US: Rating Cut Shocks, Impact Uncertain

Perhaps all those doomers and gloomers in Australia moaning about how tough times are here, will lift their blinkers and have a quick look at Australia's AAA credit rating and compare that to the US after Standard & Poor's cut on Saturday, our time.

And perhaps they might also like to look at the separate statement on Saturday from the International Monetary Fund which said Australia was well placed to cope with a global slowdown, with low debt, room to move on monetary policy, and a solid outlook (see first story).

That is very much unlike the US and some of those other AAA-rated economies such as the UK, Germany, France and others in the eurozone where deficits, growth and debt worries remain high.

After slashing the ratings of the likes of Ireland (it used to be AAA-rated economy several years ago), Greece, Spain, Portugal, and warning others, it was perhaps about time that a ratings group like S&P took America to task for its profligate ways.

S&P had stiffened its warning to the US in April and then in June warned on the looming credit ceiling default possibility, while saying that it wanted to see spending cuts of at least $US4 trillion over 10 years.

Instead it got $US2.5 trillion at most and they are not certain by any means, thanks to the country's increasingly deadlocked political debate about spending, debt and the economy.

And that political uncertainty in the US has driven the S&P downgrade.

In arguing that last week's debt deal did nothing, but in fact raised the likelihood of another debilitating political argument over spending and debt in the not too distant future, S&P became the first ratings group to lower America's AAA colours for the first time ever.

The new rating is AA plus, but the long term credit outlook is negative, meaning another cut could happen in two years if moves to cut spending are delayed, or the US economy slides into recession, prompting a surge in the size of the budget deficit and a jump in the country's national debt.

According to S&P, the US is now in a group of AA rated economies which includes China, Taiwan, Kuwait, New Zealand and Japan.

Germany, France, Canada, the UK, the Netherlands, Sweden, Hong Kong, the Isle of Man, Denmark, Finland and Australia are among the remaining 18 AAA economies.

And it has to be remembered Australia, Canada, Denmark, Finland, and Sweden all have, at one time or another, lost their top-notch ratings before working their way back to AAA status.

But no country whose currency is the major international unit (and major reserve currency) has had its credit rating cut, so we are in unknown waters here.

After markets finished in the green in the US after a day of wild swings on Friday night, our time, the S&P move could send shockwaves through markets, pushing up US bond yields at a time of economic vulnerability, and creating a long-term threat to the status of the US dollar as the world's reserve currency.

But that's unlikely because US bonds yields have already fallen sharply in the past month in the face of the debt ceiling debacle and the belief that S&P would cut the US rating.

The impact of S&P's move was tempered by a decision from Moody's Investors Service earlier this week that confirmed, for now, the US Aaa rating. Fitch Ratings said it is still reviewing the rating and will issue its opinion by the end of the month.

So in some respects America remains an AAA-rated economy, but the move by S&P will eventually be matched by its competitors in coming months.

And it wasn't so much the current weak state of the US economy or the size of the debt of deficit that prompted the downgrade. S&P took the very contentious decision to argue that the political system of the world's biggest economy has become less stable and that the spending cuts announced last week didn't go far enough.

The rating agency said, "America's governance and policymaking [is] becoming less stable, less effective, and less predictable than what we previously believed," adding to the intense political nature of the statement.

And compounding and adding to the political nature of the decision was the well-leaked news that it was issued after an almighty argument with the Obama administration, which will be hugely embarrassed by the announcement.

Various media outlets reported the brawl, none better than the Financial Times.

"The downgrade followed an extraordinary row which put the move on hold for hours after the Treasury department claimed it had found trillions of dollars worth of errors in the agency's analysis," the paper reported.

"S&P sent a draft of its ratings decision to the Treasury at around 1.30pm in Washington. Treasury economists scrutinised the numbers and found what they believed were trillions of dollars of errors.

"These related to how S&P had handled the Congressional Budget Office baseline for discretionary spending in regard to the recent debt ceiling deal.

"The Treasury replied at about 4pm EST. "The impact was pretty substantial - about 7 to 10 per cent of gross domestic product on the debt over time," said an official aware of the exchanges.

"However, S&P pushed forward and issued its downgrade at around 8.20pm EST, "The FT reported.

The agency didn't back off from the political nature of the statement or decision.

"There are two things that we should emphasise. One is that the political discourse has diminished the credit standing of the United States. The other is a fiscal analysis," said John Chambers, managing director and chairman of the sovereign ratings committee at S&P's said in the statement.

That brought this in line reaction from the US Treasury:

"In a document provided to Treasury on Friday afternoon, Standard and Poor's (S&P) presented a judgment about the credit rating of the U.S. that was based on a $2 trillion mistake. After Treasury pointed out this error - a basic math error of significant consequence - S&P still chose to proceed with their flawed judgment by simply changing their principal rationale for their credit rating decision from an economic one to a political one."

The US Fed and chief banking regulator the FDIC said in statements on Saturday, our time, that the downgrade won't change the way they treat US government bonds and other securities (such as T-notes), meaning they will still have the highest rating and standards for capital and debt and other trading.

S&P said it would issue further statements tonight, our time "concerning affected ratings in the funds, government-related entities, financial institutions, insurance, public finance, and structured finance sectors".

And possibly the most interesting reaction came not from the Obama administration, but from China, which is America's biggest creditor.

China's state-run Xinhua News Agency said on Saturday that, "the US government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone".

"China, the largest creditor of the world's sole superpower, has every right now to demand the United States to address its structural debt problems and ensure the safety of China's dollar assets," it said.

Xinhua said the US must slash its "gigantic military expenditure and bloated social welfare costs" and accept international supervision over US dollar issues.

That is special interest arguing (reduce military spending would help China, while China won't accept international supervision of the Yuan, so why should the US accept it for the dollar).

But the Chinese, along with every other economy, wants to see America get its house in order.

S&P has fired the first of what will be some very damaging and critical comments at US economic policy and US politicians.

But will Americans listen with the 2012 elections looming ever larger? I don't think so.