Mirror, mirror on the wall, is the U.S. still the fairest of them all?
Warren Buffett’s response to the downgrading of the U.S. as a debtor was that the country is (was) not a triple A but a quadruple A. Now that is the mark of a confident man!
Buffett’s view is reflective of the one long held by most market participants – the creditworthiness of the U.S. is against which all else is compared. It is the very fulcrum point from which the global economy is levered. To move the U.S. is to destabilize the rest.
Historically, this U.S.-centric view holds that any other sovereign entity also rated as AAA is with recognition of the U.S. being the ‘corner tenant’ of the AAA office park. Implicitly, while there may be others donned with an AAA, none is as strong as that of the U.S. America, for better or worse, is the benchmark upon which all else has been compared. It is a function of not only being the world’s largest economy, biggest borrower but also the printer of the world’s reserve currency. It is the AAA (bold, 14 pt. font) rating of the U.S. compared to the merely AAA (normal, 11 pt. font) rating of everyone else. Or, that is, it was.
The conundrum in which we now find ourselves mired is shaped by the movement of the U.S. from the comparable but unassailable benchmark upon which all else is compared. The ‘special status’ has been revoked. A week ago, the world of finance was connected to (what all but a few) thought was terra firma.
While the strong pillar holding up ‘high quality/risk free’ end of the credit rating spectrum, comparisons to the U.S. credit rating only went in one direction – there was nothing ‘less risky’. Now the U.S. and those who have been so reliant upon its multifold stability (and this means all investors) have been disjointed.
The direct impact on the U.S., (as global markets have clearly shown) is only a part of the story. Seekers of risk must ask: ‘what is now our point of reference?’ U.S. debt instruments, whether 30 day t-bills or the 30 year bonds, have been the reference point for nearly every investment policy statement, asset allocation model and risk modeling system in the U.S., and in many instances, globally. That has now all shifted, or, more accurately, it is shifting. One question among many is what is now the ‘risk free rate’ in the bottom left hand corner of those handy efficient frontier models used the world over?
S&P’s action brings into question the very nature of the game. The reference point and assumed ‘risk free rate’ are shifting – as such, so are the field markers. If the U.S. is not that to which all else is compared and rated/ranked, than what is? (This is in part the catalyst for the rise of gold: the great shiny sovereign ancient king.)
Confidence is ultimately the only factor driving markets. It is the prime mover. In the face of rapid erosion in confidence, little else matters. The slipping confidence of market participants is largely driven by the shifting sands beneath investors’ feet. Our collective framework for understanding just how the world works has been shaken.