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Markets: China Wastes No Time In U.S. Credit Rating Downgrade

August 4th, 2011

Kerri Shannon:  While Standard & Poor’s mulls over a U.S. credit rating downgrade, China’s Dagong Global Credit Rating Co. wasted no time cutting its U.S. debt outlook, signaling Asia’s lack of faith in the declining U.S. dollar.

Dagong yesterday (Wednesday) cut its U.S. credit rating to A from A+ with a “negative” outlook. The agency said the U.S. debt deal failed to correct the country’s budget issues, and the $2.4 trillion debt-ceiling increase will further erode the country’s ability to reduce debt in coming years.

Two U.S. credit rating agencies, Moody’s Investors Service (NYSE:MCO) and Fitch Ratings Inc., affirmed the country’s top-tier AAA credit rating Tuesday – although both did issue a “negative” outlook, meaning the country could face a downgrade in a year or two.


But China acted much more swiftly. The U.S. credit rating downgrade puts the country several notches below the agency’s top rating, on the same creditworthiness level as Spain, Estonia and South Africa.

The move underscores how foreign lenders to the United States have become increasingly reluctant to maintain their current levels of exposure to U.S. bonds.

Foreign leaders like People’s Bank of China Governor Zhou Xiaochuan and Russian Prime Minister Vladimir Putin have harshly criticized the United States for failing to control its finances.

Putin said Monday that the United States was “leeching on the world economy,” and questioned the dollar’s status as the world’s reserve currency.

“They are living like parasites off the global economy and their monopoly of the U.S. dollar,” said Putin. “If over there (in America) there is a systemic malfunction, this will affect everyone. Countries like Russia and China hold a significant part of their reserves in American securities … There should be other reserve currencies.”

Overseas nations also attacked the debt-ceiling debacle in Congress.

China’s state-run Xinhua News Agency called U.S. congressional leaders’ inability to efficiently reach a compromise a “madcap farce of brinksmanship.” The news outlet had previously said “the ugliest part of the saga is that the well-being of many other countries is also in the impact zone when the donkey and the elephant fight,” referring to commonly used symbols for Democrats and Republicans.

China has already expressed its frustration with U.S. policies by reducing its exposure to dollar-denominated assets – something the country says it will continue to do.

China is the United States’ largest creditor, with about two-thirds of its $3.2 trillion in reserves invested in dollar-denominated assets. China’s State Administration of Foreign Exchange said last Thursday it plans to continue reducing those investments.

“They are moving away from the dollar whether we like it or not,” Stephen Roach, Morgan Stanley Asia’s (NYSE:MS) nonexecutive chairman, told The New York Times.

Roach said China is “moving now to embrace a new model which will stimulate internal private consumption.”

PBOC Governor Zhou said China hoped U.S. officials would take more responsibility in handling the country’s debt issues, because the resulting market uncertainty could hinder the global economy.

Zhou said the country would continue to diversify its reserve assets to “safeguard economic and financial stability,” implying the U.S. dollar (NYSE:UUP) is not a secure investment.

China plans to closely monitor the U.S. government’s progress on debt reduction, Zhou said.

China held $1.16 trillion in Treasuries as of May, according to the U.S. Treasury Department. While the country has said it’ll put less money into U.S. dollar assets, there isn’t a large array of other options.

“It’s probably frustration more than anything else for China,” Brian Jackson, a senior strategist at Royal Bank of Canada (NYSE:RY) in Hong Kong, told The Times. While the nation has concerns, “they realize there’s not a lot of options for them out there and so they need to keep buying Treasuries.”

U.S. Credit Rating Downgrade Not Ruled Out At Home

While China looks for safer investments than U.S. debt, the U.S. debt-ceiling saga isn’t over on the home front.

Moody’s and Fitch Ratings said Tuesday they are maintaining a “negative” outlook on U.S. federal debt – making it clear this week’s congressional debt deal failed to bring the deep-government-spending cuts the market was looking for. A “negative” outlook means the rating could be downgraded in the next year or two.

Standard & Poor’s – which has taken the hardest line, stating there’s a 50% chance it would slash the U.S. credit rating – has yet to deliver its decision. S&P said it would downgrade the credit rating by one level if Congress didn’t slash spending by at least $4 trillion over 10 years.

The House and Senate only approved $1.2 trillion in actual spending cuts, although a “super committee” must make an additional $1.5 trillion in spending reductions between 2012 and 2021, according to the Congressional Budget Office (CBO).

Indeed, with the United States shouldering $14.4 trillion in debt, some experts believe it’s only a matter of time before all three of the ratings firms downgrade America’s credit rating.

“The deal does not put the U.S. fiscal position on a sustainable path and will not prevent the U.S. from losing its AAA credit rating,” Paul Dales, senior U.S. economist at Capital Economics, told MarketWatch. “The only question is whether S&P and the other rating agencies pull the trigger this week or wait a little longer.”

Moody’s said the immediate $900 billion debt-limit raise and the plan to raise it another $1.2 trillion to $1.5 trillion by year-end eliminated the debt-default risk. It said the deal was the first step in stabilizing the United States’ fiscal issues, but lawmakers needed to continue reducing the country’s debt load, deliver on promises for more spending cuts, and effectively reduce the debt/gross-domestic-product (GDP) ratio to avoid a downgrade.

S&P last week suggested it would require a deficit-reduction agreement of around $4 trillion, along with convincing signs that it could be enforced, to affirm its AAA rating on the United States. The rating agency in April downgraded its outlook for U.S. debt to “negative,” from “stable.”

Related ETFs: SPDR Gold ETF (NYSE:GLD), iShares Silver Trust (NYSE:SLV), PowerShares DB US Dollar Index Bullish(NYSE:UUP), iShares Barclays 20+ Year Treasury ETF (NYSE:TLT), ProShares UltraShort 20+ Year Treasury ETF (NYSE:TBT).

Written By Kerri Shannon From Money Morning

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