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dcrednek (79.02)

Some observations on the debt ceiling debate

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July 20, 2011 – Comments (2)

You've been able to get plenty of opinion and sometimes some real analysis on the USA debt ceiling debate over the past three months or so.  The purpose of this post isn't to argue the relative merits of this decision, nor to get on a soapbox about the politics of the decision.   Some debt ceiling articles have mentioned how a default will lower the US government's credit rating, but what those articles failed to do was to put that potential consequence in context.

 Standard & Poor's provides free, public access to their regular report titled "Sovereign Ratings and Country T&C Assessments".  The newest one I found was dated June 28, 2011 and that's recent enough for me to make my point.  Yes, in fact the USA's sovereign rating is AAA at the moment.  If it is downgraded in August, as some suspect might occur, then it is likely to be reduced to the next lowest category, AA+.  How big a deal would that be?  Let's find out with a few statistical and comparable observations.

First, the USA is one of 20 countries who hold the highest rating of AAA.  Some of its peer group are comparable large economic powers like France, Germany, Canada, and the UK, while others are much smaller in size and influence - Austria, Denmark, Isle of Man, Hong Kong, Switzerland, and Singapore.   If the US were downgraded to AA+ status they would move into a peer group with one other country, Belgium. 

Now let's look at a few countries not mentioned in the preceding paragraph.  Some of the largest, most influential economies in the world have comparable or lower sovereign credit ratings than the US (either now or if they were downgraded):  China (AA-), Japan (AA-), Brazil (BBB+), India (BBB-), Russia (BBB+), Italy (A+), Mexico (A).

 Yes, the AA status is the actual rating, but I am confident that the '+' distinction will be granted to the US if in fact a downgrade is enacted.  And a quick glance at interest rates in some of the AA countries shows that borrowing costs aren't much, if any, higher than the rates on US government debt.  So I absolutely don't put any credence at all in the arguments that "financial armageddon" will occur if the US is downgraded for any reason.  Don't believe the story being sold by some:  these people don't seem to have done even the most basic comparative analysis of the subject.

 I am not a big fan of investing in US sovereign debt at the moment.  Several other asset classes provide a comparable notional return with an equal or better risk-adjusted return.  Make your own decisions but know that a downgrade of US sovereign debt is not, in my opinion, the beginning of the end of American economic strength and dominance.

2 Comments – Post Your Own

#1) On July 20, 2011 at 11:03 AM, outoffocus (22.74) wrote:

DCREDNEK,

Your analysis of the impact of a downgrade of US debt only scratches the surface of the problems it would cause.  I'm sorry to say that simply comparing relative ratings amongst differing countries is almost like comparing apples to oranges. Simple fact is, the US Dollar is the reserve currency based on that AAA rating that we had for so long.  That development alone will affect millions of transactions a day.  Also, US Treasuries are considered the "safest" investments in the world based on that AAA rating.   As a result, millions of contracts depend on the US maintaining that rating.  Its a huge house of cards that you will not see by simply looking at a Sovereign debt report by a rating agency.  I would say a large part of our financial system DEPENDS on the US's AAA rating.  So yes, an official downgrade of US debt could set off a domino effect larger than what we saw during the fall of Lehman Bros.  

This is why I believe the rating agencies talk a big game, but they will never PRE-EMPTIVELY downgrade US debt.  A default would have to happen FIRST before they downgrade anything. 

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#2) On July 20, 2011 at 3:00 PM, leohaas (31.76) wrote:

Yet another reason why listening to rednecks when it comes to something as complicated as the economy is not such a good idea!

When I have a plumbing problem, I call a plumber. If I'd have cancer, I'd go to an oncologist. When it comes to global warming, I listen to climatologists. And when it comes to the economy, maybe we should let economists do the talking.

And please, when you provide an opinion, don't start off saying that "The purpose of this post isn't to argue the relative merits of this decision, nor to get on a soapbox about the politics of the decision." You are exactly doing that.

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