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S&P’s Downgrading of US Debt and Analytical Inconsistency

August 8, 2011

The US has not been a top-notch credit since the mid -1990s when the country went on a debt financed binge.  Households did not save because they were assured of Social Security benefits and because they expected the stock market to go up forever.  In this debt financed binge, US government and local government finances seemed to be in better health than they actually were.  Tax receipts (whether corporate, income, property or capital gains) went up. Payouts for unemployment benefits was low.  And the baby boomers were still consuming like there was no tomorrow.

Nonetheless, the downgrade of the US last Friday has serious analytical flaws.  Firstly, it should have been accompanied by downgrading of China, a country whose fortunes are tied to US & European consumption and which has financed this consumption through currency manipulation (which resulted in the country storing a chunk of its “assets” in USD denominated notes).  Secondly, downgrading of US before downgrading countries with far weaker prospects UK and France is analytically untenable.

S&P just provided long-term investors such as pension funds and sovereign wealth funds the reason, should they require one, that they should not rely on rating agencies but put their faith in investment researchers who “tell it as it is”, dispassionately, without fear or favour and who need to please no one but those who pay them for their research and insights.   

 

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From → Credit Analysis

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