Putting The U.S. Credit Downgrade Into Perspective

In the wake of the decision by Standard and Poor’s to downgrade the United States credit rating, the reaction worldwide has been somewhat muted. Of course, if nothing else, this is a gigantic embarrassment to the U.S. government, especially the congress and the Obama administration. It was on their watch that the first ever downgrade of U.S. debt has taken place. And the fact that it came on the heels of the so-called debt-reduction plan passed on August 2nd was pretty much a “smack-down” for the U.S. government.

US credit downgrading

Reaction to the US credit downgrading has been somewhat muted. Image courtesy of Adam_t4

The U.S. Treasury reacted immediately by saying that Standard and Poor’s made a two trillion dollar error. My mother would have said that’s nothing but “the pot calling the kettle black”. The idea of the U.S. government accusing a credit ratings agency of massive accounting errors is something that ought to be fodder for late night TV comedians. We all know that government accounting gimmicks are the essence of most so-called “cuts” in spending. The U.S. government has mastered the art of accounting tricks. And the thing is, we all know it.

Standard and Poor’s really had little choice, given the beating that they and the other credit ratings agencies have taken over the 2008 market crash. Between the tech-bust and the 2008 melt-down, they had all but lost credibility by failing to spot major problems with corporations that were cooking their books, and continuing to over-rate the credit worthiness of dozens of companies that have since collapsed. And they had been threatening a downgrade for weeks, if the U.S. Congress failed to pass a “meaningful” debt reduction plan. Most people in the U.S. certainly would not consider the recent spending agreement / debt ceiling increase to be a “meaningful” plan to reduce the U.S. debt. So they had to act or risk losing what credibility they had left.

Standard and Poor's had little choice to downgrade the US' credit rating. Image courtesy of Funky Tee

With that in mind, I would think that Moody’s and Fitch are struggling with how to respond to this opening shot by Standard and Poor’s. If anything, a downgrade from AAA to AA+ is not really enough of a downgrade to represent the true nature of the U.S. debt problem. Still it took some guts for S and P to take this action, knowing that the weight of the Obama administration was going to come down on them like a ton of bricks. Moody’s or Fitch could come back with a slightly bigger downgrade, in order to look even more credible than Standard and Poor’s. But if they fail to issue any sort of downgrade, it could compromise their own credibility even further.

There are few people in the world who do not realize that the U.S. has a very serious debt and credit problem, but since the dollar is still the worlds reserve currency, and other nations are holding trillions of dollars worth of U.S. treasuries, the global response will be muted at best, at least for now. Any panic selling of U.S. treasuries among major nations would simply serve to undermine their own economic position.

US Dollars still represent one of the safest investments in the world. Image courtesy of Andres Rueda

When you’re holding a trillion dollars worth of U.S. treasuries, you’re going to do everything you can to maintain their value, not engage in panic selling that could send global financial markets of a cliff.

And the fact remains that even with the major economic problems faced by the U.S., those treasuries still represent one of the “safest” investments in the world. As ridiculous as that sounds to those of us living in the U.S., for now at least, there are few if any, other places in the world that are a better option for parking such huge sums of money.

Still, Standard and Poor’s now has the distinction of being the first independent credit rating agency to fire a shot directly across the bow of the U.S. government. And considering the rate of spending that is already scheduled by the U.S., it’s likely only a matter of time before yet another credit downgrade will take place. But governments, like alcoholics, can only change their ways if they really want to. And it’s anyone’s guess as to whether the U.S. actually has any intentions of changing it’s habits before it’s too late.***