AAA Credit

What the US debt kerfuffle is revealing is an interesting end game re true AAA debt. Even if the US successfully kicks this current can down the road, US sovereign debt can no longer be considered truly AAA safe. Which raises a serious problem for the global credit markets. If US Treasuries aren’t AAA, what bond issuer on Earth IS? And what will happen to such AAA bonds if/when the US gets formally downgraded?

As to the first question, the list is teeny. The universe can only be sovereign bonds of sovereigns who have very comfortable total debt limits and who are also comfortable with their currency skyrocketing in value relative to other fiat currency issuers who may debase their currency in order to pay off debt. And companies that are both financially strong enough to merit a AAA and are also global enough to avoid getting hammered by confiscatory taxes in those countries that may confiscate their way to a balanced budget or debt reduction. Among the sovereign issuers — Australia, Denmark, Finland, Luxembourg, Norway, Sweden, and Switzerland. Followed at the true AA+ level by Netherlands, Austria, and perhaps Canada and Germany. Chile would be AAA as well except that it has no government debt. Among corporate issuers — Johnson and Johnson and KfW (a German bank). That’s it.

AAA rated bonds — accurately rated AAA — are the core of global credit markets and credit creation. Anyone who is issuing credit to anyone needs some “riskless” asset against which they can measure/rate the risks of the credit to someone riskier. Riskless bonds also serve as the collateral/reserve for, literally, the entire global economy. The countries I’ve listed above are teeny. The US’ current AAA rating – along with the UK and the core Eurozone – have provided that credit foundation for the growth in the global economy for decades. If those sovereign bonds become less than AAA, then “globalization” itself loses its foundation.

That’s the real deflation we face. Global trade/finance becomes much riskier because it is based on less-than-AAA credit. The bubbles, crashes, panics, liquidity injections (resulting in commodity inflation), etc are merely the manifestation of that riskiness. If global trade/finance instead becomes based on a smaller pool of true AAA credit (countries above plus AU), then it will shrink dramatically. And until time passes and large economies can delever and become truly AAA again; then nothing CAN fundamentally change. It is why this sort of deflationary “cycle” can last so long – think decades.

What will happen? Globally, those AAA credits (and gold – as an asset with no liability risk attached) will rise in value. They are the “last man standing” – under any and all investable scenarios and so will attract whatever credit needs a riskless foundation. The only true “sleep at night” credit. Their value is NOT going to be merely the “price” or the “income yield” of the asset. Rather, their value is that they are the only source of riskless credit/leverage. That value will not be apparent most of the time – but when it does become apparent it will become glaringly apparent. To the degree that that pool of AAA credit is simply too small to support a global economy, then investment will overflow to riskier credit – but that will be erratic and depend on news flow and such.

For more details – read Nicolai Kondratieff, Joseph Schumpeter, Irving Fisher, Hyman Minski, Melchior Palyi, Antal Fekete. This is not mainstream economics. Then again, mainstream economics has been a colossal screw up for a few years — and everyone knows it.

On edit: After close of business today, the Chicago Mercantile Exchange issued a new set of guidelines re margin collateral. Short-term Treasuries will from now on get a “haircut” (0.5%) when used as collateral. This haircut will get larger over time. Which will in turn reduce the amount of leverage that is possible and the amount of credit that is made available. It will affect margin credit, bank credit, derivatives credit, trade finance credit, everything. This particular move is small but the direction and future moves are inevitable.

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