This page has been archived and commenting is disabled.
A U.S. Sovereign Credit Downgrade Is No Laughing Matter
By EconMatters
With a stalemate heading into the weekend, the debt drama of the United States is going down to the wire, and when the clock strikes twelve midnight on August 2 (countdown clock at our homepage), the world's largest economy could be looking at an unprecedented technical default. The current consensus suggests that although a total default is nothing but a remote possibility, the damage is already done to the dollar, and a sovereign debt downgrade could be inevitable even after the debt ceiling deadlock is resolved.
China, as the largest foreign holder of the U.S. debt, is totally freaking out. NPR reported that "State Department officials now admit that China has been using diplomatic channels to express its concern. It has sent several official demarches urging Washington to abide by its financial commitments."
The Middle Kingdom has the world's largest foreign exchange reserve at about $3.2 trillion, which is mostly in US dollar holdings, and holds $1.16 trillion in U.S. debt, followed by Japan with $912.4 billion and the United Kingdom with $346.5 billion (See Chart)
 |
| Chart Source: NPR.org |
According to China Daily, China's central bank must buy dollars and other currencies from foreign capital inflow and exchange them into yuan, because the Chinese currency isn't freely convertible. The book value of these assets reported fell significantly after the year 2000 due to a devaluation of the US dollar.
Beijing has been trying to diversify away from the dollar in recent years; however, with its huge reserve size, the effort has not made much of a dent. So needless to say, the prospect of a U.S. default, and/or a sovereign credit downgrade has put China’s own wealth in a dire predicament. On that note, I’m having a hard time making sense of the comment made by Sen. John Kerry, as reported by the Huffington post,
"The Chinese are laughing all the way to the bank,” said the former Democratic presidential nominee, because a downgrading of US Treasury securities will mean enormous and completely unnecessary increases in our interest payments to the nation’s largest creditor — and our most important competitor in the international arena."
The dollar (and the U.S. Treasurys), despite the long standing weak-dollar policy of the U.S., is nevertheless the world's top reserve currency on U.S. bond's deep market liquidity, and amid the ongoing euro debt crisis. Many U.S. debt holders and central banks, including China, basically have no choice but to keep buying Treasurys supporting the dollar, or they will see their own wealth dwindling along for the 'Dollar Dipping Ride'. In other words, most of the U.S. debt holders are in essence the "enablers" of the U.S. debt and spending binges.
For now, I’d give Sen. Kerry benefit of the doubt that his remark was meant to
1) Mock China knowing Beijing has very few alternatives. Actually, Chinese wealth only buys 8% of the total U.S. debt, whereas over 50% of Uncle Sam's debt is owed to the private investors, American as well as international. (See Chart). So if Sen. Kerry is mocking China, he is also mocking the American taxpayers, and many of the nation's trading partners, not to mention the loss of purchasing power, the inflationary effect, and higher interest rates that a weak dollar and a sovereign credit downgrade would bring.
2) Divert and downplay this self-inflicted crisis and the incompetency of this government. Spin-control seems a bit late at this hour.
And there's always the call-it-as-you-see it 3) Kerry does not understand the cause and effect of global credit and currency markets. This would be far more dangerous considering his current position as the head of the Senate Foreign Relations Committee, and once a Democratic presidential nominee.
Regardless, if the United States really goes into a technical default, and/or receive a sovereign credit downgrade, expect serious sell-off's in commodities such as crude oil, copper, agriculture, and equities tripping multiple exchanges' circuit breakers. Gold, more so than silver, would benefit on the flight to safety. But Treasury would also get a boost (No, this is not one of my typo's.)
As I noted before, fundamentally the U.S. has no immediate liquidity issue, and on the fact that this 'crisis' is self-induced, when a near world-ending event such as a U.S. credit downgrade occurs, people would still go into U.S. Treasury as the safe haven ('the dog' with less fleas).
So a dollar rout is unlikely whereas a rew round of Euro rout could be in the cards if some more bad news erupt in the Euro Zone. And unfortunately, PIMCO's Bill Gross would have to wait just a little longer to be the Roubini of the Bond Market.
However, if the U.S. Congress is short-sighted enough (which seems more and more likely), things could really hit the fan, then nothing would be immune to the rush to exit en masse. Cash is king while the big boys duke it out.
More importantly, I think this debt ceiling 'crisis' really has shed a spotlight on the nation's government and its leadership. That seems to be the more imminent clear and present danger than any fiscal or debt problems the U.S. has right now.
Further Reading:
New Fall Looks For The Dollar: The Debt Ceiling Collection
Staring down China's Inflation Dragon
(h/t Stan Abrams at China Hearsay)
EconMatters, July 30, 2011 | Facebook Page | Twitter | Post Alert | Kindle
»
- advertisements -
I vote for #3) Kerry does not understand the cause and effect of global credit and currency markets.
and the scary part is that his fellow congresscritters don't either...
Kerry's wife is infinitely smarter than her old man...
<--My wife glazes over whenever I discuss what I learned on ZeroHedge
<--My wife is all about me buying guns, gold, food and reading ZeroHedge
If you're like me you know the glazed look all too well. I've tried to explain to her all that I've learned here and elsewhere, but all I get in return is hell for being on the Internet all the time. Same for most of my friends. Amazing just how unaware the general populace is that they're being robbed blind.
Just wanted to see how many others are in the same boat.
My wife used to be, but has come more and more on board over the years, especially since 2009. I'd suggest you feed her with a teaspoon, not a firehose.
Stick to the less esoteric ideas that are fully supported and do not rely on speculation (full disclosure, I don't buy a lot of the conspiracy stuff (some, but not most), but I think these rules apply regardless).
From a preparation standpoint, emphasize the low cost items that make sense anyway, especially those that make sense to live out an ice storm, tornado, hurricane, earthquake, or whatever disruption your local area is prone to.
Build on that foundation to deeper items.
You may get some glazing anyway, but probably a lot less of it, and a lot better reception on the whole
I agree. this is absolutely no laughing matter. however i have just receieved from my secret Senatorial "sources" this video of "the two parties approach to getting the various stragglers in line" method prior to voting on the various "default options": http://www.youtube.com/watch?v=i0GW0Vnr9Yc&feature=player_detailpage
as you can see it's highly disturbing.
Looks like I picked the wrong day to quit sniffin' glue
You get whom you voted for MASS. Love NEW ENGLAND, but your Representatives SUCK BIG TIME, Barney inclueded. Do you hear that sucking sound small Democrats. It sucks all the way to DC where you accually have a VOTE thru your REPS. Give me a lobster.
The bailout was a default. The artificially low interest rates was a hyper default. The incessant devaluation of the currency is a default.
America can no longer back up their jaybird ass with their drunken alligator mouth.
All the fake money created fake signals and burned out the real economy backing the paper.
Americans, WHAT IS YOUR ROCK BOTTOM YOU FUCKING TARDS?
hint: we ain't even close yet.......
I've got a great idea. Let's take a free country with a bill of rights and subvert the ignorant citizens into giving up their rights for nonsense trinkets. Meanwhile we'll take our wealth from their paychecks and throw them in bf'ing prison if they don't concede. Then we'll centralize power more and more until our hegemony is complete and create a dependent class of people to act as goons if the working people figure out what's going on. The whole time we'll assure them they're free.
Land of the fleeced, home of the slave.
The U.S. will make good it's debts to all foreign governments and U.S. citizens will pick up the tab.
The Fed has already sent trillions to bail out foreign banks and companies, what makes you think
they would stop now?
So UK holds 2.5% of US debt, whilst China holds 9%.
With those size ratios, I'd say we're well and truly fucked here in the UK.
I was just saying that to the Mrs.!
Uummm, yeah, pretty much it is.
laughing my ass off at the livestock who are buying this debacle
During all of 2010, the national debt went up by 1.7 trillion dollars for the year. It rose from 12.3 trillion on January 1, 2010 to 14 trillion by December 31, 2010. This year it rose by only 340 billion from January 1, 2011 to the end of July of 2011. If the deficit is 1.65 trillion this year, won't we have to sell a humongous amount of treasuries just to make up for the money we didn't borrow during this debt ceiling standoff? Like about 1.4 trillion dollars in treasuries from now to the end of the year? And couple that with an article I read on Zerohedge that says that almost a half trillion dollars in treasuries will be maturing in August alone. Won't this increase the demand by the treasury dept. to sell a ton of treasuries to fulfill all it's obligations once the debt ceiling is raised just in August alone? And also, not to mension the extra 135 billion per month the govt. needs for normal operations on top of this? Won't the treasuries take a substancial dive? Some one correct me if I'm seeing this wrong.
Now Knumbskulls who think Social Security is brankrupt can even see it here! Social Security owns 17% of the countries debt! Thats 2.5 TRILLION dollars! Now you can see for yourself why O'Bummer and the Republicons want to steal the money from us! They borrowed the TRUST FUND to pay for their wars and now want us to take it in the rear!
Thank you! It's about time an intelligent article on the true probability and consequences of technical/selective default was written instead of the usual clueless and polarizing jingoistic deflections.
-HOWEVER-
While it is true that the US has no liquidity issues (Hell, we're about to see another huge printing spree by the Bernanke in the next quarter during QEIII according to his boss, GS), that is precisely why other nations who are not completely insane do not want to play the game of who can take their currency to the bottom any more. Couple that with the unprecedented level of debt, cash flow problems, as well as the diminishing value of diluted cash, and what do we have? More trouble ahead.
Your optimism on the bond market is justified, but like all things it is unlikely to last. Not all central bankers think alike, and there are plenty, like Britain's Mervyn King, who can see the folly of debt-as-asset economies, leveraging on future production (ie thin air), and grand-scale fractional reserve banking.
Is cash king? I don't know about your cash, but my cash does not buy 60% of what it did a couple of years ago. If a US credit down-grade occurs, it will give impetus to those who are slowly being priced out of staple foods (That's almost everyone on the planet now), to detach completely from the reserve currency and rescind all the perks of that status like getting a free ride as a majority currency in the SDR. So not only will the USD be Billy-no-mates with everyone running away from it, but the invisible foreign revenue streams will be cut off at the same time. A rout on the Euro is just as likely as a rout on the USD, imo.
Based on recent past data, you are much more likely to be right than I am about US Treasuries as a safe haven. But, reality has a habit of upsetting linear regression, and I think the future could be as the "doomers" have predicted, and US Treasuries will be the last place of refuge when the proverbial Bernanke hits the windmill.
There have been talks for years among the Chinese, Russian, and even the Middle East Gulf States to ditch the dollar, but in reality, it will most likely take a decade or two before another substitue could be developed into maturity in terms of market size and 'tradability.' Our government trashed the dollar, but in the back of their minds, they know they could get away with it, at least in the foreseeable future.
If you look around the world, the U.S. is still the most politically stable, resource rich with a comparatively highly educated workforce. Eventually, as any previous world economic cycle, the U.S. will gradually relinquish its world leader position, but we are not talking about significant changes in the next 10 or 15 years. So, if doomsday comes within the next 10-15 years, people will flee to the US assets.
The emerging economies have their own set of problems and eventually will evolve into the ones similar to the U.S. I'm more optimistic about the U.S., which is not to say we have no problems, but relatively speaking, the U.S. is no worse off than other nations, and is one of the few that theoretically, have enough resource to dig out of hole.
There have been talks for years among the Chinese, Russian, and even the Middle East Gulf States to ditch the dollar, but in reality, it will most likely take a decade or two before another substitue could be developed into maturity in terms of market size and 'tradability.' Our government trashed the dollar, but in the back of their minds, they know they could get away with it, at least in the foreseeable future.
If you look around the world, the U.S. is still the most politically stable, resource rich with a comparatively highly educated workforce. Eventually, as any previous world economic cycle, the U.S. will gradually relinquish its world leader position, but we are not talking about significant changes in the next 10 or 15 years. So, if doomsday comes within the next 10-15 years, people will flee to the US assets.
The emerging economies have their own set of problems and eventually will evolve into the ones similar to the U.S. I'm more optimistic about the U.S., which is not to say we have no problems, but relatively speaking, the U.S. is no worse off than other nations, and is one of the few that theoretically, have enough resource to dig out of hole.
As you probably already know being the issuer of the 'world reserve currency' carries both positive and negative baggage.
See Triffins paradox...
http://en.wikipedia.org/wiki/Triffin_dilemma
What's interesting is that you do not need a currency to effect trade, but you need a currency to mark trade imbalances. So currency and credit eventually blur.
So is Mobius passing wind.........??? Could he be the next Paulson?????
http://www.cnbc.com/id/43938134
As I wrote previously, you are much more likely to be right than I am, but Taleb's black swans have a way of trashing preconceptions. I ask myself almost daily if we are approaching the breaking point of the USD or if it has a long way to go. If we take Japan as an example, clearly you are right and we have a very long way to go. But the noises of discontent I hear every day sound more like the beginnings of stress fractures before a complete break. Hence my post.
Once again, thanks for the article. I may take a different view, but it's well appreciated.
But the third and most important side effect of the fiscal crisis in Washington is that people around the world will start to diversify both commerce and financial transactions out of dollars and into other currencies. Far from being a threat, I welcome such an evolution. The less of world trade and finance that flows through dollars, the less easy it will be for the Treasury to issue debt or for the Fed to monetize this borrowing on the backs of US consumers and businesses via steady, unrelenting inflation.
Of course Nobel Prize winning economist Paul Krugman rightly notes that a reduction in federal spending will result in pain for many Americans. But what he fails to tell these Americans, especially low income working people he pretends to love, is that the cost of the borrow and spend policies advocated by second generation New Dealers is persistent inflation, a diminution of purchasing power that is just as surely killing the hopes and dreams of all Americans.
The right choice for Americans is to say no to ever more debt and to instead embrace debt reduction and restructuring of insolvent banks and markets to restore economic solidity. Both in the EU and the US, debt levels by governments and consumers must be reduced to restore national and personal solvency, and thereby start the great growth game all over again.
http://blogs.reuters.com/christopher-whalen/2011/07/27/why-the-us-debt-c...
The debt crisis will end up punishing the middle income and does not fundamentally change anything at Washington and Wall Street, which is the root cause of the financial crisis as well as the current self induced 'debt crisis'. So yes, theoretically, this should serve as a wake-up call to the world, so that everybody else in the world would "do the right thing", but in realilty it only will deepen the crisis at the Middle America as the 9-5ers have somehow become the 7-7er's working harder than ever and making relatively less.
And btw, I don't ever ever read anything by Krugman as he is a lost cause a long long way from his Nobel days.
They will make the middle class, along with the poor, utterly desparate and vulnerable. They will beg for a police state.
I think Mr. Kerry has his economics a little backward. If the US defaults or is downgraded and interest rates rise, the value of the paper China is holding goes down in value. Definitely not a laughing matter. Of course, when (or, pehaps, with a default, it's if?) we refinance the debt, interest rates will be much, much higher. I think China is more likely just as concerned as the rest of the world as to what happens after the default/downgrade. But, given his hyperpartisanship in the past, Mr. Kerry is certainly not blameless that this fiasco has gone on this long. Neither party and virtually no politician in DC can claim to be blameless.
china is laughing all the way to the bank. not today's bank but tomorrow's bank. they are laughing because they can't believe the usa is handing the world over to them so easily almost as a gift without a single shot fired. the problem the chinese have is that it is happening too quickly. the domestic economy of china and it's financial and trade relationships with it's partners are a few years away from the critical mass needed for the ball to roll on it's own momentum. it is a nice problem but difficult to manage with the coming riots and other civilian turbulence.
The US won't default. At least not for longuer than a month and that's really the max.
China will get it's money. So will the UK. So will the banks.
And Americans will get a higher tax receipt in return.
China will get it's money.
Maybe Ben's been printing up a whole oil-tanker's worth of Franklins to ship over to China. Pay 'em off in one fell swoop! Hey, he could fill a few more barges with Benbux and square away all our debts. Then we only have an annual deficit problem to deal with!
So what if we get a little inflation?
/sarc off/
"We're never going to pay China's back its money. It's impossible" "China can't even vote. You think we're going to tax voters to pay non-voters? Come on. Who are you kidding?" -- Peter Schiff
http://www.youtube.com/watch?v=NkEtArDFNYA
Obtaining credit at current rates ia a good deal for US and even if doubled is not considered usuary which is what banks charge consumers. Bring on higher interest rates to force us to live within our means. Low interest rates for the last decade lead to severel bubbles and now unsustainable because problem is no longer cyclical . It is systemic dependancy on China and no amount of growth expectations or reliance on reserve currency status can save us.
Well,
Seems the reserve currency, has China,and a lot of American suckers by the Nads.......................Gotta buy them, or lose money, as for fleeing to the Saftey of Treasuries, this has to be the KNEE SLAPPER of all time.
I have a lot of Studebaker, and Tucker stock for sale, line up please.Going fast, as it's a very SAFE bet!!.
But, but, but the Fed and the US Gubbermint owns most of the debt that will get paid back by the Fed and the Gubbermint. Mostly, an accounting trick. Thank god for OCB, FASB and GAPP, which mean absolutely nothing when virtually Everyone's (company's and nation's) books are cooked.
the boomerang effet hits the BRIC wall.
Scales falling away from eyes,
Paper tigers limp in the rain
Reptiles submerge in silvery depths.
Nevermore, nevermore.
Lurch Kerry is an idiot.
A gift to the American people brought to us by the same ignorant liberal pukes that continually foisted Barney Frank and Teddy Kennedy on the nation.
http://www.youtube.com/watch?v=lLQjR10iZ3c
Only a purblind fascist nutsucker would use the phrase "ignorant liberal puke."
Kerry is as ignorant as the rest of Congress about economics. If the Chinese own 8% of the debt, they are going to lose money as the price of bonds decline.
Did I tell you that I have three purple hearts?
Hes coming after Americas creditors with his purple heart on.
kerry is like another James Bonds. Agent '00' - who lost the '7'.
Sorry China. You fucked up and trusted us. This is what happens.
I read the dollar has lost over 70% of its value since 2000. Possible yes?
I think that number only makes sense when applied to gold. To other currencies no.
"I think that number only makes sense when applied to gold. To other currencies no."
In 2001 AUD dropped to 47 US cents .... today it's $1.10 US
You know 12% of that debt is held by people in the US, right?
Fuck me? No, FUCK YOU!
It's weekend!
EVERYBODY SHOULD GET FUCKED DURING THE WEEKEND!
Don't bend over.