Why is Uncle Sam’s credit rating higher than China’s?
By OH BOON PING 11 March 2010
Moody’s Investor Services warned last month that the triple A credit rating of the highly geared US economy should not be taken for granted.
And that’s hardly surprising, given the intense scrutiny that has now fallen on the Club Med economies - Greece, Spain, Portugal - and their debt woes.
Still, Moody’s credit caution on the US begs the question: Why should Uncle Sam deserve a triple A, or indeed a rating above, say, China’s A plus, when its debt is now at unsustainable levels and its financial institutions have shown themselves to be deficient in policing market excesses.
Let’s look at the numbers. As at Sept 30, 2009, the US had chalked up total liabilities of US$14.12 trillion, compared with assets of US$2.67 trillion, putting it in a net position of minus US$11.46 trillion.
These liabilities include US$92 billion of future payments under liquidity guarantees to mortgage backers Fannie Mae and Freddie Mac, and an estimated additional liability of about US$130 billion related to these guarantees in an ‘extreme case’ scenario.
The staggering figures have clear implications for America’s sovereign rating, which measures the relative likelihood that a government borrower will default on its obligations.
High debt levels basically point to a higher risk of default, especially when an economy is fundamentally weak.
In this respect, a recent paper by economists Kenneth Rogoff of Harvard University and Carmen Reinhart of the University of Maryland, ‘Growth in a Time of Debt’, say that historically, advanced economies have slowed noticeably when their debt-to-GDP ratio has exceeded 90 per cent.
‘The relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 per cent of GDP,’ they said. ‘Above 90 per cent, median growth rates fall by one per cent and average growth falls considerably more. We find that the threshold for public debt is similar in advanced and emerging economies.’
According to the Obama administration’s Office of Management & Budget, the total debt-to-GDP ratio was 83 per cent in fiscal 2009 and is on track to hit 94 per cent this year, 99 per cent in 2011 and 101 per cent in 2012.
In contrast, China’s ratio is estimated at 12.2 per cent in 2009, rising to 12.8 per cent this year and 13.1 per cent in 2011.
If economists Rogoff and Reinhart are right, then in strictly economic terms, America’s high debt ratio makes it less creditworthy than China, since the high leverage is not only costly to service but affects America’s ability to repay borrowings by impeding its economic growth.
Granted, some have pointed out that a country should not be downgraded just because it has run into problems, but only when it cannot get out of those troubles.
Bankroll US deficit
In the case of America, the belief is that investors, including foreign governments, will continue to bankroll the US deficit by snapping up Treasuries denominated in dollars.
But as Greece has discovered, investors’ confidence can quickly fade and should not be taken for granted.
There have been reports that China - the biggest holder of US Treasuries - recently sold US$34.2 billion of the paper in a month, after warning it would cut back on US dollar-denominated assets.
Plus, total interest payments will shoot up should lenders demand higher rates to finance the sizeable US debt. Not only does that make debt financing much harder, but the government may end up having to cut spending and/or raise taxes, resulting in premature stimulus withdrawal.
In terms of default track record, Uncle Sam is hardly clean, though even a clean past is no guarantee of future performance.
For example, back in 1971, America ‘defaulted’ on its gold payments under the former Bretton Woods regime. The US government had promised to back every US dollar printed by gold at the rate of US$35 for every ounce of the bullion.
However, Uncle Sam issued more notes than permitted, given its gold holdings, thus exporting inflation to foreign economies.
Because of the excess printed dollars, and a negative US trade balance, countries began demanding fulfilment of America’s ‘promise to pay’ - that is, the redemption of their dollars for gold. Switzerland redeemed US$50 million of paper for gold, while France acquired US$191 million in gold.
The rapid depletion of US gold reserves eventually compelled then-president Richard Nixon to ‘shut the gold window’ - ending the dollar’s convertibility to gold. The result was the dollar’s devaluation.
In 2002, rating agencies downgraded Japan’s sovereign rating to below that of Botswana and other much less-developed countries, due to factors such as a huge fiscal deficit, negative economic growth and deflation, even though Japan is the world’s second largest economy.
Given this, perhaps it is time for these agencies to rethink the US rating?
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Why is Uncle Sam’s credit rating higher than China’s?
By OH BOON PING
11 March 2010
Moody’s Investor Services warned last month that the triple A credit rating of the highly geared US economy should not be taken for granted.
And that’s hardly surprising, given the intense scrutiny that has now fallen on the Club Med economies - Greece, Spain, Portugal - and their debt woes.
Still, Moody’s credit caution on the US begs the question: Why should Uncle Sam deserve a triple A, or indeed a rating above, say, China’s A plus, when its debt is now at unsustainable levels and its financial institutions have shown themselves to be deficient in policing market excesses.
Let’s look at the numbers. As at Sept 30, 2009, the US had chalked up total liabilities of US$14.12 trillion, compared with assets of US$2.67 trillion, putting it in a net position of minus US$11.46 trillion.
These liabilities include US$92 billion of future payments under liquidity guarantees to mortgage backers Fannie Mae and Freddie Mac, and an estimated additional liability of about US$130 billion related to these guarantees in an ‘extreme case’ scenario.
The staggering figures have clear implications for America’s sovereign rating, which measures the relative likelihood that a government borrower will default on its obligations.
High debt levels basically point to a higher risk of default, especially when an economy is fundamentally weak.
In this respect, a recent paper by economists Kenneth Rogoff of Harvard University and Carmen Reinhart of the University of Maryland, ‘Growth in a Time of Debt’, say that historically, advanced economies have slowed noticeably when their debt-to-GDP ratio has exceeded 90 per cent.
‘The relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 per cent of GDP,’ they said. ‘Above 90 per cent, median growth rates fall by one per cent and average growth falls considerably more. We find that the threshold for public debt is similar in advanced and emerging economies.’
According to the Obama administration’s Office of Management & Budget, the total debt-to-GDP ratio was 83 per cent in fiscal 2009 and is on track to hit 94 per cent this year, 99 per cent in 2011 and 101 per cent in 2012.
In contrast, China’s ratio is estimated at 12.2 per cent in 2009, rising to 12.8 per cent this year and 13.1 per cent in 2011.
If economists Rogoff and Reinhart are right, then in strictly economic terms, America’s high debt ratio makes it less creditworthy than China, since the high leverage is not only costly to service but affects America’s ability to repay borrowings by impeding its economic growth.
Granted, some have pointed out that a country should not be downgraded just because it has run into problems, but only when it cannot get out of those troubles.
Bankroll US deficit
In the case of America, the belief is that investors, including foreign governments, will continue to bankroll the US deficit by snapping up Treasuries denominated in dollars.
But as Greece has discovered, investors’ confidence can quickly fade and should not be taken for granted.
There have been reports that China - the biggest holder of US Treasuries - recently sold US$34.2 billion of the paper in a month, after warning it would cut back on US dollar-denominated assets.
Plus, total interest payments will shoot up should lenders demand higher rates to finance the sizeable US debt. Not only does that make debt financing much harder, but the government may end up having to cut spending and/or raise taxes, resulting in premature stimulus withdrawal.
In terms of default track record, Uncle Sam is hardly clean, though even a clean past is no guarantee of future performance.
For example, back in 1971, America ‘defaulted’ on its gold payments under the former Bretton Woods regime. The US government had promised to back every US dollar printed by gold at the rate of US$35 for every ounce of the bullion.
However, Uncle Sam issued more notes than permitted, given its gold holdings, thus exporting inflation to foreign economies.
Because of the excess printed dollars, and a negative US trade balance, countries began demanding fulfilment of America’s ‘promise to pay’ - that is, the redemption of their dollars for gold. Switzerland redeemed US$50 million of paper for gold, while France acquired US$191 million in gold.
The rapid depletion of US gold reserves eventually compelled then-president Richard Nixon to ‘shut the gold window’ - ending the dollar’s convertibility to gold. The result was the dollar’s devaluation.
In 2002, rating agencies downgraded Japan’s sovereign rating to below that of Botswana and other much less-developed countries, due to factors such as a huge fiscal deficit, negative economic growth and deflation, even though Japan is the world’s second largest economy.
Given this, perhaps it is time for these agencies to rethink the US rating?
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