Experts: If US Credit Is Downgraded, 'There Will Be No Winners'

Monday, 25 Jul 2011 08:10 PM

By David A. Patten

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Experts agree that the more that D.C. politicians play “chicken” over raising the debt ceiling, the greater the chance Moody’s and Standard & Poor's will downgrade their rating of U.S. debt from AAA to AA.

But what analysts disagree over is just how big an impact such a downgrade would have.

Just raising the debt ceiling, the ratings agencies have warned, won’t be enough to avert a credit downgrade. Rather, serious progress must be made in curtailing runaway government spending, they warn.

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But a short-term deal to keep the government running might not show the progress the ratings services want to see. Thus, some analysts are pessimistic a downgrade can be avoided.

How much will that affect the economy? One useful precedent to study occurred during the two government shutdowns in 1995 and 1996, which closed the federal government for all of six days. The Clinton administration later estimated the disruptions cost taxpayers nearly a billion dollars.

The U.S. credit rating during those standoffs remained unchanged. But the example shows how a budget impasse over excess spending can actually increase operating costs for the government — a self-defeating proposition for those who want less government spending, in the short-term at least.

Conservatives continue to hold the line on spending cuts, despite indications Monday that global markets may be getting increasingly skittish.

"The rating agencies aren’t going to go away after Aug. 2 even if we do get a deal,” CATO economist and tax policy expert Chris Edwards tells Newsmax. “If we keep up our huge deficit spending, the government will get downgraded down the road for sure. And even if Congress trims spending a bit in this deal, we are going to have to keep on cutting in future years to get debt under control.”

House Speaker John Boehner and GOP leaders at a press conference Monday.
Or as Rep. Darrell Issa, R-Calif., put it during an appearance on “Imus” on Monday morning: "Until we stop spending more, we should be downgraded."

Many analysts say the media has greatly exaggerated the significance of being downgraded from AAA to AA anyway. After all, S & P itself has described its AA rating as “VERY STRONG capacity to meet its financial commitments … differs from the highest-rated obligors only in small degree.”

And it’s not as if there are a lot of countries on sounder overall footing where capital could flee.

The Wall Street Journal has noted that Japan had its rating cut three times between 2001 and 2002, and the markets weren’t overly rattled and government borrowing costs did not soar precipitously. Nor was the strength of its currency adversely impacted.

But that was Japan, which has a much smaller economy and which does not act as the reserve currency for the entire world. There are worrisome indications that if President Barack Obama and House Speaker John Boehner continue to butt heads and fail to reach an agreement, the impact in the United States could be worse.

“If the impossible occurs, everything else becomes possible,” James Melcher, president of Balestra Capital in New York, tells Reuters. “It would have psychological repercussions that could be serious, and that certainly sets the stage for things to deteriorate.”

One outcome appears clear if the U.S. credit rating is downgraded, however: Voters will be furious, and the political consequences for whomever they blame could be steep. Most analysts think there would be plenty of blame, and subsequent political damage, to impact everyone involved.

“If the U.S. credit rating is downgraded, there will be no winners, politically or economically, in a bad situation,” Fox News commentator and Newsmax Magazine columnist Doug Schoen says.

The University of Virginia’s Center for Politics director and author Larry J. Sabato predicts “there will be hell to pay, and all elected officials in Washington will catch some of that hell.

“To most people, it seems inconceivable that the Beltway power centers can’t just sit down and split the differences in some fair fashion,” he says. “This deadlock confirms people’s worst fears about Washington and the egos of the politicians. Of course, it really isn’t as simple as all that, but it is how most people look at it.”

Among the potential economic consequences of a debt-rating downgrade:

• It would cost more for the United States to finance its $14.3 trillion national debt, although how much more is difficult to say. Through June, the United States had already paid $386 billion to finance the national debt for fiscal year 2011.

• Moody’s has stated it would cut the municipal bond ratings of some 7,000 U.S. cities, if the U.S. government loses its AAA grade. That will raise their costs of borrowing money as well.

• Mutual funds with large U.S. Treasury holdings probably would suffer. JPMorgan Chase & Co. has reported financial companies have begun shifting from long-term to shorter-term bond investments. “The possibility that the United States could be downgraded for the first time is seeping into investor consciousness," Ajay Rajadhyaksha, the senior U.S. debt strategist at Barclays Capital, told the Washington Post.

• Because treasuries are often used as loan collateral, a downgrade cold trigger a wave of margin calls. The rush for cash could impact stocks and corporate debt as well, Reuters reports.

• Look for investors to shift more to Euros and Asian currencies. To some extent this has already begun. In May, for the first time in 11 months, foreign entities became net sellers of U.S. assets. They reportedly doubled their acquisition of Canadian debt in May, as well.

• The Wall Street Journal’s Simon Constable warned Monday that a drop to a AA rating would eventually hit consumers as well. If the government’s cost of borrowing goes up, he told Fox News on Monday “that means [ours] will too. Not just in our taxes, but when we get a mortgage, or buy a car if you want to borrow money to do that, or use a credit card, you’ll pay more there .. this will filter through to everything.”

But some analysts believe the impact of a ratings downgrade has been greatly exaggerated. Mark Weisbrot, co-director fo the Center for Economic and Policy Research in Washington, D.C., told NPR earlier this month: “I’m not sure it would have any impact … investors haven’t changed their view of the creditworthiness of the United States at all, and I don’t think they’re likely to in the foreseeable future.

Editor's Note: Prepared for the next financial collapse? Watch Newsmax's exclusive Aftershock Survival Summit — Click Here Now!

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