Despite Downgrade, U.S. Still Towers Over Peers
Dont let last weekends credit downgrade fool you; the U.S. is still the worlds preeminent economy and has countless underlying advantages that no one else can boast of.
While the U.S. economy has suffered a number of setbacks, the global role of the dollar, safe-haven quality of Treasurys and Americas long track record of political stability and economic strength remain firmly in place.
These qualities and strengths are central to why rival ratings companies Moodys and Fitch have chosen not to follow in Standard & Poors footsteps. Unlike S&P, they dont believe there is a legitimate risk of the U.S. defaulting on its obligations.
The financial markets appeared to endorse that thinking on Monday as yields on U.S. Treasurys tumbled amid a general flight to safety away from riskier assets like stocks and bonds. That means it just got even cheaper for the U.S. to finance its heavy debt load.
Where does the flight to quality go? To the market thats just been downgraded, said Josh Feinman, global chief economist at DB Advisors, Deutsche Banks institutional asset management business.
In afternoon action, the price of the 10-year Treasury was up 2 points and the yield tumbled to 2.34%, down from 2.55% on Friday.
To be sure, the U.S. is facing a slew of headwinds on a number of fronts, as Mondays 500-point plunge on the Dow Jones Industrial Average signals. Worries about a double-dip recession and Europes sovereign debt crisis remain. But that doesnt necessarily mean the U.S. doesnt have characteristics that support a AAA credit rating.
If there were a quadruple A, Id give the U.S. that, billionaire investor Warren Buffett told FOX Businesss Liz Claman on Friday after the downgrade. "We have well over $40 billion in T-bills and what happened tonight doesn't tempt me to sell. We will stay there."
One of the most unique aspects of the U.S. economy is the fact that its debt is predominantly issued in its own currency -- something that is not true of euro-zone countries. Crucially, American debt is issued in the worlds go-to currency: the U.S. dollar.
That is absolutely vital because it means the U.S. has unmatched access to financing and that in an absolute worst-case scenario where a default was imminent, the Federal Reserve could simply print more dollars to repay its bills.
It could choose inflation if it wanted to erode the value of its debt. Thats an option not available to a company or municipality, said Feinman.
Of course, printing more money would have negative effects, namely inflation. But that option still seems to make the risk of default extremely low.
Are they saying we cant repay dollars? Its hard to imagine, said Dean Baker, co-director of the left-leaning Center for Economic Policy and Research.
American Economy Still the Strongest
Moodys released a compelling note on Monday highlighting the strengths behind the U.S. creditworthiness.
First and foremost, Moodys listed the unparalleled diversity and size of the U.S. economy, which is still the strongest in the world.
U.S. gross domestic product stood at $14.7 trillion last year, representing an incredible 25% of global GDP. That towers over the GDPs of its next closest competitors, China at $5.9 trillion and Japan at $5.4 trillion.
We are a huge diversified economy, said Baker. Even though it hasnt been run that well for the last decade or so, we still have vast amount of industrial and high-tech capacity.
Moodys also pointed to the long track record of American growth, which helps the country pay down its debt by increasing revenues. While there are a number of negative influences hitting the U.S now such as high household and state debt and depressed housing market those factors are expected to ease.
No matter what some agency may say, weve always been and always will be a triple a country, President Barack Obama said in remarks on Monday. We continue to have the best universities, the most productive workers, the most innovative companies and most adventurous entrepreneurs on Earth.
In the U.S., GDP is expected to grow at 2% to 3% in 2012, a stronger performance than those of the European Union, Japan or the U.K.
Its also worth comparing where the U.S. stacks up against other countries deemed to be risk free. According to Moodys, debt-to-GDP in the U.S. is expected to climb over 90% by the end of 2012, but thats not far off from the other four large AAA countries: from 74% in Canada to 89% in the U.K., with Germany and France sandwiched in between.
Despite the outlook for some further deterioration in the governments debt metrics over the coming few years, we believe that the U.S. continues to exhibit the characteristics compatible with a Aaa rating, Steven Hess, senior credit officer at Moodys, wrote in the note.
Hess also said the global role of the dollar and deep demand for Treasurys means the U.S. has the ability to run higher deficits than other countries.
The political circus in Washington over raising the debt limit left many with a bad taste in their mouths and helped lead to S&Ps deciding to downgrade.
Make no mistake; that was bad political theater. But I didnt need S&P to tell me that, said Fineman.
Despite that sideshow, the U.S. can still brag about an incredible track record of institutional strength in terms of governance, the rule of law and transparency. Contracts are honored, judges enforce laws and citizens and as 2008 showed, policy makers at the Fed generally respond relatively quickly to crises.
Its very far from perfect, but it really is one of the best in the world, said Baker. Were way ahead of just about everyone in the world in those respects.
Many believe that while imperfect, the last-minute deal reached last week to raise the $14.29 trillion debt ceiling was a step in the right direction. That agreement mandated $917 billion in spending cuts over the next decade and installed a mechanism for another $1.2 trillion to $1.5 trillion in mandated cuts.
All told, the agreement slashed spending by $2.1 trillion to $2.4 trillion far deeper cuts than those on the table mere months earlier.
Ironically, S&P, which wanted $4 trillion in cuts, cited this deal as part of the rationale in downgrading the U.S.
We dont seem worse than the other countries that are AAA and youre downgrading when were reducing our debt rather than increasing it. It seems kind of perverse, said Baker.