The news dominating discussion today is that Moody’s has cut its credit rating for Spain to Ba3 from A3, just one notch above Junk. This in turn has pushed Spain’s bond yields above 7.0% for the first time, the same position at which Portugal, Ireland and Greece received bailouts, as everyone knows by now.
Clearly this is bad news for the Eurozone. And yet before we do anything, it’s worth asking: Is this justified? Does Spain deserve to be saddled with 7.0% bond yields, effectively locking it out of the markets?
The markets: rational or reactive?
After all, to the extent that Spain’s being pushed to 7.0% is a reflection of Moody’s judgement, it doesn’t reflect anything new about Spain’s economic situation. Did people who felt sanguine about Spain, learn something new and decide to panic when Moody’s piped up? Unlikely. To that extent, the move to 7.0% doesn’t reflect any rational analysis on the part of the markets, but a reaction to an authoritative voice making a statement.
It’s a bit like when there’s a news of a petrol strike going around, and a government official comes out and confirms it, and everyone rushes to the pumps. There isn’t any new information per se, but people panic. To that extent, I don’t think Spain’s being pushed to 7.0% makes sense.
If debt’s not the problem, what is?
Furthermore, given that this rise in Spain’s bond yields reflects sentiment as much as fact, it’s also worth thinking about why Spain is in this situation in the first place.
For instance, this latest deterioration in Spain’s situation comes after its bailout, when it accepted €100bn in EU aid to support its banks. The initial market response to this was jubilation, but that faded when people realised the aid would add to Spain’s debts.
And yet, what’s the problem with that? Why is national debt in itself a problem? If that were the sole basis by which the markets decided which countries were problematic, Japan would be in pole position, with a debt to GDP ratio of some 220.0%. By comparison, Spain’s is closer to 70.0%. So why this doubt?
The Eurozone: tested to destruction?
It seems to me that Spain itself is not a problem. With its relatively low debt ratio, even in the midst of a recession, it should be fine. Instead, as other people have pointed out, the problem must be Spain’s place in the Eurozone.
The Eurozone debt crisis emerged because, prior to 2008, the markets treated the individual members of the Eurozone as a combined entity,equally safe. So Greece could borrow at the same rates as Germany, even though its economy was much less productive, because of an assumption that Eurozone members would support each other. Obviously, Greece took advantage of this to a massive extent.
And yet, post-2008, markets began to test more actively the extent of the Eurozone’s mutual support. It quickly became apparent that German, Finnish and Dutch, taxpayers were not willing to pay for the profligacy of Greeks.The possibility emerged that, if the Eurozone would not stand behind its members, the union could break up.
Back to the present day
This then is how we find ourselves in the position we’re in today. Since Greece, the markets have been systematically testing Eurozone integration,by pushing each country to its limit, to see how ‘safe’ an investment it is depending on whether it receives support. In that sense, Spain doesn’t deserve to be in its current position at all. Its debt dynamics are good compared to others.
But this is about, given Spain’s relationship to Germany, France and Italy,what will those countries do to make sure Spain is a ‘safe’ investment? It’s about ‘defining’ the investment safety offered by each country, given their place in a wider currency union.
Unfortunately, the Eurozone has repeatedly refused to give a clear answer to the markets. That’s why the crisis continues to escalate, culminating in Spain’s 7.0% bond yields.
Peter Lavelle at foreign exchange specialist Pure FX