The West Loses Its AAA… Sort Of

by Addison Wiggin & Ian Mathias

  • A fitting first blow: U.S. has its credit rating cut… by China!

  • A closer look at ratings agencies… who exactly decides which can be trusted?

  • Chuck Butler’s latest global interest rate and currency forecast

  • In spite of reports to the contrary, banks still not lending… just playing with accounting rules

 

  Breaking news: As we’ve been forecasting for some time, the U.S. has been stripped of its AAA credit rating. So have Britain, France and Germany…

The great reckoning has begun… let your crash flag fly!

Wait a second…this one’s a fake.

Like an iPod nano purchased at the Pearl Market in Beijing, this credit rating downgrade will stop working before you even get it home.

When we were in China last month, we had a chance to fire Chinese-made M-16s and AK-47s. The Chinese are reverse-engineering the weapons and mass-producing them. Heck, if the U.S. and Russia are making money in the global arms trade, why shouldn’t China get a piece of the action?

The same logic apparently applies to the global credit markets, too.

  This morning, the Dagong Global Credit Rating Co., China’s first real attempt at a ratings agency, initiated coverage on the sovereign debt of 50 different countries.

“Dagong’s sovereign credit ratings are based on the new sovereign credit rating standard created by Dagong,” the Dagong report explains in a perfectly logical, if circular, fashion.

Dagong analysts claim to give a greater value to nations with the best “wealth-creating capacity” and biggest foreign reserves. They strive to “not be affected by ideology,” insisting that “it is the newly-created social wealth that supports the national funding capacity and constitutes the primary source of debt repayment.”

Here’s how global debt looks when expressed in terms of the agencies’ outlook for each of the top 20 countries’ currency.

Not bad at all. If anything, we note this is yet another subtle shot across the bow from the Far East… they are not nearly as ignorant as most Westerners will them to be.

  Who on Earth is going to buy such circular logic and take these ratings seriously? C’mon.

If the Chinese are serious about this game, they should do it the way the SEC does here in the U.S. Let’s see what real criteria they use to determine if an agency can issue credible credit ratings:

“The single most important factor in the Commission staff’s assessment of Nationally Recognized Statistical Rating Organizations (NRSRO) status,” reads the SEC’s website, “is whether the rating agency is ‘nationally recognized’ in the United States as an issuer of credible and reliable ratings by the predominant users of securities ratings.”

Hmmmn…

“The [SEC] staff also reviews the operational capability and reliability of each rating organization. Included within this assessment are… the rating organization’s independence from the companies it rates… the rating organization’s rating procedures (to determine whether it has systematic procedures designed to produce credible and accurate ratings)…”

Ha! Take that, you Chinese credit raters. The SEC is the decider!

Only 10 organizations in the world are labeled a Nationally Recognized Statistical Rating Organization (NRSRO)! Any worldly company that wants to both utilize a credit ratings agency and comply with U.S. financial regulations has to use one of these NRSROs… thereby making any alternative ratings agencies mostly irrelevant, regardless of the quality of their ratings.

So there.

Of the 10 sanctioned NRSROs, seven are U.S. companies. Naturally. Two are Japanese, and one is Canadian. But we’re pretty sure these last three don’t count. Clearly, no other country in the world is capable of accurately assessing credit conditions.

Sorry, Dagong Global… wrong country, wrong era. We hear the U.S. Congress is trying to amend this, but you know how that goes.

  Moody’s (one of the REAL credit agencies) cut Portugal’s credit rating two notches this morning.

A savvy combination of dart throwing and dice rolling gave Moody’s analysts the rating of A1 — their fifth highest sovereign credit rating. Portugal had maintained its previous rating since 1998, despite a budget gap of over 9% of GDP this year. (Interestingly, that’s the best of the GIIPS nations.) 

  “As future bond issuers belly up to the bar with their rating agency seals of approval,” PIMCO’s Bill Gross wrote earlier this year, “it is incumbent on the buying public to treat those IDs with a healthy skepticism. Firms such as PIMCO with large credit staffs of their own can bypass, anticipate and front-run all three, benefiting from their timidity and lack of common sense. Take these recent examples, for instance: S&P just this [April] downgraded Spain “one notch” to AA from AA+, cautioning that they could face another downgrade if they weren’t careful. Oooh — so tough! And believe it or not, [up until May of 2010] Moody’s and Fitch still have them as AAAs. Here’s a country with 20% unemployment, a recent current account deficit of 10%, that has defaulted 13 times in the past two centuries, whose bonds are already trading at Baa levels and whose fate is increasingly dependent on the kindness of the EU and IMF to bail them out. Some AAA!”

That’s the biggest bond manager in the world publicly mocking the ratings establishment. How much longer can the status quo last?

  Perhaps the stock market is finally wising up to sovereign rating — or rating agency — irrelevance.

The S&P 500 opened up over 1% this morning, in spite of the Moody’s cut. Traders are in the buying mood thanks to a good start to the second-quarter earnings season. Alcoa, BMW and CSX all beat earnings in the last 24 hours.

  In a clear and distinct corollary, good news for stocks is bad news for the dollar. The dollar index is down about half a point from yesterday’s high, to 83.9 as we write.

  On the other hand, here’s some more good news for the Canadian dollar:

“Two Bank of Canada surveys released this morning indicate an improvement in lending conditions from both a borrower's and a lender's perspective,” Chuck Butler reports. If you haven’t been following his Daily Pfennig (shame!), Chuck’s referring to the Bank of Canada’s second-quarter 2010 Business Outlook Survey and Senior Loan Officer Survey.

“Both indicated that credit conditions are easing. Both reports also suggested that there is

strengthening in economic conditions and that the availability of credit improved in the second quarter…

“Having this kind of feeling about the domestic economy and the ability to lend and receive loans is the final nail in the rate hike coffin for the Bank of Canada next week. I fully expect them to raise rates 25 bps (1/4%), to 0.75%, at their July 20 meeting.

“The Canadian dollar/loonie isn't reacting positively to this news, though, as the currency has backed off its three-day rally. That's OK… It just means that buyers get a chance to buy at a cheaper level than yesterday!”

  “Lenders should do all they can to meet the needs of creditworthy borrowers,” Fed Chairman Ben Bernanke suggested helpfully at a conference in Washington last night. While credit in Canada is loosening a bit, “credit conditions remain very difficult” in the U.S., Mr. Bernanke reports.

Funny how credit gets tight in a post-binge bust.

  “Total bank loans have, indeed, grown,” GoldMoney’s James Turk comments, following up on a bit we cited back in June, “but not because banks made new loans. Instead, the increase was a result of pure accounting.

“On April 1, 2010, the accounting rules for banks changed. Credit previously extended in the form of derivatives booked off bank balance sheets now has to be accounted for on a bank’s balance sheet. Thus, in accordance with rule FAS 166/67, banks brought about $300 billion of assets and liabilities onto their balance sheets in April. This was credit already extended.

“Contrary to earlier conclusions, bankers are still sitting on their hands. They are not making new loans, when taking into consideration the bookkeeping change. Bankers are still trying to repair their own overleveraged balance sheets,” a task that is going to take a lot of time yet.

  The FDIC closed four more banks over the weekend, bringing the annual total to 90.

  Glory be, U.S. state governments enjoyed their first rise in tax revenue since 2008, says a report today from the Nelson A. Rockefeller Institute of Government. Tax receipts for states rose 2.5% in the first quarter, year over year. That hasn’t happened since the third quarter of 2008, on the eve of the Panic.

Curiously, the Rockefeller report interprets the first-quarter increase as a reason for small celebration. The revenue gains coupled with recent data “show an unmistakable improvement in the economy.”

Of course, if you dust off the cover of the report, you’ll see that personal income and sales tax increases in California and New York were the main drivers of the revenue increase. Without them, national tax revenue would have fallen 1.5%.

The executive summary of the report doesn’t explain how increased taxes can be interpreted as an improvement in economic activity. But there you have it. Whoopee!

  Gold is back on the rise. We saw a big drop in late June/early July, stabilization over the last week and now — with the return of the euro debt crisis — gold’s inching back up. An ounce goes for $1,215 as we write.

  “The analysis of the Dow-to-gold ratio was interesting,” a reader responds to yesterday’s 5. “But how about real estate? When I was in high school in the late ’60s, a typical three-bedroom house in suburban Atlanta would have cost as much as 300, 400, 500 ounces of gold, or even more. Now you could easily buy such a residence for the price of 200 ounces.

“Time to buy real estate? You gold bugs and doomsayers really don't want this to get around, do you?

“But maybe printing this would be a public service. If people perceive real estate to be undervalued, they will buy, and the price will go up. We'll be rich again. We'll be able to spend, spend, spend…. and all our problems will be nothing more than a bad memory!

“To paraphrase the Mogambo Guru, this economics stuff is easy!”

The 5: Here’s the chart you seek, courtesy of our friend Charles Vollum, Vancouver perennial, who runs the website pricedingold.com:

By this metric, either houses are historically cheap or gold is rather expensive. The funny thing about trends like this one, however, is they tend to overcorrect. Houses can and probably will get cheaper still… and gold is likely to keep rising. For now.

  “Your item the other week about sea level rise and the melting ice sheets drew some interesting reactions,” our friend — and alumni of the first Chill Weekend — John Englander wrote us yesterday.

You might recall, John offered his unique expertise on the melting of Greenland… complete with a photograph of what Manhattan would look like impersonating a drowned rat.

“As an avid reader/subscriber and Reserve member myself,” writes John, “I know that most of your readers are open-minded, independent thinkers who are on the lookout for good insights and information that has not hit the mainstream press.”

For the record, John’s work is not related to Al Gore, “global warming” in the popular sense or hydrocarbon emissions. He’s almost entirely focused on the economic impact of rising sea level on coastal communities.

“I realize that the data I've assembled about sea level rise are unsettling and require a bit more explanation than The 5 allows. For any readers who want more details, I've prepared a special email, with considerable information from my forthcoming book. If they send a message to agora@johnenglander.net they will immediately receive "Effects of Rising Sea Level on Coastal Real Estate" by auto-responder.

“See you in Vancouver!”

Indeed,

Addison Wiggin

The 5 Min. Forecast

P.S. We had a nice conversation with notable gold commentator and radio talk show host Jay Taylor yesterday. Turns out his son and I share a passion for history and the classics. We both read the Western canon at St. John’s College in Annapolis, albeit several years apart.

If you’re interested in tuning in, Jay and I will be discussing our thesis “deflation now, inflation later” on his program at 3:45 p.m. EST this afternoon. You can listen in on VoiceAmerica Business, right here.

P.P.S. There are a few spots left at our Chill 2.0 excursion to Rancho Santana. If you’re a Reserve member and would like to join us, click on this short video. Our man on the scene, Marc Brown, will walk you through the details of the project:

rspertzel

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