How Does China Feel About the United States Debt Future?

Now that we're all aware of the State of the Union, I thought it would be interesting to see how another country views the issues facing America's fiscal future.  As consumers of information from the mainstream media, we tend to hear a lot about sovereign debt ratings from the major ratings agencies; S&P, Moody's and Fitch.  Most non-financial people seem quite unaware of another ratings agency by the name of Dagong Credit.  I stumbled on this agency while reading a summary of agency credit ratings for the United States and Dagong stuck out like a sore thumb by giving the United States an "A" rating, rather than the AAA or AA+ granted by most other agencies.  Interestingly, the United States Securities and Exchange Commission refuses to recognize Dagong's debt ratings because the Commission cannot supervise the Beijing-based agency!

From their website, here is a brief summary outlining who Dagong is:

"Dagong Global Credit Rating Co. Ltd. (hereinafter referred to as "Dagong") is a specialized credit rating and risk analysis research institution founded in 1994 upon the joint approval of People‘s Bank of China and the former State Economic & Trade Commission,  People’s Republic of China, and is also a key credit information and credit solution service provider in China.

As the most influential founder of China‘s credit rating industry and market, Dagong has all franchise qualifications granted by the Chinese Government, and is an official institution providing credit rating services for all bond issuers in China."

I was rather shocked to find out that the former Communist Empire had a ratings agency.  Dagong has over 500 employees, among them, 200 with Master's or Doctorate level education and 50 with post-Doctoral education.

Here is a two page screen capture showing Dagong's debt ratings system:

Now, let's see what Dagong has to say about the United States sovereign debt.  Dagong's assessment opens by noting that the United States Congress has, as of August 2, 2011, approved the bill on raising the debt ceiling of the federal government.  They then note the following:

"Though this decision enables the government to continue the practice of repaying its old debt through raising new debt, it has not changed the general trend that the increase in national debt outpaces the increase in economy and revenue, making this incident a turning point for the US government’s solvency to decline even further. Hence, Dagong decides to downgrade the local and foreign currency credit rating of the US put on the negative watch list on July 14 from A+ to A with a negative outlook." (my bold)

If you look back at Dagong's ratings system, you will see that the agency ranks American debt at third from the top, denoting expectations of relatively low default risk and vulnerability to adverse economic conditions.

I find the comment that the practice of repaying the old debt by issuing new debt most interesting, particularly, since I have observed (and posted) that governments never, ever talk about actually repaying their debt obligations, rather, as in the case of Congress, they make vague statements about cutting the growth rate of the debt.

Here are the four reasons for Dagong's downgrade:

1.)  The bipartisan struggle over the debt ceiling has exposed growing defects in the United States government's ability to resolve the debt crisis.  This means that United States’ creditors lack any sort of a guarantee from both the political and economic system of the country.  The growing difference in political views between the two Parties is preventing efficient decision-making.  Here's a quote from the assessment:

"...at this crucial juncture, neither the Democratic Party nor Republican Party has shown any consideration for the general interest in order to argue for their own partisan interest; they had a hard time making the correct choice in a timely manner leaving the world in terror, which highlights the negative role of the US political system on an economic basis. This incident will definitely exert its continuous impact on investors’ confidence in US Treasury bonds, affecting the stability of the US debt income." (my bold)

I couldn't have said it any better.  Apparently the children of Congress simply don't wish to share their toys or play well together, preferring to act like an immature class of Grade One children (my apologies to Grade One children everywhere).

2.) By raising the debt limit, the U.S. staves off default, however, by increasing the debt burden, the American debt crisis ultimately deepens further.  The solvency of the United States will continue to decline and "...the accumulation of the contradiction between the lowering solvency and the rising debt add to the inevitability of triggering a sovereign debt crisis".

3.) The pace of the proposed United States' deficit cut is far lower that the growth rate of new debt, largely as expenditure growth outstrips growth in revenue.  The deficit cut objective matches the size of the increase in the debt, however, there is an eight year difference between the two objectives.  Dagong estimates that the United States will have to cut its deficit by at least $4 trillion within the next 5 years to maintain the current debt level, a highly unlikely occurrence in this divisive political environment.

4.) The United States Congress has not come up with a substantive plan for growing the domestic economy.  This means that the Federal government cannot resolve the influence of low growth, high deficit and higher debt through an increase in wealth creation, making a decline in national solvency irreversible.  Dagong also notes that the implementation of another round of easing (the Twist?) will throw the world economy into an overall crisis which will shake the status of the United States dollar as a reserve currency.

Here's Dagong's summary:

"The radical deterioration in the state management capability, economic strength and fiscal strength that affect the government debt service capability and willingness revealed in the struggle over the debt ceiling determines the outlook of the sovereign credit rating of the US as negative."

I found this a rather profound and interesting summary of the issues facing the United States.  China has a great deal to lose in this process; with $3.18 trillion in foreign reserves including $1.13 trillion worth of United States Treasuries, they have a vested interest in assuring that the United States dollar remains the world's choice for a reserve currency as shown here:

At least until China has a viable alternative in place as shown in this Wikileaks document where China suggests that as countries around the world increase their gold reserves, the importance of the renminbi will increase at the expense of the United States dollar.