The US downgrade

It is for the first time in the history of financial markets that a global rating agency has dropped the US credit rating down a notch, from AAA to AA+, amid some grave concerns that such a development would have far-reaching consequences for the economies of the world. While announcing the decision, Standard and Poor's (S&P), the world's leading credit rating agency, was emphatic that the downgrade was due mainly to America's budget deficits and climbing debt burden.
Political brinkmanship was another major factor to compound an already worsening position. According to the S&P, "our lowering of the rating was prompted by our view on the rising public debt burden and our perception of greater policymaking uncertainty." To clarify its assertion further on the second point, the rating agency added that the elected US officials continue to remain 'wary of tackling the structural issues required to effectively address the rising US public debt burden in a manner consistent with a triple A rating and with 'AAA' rating sovereign peers."
It was also noted that the bipartisan agreement reached on 2nd August fell short of what was necessary to tame America's debt over time and the leaders would not be able to achieve the required savings to pull the country out of the quagmire. Warning was also given by S&P that "we could lower the long-term rating to 'AA' within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period, result in a higher general government debt trajectory than we currently assume in our base case."
It was surprising that despite the downgrade, the blame-game in Washington continued without a pause to gain an upper hand and that too with the same arguments. House Speaker John Boehner, a Republican, attributed the downgrade to government spending, saying that "decades of reckless spending cannot be reversed immediately, especially when the Democrats who run Washington remain unwilling to make the tough choices required to put America on solid ground."
Senate Majority Leader, Harry Reid, in a tit-for-tat, blamed the Republicans for obstructing the administration's efforts to correct the American economy. As was expected, he said that "the action by S&P reaffirms the need for a balanced approach to deficit reduction that combines spending cuts with revenue-raising measures like closing taxpayer-funded give-aways to billionaires, oil companies and corporate jet owners."
Predictably, China was most concerned with the downgrade, and immediately after the announcement, called for a new stable global reserve currency, saying that the US had itself to blame for its troubles. It was also quick to remind that "the US government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone." By any standard, these were very tough words to tell the sole superpower that its economy was declining first and needed a major overhaul to regain its lost status.
However, the problem is much more complex and intertwined than ordinarily perceived or highlighted by the interested parties to make a case in their favour in any future arrangement. Until recently, America reigned supreme, with its economy being the engine of growth everywhere else, and its triple A rating was considered a strong constant factor of the global financial system.
The US dollar was the standard mode of settling international transactions and a preferred instrument of global savings with almost an unchallenged status of international reserve currency. While the impact of the rating cut in the financial markets is going to be substantially negative, the shift would also have a long-term impact for the overall US standing in the world, the dollar's status, and the global financial system.
Of particular concern would be the effect of downgrading on the level of world trade and growth of the world economy because the global system would now have to readjust to the many implications/uncertainties of the once-unthinkable loss of America's AAA rating. How soon the world would be able to get out of the present difficulties, would not only depend on the attitude of the two major political parties of the US but also on the behaviour of the major emerging economic powers of the world such as Brazil, India, China and Russia.
Blaming the US political system and its habit to live beyond means for the present crisis may be justified to an extent but the insistence of some countries, especially China, not to revalue their currencies according to market conditions were also responsible to bring the day of reckoning nearer. However, it must be remembered that the propaganda about the crisis may be somewhat overblown and the system could still be saved by acting co-operatively at all levels.
While the US leaders could rise above the party lines to forge a proper consensus on the issue, emerging market economies could also conclude that they are also sailing in the same boat and would suffer immensely if the crisis becomes deeply entrenched. Also, for the time being at least, they need to continue to support the US dollar because there is no possibility of an alternative reserve currency emerging soon. Besides, a drop of only a notch by a currency and that too from the top most ranking is not something catastrophic.
The loss could be recouped if a decision is made earnestly to cover the lost ground. In any case, the US rating, even after the downgrade, may not affect the decision-making of the investors and other players in a significant manner. There is a limit to the lust of acquiring gold, silver and other precious metals even in an extraordinary situation. Normal investors would prefer to revert to other forms of investment/businesses as soon as possible because they know that such crises are part and parcel of a free market economy.
Unfortunately, while Pakistan has nothing to do with the downgrade, it could have certain implications for the economy of the country. Any adverse development in the US like a drop in credit rating and recession would obviously have a negative impact on Pakistan in terms of aid flows, exports, home remittances and even war on terror. This would deepen our own economic crisis and add to difficulties of common man in the country. Therefore, while hoping for the crisis to be over soon, our economic managers need to monitor the situation very closely and readjust their policy priorities in order to minimise the potential risks to country's economy the US downgrade can possibly cause.