Yesterday, Standard& Poor’s, one of the three best known credit rating agencies, downgraded the US debt to AA+ from AAA. Yes, this is a historical moment as the US debt credit has been an absolute AAA since the times of the founding fathers.
There is no question that the downgrade will cause a panic on Monday. Yes, people are not going to dump the US debt because it is still one of the most attractive assets in the world. However, bear in mind that the downgrade will increase the likelihood of a US default on its obligations. Here is why.
The AA+ credit rating means that US will likely to pay more interest on every dollar it borrows in the future. The US hardly avoided a default on Tuesday and a higher cost of borrowing is going to make the situation even uglier. We need to remember that the debt deal reached on Monday is a deal that pays the current obligations by borrowing more. In other words, US has been avoiding a default simply by relying on its low borrowing cost. The US has lost this advantage.
Secondly, with S&P lowered the credit of the US, we cannot be sure that the other two major rating agencies will not do the same in the future. Rating agencies are largely criticized by the public for their failure to perceive the risk of CDOs during the 2007 crisis. It is a positive thing for us to see that S&P has learned a lesson from these criticisms. Fitch and Moody’s will be risking their reputation if they choose to keep the credit rating of the US as it is while the country is having trouble to pay back its debt.
We will see the reaction of the market on Monday, but investors will most likely pull money out of the US stocks and bonds in seeking for a better heaven, such as gold and platinum.
