What’s This AA+ on Your Report Card?

A Primer on the Nation’s New Credit Rating

Saturday, August 13, 2011

In the long term, it is possible to understand the economy. Production, growth, revenue, and debt all fluctuate according to financial principles that can be understood—as long as we are looking backward.

It is only when we try to understand short-term economic changes that we encounter the type of uncertainly that leads to anxiety. This is actually considered normal because, in the short term, the economy suffers day-to-day mood swings that are controlled by two important emotional forces: fear and greed.

Harley Hahn

One of the most important economic forces in the world is what we call sovereign debt. Indeed, sovereign debt is so powerful that it can, under special conditions, create so much fear or greed as to cause massive waves of anxiety or elation to sweep through the world within hours.

The term “sovereign debt” refers to money that is owed by a country as a whole. For example, when the U.S. Treasury borrows money by selling bonds, it has the effect of increasing our sovereign debt. When the government raises the “debt ceiling,” it allows the country to increase its sovereign debt by borrowing more money.

As you know, in the U.S., your credit worthiness is rated by three different companies (Equifax, Experian, Trans Union), each of which awards you a specific credit score. If your score is high, you pay less interest on what you borrow.

A similar system is used for sovereign debt. The countries with the highest credit ratings pay the least to borrow money. If a country’s credit rating goes down, it is forced to pay more interest to borrow money. That interest comes directly out of the national budget, which can put a significant strain on the country’s economy.

This raises an interesting and important question: How many countries in the world actually have the highest possible credit rating? Here is how it works.

There are three companies that rank the credit worthiness of countries. These companies are:

• S&P (Standard and Poor’s)
• Moody’s
• Fitch Ratings

Each of three companies publishes its own independent ratings. Thus, to understand the credit worthiness of a country, we need to look at what all three companies have to say about sovereign debt of that country.

The three companies each use their own particular rating system. However, they all use the same designation, AAA, for the top countries.

To discover which countries have AAA ratings, I went to the Web site for each company and hunted for the latest rankings for long-term sovereign debt. I then extracted this information and eliminated all but the AAA countries. The results are shown in the table below.

The countries with AAA ratings are marked with an “X.” As you can see, not all countries are considered AAA from all three rating companies. In particular, the U.S. has a AAA ranking from only two of the three rating companies.

S&P Moody’s Fitch’s
Australia X X -
Austria X X -
Canada X X -
Denmark X X X
Finland X X X
France X X X
Germany X X X
Guernsey X - -
Hong Kong X - -
Isle of Man X X -
Liechenstien X - -
Luxembourg X X X
Netherlands X X X
New Zealand X X -
Norway X X -
Singapore X X X
Sweden X X X
Switzerland X X X
United Kingdom X X X
United States - X X

In the entire world, there are only 11 such countries with AAA ratings from all three companies. Compared to these 11, all the other countries in the world pay more to borrow money.

• Canada
• Denmark
• Finland
• France
• Germany
• Luxembourg
• Netherlands
• Singapore
• Sweden
• Switzerland
• United Kingdom

For decades, the U.S. was a member of this rarified club. However, on August 5, 2011, S&P lowered the United State’s long-term credit rating from AAA to AA+. This action created substantial fear among investors all over the world, resulting in severe short-term “mood swings” in the global stock markets.

To make sense out of all this, all you have to do is tease out the emotional problems from the financial problems:

The U.S. does have important, long-term obligations that will, in the fullness of time, need to be rebalanced. Realize, however, that in the short-term, very little has actually changed. The United States on August 6, 2011, was pretty much the same as it was on August 5.

What did change was that investors around the world became a lot more fearful, creating a significant amount of anxiety and a huge “mood swing.”

The anxiety, however, will pass. In the meantime, if you want to make money, with so much fear in the air now is the time to be greedy.

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