"Pimco's Mr. Gross declined to say what the U.S. 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," he said."
CREDIT MARKETS
Some Question U.S. Bond Rating
By AARON LUCCHETTI Staff Reporter of THE WALL STREET JOURNAL December 7, 2004; Page C1
In a development that underscores the growing concern over America's twin deficits, some investors and analysts are starting to question the unquestionable: the U.S. government's triple-A bond rating.
They are anxious about years of budget and trade deficits. Their fears have been compounded by a weakening dollar and looming questions about how the U.S. will pay for Medicare and Social Security as scores of baby boomers start retiring.
To suggest that the U.S. 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."
Of course, the Treasury bond still is the benchmark by which all other debt is measured. Bond yields remain relatively low, a sign of investor confidence. And the three major credit-rating companies -- Moody's Investors Service, Standard & Poor's and Fitch Ratings -- all still rate the U.S.'s debt as a triple-A, with no downgrades in sight.
"We expect that somehow the politicians will come up with reform" to address long-term financial challenges, says Steven Hess, U.S. analyst at Moody's. If they don't, the triple-A rating would be "in jeopardy at some date." At S&P, John Chambers, a managing director, says: "The triple-A credit standing of the U.S. is secure against all reasonable scenarios."
The three ratings companies point out it would be very difficult for a nation such as the U.S. to default when it issues virtually all of its debt in dollars, even the bonds bought by foreigners. But the triple-A rating isn't guaranteed. In the late 1990s and early 2000s, ratings firms downgraded Japan's sovereign debt, even though most of it was denominated in yen. And ratings analysts acknowledge that the U.S. financial picture could deteriorate someday to the point that they would consider a downgrade, possibly if defense costs soar or changes weren't implemented to curb the costs of government programs such as Social Security.
Such deterioration might force foreign bondholders to demand that the U.S. issue more of its debt in foreign currency, which would be one of the longer term risks to the rating, says Moody's Mr. Hess. "The U.S. is a long way from not being triple-A," adds Lionel Price, Fitch's chief economist. "But it's not set in stone."
While the big credit-rating companies remain confident in the U.S. debt rating, one small upstart has taken a different tack. On Friday, Egan-Jones Ratings Co. sent a research note to clients arguing that U.S. bonds should carry a double-A rating, two notches below the highest possible rating of triple-A and below countries such as Canada, the United Kingdom and France. While still a strong rating, double-A is a world apart in perception, especially for a bond that has been -- and remains -- the gold standard of safe investing.
A country's debt rating influences how much interest it has to pay on the money it borrows. The high level of confidence investors have in the U.S. helps keep the country's borrowing costs low compared with other countries, and keeps U.S. consumers' debt-servicing rates relatively low when they borrow to buy homes, cars and other goods and services.
But how much debt can the U.S. take on? This year, S&P estimates that the U.S.'s net general government debt will increase to about 60% of gross domestic product, far more than the 20% that is typical for a triple-A rated country. The U.S.'s current-account deficit, a broad measure of debt, meanwhile, will grow to a record 5.1% of GDP, up sharply from 1.6% in 1997, according to Moody's.
Many say the numbers alone aren't cause for concern. The American economy is huge and fast growing, and taxes are relatively low: all making it easier for the U.S. to pay back its debts. The U.S. also has another advantage: It borrows in its own currency, meaning that a decline in the dollar doesn't hurt its ability to pay back debt.
The dollar has been weakening for some time and recently dropped to multiyear lows against other currencies, much to the chagrin of foreign investors who own about 40% of Treasury securities. While the 10-year Treasury note has returned 4.3% this year through Friday, Japanese holders have lost 0.8% after converting the return into yen, and European investors have lost 2.5% in euro terms.
The weaker dollar is a double-edged sword. While it may spur exports, it could bring inflation and cause foreign investors to slow purchases of Treasurys in search of better-performing investments. Both would likely force U.S. interest rates higher, hurting the value of existing U.S. bonds and making it more expensive for the U.S. to pay future debts. Higher rates could also eventually slow the economy, making it harder for the U.S. to generate tax revenues.
The U.S. has been through worse since it was first rated triple-A by Moody's in 1917. During the Depression, it paid back some bondholders in depressed dollars instead of gold. During World War II, it took on debt greater than its annual GDP. Its debts also rose, without a ratings downgrade, during the oil spikes of the 1970s and the heavy defense spending of the 1980s.
The debt of the U.S. government when compared with GDP is also comfortably below where Japan's was when that country's bonds lost their triple-A rating after years of financial problems.
"While the probability of default is low, the U.S. is allowing its currency to deteriorate and we're reflecting that in our rating," says Sean Egan, managing director of Egan-Jones. The Haverford, Pa., firm has rated corporate bonds since 1995 and is seeking recognition by the Securities and Exchange Commission as an official ratings firm.
Moody's officials, meanwhile, lately have faced questions from foreign investors and officials about the U.S. rating. At a conference in London this fall, for example, two investors raised the issue.
At Payden & Rygel, an investment-management firm specializing in bonds, deficits are a hot topic. "It's a question of confidence," says James Sarni, a portfolio manager at the firm who is thinking about the U.S. rating for the first time in years.
Pimco's Mr. Gross declined to say what the U.S. 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," he said.