Standard & Poor's Downgrades U.S.; Country in Shock, World Full of Doubt

The U.S. loses its top rating and the world trembles at the consequences. What the American and global economies are in for, how justified Standard & Poor’s decision really is and why Germany could even profit from the new U.S. rating — the most important questions and answers about the downgrade.

Why did Standard & Poor’s downgrade the rating?

The debt compromise from last Tuesday is not enough for the rating agency. In it, Democrats and Republicans came to an understanding to cut $2.5 trillion in the coming years. A 12-member, non-partisan commission must develop the concrete savings amounts. If they cannot come to consensus, there will be automatic cuts in all political areas, from health insurance to the military.

Standard & Poor’s, like the other two rating agencies, Moody’s and Fitch, has two basic problems with this deal. On the one hand, the total debt of the country already amounts to $14.3 trillion and will continue to rise in the coming years, to more than $17 trillion. When should one ever pay that back? On the other hand, the rating agencies doubt that the politicians will now actually tackle saving the agreed-upon trillions.

With that comes something like a wish to start a fight with the largest economy in the world. When the Standard & Poor’s raters criticize — almost somewhat insulted — that their April warning didn’t even provide for a shift in thinking by the politicians, it shows a pertinent measure of vanity. In addition, the rating agency was accused of having reacted too late in the financial crisis of 2008. Standard & Poor’s, Moody’s and Fitch don’t want to hear that again.

Is this step justified?

On the one hand, the rating agency’s decision is completely understandable. No signal is coming from Washington of how the immense debt owed could be lowered — a problem that can also be found in many European countries.

What will now happen to the U.S. economy?

On the other hand, this step is daring for several reasons. First of all, the financial markets are currently in such an agitated state that many observers ask themselves why Standard and Poor’s had to pile on such a decision just now. Secondly, the U.S. has historically always fulfilled its obligations, and U.S. government bonds are deemed the most secure investment in the world. And thirdly, there are countries with an AAA rating in a similar position as the U.S. — for example, France.

Seen thus, the rating agencies are placing themselves under pressure: This step is only truly justified if France were to lose its top creditworthiness in the next few days. That would be consistent, but would naturally further exacerbate the situation.

What does the downgrade of creditworthiness mean for the U.S.?

A few hours after the downgrade, the Obama administration tried to relativize the rating. Democratic representative and former chairperson of the Committee on Finance, Barney Frank, even denied on television that the downgrade would have any consequences at all. But that is political rhetoric. In fact, no one knows exactly what consequences the downgrade will have at the moment. There has never yet been a case like this, and as is known, psychology plays a great role in world financial markets.

In principal, agreement prevails among experts that interest will climb because of the downgrade. Some members of financial markets emphasized on Friday evening that the possible jump in interest would only be marginal — if it comes at all. But even a small interest increase would hit the U.S. hard at this time. Debt service currently costs Washington around $250 billion a year, so even small percentage increases make a considerable difference.

The already weak U.S. economy would possibly be taken town a notch because higher interest rates would lessen the inclination of businesses to invest. That in turn would strain the sluggish employment market, with negative consequences on the willingness of consumers to spend — it would get a downward spiral underway.

A chain reaction is also threatening the U.S. real estate market, which has not yet completely recovered from the sub-prime crisis of 2008. If a higher interest rate level led to higher mortgage rates for homeowners, there would be the danger of a new wave of personal bankruptcies.

What consequences does the decision have for the global economy?

Short-term, the world is watching the next trading day on the stock markets on Monday: Will it come to a further, still larger crash — or did the market already anticipate the downgrade in the past turbulent days and process it in advance?

Apart from that, and seen in the intermediate term, the rating means that doubts about the ability of the world’s largest economy to pay are growing. In a time in which the eurozone countries are also having problems keeping confidence in the solvency of the financial markets, such doubts could lead to new insecurity.

Germany as profiteer?

The stock exchange speculators are already questioning whether the Western industrialized countries can still service their government debts at all. Possibly, lenders will now fear more strongly for their loans and lend their money more cautiously. The eventual consequence would be a credit crunch, like there already was at times during the sub-prime crisis in 2008. At that time, banks were not prepared to give new credit because they feared default. In such a moment, the dangers for the global economy would be gigantic — and the consequences unforeseeable and controllable.

If that doesn’t occur, solid debtors like Germany could even profit from the downgrade of U.S. creditworthiness. It came out during the political tug of war over raising the U.S. debt limit that German bonds were in much greater demand in international financial markets than ever before. Because creditors’ insecurity in the U.S. became too great due to the political squabbling, they turned to other borrowers — in this case, Germany. This effect could now become stronger after the downgrade of the U.S.

What role does China play?

For China, the largest creditor of the U.S., the decision is a severe setback. Because of the downgrade, the prices of U.S. government bonds could come under pressure. The bond holdings would lose value. It is a matter of a lot of money; altogether, the U.S. owes China more than $1 trillion.

Clinton, Bush and the Search for the Guilty Ones

Correspondingly harsh came the reaction from Beijing immediately after Standard & Poor’s decision. In a commentary, the news agency Xinhua criticized the U.S. with rare directness: “America must pay for its debt addiction and short-sighted political wrangling.” As the largest U.S. creditor, China has every right now to demand the United States address its structural debt problems and ensure the safety of China’s dollar assets, it continued. China urged Washington to cut its military budget and social expenditures.

Who is to blame for the downgrade?

Obama’s administration must now bear the downgrade — and it wore itself out in the battle for the debt compromise. It also carries a certain responsibility, but is surely not solely responsible.

Standard & Poor’s justified the downgrade with the concern that the U.S. would not get a handle on its national debt. In fact, the total debt of the government has been climbing in a dramatic way since the beginning of the year’s financial crisis. In 2000 the federal debt still lay just under 55 percent; by 2010 it had grown to just under 93 percent — and for the coming year it is anticipated that the debt ratio will be larger than the gross domestic product.

At the same time, the years 1993-2001 (the Clinton years) were characterized by a sizeable success in financial restructuring, after it had already come to a considerable debt in the ‘80s (Reagan years). In contrast, during Clinton’s second term in office, budget surpluses were generated in four fiscal years. There were two causes of this success: an unusually long-lasting economic upswing and efforts to achieve a balanced budget.

During the term of office of George Bush Junior, however, this changed strongly. Under the effects of the attacks of September 11, 2001, and the war in Iraq, the U.S. government already suffered budget deficits of considerable magnitude before any disciplined expenditures finally got lost in the financial crisis.

There is also the fact that the American Federal Reserve began buying up large quantities of government securities in past years. Politically charged: The government apparently is no longer finding enough creditors who will finance its debts.