Chinese ratings agency Dagong Global Credit Rating Group made a media splash in July when it launched its sovereign debt ratings by stripping seven developed nations of their AAA ratings, putting nations such as France, Britain, and the U.S. below China.
Now the firm has just downgraded the U.S. further, to ‘A+’ from ‘AA’, blaming QE2, and they’re throwing out some real whoppers:
The serious defects in the United States economic development and management model will lead to the long-term recession of its national economy, fundamentally lowering the national solvency. The new round of quantitative easing monetary policy adopted by the Federal Reserve has brought about an obvious trend of depreciation of the U.S. dollar, and the continuation and deepening of credit crisis in the U.S. Such a move entirely encroaches on the interests of the creditors, indicating the decline of the U.S. government’s intention of debt repayment. Analysis shows that the crisis confronting the U.S. cannot be ultimately resolved through currency depreciation. On the contrary, it is likely that an overall crisis might be triggered by the U.S. government’s policy to continuously depreciate the U.S. dollar against the will of creditors.
The total output value of the U.S. financial services industry is composed of two major parts: one is the transferred production value, most of which comes from value distribution of participating in international production. Another part is the inflated value originated from credit innovation, which belongs to bubble value. In addition, due to the high economic financialization, more than half of the profits in the real economy come from the returns of financial activities. If we exclude the factor of virtual economy, the U.S. actual GDP is about 5 trillion U.S. dollars in 2009, per capita GDP about $ 15,000. Meanwhile, the total domestic consumption was 10.0 trillion U.S. dollars and government expenditure was 4.5 trillion U.S. dollars.
There’s of course nothing wrong with a firm claiming that the U.S. or any nation has a much lower credit rating than many others believe. There’s also nothing wrong with placing China higher up on the ratings ladder if your analysis leads to such a conclusion.
But Dagong better hope that its forecast of long-term U.S. recession (GDP contraction over multiple years) and a U.S. GDP of only $5 trillion (versus over $14 trillion right now) comes true… for the sake of their own credibility. Because thus far they’re looking rather ridiculous, and it’s no wonder that their application to become a registered ratings agency was rejected by the SEC. Note even Japan hasn’t succumbed to the fate above, and its in 10 times worse shape than the U.S..
Dagong also fails to mention something which most commentators on U.S. solvency forget — private net wealth, which in the U.S. economic system is enormous at $53.5 trillion dollars, which is a few multiples of the U.S. government’s total debt. They also fail to talk about demographics, whereby the U.S. GDP will enjoy a tailwind simply from population growth through 2050, while China will experience the exact opposite.
It’s also important to note that when it comes to dollar depreciation, far more happened before the crisis, based on the dollar index (Bloomberg: DXY), than in the aftermath of the crisis with quantitative easing (QE). In fact, the dollar index is higher right now than where it was at times in 2008, despite QE2. So even the motivation for their latest downgrade, QE2, seems questionable. U.S. entitlement programs pose a far greater risk to U.S. long-term debt service, and QE2 is a drop in the bucket on a 10-year view.
But yes, we get the game Dagong’s playing. They are feeding into some people’s need for a ‘Chinese perspective’, regardless of how well formulated, and they’re making a media splash by presenting radical views. But the deeper you dig into their views, the more tenuous their ratings become.