S&P recognized that the interconnectedness of the eurozone means that their fates are sealed. Further deterioration of the eurozone will mean a recession for all of its members, including those in the north, raising the risk level of their debt.
Germany and France met last weekend to discuss forming some sort of fiscal union. Such a union would be a giant leap forward in solving this crisis. Trouble is, the "union" that was proposed by the two anchor members of the euro doesn't seem to be much of a union at all. Preliminary reports show that the fiscal union proposed would push nations to comply with debt ceiling levels that are already on the books. Those rules, which bar countries that have a debt to GDP ratio of over 60% from running budget deficits in excess of 3%, have been violated by almost all members of the eurozone at some point in the last decade – including Germany. Why? Because there was no consequence in doing so. The "rule" became more of a suggestion and everyone just ignored it, leading up to today's crisis.
The agreement would now levy "sanctions" on those members that fail to adhere to the deficit rules. It is unclear how this will all work. Germany had originally wanted the European Court of Justice to be able to declare national budgets invalid and force nations to comply with the deficit rules, but France objected to that proposal. If the ECJ had that power, then this agreement might have stood a chance of impressing the markets. Taking that provision out now makes this union more a suggestion than a binding agreement. To make matters worse, both nations agreed that the issuing of a common debt instrument, known colloquially as a Eurobond, would not be in their best interest.
But a true fiscal union would involve the pooling of tax receipts and debt among all members. The fortunes of Germany would need to be shared with that of Greece, while the burdens of Italy would need to be shouldered by stronger members, like the Netherlands. The redistribution of taxes and the harmonization of spending policies would ensure that the eurozone moves in lockstep with the monetary policies of the euro's central bank, the ECB.
Without the pooling of debt and taxes, the only way that the euro can be saved is if the ECB officially becomes the lender of last resort for the eurozone. The ECB would be able to print as much money as needed to buy and support the debt of the southern European nations, until private investors get back in the game. The head of the ECB signaled last week that the bank would become more active in the market if it saw a more meaningful alignment of fiscal policies across the eurozone.
It is unclear if the ECB would interpret the Franco-German plan as meaningful. As it stands now, the plan looks toothless. S&P noted that ECB backing would be critical to solving this crisis and that its support could avoid a mass downgrade. After S&P's announcement yesterday, France and Germany issued a joint statement saying they stand by their agreement. But if the plan isn't beefed up this weekend, then both nations should be prepare to fall together.
