FYI | Jul 13 2010
By Greg Peel
Before the European crisis ever erupted, there had been talk that at least the UK, and possibly even the US, would ultimately have their sovereign debt ratings downgraded from the top level of AAA. Europe momentarily drew attention away from the US in particular, especially given the whole world rushed into the “safe haven” of US Treasuries at the time. They did not rush into Aussie bonds.
But the UK and US have both been forced by the GFC to print vast sums of new banknotes, which is basically an analogy for quantitative easing, fiscal stimulus and the partial nationalisation of financial institutions by two countries already very heavily in debt. It is for that reason the triumvirate of “global” credit rating agencies – Standard & Poor's, Moody's, and Fitch – have previously warned that even America's AAA rating is not sacrosanct.
By contrast, S&P rates China A+, being the fifth highest score. This is despite the fact China runs a massive trade surplus and boasts a very high savings rate, while the US runs a massive trade deficit, budget deficit, and is generally carrying vast amounts of debt at every level from government to corporate to consumer.
Who would you rather lend money to? That's basically all a credit rating measures.
China is still pretty new to this capitalism game, but part of its process of maturity has included the formation of the Dagong Global Credit Rating Co in 1994 to rate local corporate debt. The company claims to be privately owned, and has now increased its coverage to include sovereign debt ratings for the first time. And lets just say they look a little different to S&P's equivalent ratings.
If you take S&P's current ratings as a benchmark, Dagong has “downgraded” the US to AA, which is the third highest notch. China has been upgraded to AA+ which matches Germany and Canada at the second highest notch. This implies it's safer to lend money to Beijing than it is to Washington.
Britain and France have scored AA-, while those countries remaining on AAA are Switzerland, Denmark, Norway, Singapore, Australia and New Zealand. So if you lend money to Julia Gillard, you have a better chance of getting it back than if you lend money to Barrack Obama, according to Dagong.
In April this year, Chinese president Hu Jintao suggested the world needed “an objective, fair and reasonable standard” for rating sovereign debt. Dagong has since stepped up to the plate, suggesting its own ratings are “not affected by ideology” (or in other words, a consideration of God-given Western hegemony).
And well – who could argue? China's got all the money; America's got all the debt. Seems pretty straight forward. According to Dagong, the controller of the world's reserve currency is only the thirteenth best credit risk on the planet.
And that's where Dagong's argument begins to break down.
When it comes to sovereign risk, Western credit ratings agencies are not just looking at balance sheets alone. China argues that had credit ratings agencies not been so biased, they would have correctly foreseen the crisis which became the GFC. It's a fair point, but probably for the wrong reason.
Michael Lewis, author of Liar's Poker, points out in his latest book The Big Short that people who work for ratings agencies are just those who weren't smart enough to be employed by a Wall Street firm. So it's hardly a surprise that Wall Street had little trouble pulling the wool over the ratings agencies' eyes with the likes of AAA subprime CDOs.
In the meantime, the US economy is still by far the largest on earth, is equivalent to all of the EU put together, and more than three times larger than China's in GDP terms (and about 15 times larger Australia's). The US accounts for two-thirds of the entire planet's annual defence budget, so it has all the guns. The US holds the highest level of gold reserves – nearly three times more than second placed Germany – and also controls the IMF, which has about as much gold as Germany. China's gold reserves barley rate a mention. The US is also arguably the most innovative nation on earth, if not by a per capita measure at least by sheer volume, particularly in the “new world” of technology. China has to steal this intellectual property to compete.
And finally, the US controls the world's largest and most mature financial market, even if it does stuff it up occasionally. China's financial markets are fledgling at best. China only issued its first sovereign bonds, tradable outside China, in 2009. As this recent round of economic fear has shown, the world rushes to US bonds as the safe haven. China is the world's biggest holder of US bonds.
The simple fact is that the US dollar is not the world's reserve currency for no reason. To that end, one wonders what the point of a reserve currency would be if it were not AAA-backed. It's all relative, and China pegs its currency to the dollar. If China's credit rating is so much better, why not float?
In other words, Dagong's ratings are an interesting and typical exercise in Chinese spin. We get the point, but we'll move on now, thanks.
