US Takes a Tumble

The following is the first in a three part series about the US downgrade and the effects it will have on the consumer, investor, and economy.

What does the downgrade mean to me?

Friday evening after markets closed, the S & P (Standard and Poor’s) downgraded the US Credit Rating from AAA to AA+. Everywhere you look it seems that this is spelling catastrophe for the investor and consumer alike. However, let’s take a deeper look into the downgrade and what actual effects it has on the average American.

The Risk of Risklessness.

For a long time, the United States’s debt has been seen as an instrument of riskless investment. In fact, the US treasuries have set the precedent for the risk free rate. For the S & P to downgrade the US Debt rating, it would appear that investors are recognizing that the US potentially contains some default risk.

While any investment inherently contains some risk, it is generally accepted that US debt is a safe haven for money. This downgrade, however, has put that general assumption into question. With that said, nothing has really changed. The debt ceiling is still raised, politicians will still philander, and the US will continue to mint dollars to pay its debt. The downgrade hasn’t changed the balance sheets of the American Consumer or the government for that matter. It has no “physical” effect on the United States ability to pay its debts or sell debt instruments. Think of this downgrade as a bruise. The damage to the body has already been done, and what we’re seeing are just the cosmetic effects.

What we may see is that interest rates eventually will inch higher because a credit downgrade, which essentially increases the United State’s cost of borrowing. However, because the US is still widely seen as a “safe haven” it is doubtful we will see any real increase in cost of borrowing to the consumer:

• Mortgage rates are typically tied to Treasury yields which are at historic lows.

• Credit card rates tend to follow the prime rate, which the federal reserve has given no indication of raising any time soon.

Then why the stock market crash?

On the word of a downgrade, we saw the stock market loose significant points. With that said, any real cost to consumers will take months to be felt.

The stock market is a generally good indicator of investor confidence and overall market/economic health. What we saw today was a reaction of investors to the overall health of the economy. A good example would be the decline in oil to just over $81 a barrel. The price of oil went down on the speculation of a decrease in demand, not an actual demand decrease. The same thing happened with the majority of declining stocks on Monday.

If not this, then what?

Until we can see the actual effects of increase cost in borrowing, the pressure investors and consumers will feel will come from the slowly growing economy. The job markets will not take a change for the worse solely because of the downgrade. What we will see is a decrease in consumer uncertainty which could decrease spending and lead to cuts in the job market. With the economy already reeling from the last recession, if we were to see a “double-dip,” the impact would be very dramatic. Businesses and consumers alike are already running lean. Another wave of spending woes would leave them with next to nothing to trim down.

Thus, as a consumer and investor you have little to feel directly from the downgrade. What we’re feeling right now is the market’s reaction to the possibility of another recession.

In the next part of our three part series we will examine whether or not there will be a double dip recession. And, if there is a recession how will it compare with the last.