Debt dive: why is the US at the mercy of anonymous credit agencies?

Stock markets around the world plummeted after news of the US credit rating downgrade (EPA/FRANK RUMPENHORST)

Without the firing of a single shot in anger, a country has been, at least in a sense, brought to its economic knees. The capitalist system, with variations and aberrations, is now reacting.

Shares are shedding their global value, with $2.5 trillion lost last week and further falls continuing across the Australian and regional Asian markets.

Who is the culprit behind this move? A credit-rating agency. There are no named individuals, we only have an entity – Standard & Poor’s.

Predictions that the agency would show restraint and be politically sensitive proved unfounded.

It is a perverse world we live in – but debt is valuable. The person with grand debts is not necessarily poor. In truth, that person might be deemed fabulously rich. It depends on what rating you get, and how that debt is valued.

The American credit rating system rates one not on thrift but on the immense value of the debt one has. The system seems to say “pay by all means, but don’t pay all of it. For heaven’s sake, keep some afloat.” The good debtor is indispensable.

The press release from S&P’s via The Wall Street Journal, had a crude finality to it. “We have lowered our long-term sovereign credit rating on the United States of America to AA+ from AAA and affirmed the A-1+ short-term rating.”

The press release continues by saying: “The downgrade reflects our opinion that the fiscal, consolidation plan that Congress and the Administration recently agreed falls short of what, in our view, would be necessary to stabilise the government’s medium-term debt dynamics.”

When governments are at the mercy of the anonymous, surely democracy is well and truly deceased?

A sense of how wary one should be by this was that S&P had gone through the downgrade despite a vital miscalculation. The Wall Street Journal’s Damian Paletta noted that a battle of mathematics was taking place between the White House and the agency.

Treasury Officials, after S&P’s notified them of their plan to downgrade the debt, got to the figures and found a miscalculation of “future deficit projections by close to $2 trillion. It immediately notified the company of the mistakes”.

It begs the question, should we even believe these people? These are the same individuals who failed in their task of rating mortgage-backed securities when they were asked to. There is little doubt that the instilled myopia of an agency such as S&P’s succeeded, in part, in precipitating the financial crisis that has gripped global markets for some years now.

Nor are economists in agreement over how much debt as a value of GDP is too much debt. The American economist, Paul Krugman‘s view that there is a debt “threshold” is a fantasy, or at the very least, an exaggeration.

Outcomes here will vary, but lowering a credit rating can have the effect of increasing the cost of borrowing. Eventually, costs are moved down the chain. Government, one of the largest of consumers, is one – but then come the public.

Given that the US economy is already a sick patient, this is not the blow the Obama administration needed.

Other credit agencies have not decided to join the party. Moody’s and Fitch have shown greater restraint in pegging down the rating – for now. What will worry the Barack Obama administration will be the Chinese reaction – and the flutter the downgrade has caused other members of the G7.

Being the single biggest creditor, the Chinese will be wondering if its debt-addicted client has the deep purse to repay its debts. The official Xinhua news agency was strident in its tone: “The US government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone.”

In its position as the largest creditor, China had “every right now to demand the United States address its structural debt problems and ensure the safety of China’s dollar assets.”

Strong measures had to be taken. Don’t, urged Xinhua, spend more on the bloated military or welfare entitlements. Make deep cuts.

This tightly bound relationship – one “between a compulsive saver and a chronic spender”, to use Niall Ferguson’s words, is heading for an acrimonious divorce.