America suffered a blow to its prestige at the weekend when Standard and Poor’s downgraded its credit rating, removing its AAA status. President Obama’s opponents are blaming him for running up a high debt, as if the country’s debt problems only started in 2009. But credit ratings are about more than just a country’s debt. Quite a lot more.
Former Central Banker Tigger Therese noted that, with the downgrading of the USA, only nineteen governments still have AAA credit ratings. They are: Australia, Austria, Canada, Denmark, Finland, France, Germany, Guernsey, Hong Kong, Isle of Man, Liechtenstein, Luxembourg,Netherlands, New Zealand, Norway, Singapore, Sweden. Switzerland & the UK.
What, she wondered, do these countries have in common? Of course, I had to point out that twelve of the nineteen are monarchies, giving further weight to the arguments I made in this post. I also noticed that all were either in northern Europe or were formerly part of the British Empire.
Joking aside, though, the other unifying factor is political stability. That is as important as debt levels when assessing a country’s credit risk.
Take a look at the following table. Here we have current and projected debt levels, S&P’s credit rating, the 5 Year CDS price and current and projected growth levels for a selection of countries.
Sources: Debt and growth: IMF World Economic Forecast 2011. Credit Ratings: Standard and Poor’s. 5 Year CDS: Bloomberg and Seeking Alpha.
You don’t have to look at this for very long to see that something funny is going on. How come countries with low debt levels and high economic growth have lower credit ratings than debt-burdened Britain and Germany? Why does it cost $229 to insure $10,000 of Turkish debt but only $76 to insure the same amount of British debt? Why are the ratings and debt insurance costs for oil-rich Bahrain and Venezuela so high?
Looking at Japan, with a slightly lower credit rating than the UK due to its humongous debt, things look more bonkers still. Why does Japan, with its debt at 220% of GDP and rising, have the same credit rating and insurance costs as Saudi Arabia, with its debt at 10.8% of GDP and falling?
The economic data seem to indicate that debt-ridden Japan and low growth (or no growth) Britain should have the basket-case credit ratings and high debt insurance costs. So why haven’t they?
Credit ratings and CDS prices measure the likelihood of investors getting their money back. Debt and GDP levels are only part of the story. Investors need assurances that governments have the means and the will to turn that GDP into taxes with which to service debts. They need to know that the governments will not be held hostage or overthrown by people who refuse to honour the debts. Crucially, they need to be sure that the state itself will survive. For this reason, politically stable countries, even ones with high debts and stalled economies, are seen as a safer bet than low debt high growth ones with volatile political systems.
The AAA countries all have stable governments with high levels of political legitimacy. People might not like the governments that are in office at a particular time but they rarely question their right to be there. In these countries, acceptance of the processes and institutions of government and the law is almost universal. This legitimacy is underpinned by relatively strong social cohesion.
Now before anyone starts, because someone is bound to, I know that there were riots in London last night, that a Christian fundamentalist shot people in Norway and that an Islamist in the Netherlands murdered an artist for making a film. Much is made of our ‘fractured society’ but, relative to what goes on in the rest of the world, incidents like these are unusual. For the most part, people in the AAA countries obey the law, pay their taxes and accept, albeit grudgingly, the right of the elected government to run the country. And countries like these almost always pay their debts on time. That’s why they have high credit ratings.
Japan is one of the most orderly societies in the world. That is why, even with its huge debt levels, its credit rating is still relatively high and its debt insurance costs low. Japan’s debt level was about where Greece’s is now before it lost its AAA rating. Investors will accept debts of 130 percent of GDP in countries like Japan in a way that they won’t in countries like Greece.
For the countries with low levels of debt, the low credit ratings are a reflection of political as much as economic risk. Many have unstable governments or potentially explosive ethnic, religious and cultural splits. In Venezuela and Brazil, as in much of Latin America, there are deep ethnic and class divisions, fuelling political turmoil as indigenous peasants begin to assert themselves. Brazil is improving rapidly but its class divisions still run deep. Venezuela is as volatile as ever. No-one is quite sure what President Chavez will do next, hence, despite its oil revenues, it costs $1,034 to insure $10,000 of the country’s debt.
Turkey is growing like mad but tensions between the secular elite and the more traditional peasantry manifest themselves in the political standoff between the military and the moderately Islamist government. Political instability and military intervention can’t be ruled out, hence the low credit rating.
Indonesia too is growing rapidly and is forecast to have a bigger economy than the UK by 2050. But it is also riven with religious and ethnic divisions. The threat of disintegration seems to have receded as the economy has improved but the potential for ethnic, religious and regional strife is still there. As Lebanon showed, even relatively prosperous countries can tip into civil war under the right conditions.
Ukraine is split between a Ukrainan-speaking EU orientated West and a Russian speaking, Russian orientated East. It is this division that is behind the current political instability and, therefore, the low credit rating. People are not keen to lend money to a country which might split in half sometime in the next few years.
Saudi Arabia and Bahrain have lots of oil but they also have significant Shia minorities who are opposed to, and badly treated by, the countries’ ruling elites. Repressive regimes make it difficult to assess the level of dissent but we got an indication of it earlier this year. The collapse of either or both and their replacement with radical regimes is not inconceivable.
Those of us in the AAA countries face few of these problems. Our credit rating is relatively secure because our societies and governments are relatively stable. The AAA ratings are a stability premium. We borrow at lower rates not because of our fiscal position but because we live in safe and orderly countries.
So what of the US then? Does the S&P donwgrade indicate that it is no longer considered to be a stable society. Well the S&P report said as much. Look at the title:
United States of America Long-Term Rating Lowered To ‘AA+’ On Political Risks And Rising Debt Burden; Outlook Negative.
It goes on:
[T]he downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.
The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year’s wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge….
The Economist’s GI column agrees:
I never had much sympathy for the view that America’s economy was about to be eclipsed by China’s, and the main reason was our political institutions. Those checks, balances and laws provide an orderly means to change course in response to new challenges. China’s authoritarianism deprives the government of a feedback mechanism to tell it when it is meeting the needs and aspirations of its people. That makes its system intrinsically fragile.
Events of the last few weeks have forced me to reconsider. While the crash of a high-speed train highlighted many of China’s ongoing weaknesses, it also revealed, in the vigorous reporting and commentary that followed in print and online, a nascent apparatus of accountability. Conversely, America’s ostensible success in avoiding default in fact highlighted the growing dysfunction of its political institutions. If these events are portents of things to come, then the day when China displaces America as the world’s economic superpower is closer than I thought.
Some see America’s political deadlock is a reflection of its increasingly divided society. As financial journalist and anthropologist Gillian Tett remarks:
While rowdy battles have always been a feature of American politics, what makes the recent spectacle so striking is the sheer sense of poison and lack of common meeting points.
The two sides seem so polarised they have little interest in creating peace. Or as Peter Orszag, the former White House budget director, recently wrote: “Our political system is so plagued with polarization it is difficult to move any legislation forward.”
[P]eople like Mr Orszag argue that a longer-term structural shift is under way, too: American politics, he argues, is becoming more polarised in tandem with society as a whole. One sign of this is congressional voting patterns: between the 1940s and 1970s, there used to be significant overlap between the votes cast by Democratic and Republican politicians. Since the 1980s, however, polarisation has risen to record levels, eclipsing even the 1930s (which were also a fairly polarised period, albeit less than today).
Geography is also interesting. Anyone baffled by the antics in Washington should read Bill Bishop’s brilliant and thought-provoking book The Big Sort, published three years ago, which shows that Americans are increasingly “clustering” in neighbourhoods that have similar political views. Thus, while just 19 states had “landslide” elections in 2006 (for both the Republicans and Democrats), by 2008 that had risen to 36. At the district – or local level – this was even more extreme.
Television has also become tribalised. Though some popular channels (such as CNN) are still centrist, the wildly rightwing FoxNews was the most popular news channel last month, while the leftwing MSNBC came third. And the social media, far from bridging these silos, is spawning a new form of cyber-tribalism of its own.
Certainly, America appears to be a less cohesive society than it was a couple of decades ago. Apart from a brief outbreak of consensus after 9/11, the religious/secular, square states/coastal states and liberal/conservative divisions seem to have become more vicious and visceral. We have nothing quite like the Culture Wars in the UK and it can be difficult to understand the passions they arouse. I have noticed, in my recent trips to the US, that almost anything can be defined in terms of the Culture War, even the things that people eat and drink. The rage it inspires is beyond anything I have seen in Britain.
Just at the point when America’s status as Top Nation is under threat, its people and politicians are more divided than at any time since the civil war. Or could it be that the divisions were always there and it is only power, prosperity and growth that have kept them at bay?
Having said all this, media slanging matches between two noisy groups should not be taken as signifying a meltdown of American society. There are still plenty of swing voters and people who don’t vote at all to suggest that talk of polarisation might be premature. The US is not, despite what some might say, about to become a banana republic. It has a long way to go before social divisions and dysfunctional politics see its credit rating sink to Venezuelan levels. Amidst all this noise, it should be remembered that, despite the loss of its AAA status, American debt is still cheaper to insure than German or British debt.
Nevertheless, the move by S&P is a warning to America. Its political system is creaking. Even if it manages to reduce its deficit significantly, if the price is further political polarisation, it might not be enough to get the AAA rating back.
This isn’t just about reducing the deficit or cutting public spending. The AAA rating is a measure of political stability as well as low debt levels. The action by S&P is as much a punishment for America’s politics as it is for its fiscal problems.
If American society fractures any further, America’s political stability will be the casualty. Further chaos and credit downgrades might then follow, which would be a severe blow to the country’s self-image. This weekend, in the clear hand of Standard and Poor’s, the writing appeared on the wall for America.