European Downgrades: Will There Really Be a Fallout?


On Friday, after the close of business in the stock market, S&P downgraded 9 European countries. Spain and Italy were both taken down another notch, leaving Italy with a BBB+ rating and Spain with an A.

But the headline damage was done to France, whose triple-A rating got downgraded to AA+. France had been rated AAA for 36 years.

The French bid adieu to their triple-A status…said they didn’t care about it, expected it, and didn’t believe it anyway. But it was a blow, not just to the French but to the whole European experiment. France, with Germany, was one of the strong, big economies at the centre of Europe. It was one of the economies the others were depending on to bail them out. Now, it looks like France may need its own bailout.

The Wall Street Journal warned that markets needed to “brace for European fallout,” this morning.

But maybe there won’t be much fallout. The US lost its AAA status last year. And it wasn’t at all inconvenienced as a result. Instead, yields on US debt went down…meaning, its bonds were more desirable than before. Investors knew they would get their money back, they didn’t seem to care about what the money would be worth.

Mr. Market often plays tricks on investors. He makes the thing that is the most risky seem the safest. The safest asset, on the other hand, he makes seem like the riskiest thing they can buy.

That was what investors thought about US Treasury bonds 30 years ago. Inflation had reached over 13%. The US 10-year note yielded 15% (from memory). Investors had taken to calling them “certificates of guaranteed confiscation.”

But instead of confiscating investors’ money, bonds proved to multiply it. Yields soon began to tumble. They’ve been coming down, more or less, ever since. Which means…people who bought bonds in the early ’80s have made a lot of money. Bonds turned out to be a very safe investment.

Meanwhile, gold was seen as the safest thing you could buy in the early ’80s. It had been going up for the last decade. Investors saw no reason the trend should stop.

But barely had the ’80s begun when gold put on the brakes. Then, it began to back up. The price fell from over $800 to under $300 – over the next 18 years. Investors would have been safer on an Italian cruise ship!

And how about now? Money rushes to the safety of US bonds. Yields are as low as they’ve been in 100 years. But are they safe?

Nope. They’re probably the riskiest investment you can make.

France has about the same financial profile as the US. In this respect, both are at the centre of the developed world – with government debt of about 100% of GDP. Neither can expect to work its way out of debt unless it can keep its deficit below its rate of growth. And that’s going to be almost impossible. Europe appears to be heading into a recession (negative GDP growth)…and the US is not far behind. Despite the renewed talk of a ‘recovery’ in the US, the country limps along with a budget deficit of nearly 10% of GDP…and will probably tip back into recession later this year. In any case, there is no end in sight to America’s huge deficits. And no chance that growth will rise high enough to offset them.

This is going to end badly, dear reader…


Bill Bonner
for The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Bill Bonner

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