But America Has Only Two A's …

The AAA evaluation that credit rating agencies have given the U.S. for decades is the biggest optical illusion that has been fooling the eyes of financial markets. Investors know that there is no such thing as a risk-free investment, but they prefer to believe that American Treasuries are an exception to the rule. They compare everything to the U.S. Treasuries. The misleading feeling that just putting an AAA sign on something will make it risk-free had dominated the markets and had pumped air into the big balloon that eventually popped in a spectacular manner.

For the last couple of years the AAA illusion has been withering away in a slow and painful manner. Still, the myth that American debt — which is approaching $15 trillion in a sinister way — is risk-free remained intact. The first crack on the surface broke last week when one of the largest credit rating agencies, Standard & Poor’s, downgraded American credit from “stable” to “negative,” which means that one of the cherished A’s of the U.S. may be removed in the future.

Now the big question is whether investors are ready to give up on the idea that a risk-free investment standard is possible. They may need to learn to sail in much stormier water, where risk could be shared out but not eliminated. If S&P does fulfill its threat to remove one of the A’s from the U.S. in the future (which is not very likely to happen), the American economy will have to swallow tons of water. The problem is that this is going to set the pattern for everybody on deck, especially China and Japan. Even if both S&P and investors decide to continue sustaining the optical illusion, it does not mean that the U.S. is forever capable of paying with pieces of paper with no backing value. There is one more option here: The U.S. could just let inflation depreciate the dollar, which will depreciate its debt too. Then the United State will have just two A’s on its title, and the world’s wealth will shrink by a couple of trillions.