Thoughts on Dagong's U.S. Treasuries Downgrade

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by: Patrick Chovanec

This week, all three of the top three credit agencies — S&P, Moody’s, and Fitch — signaled that they would continue giving U.S. Treasuries their top (AAA) rating in light of the political deal struck over the weekend to raise the U.S. debt ceiling in return for at least $2.1 trillion in spending cuts. However, one agency — the Chinese credit rating agency Dagong — announced Tuesday that it was downgrading U.S. debt from A+ to A with a negative outlook. Given the timing, and concerns over global reaction to the fractious debt ceiling stand-off, the announcement attracted more attention than normal.

I was on CNN yesterday as part of a report on Dagong’s downgrade and what (if anything) it may mean. You can watch that report here. I was also interviewed on Bloomberg this morning, on the very same subject; you can check out what I had to say here.

Dagong’s move is not out of character: the company has been negative on U.S. Treasuries for some time. To offer some perspective, it’s worth nothing that even before this latest downgrade, Dagong rated U.S. sovereign debt one step below several issues of local Chinese government-sponsored infrastructure bonds (the infamous LGFVs) that have virtually no cash flow and highly questionable collateral (see this earlier blog entry for more details). As I told Bloomberg, I think Dagong is a bit hypersensitive to U.S. risk, and tends to be a bit blind to domestic Chinese risk.

Most of the concerns that Dagong raises are valid, and are widely shared by global investors. But Dagong takes those concerns and runs with them to conclusions that I doubt many investors would agree with. In rating China, relative to the U.S., it tends to assume that running a trade surplus and accumulating reserves is always a good thing (which it can be, in moderation) and ignores how chronic global imbalances can create as many problems for surplus countries like China as for deficit countries like the United States. More disturbingly, there are times when Dagong seems to have a bit of a nationalist chip on its shoulder, railing about the “defects” of the U.S. political system without recognizing any of the strengths that continue to make the U.S. attractive to investors, despite its problems. This tends to undermine rather than support its case.

In any event, Dagong’s downgrade is unlikely to have any effect on China’s massive holdings of U.S. Treasuries as part of its official reserves. As I’ve pointed out previously, and repeated on both CNN and Bloomberg, it’s a myth that China holds U.S. Treasuries at its discretion, that if it doesn’t like what it sees, it can take its money elsewhere. Even if Chinese officials agreed with Dagong’s analysis, and tried to diversify their holdings (as they’ve been talking about for at least the past two years), they would be forced to continue to buy and accumulate dollars in order to keep the RMB from rising and maintain their trade position, and Treasuries are the only practical place to put them. Unless China were to abandon that policy — which is precisely what the U.S. has been pressing it to do! – China is stuck being a big holder of U.S. debt.

Last Tuesday, I was actually on China Radio International (CRI) with a couple of Dagong analysts, talking about the role of credit rating agencies, with a focus mainly on the eurozone debt crisis. You can listen to that discussion here. As you can see, I tried to bring up the topic of Dagong’s own rather provocative ratings perspective, but nobody took the bait.

[UPDATE: I just noticed that Tom Orlik at the Wall Street Journal has a good blog post today detailing the various options China has for stashing its ever-growing reserves somewhere other than U.S. Treasuries. The conclusion: there are some alternatives -- U.S. bank deposits, non-U.S. sovereign bonds, gold -- but they are extremely limited, and not necessarily that much more attractive.]