Standard and Poor (S&P) have reduced America's sovereign credit rating from AAA to AA+. The rating puts the U.S. on par with Kuwait and Taiwan. America's $US14.3 trillion debt makes the world's richest nation a worse credit risk than Australia, Germany, Britain and the Isle of Man. The downgrade followed the biggest weekly selloff in U.S. stocks in 32 months.
S&P's decision rested on two factors: America's decision to raise the debt ceiling and concerns about America's political processes. S&P were reportedly concerned about the "political brinksmanship of recent months" which had highlighted what they saw as "America's governance and policymaking becoming less stable, less effective, and less predictable" than what they had previously believed. S&P were "pessimistic" about the ability of Congress and the White House to reach a broader plan to rein in the deficit "any time soon." It has been widely reported that the legislation signed by Barrack Obama on 2 August to reduce the fiscal deficit by US$2.1 trillion over 10 years was well short of S&P expectations of US$4 trillion.
The rating agency is also reportedly considering the possibility of lowering the rating to AA within two years if the U.S. government does not cut spending as much as recently pledged, or if higher interest rates and new fiscal pressures worsen the state's financial picture. The Wall Street Journal has reported that the S&P decision will likely send "shock waves through global financial markets and potentially undermine world economic growth."
In July, S&P had placed the United States' rating on "credit watch with negative implications" as the debt ceiling debate devolved into partisan bickering. In the same month Moody's Investors Services announced it had initiated a review of America's sterling bond rating because of the likelihood of a U.S. default on its debts. Unlike S&P who wanted to see no increase in the debt ceiling, Moody's concern was based on the fact that the rise in the debt ceiling would not be high enough. In both cases however it seemed America's rating was in trouble last month.
The downgrade of America's credit rating is the first time the U.S. was downgraded since it received an AAA rating from Moody's in 1917 and S&P in 1941. It is the first time that S&P has issued a "negative" outlook on the U.S. government since it began rating the credit-worthiness of railroad bonds in 1860.
A downgrade is uncharted territory for the U.S., but one outcome seems likely: Americans could face higher interest rates on mortgages, car loans, credit cards and other consumer loans. Business probably will also have to pay more to borrow money, none of which will boost the already flagging economy. The likely domestic cost of the downgrading will be increased borrowing costs, which will have a drag effect on economic growth. It is predicted that the U.S. downgrade is likely to cost the U.S. economy US$100 billion a year. Variable borrowing rates and mortgage rates will rise; conversely mortgage-backed bonds will face a downgrade. Money market mutual funds will come under significant pressure. The downgrade will negatively impact on the borrowing capabilities of American state and municipalities and companies, particularly those with debts linked to federal payments.
A larger concern will be whether the appetite for U.S. debt might change among foreign investors, in particular China, the world's largest foreign holder of U.S. Treasurys. In 1945, foreigners owned just 1 per cent of US Treasurys. Today they own a record high 46 per cent. U.S. Treasury bonds, once undisputedly seen as the safest security in the world, are now rated lower than bonds issued by countries such as Britain, Germany, France or Canada.
Prior to the S&P and Moody's decision, Dagong, China's Global Credit Rating agency, had already pushed the U.S. rating from A+ to A, and placed the rating on negative watch (indicating the potential for a further cut). Other than the U.S. Federal Reserve, China is the biggest holder of American debt, with US$1.16 trillion. It maintains the value of its currency through buying U.S dollars: a monetary policy that is likely to continue if only to protect its own currency.
The downgrade, accompanied by a continuing weak U.S dollar, could affect Chinese exports and this will directly affect the Australian economy. Less demand for consumer goods in both the regional and global economy would directly lead to weaker demand for China's exported goods; this then weakens demands for imports particularly in the energy sector. If the Chinese currency appreciates as a response to the weakening U.S dollar it will make Chinese goods more expensive. This will result in China shifting its focus away from export production to production for domestic consumption. With China continuing to buy U.S debt and shifting its focus to domestic economic production, the results will mean less Chinese currency floating in the regional and global economy. This coupled with contractions in Eurozone spending, bodes badly for any economy that is being driven by exports: as Australia currently is.
Prime Minister Julia Gillard has immediately responded to the downgrade saying: "Australia's economy is strong and should not be badly affected." She maintained the Labor mantra that the Australian economy was, and would remain strong, because of China's demand for Australian resources. However, world stock markets had already plunged prior to the S&P decision, stripping more than $100 billion from the value of listed Australian companies. Following the downgrade decision the Australian share market is expected to face more losses. No amount of Gillard or Swan rhetoric is likely to stop further significant domestic losses. Similarly, the Canadian government is putting on a brave face in its acknowledgement of its interconnectedness with the U.S. The country's finance minister Jim Flaherty has said that Canada is "well-positioned to face global headwinds."
Apart from the economic impact of the downgrade on American and international economies, the downgrade has a political context. The world's economic superpower has been sharply criticised for its political handling of the debt ceiling issue. S&P issued a "sharply worded critique of the American political system". There is a view that the U.S. does not deserve a triple-A rating, and the reason has nothing whatsoever to do with its debt ratios. America's ability to pay is not the issue: the problem is its willingness to pay. It is not entirely clear that this is the position of Barrack Obama and the Democrats, rather is likely being driven by those in Washington who are willing to "drive the U.S. into default."
It is possible that the S&P factored in the machinations of the Republican Party, and in particular the Tea Party, that took the U.S. to the brink of default. A smaller deficit-reduction deal was on offer, but was refused by the Republicans possibly hyped up by the Tea Party, who are desperate to remain relevant in a rapidly changing political landscape. This being the case, the S&P have punished America because of the action of recalcitrant Republicans for refusing to accept any legislation that would increase taxes. The political machinations of Washington confirmed to S&P the debilitating state of American politics.
America emerged as the dominant, hegemonic power at the end of the Cold War. It played a preeminent role in shaping the post-war international economic system and was a key actor in many of the international organisations that now shape global economic and monetary policy. The decision to downgrade its credit rating is economic, political but also powerfully symbolic. In New Zealand, the downgrade was reported as "a dramatic reversal of fortune for the world's largest economy." The Australian media is reporting it as "a symbolic embarrassment for President Barack Obama, his administration and the Americans" and as a "symbolic blow." As one American commentator has said: "The symbolism is undeniable." The downgrade is a "blow to U.S. prestige."
The downgrade to America's credit rating is a historic assault on the superpower's prestige and a symbol of the changing world order: that is, the demise of the U.S. and the rise of China.