In her dystopian novel The Mandibles, Lionel Shriver describes how the US federal government in 2029 summarily defaults on its growing debt. The dollar loses the role of world reserve currency to a multilateral “bancor”, thus belatedly bringing to life Keynes’ plan for the postwar world currency order.
The economy collapses and the formerly comfortable middle class is plunged into destitution. In the novel the rating agencies, whose job it is to foretell defaults, are conspicuously absent in the run-up to the financial disaster that engulfs the US.
Back in the real world, what is the likelihood of the ratings industry detecting and calling a deterioration — however gradual — of the solidity of the US government’s full faith and credit obligations? In part, of course, this has already occurred. While Fitch and Moody’s continue to rate the US government a top-notch AAA, S&P lowered the rating to AA+ in August 2011 at the time of the debt ceiling row.
At the time S&P argued that Washington’s fiscal plans failed to stabilise the government’s upward trending debt burden and that, more broadly, “the effectiveness, stability and predictability of American policymaking and institutions have weakened”.
Arguably, both negative tendencies have since intensified. Factoring in the unfunded tax cuts passed in late 2017, the International Monetary Fund forecasts the US public debt ratio to rise to 117 per cent of GDP by 2023, doubling within two decades. S&P simulated that this ratio could surpass 250 per cent in 2050, thanks to the pressure of unreformed entitlement programmes in an ageing society — and not far from the breaking point in Ms Shriver’s 2016 novel.
Yet all of the main agencies assign a “stable” outlook to the US rating. So do not hold your breath for another downgrade anytime soon. The agencies will most probably continue to stress the privilege of issuing the world’s foremost reserve currency and the monetary flexibility that bestows. The agencies are also likely to argue that the growth prospects and debt capacity of the US will continue to outdo the country’s G7 peers.
Finally, we will hear that the constitutional checks and balances are still operational. This would prevent self-damaging policy choices, even in our age of a more volatile White House tenant. All of these arguments contain a lot of truth. Yet the ratings scale is not an all-or-nothing affair and the gradations are particularly granular at the top end. A stable outlook on a triple A rating is the gold standard of the ratings industry. It is as close to perfection as you can get.
No plausible threat to the dollar’s dominant reserve status will emerge, given the troubles of the European economy and the lack of full convertibility of the renminbi. More likely triggers to move the US rating would be a further deterioration of the political environment; for example, through a succession of government shutdowns or another debt-ceiling impasse. While such events would cast a dark shadow over US governance, they would also negatively impact the growth and public finance outlook.
The stable outlook on US ratings suggests the agencies do not believe these triggers will be pulled during the Trump presidency. This is a justifiable position. There may be also some reluctance to lower the rating during an election campaign, so as to appear not to meddle in the political process. Yet things that have never happened before keep happening since the 45th president took his oath of office, ranging from reversing the decades-old trend of trade integration and multilateralism to Mr Trump’s being “proud” to shut down the government for border security. Downgrade scenarios remain within the realm of possibilities.
So imagine a surprise one. Could it precipitate a downward public finance spiral through higher government borrowing costs? Unlikely. In the aftermath of the S&P downgrade Treasury yields fell. This pattern would probably repeat itself should another agency follow suit. This is hardly surprising. In uncertain times investors seek quality. US Treasuries would be the safest securities around, even if they were docked one notch. Investment mandates would adjust to make AA the new AAA. Whereas a near-term downgrade appears unlikely it would not create a worrisome market dislocation even if it did.
There would, however, be political repercussions. Beyond the partisan blame game we could take for granted, there could be other, less obvious consequences. For example, the US Department of Justice filed a lawsuit in February 2013 against S&P over what it considered misleading analysis of the mortgage sector. Some observers wondered whether the lawsuit was some kind of retaliation for the agency’s downgrade. Whether a Trump administration would act less vindictively is a speculation most safely left to novelists like Ms Shriver.
The author is chief economic adviser of Acreditus, a risk consultancy headquartered in Dubai. He was S&P’s sovereign chief ratings officer between 2013 and 2018
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