Financial crisis: full force of US downgrade is felt around the world

A Wall Street sign in front of the New York stock exchange. Recent events have changed the US as an unassailable economic superpower. Photograph: Lucas Jackson/Reuters

When India joined China in criticising the United States' chaotic handling of its hefty debts this weekend, describing the challenges facing the White House as "grave", it was the clearest indication yet that the old order had been swept away.

Until recently the US was the unassailable economic superpower, and the prospect of the White House being bossed about by the bond markets – let alone by Beijing or New Delhi – was unthinkable.

But following a week when an estimated $3tn (£1.8tn) was wiped off the value of world shares, Friday's downgrade of America's cherished AAA rating to AA+ by Standard & Poor's is set to cause more turmoil on global markets and potentially jeopardise Europe's attempts to solve its ownfinancial crisis.

With currency markets, particularly the dollar, expected to come under pressure, and US bond yields almost certain to rise, this could have the knock-on effect of raising borrowing costs in the eurozone at a time when Spanish and Italian bonds in particular have seen yields soar.

This could prove to be a tipping point for the transfer of global power from the US to its great rival China, even though the fortunes of Asia and the west are inextricably linked.

The boom of the past two decades in the US, the UK and much of Europe came at the expense of an extraordinary growth in borrowing, much of it from the Chinese and other fast-growing Asian economies, which were happy to keep piling up Treasury bills and buying blue-chip companies, so long as the billions of dollars they spent were recycled into cheap consumer goods.

At the height of the credit crunch, it seemed both lenders and borrowers were finally getting their comeuppance, but as the Bank of England governor, Mervyn King, has repeatedly pointed out in the past 12 months, the "global imbalances" that led to the crisis – the vast trade deficits and debts – never went away.

Gerard Lyons, chief economist at Standard Chartered, blames the turmoil of recent days on a combination of "ineffective policymakers, excitable markets and a realisation that the recovery is going to be very slow in the west".

David Blanchflower, a former member of the Bank of England's monetary policy committee, went further: "What we've seen is a once-in-100-years financial crisis that will take 20 years to adjust to."

As for the US itself, Alan Greenspan, the former Federal Reserve chairman, said on NBC that the downgrade was having a salutary effect on the public as well as on policymakers. He said: "It gave the sense there is something basically bad going on. And it's hit the self-esteem of the United States, the psyche."

But there is little glee in China about the west's travails. Beijing has repeatedly expressed concern about the mounting US debt burden and the reliance of the global economy on the mighty dollar. Now, the gloves are finally off. The official news agency has accused the US of "debt addiction" and insisted that, as its largest creditor, China now "has every right to demand the United States address its structural debt problem and ensure the safety of China's dollar assets".

The Chinese economist Sun Lijian, in a commentary for the People's Daily, said: "The biggest victims [of the downgrade] may not be the United States itself, but other countries that have depended on external demand to amass national wealth – be they Asian nations that depend on exporting goods, or nations in Latin America and the Middle East, as well as Russia, that depend on exporting resources."

For decades, the interest rate on American debt has been known as the "risk-free rate", because a US default was as close to impossible as anyone in financial markets could imagine, and all other bonds were priced relative to America's.

Now that the markets have been forced to think the unthinkable, it is not at all clear what happens next. Erik Britton, of the City consultancy Fathom, says one possibility is that borrowing costs everywhere will rise.

"It's the cascade effect – it's the chain reaction that we're concerned about. Do other countries retain the same risk premium relative to the US? If that's the case, then all bond yields will go up. Everybody's borrowing costs will go up, and that includes Italy and Spain, where it won't take much to make their situation unsustainable."

And while Standard & Poor's verdict on the US is a humiliating blow, it merely raises the distant fear of a future default, while for Italy and Spain that risk is much more immediate. When the crisis reached Rome, it finally became impossible for Europe's leaders to write off the turmoil in bond markets as a problem of the "periphery" – little Greece, Ireland and Portugal.

As German officials told Der Spiegel this weekend, Italy's economy simply looks too big to rescue, certainly by the current bailout fund, the European Financial Stability Facility (EFSF).

Jean-Claude Trichet, president of the European Central Bank (ECB), has reluctantly ridden to the rescue many times during the crisis; the ECB will begin large-scale buying of Italian and Spanish bonds on Monday. The eurozone has repeatedly drawn back from the brink over the past three years, but a default by Italy or Spain would pose a threat to the single currency's existence.

Sony Kapoor, of the Brussels-based consultancy Re-Define, said the ECB decision to buy bonds would not be enough; eurozone politicians also needed to revisit their plans for beefing up the EFSF.

No one knows what will happen this week, but no one believes it can ever be back to business as usual for the global economy.

Barack Obama: 'We have always been and always will be a AAA country' - video

Us president Barack Obama blames the recent downgrade in United States' credit rating on political gridlock in Washington. Obama's statement comes as stock markets continue a steep slide. In an attempt to stem a fresh tide of selling on global markets on Monday, Obama said America's loss of its prized AAA rating should provide a 'new sense of urgency' for Washington to tackle its chronic debt problem. The president called for an extension of tax cuts to boost the world's biggest economy!

For more news, visit www.alphaoculus.com

Global finance has dysfunction at its heart

Barack Obama's debt crisis deal may have averted catastrophe in the US, but only structural reform can prevent future crises. Photograph: Jason Reed/Reuters

The world economy is in turmoil again. We have seen two weeks of near-universal falls in major stock markets, prompted by the spread of the eurozone crisis to Spain and Italy, the phony fiscal crisis in the US manufactured by the Republicans, and the economic slowdown around the world. The first ever downgrading of the US debt by Standard & Poor's last weekend has certainly added to the drama of the unfolding events.

The debate focuses on how budget deficits should be controlled, with the dominant view saying that they need to be cut quickly and mainly through reduction in welfare spending, while its critics argue for further short-term fiscal stimuli and longer-term deficit reduction relying more on tax increases.

While this debate is crucial, it should not distract us from the urgent need to reform our financial system, whose dysfunctionality lies at the heart of this crisis. Nowhere is this more obvious than in the case of the rating agencies, whose incompetence and cynicism have become evident following the 2008 crisis, if not before. Despite this, we have done nothing about them, and as a result we are facing absurdities today – European periphery countries have to radically rewrite social contracts at the dictates of these agencies, rather than through democratic debates, while the downgrading of US treasuries has increased the demands for them as "safe haven" products.

Was this inevitable? Hardly. We could have created a public rating agency (a UN agency funded by member states?) that does not charge for its service and thus can be more objective, thereby providing an effective competition to the current oligopoly of Standard & Poor's, Moody's, and Fitch. If the regulators had decided to become less reliant on their ratings in assessing the soundness of financial institutions, we would have weakened their undue influence. For the prevention of future financial crises we should have demanded greater transparency from the rating agencies – while changing their fee structure, in which they are paid by those firms that want to have their financial products rated. But these options weren't seriously contemplated.

Another example of financial reforms whose neglect comes back to haunt us is the introduction of internationally agreed rules on sovereign bankruptcy. In resolving the European sovereign debt crises, one of the greatest obstacles has been the refusal by bondholders to bear any burden of adjustments, talking as if such a proposal goes against the basic rules of capitalism. However, the principle that the creditor, as well as the debtor, pays for the consequences of an unsuccessful loan is already in full operation at another level in all capitalist economies.

When companies go bankrupt, creditors also have to take a hit – by providing debt standstill, writing off some debts, extending their maturities, or reducing the interest rates charged. The proposal to introduce the same principle to deal with sovereign bankruptcy has been around at least since the days of the 1997 Asian financial crisis. However, this issue was tossed aside because the rich country governments, under the influence of their financial lobbies, would not have it.

There are other financial reforms whose absence has not yet come back to haunt us in a major way but will do so in the future. The most important of these is the regulation of complex financial products. Despite the widespread agreement that these are what have made the current crisis so large and intractable, we have done practically nothing to regulate them. The usual refrain is that these products are too complicated to regulate. But then why not simply ban products whose safety cannot be convincingly demonstrated, as we do with drugs?

Nothing has been done to regulate tax havens, which not only depriven governments of tax revenues but also make financial regulations more difficult. Once again, we could have eliminated or significantly weakened tax havens by simply declaring that all transactions with companies registered in countries/territories that do not meet the minimum regulatory standards are illegal.

And what have we done to change the perverse incentive structure in the financial industry, which has encouraged excessive risk-taking? Practically nothing, except for a feeble bonus tax in the UK.

A correct fiscal policy by itself cannot tackle the structural problems that have brought about the current crisis. It can only create the space in which we make the real reforms, especially financial reform. Without such a reform we will not overcome this crisis satisfactorily nor avoid similar, and possibly even bigger, crises in the future.

Debt crisis: Barack Obama's call for urgency fails to prop up shares

Barack Obama walks towards the podium before making a statement at the White House. Photograph: Alex Wong/Getty Images

Barack Obama tried to stem a fresh tide of selling on global markets on Monday when he said America's loss of its prized AAA rating should provide a "new sense of urgency" for Washington to tackle its chronic debt problem.

The president called for an extension of tax cuts to boost the world's biggest economy but the insistence that the US would always be a "AAA country" had little impact on Wall Street, which continued to plunge after his address.

The Dow Jones average was down 500 points by early afternoon as markets had their first opportunity to pass judgement on the decision by S&P to downgrade the US's sovereign credit rating following months of wrangling between Democrats and Republicans on Capitol Hill.

US banks, in particular, were badly hit. The Bank of America was down nearly 18%, Citigroup 17% and Morgan Stanley 14% as investors feared a second credit crunch could engulf the sector.

London witnessed a resumption of last week's panic selling, with the FTSE 100 index falling by more than 100 points for the fourth successive day – for the first time in its 27-year history.

On another bleak day in the City, a further £46bn was wiped off the value of the FTSE, bringing the total cost of its losing streak to £210bn. The index closed 178 points lower at 5069 and has dropped by more than 800 points since 29 July. Only one company in the FTSE saw its shares rise on Monday and with Wall Street in turmoil, early indications were that shares in London would again open loweron Tuesday.

Markets in the rest of Europe also registered sharp declines despite the success of the European Central Bank in driving down the interest rate on Italian and Spanish bonds – a key concern for investors during last week's turmoil. Dealers said the ECB had been aggressively buying bonds to prevent interest rates hitting the levels that led to bailouts for Greece, Ireland and Portugal. At the close, both Italian and Spanish yields had fallen by almost a percentage point to just over 5%.

Oil prices fell sharply amid fears the global economy was about to enter a double-dip recession. Brent crude was down by $4 at $105, while the search for a haven sent the price of gold soaring by $70 an ounce to a fresh record of $1,721 an ounce.

US bonds were also snapped up by nervous investors, who took no notice of the downgrade by S&P late on Friday night. The price of 10-year Treasury bonds rose, pushing the yield down to 2.35%.

In a press conference S&P chairman, John Chambers, defended the decision to cut America's rating to AA+, the first time it has not had the top grade on its debt since 1917. "We think elected officials across the spectrum are unable to proactively take measures to put US public finances on a sustainable footing in the same sort of matter as some of our most highly rated governments," Chambers said.

The press conference was part of a PR offensive with Chambers and David Beers, head of the ratings agency's sovereign ratings unit, appearing on several US morning TV shows to rebut suggestions that they got their maths wrong. Beers called the attacks "simply a smokescreen for the unhappiness, in our view, about our decision". S&P followed up the US downgrade by trimming the credit rating of the US's massive government-backed lenders Fannie Mae and Freddie Mac.

Shares in Bank of America (BoA) were especially badly hit after AIG, the insurance giant that was bailed out by the US government, launched a $10.5bn lawsuit alleging "fraud, misrepresentations and omissions" in deals on mortgage-backed securities. AIG alleges that BoA wrote subprime mortgages to borrowers it knew could not repay and then sold on the loans.

Obama said the markets continued to believe the US was AAA, noting that the veteran investor Warren Buffet considered America to be AAAA. S&P cut the credit rating on Buffet's Berkshire Hathaway investment company.

Jack Ablin, chief investment officer at Harris Private Bank, said: "It is hard to tell when this is going to end." He said investors appeared to be ignoring news from Europe where the ECB has stepped in to aid in Italy and Spain.

Ablin said investors seemed to be agreeing with S&P. "Unfortunately Congress has had a poor record of making difficult choices. This is an indictment of the process, not so much the US's ability but their willingness to tackle the debt."

Mark Zandi, chief economist of Moody's Analytics, said in a note to clients that the selloff should be short lived. He said the downgrade was "a blow to the American ego, but it should be nothing more than that. The timing was especially inopportune given the fragile collective psyche, thus its immediate impact may be amplified, but it should produce no long-lasting repercussions. If history is any guide, there is no meaningful probability that the US will default on its debt."

US investors are betting that volatility will continue. The Chicago board options exchange volatility index, or VIX, the so-called "fear gauge" jumped 21% in early trading Monday.

8.3.11 -- Out-of-control debt and gold prices

Gold prices shot above $1,665/oz. Wednesday on safe haven buying amid rising debt and economic uncertainty. Gold last traded at $1,661 an ounce, silver shot up to $41.73 an ounce.
"GOLD PRICES SPIKE AS RECESSION WORRIES SPREAD," says TheStreet.com.
Gold prices closed in on $1,700 an ounce, as worries that governments won't be able to grow their way out of debt caused a rush into the safe haven asset.

"GOLD GOING TO $2,400 AN OUNCE," SATC CHAIRMAN CRAIG R. SMITH told the Common Sense Coalition radio show today. "We are in a recession...common sense tells Americans they can't spend more than they earn or they go bankrupt. Governments can do it for a while, but eventually face the consequences of a hyperinflationary depresson."

"GOLD TO HIT $2,000 BEFORE YEAR END," reports London Telegraph.
Last week's events on Capitol Hill in the US were very damaging. After we abandoned the gold standard, the dollar is now the globe's reserve currency, and US politicians decided to play a game of chicken with the debt ceiling. There is also an uncanny correlation between the gold price and the US debt ceiling.

"GOLD TO HIT $3,000 IF US KEEPS SPENDING", concludes FOX Business.
Gold could hit $3,000 an ounce in the future, almost double its current per-ounce prices, if the U.S. doesn't cut spending and stop flooding its economy with cheap dollars."

8.8.11 -- Gold tops $1,700, investors flee stocks

Gold prices shot up to fresh highs over $1,700/oz. Monday on U.S. credit downgrade, stocks tank on global recession/debt fears. Gold last traded at $1,720 an ounce, silver at $39.38 an ounce
Dow plunges 635 points, sixth biggest drop in history, extending last week's smackdown, with Standard & Poor's downgrade of U.S. credit exacting a heavy toll on already troubled investor sentiment.
In the last thirty days gold sales worldwide surpassed the previous six months combined. Savvy investors understand gold is the ultimate currency and store of value in a world awash in debt, led by the U.S. government, Federal Reserve several EU countries.
Former Fed Chairman Alan Greenspan told CNBC Sunday, "there is no chance of a U.S. default" because the Fed can print unlimited amounts of money to prevent it - in essence, to attempt inflating the debt crisis away.

Europe Must Federalize and Monetize (i.e. Become Like the U.S.)

by Alpha Oculus Worldwide News

Dear Reader,

With each passing day, markets seem to get wilder and woollier.

This is only natural after a long, calm stretch. Volatility expands and contracts like an accordion. Mildness begets wildness and so on.

The sharp declines are also a function of harsh reality asserting itself. As we have said many times in these pages, the stimulus never actually worked (in terms of getting the U.S. economy going again). Corporate profits were pumped up, but unemployment levels and heavy household balance sheets were not addressed.

In fact the short-term solutions put in place, bent on avoiding downturn at all costs, only served to make the long-term danger worse.

And this goes as much for Europe and China as the United States...

In Europe, now that investors have shifted their focus to the bigger periphery countries -- Italy and Spain, rather than Greece and Portugal -- the eurozone crisis has entered a new and more dangerous stage.

Some time ago we argued that Europe is "being held together with duct tape." Now the duct tape is being violently ripped. When questions swirl as to how even Italy will hold it together, the end game is much closer.

All of this affects the United States (and the rest of the world) because financial institutions and trade flows are so deeply interconnected. Last week we saw huge gyrations in the S&P and the Dow keying off announcements as to what the European Central Bank might do.

How will the eurozone crisis finally be solved? Ultimately there are really only three paths:

• Kick some of the periphery countries out of the euro (or let them leave voluntarily).
• Move toward federalization, where Europe gets a central treasury and a unified set of rules (like the United States).
• Monetize the peripheral country debt (buy it up with printed currency).

There is widespread agreement that the first option -- kicking countries out of the euro -- could never work.

Just the threat of such an action is enough to inspire huge bank runs. Depositors who fear their local currency might depreciate 50% overnight on a euro exit, or that their local bank might close, have little reason to leave their savings at risk. In contrast, they have strong reason to transfer their cash elsewhere (into stronger currencies or precious metals).

As the pain gets worse, countries like Greece and Italy and Ireland will be tempted to leave the euro voluntarily. But the terror in that solution is a possibility of Zimbabwe-style fiscal collapse for the country doing the leaving. What would a new Italian lira or a new Greek drachma be worth? Who would stick around to hold onto it?

With the exception of Germany, any country attempting to leave the eurozone -- to swap the euro for their local currency -- would become a financial pariah overnight. Just the hint of such a move would accelerate mass capital flight. Exposed financial institutions would not survive.

And if Germany tried to leave, they would have the opposite problem. A new D-mark would be far too strong, creating the same type of problem experienced by Switzerland and Japan.

When a currency is in strong demand as a safe haven destination, it rises so high that exports are threatened, in turn threatening the whole economy. That is why Switzerland and Japan intervened to push their currencies lower in recent days. A new D-mark would go straight up, and the German export machine -- one of the most powerful in the world -- would be strangled by a euro exit.

That leaves the other options, federalize and monetize. Europe can become more like the United States in empowering a single financial body. And they can get over their inflation fears and start printing euros with which to buy (monetize) debt.

The Germans may not like the Greeks or Italians and vice versa, but, barring the acceptance of temporary catastrophe, there is no way to get out of the deal.

Germany will have to embrace the likes of Italy and Greece fully. They will have to say "Our credit is your credit... Our wallet is your wallet." German taxpayers may scream and yell and threaten open revolt at this prospect.

But what else is there? Where else is there to go, without letting the entire eurozone project turn to ash?

At the same time, the periphery countries will have to accept a permanent loss of sovereignty. Europe will have to move toward one ruling body that makes financial decisions for everyone. And Germany, being the "deep pocket," will call the shots.

At the end of the day, fiscal union is a basic requirement of currency union. You can only get by without it when times are good. When times are bad, the weak points in the system are tested to the breaking point.

It is a really harsh deal for everyone. There is plenty of reason for all parties to be furiously angry.

The Germans will be outraged at the prospect of spending huge amounts of money, conceivably without end and without limit, to prop up their Mediterranean currency partners.

The Greeks and Italians et al. will be outraged that, in exchange for this future flow of money, they will have to hand their financial destiny -- the ability to call the shots on important decisions -- to someone else.

And last but not least, the Germans' heads may nearly explode at the need to accept currency debasement, and the prospect of heavy inflation, in order to save the euro currency experiment from fatal disaster. The Bundesbank attitude that says "no inflation at all costs," deeply embedded in the DNA of the European Central Bank, will have to be abandoned.

It's an extraordinary situation. The changes being forced on Europe -- changes forcing it become more like the United States -- run so against the grain that politicians and the populace would NEVER accept them under normal circumstances. Not in a thousand years.

Now, though, the other avenues are all closed off... apart from letting Europe stumble into a "Lehman 2.0" event and total chaos.

Warm Regards,

Alpha Oculus.