China, the largest foreign holder of U.S. debt, said on Saturday it had every right to demand the nation address its structural debt problems and ensure the safety of the $1.2 trillion of US debt that it holds.
In the wake of Standard & Poor’s decision to downgrade the U.S. credit rating, China warned that the rating cut would be followed by more “devastating credit rating cuts” and global financial turbulence if the US fails to learn to “live within its means”.
“The US government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone,” China said in a commentary carried by the Xinhua News Agency.
“China, the largest creditor of the world’s sole superpower, has every right now to demand the United States to address its structural debt problems and ensure the safety of China’s dollar assets,” it said. Xinhua said the U.S. must slash its “gigantic military expenditure and bloated social welfare costs” and accept international supervision over U.S. dollar issues.
Last month, China’s top general, Chen Bingde, also linked America’s financial woes to its military budget and asked whether paring back on defense spending wouldn’t be the best thing for U.S. taxpayers. Such comments reflect Beijing’s desire that Washington reduce its military presence in Asia. The U.S., rattled by China’s military buildup, also routinely chides Beijing for its fast-growing defense spending.
The downgrade of America’s AAA credit rating followed a week of market panic with many analysts predicting more turmoil on Monday. Finance ministers from the G7 industrialised nations are said to be talking this weekend about coordinated action to calm market fears.
“There is a complete lack of political direction in the US and across the western world,” said Terry Smith, the chief executive of broker Tullett Prebon, in his blog on Saturday. “The US Government, and governments across the western world, need to face up to the cold hard reality that for the last 30 years we have simply been living way above our means.”
The downgrade by S&P is a major political embarrassment coming less than a week after high-stakes wrangling among Republicans, Democrats and The White House pushed the US to the brink of default.
S&P had threatened the move in July if Washington failed to deliver what it judged to be a serious plan to tackle the country’s deficit and last night, after several discussions with administration officials, the agency followed through. The US government’s rating was cut to AA+ and the outlook for the debt was kept on negative in a move designed to keep pressure on Capitol Hill to go further than it has in addressing its $14 trillion of debt.
“The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed falls short of what, in our view, would be necessary to stabilise the government’s medium-term debt dynamics,” S&P said.
By calling the outlook “negative” S&P signalled another downgrade is possible in the next 12 to 18 months. In its statement, S&P said that it had changed its view “of the difficulties of bridging the gulf between the political parties” over a credible deficit reduction plan.
In an explanation of the decision, S&P said that despite last week’s agreement, which raised the $14.3trillion debt ceiling and promised cuts of $2.5 trillion to the deficit over the next decade, the ratio of America’s public debt to the size of its economy may climb to 79pc in 2015 and 85pc by 2021. It is understood that an agreement that had delivered a $4 trillion reduction in the debt pile would have preserved the AAA rating.
The US government quickly hit back at the decision, describing it last night as “flawed”. The rating agency, which has been the subject of heavy criticism for its role in the financial crisis, informed the administration on Friday morning that it would be taking the unprecedented step of downgrading the US and offered its findings. Officials at the Treasury department said they found a $2 trillion error in S&P’s calculations, which the rating agency disputed.
The decision was eventually made public about four hours after the S&P 500 ended its worst week since the financial crisis amid fears the US risks sliding into recession and as Europe’s debt crisis again intensified.
The cost of the financial crisis and recession, as well as the wars in Iraq and Afghanistan, have each driven America’s debt higher over the last decade and wiped out the surplus the country had under President Bill Clinton. But it’s the projected future cost of a number of major health care and pension plans including Medicare and Social Security that has left the country’s debt on a path many, including S&P, believe to be unsustainable without further cuts and tax increases.
US government debt is a cornerstone of the world’s financial system, is held in large amounts by foreign creditors such as China and Japan and is used as collateral on a daily basis by banks and investors. While the move has been anticipated by markets since last week’s deal in Washington agreed a cut of only $2.5 trillion in the deficit, it’s unclear how markets will react when they open on Monday. America’s debt is still rated AAA by Moody’s and Fitch, the two other largest agencies.
Analysts at Capital Economics said the move will “surely rock the financial markets when they open on Monday” but added that any moves are likely to be short-lived because the slowing global economy makes US government debt, or Treasuries, an attractive place for investors to park money. Despite the threat of the downgrade, the prices for Treasuries are close to their highs for the year as investors seek safe-havens and expectations for economic growth diminish.
Whatever the reaction next week, investors are clearer that the downgrade is a severe blow to America’s prestige and is also likely to increase the US government’s borrowing costs. JPMorgan this month estimated that such a move could add about $100 Billion a year to America’s funding costs as lenders demand more to compensate for the greater risk. The US spent $414 Billion last year on interest payments. [via The Telegraph (UK) and The Huff Post]