France’s Credit Rating at Risk

Standard & Poor’s caused an economic storm last week when it downgraded the credit rating of the United States. Now many investors are speculating: Who’s next?

By S&P’s assessment, there are 18 safer places than the US to invest your money. On the list: Austria, Canada, Denmark, Finland, Germany, Luxembourg, the Netherlands, Norway, Singapore, Sweden, Switzerland, the United Kingdom, Australia, Guernsey, Hong Kong, the Isle of Man, and Lichtenstein.

And then the one that really irks American pride: France. But that country has a higher unemployment rate, slower growth, and carries a higher debt ratio.

Is the US really a riskier investment than France?

“No, clearly France doesn’t deserve a higher rating than the United States and that will soon evaporate,” said Harvard University economist Ken Rogoff. “They (The French) have their own political factors. But this feels a little bit like a student (The Americans) who got the grade that they didn’t want and is pointing at somebody else’s paper who maybe was graded too high, and then said I should be graded high too. The United States had a very, very awful debt debate debacle and it undermined our institutions, it undermined the power of the president, and it didn’t point to any end, forget about the economics.”

In a sense, that’s what S&P did when they clarified why the United States was downgraded last week. S&P uses five criteria to determine a country’s bond rating. The first four are related to a nation’s economy and how it manages its money. John Chambers, head of S&P’s sovereign ratings committee, said the fifth factor is a matter of politics.

“You look at the political settings, you look at the political economy, you look at the ability of policymakers to respond in a timely fashion to key public finances in a sustainable footing,” said Chambers.

And that’s where the US fell short.

“It’s not just about the ability to repay, it’s also about the willingness to repay,” said Frank Warnock at the University of Virginia’s Darden School of Business.* “And what Congress has shown us is that they are willing to dangle that, the threat of default, for political reasons.”

France hasn’t done that.

But France does have its own set of political and economic challenges that the United States doesn’t face.

“The US can create dollars, but a European country cannot just produce Euros because it’s a shared currency. It’s different,” said finance professor Donald Smith at Boston University’s School of Management and author of the new book Bond Math: The Theory Behind the Forumlas.

“So I can understand where one might say the ability of Italy or Spain to pay off debt denominated in Euros might be questioned given economic problems,” Smith said.

Questions spread to France this week. The three credit ratings agencies — S&P, Moody’s, and Fitch — said Wednesday that France’s credit rating was not at risk. Still, experts say it’s just a matter of time before more downgrades come.

“This act of downgrading the US then raises the challenge to everyone else,” Smith said. “Any country that’s rated above the US is going to be questioned.”

And it’s not just France that should be worried about losing its gold-standard rating. Everybody in the Eurozone is caught up in the continent’s economic problems.

“Even Germany, which famously has a tremendous commitment to repay its debt and to financial stability because of the scars of WWI and WWII and the horrible inflations they had afterwards,” Rogoff said. “Even Germany is not really AAA anymore because it’s going to be bailing out Spain and Italy and absorbing so much debt. It’s going to have trouble.”

But all of this talk of downgrade, it doesn’t signal the end of western civilization. Rogoff said we’re not talking about top tier countries defaulting on loans. “We’re talking about AA+, it’s still investment grade, it’s still very high investment grade.”

Warnock said, “I don’t think there’s much difference, really. Does France deserve a higher rating then the US? I don’t know. These are all roughly the same to me: AA+ vs. AAA, there’s not much of a difference there.”