Recognizing America’s Less-Than-Perfect Credit

The U.S. Treasury is not yet a subprime borrower, but it is no longer a top-tier credit risk, either. It took a Chinese company to finally come out and say so.

Dagong International Credit Rating Co. made headlines this month when it gave the United States a lower credit rating than it assigned to up-and-coming China. That, however, is beside the point. Dagong, which says it wants to break the monopoly that Western companies have had on rating sovereign debt, evaluated the borrowings of 50 nations and gave a dozen countries better credit scores than it assigned to America – thereby becoming the first large agency to assign Washington a rating lower than AAA.

In Dagong’s opinion, the United States deserves only a AA rating, with a “negative” outlook that hints at future downgrades if we fail to get our fiscal act together. Moody’s, Fitch and Standard & Poor’s all maintain their traditional AAA rating on Treasury obligations, though they, too, are starting to grumble about our government’s financial irresponsibility.

Credit ratings are statements of opinion, not Delphic predictions. A triple-A rating should mean that the rating agency sees virtually no credit risk under any conceivable set of circumstances short of a meteor strike or a nuclear war. Ratings below AAA are the rater’s attempt to quantify the degree of risk presented by a less-than-perfect borrower.

There is no such thing as a “correct” opinion of credit risk. We can only assess whose opinion is more credible and more consistent with the known facts.

So, let’s consider this for ourselves. Given the U.S. government’s $13 trillion accumulated debt, its continuing $1 trillion annual deficits, its failure to deal with a rapidly approaching explosion of entitlement spending, and its near-total state of political gridlock, which view is more credible: The United States is an exemplary borrower, or it isn’t?

Dagong says it isn’t, which, in my view, makes more sense than the other agencies’ insistence that this country remains one of the world’s safest bets.

In its recent report, Dagong explains that its ratings emphasize a nation’s ability to repay debt by generating future income, rather than by refinancing old loans with new borrowing. Refinancing can become difficult or impossible if financial markets lose confidence in the borrower, Dagong notes. We need only look to the recent example of Greece to see this for ourselves.

The United States, alone among the world’s economies, has a third way to repay its debts – by printing more dollars. The greenback’s global role as the primary reserve currency makes this possible. This basically means that the United States ought never to default on its debt because it can just create the money to pay what it owes. The Western credit rating agencies could always point to this to justify their continuing AAA ratings, though it would be an embarrassing admission.

Printing money willy-nilly is a recipe for disastrous inflation and devaluation. Creditors would be repaid, but they would be repaid in dollars whose value has been so diminished that the creditors, though nominally made whole, would in reality suffer significant losses. Dagong’s credit rating implicitly acknowledges this inflationary risk.

Dagong says China, with its fast-growing economy, large trade surplus and huge foreign reserves, deserves a rating of AA+. Canada gets the same rating. The AAA nations are Switzerland, Singapore, Australia, Denmark, Norway, Luxembourg and New Zealand. Saudi Arabia gets a AA rating like the United States, but with a “stable” outlook.

Another disconcerting aspect of Dagong’s report is the influence it may have on the officials who invest China’s foreign reserves, which total well over $2 trillion. Right now, much of that money is lent back to the United States. A Chinese pullback in such lending would probably force the Treasury to pay significantly higher interest on its debt, which will only aggravate our federal budget deficit and – without spending cuts – force more borrowing, in a nasty and unsustainable cycle.

Dagong’s study is not without its own biases and baggage. As a Chinese company, is less able than Western firms to freely and openly evaluate political risk, especially close to home.

Dagong’s AA+ rating and “stable” outlook for its home country glosses over the rigidity of China’s political system and the strict controls the nation’s leaders place on the free flow of information. This rigidity leaves China vulnerable to unpredictable social upheaval, such as last year’s riots in Xinjiang. Dagong has very little room to assess such risks. One would search the company’s report in vain for even a reference to Tiananmen Square.

That said, Dagong Chairman Guan Jianzhong had a point in a recent statement. “This marks a new beginning for reforming the irrational international rating system,” he predicted.

Dagong has spoken out loud something about us that our own analysts probably see but are unwilling to say. The emperor may have some clothes left, but they are most certainly full of holes.

About Larry M. Elkin 533 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

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