Sovereign Debt Downgrade

The following chart reminds us of the history of sovereign defaults:

The credit rating for the United States has just been downgraded two notches by the Chinese rating agency Dagong.

Full article here:

Some excerpts:

In this background, Dagong has recently assigned sovereign ratings for 50 countries for the first time, the geographic locations of which are in different continents around the world. Among them ,20 countries in Europe, 17 countries in Asia, 2 in North America, 6 in South America, 3 in African and 2 in Oceania. The total GDP of these 50 countries accounted for 90% of that of the whole world, and nearly all the characteristics of typical regional credit risk are involved. It reveals the distribution of credit risks around the world as well as and their changing trend. Among the 50 countries, the local currency sovereign credit risk for such countries as Norway, Australia, Denmark, Luxembourg, Switzerland, Singapore, New Zealand were assigned "AAA" ratings; China, Canada, the Netherlands, Germany were assigned "AA +"s, the United States and Saudi Arabia "AA"s; France , the United Kingdom, Korea and Japan got "AA-"s. The countries that were assigned local currency sovereign credit rating of "A-" level include Belgium, Chile, Spain, South Africa, Malaysia, Estonia, Russia, Poland, Israel, Italy, Portugal and Brazil.

A significant difference between Dagong and the three international rating agencies, i.e. Moody’s, S&P and Fitch in terms of their rating results is that Dagong emphasizes more on the country’s capability to pay its debt. If you analyze the rating grades (regardless the difference of + or - symbol), the three international rating agencies do not have much differences in their ratings to a particular country. However, Dagong’s ratings are quite different from theirs. Among these 50 countries, 27 countries received obviously different ratings from Dagong. Those countries which have received higher ratings are mainly the new emerging countries which have political stability and good economic performance. Those countries which have received lower ratings are many developed countries which have shown economic growth and are heavily burdened with increasing debt.

As elaborated, in its rating process, Dagong stresses on five principles as follows:

First, a systemic evaluation of the country’s comprehensive institutional strength and its fiscal status;

Second, the fiscal status is the decisive factor for the government to pay its debt;

Third, the government capacity to increase its revenue is the fundamental factor to the country to pay its debt while its capacity to borrow is not the guarantee factor;

Forth, the comprehensive institutional strength has a prominent role in protecting the stability of the country’s credit when the country is facing the more frequent external shocks;

Fifth, make sure that the statistics and information are reliable, timely and consistent.

While I am convinced that the timing of the credit review release is opportunistic, the emphasis on debt repayment capacity is correct, in my view.  The Chinese, America's largest creditors, are giving the US a warning that they will not be borrowing at AAA rates for much longer.

Will the Obama administration heed this warning?

The only way to keep the debt rating from deteriorating further is austerity.  To date, this has not seriously been considered, at least in public.

What if there is a second large stimulus package?

Will the Chinese tolerate this, or will it lead to a bond auction failure and much higher interest rates as we learned from the Greek experience?

Given the present course the present administration is on, I am not optimistic.