Ratings agencies would lose their credibility if they did not now cast doubt on the US government’s AAA ratings.

Once upon a time, when discussion turned to the hypothetical scenarios in which the sovereign ratings on the US might be downgraded, one very senior member of the Standard & Poor’s sovereign ratings team was known to use the phrase “over my dead body”.

We are happy to report that the analyst in question is still very much alive. He was almost certainly involved in the decision in April 2011 that brought a US sovereign downgrade a step closer, placing a 'negative' outlook on its AAA rating.

Officials at the US Treasury expressed surprise at the timing of the move, since the Republican and Democrat parties were thrashing out a package designed to tackle the budget deficit. It must surely be feigned surprise. The ratings agencies may have been rightly castigated for their opaque reasoning behind AAA structured finance ratings before the financial crisis, but the explanation for the negative outlook on the US was crystal clear.

US public debt and deficit levels are already well in excess of those for most AAA rated sovereigns. And none of the ideas currently being batted between the two US parties is sufficient to fundamentally alter the upward trajectory of public debt over the next two years – the timeline flagged by S&P for considering whether or not to downgrade.

As one former US Treasury under-secretary told The Banker more than a year ago, social security and health care entitlements are “cannibalising the rest of the budget”, accounting for 60% of current expenditures and rising faster than GDP. Changing the economics of a social welfare system is something that takes a generation, and it also takes the kind of consensus not yet evident in the US.

But there is a reason beyond mere patriotism why that S&P analyst considered a US downgrade so unrealistic. The dollar remains the only true global reserve currency, and the seemingly limitless ability of global markets to soak up however many dollar bills the Federal Reserve chooses to print means it is difficult to conceive of a situation in which the US Treasury could not roll over its debt. Even a one-notch downgrade would be unlikely to change that in the short term.

To maintain their credibility, however, the ratings agencies cannot now shy away from dropping US ratings a notch or two, even if default is still highly improbable. There were surely some officials at the Japanese finance ministry in the early 1990s who would have cast doubt on the idea of the sovereign ever losing its AAA rating. But S&P barely provoked a ripple when it downgraded Japan by one notch from AA to AA minus in January 2011. Once the gold standard is lost, the psychological barrier is broken.


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