S&P’s European Downgrade

By Mr. Curmudgeon

Late Thursday, the credit-rating wing of Standard & Poor’s downgraded the creditworthiness of 9 eurozone nations. The move was seen as the credit agency’s subtle way of spurring the 17-nation European Union to hurry a bailout plan for Greece ahead of a debt default sometime in March. “European politicians, in turn, criticized S.&P.’s downgrade plans as providing no meaningful new information to investors but simply stoking a sense of crisis,” the New York Times reported.

Sounding a more realistic note, the London Daily Telegraph said, “Just as markets had started to believe that the eurozone crisis was in retreat, along comes the credit rating agency, Standard & Poor’s, to remind everyone that the crisis hasn’t gone away at all, but has only been taking an extended Christmas break.”

Brian Dolan, chief currency trading strategist at Gain Capital, told Bloomberg News, “The Greek situation is quite dire. If they don’t reach some sort of agreement by the end of next week, they may very likely be forced in to a hard default.”

Listening to politicians, market analysts and the media, you can be forgiven for blaming credit agencies for the world’s impending plunge into a double-dip economic depression. Many see the credit downgrades as a dwindling confidence in the ability of governments to pay back their loans. And this misses the point entirely. These credit downgrades are a warning siren that Western economies cannot grow fast enough to keep pace with the rapid expansion of debt created by the globe’s central banks since the financial crisis began in 2008.

Most people do not understand how fractional reserve banking works. And governments and central banks alike are just fine with that arrangement.

Money, you see, does not represent goods and services. It represents the purchase of government debt (bonds or Treasury notes) by central banks. These central banks then lend this debt-based currency to member banks who in turn lend it to businesses or individuals. Here’s the thing: banks then lend out more than they borrow, as much as 90%. The hope, therefore, is that borrowers will create tangible assets with borrowed fiat currency, giving it value sometime in the future. Since the founding of the Federal Reserve, the value of the U.S. dollar has declined by over 90%. That means the ability of the economy to produce goods and services to keep pace with the creation of dollars has never outpaced the Fed’s ability to print them.

With worldwide government “stimulus” spending, bailouts and quantitative easing, the debt has reached unprecedented levels that make it unlikely battered economies can create real wealth – cars, refrigerators, computers, flat-screen TVs, etc., to equal all the funny money floating around the world.

That means the only tangible asset propping up what’s known as the fractional reserve banking system is confidence. S&P’s European downgrade threatens that confidence, “stoking a sense of crisis,” as the New York Times said.

Greece is approaching default because its economy is shrinking at the same time its debt is increasing. A bailout will only enlarge that nation’s debt load, the cost of servicing it, and accelerate the rate at which its economy shrivels.

Keep an eye on next week’s markets. If the European Union fails to devise a stopgap bailout for Greece, which is only temporary, expect the markets to “price in” a European Union slowdown. And that slowdown will ripple across the globe.

President Obama recently asked Congress to increase America’s debt load another $1 trillion. Frightened establishment Republican leaders, their aides tell the press, will agree rather than face the ridicule of Democrats and the mainstream media; a move that will push America, like Greece, toward the event horizon beyond which it can’t escape the black hole of insolvency.