Nadine Hani: S&P downgraded the US, but the Markets didn’t agree

“You can always count on Americans to do the right thing - after they've tried everything else.”Winston Churchill.

Standard & Poor’s dropped a bombshell when it downgraded US credit rating from the risk-free AAA ranking to AA+ despite an agreement between Democrats and Republicans in Congress to raise the US debt ceiling and avoid default. Everyone was confident the two parties would agree at the appropriate time, but the poor management of the crisis has cost the United States its excellent credit ranking. The conflict in Congress went beyond reasonable limits to the extent that the Tea Party drove the Republicans to an extreme position where they were ready to risk a default to score political gains in the upcoming presidential elections. Nothing seems to prevent using this same card again in the future. It is such kind of political brinkmanship and the adoption of a plan that does not seriously address the growing US debt that led to the downgrading of the US credit rating.

But despite S&P’s decision, financial markets still considered US Treasuries as a safe haven investment. After downgrading the US credit rating, Treasury prices rose and yields declined. The greenback remains the international reserve currency, since 61 percent of global reserves are denominated in Dollars, and no other currency today is capable of playing this leading role. The Euro is suffering from crises associated with sovereign debts in Europe. This makes it almost impossible for the United States to default, because it can always resort to printing dollar bills to pay its debt. Besides, foreign central banks invest in the US Treasury and are unwilling to change their positions in the short term for the lack of substitutes. Two countries whose treasury markets enjoy the kind of needed depth and liquidity are Japan and Italy but they have bigger debt problems than the United States.

The downgrading of US credit rating, still, shook investors’ confidence in international financial markets, inflated by and flooded with liquidity. These markets went through sharp volatility as gold and the Swiss franc, long considered “safe” assets, hit record levels. But that was for several reasons.

The latest economic figures show slowing growth in industrial activity around the world. The GDP growth of the US economy proved to be much slower than was expected. Besides, decision-makers now have limited resources to stimulate the economy. The reduction of US government spending adopted as part of the latest debt deal halted expansionist fiscal policies. On the other hand monetary policy options are limited, as interest rates are close to zero. Resorting to a third round of quantitative easing will further hurt the dollar, which is already suffering from the latest downgrade of the US credit rating. All these reasons along with the spreading sovereign debt crisis in Europe and the risk of further downgrades to European AAA rated countries such as France, led to the fall of stock markets.

The positive effect of S&P’s decision however is that it will likely push US lawmakers to be more responsible and agree on reducing government spending by the $4 trillion needed to address the debt crisis. This is unlikely to be achieved without reducing Medicare, Medicaid and Public Pension budgets along with raising taxes, steps that have not been agreed upon yet.

The Americans have made their economy the strongest in the world, enjoying the best educational system, flexible labor markets, innovation capacity, competitiveness and the rule of law. Today, it remains to be seen if Churchill’s saying will prove to be true in dealing with new debt challenge.

This article appeared originally in Arabic in An Nahar newspaper on Thursday, Aug. 11. Nadine Hani, Senior Business News Presenter at Al Arabiya, can be reached at [e-mail], and Twitter at: @Nadine_bn. The translator was Mustapha Ajbaili, of Al Arabiya, who can be reached at: [e-mail]