S & P has announced that they could downgrade the sovereign rating another notch if the United States does not clean up its act. The credit rating agency downgraded the US from AAA to AA+ on Friday August 5th 2011 for the first time in history, and the outlook is bleak. Although it has been discovered that there was a $2 trillion accounting error in S&P’s report that led to the downgrade the agency is standing behind its decision.

For the United States to regain its top rating the country would have to reduce the national debt and stabilize the economy. This does not look likely in the near future as Washington has been in a deadlock over debt reduction policies. The Republicans want reductions in spending while the Democrats are unwilling to compromise without similar increases in taxes.

This downgrade has led to a lack of confidence in all areas of the economy. The Dow Jones fell 5.56% or 634.76 points, the NASDAQ dropped 6.9% or 174.72 points and the S&P 500 fell 79.92 or 6.66%. This was the biggest single day loss for the Dow since 2008. S&P also downgraded Fannie Mae, Freddie Mac, and Federal Home Loan Bank’s credit rating to AA+ from AAA. Berkshire, an insurance company owned by Warren Buffet, had its outlook downgraded from neutral to negative. Oil is at $81.31 a barrel and gold has surged to $1714.09.

This could be the beginning of the second part of a double dip recession that could completely rock the world economy. Many of the tools that countries used to get out of the recession in 2008, such as decreasing interest rates and stimulus spending, will not be available for another round. Interest rates are already almost zero in most OECD countries, and there is no one left to borrow money from.
Alan Greenspan, former Chair of the Federal Reserve, has suggested that the United States will never default, because they can simply print more money. If they were to do so it would devalue the American dollar, which would essentially result in losses for firms and countries holding on to American debt. For example, China holds $3.718 billion of the US debt. The yuan trades at 6.4263 per dollar. If the value of an American dollar were to be devalued, the Chinese would get less yuan per dollar of debt they owned. Theoretically they could go from having 23.89 trillion yuan at a rate of 6.4263 per dollar to 16.73 trillion yuan at a rate of 4.5 yuan to the dollar. I am not claiming that this is what the American dollar will fall to; it just demonstrates the impact of the move.

Devaluing the American dollar will destabilize the world economy and will destroy the wealth of anyone who holds their assets in dollars. It would also cement the downfall of the United States as the world economic hegemon.

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