Over the weekend of August 5, 2011, Standard & Poors downgraded the U.S.’s credit rating from AAA to AA+. The downgrade from S & P is a historic moment for the U.S., one that has never happened before. I was really prepared for the worst before the market opened on Monday. Indeed, the markets all over the world slid, with the Dow Jones index falling by 635 points. The market rout prompted a friend to ask two questions: Why is this happening now, and can something be done? I wish I could answer these questions in a few lines. These are complex questions, so let’s address them one by one.
First, why is this happening now?
Time wise, the roots for this crisis were sowed in 2010, when Greece and Ireland almost defaulted on its debt payments. Since then, the Eurozone has managed to buy itself some time from the wrath of angry investors. A year later, Greece was again rescued, but this time the debt crisis had spread like a virus to other European countries.
Investors around the world are worried about the global growth. The growth in the U.S. has stalled, and as the biggest economy in the world, the U.S. is still trying to find its footing after the 2008 financial crisis. Unemployment is hovering above 9%, and the consumer confidence index is at its lowest. The GDP is in shambles, as well. Around the world, in Europe, with the exception of Germany, the prospects aren’t bright, either. With Greece, Ireland, Spain, Portugal, and Italy on a possible default list, the investors are jittery about the growth and the stability of the financial system. For a sound economy, the financial system should be strong. Well, that is not the case in the U.S. and Europe, and investors are rightly rattled by political deadlocks that are becoming a blockade to growth and future prospects. China has slowed down, and India is busy fighting inflation and corruption. But more than anything else, the slide is about a trust in governments. If the 2008 financial crisis can be blamed on Wall Street traders, then the 2010-2011 sovereign debt crises can be solely blamed on politicians everywhere. Their inability to act swiftly and efficiently has shaken the confidence of people around the world.
In the U.S., the rift in the political parties was evident during the debt-ceiling talks. Republicans want to freeze spending, which is great, but with no “new” revenues, the U.S. Treasury will find it hard to reduce the current deficit. I mean, for how long you can cut spending? Have you ever seen politicians talk about growth, economy, and job creation? I don’t think so. With all the cuts in the next decade, the unemployment rate is not going to go down anytime soon; it will increase to 10% as more workers are laid off from government jobs. In fact, I believe we have entered an era of a lost decade that started in 2008, similar to what Japan faced in the ‘90s. S & P downgraded the U.S. because they see political uncertainty for the next few years.
S & P’s downgrade is a clear message to the U.S. government to get their act together. If the U.S. is serious about getting its AAA rating back, then they will have to make amends to the budget cuts, as proposed after the debt-ceiling talks. Depending on how quickly politicians act, the U.S. can get the coveted AAA rating back by the end of the year. Today’s sell-off is a response to the downgrade. Here is another fact about the downgrade: S & P sent out its report to the Treasury Dept. at 3 p.m. on Friday. The U.S. Treasury found an error in S&P’s calculations of several trillion dollars. S&P admitted to this error, but they still went ahead and released the report at 8:30 p.m. on Friday. What gives? Ideally, they should have sat on the report for a while before thinking of downgrading. One can't help think the political motivation behind the timing of this downgrade.
Can something be done?
Sure. Over the weekend in the G-7 meeting, the U.S., Italy, Germany, and France pledged to buy bonds of the countries on the default list. Moreover, Fed has also indicated initiating another round of Quantitative Easing, QE3, in which they will buy bonds and keep interest rates at the current level. Buying bonds by the Fed is like a stock-purchase program by corporations. It is done to boost confidence in the system and in government itself. But more than the buying spree, which is surely going to boost confidence in the markets, there has to be an effort from politicians and governments to come up with a plan to create jobs, inject confidence into the private sector, and find ways for additional revenues. In addition, a well-balanced budget will be the right place to start.
The real challenge is to identify the growth inhibitors and find natural and sustainable ways to spur growth. It’s an achievable goal, but only if politicians drop all their shenanigans and beliefs and focus on thinking on how to solve the nation’s current crisis. If not addressed soon, the current crisis will soon escalate to a crisis of the decade, with many bumps along the way.
