Fresh from Standard & Poor’s on Monday — a bit of a headache for the United States:
We have affirmed our ‘AAA/A-1+’ sovereign credit rating on the United States of America.
· The economy of the U.S. is flexible and highly diversified, the country’s effective monetary policies have supported output growth while containing inflationary pressures, and a consistent global preference for the U.S. dollar over all other currencies gives the country unique external liquidity.
· Because the U.S. has, relative to its ‘AAA’ peers, what we consider to be very large budget deficits and rising government indebtedness and the path to addressing these is not clear to us, we have revised our outlook on the long-term rating to negative from stable.
· We believe there is a material risk that U.S. policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation does not begin by then, this would in our view render the U.S. fiscal profile meaningfully weaker than that of peer ‘AAA’ sovereigns.
And the rationale:
Our ratings on the U.S. rest on its high-income, highly diversified, and flexible economy, backed by a strong track record of prudent and credible monetary policy. The ratings also reflect our view of the unique advantages stemming from the dollar’s preeminent place among world currencies. Although we believe these strengths currently outweigh what we consider to be the U.S.’s meaningful economic and fiscal risks and large external debtor position, we now believe that they might not fully offset the credit risks over the next two years at the ‘AAA’ level.
The U.S. is among the most flexible high-income nations, with both adaptable labor markets and a long track record of openness to capital flows. In addition, its public sector uses a smaller share of national income than those of most ‘AAA’ rated countries–including its closest peers, the U.K., France, Germany, and Canada (all AAA/Stable/A-1+)–which implies greater revenue flexibility.
Furthermore, the U.S. dollar is the world’s most used currency, which provides the U.S. with unique external flexibility; the vast majority of U.S. trade flows and external liabilities are denominated in its own dollars. Recent depreciation of the currency has not materially affected this position, and we do not expect this to change in the medium term (see “Après Le Déluge, The U.S. Dollar Remains The Key International Currency,” March 10, 2010, RatingsDirect).
Despite these exceptional strengths, we note the U.S.’s fiscal profile has deteriorated steadily during the past decade and, in our view, has worsened further as a result of the recent financial crisis and ensuing recession. Moreover, more than two years after the beginning of the recent crisis, U.S. policymakers have still not agreed on a strategy to reverse recent fiscal deterioration or address longer-term fiscal pressures.
In 2003-2008, the U.S.’s general (total) government deficit fluctuated between 2% and 5% of GDP. Already noticeably larger than that of most ‘AAA’ rated sovereigns, it ballooned to more than 11% in 2009 and has yet to recover.
security discretionary spending to levels similar to those proposed by the Fiscal Commission in December 2010, holding growth in base security (excluding war expenditure) spending below inflation, and further cost-control measures related to health care programs. Revenue would be increased via both tax reform and allowing the 2001 and 2003 income and estate tax cuts to expire in 2012 as currently scheduled–though only for high-income households. We note that the President advocated the latter proposal last year before agreeing with Republicans to extend the cuts beyond their previously scheduled 2011 expiration. The compromise agreed upon in December likely provides short-term support for the economic recovery, but we believe it also weakens the U.S.’s fiscal outlook and, in our view, reduces the likelihood that Congress will allow these tax cuts to expire in the near future. We also note that previously enacted legislative mechanisms meant to enforce budgetary discipline on future Congresses have not always succeeded.
Key members in the U.S. House of Representatives have also advocated fiscal tightening of a similar magnitude, US$4.4 trillion, during the coming 10 years, but via different methods. House Budget Committee Chairman Paul Ryan’s plan seeks to balance the federal budget by 2040, in part by cutting non-defense spending. The plan also includes significantly reducing the scope of Medicare and Medicaid, while bringing top individual and corporate tax rates lower than those under the 2001 and 2003 tax cuts.
We view President Obama’s and Congressman Ryan’s proposals as the starting point of a process aimed at broader engagement, which could result in substantial and lasting U.S. government fiscal consolidation. That said, we see the path to agreement as challenging because the gap between the parties remains wide. We believe there is a significant risk that Congressional negotiations could result in no agreement on a medium-term fiscal strategy until after the fall 2012 Congressional and Presidential elections. If so, the first budget proposal that could include related measures would be Budget 2014 (for the fiscal year beginning Oct. 1, 2013), and we believe a delay beyond that time is possible.
And further down:
Additional fiscal risks we see for the U.S. include the potential for further extraordinary official assistance to large players in the U.S. financial or other sectors, along with outlays related to various federal credit programs. We estimate that it could cost the U.S. government as much as 3.5% of GDP to appropriately capitalize and relaunch Fannie Mae and Freddie Mac, two financial institutions now under federal control, in addition to the 1% of GDP already invested (see “U.S. Government Cost To Resolve And Relaunch Fannie Mae And Freddie Mac Could Approach $700 Billion,” Nov. 4, 2010, RatingsDirect). The potential for losses on federal direct and guaranteed loans (such as student loans) is another material fiscal risk, in our view. Most importantly, we believe the risks from the U.S. financial sector are higher than we considered them to be before 2008, as our downward revisions of our Banking Industry Country Risk Assessment (BICRA) on the U.S. to Group 3 from Group 2 in December 2009 and to Group 2 from Group 1 in December 2008 reflect (see “Banking Industry Country Risk Assessments,” March 8, 2011, and ” Banking Industry Country Risk Assessment: United States of America,” Feb. 1, 2010, both on RatingsDirect). In line with these views, we now estimate the maximum aggregate, up-front fiscal cost to the U.S. government of resolving potential financial sector asset impairment in a stress scenario at 34% of GDP compared with our estimate of 26% in 2007.
Full note in the usual place. We’ll stick some reaction up soon.
Update — Geysers in gold and silver at pixel time, via Reuters:
And in the Dollar Index…
And charts of the dollar against the euro and the yen:
The Vix was up 19.5 per cent at pixel time (1430 UK time) and the Dow had fallen 1 per cent at the open.