Investors Doubt the Creditworthiness of the United States
Published in Die Welt Online
(Germany) on 14 February 2009
by Karsten Seibel and Frank Stocker (link to
original)
Government Bonds
Many countries, including the United States, are taking on more debt to finance their gigantic economic stimulus packages. The money comes from the financial market and is then given out as loans. But now, there are concerns about the creditworthiness of the United States and investors believe Germany is more financially sound than the United States.
This news does not seem to be all that sensational at the moment. Moody's Investor Services has expressed some doubt for the first time as to whether the highest triple-A rating can actually remain in place over the long term for the creditworthiness of the United States in view of its immense economic rescue package. The explosiveness of this report, however, lies in the consequences such a downgrading would have not only for the United States, but for the rest of the world.
Every person knows this from his own experience. If he wants to buy something on credit, then he submits to a credit check. The worse his credit is, the higher the interest rates will be. It also works in much the same way for countries. The greater the risk that a country cannot pay off its debts, then the higher its interest rate will be. Ratings agencies grade this risk, and the best rating is triple-A.
Until now, the United States has always been considered an outstanding borrower. Hardly anyone expects, even at this point, that it will really come to a downgrading of the world’s largest economy. If there is one simple reason for this, it is that the United States, for all practical purposes, cannot go bankrupt. Unlike bankruptcy candidates like Iceland and Hungary, the United States does not have debts in any currencies other than the U.S. dollar. “In a pinch, it can simply print more money,” says Holger Sandte, Chief Economist of Düsseldorf’s WestLB commercial bank.
Even so, the financial backers of the United States are getting worried. Countries like China, which holds $682 billion in US Treasury bonds and is the United States’ biggest creditor, are worried about their money because of the state of America’s public finances. Their concern here, to some degree, is that bond prices will fall, although the Federal Reserve Bank has already commented that it would prevent this by buying up the Treasury notes if necessary.
But, on the contrary, this would not be of much help to foreign investors. The consequence of such a move by the Federal Reserve Bank would be allowing the dollar to lose value relative to other currencies. If this happens, foreign investors would lose some of their monetary investments. To cut their losses, investors could sell the government bonds and thereby send the dollar further into a tailspin.
To prevent a vicious cycle such as this, China and Japan may have to be leery of selling U.S. government bonds. This is because they could never quickly convert all of their assets into Euro bonds. The American investments remaining in their portfolios would lose considerable value. However, bond owners headquartered on Caribbean islands are considerably more flexible because most hedge funds hide away there. The many small investors are also far less restricted in their decision-making. "Private pension funds could absolutely be able to trigger a flight away from American investments,” says WestLB economist Sandte.
Still, this downgrading might not be so far away. "The crisis would have to intensify once again, until it comes down to a substantial flight from American securities into European securities," says Christian Apelt, a foreign currency expert with the Helaba German Federal State Bank. Much would depend on what additional steps the U.S. Federal Reserve Bank might be forced to take. Every one of its steps is being keenly followed by nervous investors. "If the Federal Reserve Bank actually starts buying up U.S. government loans on a large scale, this could lead to a sudden loss of confidence,” says Apelt. Many investors could turn their backs on the U.S. dollar.
Some investors have apparently already begun doing this, as a glance at the trend of the stock markets has shown during the past two weeks. It is striking that, during this timeframe, the German Stock Index (Dax) has clearly outperformed the American Dow Jones Industrial Average (DJIA). There are also hints of a similar movement now underway in government bonds during recent days. The ten year German federal bond appears to be somewhat more stable than its American counterpart.
Also, in comparison with government bonds from other Euro-Zone countries, German bonds have recently cemented their reputation as a secure refuge. Greece and even Ireland will definitely have to pay more than five percent interest again for a ten year bond, while German investors are just content with the three percent they receive.
“Germany is in a good starting position for the long term. We have a high savings rate, low labor costs, and a stable real estate market,” says Stefan Schilbe, chief economist with the HSBC Trinkaus bank. Even Moody’s considers Germany to be on more solid financial ground than the United States.
Addendum - Ratings Agencies
There are three large agencies in the world which dominate the ratings market: Moody’s, Standard & Poor’s, and Fitch. These agencies rate the creditworthiness of corporations and nations by means of letters. These ratings go from the lowest “D,” which means “unable to pay,” all the way up to the highest, “AAA.” A country with such a AAA credit rating is considered to be flush with cash, and an investment in its government bonds does not incur any risk. The agencies usually rate European countries with the highest marks, but, for example, they have recently downgraded Spain.
Many countries, including the United States, are taking on more debt to finance their gigantic economic stimulus packages. The money comes from the financial market and is then given out as loans. But now, there are concerns about the creditworthiness of the United States and investors believe Germany is more financially sound than the United States.
This news does not seem to be all that sensational at the moment. Moody's Investor Services has expressed some doubt for the first time as to whether the highest triple-A rating can actually remain in place over the long term for the creditworthiness of the United States in view of its immense economic rescue package. The explosiveness of this report, however, lies in the consequences such a downgrading would have not only for the United States, but for the rest of the world.
Every person knows this from his own experience. If he wants to buy something on credit, then he submits to a credit check. The worse his credit is, the higher the interest rates will be. It also works in much the same way for countries. The greater the risk that a country cannot pay off its debts, then the higher its interest rate will be. Ratings agencies grade this risk, and the best rating is triple-A.
Until now, the United States has always been considered an outstanding borrower. Hardly anyone expects, even at this point, that it will really come to a downgrading of the world’s largest economy. If there is one simple reason for this, it is that the United States, for all practical purposes, cannot go bankrupt. Unlike bankruptcy candidates like Iceland and Hungary, the United States does not have debts in any currencies other than the U.S. dollar. “In a pinch, it can simply print more money,” says Holger Sandte, Chief Economist of Düsseldorf’s WestLB commercial bank.
Even so, the financial backers of the United States are getting worried. Countries like China, which holds $682 billion in US Treasury bonds and is the United States’ biggest creditor, are worried about their money because of the state of America’s public finances. Their concern here, to some degree, is that bond prices will fall, although the Federal Reserve Bank has already commented that it would prevent this by buying up the Treasury notes if necessary.
But, on the contrary, this would not be of much help to foreign investors. The consequence of such a move by the Federal Reserve Bank would be allowing the dollar to lose value relative to other currencies. If this happens, foreign investors would lose some of their monetary investments. To cut their losses, investors could sell the government bonds and thereby send the dollar further into a tailspin.
To prevent a vicious cycle such as this, China and Japan may have to be leery of selling U.S. government bonds. This is because they could never quickly convert all of their assets into Euro bonds. The American investments remaining in their portfolios would lose considerable value. However, bond owners headquartered on Caribbean islands are considerably more flexible because most hedge funds hide away there. The many small investors are also far less restricted in their decision-making. "Private pension funds could absolutely be able to trigger a flight away from American investments,” says WestLB economist Sandte.
Still, this downgrading might not be so far away. "The crisis would have to intensify once again, until it comes down to a substantial flight from American securities into European securities," says Christian Apelt, a foreign currency expert with the Helaba German Federal State Bank. Much would depend on what additional steps the U.S. Federal Reserve Bank might be forced to take. Every one of its steps is being keenly followed by nervous investors. "If the Federal Reserve Bank actually starts buying up U.S. government loans on a large scale, this could lead to a sudden loss of confidence,” says Apelt. Many investors could turn their backs on the U.S. dollar.
Some investors have apparently already begun doing this, as a glance at the trend of the stock markets has shown during the past two weeks. It is striking that, during this timeframe, the German Stock Index (Dax) has clearly outperformed the American Dow Jones Industrial Average (DJIA). There are also hints of a similar movement now underway in government bonds during recent days. The ten year German federal bond appears to be somewhat more stable than its American counterpart.
Also, in comparison with government bonds from other Euro-Zone countries, German bonds have recently cemented their reputation as a secure refuge. Greece and even Ireland will definitely have to pay more than five percent interest again for a ten year bond, while German investors are just content with the three percent they receive.
“Germany is in a good starting position for the long term. We have a high savings rate, low labor costs, and a stable real estate market,” says Stefan Schilbe, chief economist with the HSBC Trinkaus bank. Even Moody’s considers Germany to be on more solid financial ground than the United States.
Addendum - Ratings Agencies
There are three large agencies in the world which dominate the ratings market: Moody’s, Standard & Poor’s, and Fitch. These agencies rate the creditworthiness of corporations and nations by means of letters. These ratings go from the lowest “D,” which means “unable to pay,” all the way up to the highest, “AAA.” A country with such a AAA credit rating is considered to be flush with cash, and an investment in its government bonds does not incur any risk. The agencies usually rate European countries with the highest marks, but, for example, they have recently downgraded Spain.