Gestion Férique Market Review

 

July 2011

 

Title: US debt downgrade overplayed

 

In early August Standard & Poor’s downgraded its rating on US debt from AAA to AA+. Yet while stock markets tanked after it occurred, the reaction likely had as much to do with outside events, as with the rating cut itself.

 

That is not to say that ratings cuts aren’t important. In general, countries with lower debt ratings (such as Greece, which currently has a CCC rating) pay higher interest rates when they borrow money. The effects of ratings cuts can thus throw national budgets out of whack and the repercussions can sometimes flow throughout the affected country’s economy.

 

However the United States differs from other major industrialized powers, such as China, Japan and France on several fronts. For one, despite its short and medium term economic challenges, America has a taxpayer base, which will be growing significantly in the coming years.

 

Just as important is the fact that the US, which operates the world’s reserve currency, is thus able to borrow in US dollars. That means that the Federal Reserve can literally print up all the money that the federal government needs to pay its obligations. There could be collateral costs on the inflation front if that happens, but the option is there.

 

Standard & Poor’s based its US debt downgrade in large part on the political gridlock in Washington in the recent negotiations to raise that country’s debt ceiling. But there too, concerns may be overblown. True, the rough and tumble, debate on economic issues that take place in countries like the US, whose political system is based on a separation of powers, can be rough and messy. However the openness has considerable advantages over the backroom negotiations that take place in other countries over such issues.

 

In short, while as of this writing, US stock markets have been hit hard in the wake of its rating cut, much of this relates to other domestic economic factors and troubles in European debt markets, than to the debt rating cuts itself.

 

In fact, so far bond investors, in a flight to quality, have reacted to Standard & Poor’s ratings cut, by reducing (not increasing) the interest rates they pay on US securities.

 

That vote of confidence speaks far louder than the ratings cuts itself.

 

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Peter@peterdiekmeyer.com

 

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