Why Us Credit Downgrade Impacts So Much?

Last week， the global stock markets were in turmoil， the stock markets in Europe， the United States and Asia-Pacific as well as the A share market were all reduced to be under pressure because of the market’s increasing panic about the US debt crisis.

The two parties in the US Congress eventually passed the bill for raising debt ceiling and slashing deficit before the deadline， but Standard Poor’s (SP) abruptly announced on August 5 that the US sovereign credit rating would be degraded， triggering off sharp decline in the US and European stock markets as well as the AsiaPacific stock market and the A share market. This reflects that the public is losing confidence in the US government for sustaining economic growth.

Here come some questions: why does the rating agency lower the US sovereign credit rating? And what impact will be exerted on the US economy and its financial operation?

As a matter of fact， a couple of months ago SP P degraded the outlook of the US sovereign credit to“negative” from “stable”， yet maintained the AAA credit rating on the US. However， when the US determined to lift its debt ceiling， SP announced on August 6 that the US long-term sovereign debt credit rating cut by one notch to AA+ from AAA and the credit rating outlook was “negative”， which is the first time for the US to lose AAA credit rating.

SP explained that the recentlyreached fiscal tightening agreement between the US Congress and Administration could not stabilize its mediumterm debt， as the USD 2.1-2.4 trillion to be saved over the next 10 years depending on the latest bill to raise debt ceiling and slash government spending signed by Obama President falls short of the USD 4 trillion of SP. Besides， although Moody’s Investors Services， Inc. and Fitch have both maintained the AAA rating for the US sovereign credit， but the credit outlook is “negative”.

In my view， degrading the US sovereign credit rating will bring about great impact， as the US national debt interest rate may go up slightly resulting in increasing cost for the government to guarantee debt and borrow money， which will not help to stimulate consumption demand in the future due to more spending on interests for Americans.

More importantly， in the wake of the international financial crisis， Keynesianism has revived across the world and the US is no exception. The public expected the US government to lead its economy out of recession by stimulating economic recovery with fiscal stimulus packages. But the US economy is now worse than that the market expected.

Moreover， the latest bill proposed by the US to raise debt ceiling and slash government expenditure suggests that it’s difficult for the US government to boost economic recovery by such fiscal measures as increasing investments or cutting tax. Thus， concern arises over how the debt-ridden Uncle Sam can sustain economic growth.

As the US is now stepping into fiscal retrenchment， the public may pin their hopes on the Federal Reserve to launch new stimulus packages. This indicates that the Federal Reserve may initiate a third round of quantitative easing in a bid to continuously devalue the US dollar for more exports and economic recovery by maintaining low interest rates and adopting another fresh round of quantitative easing.

Supposing the US sovereign credit degrading may lead to a slight hike in the interest rate of national debt， while the US national debt is still in demand or its interest rate may not increase sharply， then the Federal Reserve will not be forced to raise interest rate in a short run. If so， what concerns the public is what the Federal Reserve can do for the US economic recovery.

Against the backdrop that the US is adopting fiscal retrenchment while the Federal Reserve is hesitate to initiate a third round of quantitative easing， SP unexpectedly downgraded the US sovereign credit rating， which really astonishes the public once again — the US economic growth model backed by debt-fuelled consumption seems to take no effect any longer and the public worries about whether the debt-crunching US government can seek a new economic growth model and whether the US government can sustain its economic growth.

The public’s despair of the US economic recovery outlook， more or less with irrational elements， also result in panic selling from investors， which sends off a plummet in the stock markets in the US， Europe and AsiaPacific.

The US debt crisis inducing turmoil in the global stock markets signals a pessimistic outlook for the US economic recovery and the world economy may step into another sluggish stage for growth. How to revitalize the world economy may become one of the core topics to be discussed in the upcoming G20 Summit this November.

Surely， the spreading questioning about the US government’s ability to sustain economic growth may lead to a greater decline in global stock markets， including the A shares.

However， the over-pessimistic expectation of the fundamentals of the global economy including the US economy， coupled with continuous slump in the global stock markets， somehow reflects the characteristic of irrational trading on the other side， which seems to imply that the darkest time for the stock markets has gone and any latest news about the US economy may prompt a rebound to the US stock market as well as other stock markets.

(Author: Ph. D. in Economics)