A warning shot

The credit-rating outlook

A warning shot

S&P’s bombshell means more politically than economically

Washington, DC

SCEPTICS have wondered how long America could use its control of the world’s reserve currency as an excuse to rack up huge debts. Now they may have their answer. On April 18th Standard & Poor’s (S&P), a credit-rating agency, said it had lowered the outlook for America’s AAA credit rating, the highest, to negative.

Many rich countries have seen their debts and deficits balloon in recent years. According to S&P’s own calculations, America’s net debt of all levels of government, at 75% of GDP, is in the same range as the net debts of Germany, France and Britain, all rated AAA (see chart). But those countries, S&P frets, “are all now doing more about it” than America is. The agency had briefly put Britain’s rating on negative outlook, but lifted it when the coalition government swung towards austerity. The prospects of America following suit, says S&P, are hobbled by the fact that Republicans and Democrats cannot agree on how to tackle the deficit.

Although stocks fell and credit-default swaps on American debt widened when the news broke, the bond market remained oddly unruffled: yields ended lower on the day. For all the attention it drew, S&P’s move will have little effect on America’s ability to borrow. As their downgrades to subprime securities during the financial crisis showed, rating agencies usually act long after the economic fundamentals have become obvious.

Treasury investors care less about what S&P thinks than about inflation, growth, monetary policy and the relative appeal of other assets. Bond yields have edged lower lately because growth has slowed to a crawl (see article). Japan lost its AAA rating in 2009 because of a world-leading debt burden. But because of deflation, its bond yields remain at rock-bottom levels. America relies more on foreigners to buy its debt than Japan does, but many of those foreigners are official buyers such as central banks with little alternative.

S&P puts the odds of an actual downgrade at one in three. Moody’s Investors Service and Fitch, the two other leading agencies, have left the rating alone. If America actually loses its AAA, some investors who are obliged to own only AAA-rated paper might have to sell. But the sovereign wealth funds, foreign governments and central banks who are the biggest holders of Treasuries invest in a broad range of assets of varying riskiness, notes Dino Kos of Hamiltonian Associates, a firm of economic consultants. China’s central bank, for example, has been buying Spanish government bonds, rated AA.

S&P has chosen an odd moment to blame the lack of political action on the long-term deficit for making its move. The odds of such action are now better than they have been for a while, a point Moody’s made the same day as it affirmed its AAA rating. On April 15th the Republican-controlled House of Representatives adopted a budget plan that enacts sweeping cuts to Medicare, Medicaid and other government programmes. Not one Democrat voted for it; but at the same time Barack Obama was hitting the road to sell an alternative plan that relies more heavily on tax increases to achieve somewhat less deficit reduction. Meanwhile, a bipartisan “Gang of Six” senators are labouring towards their own deficit-reduction package.

Between mid-May and early June the Treasury will bump up against the legal limit on how much debt it may issue. Failure to raise the limit would force it to renege on payments such as benefits to the elderly and, potentially, interest on the debt. Republicans say they will not vote for an increase without agreement on spending cuts. Mr Obama seems to hope they will settle for a broad agreement on targets and triggers that would automatically cut spending and raise taxes if the targets are not met. That would leave the tougher details until after the 2012 presidential election.

For the moment both sides continue to talk tough, but S&P’s action has added to the pressure to strike a deal. After two years of being castigated by politicians for their irresponsible mortgage-ratings work, credit raters have turned the tables.