Poor ratings don't add up
The decision and reactions to Standard & Poor's announcement that it was downgrading the United States credit rating from AAA to AA-plus is continuing proof of the mess that the global economy is in, with bets being taken on the prospects of a double-dip recession in the US and implosion of the euro and even of the European Union.
Financial leaders of the Group of Seven (G7) industrial countries and the European Central Bank huddled in Sunday conference calls and then rushed out separate statements to try to offer reassurances before Asian markets opened yesterday.
Bloomberg quoted one leading foreign exchange trader as saying that the ECB 'has decided to bring out the bazooka'.
Unfortunately, when trillions of dollars flood the financial markets each day, bazookas are hardly more powerful than a child's peashooter.
G7 ministers declared: 'We affirm our commitment to take all necessary measures to support financial stability and growth in a spirit of close co-operation and confidence.' Words, mountains of words, not particularly inspired words, nor ones you could take to the bank. How does an 'affirm' stack up against 'promise' or 'pledge' or 'determined'?
Markets in Tokyo, Hong Kong, Singapore, all fell by 2 per cent to 4 per cent, oil fell, the dollar fell, and gold rose. All this came after stock market losses wiped US$2.5 trillion off the value of global shares last week.
S&P took away the prized AAA rating of the United States, citing the debacle between the White House and Congress over raising the US debt ceiling. The ratings agency said it was 'pessimistic about the capacity of Congress and the administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilises the government's debt dynamics anytime soon'. To add insult to injury, S&P said it was also placing the US on negative watch, meaning that further downgrades may follow.
The Australian econoblogger Houses and Holes noted that the rating was 'of a discredited leadership by an institution whose own credibility remains firmly stuck in the S-bend'. Not too long ago S&P and its peers were responsible for mountains of AAA-rated paper that could have been issued by cows. Yet here was this company declaring that the US, which issues the world's reserve currency, which can print money and raise taxes at will (tea party willing), has a creditworthiness lower than Microsoft or France.
The pantomime of the downgrade had its farcical moment when US Treasury officials pointed out that S&P had made a small error of US$2 trillion in its arithmetic. S&P staff went into a huddle, admitted the error, but then went ahead with the downgrade anyway.
Multibillionaire Warren Buffett, who has a substantial stake in rival ratings agency Moody's - which has kept its AAA faith in the US - was quick to leap to the defence of his country, declaring that the downgrade 'doesn't make sense. In fact, if there were a quadruple-A rating, I'd give the US that ... The US, to my knowledge, owes no money in currency other than the US dollar, which it can print at will.' Buffett keeps his money where his mouth is, and says he has US$40 billion in short-end T-bills, which he is maintaining.
Yves Smith in Naked Capitalism likened the fuss over the S&P downgrade to fears over Y2K when concerns arose that the world's computers would not be able to cope with the rollover to the year 2000. She said US Treasury yields fell by 50 basis points last week, unlike what was happening to Italy's and Spain's bonds.
S&P's action gave China another chance to preach against the spendthrift US: 'China has every right to demand that the United States address its structural debt problems and ensure the safety of China's dollar assets,' said Xinhua. For good measure, it demanded that the US should slash its 'gigantic military expenditure and bloated welfare costs' and repeated its demand for a new global reserve currency to replace the dollar.
It is surely time for someone to tell Beijing to come into the real world and realise that there can be no new reserve currency or early end to the US dollar's domination until China is prepared to be an international player with the yuan in play. Which other safe haven can investors run to, especially when China's door is closed?
Some economists, rather than traders, have suggested the Philippines, Indonesia, South Korea, which have far superior debt-to-GDP ratios than the US and whose bonds pay more than US Treasuries, but even Beijing has not been brave enough to be seen pouring its surpluses into Asia, except Japan.
But it is easy to understand S&P's logic. Over the few years, Washington has seen revenues fall with tax cuts, while spending has risen with costly wars and bailouts of banks, insurance firms and the economic system generally. As far as the US weekend talk shows are concerned, so-called political leaders are into the mutual blame game rather than offering any ideas of how to tackle the problems.
President Barack Obama, elected on a platform of 'change you can believe in', is increasingly leading from the rear. Even his most ardent supporters lament that he lacks the guts for a fight, which might allow him to stamp out the turf from which he will not budge. Economist Nouriel Roubini says the economy is approaching stall speed and there is a 50 per cent chance of recession, not the best foundation to start tackling deficits and debts.
The US government's total revenue in fiscal 2010, most of which came from personal income tax. Net costs stood at US$4.3 trillion