Why the U.S. Downgrade Matters

The global economy is descending into a tailspin… mainstream share portfolios have been hammered… and the Aussie dollar has dropped 10% in less than two weeks.

Just when you thought things couldn’t get any worse…

Get ready, dear reader…

Because tonight the busy-bodies and sticky-beaks are set to descend in hordes… sticking their noses in where they’re not wanted or needed.

We refer, of course to the Census.

Fortunately, your editor and family won’t be at home tonight, so we don’t need to fill out their intrusive form.

Yet, the little Oompa Loompas bashing on millions of doors tonight aren’t the only busy-bodies straying where they shouldn’t.

We noted with amusement the joint statement from the G-7.  You can read the full text here.  But here are a few choice snippets:

“In the face of renewed strains on financial markets, we, the finance ministers and central bank governors of the G7, affirm our commitment to take all necessary measures to support financial stability and growth in a spirit of close co-operation and confidence…

“We are committed to taking co-ordinated action where needed, to ensuring liquidity, and to supporting financial market functioning, financial stability and economic growth.”

Despite everything that’s happened, they still don’t get it.

The whole reason the market is in such a mess is because of “finance ministers and central bank governors… taking co-ordinated action…”

They’ve fiddled with the market for decades and what you’re living through now is the result of that meddling.

Looking to divert the blame

Not that they’ll ever admit it.

There are others to blame… apparently.

Such as… Standard & Poor’s – the ratings agency.

As you know, we’re no fan of ratings agencies.  But it’s pleasing to see they’ve finally done their job – downgrading U.S. debt.  It follows the downgrade of European sovereign debts – Greece, Ireland, Portugal, etc…

But certain people aren’t happy.  As Dan Denning, editor of the Daily Reckoning noted this morning:

“In Italy, prosecutors have raided the offices of Moody’s and S&P and seized documents.”

Meanwhile, in the U.S., the Washington Post reports:

“A Senate Banking Committee aide says the Democratic-led panel is gathering information on Standard & Poor’s decision to issue the first-ever downgrade of the government’s credit rating.”

Hmmm, perhaps the government is getting revenge on S&P for getting revenge on the government!

All we know is it’s a stinking great mess with governments and central bankers doing all they can to hold on to power.  Trouble is, the more they tighten their grip, the more pain is inflicted on the average Joe and Joanne Punter.

Zombie commentators still don’t get it

But don’t worry.  According to the zombie mainstream Australian press, there’s nothing much to worry about.

Our old pal, Michael Pascoe at the Age wrote yesterday:

“The single-notch downgrade of the United States’ long-term debt by Standard and Poor’s makes for lots of impressive headlines, but it doesn’t actually mean all that much in the short-term – just a historic market along the way of a great power’s slide.”

His Fairfax Media buddy, Jessica Irvine must have attended the same briefing yesterday morning.  She wrote:

“So in the short term, the credit downgrade potentially means next to nothing.”

And finally, over at Business Spectator, Alan Kohler had this to say:

“It’s impossible to predict how markets will react to the huge psychological element of Saturday’s downgrade, but the reality is somewhat less huge.”

Since the “Australia is different” crowd published their thoughts yesterday morning, the Aussie stock market has officially crashed.  Let’s not beat about the bush here.  Stocks have taken an almighty beating.

In fact this morning, the S&P/ASX 200 index is at 3,781.  The market is now just 16% above the March 2009 lows.

Make no mistake, the downgrade of U.S. debt is important.  No investment is isolated.  Every investment anywhere in the world is risk-rated to every other investment.

Normally, when one asset class is re-rated it doesn’t make much difference to other sectors (although it still makes some difference).  But when the re-rated asset is the global benchmark for all other assets, contrary to mainstream opinion, it’s a huge deal.

This is Investment 101 stuff.  To say the rating on the benchmark asset class can change without it causing ructions is simply wrong.  The action you’ve seen in the market the past two days proves that.

Investors now have to figure out the relative risks of every asset and work out if it’s overpriced or underpriced.  They have to decide if the U.S. bond market is still a haven for investors.

Some will decide it is.  But others will decide it isn’t.  In that case, where do they go for safety?

We don’t know the answer to that.  We do know two things: first, it creates huge volatility as investors reassess the market.  And second, we can sure say they won’t flock to the Aussie dollar.  The price action in the Aussie dollar versus the U.S. dollar is proof of that – it’s back to parity as we write.

And that’s not all…

Early warning signals going mad

Our Early Warning Signals have gone berserk… the U.S. VIX index soared 50% last night to end the day at 48 – a level not seen since early 2009.

The Aussie dollar has continued to slump against the Swiss Franc – the Aussie dollar’s supposed haven status is looking weaker (and sillier) by the minute.

And the gold price has taken off.  Not only has the U.S. dollar gold price surged through $1,700, but the Aussie dollar gold price has quickly followed.

It’s a good job the U.S. downgrade isn’t significant!  And it’s a good job Australia has China to fall back on!  Not.

Yesterday we wrote to you saying to get set to buy cheap stocks.  This morning, those stocks – including the ones we’ve got on our watchlist – have gotten much cheaper.

The market remains as risky as heck.  And just as we’ve warned for the past two years, it’s not the place to store your life’s savings.

But now you’re flooded with cash, buying a select number of cheap stocks over the next few weeks makes a lot of sense.  But only if you’re comfortable taking risks. If not, stay in cash and bullion and wait for the volatility to ease.

The way we look at it, if you don’t like taking big risks there’s no harm staying on the sidelines.  If you miss the first 5-10% of a rally, it’s not a big deal.  At a time like this, capital preservation is more important for the risk averse.

Cheers.

Kris Sayce
Money Morning Australia

Kris Sayce

Kris is never one to pull punches when discussing market developments and economic events that can affect your wealth. He’ll take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money. Kris is also the investment director for Australian Small-Cap Investigator, Diggers and Drillers and Revolutionary Tech Investor. If you’d like to more about Kris’ financial world view and investing philosophy then join him on Google+. It’s where he shares investment insight, commentary and ideas that he can’t always fit into his regular Money Morning essays.

Read more about Publisher and Investment Director Kris Sayce.

40 Responses to “Why the U.S. Downgrade Matters”

  1. j.a.w.cathcart@gmail.com'

    J.C.

    2011-08-09T17:37:56+00:00

    TRB@20,
    Actually I don’t think the gold bugs are cocky at all. I think that they’re rather dismayed at what’s happened over the last few days. Personally I don’t know any gold bugs who would be surprised at a major correction in the gold price. In fact, quite a few that I know are expecting it. In fact, the dangers of GOLD ETF on the gold price have long been highlighted here. But it’s all beside the point.
    You say QE3 will be bad for gold. I say nonsense. That will ultimately be very supportive of the gold price, not that the mainstream will have a bar of that notion.

  2. macca24@hotmail.com'

    macca

    2011-08-09T17:47:37+00:00

    gold $2000 by year end

  3. 2000@yahoo.com.au'

    Triune Rational Brain

    2011-08-09T17:57:26+00:00

    JC you think QE3 will be bad for gold is nonsense.
    Well J.C. welcome to counter intuitive thinking QE2 gold went nowhere as you well know.
    J.C gold went nowhere in GFC of 2008 please no nonsense it was not a safe haven US dollar was!
    All you gold bugs think QE3 is going to push gold higher then J.C. should be buying more put 100% of your assets into gold if you are so sure.
    Many people have said my comments are nonsense J.C. then I know I’m on the right track, all you gold bugs think FED is in control going to keep money printing, you never stop and think just maybe Mr Market had enough of the Benanke side show time to really discipline the nutters with higher interest rates.
    I say J.C. bring on the bond vigilantes,Tea Party and a minsky moment a perfect storm.

  4. asbestos@ihug.co.nz'

    KP

    2011-08-09T19:16:02+00:00

    The demand for gold will push the price up it appears, never mind the devaluation of the pieces of toilet tissue. More demand but no way of increasing supply-

    http://globalwarming-arclein.blogspot.com/2011/08/gold-production-stalled.html

    Everyone sorting out if they’re a citizen or a subject?? Filling in your census forms or burning them? Reminds me of that lovely truism-“”An armed people are citizens, an unarmed populace are subjects””

  5. j.a.w.cathcart@gmail.com'

    J.C.

    2011-08-09T19:18:11+00:00

    TRB@23,
    OK, maybe QE1,2,3,…n is unrelated to the gold price. My gold appreciated during GFC I, but I know the media is happy to report about gold going nowhere in AUD. It went up yesterday though. I’m still happy hanging with the nutters.

  6. wolframtrader@yahoo.com.au'

    The Wolf

    2011-08-09T21:50:35+00:00

    TRB… there you go again banging on about gold going nowhere during QE2… in AUD… ho hum… flimsy argument… if QE3 is enacted, you are simply adding more $T to the already packed to the gunnels financial system… which doesn’t need more $$… it needs to unwind…not be wound up…

    Having had an armchair ride on this latest cratering of markets (living in the US)… it still seems incredible to me that SO MANY “experts” have abso-frikkin-lutely no idea what drives the markets… it has been and always will be about leverage… the sell off is not a “S&P downgrade” panic… or a “debts we can’t pay back” fear… it is ONLY about the leverage in the system borne out by government debt costing six tenths of five eights of f**k all… and then a little fall precipitates one margin call that pulls in another and then another… it is simple…really truly simple… when we encountered this in 2007… ie. too much debt… we fixed it with…adding more debt…

    bb@17… if there was a mass exodus from “risk” assets to “safe” assets within the superannuation system, then bond prices would rise steeply, yields would fall dramatically…and people would be thinking about how they could live off of a 2.5% yielding note, which was previously double that… and the mum and dads would be asking their financial advisor who put their $300,000 into 5.5% paper why they only get chq’s for $7500 each year and not $16500…

    And having missed some of the rugby jibes… PF… got your back… I can say that since 1988…over the last…I dunno… what’s that… 22 or so years…the All Blacks have been probably the most accomplished and polished team ever seen…. in between World Cups… but something about every four years that turns the men from the land of the long white cloud into meek mice… :-)

  7. wolframtrader@yahoo.com.au'

    The Wolf

    2011-08-09T22:03:59+00:00

    http://www.zerohedge.com/news/central-bankers-dilemma-bubble-chart

    From our friends at ZH…

    Bloomberg has come out with the most succinct and descriptive chart summarizing the “Central Bankers’ dilemma” in which everyone is currently caught in either of four states: inflation, stagflation, recession and debt trap. Nobody wants to be in the lower left or the top right. Unfortunately, America’s future is precisely one of the two, and anything the Fed does will only accelerate America’s adverse transition appropriately.

  8. j.a.w.cathcart@gmail.com'

    J.C.

    2011-08-10T06:28:26+00:00

    TW@26,
    Maybe TRB has a point and isn’t the first to note that there are periods where AUD outperformed gold during the last few years. There does seem to be popular support for AUD as some kind of ultra-currency due to the economy’s commodity base and trade relationship with China. Before this latest shock, that seemed to be the prevailing view among the mainstream.
    Perhaps gold is simply driven by myth making and its exalted status as a store of value is absurd at best. I, for one, most definitely don’t discount that view. But while the mainstream continues to promote that position, I’m happy to hedge my bets.

  9. wolframtrader@yahoo.com.au'

    The Wolf

    2011-08-10T08:07:24+00:00

    http://www.zerohedge.com/news/must-read-ubs-andy-lees-why-us-economy-doomed-if-nothing-changes

    Awesome read…

    JC…understood… the price of gold as measured in AUD was not considered in the remit of QE2… I could say that my stockpile of $2kg frozen banana’s outdid gold in AUD terms during QE2… it means about as much…

  10. wolframtrader@yahoo.com.au'

    The Wolf

    2011-08-10T08:14:44+00:00

    JC… in hedge fund / banking terms… the AUD is considered a play on China… nothing more nothing less… it is also a nice place to park some capital and pick up reasonable interest rate…however that market is tiny in the overall scheme of things (c’mon Swannee… print a few $T !!)

    Everyone (countries, ppl, companies, etc) suffers from delusions of grandeur… in Australia, we naturally attribute outperformance to something we are doing differently… and the attribute underperformance to the “international markets”… we are but a mere pimple on a gnats ar$e…

    Am with you 100% on PM… have been in the accumulation phase… and will continue to be…

Leave a Reply