In the last 48 hours markets across the world have nose-dived and to some it may feel like Déjà vu. Financial crisis all over again and this is an expected market reaction.
While the markets are in panic mode I think it is important to look at the bigger picture to get some rationality. The US companies are sitting on over US 964 (approx ) billion in cash which is over 60% ( approx )higher than during the financial crisis. Employment picture is somewhat stable; households are relatively less leveraged than during the crisis, companies are paying out dividends among others.
The fundamentals of the global economy haven’t changed in the last 48 hours since S&P downgrade the US long term rating while affirming the top notch short term rating or we are missing something here? The downgrade was expected so nothing new in that and I believe no holder of US treasury will be running to sell their holdings. The impact on the US 4 trillion dollar repurchase ( repo) markets also been limited so far since the opening on Monday the 8th of August 2011. On relative terms US economy still looks like the better looking rubbish in a pile of rubbish.
Treasury officials in the US have already questioned S&P’s math and maybe there is some merit in their argument as some countries including of Austria, UK, France, the Netherlands, and Singapore holding AAA credit rating have a higher debt to GDP ratio than the US. The rating agency may argue that the debt curves in these countries are on a declining trend but it’s not entirely true. So the math and criteria used by S&P may be a bit questionable but having said that S&P has shown a lot of SPINE and courage by downgrading the US long term credit rating. And there are some who would even suggest that in fact US is not even worth AA+ based on its fiscal situation.
I think it is important to remember that there is an afterlife post down grade. Japan didn’t die after they were downgraded in fact the local investors hold over 95% of the JGBs so they couldn’t care less about their external ratings. The policy makers made too many bad policy decisions which did the real damage not the ratings downgrade.
Markets reaction to a rating downgrade is nothing new and generally the move is not efficiently priced in although some may argue that rating agencies are often behind the curve and in most cases they are simply following or reflecting the market reality. I believe a rating agencies job is to report the findings as they see it and the rating reports should only be used as a reference / guidance. Investors should make their investment decision based on their own independent assessment of a credit but most managers have a restricted mandate built around rating reports issued by S&P, Moody’s or Fitch . So even though some investors say they don’t heavily rely on ratings to buy a credit I wonder how many of them do that in reality because the structure of the market is such that some managers find it easier to pass the blame on to the rating agencies for a bad investment decision.
I can understand the frustration of some of the holders of the US treasury especially the government of China who is one of largest US creditor but I don’t expect them to dump the assets in the market. China as a creditor is within its right to criticise the US government but also it is in the best interest of China, Russia, Brazil among others to make sure the US economy gets back on its feet.
In my opinion there is no AAA credit around today especially if you break the credit apart and bring in all the off balance sheet obligations of the governments. The world and the market dynamics are changing and so will the methodology used by rating agencies to rate a credit. It has to happen sooner or later.
Also I think the time of super powers are gone because we live in a very inter connected world and the era of Facebook. So no single country is going to be strong or influential enough to take the leadership role of the world on its own shoulders. Collaboration is going to be the name of the game going forward. And this is probably a better world order than one country or even two countries dictating the world order. We are looking at a multi polar world order. The financial crisis has managed to shift the paradigm in favour of the emerging markets country. And as a child of emerging market I may have a bias towards it but never in my dreams I would assume that China , India , Brazil etc are ready to lead the world. Their influence will certainly increase going forward and they will provide more input on the new world order which is good but the approach has to be based on collaboration because no country is strong enough to grow in isolation.
With regards to markets the immediate reaction was as expected but I hope people will look at the bigger picture. The downgrade was most definitely not priced in based on the reactions and shock we have seen so far. This downgrade will bring the reality home to the politicians and the hope is that the policy makers in Washington DC will now find a way to fix the broken American Political system and focus on getting the economy back on track because they will feel heat from all sides including their electorates and may even lose their seats.
The problem with the US economy is the shrinking middle class. It’s one of the core spending groups that drive the US economy forward. I believe the policy makers in the US will need to address the shrinking middle class issue in order to arrest the slowing momentum of the economy and create an environment that will give ample confidence to American and global business owners and help them put the cash they are hoarding back to work in the economy.
The political leaders both in the US and Europe haven’t really managed to get ahead of the CRISIS but it’s never too late. What’s happening to commodity and Oil can only be good for the economy and for the average folks on the street. There was simply no real economic justification for such a high pricing levels on commodities and energy related assets. If people were expecting the world to grow at pre-crisis levels than they were simply mistaken and are now they having to do a reality check. And with regards to Europe its problem will probably get solved by more fiscal and political integration of EU nations. But the question is. Are the Europeans willing to give away their own national identities and interests for the greater good of European Union?
The slowdown was expected but there is nothing in the visible data to suggest that we are looking at a recession again.
The solutions are simple but I wonder if the politicians will do what’s required. I personally don’t see the downgrade as all negative for the US economy in the long run. I am starting to develop an opinion that this world is probably being RUN with very little WISDOM.
Your site is really cool to me and your topics are very relevant.