The agency is right to warn that Euroland's immediate crisis cannot be halted only by policing budgets. There must be debt pooling and a lender of last resort to stop "systemic stress".
The cannon shot across Europe's AAA creditors is a cold reminder that they too are part of the mess. It is well-timed, coming hours after Merkozy again failed to offer any meaningful way out of the impasse.
"Policymakers appear to have acted only in response to mounting market pressures, rather than pro-actively leading market expectations in a way that might have better strengthened investor confidence. The piecemeal nature of this response has helped expand the crisis of confidence in the eurozone," it said.
Christine Lagarde, the International Monetary Fund's chief, was equally dismissive of the Merkozy plan. "It's not in itself sufficient and a lot more will be needed for confidence to return," she said.
The rating agency said a credit crunch is taking hold. Euroland's policies of synchronized fiscal and monetary contraction have pushed the region into recession, and therefore into deeper debt stress. "As the European economy slows, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating."
Luxembourg's premier Jean-Claude Juncker called the move "completely over the top and unfair", insisting that Europe is "on the way to solving the debt crisis."
Claims by some that S&P is waging currency warfare are absurd. The agency has stripped America of its AAA. France is in worse shape on the same metrics, including with pension liabilities.
There is much confusion over how rating agencies operate. They measure default risk. The US and the UK have used QE to inflate away debt. This may be stealth default, but S&P deals only with "credit events". These are is less likely for countries with their own central bank that can backstop public debt in a crisis.
The eurozone's combined debts and deficits are lower than the US, but its €23 trillion (£19.7 trillion) banking nexus - three times sovereign debt - is greater. This is a contingent liability.
Eurozone banks have a loan-to-deposit ratio of 1.2, compared to 0.7 in the US. They are much larger, more leveraged, and mostly underwater on EMU bonds if forced to mark to market.
The threat in Euroland comes from a vast edifice of interlocking bank debt and sovereign debt. Each is destroying the other. This will continue until there is a circuit-breaker.
The agency calls on the ECB to act, both a last-resort lender and to halt the slump. "We will analyse the policy settings of the ECB to address the economic and financial stresses now being experienced by eurozone sovereigns.... and in staunching the eurozone's increasing output gap."
In other words, there will be downgrades if the ECB sticks to 1930s policies. It may not be a currency war, but it is a war of economic ideas.
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