The big story at the end of last week was the threat to Britain over its AAA-rating from credit rating agency S&P.
But interestingly, the biggest impact wasn’t felt here in the UK. Sterling for example, might have sold off sharply against the dollar when the news first came out, but it actually ended the day slightly higher.
If anything, the threat to Britain’s AAA-rating had a bigger impact on the US, with the likes of Bill Gross at giant bond fund group Pimco, pointing out that the States could be next.
So why has attention swapped to the US?
Why Britain’s credit rating risk is no surprise
Let’s put it bluntly. Britain is in a lot of trouble right now. We have a lame duck government that shows no sign of tackling its huge debts. And our banking system is still in trouble. Don’t take my word for it – the Treasury recently refused to release information about the results of Britain’s banking stress tests to Bloomberg, because apparently disclosure “at this time may lead to uncertainty in financial markets, either in relation to specific institutions or more generally… such instability could require further action by the authorities.”
It’s hardly reassuring. But it’s no big surprise either. And this fact does go some way to explaining why the reaction to Britain’s downgrade threat was so muted. Because everyone knows that Britain’s got big problems. I’m not saying that there aren’t any nasty shocks still out there. But expectations for the UK are so low that they’d have to be pretty bad to make the picture look any bleaker.
And this is the key point. We might have a lame duck government, but in a year’s time (maybe less than that) we’ll have a new bunch in charge. And the hope is that – whoever they are – they’ll be better placed to make the tough decisions necessary for the UK to tackle its deficits. To say that “things can only get better” is probably too optimistic. But we might see a bit more stability and certainty in the future. That hope is arguably one of the main things keeping our currency and our government debt afloat.
The same can’t be said right now for America. They’ve had their election, and it seems that they’ve just swapped one group of big-spending wishful thinkers for another. I have no strong views on the merits of either US political party but I do find it odd that Republican pundits are quite so up in arms about Barack Obama’s spending plans – I don’t recall fiscal conservatism being particularly high on George Bush’s agenda.
In any case, anyone looking for a plan to control the US deficit will look in vain. The Obama administration needs to raise $2 trillion this year alone, reports Ambrose Evans-Pritchard in The Telegraph.
America looks set to face a downgrade
And investors who already knew the UK was in trouble, are now worrying that the US might go the same way. As the FT’s Lex column puts it this morning, until recently, “talk of genuine sovereign risk was the preserve of mega-bears and gold nuts”. But S&P’s downgrade of the UK outlook meant that “the nightmare scenario suddenly became much more real.” Bill Gross at Pimco, manager of the world’s biggest bond fund, last week warned that the US would face a downgrade in “at least three or four years, if that, but the market will recognise the problems before the rating services.”
It seems the markets already are. The dollar has fallen by more than 10% against a basket of currencies since early March. And despite the Federal Reserve’s plans to purchase US debt directly, the 10-year Treasury yield has also risen sharply over the same period, and stands at around 3.4% now, from as low as 2.5%. That’s bad news for the Fed, because it threatens the central bank’s grand plans to boost the economy by lowering borrowing costs for consumers and corporations.
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With China becoming increasingly strident in its warnings to the US over “printing money”, the danger is that foreign investors will tire of funding America’s deficits. This may well take some time – no one wants to see a dollar collapse, least of all those countries who have reserves stuffed full of greenbacks. But without any coherent plan to turn things around, it’s inevitable that one day the US dollar will lose its status as the reserve currency. In any case, it looks like it’s the dollar’s turn to be the whipping boy of the currency markets for a while.
Meanwhile, with its nuclear tests, North Korea has also provided us with a little reminder that financial instability isn’t the only problem facing the world. As our politicians and bankers rush around covering their backs and trying to work out ways to get their gravy trains back on track, events in the ‘real’ world show the dangers that arise when the “developed” nations take their eyes off the ball. We can expect more defiance from the world’s more unstable states as this economic slump continues.
So how should you invest?
So how should you invest for a weakening dollar and rising global insecurity? The most straightforward investment is to buy gold. As we’ve said before many times, at times of uncertainty, it’s a good form of portfolio insurance. And for all the talk of green shoots, it looks like people are starting to wake up to the fact that this financial crisis has a long way to go before we have a clearer idea of what the future will look like.
Why the FTSE’s rally is doomed
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