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Tuesday, December 07, 2004

 

triple-a rated


bill gross is portfolio manager of the pimco total return fund, one of the great bond mutual funds, and an erudite and respected figure in the world of debt trading.

and i see he's on the front of section c of the wall street journal, questioning the AAA rating of american treasury debt.

to suggest that the US is a triple-a credit "would be to suggest that it can pay its bills over a long period of time in a stable currency," says william gross, chief investment officer at pacific investment management co., or pimco, which runs the nation's largest bond mutual fund. "that is no longer true."

... pimco's mr. gross declined to say what the rating should be, but cast doubt about whether it should remain at the top. "take away our military might, and a lower rating would be a near-unanimous opinion."
a small debt rating firm, egan-jones ratings co., took the pre-emptive step friday of issuing a research note to clients stating that american bonds should be rated double-a (which is, convolutedly, two notches below triple-a).

"while the probability of default is low, the US is allowing its currency to deteriorate and we're reflecting that in our rating," says sean egan, managing director of egan-jones.
the declining dollar has become a hot topic, and the two notions -- american debt and the dollar -- are inextricably linked in the person of foreign holders of american debt. while the economist has been warning about the impending potential difficulties of the massive american trade deficit and debt, they've made it their december 4 issue cover story.

Many American policymakers talk as though it is better to rely entirely on a falling dollar to solve, somehow, all their problems. Conceivably, it could happen—but such a one-sided remedy would most likely be far more painful than they imagine. America's challenge is not just to reduce its current-account deficit to a level which foreigners are happy to finance by buying more dollar assets, but also to persuade existing foreign creditors to hang on to their vast stock of dollar assets, estimated at almost $11 trillion. A fall in the dollar sufficient to close the current-account deficit might destroy its safe-haven status. If the dollar falls by another 30%, as some predict, it would amount to the biggest default in history: not a conventional default on debt service, but default by stealth, wiping trillions off the value of foreigners' dollar assets.

The dollar's loss of reserve-currency status would lead America's creditors to start cashing those cheques—and what an awful lot of cheques there are to cash. As that process gathered pace, the dollar could tumble further and further. American bond yields (long-term interest rates) would soar, quite likely causing a deep recession. Americans who favour a weak dollar should be careful what they wish for.
all this -- cover stories, debt downgrades -- might have the smell of hubris, and be a possible indication of a short-term rally in the buck. (after all, once everyone has gone short, there's no one left to sell.) however, the longer-term macro situation is crystalline and getting more onerous by the day.

A recent paper (registration req'd) by Nouriel Roubini, of New York University, and Brad Setser, of Oxford University, estimates that, if the real trade-weighted value of the dollar remains close to its average in 1990-2003 (slightly above current levels) and there is no change in domestic policy, America's current-account deficit would rise to 8% of GDP in 2008, and its net debt would increase to over 50% of GDP. In practice, such levels are unlikely to be reached because private investors would be unwilling to finance debts of that size without much higher interest rates and/or a lower dollar, both of which would help to shrink the current-account deficit.
as i've said previously, if this point is reached -- where investors are simply unwilling to finance american indebtedness any longer -- the pain that will be visited upon not only the united states but the western globalized economy is hard for any living american to imagine. its nearest analog hasn't been seen since the 1970s; but the scale of the problems now utterly dwarfs that era's troubles.

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