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Rating Agency Foolishness (with Chinese Characteristics)

News flash!  Not only is the United States no longer a AAA-rated creditor, it isn’t even worthy of a AA rating anymore.

At least that’s the conclusion reached this week by China’s flagship domestic rating agency, Dagong Global Credit Rating Company, which downgraded the US credit rating another notch to A+, while reaffirming its “negative” outlook.

While few, myself included, believe the United States is doing itself any favors with the Fed’s latest round of quantitative easing, Dagong’s inability to separate debt economics from the politics behind it shows that the firm is still not quite ready for the big time.

According to China’s state-run Xinhua News Agency,

The United States has lost its double-A credit rating with Dagong Global Credit Rating Co. Ltd., the first domestic rating agency in China, due to its new round of quantitative easing policy.

The Chinese rating agency said the downgrade reflected the US’ deteriorating debt repayment capability and drastic decline of the US government’s intention of debt repayment.

“The serious defects in the US economy will lead to long-term recession and fundamentally lower the national solvency,” Dagong said in [the] report…

“The credit crisis is far from over in the United States and the US economy will be in a long-term recession,” Dagong [warned], adding a weakening greenback will cripple the US’ capability to attract dollar capital reflow.

Dagong rationalizes the new downgrade by explaining that QE is bound to exacerbate the “potential overall crisis in the world caused by the US dollar’s depreciation [and thus] increase the uncertainty of the US recovery”.  Calling QE “entirely counter to the interest of creditors,” Dagong concludes “the US government’s move to devalue the dollar indicates its solvency is on the brink of collapse”.

No one yet knows where this new round of money printing will take the US economy.  But even under the more cynical scenarios, Dagong’s mangled logic misunderstands the very nature of rating government debt.  In fact, the one thing that QE will do with near certainty is make it easier for the US to service its debt, making it more—not less—likely that US creditors (aka debt purchasers) will get paid back.

While it’s true that investing in US T-bills may now be an increasingly foolish investment from a returns basis, an ability to repay debt isn’t something directly affected by QE, and in fact (as stated above) QE probably makes repayment more likely as cheaper dollars make the debt burden eminently more manageable.

What Dagong, and its Chinese government sponsor, are protesting through issuance of this report are foreign investors’ diminishing investment returns, not diminishing serviceability of the debt.  Yet the place for investors to voice their concern over returns is in the debt market, by bidding up the rates at auction.

This dynamic should be happening—but investors, including the Chinese, are still accepting astonishingly low interest rates.  As Director-General of China’s Banking Regulatory Commission Luo Ping famously quipped last year, “US Treasuries are the safe haven.  We hate you guys, but there is not much we can do.”

What’s left is a war of words—one that China is waging aggressively in the run-up to the G-20 summit, even through one of its supposedly “independent” rating agencies.  The fact that the SEC in September turned down Dagong’s application to rate bonds in the US makes the report’s prognosis, if not its timing, even more suspect.

Bottom line: The US economy may indeed prove to be as vulnerable as Dagong’s report suggests.  But if China truly wants to establish its own credible credit rating system, it should stick to rating debt, not berating debtors.

With this latest report, Dagong has significantly set back its efforts to be taken seriously.
 
 
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