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Germany Fires Debt Shot at US

-- Posted Thursday, 16 June 2011 | | Disqus

By: Dr. Jeffrey Lewis


In what will likely be the first of many European debt downgrades for the United States, Germany’s own Feri credit rating agency took down the United States’ debt rating from AAA to AA.  The difference is marginal in many ways (after all, few countries ever get to become AAA rated), but for the United States, which has always been AAA, this confirms that the downside is here.


In addition to downgrading the United States’ debt, the agency also had a few warnings for Washington DC.  The ratings agency CEO Tobias Schmidt is reported as saying, “The U.S. government has fought the effects of the financial market crisis primarily by an increase in government debt. We do not see that there is sufficient attention being paid to other measures.”  Later on in the release, he would remark that the current deficits are not sustainable.


Why Ratings Matter


Ratings agencies are some of the most important businesses in the world.  In evaluating the debt issues by various governments and corporations, they help allocate trillions of dollars of investment capital. Their ratings are often carved into law and made valuable with the help of regulators, who see their ratings as the end-all opinion for organizational stability.


In the United States, laws surrounding credit ratings can have a huge impact on how Americans invest their money.  Pensions, for example, are often told to stick to A-rated debt or better, which keeps them out of the junk (b-rated) bond markets and only in high quality issues.  During the financial crisis, investment banks turned plenty of otherwise B-rated debt into A-rated debt and forced many future pensioners to buy their fellow Americans mortgage debt. 


Was it really A-rated?  No, of course not.  But the companies like AIG who promised to insure it against default were A-rated.  So, essentially, with a few tricks, B-rated debt was turned into A-rated debt.


Just as we’ve seen disaster in making bad debt look good, there is equal disaster in watching A-rated debt turn into B-rated debt.  On the triple-A scale, only a few nations have reached triple-A.  However, AA is far easier achieved—many corporations such as Berkshire Hathaway earn a AA-rating from the many US based credit rating companies.


Rising Debt Costs


The fastest way to ruin a reserve currency is to see the underlying economy weaken, and for the debt of the country backing up the reserve currency to grow too far, too fast.  Reserve currencies like the dollar are reserve currencies because their governments are supposedly fair, their currencies are stable, and their debts are as good as interest-bearing cash.  (Most institutional investors buy US Treasury bonds because they’re like dollar bills that pay interest.)


However, if the US debt is downgraded, then so too is the US dollar and the US economy.  When the cost of borrowing in the United States rises, it does not affect just the US government.  Instead, it affects every loan made in dollars, from mortgages to car loans, and even business loans.  If the US government doesn’t get its fiscal house in order, you can only sit back and watch as rising dollar-denominated yields wipe out every American household and business.


Dr. Jeffrey Lewis

-- Posted Thursday, 16 June 2011 | Digg This Article | Source:

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