Tuesday, August 16, 2011

The AAA Ratings Downgrade Could Be a Blessing

The US has been the cornerstone of the global economy for the last 50 years. Now that we have lost our triple A rating, what will happen?

Maybe not much. Even though there will have to be a new perspective on risk, the US is likely to remain the safest place to invest. For example, while China has $3 trillion in US cash reserves, $1.2 trillion is invested in US treasuries. So it is unlikely they will take their money out. A massive withdrawal would destabilize the value of their financial assets. And where else would they put it? Europe?

France, for one, has a triple A rating. At the same time, they have similar challenges as the US, and a proportional level of government debt. So one potential outcome is that agencies take a closer look at the remaining triple A countries like France and perhaps downgrade their rating as well. If that were to happen, it would be a greater catalyst for investors to view risk and to find new safe havens for money.

Otherwise, if these countries maintain strong ratings, there still is no market large enough to support the amount of global investors besides the US. China’s economy is huge, yet there are limits to how many assets are available to foreign investors. So as it stands, the US may retain its place in the global economy by default.

Even if the downgrade doesn’t have any major consequences for investor countries, it may be a great blessing in disguise if it can force countries to come together to solve the fluctuations in the global economy.

To be sure, the US government will have to rethink itself. Whether the downgrade is appropriate or not, the government will have to deal with a new reality – it can’t borrow its way out of its self-imposed dilemmas. The time has come for the US government to develop new financial instruments to manage the economy. And since what happens here affects economies of other countries and vice versa, it may be time for the world economies to work as one to develop new tools to instill balance in the global economy.

I once attended a breakfast at the Economics Club of NY. The speaker was the Deputy Director of the International Monetary Fund. I asked him if there was a room of people from different industries and expertise from around the world working for one purpose – to develop new tools and thinking for the new global economy. To which he responded, “If you know where those people are, please give me their address.” 

And it’s true; the world lacks this kind of bold leadership and initiative. However, the intensity and symbolic enormity of a US downgrade requires an equally enormous and intense effort. As Albert Einstein said, the level of thinking that got you into a problem is not the same level of thinking that will get you out. Perhaps it’s not such a bad idea to start looking for those people.

After the financial crisis, Standard & Poor’s was seen as missing the mark when evaluating mortgage backed securities. It is said they focused too much on past performance to predict the future. Similarly, some believe they downgraded the US in error because it is once again based on past performance. In the end, only time will tell if the future performance of the US economy will hold up its reputation as the global economic leader.     

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