Us Rating Downgraded

US rating downgraded

Original Work: No

1. Introduction

On 5 August, 2011, one of the world's leading credit rating agencies, Standard & Poor's, has downgraded the United States' top-notch AAA rating for the first time ever since 1917. S&P has cut the US long-term Sovereign Credit rating by one notch to AA+ with a negative outlook, citing concerns about budget deficits. Besides proceeding on, we need to first clarify what is mean by Sovereign Credit rating. Sovereign Credit rating is a benchmark which uses to assess a sovereign's ability and willingness to service financial obligations to commercial creditors, or simply the ability and willingness to pay back debts. A credit rating of AA+ means that the sovereign credit level of U.S. will be lower than U.K, France, Germany and Canada.

2. Effect of the US rating downgraded

Since after the subprime mortgage crisis, the U.S economy had already experienced a great recession, with the addition of U.S rating downgrade, most people begin to treat it as a sign that the global economy is going to worsen and expect that the financial crisis will come once more, of which the most direct way is that the U.S. economy is harmed by the increase in cost of debt raising, causing the Fed to launch another Quantitative easing, USD devaluate, hot money flowing around the world pushing up the price of other countries, a new round of currency devaluate competition causing the world economy to fluctuate. So, in the following section, it shows what will be the impact of U.S. rating downgrade brought to the global economy.

2.1 Immediate effect of the US rating downgraded

U.S. loses an "A", "A" share in China loses a trillion. After the downgrade of U.S. credit rating, the global stock markets encounter a black Monday. The effect was firstly landed on the Asian market on 8, August (the first trading day after weekend). Japan, Australia, Hong Kong, Singapore and China stock markets both experience a huge drop, especially China. On 9 August, the Hong Kong Hang Seng Index had dropped about 8% in only 2 hours, down to 19,000 points. On the same day, Korean stock market dropped by 10%, Japan 3.7%, Australia 5% and Russia 4%. The china stock market had even suffered most. The Shanghai Composite Index had dropped to 2526.82 points, with a loss of 1.03 trillion in total market value of Shanghai and Shenzhen Stock Exchanges. The Dow Jones Industrial Average had also decreased 600 points. If the only difference in the stock markets is the U.S. rating downgrade, then the stock markets should not be at that worse. The main problem is not the downgrade of U.S. rating itself, but is a series of events caused by the chain effect of the U.S. rating downgrade as a sight of economic down turning.

2.2 Chain effect of the US rating downgraded

2.2.1 Increasing cost of debt rising

The U.S. bonds market has long been seen as a risk free investment. After the downgrade of U.S credit rating, it forces investors to revaluate about its risk. S&P forecasts that from 2013, the interest rate of U.S. 10-year treasury bonds will increase about 0.5% to 0.75%, meaning that now normal consumers will have to pay a higher interests when they are using their credit cards or paying back their mortgages, just like adding taxes to every single U.S. citizen. J.P. Morgan also estimates that every year the Federal State has to pay an addition 1000 billion USD as interests after downgrading from AAA to AA+. If the interest rate offered by the U.S. bonds increases, then those government-sponsored enterprises, Municipal Bonds and Insurance companies will also face a higher cost of rising capital, which will negatively affect their profitability, liquidity and loaning ability, results in a larger budget deficit and risk of economic down turn. According to The Independence, a British Newspaper, almost every single bank, pension fund on the earth has bought U.S. treasury bonds. Even a little downgrade of U.S. credit rating, it will affect everyone on the earth. This means that the U.S. purchasing power of Korean television, German Car, Chinese toy and other products will decrease. As U.S., a final consumer, stop to consume, it will lead to a slow economic growth in all other countries.

2.2.2 Increase in pressure of managing foreign reserve

According to the U.S treasury, till this year May, the total amount of U.S. bonds had already reached 45,140 billion USD, of which China, Japan, England, Brazil and Taiwan account for 30,133 billion, around 70% of the world. Here is a sentence quoted from John Keynes : " If I owe you a pound, it is my problem; If I owe you a million, then it is your problem." As the world largest foreign exchange reserve country, only China itself owns about 3.2 trillion USD as foreign exchange. Among those assets, 70% come from U.S.. The downgrade of U.S. credit rating must bring