U.S. Credit Rating Concerns
By Chris on May 26, 2009
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Last Thursday, bond fund manager Bill Gross warned that the U.S. may lose its AAA credit rating. The same day, the Dow Jones Industrial Average lost nearly 130 points. (source) The following day, White House spokesman Robert Gibbs reassured the press that the White House isn't too concerned about the U.S. losing its perfect credit rating. (source)
Continued...
Britain's credit rating outlook was recently downgraded from "stable" to "negative" by Standard & Poor's credit rating agency; a stern warning that Britain may lose its AAA rating. Four countries in the European Union; Greece, Ireland, Portugal and Spain; have already seen their credit ratings downgraded this year. (source)
Though not yet imminent, it is important to consider some of the possible ramifications of the U.S. losing its triple-A credit rating.
A credit rating downgrade indicates a greater risk to lend to the United States. Should this occur, America would be seen as being more likely to default on its debt. Investors seek a greater reward when buying riskier debt, thus the United States would be forced to raise its interest rates to continue attracting buyers.
In 2008 the United States paid roughly eight percent of its entire budget (nearly one quarter of a trillion dollars) in interest payments alone. Without paying off a significant portion of our debt, or balancing the federal budget, a credit rating downgrade will likely increase this figure substantially.
The U.S. Dollar is the most widely used reserve currency, composing over 60% of foreign exchange reserves. A reserve currency "permits the issuing country to purchase [oil, gold, etc.] commodities at a marginally cheaper rate than other nations, which must exchange their currency with each purchase and pay a transaction cost...It also permits the government issuing the currency to borrow money at a better rate, as there will always be a larger market for that currency than others." (source)
Three of America's largest foreign holders of debt include China, Russia and Brazil. Russia and China have recently speculated about replacing the dollar as the world's largest reserve currency (source), and it also has been rumored that China and Brazil have discussed replacing the dollar in bilateral trade. (source). Kathy Lien of seekingalpha.com reports, "a credit rating downgrade is the perfect excuse to push through an alternative reserve currency to replace the dollar because it would strip the confidence of sovereign funds like China that have been buying dollars to prop up the U.S. economy." (source)
Losing our status as the world's largest reserve currency, losing investors, or high interest rates may force the government to print its way out of debt. This will lead directly to inflation; i.e., your money will be worth less; or worse yet, hyperinflation.
Though it may not be time to panic quite yet, perhaps it is time we start electing fiscal conservatives.
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