On US Credit, Rating Agencies are "Out of Their League"
In his latest column, Daily Telegraph international business editor Ambrose Evans-Pritchard takes a close look at what tools remain in the US’ default-deferring toolbox.
In the event that the August 2nd deadline comes and goes without a deal in Congress, options range from a White House constitutional challenge to the legality of the very existence of a debt ceiling to the US Treasury potentially vanishing the Federal Reserve’s bond holdings.
Regardless of the path taken, or whether it’s a path chosen or forced, he believes the looming deadline to be much less doomsday than many decry and, in particular, finds it unlikely a US credit downgrade would have few of the gravest consequences many fear.
From The Daily Telegraph:
“Bill Clinton advised Obama to do just that [a Supreme Court challenge to the constitutionality of the debt ceiling in Congress]: blaze ahead, break the debt ceiling in defiance of Congress, and ‘force the courts to stop me’.
“Or, the US Treasury could eliminate the Fed’s entire holding of Treasury bonds at a stroke, gaining an extra two years. This would be a simple accounting transaction. Ben Bernanke might feel uncomfortable, and gold might blast to $3,000, but the Bernanke Fed has proved itself supple.
“The Treasury also has the authority to issue infinite amounts of platinum coins at any denomination it chooses (ie, like fiat paper currency, far above the metallic value): a chest of $1bn coins, say. This is seignorage on steroids, pace Prof Summers.
“You get the drift: nothing will in fact change when the deadline expires on August 2. The US is the world’s paramount strategic and economic power, with debts in its own sovereign currency. It can do as it pleases. Yes, the US may be stripped of its AAA by Standard & Poor’s. A nice one-day story, but otherwise irrelevant. Global bond vigilantes are quite able to make their own judgement on the substantive default risk of the US. The rating agencies are out of their league on this one.”
As a model, Evans-Pritchard points to the consistent downgrades of Japanese sovereign debt. Despite having its rating lowered, investors never doubted the creditworthiness of that nation. With that perspective, it seems unlikely that US debt, backed by “the world’s paramount strategic and economic power,” would be treated much worse in the bond markets. You can read more details in Ambrose Evans-Pritchard’s commentary on the US’ unfolding debt ceiling drama.