The problem with ratings agencies is they often come in after the horse has left the barn to try to close the door. In the case of Greece, the market was already saying their debt was junk, so coming out with a rating now and saying we're downgrading it to junk doesn't mean much to the market -- they were already regarding it that way -- they're just matching reality right now.
In the case of Spain, which was downgraded, it's still rated as an investment grade bond. That means institutions can still own it. They may want a better mix of higher grade bonds in their portfolio, but they don't have to dump the Spanish bonds yet because there's no danger Spain is in danger of defaulting the way Greece is.
Greece and Spain aren't the only countries with massive debts. Why are a few European countries being treated so differently? what is unique about their situations?
Every country during this current economic crisis has taken on much larger deficits to cover rising social costs and to try to stimulate their economies. But other countries with very high debt levels like Italy, for instance, don't have the same exposure in the credit markets. Because they have larger economies, the French, the Italians and others with high debt levels can mostly finance them on their own. They have taxing capacity, capacity for economic growth and creditors aren't as exposed in these countries as they are to the smaller ones, where the countries really can't make the changes they need to quickly enough to turn things around.
Britain has a very high debt level, but it has its own currency, and it can devalue that currency -- it already has. Once you devalue a currency, your domestic economy improves because people tend to buy more domestic products and import less. Your export market improves because your costs of production and exporting go down. Greece and Portugal, which are very small economies, don't have that flexibility because they're tied to the euro, and they can't devalue their currencies to fix any of this. So they're stuck with a relatively strong currency, which means that they have these imbalances continuing. Ireland is in the same boat, although it has taken much tougher measures to get its fiscal house in order.
What does all this mean for the strength of the euro currency and its future?
The euro has been coming down in value as investors lose confidence in the region, there's no question about that. But for Greece and the other smaller southern European countries to benefit, the euro would have to basically plunge to 80 cents (U.S.) and right now its still around $1.30, so you can see the difference. If Greece still had its own currency, the drachma, it probably wouldn't have got into this pickle in the first place, because the markets would have told them, you have too much debt, but because it was issuing debt in euros, it never got that signal, the market was perfectly happy with the euro for a long time as an alternative to the American dollar, because they were worried about American economic prospects, and they needed to balance their portfolios so they were buying Greek bonds, even as the Greek economy was collapsing.
That wouldn't' have happened with the drachma so they lose an important signal in the market place that's there if they have their own currency. A slightly falling euro benefits the strongest economy in the region quite a lot. That's Germany, because it's a huge exporter. But the fall won't be enough to benefit these smaller countries, and there would be no stomach for a drastically reduced euro because then the Germans and the French could say, well, if we're only going to have an 80 cent euro, we might be better off going back to our own currencies. A lot of risks are going forward for the euro. It's been overvalued for a long time, and most analysts say it probably should never have been above $1.20, based on Europe's economic prospects on its demographic issues and structural problems.
But the problem is when you have a single currency and 16 separate fiscal policies, you're going to have these issues. They were very lucky for nearly the first decade of this currency that they didn't have this crisis and that's because they had this booming global market. That's not there now, aand they're going to have to readjust and that's going to mean further stresses on this particular currency.
Why are investors flocking back to the U.S. dollar?Report Typo/Error