Last
week, Moody’s downgraded the U.S. credit rating from stable to negative, citing
high budget deficits, deteriorating debt affordability and political
polarization.
It’s a
little strange that they are just now realizing this, isn’t it?
The
problems mentioned arose long ago, primarily due to irresponsible policies
during the pandemic. Maybe the monetary helicopter idea wasn’t the best after
all.
By
pulling the economy out of the Covid-19 mess, we could be setting ourselves up
for an even worse crisis in the future. The situation is becoming
unsustainable.
And yet
the agency maintains the country’s long-term rating at AAA…Could it be that
they are waiting for a miracle not to happen and the debt will not disappear, or do they simply not
want to fall foul of the significant forces?
Just
because you don’t see the problem doesn’t mean it isn’t there
Investors,
judging by the dollar index’s lack of reaction, seem unperturbed by the news of
Moody’s downgrade, with demand for Treasuries rising and yields falling.
The
reason for such optimism could be that the country has consistently met its
obligations to creditors. But in reality, it is a myth; albeit technical, there
have been defaults.
The
first “de facto” U.S. default occurred in the late 18th
century, when Congress announced the devaluation of “continental
dollars” and then agreed to redeem its bonds at 1% of face value.
Then, 70
years later, in 1860, there was a nasty story with Greenbacks for $60 million,
and in the end, the investors received 50% of what was promised. These
actions can be considered as an acknowledgement of insolvency.
Then
came the default of 1933. Bonds totalling $7 billion were issued to finance
World War I. On paper, the collateral was gold, thus a safe haven at the
time.
However,
at the request of President Roosevelt, Congress passed a resolution denying
U.S. holders payment in gold, devaluing the dollar by 40% compared to foreign
currencies.
Interestingly,
in February 1935, the Supreme Court upheld the congressional resolution as
constitutional. Chief Justice Charles Evans Hughes called the resolution “amoral” but legal.
In 1979,
there was already a technical default of US$122 million, albeit a very brief
one. Even so, the government had to pay additional interest for the delays.
What
prevents the Government from repeating history?
Although
there have also been some dark episodes in the history of U.S. debt repayments,
this does not mean rushing to get rid of Treasury bonds.
It is
necessary to act according to the current situation
Despite
the fact that the debt reached a growth rate of $2 trillion a year, and this
year’s budget deficit is up 23% over last year to $1.695 trillion, default is
not yet on the horizon.
However,
if the geopolitical situation in the world continues to deteriorate and the
government continues to spend money like there is no tomorrow, risk will
increase.
Eventually,
US Treasuries may turn from safe assets to risky assets. At that point, it is
recommended to keep an eye on the volume indicator to understand the market
sentiment.