If the United States were Japan back in the 1998, its credit rating would too have been downgraded by now from its AAA credit risk to AA+ or lower. Indeed, the once-stellar credit ratings of European countries Ireland, Italy, and Spain have already been shown the axe. Spain’s unemployment is now edging upward towards 20%.
Ireland’s recent loss of its coveted ‘Triple-A’ status has touched off a financial crisis which is rapidly deteriorating into a political crisis. As a result, the center-left party will probably be swept away and replaced with a pro-business center-right party when the voters next get their chance. As the say in Europe, “we like to vote in the socialists when we’re feeling fat and full of cash, but when times get tough economically, we like to replace them with the ‘grown ups’ who won’t run our country into the ground fiscally”.
The UK is also teetering on the brink of losing its cherished AAA status. And with it will go the pound (down) and unemployment (up).
How does the credit worthiness of a country affect its fiscal health? And why should the politicians and bureaucrats in the White House, the Treasury and the Fed be quaking in their boots right now?
If a country, like the US, should lose its pristine credit rating, it will instantly lose the ability to sell its bonds to many potential buyers. And, God knows, with all the monster deficits being wrung up by the White House these days, the US government needs all the newly minted Treasury Bills – in the tens of billions of dollars – to be safely sold, without fail, week after week.
The fate of the US government hangs in the balance by the analysts at the three global credit rating agencies who daily measure the financial health of 125 countries. They’re akin to the 3 personal credit bureaus whose “Fico scores” compiled by the Fair Isaacs company determine whether you can get a credit card or car loan or even a decent home mortgage.
With a really good Fico score, like 800 or above, you’ll be offered the lowest loan interest rates. As you score drops down to the 700’s and 600’s, your credit risk goes up, and borrowers begin to disappear. Those that remain will charge higher interest to make the same loan. Your risk of defaulting on the loan jumps. Drop below 600, and you probably can’t get a loan from anyone except, perhaps, the local loan shark – at 10% interest – per month.
Unfortunately, many major buyers of bonds — government or corporate, US or overseas – have restrictions on what they can legally buy. US Treasury bonds are often owned by central banks of other countries — like China — and retirement programs, mutual funds and pension funds. Many are only allowed to own only ultra-safe ‘Triple-A’ rated ‘paper’.
Lose that rating, and the next day, the market will see hundreds of billions of dollars of US government Treasury bonds dumped as ‘secondary sales’ — perhaps at fire sale prices.. When such an oversupply of sellers dumps T-bills, their price will fall smartly, and the Treasury bond interest rates will skyrocket, as many of the potential buyers are forced to sell too. So the cost of borrowing money both short and long term will spike up. Then, almost immediately afterwards, the interest rates on credit cards, corporate borrowing, and most importantly, home mortgages will shoot up as well.
The rating agencies are terrified to tell the truth. Because the US is the principal money center on the planet, and because the US dollar is the world’s reserve currency, such a lowering of the US AAA rating — which it has maintained for over a century — will ripple through the global economy as bond and stock markets recoils in shock and follow the US downward. Credit rating agency fees will soon follow.
They have not yet downgraded the UK pound-based ‘Gilts’ (government bonds). These are on the ropes as the UK has been faithfully following in the US footsteps by taking over its banks, printing up funny money to pay the bills, and running massive government deficits to add its own ‘stimulus’ package to the economy. Naturally, the UK’s unemployment rate is shooting upwards as well.
The UK’s Labour (socialist) government is teetering on collapse with the lowest voter rating in over 100 years. The fall of their government, due to the fiscal incompetence of Prime Minister Gordon Brown, the former “wunderkind” Chancellor (their equivalent to the Treasury Secretary) and his decade long spend-and-spend policy, is predicted to occur this autumn, if not sooner. When that happens, the dam will likely break, and the UK will be stripped of its AAA rating.
The pressure will immediately shift to the US as overseas money — now funding 50% of government bond sales — begins to flee. Interest rates will go up as the Treasury must continue to conduct ever-bigger weekly bond sales to fewer and fewer buyers. Eventually, the other show will drop, and the US will lose its Triple-A rating as well.
This is uncharted territory. Over the past few decades. countries like Mexico, Argentina, and Zimbabwe have seen their ratings plummet – along with their standard of living. Unemployment figures have recently reached 25% or more in other developed countries. But not yet in the US.
Faced with the problem of declining bond sales and raising interest rates killing the economic recovery, and unable to turn to the Chinese or Japanese to bail out the government, the only course of action left will be for the Federal Reserve to “re-liquify” the market. That is, the Fed will simply ‘print up’ more money to use to buy the non-selling Treasury bills itself. And when this new money hits the marketplace, the amount of overall money in circulation will quickly increase.
The dictionary defines “inflation” as simply an increase in the money supply. When you increase the total amount of money — but not correspondingly increase any more goods or services being produced — the cost of everything you buy denominated in the unit of money (in this case, the dollar) will go up. It takes more of the pieces of paper called ‘dollars’ to buy the same goods and services.
Real wealth and hard-assets such as commodities (food, metals, gold) will go up in dollar terms. Other stronger currencies will go up too. Fixed-interest-rate loans (like 30-year fixed mortgages) will be a disaster for the lender and a magical liability for the borrower, who will be able to repay the loans years later in dollars that will be worth far less, if not worthless. Those lenders will be forced out of business by rising costs, reducing the supply of consumer and business credit even more.
This negative-reinforcing downward spiral, once started, cannot be easily stopped short of a massive depression. Interest rates could shoot up to 30-50% per year. In the worst-case scenario, hyperinflation, or monthly inflation above 50%, could occur. Such an event nearly always ends with a war or internal revolution.
The above scenario is what the strategic planners at the White House, the Treasury and the Federal Reserve desperately fear. And we are now likely on the knife edge, as Gerald Celente of Trends Research Institute has recently predicted.
I too, see this as an exceptional time. Fortunately, the White House is quite good at twisting both the arms of powerful people on Wall Street and Main Street. They’ve fired the Chairmen of General Motors and Chrysler and AIG. They’ve forced major solvent banks like Wells Fargo to take the so-called ‘Tarp’ bailout money even when they didn’t need to and didn’t want to. They’ve taken over 80% of all home mortgages with the nationalization of FreddyMac and FannieMae. And they’ve gotten gentle press treatment from those “main stream media” outlets (with the exception of CNBC’s Rick Santelli).
I expect that the 3 New York-based bond rating agencies will go along with the US government and maintain the charade of its AAA rating for as long as possible, hoping that a miracle occurs and the fabled “green shoots” quickly grow into a sustained recovery, rather than a man-eating plant.
But I’m not optimistic, and I invite any reader to argue against my position. While I am hopeful in the future of humankind and the wonders that the free market and science can bring over the long term, in the short term I fear that the light I see at the end of this tunnel is, in fact, an oncoming train.