Vicious circle

The decision of the international credit rating agency Standard and Poor’s to downgrade the United States’ sovereign credit rating  has sent shockwaves across the world. It is a vote of no confidence in the ability of the government of the country, which has the world’s biggest  economy,  to pay back its debts. US bonds were considered risk-free all over the world and after a century of strong standing they will no longer be the most preferred instrument for public investment. Obviously this has long-term implications not only for the US economy but for international markets. There are also chances of a further downgrading,  though not in the near term. The serious question marks that have been raised about the US supremacy in economic and political terms will not easily go away.

The S&P’s decision had more to do with the US government’s ability to finance its debts  and the  political brinkmanship seen last month over raising the country’s debt ceiling than with the state of the economy. But both are intrinsically linked.  The US is still grappling with the 2008 meltdown and instead of a full recovery it may be heading towards another recession.  Many of the Eurozone economies are in dire straits.  Since the downgrade will make borrowing costlier for the US it will be unable to raise public expenditure which is necessary to ward of another recession. Social security spending  will have to be cut and this will create political problems. Apart from the debt-happy ways of the US public and government, it was the defence spending, especially that related to the wars in Iraq and Afghanistan, that has led to the present crisis.

The situation again demands a review of the status of the US dollar as the world’s reserve currency. China has already demanded it and the present troubles may accelerate the search for alternatives. The downgrading may lead to a reallocation of portfolios by governments and central banks which now hold US bonds, and it may lead to global churning and weakening of the dollar. This will have consequences for world trade, including on India’s export and import numbers.  India’s financial authorities  have played down the possibility of major consequences for the country,  but in a world of interlinked economic and financial forces,  an adverse impact can not be wished away.