This article was originally published August 6, 2011 on FT.com.
There will be endless debate on whether S&P, the rating agency, was justified in stripping America of its AAA rating and -- adding insult to injury -- even attaching a negative outlook to the new AA+ rating. But this historic action has now taken place, and the global system must adjust. There are consequences, uncertainties, and a silver lining.
Not so long ago, it was deemed unthinkable that America could lose its AAA. Indeed, "risk free" and "US Treasuries" were interchangeable terms -- so much so that the global financial system was constructed, and has operated on the assumption that America's AAA was a constant at the core, and not a variable.
Global financial markets will reopen on Monday to a changed reality. There are immediate operational consequences, from re-coding risk and trading systems to evaluating collateral and liquidity management. Key market segments will be closely watched, including the money market complex and the reaction of America's largest foreign creditors.
Meanwhile, for the real economy, credit costs for virtually all American borrowers will be higher over time than they would have been otherwise. Animal spirits, already hobbled by the debt ceiling debacle, will again be dampened, constituting yet another headwind to the generation of investment and employment.
It is hard to imagine that, having downgraded the US, S&P will not follow suit on at least one of the other members of the dwindling club of sovereign AAAs. If this were to materialize and involve a country like France, for example, it could complicate the already fragile efforts by Europe to rescue countries in its periphery.
The future role of rating agencies will also now come under close scrutiny, bringing to the fore the question of who rates the rating agencies? S&P's action will likely unite governments in America and Europe in an effort to erode their monopoly power and operational influence. This will also force all investors to do something that they should have been doing for years: conduct their own ratings due diligence, rather than rely on outsiders.
More worryingly, there will now be genuine uncertainties as to wider systemic impact of this change. With America occupying the core of the world's financial system, Friday's downgrade will erode over time the standing of the global public goods it supplies - from the dollar as the world's reserve currency to its financial markets as the best place for other countries to outsource their hard-earned savings. This will weaken the effectiveness of the US as the global anchor, accelerating the unsteady migration to a multi polar system while increasing the risk of economic fragmentation.
These factors will play out over time, and will possibly do so in a non-linear fashion. Some of the immediate impact will be forestalled by the fact that no other country is able and willing to replace the US at the core of the global system. Other than a general increase in risk premia and volatility, it is therefore hard to predict with a high degree of conviction how the global system will react. Specifically, will it simply come to a new normality, with an AA+ at its core, or are further structural changes now inevitable?
All of that said, there a sliver of a silver lining -- and an important one. America's downgrade may serve as a wakeup call for its policymakers. It is an unambiguous and loud signal of the country's eroding economic strength and global standing. It renders urgent the need to regain the initiative through better economic policymaking and more coherent governance.
There is a risk, of course, that different political factions will use S&P's action as a vindication of their prior beliefs. Democrats would argue that it is recent Republican political sabotage that pushed S&P over the edge while Republicans would argue that we are here due to irresponsible government spending by the Democrats.
For the sake of their country and the wider global economy, both parties should resist the urge to begin bickering. Instead they should seize this potential "Sputnik Moment" -- a visible shock to the national psyche that can unify Americans around a common vision and a renewed sense of purpose -- that of halting gradual secular decline by putting the country back on the path of high growth, job creation and financial soundness.
Credit ratings indicate the credit worthiness of issues/issuers and generally range from AAA, Aaa, or AAA (highest) to D, C, or D (lowest) for S&P, Moody's, and Fitch respectively. All investments contain risk and may lose value.
This material contains the opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. This material is published by The Financial Times. Date of original publication August 6, 2011.
Jeff Reeves: Don't Panic: The U.S. Credit Downgrade Changes Nothing
What do they want this time? For us to be afraid or to give them our pants?
I look at this thing as a positive. The bickering you spoke of is a local phenomenon. The world exposure to our debt precariousness will force a more sane approach to our government spending.
IMO this downgrade event is indeed a watershed moment. As an optimist, I am confident that our government will shed its appetite for growth. Sanity is around the corner.
Relax - they don't bite too hard. They live on the inside of a bubble. The biggest fear they have is that bubble - bursting. So just be nice with them. Let them know that the bubbles are about to burst nationwide and that we'll be there to help them build new realities- outside the bubble.
The conspiracy to bring down Obama should be stopped.
There are nuclei of people who are willing to bring down the world economy just to get rid of a - not even left wing - but a political center US president with a black father.
But if that is clear, the American people, and even American economic forces that want the country to thrive, can foil the criminals.
American unite against the bandit right-wing.
Ok, help me out here.
What "irresponsible" government spending by the Democrats?
What "irresponsible" government spending by the Democrats/Repulicans?
The arguments between D and R no longer are relevant. This is a world platform. It has nothing to do with what Bill Mahar thinks.
The answer is Free Market Hemp, we can grow our own fuel, jobs and future. The era of industrial power is over, welcome to Every Tub Must Sit On Its Own Bottom Age.
And call for Reagan era taxes.
-Good luck with that one!
El-Erian’s imposed narrative would have us believe that “financial soundness of the U.S. government” is the central issue that affects the U.S. economy, but NOT private-sector bankster securities fraud, not SEC's failure to regulate, NOT the deregulation that murdered Glass-Steagall, NOT the 1999 Gramm-Leach-Bliley Act or the (Phil Gramm) 2000 Commodity Futures Modernization Act, NOT the $1.4 Quadrillion-dollar unsoundness of the derivatives boom.
One more time: Government debt is not the issue. Government debt is misdirection. Private sector deregulation & bank fraud is the cause of the economic crisis.
So, even if the world listens to them and it turns out bad for us let's hold our heads up high, come together, and solve this problem as we have in so many times in our past. Abraham Lincoln in his first Inaugural Address begged the people to listen to the better angels of their nature. We need to listen to him for once, solve this, and get back to work being American. This especially is directed towards our politicians, but it also applies to us regular citizens.
In stark contrast to the author's article I don't think we should really come together with Europe until we have our own affairs in order because if we don't have our problems settled how can we in any shape, fashion, or form aid them in their time of crisis? In fact, we need to stop acting as their nanny and let them sort their problems out for a while. We need to stop being their military and wasting trillions of money fighting their wars while supplying them with military equipment they never use because they usually have no one to use it against. The Soviet Union doesn't exist anymore. We need to stop sticking our noses into every little bitty worldly affair, only aiding when our assistance is requested. Only then can we really help Europe and be America again.
There's nothing wrong with not being the top dog. However, there's zero reason why we shouldn't be the top economy in the world. We became the top economy in the world by being who we are. Today, we're not Americans. We're a bunch of bickering crybabies exclaiming how great things used to be and how now we're all doomed. We'll be doomed when there's no one left in this country that believes in it.
Okay. S&P downgraded the US's debt, and they made a fool out of themselves in the process. They were already fools, especially when they're downgrading the country who reached into its own already-enormous debt pouch to bail them out when their insolent actions was one of the causes of the 2008 recession. It'll be up to the world market at large whether to place any creedance on credit ratings placed by a company that can't even get its own finances in order.