March 23rd, 2010
05:19 PM GMT
Ever get the feeling that something is about to happen, but you just don’t know what, or when, or how serious it will be? The last week has given me that feeling of unease in the financial world but I am not entirely sure why.
There were lots of little things that we could get excited about. For instance, the Obama health care package getting closer to a vote in the US congress; the Greek Government flirting with going to the IMF; the UK Treasury borrowing less than it forecast… But there was actually very little to get your teeth into and say “now we have direction”.
So, it is not surprising that the markets on both sides of the Atlantic didn’t do much at all. A look at the daily movements tells the tale. The Eurostoxx 50 closed the week just 0.01% lower. While the Dow Jones in New York gained on four of the five days last week, but barely budged more than 1% over the total week.
This was hardly exciting stuff.
However, if you looked beneath the surface there were indeed matters worthy of note. For instance, the warning by the rating agencies, including Moody’s that the AAA rating on US government debt was at risk because of the high government deficit.
At first blush this is huge. Absolutely monumental. The very thought that the US could lose its gold-plated top notch rating is just about unthinkable.
US treasury bonds are the backbone of the financial system. Any change in the debt rating would not only push up the cost of servicing the debt to the federal government, it would hit the dollar, and of course the value of those investments.
According to the US Treasury, China alone, holds $890 billion dollars worth of bonds. No wonder Beijing has been getting antsy about its investments.
Initially there was a lot of scepticism about these warnings. The US dollar is still the world’s principle reserve currency, with more than 62% of all reserves held in dollars, so there will always be buyers for US debt.
Then there are the agencies themselves. These are the very groups who continued to award investment grade ratings to the sub prime and collateralised debt that exploded during the crises. The agencies’ failure to issue warnings of dangers ahead, means their reputation has been sullied to say the very least.
With those caveats in mind, however, we shouldn’t allow our distaste of the messenger to destroy the message.
At 10%, the US is running a deficit which is unsustainable in the long term. Even though the President has forecast that the deficit will be reduced to 4% by 2013, there are so many optimistic assumptions, forecasts and simple unknowns that it is easy to obfuscate the true picture, and therefore the balance is probably on the downside.
This is really what the warnings from the agencies were about: a call that they should not temporize on cutting the deficit. . Begin now before it is too late and avoid trouble later. Alas, the warnings have been lost – the popular belief that the rating would ever be cut. And so the good ship ‘Borrowing’ sails majestically forward.
A boring week ? Not a bit of it. We may look back on last week as the start of something big.