France’s credit downgrade, medium term borrowing costs and ‘competitiveness’
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Today Reuters reports that Moody’s, the credit rating agency, has downgraded France by a notch from the excellent Aaa rating to Aa1. The rationale underpinning this decision is, as the article notes:
[France’s persistent structural economic challenges] include the rigidities in labor and services markets, and low levels of innovation, which continue to drive France’s gradual but sustained loss of competitiveness and the gradual erosion of its export-oriented industrial base.
There are a few comments worth stating. At first the downgrade per se will have no impact on either France or the overall (im)balance in the Euro area. As I have noted in my analysis on The Truth about Credit Rating Agencies and speculators, such downgrades only confirm what we already know, as far as the orientation of investors is concerned. Over the medium term France will face higher borrowing costs than currently, but not to the point of dealing with a debt crisis, or even worse a feedback loop between a cash-strapped sovereign and its failing domestic banks.
And I say so because of point 2 in my commentary, which bears the name Outright Monetary Transcactions, the programme that the European Central Bank concocted in early September as a means of purchasing large—”unlimited”— amounts of sovereign bonds from the secondary bond market, in an effort to keep yields at sustainable levels, and consequently to hold together the otherwise unfolding euro edifice. The specifics of the OMT programme were outlined in a previous article of mine, but what I draw out of it with regard to France’s downgrade and the expected rise in interest rates over the medium term, is this insight I gave:
Implicit in the OMT is a yield target for any country that will apply for the programme. If we make the assumption that the ECB will buy “unlimited” quantities of government bonds to produce an artificial rate of, say, 4%, it is safe to expect, after also considering the above two points [mentioned in that article], that there will be a gradual convergence of interest rates across the euro area, around that arbitrary target.
Investors will effectively price the 4% threshold as risk-free, since the ECB will be a massive source of demand, and will thus have a strong incentive to buy at that rate. Besides the profit margin between the near-zero borrowing costs and the yields that will most probably result from the OMT operations open up great opportunities for those who will first gain access to the cheap liquidity.
Thus while French borrowing costs will rise once Spain and Italy stabilize, if they eventually do, no exorbitant rates will ever be witnesses, ceteris paribus, because of the backstop the ECB has provided through its OMT. Of course should borrowing costs rise to worrying rates, France will be faced with tough political dilemmas and its government might once again be forced to violate its socialistic palaver in favor of austerity/conservative policies. Regardless of that, the plain fact is that the OMT exists for the Euro area as a whole, and despite all political hurdles it will be effective in achieving its pursued ends.
Another aspect of the credit downgrade of France deserving a comment, is this recurring theme of ‘competitiveness’, which keeps reminding us how divorced some terms are from any sort of realism. It must first of all be stressed that there is no such thing as “competitiveness” in the abstract, in general, or for a country as a whole. In economic terms only individuals and individual firms may compete with one another and the variances between them are comprised of several sector- or industry- specific particularities. To treat aggregate “competitiveness” as a meaningful concept is to reduce the complex system of economic relations and interrelations into a simplistic factor or index; it is therefore a crass misrepresentation of what the economy is about in its specifics (and of course this extends to a much more thoroughgoing epistemological discussion on economics in general and macroeconomics in particular, but let us not delve into that subject for the time being).
Yet there is another egregious fallacy or misunderstanding in this notion of national “competitiveness”, which is encapsulated in the labor factor or in labor costs. There seems to be a consensus among entrenched market insiders and the political establishment of Europe that labor costs are the single most important element of such ‘competitiveness’ and that slashing labor rights and reducing welfare to sweatshop conditions will make “us” Europeans super-strong in exporting our products and in standing up to competition. This too is a pernicious oversimplification for it reduces a vast array of factors into a mere variable, wages and labor rights, and it sees it only from a purely accounting perspective, ignoring the social, cultural and political dimensions it has, as well as the ramifications of targeting only a very narrow policy area, in an effectively ideological struggle that has nothing to do with genuine economics (not to mention the neo-mercantilism of the “boost our exports” narrative).
Finally I wish to address my friends on all sides of the political spectrum who will dredge up the palaver of “markets attacking” us when we are about to recover. Two short points here: (i) markets cannot possibly attack because markets qua ontological entities with faculties of acting and therefore attacking, cannot possibly exist, except in a wildly surreal political reverie, (ii) credit rating agencies like Moody’s have nothing to do with a genuine free market, since they officially enjoy an oligopolistic status, representing therefore the hypertrophic corporate-capitalist system that has grown in the United States (and elsewhere) over the last decades.
To recapitulate, France’s borrowing costs will eventually rise to whatever the risk-free threshold of the ECB’s Outright Monetary Transactions programme will be. Let us hope this turn of events will not provide the impetus for launching another round of inane policies.