Good article, a bit verbose in parts, especially for the uninitiated in economics. What jumped out at me was the statement about reserves. It is mind boggling the folly of sucessive Barbadian governments with respect to wealth preservation via forex diversification and gold….but especially gold. If one thinks that what happened in the U.S.A in the past few days will kick the can down the road more that a few months, well you need your head checked. The second wave of this debt crisis is coming and it will be a tsunami, this time will be epic!

N.B Fundamentally it boils down to this:
http://fofoa.blogspot.com/2010/07/debtors-and-savers.html

Stock markets had a meltdown today. Another recession could soon be upon us.

Here is an interesting view which Clyde Mascoll should read. He seems to think we are operating in a fish bowl.

Posted at 01:58 PM ET, 08/04/2011
The reason the markets are diving
By Ezra Klein
(Scott Olson – GETTY IMAGES) Washington likes to talk about the economy in terms of things it can control. Spending and deficits. Stimulus. Policy uncertainty.
But the Dow Jones isn’t diving because spending has risen, deficits have grown or stimulus policy has changed. It’s diving because of forces Washington can’t control, and in many cases, doesn’t understand very well. How many members of Congress do you think could give a coherent account of what has happened to oil or steel prices over the last three years? Or what’s happening in the Eurozone? Or to the yuan?
A dramatic gap has opened between the economy as Washington sees it — and wants to intervene in it — and the economy that actually exists. Whatever weak recovery we might have hoped for is being hindered by global commodity prices, consumer deleveraging, fears of flagging demand in emerging markets, earthquakes in Asia, and much more. Globally, it’s been an almost uninterrupted run of crises and bad luck. Meanwhile, Washington just spent two months arguing over whether it would pay its bills or spark an unnecessary financial crisis.
http://www.washingtonpost.com/blogs/ezra-klein/post/the-reason-the-markets-are-diving/2011/07/11/gIQA1ScWuI_blog.html?tid=sm_twitter_washingtonpost

More anecdotal evidence of the problem.

“British banking group HSBC said Monday it will cut 25,000 more jobs worldwide by 2013 and sell almost half its retail bank branches in the U.S.”

There is a whole lot to discuss but the BU family are all at the Rihanna concert. lol

Stock markets crashing. Emera stock price dropping. (Hants might make a little buy if it hit $25cad.

Canadian government warning about the possibility of another recession.

Interesting times ahead. Bajans gine soon fuget cropover.

The US long term credit rating just got downgraded from AAA to AA+ by Standard & Poors. Moodys and Fitch currently have a AAA ratings for the USA.

Some points to ponder and hopefully discuss

1. The recent debt ceiling debate does raise questions about the willingness of the USA to pay its debts. The raising of the debt ceiling was to allow the USA to raise the money to pay debts for expenditure already undertaken. The fact that raising the debt ceiling, which was routinely done around 60 times previously, became and may well remain a political issue must have been a major factor contributing to the downgrade. However, in my opinion, the downgrade would have been far more credible if S&P had waited to see the outcome of the long term deficit reduction process set up by the US government, as aprt of the congressional deal to raise the debt ceiling. S&P could and probably should have waited to see what the so- called “super committee” of congress came up with before concluding that the political process in the USA was incapable of producing a credible deficit reduction plan.

2. The USA does have a large national debt, and long term fiscal issues in terms of financing the major entitlement programs such as Medicaid and Social Security. There has also been a slew of bad economic data in recent times. However, the entitlement issues are not new, and long term credit ratings should not be that impacted by recent economic news. It would seem difficult to justify a downgrade on these grounds.

3. The downgrade does seem to expose the high degree of subjectivity in sovereign credit ratings and there are now a number of glaring inconsistencies. The USA has a reserve currency and can print money to pay its debts (what economists call monetizing the debt), yet France with its generous entitlement programs, aging population and an inability to print money (due to its membership of the Euro) maintains a AAA credit rating. How do you justify that? The US Central bank has been downgarded to AA+ as well, yet the European Central Bank with its large holdings of Greek, Portugese, Italian and Spanish government debt, retains a AAA credit rating. How do you justify that? If the USA is AA+ what rating should Japan with its aging population, limited growth prospects and its 200% debt to GDP ratio command?

4. This decision may well in view hasten a dramatic reduction in the role and influence of the rating agencies. Financial economists have long questioned the value added by the rating agencies. My public lecture on this topic was posted on BU at an earlier date and outlines most of the points in that regard. To put it simply, many argue that in good times, rating agencies upgrade, and in bad times they downgrade. Do you really need them to state the obvious? Much of the power of the rating agencies comes from the fact that the credit ratings have been written into law and contracts in many countries. I think this decision by S&P will hasten the loss of influence among the major rating agencies for two reasons:

a. By law or contractual agreement many institutions are only allowed to hold financial instruments carrying a certain credit rating by one of the major agencies. Also, financial instruments posted as collateral for a loan may be required to have a AAA rating for example. Due to this fact attaining or losing a certain credit rating by one of the major agencies is a major issue for many investors and financial institutions. If these are enforced, then come Monday a number of contracts would have been violated and investors may be forced to sell assets, find new collateral and so on. My guess is rather than face this massive inconvenience, or rather chaos, a number of clauses will either not be enforced or simply changed to allow US government securities to continue to play the role of a risk free asset in the financial system. If this happens it may well constitute a major reduction in the influence of the credit ratings.

b. US government securities have traditionally been viewed as the safest investment in the world. By removing the AAA rating, S&P are in effect saying they are not. If this opinion carries weight then we should see major investors like the Chinese and other Asian governments move money out of US treasuries into the now “safer” investments of Canada, France, UK, Germany, Australia and every other country with a AAA rating. My own sense is that many investors will still continue to pour their money into US government debt, in effect ignoring S&P. The Chinese for example will now have a choice of continuing to buy US debt, buy more European debt or allow the Chinese currency to appreciate and undermine its export lead economic growth. I suspect they will choose to continue to buy US debt, in effect ignoring S&P and the downgrade.

While the immediate loser is likely to be President Obama, I think in the medium to lomg term the real loser will be the rating agencies themselves. This decision exposes the subjective nature of the ratings and will force investors to use their own judgement rather than slavish follow ratings. This would be agood development.

What are your thoughts?

A couple of responses:
1. What did investors find out about the USA on friday night that they did not already know? Investors who had concerns about US credit quality already had more than enough info to make their own decisions, most have chosen not to act before now. Eagan Jones has already downgraded the USA and most investors have not reacted. The central point I have been trying to make for a while is that the power of S&P does not seem to derive from any real value added in terms of informational content, but the contractual and legal powers their ratings have been granted. I think this is about to change.

2. If all of these downgrades of other countries takes place, then the ranking order of creditworthiness across countries may well remain unchanged, somewhat rendering the downgrade meaningless.

3. While yu and others may be aware of the subjectivity of the ratings process, I think the generalm public will become mroe aware of this and the ratings may well come to be viewed as what they are, the opinion of a group of humans based on a rather human process. I don’t think I am being unfair if I suggest that the ratings currently enjoy a sort of sacrosant status they might well not justify. I think this is about to change.

@Moneybrain
I agree everyone needs some amount of cash in a shoe box for this crises, but the global central banks will never allow the deflation to run its course. How violent the printing will be, is impossible to predict. But don’t expect more than one quarter 10-14 weeks of deflation.This will be the ultimate test to see who can hyperinflate themselves out of this debt crisis, Fed or ECB?but no matter it ends the same way. There is no political will to do otherwise.

As for Japan, as monstrous as debt to gdp is, a large part of it is own domestically, also much like South Korea during the 97-98 crisis, Japan has the cultural capacity to act in a nationalistic way. The gross mismanagement of there nuclear asset is the true seppuku.

Europe is where the counterparty risks and contagion is greatest, and it is really only a matter of time before one of the large banks fails, with the attendant risk of sovereign default…..this is going to get ugly fast. Yet no matter the s&p downgrade people will still run into U.S treasuries in the shirt term, expect negative interest rates. These predictions are what earn the behaviour economist their due. The herd is just to use to running for T-bills.

Cash is for spending
Gold is to shuttle wealth over to the otherside of the system reboot but it must be PHYSICAl.

Silver may have a play for spending and saving but ultimately will fail for both purposes. Due in part to supply elasticity….and not being able to compete with cash for spending or gold for saving.

Imagine where we have come when Red China is criticizing the USA for spending too much and its affinity for attracting debt:

“The U.S. 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,” China’s official Xinhua news agency said in a commentary.

After a week which saw $2.5 trillion wiped off global markets, the move deepened investors’ concerns of an impending recession in the United States and over the euro zone crisis.

Finance ministers and central bankers of the Group of Seven major industrialized nations will confer by telephone later on Saturday or on Sunday, a senior European diplomatic source said.

The source said the credit rating downgrade had added a global dimension on top of the euro zone debt issue, raising the need for international coordination.

http://www.reuters.com/article/2011/08/06/us-eurozone-idUSTRE7712HB20110806

@AOD
We are on the same page. Silver coins (actual high silver content) may prove very useful in a real nasty all out collapse.

@David and AOD

Central Bankers, Economists and financial types have long viewed Gold as a” BARBAROUS RELIC”. WHY??? Simple, it is very difficult to create out of thin air like bank notes! What they dont tell anybody is that there has NEVER been a currency system created by their ilk that has survived for much longer than 100 yrs. The current US system began in 1913 and the purchasing power has declined 99% since then! There were several currency failures in the US prior to this.

@Justin Robinson,

I agree with you that:
– the impact of the rating agencies is to pour fuel on already raging fires (sometimes, but their actions might also maintain calm)
– the $2 trillion error should not have happened and reduces their credibility

I also agree with you that investors should not place total faith in the ratings, but I believe that the analytical work done by the ratings agencies is essential. Unfortunately too much emphasis is placed on the actual rating, which as you have pointed out is highly subjective. I don’t know if we can blame the ratings agencies for this. People look for the simplest indicator so it is much easier to act based on the rating than to read and try to understand the analysis.

My concern, especially for corporates, is if we do not have the ratings agencies who would do the analytical work?

@Professor Robinson

Why do you think that the Rating agencies should wait for the report from the “Super Committee” before lowering the US’s credit rating ?

The agencies are correct in that in the present political climate the US Gov’t will not be able to agree on a deficit reduction plan unless one Party controls both Houses and the Presidency. The establishment of the Committee was just a face saving measure agreed to at the last minute as a way of reaching agreement to raise the debt ceiling. Both Parties blinked as they didn’t want to venture into the unknown of a US default..

Any report that this Committee issues will be still born as right off the bat the Republicans stated that they will not appoint any politician who will propose any tax increase. If you remove a major plank without even looking at the issue how will they achieve consensus? How do you get agreement on an important subject with six Republicans and six Democrats?

This issue will come up again in 2013, if the Republicans control the house and there is a Republican President then he will accede to all their demands, if the Democrats control the House and Obama is President then you have a different scenario. If Obama is still President and the Republicans control the House Obama will adopt a “Burn the Boats” strategy i.e. no retreat because he would be in his last term and doesn’t have to worry about reelection.

@David

I was going to pose that question; these agencies are a “for profit” organization who pays for analysis? How do we know if they have conflicting interests?

While on the subject of World Finance why is there a gentleman’s agreement that the head of the IMF should be European and the Head of the World Bank should be North American (Read USA).

As soon as DSK resigned France was busy lobbying for its Finance Minister to be the next Head of the IMF, The present Head of the World Bank (Robert Zoellick) was the former Managing Director of Goldman Sachs. (He replaced Paul Wolfolwitz who was felled by his own sex scandals and who was an architect of the Iraq War). Both of these men were appointed by GW Bush.

Perhaps the conspiracy theorists are right.

I think this downgrade is very bad news for the global economy. There is a real possibility that it will deal such a hit to consumer and corporate confidence that private spending and investments are significantly reduced. If that happens and governments also tighten spending and/or raise taxes due to fears of further credit downgrades or in an attempt to regain lost ratings, then the world economy could really enter a double dip recession.

Of course a deeper recession would worsen the debt problems of the USA and other countries, and this is one of the real dangers of hasty ratings adjustments. They can be self-fulfilling prohecies.

The province and Ottawa are backstopping the new production, each chipping in half of a $140 million investment in Toyota’s Project Green Light, announced in early July. Toyota is putting up another $400 million to the project.

Canada continues the “Stimulus” to create jobs. The GOB could do the same if they have the money.

The past US folly was a bimetallic currency and a fixed ratio of cash to gold, or a gold standard. Gold standards will always fail because of pressure to expanded the money supply. A supply expansion that is impossible for gold to achieve. To be compatible with a debt based , fractional reserve system, where new debt creates money in the system, but no adds no value, gold would have to be free to float.