Eurozone nations’ sovereignty v AAA

French and German flags Germany could follow France by having its AAA credit rating downgraded

Late last night Moody's put the eurozone's operational bailout fund, the European Financial Stability Facility, on so-called "negative outlook", which means it is at serious risk of losing its AAA credit rating.

There was nothing surprising in this announcement. It was made inevitable by Moody's earlier decision to declare that Germany, the Netherlands and Luxembourg were in danger of losing their cherished AAA ratings - in that Germany guarantees 29.1% of the EFSF's borrowings, the Netherlands guarantees 6.1% and Luxembourg 0.3%.

Among the EFSF's guarantors, only Finland retains a stable AAA. And there is no way that the EFSF's AAA can be sustained by small but fiscally super-strong Finland alone (Finland, like its non-EU neighbour Norway, has no net debt at all on a net basis).

Inevitably, eurozone leaders are grumpy with Moody's. But perhaps they should, for once, thank this member of the widely reviled credit-rating fraternity. Because Moody's may have presented an opportunity to them to frame the debate on the future of the eurozone in a way that makes the choices for the citizens of Europe easier to see.

Actually, I should slightly rephrase that. What Moody's has done is to narrow the choices available to Germany and its people - and some would see that as a good thing given that the eurozone's financial survival depends on a willingness of Germany to deploy more of its financial resources to the benefit of its over-stretched eurozone neighbours.

The simple message from Moody's to Germany is that it won't retain its AAA rating if the eurozone continues on its course of muddling through each successive crisis. Providing emergency loans to the eurozone's weaker members, each time they are locked out of markets, progressively increases the burden on Germany's public finances, because Germany is by a margin the biggest contributor to these funds.

Now that Spain looks to be in need of a full scale bailout - which to be credible would have to involve around 500bn euros of emergency loans (see my post Spain moves nearer to full-scale rescue) - the underwriting burden for Germany is looking very heavy.

Were the contagion to Italy to worsen, such that it found itself unable to borrow from commercial investors, a bailout for the Italian government would be of the order of 750bn euros or more.

Even assuming that the IMF took some of the strain of such rescues, the increase in the implied indebtedness of Germany of rescuing both Italy and Spain would be in the order of well over 10% of its GDP or output.

And that would be to ignore Germany's ever rising exposure to the emergency funding of the eurozone's ailing banks via the so-called TARGET2 payments system. Germany's de facto loans to these banks is equivalent to around 30% of its GDP (this figure is based on the assumption that, in a worst case of a eurozone breakup, Germany was unable to share the cost with other eurozone members on the basis of an official burden-sharing formula).

To put all this in simple terms, the absence of a comprehensive solution to the eurozone's woes is progressively poisoning the German balance sheet: on the "are-what-you-eat" principle, Germany is gradually turning into Italy and Spain, in a fiscal sense.

So the status quo is arguably becoming less and less sustainable for Germany.

That leaves only two options: the pronounced economic, financial and political shock (ahem) of breaking up the eurozone; or the pronounced economic, financial and political challenge (ahem) of merging the balance sheets of eurozone members in a full-scale fiscal and banking union, which would look quite a lot like the creation of a United States of Europe.

To return to Moody's for a second, it is difficult to see Germany retaining its AAA rating in the immediate aftermath of a eurozone breakup or in the transition phase to a United States of Europe - though it might well get the AAA back in both cases, in time.

In a dismantling of the eurozone, the losses on German credit extended to weaker eurozone economies would be huge, while German industry and employment would be hurt both by a rise in the value of a new German currency and by an inevitable recession in much of Europe.

As for the creation of a eurozone federation, during the implementation phase the perceived strain on German public finances would increase.

But here is the thing, at the moment that the eurozone was perceived as a credible single entity, for fiscal and monetary purposes, the whole region might enjoy AAA status - so long as, in these circumstances, the European Central Bank was put in the same position as the US Federal Reserve, Japan's central bank and the Bank of England, that is able to be the buyer of last resort of eurozone sovereign debt.

A combination of credible controls on eurozone-wide spending, taxing and borrowing, with a central bank endowed with the ability to stand in for the market when the market won't lend to governments, would allow the eurozone's public finances to be compared directly with those of the US and the UK.

The point, as many of you will know, is that seen as a single entity the deficit of the eurozone is smaller than that of the US and UK. And eurozone gross debt as a percentage of GDP is less than that of the US - which still has AAA from most rating agencies - and is comparable with that of the UK, which retains AAA from all agencies (of course, whether the UK will keep AAA is moot).

To put it in more practical terms, a monetarily and fiscally integrated eurozone should be able to borrow as cheaply and easily as the other major developed economies, namely the UK, US and Japan.

There is only one snag. For the people of Europe, would the financial benefits of this kind of federation outweigh the perceived erosion of their control over the destinies of their respective nations?

That is the European question of our age.

Robert Peston Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 227.

    Draghi now says the ECB will do whatever it has to to save the Euro. I suppose that means if it costs Germany every last Euro it's got.And that's what it would take and then some. However, both the ECB and Germany's government have legal constraints that will prevent them from betting the entire farm away. Besides, there are probably plenty of Germans already fed up seen their savings put in peril

  • rate this

    Comment number 226.


    Not specifically my rights. I have neighbours, some without jobs.

    Private insurance and services are not universal. As you mention it, what is your view of safety nets? What is a right, and what isn't?

  • rate this

    Comment number 225.

    224. Didn't know we were discussing unemployment nor have I offered a view of UB or a safety net. I thought we were talking about your rights to NH dentistry (which it seems you can afford to do without).

  • rate this

    Comment number 224.


    Can you afford insurance if you're made redundant? (I assume so as you're filthy rich and pay a ton of tax).

    You can insure against redundancy, but that has to be done in advance. How does that work with youth unemployment increasing?

    What of those who can't afford the insurance? Is a minimum wage worker meant to simply put up until they keel over from cancer (say)?

  • rate this

    Comment number 223.

    Only one way to go, ECB lender of last resort, fiscal/political union (remember Europeans are 'people' just like us), bond rates fall, confidence returns to sovereigns and banks, banks lend to each other, banks lend to business, small business & banks make money again, confidence returns, growth comes back, Euro recovers, the financial gamblers pay and Govt fines the banks for fleecing us..!

  • rate this

    Comment number 222.


    But wait. It gets better!

    The insurance contributions are essentially unrelated to the amount claimed by that user. Contributions are usually determined by assessing the risk that a payout would be needed.

    Similarly, tax does not equate contributions to value of services recieved (nor can it - the whole thing's too nebulous). Contributions are determined instead by ability to pay.

  • rate this

    Comment number 221.

    Yes, indeed & thus I pay for all types of insurance incl health. I am no coerced into doing so, I have a wide selection of org prepared to offer me insurance & select according to price & service & I can work out the benefits of what I receive from the contract. The state provided model you set out has none of these features and in particular knows little or nothing about service.

  • rate this

    Comment number 220.


    Ever heard of insurance? It's a clever idea.

    Lots of people contribute a small amount and in most cases do not ever see a return. However, the insurer ensures the relevant services are available to all that need them as and when.

    Nifty, eh?

  • rate this

    Comment number 219.

    "a monetarily and fiscally integrated eurozone .. able to borrow as cheaply .. as .." as Germany perhaps already can or a little higher?

    What good is that to Greece et al if Germany et al still don't throw any cash in that direction?

    As I see it, the only way integration might make things better is if it allows money to go south without northern tax payers knowing about it.

  • rate this

    Comment number 218.

    "bundled energy or telecom 'products'"

    Nonsense. You have a choice on what you choose to buy as a consumer. You have little option in terms of tax you pay or what it is used for. The state cannot know what bundle of goods you would choose (with this payment of tax) against say me, even if we were paying same levels of tax (unfortunately I pay massive amts) & then provide this.

  • rate this

    Comment number 217.


    The state pays for the NHS. I pay the state in taxes.

    The fact that there is no direct one-for-one link is irrelevant. It is in that respect no different from buying bundled energy or telecom 'products'.

    The state is a very large service provider with a very large bundled portfolio. If it is operating at a loss, it should increase charges like any business.

  • rate this

    Comment number 216.

    ".As a taxpayer, I already do."

    CO no you don't. You do not pay taxes X in expectation of y return. Taxes are paid to maintain state & to achieve redistributive goals. Your payment of T is not linked to utility you directly gain from doign so. Moreover, current state provision is being maintained by enormous borrowing so future generations are in fact paying for much of what is spent now.

  • rate this

    Comment number 215.


    "CO if you can pay you should."

    1) As a taxpayer, I already do.
    2) What of those that can't? (remember, no NHS dentists where I live).

  • rate this

    Comment number 214.

    "I have to go private and pay it"

    CO if you can pay you should. Afterall all it creates incentives for you to look after your fangs. Also get far better treatement. Ive v good friends who are dentists & one runs an extremely successful practice. As I've said their incentives & those created for patients are perverse & I hear horror stories every Fri when I meet them for a drink after work.

  • rate this

    Comment number 213.


    As far as government goes I'm more with Bakunin. Seems closer to Bastiat than I thought.

    The goverment pays NHS dentists but as they're almost extinct it ain't paying much. As I said, I can only get an NHS dentist by going on a list and literally waiting for someone to die. I have to go private and pay it all. Is there some different, economic jargonese term for privatisation too?

  • rate this

    Comment number 212.

    210. I love idea that bec something is provided by private sector but still paid for by govt (although NHS dentist barely get there) is in some way "privatising".. Healthcare provision in Germany , France, Switzerland etc is combination of private & public with over 1/2 of German hospital admissions to inst run by private sector. Yet efficiency & outcomes of Germ, Franc HC better.

  • rate this

    Comment number 211.

    210. And how is it privatised? And was there ever a "service". As for your garage yes indeed but of course you would favour other council tax payers paying to clear out your garage as you would tawptyers to care for your fangs. Once again Bastiat's prophetic words come to mind:

    "Government is the great fiction, through which everybody endeavors to live at the expense of everybody else."

  • rate this

    Comment number 210.


    "The system is a complete sham though with perverse incentives (both to patients & dentists)"

    Quite right! I'm glad you agree that privatising dentistry hasn't worked. Still, let's see what's left of the rest of the NHS when Lansley's finished.

    And more fool the poor for not paying extra for a basic service that their tax should already cover. That'll learn to not be brokers!

  • rate this

    Comment number 209.


    You know the funny thing? The missus keeps telling me I need to clear out the shed. I'm probably never gonna need all those F-35s but they do take up such a lot of space!

    I'll need to get the trailer out. The council would charge to collect junk. Cheeky public sector 'services'!

  • rate this

    Comment number 208.

    205. Ahh I wonder who pays for it then?

    More fool you for going to an NHS dentists The system is a complete sham though with perverse incentives (both to patients & dentists) and, given its public service nature, no service is provided at all (mroe a dis-service).


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