Sic transit gloria mundi
How doth the busy bee
Dum vivimus vivamus
I stay my enemy!
Last night, I had the most peculiar of nightmares.
I woke up this morning in a cold sweat after having a dream involving rallying around my family with a pocket full of shells. I was holed up in a small bar located in what felt like the Deep South, but looked like it was nestled in the midst of the Mojave Desert.
Armed with an old Winchester rifle, I was organizing the defense of a town from a group of religious fanatics who wanted to kill me.
Coincidence or Prescience?
After being roused from my disturbing dream, I could not fall back to sleep, so I checked my email.
What I found was shocking.
For the first time in history, Standard & Poor’s lowered America’s credit rating from AAA to AA+, and warned that a further downgrade to AA was possible.
The agency argued:
“The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.”
The agency further maintained:
“The outlook on the long-term rating is negative. We could lower the long-term rating to ‘AA’ within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case.”
It turns out that a failure to raise additional revenue, cut entitlement spending, and the general instability of America’s political process drove the downgrade.
In other words, the wing nuts of both parties are putting the country’s financial stability at risk.
While some my argue that this downgrade is largely symbolic, I disagree.
There is a reason S&P announced its decision on a Friday afternoon, after market close.
For the first time in history, U.S. Treasuries are no longer deemed risk free investments.
A lower credit rating implies higher credit yields, because investors will demand a higher return on a riskier asset. As Treasury yields rise, so too will other interest rates ranging from borrowing costs for corporate debt to mortgage rates. Higher interest rates increase borrowing costs, and thereby reduce business investment, and make financing a house less affordable. To sell a home, prices will have to come down further to accommodate higher mortgage rates.
The bottom line is that a downgrade increases the probability that the country will experience a double dip recession.
Furthermore, the U.S. debt rating has been stable for so long, that a change in its status will increase global uncertainty. For instance, in business school, professors teach students to use the 5 or 10-year Treasury rate as the so-called “risk free rate” when valuing companies via the capital asset pricing model (CAPM). Now that U.S. Treasuries are no longer risk free, how does one value an asset without using U.S. Treasuries as the risk free rate? I suppose one should now be using the yield on Canadian, or Australian sovereign debt.
Either way, the glory and prestige of American power is starting to fade.
All Shall Fade
And so passes the glory of America.