What would happen if the United States lost its AAA credit rating?

by Adam Crum

Two years ago‚ a company that performs financial research and analysis on commercial and government entities and has a 40% share in the world credit rating market warned the United States government that it risked losing its triple A rating if it didn’t get its finances under control. That company was Moody’s and the warning was motivated by the future of healthcare and Social Security costs and long before the present financial upheaval.

Does our government deserve a triple A credit rating?

While the U.S. government has had a triple A credit rating since 1917‚ there are those who feel that if the United States were any other country‚ its coveted top-tier credit rating might have been stripped away by now.

“For too long‚ the U.S. has delayed making the tough but necessary choices needed to reverse its deteriorating financial condition‚” David Walker‚ chief executive of the Peter G. Peterson Foundation and a former comptroller general of the United States‚ recently wrote in the Financial Times. “One could even argue that our government does not deserve a AAA credit rating based on our current financial condition‚ structural fiscal imbalances and political stalemate.”

“The triple-A rating is undeserved‚” suggests Peter Morici‚ a professor of international business at the University of Maryland. “If Washington were a state capitol‚ we would have lost the AAA with the current budget.”

Here are just some of the reasons Mr. Walker and Professor Morici would make such statements:

• Equal to about 80 percent of total output of the United States‚ the Treasury Department recently reported that the total U.S. government debt is $11‚270‚547‚397‚564.64.
• With the U.S. relying on foreign buyers to keep its borrowing costs low‚ China and Japan alone hold more than $1.4 trillion of U.S. Treasury bonds as of March‚ according to U.S. Treasury data. A sovereign downgrade would certainly alarm at least some of those buyers.
• The Fed is now burdened by the same kind of toxic paper that has been plaguing private U.S. banks for several quarters.
• Leveraging its capital 48-to-1‚ Fed banks are holding total capital of just $45.7 billion against the sum total of $2.19 trillion in assets. Two years ago the ratio was only 27-to-1.
• The government's $787 billion economic stimulus package and $700 billion bank bailout fund have strained the country's resources and the jury is still out as to whether any of this will actually make a difference.
• The International Monetary Fund expects the debt-to-GDP ratio to hit 97.5 percent next year. Standard & Poor reaffirmed its AAA sovereign rating for the United States in January; however‚ the ratings agency also cautioned that the hundreds of billions of dollars committed to bailing out the banking sector would lead to a “noticeable deterioration in the U.S. fiscal profile.”
• The Chinese premier and the head of the People's Bank of China have expressed concern over America's long-term credit worthiness and the value of the dollar. China has also called for the creation of a new international reserve currency to replace the U.S. dollar.
• With a loss of 5.7 million jobs since December 2007‚ the number of workers collecting unemployment checks increased to a record of more than 6.6 million in the week ending May 9‚ the highest level of unemployment since 1983.
• The present economic situation in the U.S. is taking a huge chunk out of tax income‚ reported to be down 34%.
• Manufacturing in the U.S. Mid-Atlantic area shrank in May for the eighth straight month.
• States like California have been hit hard by the credit crunch and are struggling to arrange backing for municipal bonds and short-term debt.

Then there is still that two year old warning of Moody’s. The significance of that warning appears to be even greater now. A government report released on May 12 found that the Social Security trust fund would be exhausted by 2037‚ four years earlier than previously estimated‚ and the Medicare hospital trust fund would become insolvent by 2017‚ two years earlier than estimated. All of that in light of the fact that the first big wave of the 72 million strong Baby Boomers (folks born from 1946 to 1964) will soon become eligible to start collecting retirement benefits.

Is losing a triple A rating that big of a deal?

The answer to whether it’s a big deal or not for the United States to lose its triple A rating would be a resounding “Yes‚ it is a big deal!”

• A credit rating reflects the risk of default. A downgrade will raise the cost of borrowing for the United States government‚ could have a spillover effect on corporate debt and investors will buy fewer U.S. Treasuries.
• There could be a massive outflow of foreign investment. Some global funds are mandated to invest only in AAA debt and if the U.S. loses its AAA rating‚ it loses those investors.
• A credit rating downgrade provides a perfect excuse for an alternative reserve currency to replace the dollar. China‚ Russia and other countries are already suggesting creating a “basket of currencies” that would replace the U.S. dollar.
• Interest rates will increase. Should the United States lose its AAA credit rating‚ it will trigger rising interest rates in an already unfrozen credit market.
• The risk of inflation increases. Philadelphia Federal Reserve President Charles Plosser has warned that the U.S. government’s emergency programs for the economy undermined central bank independence and raised the risk of inflation. “When a nation’s treasury or finance ministry and its central bank work too closely together‚ there is a clear risk that the government’s spending will end up being financed by the central bank’s power to create money‚” Plosser cautions. “History shows us that you can get very bad economic outcomes with rapidly rising inflation.”

The ultimate outcome depends upon the reaction of the capital markets and the actions of the Federal government.

• Will investors continue to aggressively bid on U.S. Treasuries at auction?
• Will foreign creditors start balking at supporting the country's irresponsibility?
• Will the AAA credit rating of the United States come under even greater scrutiny?
• Will the dollar start to reflect the fact that the Fed is throwing money around like never before—and taking on any and all kinds of bad assets?
• Will the federal government enact tough spending‚ tax and budget control measures after we turn the corner on this shaky economy or will we discover that the government and our political system is not up to the task of addressing the economic imbalances that confront us?

Don’t look for answers to these questions anytime soon. But that doesn’t mean we shouldn’t discuss the risks now. The reality is that you must start taking protective steps immediately if you haven’t already. I recommend you consider buying gold.

Are you hedged against this very real possibility?

In the 19th century‚ the gold standard was the monetary system that dominated the developed world. Then with the final breakdown of the Bretton Woods system in 1971 and exchange rates “floating‚” investors searched for investments that provided a “safe haven.” It is ironic and not surprising that among the ways investors found security was by returning to gold in its many forms‚ such as rare gold coins.

• Rare coins have always provided an ideal hedge against inflation‚ thrived in times of insecurity and rising interest rates and provided a long-term storage of wealth that has consistently outperformed other assets in times of turmoil against the dollar.
• Numismatic quality rare gold coins have proven time and time again to be an excellent hedge because they have become a standardized asset easily traded in a market that is always open.
• Rare gold coins have become a solid asset because governmental authorities cannot produce and thus debase them. Because of this characteristic they have acquired long-term wealth preserving properties over the centuries.
• Gold coins have intrinsic‚ aesthetic and historic value as well. They are‚ quite honestly‚ works of art and pieces of history‚ making them highly collectible and desirable.

I encourage you to call one of Monaco Rare Coin’s account executives toll-free today at 1-888-900-9948 to initiate or enhance the rare coin portion of your portfolio. Monaco’s investment professionals can:

• Assist you in planning your rare coin investment strategy or reviewing one that is already established;
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