaps they would resume next week. The IMF promptly began jawboning to get the parties back to the table, because without the forgiveness of 50% of its bank-held debt, Greece will default in it payments - UNLESS France and Germany provide the coverage that the ECB needs in order to buy Greek debt to fund the country’s ongoing cash needs.

It is here that the French downgrade is important, because the cut means that France will have to pay more to borrow funds, not only for its own use but also to help its ailing partners in the Eurozone. There may also be fewer lenders, simply because some funds and investors have rules about the level of risk they can take when buying government debt - AAA obviously being the least risky, and perhaps France will lose a few lenders because of such criteria.

That leaves Germany holding the bag…and we know that German citizens are not thrilled about offering a blank check, at their taxpayer expense, to every Eurozone country that managed its fiscal house so badly as to end up without funds.

And, it is no surprise that in this French presidential year - the vote is 100 days away - the Socialists and just about everyone else in France is blaming President Sarkozy for poor fiscal management of the country. If this sounds familiar, cut to the US presidential race where President Obama is accused of the same thing.

Of course, German and French officials are downplaying the cut, saying it will not affect their political goals or France’s place in the financial markets.

So, we are approaching yet another crunch point in the Eurozone and the European Union. Somebody has to come up with the cash to keep the region running.

It used to be France and Germany. Now it is Germany. For how long??

NOTE : Just for the record, France, Italy, Spain, Portugal, Austria and Slovakia had their government debt ratings cut today by S&P. But, it was Austria and France which lost AAA ratings. The others had already been downgraded several times. For example, Italy is now at BBB+.

That leaves just 13 countries in the world with S&P AAA ratings:  Australia, Canada, Denmark, Finland, Germany, Hong Kong, Luxembourg, The Netherlands, Norway, Singapore, Sweden, Switzerland and the United Kingdom (Great Britain).