The U.S. Treasury is not yet a subprime borrower, but it is no longer a top-tier credit risk, either. It took a Chinese company to finally come out and say so.
Dagong International Credit Rating Co. made headlines this month when it gave the United States a lower credit rating than it assigned to up-and-coming China. That, however, is beside the point. Dagong, which says it wants to break the monopoly that Western companies have had on rating sovereign debt, evaluated the borrowings of 50 nations and gave a dozen countries better credit scores than it assigned to America — thereby becoming the first large agency to assign Washington a rating lower than AAA.
In Dagong’s opinion, the United States deserves only a AA rating, with a “negative” outlook that hints at future downgrades if we fail to get our fiscal act together. Moody’s, Fitch and Standard & Poor’s all maintain their traditional AAA rating on Treasury obligations, though they, too, are starting to grumble about our government’s financial irresponsibility.
Credit ratings are statements of opinion, not Delphic predictions. A triple-A rating should mean that the rating agency sees virtually no credit risk under any conceivable set of circumstances short of a meteor strike or a nuclear war. Ratings below AAA are the rater’s attempt to quantify the degree of risk presented by a less-than-perfect borrower.
There is no such thing as a “correct” opinion of credit risk. We can only assess whose opinion is more credible and more consistent with the known facts.
So, let’s consider this for ourselves. Given the U.S. government’s $13 trillion accumulated debt, its continuing $1 trillion annual deficits, its failure to deal with a rapidly approaching explosion of entitlement spending, and its near-total state of political gridlock, which view is more credible: The United States is an exemplary borrower, or it isn’t?
Dagong says it isn’t, which, in my view, makes more sense than the other agencies’ insistence that this country remains one of the world’s safest bets.
In its recent report, Dagong explains that its ratings emphasize a nation’s ability to repay debt by generating future income, rather than by refinancing old loans with new borrowing. Refinancing can become difficult or impossible if financial markets lose confidence in the borrower, Dagong notes. We need only look to the recent example of Greece to see this for ourselves.
The United States, alone among the world’s economies, has a third way to repay its debts — by printing more dollars. The greenback’s global role as the primary reserve currency makes this possible. This basically means that the United States ought never to default on its debt because it can just create the money to pay what it owes. The Western credit rating agencies could always point to this to justify their continuing AAA ratings, though it would be an embarrassing admission.
Printing money willy-nilly is a recipe for disastrous inflation and devaluation. Creditors would be repaid, but they would be repaid in dollars whose value has been so diminished that the creditors, though nominally made whole, would in reality suffer significant losses. Dagong’s credit rating implicitly acknowledges this inflationary risk.
Dagong says China, with its fast-growing economy, large trade surplus and huge foreign reserves, deserves a rating of AA+. Canada gets the same rating. The AAA nations are Switzerland, Singapore, Australia, Denmark, Norway, Luxembourg and New Zealand. Saudi Arabia gets a AA rating like the United States, but with a “stable” outlook.
Another disconcerting aspect of Dagong’s report is the influence it may have on the officials who invest China’s foreign reserves, which total well over $2 trillion. Right now, much of that money is lent back to the United States. A Chinese pullback in such lending would probably force the Treasury to pay significantly higher interest on its debt, which will only aggravate our federal budget deficit and — without spending cuts — force more borrowing, in a nasty and unsustainable cycle.
Dagong’s study is not without its own biases and baggage. As a Chinese company, it is less able than Western firms to freely and openly evaluate political risk, especially close to home.
Dagong’s AA+ rating and “stable” outlook for its home country glosses over the rigidity of China’s political system and the strict controls the nation’s leaders place on the free flow of information. This rigidity leaves China vulnerable to unpredictable social upheaval, such as last year’s riots in Xinjiang. Dagong has very little room to assess such risks. One would search the company’s report in vain for even a reference to Tiananmen Square.
That said, Dagong Chairman Guan Jianzhong had a point in a recent statement. “This marks a new beginning for reforming the irrational international rating system,” he predicted.
Dagong has spoken out loud something about us that our own analysts probably see but are unwilling to say. The emperor may have some clothes left, but they are most certainly full of holes.