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 US and the rise of China.
Ironically, the Chinese will not be happy about getting the upper hand on the ratings front. China is the single largest investor in US debt. It is sitting on a quarter of all foreign holdings of US treasury bonds. And that $1.2 trillion investment just got stung with its first ever downgrade.
The financial impact, however, of the move by Standard & Poor’s is not so menacing. For one, the ratings agency had already said it was considering a downgrade and Wall Street had, to a large extent, anticipated it.
When markets open for trade again on Monday morning, this will be but one of a host of things already rattling confidence. The turbulence on world markets at the moment boils down to two basic factors: one, soaring debt levels in Europe as well as the US, and two, rising fears the world is heading back into recession.
We emerged from recession only two years ago in the wake of the global financial crisis – ”we” meaning the world, not Australia, whose fortune as a low-debt, big commodity producer for China quarantined us from recession. But the trillions spent by governments around the globe to stimulate a recovery has simply turned into humungous debts.
Governments borrowed to finance their assorted ”cash splashes” and stimulus programs. The measures were designed to make people spend more and revive the economy.
Instead, people saved more. Now recovery looks in doubt. Hence the tremendous disappointment and loss of confidence in world markets over the past couple of weeks. These concerns dwarf the S&P downgrade, which is largely symbolic. S&P’s two rival credit agencies, Moody’s and Fitch, had already announced they would keep their triple-A ratings.
Moreover, the ratings agencies are struggling to regain credibility following their ”colossal failure”, as one congressman described it, during the financial crisis of 2008. Before the stockmarket boom, only the cream of sovereign states and a handful of big blue-chip banks attracted triple-A ratings. In the boom years, though, the agencies began to sell triple-A ratings to investment bankers for their financial products. It famously emerged at a congressional inquiry that they would ”rate a cow” if paid.
There will be some direct financial market implications of the S&P downgrade. Many investors are bound by rules and charters which restrict them to holding triple-A-rated investments. And as the rating on US government bonds, according to one agency, has now been lowered there will be some tweaking of investments and portfolios.
Overriding this, however, will be the fact the US has become even more of a ”safe haven” for worried investors during the turmoil of the past week. US bonds, despite the S&P downgrade, were the world’s best performing investments last week. As sharemarkets dived 5 per cent to 10 per cent around the world, US bonds rallied by the same magnitude.
The paradox is – and S&P has just reaffirmed this – the US is higher risk these days; still, in the past week when people hit the panic button they still sent their capital to the US.
In the longer term, many will dread China’s rise. It has often been said that ”whoever controls the debt controls the asset”. And if China began to sell down its $1000 billion holding in US treasuries, the world would really have a problem.