The US lost its 70 year ‘gold plated’ triple A credit rating yesterday as S&P (Standard and Poor), one of the three major sovereign debt credit rating agencies, downgraded US debt by one notch to AA+. Although this was widely expected following S&P’s ‘negative’ outlook in April, the announcement to downgrade the world’s largest economy sent shock waves around the global economy. Credit ratings, which are used by overseas investors to assess economic and political risks, including the risk of default on newly issued debt, play an increasingly important role in the global economy. Credit ratings are also used by investors to calculate a ‘fair’ price for existing government securities sold in the secondary capital markets. Although the subject of scathing criticism for failing to predict the financial crisis, credit rating agencies provide an essential service to international investors. The downgrade will almost certainly lead to higher interest rates across the spectrum of debt – including credit cards, mortgages and overdrafts.
S&P defended its decision by claiming that the budget agreement this week between Congress and the US Administration fell short of what it believes is required to stabilise US’s medium-term debt position. The downgrade signals a wider loss of confidence in the current US political system, and its inability to act quickly and decisively in the face of economic events. S&P were also concerned about the predictability of the political situation in the US in the medium term. This comes at a time when even more serious doubts exist about the ability of the Eurozone politicians to come to terms with the Euro debt crisis. As world stock markets crash, China (the US’s main creditor, holding $1.15 trillion of debt) and India have called for a reform of the global monetary system to include a new reserve currency, similar to that proposed by Lord Keynes during the Bretton Woods conference in 1944. While China’s call for a reserve currency is likely to fail, just as Keynes failed to convince the US to adopt this element of his plan for post-War economic stability, it is clear that the time for reform is fast approaching.