So I have been watching CNBC the past few days (and have been surprised to find much of the commentary reasonably informative!). Over the past week, investors have seen the U.S. Government's credit rating cut from AAA to AA+ by S&P. Following the downgrade these investors have seen wild swings in global equities markets, with the result that large numbers of investors have been piling in to U.S. Treasuries pushing interest rates down even further! So far the "market" seems to think the credit of the U.S. Government is still pretty solid. Listening to the coverage of
media speculation that France was going to have its sovereign rating slashed from AAA to some other combination of letters and +/- signs, the following scary thought occurred to me...
Suppose that investors start start thinking the following:
- The U.S. Government bond is still the safest, most risk-free asset around.
- S&P is correct in their assessment that the U.S. Government no longer deserves a AAA credit rating.
If you believe 1) and 2), then do you conclude that no other government bonds, say for France, Germany, Netherlands, Luxembourg, Austria, Finland etc can be AAA either? If investors start to believe this in mass, then interest rates for one or more of the above countries may rise, which will increase debt burdens, which could cause one or more of the above countries to receive a downgrade, and the cycle would continue...
This would be a very bad self-fulfilling prophecy for the Euro zone.
Why should anyone believe 2?
ReplyDeleteIf a "market" (ie a price discovery mechanism) has to rely on rating agencies to discover prices for it then it is clearly in massive institutional failure and isn't up to the job. Having said that, you make a good point. I imagine now the France has been attacked, Germany will be next and after that presumably the EFSF will get its act together (and hopefully Europol too).