The Canadian loonie is increasingly being viewed globally as a safe haven, backed by one of the world’s strongest banking systems, a federal government with at least nearly balanced books and a generally healthy economy that’s by no means overleveraged.
— Roger Conrad, Canadian Edge
Late Friday (Aug. 5th) after the market close, Standard and Poor’s did what was unthinkable just a few months ago: it downgraded the sovereign credit rating of the United States from its highest rating of triple-A (AAA) to its second-highest rating of double A-plus (AA+). There are now 15 countries with the top AAA rating and the U.S. is no longer one of them. I briefly mentioned the S&P downgrade in my Friday article entitled Market Crash Optimism, saying that it was “expected,” but the stock market this morning is taking the news hard with the Dow Jones Industrial Average down 350 points.
I say the downgrade was expected because S&P expressly stated back in July that — to avoid a downgrade — the U.S. needed to reduce its budget deficit by at least $4 trillion over the next ten years (i.e., by 2021). The August 2nd debt-ceiling deal struck in Washington only reduced the deficit by somewhere between $2.1 trillion and $2.4 trillion. So why are investors surprised? Did they think S&P was just bluffing? Don’t expect S&P to give the U.S. back its triple-A rating anytime soon, either. John Chambers, chairman of S&P’s sovereign-ratings committee, stated that only five governments have ever regained a triple-A rating after losing it, and the earliest any of them got it back was nine years. Adding insult to injury, S&P said that there was a 1-in-3 chance it would downgrade the U.S. again to double-A (AA) over the next six months to two years. Ouch.
Predictably, the Obama administration took the downgrade badly, choosing to shoot the messenger instead of calming the markets by promising to reduce budget deficits further. I’m not surprised, given Obama’s complete disregard of the U.S. Debt Commission’s recommendations in December 2010 that resulted in him sending a spendthrift budget to Congress that was rejected 97-0 by the U.S. Senate. And, of course, nobody can forget Obama’s healthcare “reform” that will add trillions of dollars to the U.S. budget deficit.
Anyway, the U.S. Treasury released a statement attacking S&P’s debt calculations, arguing that S&P had overestimated the U.S. budget deficit in 2021 by $2 trillion. The result is that S&P erroneously calculated the U.S. debt burden in 2021 as 93% of GDP instead of 85% of GDP. According to the Treasury department, an 85% debt-to-GDP ratio doesn’t warrant a debt downgrade. S&P shot back that its downgrade was based on a 3-to-5 year time horizon, not a 10-year horizon, and the “trajectory” of debt rather than an absolute debt-to-GDP ratio. Bottom line: the initial miscalculation of the 10-year debt-to-GDP ratio did not change the basis of the downgrade decision:
The primary focus remained on the current level of debt, the trajectory of debt as a share of the economy, and the lack of apparent willingness of elected officials as a group to deal with the U.S. medium term fiscal outlook. None of these key factors was meaningfully affected by the assumption revisions to the assumed growth of discretionary outlays and thus had no impact on the rating decision.
Interestingly, S&P admits that the 2015 debt-to-GDP ratio of France will be higher than that of the U.S. (83% vs. 79%), and yet it downgraded the U.S. and left France at triple-A. The reason: “In contrast with the U.S., we project that the net public debt burdens of these other sovereigns will begin to decline, either before or by 2015.”
The S&P Downgrade of the U.S. is Not Based on Financial Ability
The credit default swap (CDS) market – which I discussed in my article entitled New Sovereigns — doesn’t agree with S&P’s downgrade. As of this weekend, the annual cost to insure against a U.S. five-year bond default was only 58 basis points, lower than that of triple-A credits Australia (69), Germany (74), United Kingdom (77), and France (144).
Warren Buffett also disagrees with S&P, saying the downgrade “doesn’t make sense” and that he would personally give the U.S. a “quadruple-A” rating if one existed. Buffett also makes a good point in noting that the U.S. is the world’s reserve currency and that provides advantages no other country has:
Think about it. The U.S., to my knowledge owes no money in currency other than the U.S. dollar, which it can print at will. Now if you’re talking about inflation, that’s a different question.
Buffett’s point about inflation is that the ability of the U.S. to print U.S. dollars ensures that creditors will get paid back in full, but it doesn’t ensure that the payment will be composed of a strong currency. Getting repaid in a depreciated currency may severely hurt a creditor’s wealth, but that is different from a default. Regular U.S. Treasuries do not include an inflation-adjustment clause, so there is no obligation on the part of the U.S. to compensate creditors for a depreciated currency.
Political Dysfunction is the Real Reason for S&P’s Downgrade
Okay, since a U.S. default won’t happen, how can S&P justify downgrading the country with the world’s reserve currency? While S&P concedes that “the role of the U.S. dollar as the key reserve currency confers a government funding advantage that could change only slowly over time,” it curiously fails to explain why the U.S. status as a reserve currency is insufficient to keep the U.S. at triple-A. In contrast, Fitch emphasized the U.S. dollar’s role as the world’s reserve currency when it affirmed the U.S. rating at triple-A on August 2nd.
The only explanation I can think of is that S&P was completely freaked out by the political brinkmanship Washington politicians demonstrated during the debt-ceiling debate. The fact that 161 members of the House of Representatives and 26 members of the Senate were willing to vote against the last-minute deal and accept a U.S. default is truly frightening. Granted some of the members that voted “no” only did so after they had been assured that the deal would pass, but others are extremists like Tea Party House Republicans Jim Jordan of Ohio and Michele Bachmann of Minnesota who are on record stating that a U.S. default would be “acceptable” if it were to lead to additional spending cuts.
In conclusion, S&P’s downgrade had everything to do with its assessment of the U.S. government’s future will to avoid default and nothing to do with its assessment of the U.S. government’s future ability to avoid default:
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 differences between political parties have proven to be extraordinarily difficult to bridge, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics any time soon.
And on that point, I must agree with S&P. The U.S. government has become completely dysfunctional, something that I never thought would happen. Unfortunately, there is no reason to believe that this dysfunction is going to change anytime soon. Get ready for another nauseating U.S. debt-ceiling dispute full of default brinkmanship soon after the 2012 presidential election.
Find the Best Canadian Stocks with the Help of Canadian Edge
According to Standard and Poor’s, of the four triple-A rated countries (Canada, France, Germany, and the U.K.) that constitute the most relevant peers to the U.S., Canada stands out as the one with the lowest debt-to-GDP ratio both currently and in 2015:
Including the U.S., we estimate that these five sovereigns will have net general government debt to GDP ratios this year ranging from 34% (Canada) to 80% (the U.K.), with the U.S. debt burden at 74%. By 2015, we project that their net public debt to GDP ratios will range between 30% (lowest, Canada) and 83% (highest, France), with the U.S. debt burden at 79%.
Why waste time investing solely in the U.S. when you can invest in dividend-paying companies located in Canada, the country with the world’s soundest banking system and the lowest debt-to-GDP ratio among the United States’ triple-A rated peers?
Roger Conrad, editor of the market-beating Canadian Edge investment service, has uncovered not only the highest-yielding Canadian stocks, but those with the strongest business fundamentals to sustain their dividends and grow them further. Not only is the Canadian economy growing, but its currency is also set to appreciate further against the U.S. dollar:
As we’ve pointed out here many times, the loonie is strong for many reasons. For one thing, it’s tended to follow oil prices, which have been in a bull market since early in the last decade. The loonie itself has been in a bull market for a decade as well.
Canada is an economic oasis of peace and prosperity. To find out the names of the Canadian high-income stocks Roger likes best right now, give Canadian Edge a try today!