Last updated: September 06. 2013 6:32PM - 73 Views

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By now everyone is aware that the U.S. government has lost something the country has possessed since 1917 — its “best-of-the-best” stamp of financial approval from all major debt ratings agencies. Last Friday Standard and Poor’s downgraded U.S. Treasury securities from AAA to AA+, suggesting the U.S. government seems a little less likely to repay in a timely fashion both principal and interest on Treasury securities.

According to S&P, the recent fiscal impasse in raising the U.S. debt ceiling is a prime example of the paralysis that is afflicting policy makers. As well the U.S. economic growth outlook is highly uncertain, and no serious efforts have been made to bring the trifecta of entitlements (Medicare, Medicaid and Social Security) under control and allow U.S. borrowing needs to moderate over time. Finally, S&P indicated that an additional downgrade over the next couple of years could occur if Congress and the president fail to address our fiscal problems in a timely fashion. Seemingly, they are highly interested in decisions made by the “super committee” that must recommend policy choices over the next few months before automatic across-the-board spending reductions take place under the debt ceiling agreement signed into law last week.

The Obama administration immediately responded to the downgrade by noting a $2 trillion mistake by S&P, reflecting an improper baseline used to make its 10-year projections upon which the downgrade was based. S&P responded that the mistake did not materially change its outlook and the government was simply using it as a smoke screen to hide its fundamental inability to address serious financial failings.

For most of us, the real issue is not one of politics and the accompanying egos of the reality TV-like drama that is unfolding, but what is likely to be the short and longer term consequences of the S&P downgrade. To be sure, trying to estimate the impact is highly problematic, particularly given the lack of historical precedent for the U.S. Of course, that won’t keep others (or me) from taking a stab at possible consequences.

To begin, it is important to realize that only one of the three major credit ratings agencies has downgraded U.S. government debt instruments. The other two — Moody’s and Fitch — have confirmed they still give the U.S. government their highest rating, though a “negative” outlook has been attached to those ratings. That is a fancy way of saying they are hedging their bets and realizing they may also downgrade U.S. debt instruments in the future. Until that happens, however, the impact of the downgrade by just S&P is likely to be muted.

As well, despite the S&P downgrade to AA+, the ability of the U.S. to repay its obligations is still viewed as very high and thus investors around the world are still likely to invest heavily in Treasuries. In part this “desire” to invest in U.S. Treasuries is really a “need” to invest in such financial instruments given the lack of good alternatives. Presently, the few other major economies around the world of some significant size are limited in their ability to provide an alternative.

The European sovereign debt crisis has caused the stability of euro-denominated financial assets to be called into question. The yuan is not an alternative, since its value is tightly controlled by the Chinese government and is not readily convertible on world currency markets. The Japanese yen has been rising in value in recent months — despite the disasters in March — and the Japanese government is responding by attempting to flood currency markets with yen to drive down its value so that Japanese exporters will not find their products becoming prohibitively expensive. Finally, other non-euro nations presently rated AAA (such as Australia, Canada and New Zealand) are far too small to effectively absorb the monstrous volume of funds which flow daily into world financial markets. In short, there are no good alternatives to dollar-denominated asset, including U.S. Treasury securities.

So, will there be any impact? Over time, yes, primarily in the form of higher interest rates that will need to be paid by the U.S. government/ businesses/consumers to raise funds. But even this is likely to take some time given the precarious state of the economy. As of early Monday afternoon of this week, the stock market was in decline as investors pulled money out of equities. And where were they placing their money? Among other things, super-safe U.S. Treasury securities! How’s that for irony?

Dr. James Newton serves as chief economic advisor to Commerce National Bank and is an auxiliary faculty member in economics and statistics at Ohio State University-Marion. Dr. Newton’s views do not necessarily reflect those of Commerce National Bank or OSU-Marion.

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