The unprecedented downgrade by Standard & Poor’s (S&P) of the US’ credit rating a week ago to “AA+” from “AAA” has received a wide range of responses and caused stocks to plunge around the world. Some challenged the credibility of S&P and others praised the ratings agency for simply telling the truth. Some people predicted further downgrades, while others said concerns over more bad news were overblown.
However, the impact may be less than expected because, first, another two major ratings agencies, Moody’s and Fitch Ratings, still stick to their top-notch credit rating on US debt and also the 2002 downgrade by S&P of Japan’s credit rating shows that the country was still able to borrow at lower interest rates, as the rate on Japan’s 10-year government bonds remains around 1 percent today.
Second, S&P’s downgrade has not much altered investors’ appetite for US Treasuries, which ironically will remain a safe haven for nervous global investors seeking to avoid risk, at least in the short run. A plain fact is that global investors still like doing business in US dollars and they have little alternative but to continue parking their holdings in Treasuries.
Third, S&P said on Monday that there is no immediate impact on either Asia-Pacific sovereign ratings or the region’s corporate, financial institutions, project finance or structured finance ratings following the US downgrade.
However, S&P’s downgrade is a wake-up call for the US about its economic woes, albeit in a humiliating fashion. Feelings of embarrassment aside, if the downgrade could prompt Washington to deal with the country’s debt problem in a more serious way, it would actually help the US economy and bring stability to the world economy in the long run. Furthermore, if S&P’s downgrade on US debt could force policymakers in debt-laden European economies to find real and effective solutions to their own debt problems, it would be another blessing to investors at home and abroad.
However, what has unnerved us here in Asia was the statement issued by the Federal Open Market Committee on Tuesday that the US Federal Reserve would likely keep interest rates at exceptionally low levels until mid-2013 and that its policymaking members had discussed a range of policy tools to boost the US economy, if necessary.
This is because the US central bank’s commitment to maintain interest rates near zero for such a fixed duration is also an unprecedented step, which will continue to weaken the US dollar and place appreciation pressure on the currencies of emerging economies.
The problem is that if the low interest rates proved ineffective, the Fed’s potential use of other policy tools to stimulate the US economy — a resumption of quantitative easing measures in some form, or QE3 — is no guarantee that it would boost the economy more than its previous two rounds of quantitative easing did, if the law of diminishing returns holds true, but would surely flood emerging markets with speculative capital, resulting in problems such as asset bubbles and currency appreciations, and could even spark currency wars and trade protectionism.
Moreover, if US companies still do not want to increase hiring and US consumers begin to cut back on spending despite the Fed’s implementation of QE3, one might have to wonder whether the slowing growth in the US economy would eventually lead to another downturn.