What US downgrading means

Investors may move from US to markets that offer better profit, providing a shot in the arm for China and other rising economies

Despite a two-day weekend buffer, the downgrading of the US credit rating on Aug 5 by Standard & Poor's from AAA to AA+ with a negative outlook and threat to lower it further to AA within two years has rocked the global capital market.

The Dow Jones Industrial Average fell 5.6 percent on Monday, the biggest one-day drop since December 2008, amid rising fears over the US and global economies. Stock prices rebounded on Tuesday after the US Federal Reserve announced that it would maintain the low interest rates until at least mid-2013 but fluctuated drastically on Wednesday and Thursday.

The downgrading is a serious blow to the US. As the world's largest economy, the US has occupied an unchallenged economic and financial position since it became the largest industrial country at the end of the 19th century, especially since it became the largest creditor and New York replaced London as the No. 1 financial hub after World War II.

The US had enjoyed a triple-A credit rating ever since Moody's established the sovereign credit rating system in 1917. The Dagong Global Credit Rating Co lowered the US credit rating last July, but that did not have a major impact because the Chinese agency's influence is limited compared to that of S&P's, Moody's or Fitch.

S&P's was under huge pressure, given its Wall Street background, not to downgrade the US credit rating. That it ultimately chose to go ahead is a reflection of the poor investor confidence in the US economy, its political system and governance capability. S&P's had to distance itself from the US economy to maintain its self-proclaimed image of neutrality and objectivity after Democrats and Republicans haggled for months over lifting of the national debt ceiling.

The downgrading was the result of the US' lingering economic predicament and systematic defects that were exposed in the partisan contentions of the Democrats and Republicans over the national debt ceiling. Responding to the downgrading, US President Barack Obama said that it did not reflect S&P's doubts over US' economic ability to repay its debts but over Washington's political ability to act under the current political divide in the country.

Considering the US' position as the world's largest debt market and the dollar's dominance over the international monetary system, the downgrading is expected to change benchmark interest rates in the American financial market. It may prompt investors to ask for higher interest rates for investing in the US to ensure a higher return ratio for taking increased risks. At the same time, it is likely to cause large-scale selling of US national debts by some prudent private investment agencies because of fears over safety.

But there is not much possibility of an all-out and large-scale selling of US debts worldwide, given that the US holds an astronomical amount of debts. Besides, other countries' central banks would not want to incur huge losses which large-scale selling could result in. In this sense, repercussions of the downgrading of the US credit rating on the international financial market are not likely to last long.

But that does not suggest investors' have great confidence in the US market. Investors have to choose the US as their investment destination simply because of lack of better investment avenues.

The possible rise in interest rates for some US assets investment after the downgrading of the US credit rating, to some extent, would not favor the recovery of its real economic domain. But increased rates are not expected to deal a deadly blow to them, given that many companies that survived the global financial crisis have maintained high cash-holding ratios in their assets composition. Under these circumstances, the downgrading of the US credit rating may extend the US and European economic slump, but it is unlikely to induce a widespread and lingering economic recession.

Given that Washington has become accustomed to blaming others for its mistakes and wrongdoings, there is rising concern that the US will put further pressure on China to accelerate the pace of the yuan's revaluation.

In the long run, the combined impact of the US subprime crisis, the Federal Reserve's quantitative easing policy, American politicians' bickering over the national debt ceiling and the downgrading of the US credit rating will shake the long-established financial dominance of Washington.

Though investors continue to passively hold US debts, they will inevitably begin eyeing other markets as better substitutes. Once that happens, China and other emerging economies will get to play a larger role in international financial affairs and exercise greater say in the global financial market.

The author is a research scholar with the Chinese Academy of International Trade and Economic Cooperation, affiliated to the Ministry of Commerce.

(China Daily 08/13/2011 page5)