S&P: downgrade of US debt outlook

A rating agency S&P kept America’s credit rating at AAA. However for the first time in its 70 years rating history of the US debt, the agency cut its outlook from “stable” to “negative”. A negative outlook means there is a one-third chance of a downgrade below AAA in the next two years. It is yet another sign that the financial crisis is progressing as expected. This can hardly be called a blow for US debt. It is simply a well predicted result. One can also reasonably expect a US grand finale in some form predicted in an article "A US way out?" two years ago.

The lower the US, and indeed any other country's, debt rating the higher the interest rate that has to be paid on it. Hence the beneficiaries are the banks that, incidentally, caused such massive sovereign debt mounting in the first instance by engineering the pyramid scheme that collapsed causing the credit crunch in September 2008. As predicted two and half years ago "The largest heist in history" continues and there seems to be no end to it in sight.

China is buying up the world

(making the US a debtor of the whole world)

The US is hooked on China produced consumer products. The US buys massive volumes of goods from China and pays for them with the US treasury papers (the US debt). Can the US stop it? No. That would require moving production from China to the US which would take years (possibly decades) as it took decades to large scale of production of consumers goods to China. Never mind the fact that it could cause the US economy to collapse or at least massive hardships and internal implosion of home budgets as the US produced goods would be far more expensive that China's for the US consumers.

China is getting this massive volume of the US debt papers. These papers on the markets are AAA-rated and markets have to consider them as good as cash in international transactions. Otherwise the US dollar would have collapsed. So the 2/3 of world reserves that are held in the US dollars. No country can afford this to happen as this would have been a financial Armageddon. So China is buying access to the world natural resources, funding development of key infrastructure in many countries, investing in companies paying for it all with the US debt papers. The same logic will apply if China decides to use its massive stockpile of the US treasury papers to buy the European debt or help to finance the ailing European banks. Effectively China is using its cheap labour force to get as much as possible US debt papers which it uses to "buy" the world.

However this way China makes the US a massive debtor to the entire world (wherever China invests). It is impossible to rollover debt to infinity. So at some point, difficult to tell when, the US debt spread all over the world will become too big to roll it over once more. (Technically the growth of the US debt from trade imbalance with China is a pyramid.) In the same way as liquidity crisis happened in 2008 making banks debtors to the taxpayers, the collapse of the US debt and dollar will make the US insolvent to the rest of the world. All the countries and companies that China effectively paid with the US debt whilst "buying" up the world). Also all business entities that sit on the US debt, a huge part of the financial system, will also end up with a mountain of worthless US papers. No one will be able to come to the US rescue. However China will be left "owning" the world. (There is an element of exaggeration in using the words "buying" and "owning". This is to make this risk scenario clear.)

Furthermore China also buys debt of other countries using the US debt papers thereby making the US even a bigger debtor to the rest of the world.

Even if it does not end in such an extreme way (and there is no reason why it should not), China is slowly but heavily undermining the US world position using the trade imbalance between the two countries: by taking over key assets all over the world and buying influence with funding infrastructure project and by making the US a debtor to many countries and significant business interests.

In the same way as countries used to use and sacrifice health and life of soldiers to build their greatness (as we know it from history), China treats its cheap labour force in the same way: it is their real frontline that lets China acquire massive volumes of the US debt, at the same time keeps the US locked in such arrangement.

It does not look too good at all. The US is likely to react at some point (at the end it is a military hyperpower). It is anybody's guess how it will look like.

NB. for those who like historical perspective: Germany started World War 2 in 1939 because Hitler came to conclusion that it was cheaper to kill the creditors than to pay them off. One may start wondering whether the US may, at some point, start thinking in the same way.

Bankers having a free lunch

Robert Peston published an interesting piece on his blog "Can banks dodge the break-up?". He wrote: "the Bank of England estimated this [state] implicit subsidy [of being protected by taxpayers against failure] as being worth around £100bn per annum at the peak of anxiety about the fragility of banks in 2008-9, and perhaps half that figure subsequently."

The state, taxpayers, are part of economy. Their subsidies, of whatever nature, come at the costs: they are paid for one way or another. If subsidies cost hundred of billions of pounds, these hundreds of billions of pounds must come from somewhere. For example taxpayers pay them by additional costs of government bonds or through some other transactions with the financial markets. "There ain't no such thing as a free lunch."

The City of the 2010's is strikingly similar to the British heavy industry of the 1970's. It provides no financial value to the economy and can only survive with taxpayers subsidies. Any tax receipts from the financial industry are dwarfed by the subsidies, bailouts and stimulus packages. Even City luminaries, top financiers and bankers, bear a striking resemblance in their attitude and characters to their trade union counterparts, so called "barons", of the 1970's. Will the City share the same fate as British heavy industries of the 1970's? The signs are not particularly optimistic.