When Standard & Poor’s downgraded the United States’ credit rating to AA+, the effect should have been a sobering one. What S&P argued, and what political commentators have been bemoaning for months, is that deadlock has overtaken Congress throughout President Barack Obama’s time in office.
In literal terms, however, the downgrade was an infinitesimal one; yes, it meant that American investments could no longer be considered absolutely failsafe, but they were still extremely stable. As of March 2011, America’s Country Risk rating was 82.07, good for 15th in the world. Why, then, has the effect of the downgrade been so catastrophic?
In a nutshell, it boils down to investor panic. Across the world, there was a fire sale of American assets as investors feared the worst and dumped their investments to insure themselves against a stock crash. This proved a self-fulfilling prophecy, as the wholesale dumping of assets then actually caused a crash. Over the last three weeks, the Dow Jones has been ping-ponging around wildly, leaving analysts and investors alike confused about just what the state of the American stock market is.
Currency markets have also been adversely affected. I’ll comment on the Australian to U.S. dollar exchange rate, as that’s where I’m from and that’s how I was burned. Prior to the S&P downgrade, one Australian dollar was buying around 1.06 U.S. dollars – as I was preparing to come over to UW, this was great news. In the following two weeks, the Australian dollar dropped about 10 percent in value as investors worldwide fled from the stock market and sought safer investments in the bond and cash markets. Over a two week period, I lost about $1500 that I had planned to use to fund my semester on exchange here at UW.
Thus, my frustration is twofold. First, I am frustrated at the American government for not being able to reach a suitable compromise on the debt ceiling until the 11th hour, and second, I am frustrated at investors for panicking and dumping their stocks en masse when the actual effect of the credit downgrade should have been mild. But what does this mean for the future?
The government needs to figure out what it’s doing. Both sides need to recognize that the needs of the American people (and the entire global economy) come before the petty brinkmanship that characterized the debt ceiling debacle.
Time and again news reports emerged of either Obama or Rep. John Boehner, R-Ohio, walking out of negotiations in a huff. The aggrieved party would hold a press conference decrying the other side, and moments later we’d see his opponent shrugging his shoulders in confusion, asking the public what he’d done wrong.
When the Gang of Six plan emerged, it appeared that finally we’d see an end to the intractable negotiations. Even this proved a false dawn as both Obama and Boehner quickly squashed the plan for different reasons. When an agreement was finally reached, the American public had seen that politicians on both sides were no longer protecting their citizens. They were fighting like children in a sandbox, and no one was impressed.
The credit downgrade should be a shock to politicians on both sides. They need to realize that if they continue to squabble, there will be even more severe consequences for America and the world economy.
On the other side of the equation we have investors. As the debt ceiling negotiations stretched to breaking point, investors were pulling their hair out, and rightly so. If the unthinkable happened and America defaulted on its debt, trillions of dollars would be lost in stock value.
As an agreement was finally reached and crisis was averted, things should slowly have returned to normal. Investor sentiment would be characterized by a modicum of caution, but the stock market would grow incrementally and eventually the whole issue would be forgotten.
But when S&P issued its statement on Aug. 5, mayhem broke loose – first on Wall Street, and then across the globe. The overreaction was on an unfeasible scale. In the two-week period of havoc I mentioned earlier, Australian stocks lost $55 billion. The commensurate loss on the New York Stock Exchange was closer to $1 trillion, fueled entirely by investor panic.
Time will tell as to how long it takes investors to return to normal. It may be months or even years before we see the rapacious melee of buying and selling that characterized Wall Street during the Bush era boom. God forbid, we may even see some restraint and moderation in the stock market, but probably not.
The lessons are clear: Investors need to calm down and Congress needs to pick up its game, or the consequences of the credit downgrade will be a mere shadow of what is still to come.
Shawn Rajanayagam ([email protected]) is a senior majoring in political science and American studies.
