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We are finally on the brink and the financial
markets are finally beginning to take a serious look at the prospect of a
downgrade of the U.S. AAA
credit rating, which it has held for nearly a century, very seriously. As Republicans and Democrats
continue to move further apart on their plans to reduce the nation’s
deficit and its borrowing limit the realization of what a catastrophic event
this would be is finally beginning to sink in.
In a prime time televised speech,
President Obama warned the nation that with no clear resolution insight the
government is on the brink of a credit down grade that would deeply damage
the economy and send a global ripple effect through the world markets. For
the first time in our nation’s history the AAA credit rating could be
downgraded, leaving global investors to wonder whether the United States can
meet its financial obligations.
Republican House Speaker John
Boehner responded to the president’s speech by asserting that his plan
would avoid a downgrade and characterizing the president’s plan as a
“we spend more, you pay more” philosophy.
Meanwhile
House Speaker Boehner and Senate Majority Leader Harry Reid both launched
separate plans that would stave off the possibility of a downgrade. Oddly,
Senator Reid’s proposal, which would include no additional tax revenue,
was endorsed by President Obama. This is a striking contradiction to his
assertion that any plan must include added tax revenues. The president in his
address to the nation never mentioned this.
Despite
all of the last minute maneuvering the markets seem to believe that
Washington will find some way to reach an agreement that will allow the
government to keep paying its debts. There are those, however, that believe
that it may not be enough to avoid a downgrade of our credit rating. Indeed,
several unnamed sources were cited as saying that S&P has said that a $4
trillion debt reduction would be needed for the U.S to keep its AAA rating
and neither side is even remotely close to that figure.
The
possible downgrade from AAA caries serious implications because there are
many pension and mutual funds that are prohibited from investing in anything
that is not AAA grade.
According
to an article in Tuesdays Wall Street Journal, J.P. Morgan said that the
possibility of a downgrade would raise the treasury rates by 70 basis points
in the long term or in terms of dollars; that’s a permanent increase in
U.S. borrowing costs of $100 billion a year. While the credit rating does not
determine interest rates, I can only conclude that the psychological effect
it would have on foreign Treasury buyers would be significant.
Yesterday,
President Obama was reported to have said that he would veto anything that
House Speaker John Boehner put in front of him. I must conclude that he was
misquoted. With the credit rating of the U.S. Government hanging is the
balance I find it unbelievable that he would have the arrogance to say such a
thing. Be that as it may, whether he was misquoted or not as soon as the
reports hit the wires the market turned around and closed down 91 points on
the DOW and 5.5 points on the S&P.
In
conclusion, if a resolution is not reached by August 2nd all three credit agencies will
likely make good on their threat to downgrade our credit rating, which I
assume will be from the current “AAA” rating to
“AA”. While I
see a massive selloff of our Treasuries as very unlikely, I do believe that a
downgrade would force money market funds and other institutional holders
would have no option but to sell because they work within strict parameters
that mandate that they hold only AAA rated instruments. Sadly I also see
interest rates moving higher which would further weaken or already fragile
economy. While the market would sell off the big winners in this scenario
would be gold and silver. Also, as the market sells off my readers who have
properly positioned themselves in precious metals such as GLD,SLV and cash would have the opportunity to buy
into safe haven stocks at a once in a lifetime price.
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