The Impact of a Potential Downgrade on the United States Credit Rating

[MarcoD]

What happens when the Chinese decide not to loan us any more money - or demand a higher interest rate? We already borrow about 40% of our budget - who will loan us money to pay China in the future?

Man, don't worry about it. At the moment, China trades goods for paper, and part of that paper is used to buy other stuff like oil. I think it is pretty unlikely that China will get an equivalent amount of goods back, the paper will just devalue.

 

[Ryan_m_b]

Man, don't worry about it. At the moment, China trades goods for paper, and part of that paper is used to buy other stuff like oil. I think it is pretty unlikely that China will get an equivalent amount of goods back, the paper will just devalue.

Errr what? China has US bonds and you have a large debt with them. Modern economies rely on being in a constant state of debt and lending, if suddenly people won't lend to you or ask for a higher interest rate you're going to suffer.

 

[MarcoD]

Errr what? China has US bonds and you have a large debt with them. Modern economies rely on being in a constant state of debt and lending, if suddenly people won't lend to you or ask for a higher interest rate you're going to suffer.

I misunderstood it I think, must have been thinking about something else.

As far as I know bonds are traded in some manner on the free market. If China suddenly stops buying, I guess interest rates would suddenly [STRIKE]drop[/STRIKE] increase. Otherwise, interest rates I guess will remain the same - they don't determine interest rates, the market does.

Is it possible that if China doesn't buy back bonds not enough bonds can be sold and US government defaults because they don't receive money from the market? I actually have no idea. Negative interest rates? Deflation? Is it even possible for China not to buy back bonds? Where would all the money go, in ships from the US to China? I really have no idea.

But as far as I know, all that money abroad has nowhere to go, and China has no interest in suddenly destabilizing the market.

 

[Ryan_m_b]

I'm not an expert either but start here and work your way through if you want to know more. Whilst I'm sure China doesn't want to destabilize the market it's not really under their control. The US owes many countries money (Including the UK). Defaulting means that the US will miss a payment, this will have huge obvious knock on effects such as the companies/countries relying on that money coming in not being able to pay for stuff either. The result will be that the US has it's credit rating reduced meaning people will be less likely to lend it money and would do so at higher interest rates.

 

[MarcoD]

I'm not an expert either but start here and work your way through if you want to know more. Whilst I'm sure China doesn't want to destabilize the market it's not really under their control. The US owes many countries money (Including the UK). Defaulting means that the US will miss a payment, this will have huge obvious knock on effects such as the companies/countries relying on that money coming in not being able to pay for stuff either. The result will be that the US has it's credit rating reduced meaning people will be less likely to lend it money and would do so at higher interest rates.

I never thought, and still don't think, that they will default, so this is just academic interest.

If we don't generalize anymore on national terms (getting tired of the US/China divide, China banks just hold 1Tn I thought), but think in terms of banks, financial institutions, private investors and companies: would the interest even go up that much?

Most institutions/small time investors can find other places to go with their money, but does the same hold true for banks or big funds?

I mean, are all the international banks not just that much tied up in US debt that they have no other option than to (re-)buy US debt with their dollars, no matter what? Or even, does an informal agreement exist between all these banks that it is just better to roll over debt of the US because of the consequences if they don't? They have a lot to lose if the US economy stalls, and suppose one of them owns several hundreds of millions of US debt, what could it do with it? Buy gold? They would suddenly need to find another market which would be big enough and deliver the same yield, and they would need to do that fast - money just standing around loses value.

Maybe losing AAA doesn't mean anything.

If the amount of money 'fighting' to be reinvested hardly changes, the interest rates can't change. If the amount of money, next time US debt is rolled over, suddenly dramatically changes -even if they strike a deal, but banks find it now necessary to reposition- I guess interesting times are ahead anyway.

 

[Ryan_m_b]

I never thought, and still don't think, that they will default, so this is just academic interest.

We'll see, there is a real and frightening chance that they will.

If we don't generalize anymore on national terms (getting tired of the US/China divide, China banks just hold 1Tn I thought), but think in terms of banks, financial institutions, private investors and companies: would the interest even go up that much?

Most institutions/small time investors can find other places to go with their money, but does the same hold true for banks or big funds?

I mean, are all the international banks not just that much tied up in US debt that they have no other option than to (re-)buy US debt with their dollars, no matter what? Or even, does an informal agreement exist between all these banks that it is just better to roll over debt of the US because of the consequences if they don't? They have a lot to lose if the US economy stalls, and suppose one of them owns several hundreds of millions of US debt, what could it do with it? Buy gold? They would suddenly need to find another market which would be big enough and deliver the same yield, and they would need to do that fast - money just standing around loses value.

Maybe losing AAA doesn't mean anything.

If the amount of money 'fighting' to be reinvested hardly changes, the interest rates can't change. If the amount of money, next time US debt is rolled over, suddenly dramatically changes -even if they strike a deal, but banks find it now necessary to reposition- I guess interesting times are ahead anyway.

Essentially it will make borrowing a lot harder for the US and increase it's debt. Whilst it is true that it is in no-ones interest to see the US economy stall (well actually I would dispute that, many countries could see a boost by filling the gaps that the US leaves) that doesn't give the US a get-out-of-jail-free card.

The institutions and countries that hold US debts might need that money, it's not a case of "don't worry about it I know you're good for it". For example;
Alice lends Bob 10 credits in return for an IOU. Alice then wants to buy 10 credits of goods from Carol and so gives Carol Bob's IOU. If Bob suddenly can't pay both Alice and Carol are in trouble and in future Alice will be less inclined to lend to Bob and Carol will value a Bob IOU less. So yes the US is a huge part of the global economy and there would be dramatic consequences if it defaults, the result will be repercussions in the market as people's money vanishes (a good example would be the US troops in Afghanistan who may not get paid next month) and in the future the US takes an ever decreasing roll on the global stage. If the US defaults and gets it's credit rating down rated businesses will move to other countries where their money is safer.

 

[SixNein]

IMO the biggest problem with this whole default crisis is that the average person doesn't entirely understand the situation (i.e. how can a country owe money and to who?) and has a bit of a cognitive dissonance believing that the US will always be number-one.

In addition to the above, many people seem to believe that America's budget and economic problems have 'obvious' solutions. But I don't see anything obvious about these problems. Some people think we should 'obviously' make deep spending cuts, and others think we should 'obviously' stimulate the economy. There is nothing obvious about either decision, and there is nothing obvious about how much one should pursue the path of either choice. Either path in my mind comes with substantial risk and uncertainty.

Just take the topic of a tax cut stimulus. Many will argue that tax cuts are the best way to stimulate the economy, but how can they be so sure? A great deal of our consumer goods are from foreign lands, so tax cuts may stimulate foreign economies instead of the American economy. We went with substantial tax cuts to stimulate the economy without ever asking important questions; as a result, we may be subsidizing economic growth in China instead of America.

In my mind, the largest problem America has right now is its lack of production. America is by and large a financial economy that just suffered a major financial collapse, and we don't have a backup plan. So how do we recover from this situation?

 

[WhoWee]

THIS IS A MUST HEAR INTERVIEW!

According to Barney Frank - the recent financial reform legislation - in anticipation of a downgrade - removes the federal requirement that AAA securities be liquidated (by pensions for instance) in the event of a downgrade. He stipulated the statuatory requirements have been removed and the regulatory rules are being disassembled currently.

http://video.foxnews.com/v/1087633549001/credit-rating-downgrade-a-done-deal/

Did anyone listen to this interview with Barney Frank? Apparently (and contrary to rhetoric -a reference to Geithner comments just 3 months ago), the Dems have anticipated a downgrade (for about a year?) and took steps in the finance Bill to offset some of the damage.

 

[Ivan Seeking]

Did anyone listen to this interview with Barney Frank? Apparently (and contrary to rhetoric -a reference to Geithner comments just 3 months ago), the Dems have anticipated a downgrade (for about a year?) and took steps in the finance Bill to offset some of the damage.

He was talking specifically about municipalities [and I think some States]. And what's news isn't the downgrade of some bonds, it is that the Fed is not requiring an automatic sell [by the banks] due to a downgrade. Arguably some of these bonds should have been downgraded long ago, so in practical terms, a downgrade does not mean there is an increased risk.

 

[WhoWee]

He was talking specifically about municipalities [and I think some States].

listen to the entire interview - he also references pensions/funds.