The US and its AAA Rating

I have talked about this before, but figured I would bring it up again as it is making headlines that the US may lose its coveted AAA rating. Does it really matter if the US loses this rating or not? It does from an ego point of view, but that is about it since it is highly unlikely that the US will default on its debt. Instead the US will more than likely simply inflate our way out of the mess we are in rather than actually default, but that would still count as a “default” to a certain degree.

What you need to know about rating’s agencies and how they rate sovereign debt is that the game is rigged. We know these agencies did a bad job with the mortgage debt and other private debt in the recent past, but Green Light Capital wrote a great piece on how Moody’s in particular rates sovereign national debt. Basically, the firm only looks about a year out to see how these countries can finance themselves and they do not tax demographics or tax policy into account yet they are predicting some 5 to 7 years out. It was a very interesting read and I will post the article below. Essentially, Moody’s is telling everyone that there is nothing wrong until there is something wrong and then they downgrade the paper, sound familiar?

I could also point to Executive Life which carried AAA ratings right up until the day it filed for bankruptcy, but I would be dating myself. This is what ratings agencies do, they have a CYA policy and then try to argue that their service is covered under the 1st Amendment, when clients pay for it which is not how the real world works. Anyhow, getting back on point, would the US lose its AAA rating? More than likely we will, but not because of default, but because of devaluation of the currency.

Investors will always get back the face value of the debt they buy from the treasury, I would guarantee that, but the US never guarantees the value of said dollars. Hell, Zimbabwe guarantees you will get back the face value of their debt, but, well you get the point. In a nut shell, even if get taken down to a AA rating it will not even impact our interest rates since we set them. Until we actually have a real crisis, meaning a currency crisis or consistent failed treasury auctions which would force higher interest rates – see Argentina – then the borrowing costs will remain wherever we set them.

Essentially, until the market says otherwise we still call the shots, but I will be the first to tell you that we cannot and will not be able to call the shots forever. With the total public debt, including intra-government debt, at $11.9T, according to treasurydirect.gov, which is 83% of 2008 GDP, we are getting up to a level when people are going to question are ability to pay them back. I mean, it’s not like we were really going to pay them back to begin with, but at least we gave them the illusion of repayment with debt-to-GDP well below 100%.

With the administration and CBO, I never give estimates much weight because they are always wrong as in way too low, calling for trillion dollar deficits for the next 10 years and that is if we have an actual recovery I think we need to think worst case scenario. If we do not recover in the next year or two then double those numbers and then we are talking reality or close to it. That is when the market will tell us that we know you are full of it and will demand higher returns on their loans to us. Basically, a credit rating means nothing on sovereign debt as it is still market driven and a great example is Japan who lost most of its AAA ratings already.

My big fear is and I think we are far away from this unless something funky happens in the currency market is a failure in the USD. However, in my opinion I think we would need to see treasury auction failures happen well before we see a currency failure occur and based on demand right now that simply is not going to happen. China, Russia and India can talk all they want, we are listening, but they are still buying and that is all that matters right now. Yes, we need to get our act together, I am not denying that, but it is not as severe as many are saying, unless the DXY slips below the 71 level then I will be a bit worried and you should be too.

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