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What is a sovereign credit rating and does it really matter?
BUZZARDS BAY, Mass. — The United States is in trouble. BIG trouble. Or so it seems.
Despite a last-minute save from Capitol Hill that averted what could have been financial Armageddon, the damage to America’s reputation will be lasting, according to the experts.
Uber-investor Warren Buffet is calling the whole near-default crisis debt ceiling “an act of pure idiocy,” and warning Washington it’s in danger of being seen as, well, spoiled: "Credit worthiness is like virginity, it can be preserved but not restored very easily,” he told CNBC.
Fitch, which with Standard & Poor’s and Moody’s forms a holy trinity of ratings agencies, said Tuesday it put the United States on notice that it could face a credit rating downgrade if it did not stop playing chicken with the economy, and changed the outlook on US debt to “rating watch negative.”
China, of course, has been fulminating about Washington’s “hypocrisy and irresponsibility” for days. On Thursday, to add injury to insult, Chinese credit rating agency Dagong demoted the US from A to A-, on the credit worthiness scale, with a negative outlook.
"For a long time the US government maintains its solvency by repaying its old debts through raising new debts, which constantly aggravates the vulnerability of the federal government’s solvency. Hence the government is still approaching the verge of default crisis, a situation that cannot be substantially alleviated in the foreseeable future," Dagong said in its justification for the downgrade.
But how much does all of this really matter?
CNN’s Erin Burnett certainly thinks it does. Each night on her show “Out Front,” with Cronkite-like solemnity, she gives the count from the fateful day when Wall Street first fell from its lofty pinnacle: “It’s been 803 days since S&P downgraded the US AAA credit rating,” she said Thursday night. “What are we doing to get it back?”
In August 2011, amid another debt-ceiling crisis, S&P caused a flutter in the market when it knocked US debt down to AA+, with a negative outlook. It was the first time anyone had dared to suggest that the US government’s commitment to paying its bills was anything other than rock-solid, and the reaction was fierce.
“The stock market lost its collective mind, “ writes Jeff Macke, of Yahoo Finance. “[It fell] nearly 7 percent the following Monday alone and nearly 17 percent in the three weeks surrounding the downgrade.”
But the panic did not last long; a year later, Treasury securities were stronger than ever. That meant the US government was able to borrow for historically cheap rates, a privilege suggesting confidence in Washington’s credit worthiness had reached a new peak.
“Since then, demand for Treasury securities has only grown,” the Wall Street Journal writes. “Even for investors worried about the long-term health of US finances, last August's reaction showed that Treasurys have a stronghold on safe-haven seekers.”
So what is all the fuss about?
According to S&P, “Credit ratings are opinions about credit risk. Standard & Poor’s ratings express the agency’s opinion about the ability and willingness of an issuer, such as a corporation or state or city government, to meet financial obligations in full and on time.”
The key word here is “opinion” — credit ratings are subjective, and take many different factors into account.
The highest rating is AAA for S&P and Fitch, with Moody’s using Aaa.
Only 11 countries now have perfect credit with all of the top three rating agencies, and, thanks to S&P, the US is no longer in the lofty company of Australia, Canada, Germany, Norway and Singapore, and Luxembourg.
However, to be blunt, so what?
Certainly Buffet, along with China and other international bodies, is right to lecture Washington about political brinkmanship and fiscal irresponsibility. But in the end, deep-pocket investors in Beijing, Tokyo and elsewhere will buy up US debt with alacrity: It is, for many, the only game in town.
“We continue to be the one indispensable nation,” President Barack Obama said at a news conference in Washington earlier this month. “There are countries across Asia who … want to do business with us, they admire our economy, they admire our entrepreneurs, they know that their growth is going to be contingent on working with us … So it's not as if they've got other places to go.”
That is, indeed, the case: Should a country with a lot of cash to invest decide to stick only to economies with pristine credit reports, its options are limited.
The combined gross domestic product (GDP) of all 11 of the top-rated countries is just a little more than half of the US’ staggering $16 trillion. Furthermore, the United States maintains a debt-to-GDP ratio that would make many other countries blanch: For 2012 it was over 100 percent, or $16.7 trillion, nearly $5 trillion of which is held by foreign governments.
That’s a lot of debt.
“Having low debt to GDP … is not necessarily a sign of a stable economy,” USA Today writes. “For some countries, high debt is a sign of a healthy economy. Five of the AAA-rated countries had debt exceeding 50 percent of national GDP as of 2012.”
The United States, then, must be in great shape, no?
Agencies weigh several factors when rating a country's debt. Political variables are among them. Lately, with the squabbling likely to continue in Congress, that's bad news for America.
Out of the top 10 world economies, only Germany has an AAA rating; China and Japan, Nos. 2 and 3, respectively, are rated AA- by S&P, with China given a “stable” outlook and Japan “negative.”
According to S&P, while Japan has a “prosperous and diversified economy,” it also has “a very weak fiscal position, aging demographics, and persistent deflation,” which are dragging it down.
Russia, the eighth-largest world economy, with a GDP of $2.2 trillion, is just one step above junk bond status with the three major ratings agencies. While its economy is huge, it has “limited diversification” and a “focus on commodities” that, for Moody’s, keep it on the risk level of Mauritius.
China is also in trouble, experts say, due to an over-reliance on credit to finance growth.
“Risks over China’s financial stability have grown. Credit has grown significantly faster than gross domestic product,” the Financial Times writes, citing Fitch’s downgrade of China’s credit rating earlier this year.
China holds nearly $1.3 trillion in US Treasury securities, meaning that, for all its bluster, the world’s second-largest economy is dependent on the United States.
“China got into bed with the US Treasury and can’t get out,” Time magazine writes.
So, credit ratings aside, the United States is still the world’s prime destination for investment, and is likely to stay that way for some time to come.
“The US possesses unparalleled assets, including the size and resilience of its economy and the dollar’s standing as the world’s reserve currency,” according to Bloomberg Businessweek.
“Few investors are willing to bet the US government will fail to meet its debts, no matter how dysfunctional the politics become in Washington.”