It’s very risky for an American credit ratings agency to downgrade the US Government.
Standard & Poor’s found out when it stripped the US off its AAA rating in 2011 over the debt-ceiling charade. The Department of Justice then sued S&P over its role in the financial crisis, i.e. for slapping AAA-ratings on toxic securities to pocket fatter fees from issuers. But the other ratings agencies did the same thing and have not been hounded. So S&P claimed that the “impermissibly selective, punitive and meritless” lawsuit was “in retaliation” for the downgrade.
Though the Government denied the retaliation angle, it was a lesson no credit ratings agency within the long and sinewy arm of the Government would ever forget. But now Fitch is inching gingerly toward that abyss. While it affirmed (text) the US at AAA, Outlook Stable, it threw in some potentially devastating caveats.
What drives America’s dubious AAA-rating? “Unparalleled financing flexibility as the issuer of the world’s pre-eminent reserve currency….”
So endowed, “the US rating can tolerate a higher level of public debt than other ‘AAA’ sovereigns.” The “threshold” for the US is a gross national debt of 110% of GDP, the highest threshold of any country “owing to its exceptional financing flexibility.” But if the US hits that 110%, it would be “incompatible with ‘AAA.”’
Other factors also contribute to that “exceptional financing flexibility,” including America’s vast and liquid capital markets, its “large, rich, and diverse” economy, “one of the most productive, dynamic, and technologically advanced in the world.” Nevertheless, growth in that miracle economy in 2014 is going to be a “sluggish” 2%, just above stall speed. And Fitch sees the medium-term growth potential at a languid 2.2%.
The budget deficits will be shrinking only through fiscal 2015. In fiscal 2016, they’ll be rising again, due to, among other reasons, “higher net interest costs” as rates go up. Fitch hopes that normalization of monetary policy would “not fundamentally destabilize the recovery or financial markets.” But it would trigger more volatility. And “downside risks are material….”
Other issues are also dogging the US: High external liabilities, a result of “persistent current account deficits and low national savings rates,” which make the economy “more vulnerable to adverse external shocks.”
So Fitch estimates that the gross national debt – “excluding trade payables and unfunded pension liabilities, consistent with EU countries” – would hit 100% of GDP at the end of 2014. It sees a “debt peak” of 104% of GDP in 2024, based on this way of counting, which excludes any kind of recession or a market swoon. Since this 104% is “below the threshold of 110%,” Fitch does not “anticipate” a downgrade.
A downgrade would be triggered by: “material deterioration in the coherence and credibility of economic policymaking,” whatever that means in Washington; a deterioration of the deficits and the debt-to-GDP ratio; and an erosion of “the role of the US dollar as the pre-eminent global reserve currency.”
There it is again, the dollar’s erosion as the pre-eminent global reserve currency. It is very inconvenient.
It would deprive the US of much of the “financing flexibility and debt tolerance” that it has so enormously benefitted from up to now. When China starts hoarding euros, and when European countries start hoarding Chinese yuan, and when other countries start hoarding both, and when they’re hoarding other currencies as well, such as the UK pound, the Canadian and Australian dollars, even the yen (though that’s increasingly a losing proposition), and some other currencies, instead of US dollars….
And that is already happening.
The euro is already heavily represented on the balance sheets of China and other countries as a reserve currency and is breathing down the dollar’s neck as a trading currency. Every day, new bilateral accords are being implemented around the world to elevate the yuan, especially in the financial centers of Asia and Europe.
Everyone knows by now that there will be three big reserve currencies in the near future: the dollar, the euro, and the yuan, with smaller currencies thrown into the basket. And the day is nearing when the dollar’s status as the “pre-eminent global reserve currency” erodes to less than 50%.
That’s when the US dollar hegemony will be over. The US will face a new world of funding constraints. It will no longer be able to dictate financial terms. Its long and sinewy arm that can hit banks around the world and impose rules and sanctions and penalties will atrophy. And life for US policymakers will become a lot more complex. It will be a humbling experience.
Courtesy Wolf Richter at WolfStreet.com (EconMatters archive HERE) The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.