International Investors Weigh Options After U.S. Downgrade

BY Larisa Epatko  August 8, 2011 at 4:15 PM EST


Trader at Frankfurt Stock Exchange. Photo by Ralph Orlowski/Getty Images

The latest U.S. economic woes could be wielding a larger impact overseas if it weren’t for two things: a lack of foreign investment options for U.S. dollars and the economic problems of other regions of the world, some analysts say.

Markets, which took a dive on Monday, will likely continue to be volatile this week as people digest the implications of changes in the U.S. credit rating and other economic indicators, said Wayne Arnold, an Asia strategist and Breakingviews columnist for Reuters who is based in Hong Kong.

For the first time, credit rating firm Standard & Poor’s decreased the United States’ rating one notch from triple-A to AA+ on Friday night.

The move was not entirely unexpected: S&P had put the U.S. on a credit watch in July while Congress was debating raising the nation’s debt ceiling.

“There’s a lot of speculation that this might cause a great unraveling in credit markets, but I don’t think that’s going to be the case,” said Arnold.

Central banks around Asia are expressing support for U.S. treasuries “and basically confirming what people had realized two weeks ago that the rating doesn’t really matter when you’re talking about how to manage and where to invest $10 trillion in a global foreign exchange reserves,” he said.

Countries have few options for where to invest U.S. dollars, besides U.S. treasuries, so while they might lament their situation, “there’s really not much for them to do other than keep buying,” he added. “As a matter of fact, there’s an argument where they should buy more, because they don’t want the value of their existing holdings to go down.”

Catherine Mann, a professor of global finance at Brandeis University, agreed that global investors don’t have a lot of choices.

Emerging markets are still very small, she said, and other parts of the world are experiencing their own economic problems, namely Japan’s tsunami and nuclear plant problems and Europe’s own rolling sovereign debt crises.

“I think that if the rest of the industrial world were on more healthy footing, we would have seen much, much more consequences as reflective in the dollar and in financial markets than we actually observed,” said Mann. “We are lucky that everybody else is in at least as bad shape as us.”

Joseph Gagnon, a senior fellow with the Peterson Institute for International Economics, pointed out that Japan’s credit rating was downgraded years ago and it didn’t seem to have much of an effect. It can still borrow at a lower rate than the United States.

People have a tendency to rush to extremes when regarding the United States economically, he continued. “If a country has problems, it’s suddenly weak and it’s declining. And if it has a few good years, then it’s ‘America the superpower.’”

“There’s an economic silver lining if it means the dollar weakens and we get more exports.”
Joseph Gagnon, Peterson Institute for International Economics

Gagnon said a possible positive ripple effect is that if people buy fewer U.S. treasury bills, the value of the dollar declines and people will buy more exports, which would help boost the U.S. economy.

“It’s not good to be underestimated in the world opinion — it might lead to geopolitical problems if they think we’re weak,” he added. “But there’s an economic silver lining if it means the dollar weakens and we get more exports.”

What might have done more damage to how other countries view the United States was the debt ceiling debate, said Arnold.

“I think what was interesting about the debt ceiling debate wasn’t that people lost faith in U.S. creditworthiness or U.S. debt, specifically U.S. treasuries, but what was interesting to me was that it underscored how the political system in the U.S. seems to be deadlocked,” he said. “That’s what I think has scared Asian investors the most is there’s a group in American politics that I don’t think [investors] are altogether familiar with that seems willing to hold the U.S. economy hostage. And that’s a very frightening prospect for the rest of the world because the U.S. economy is so important.”

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