For as long as anyone can remember, American government bonds have been the backbone of the

global investment market. Uncle Sam’s IOUs have exuded the solidity and stability of the powerful
Treasury Department’s imposing headquarters in Washington.
Now, a once unimaginable humiliation seems imminent - American bonds will lose their AAA credit
rating. For most borrowers - nations or companies - that rating is highly prized and jealously
guarded. For the United States it has been seen as automatic, but it is now being thrown away in a
piece of economic and financial self-harming of epic proportions.
Congress and the White House are locked in a struggle over cuts to the deficit - the annual amount
borrowed by the federal government. It is this bitterly contested issue that has dominated the
headlines and raised the prospect of a default on Tuesday should there be no agreement between
President Obama’s Democrats and the Republicans.
But the looming loss of the AAA rating relates not to the immediate deficit, but to the failure of
America’s rulers to draw up a long-term plan to get on top of the total national debt. This currently
stands at an astonishing $14 trillion (£8.75 trillion) and counting. Quite an achievement considering
that Bill Clinton left office in 2001 with a zero deficit.
And if you thought all sides - Congress and the White House, the Democrats and the Republicans -
were far apart on deficit reduction, they inhabit different planets in terms of bringing down the debt.
This is why the downgrade of the once unassailable bonds some time between now and the autumn
is looking inevitable.
Julian Jessop, chief international economist at Capital Economics, said: “It is increasingly hard to
see how America can keep its AAA rating. It seems this would require the politicians to agree a
package containing spending cuts and tax increases worth at least $3 trillion and perhaps as much
as $4 trillion over the next ten years. None of the current proposals comes close enough to this.”
But what would be the practical impact of a credit downgrading? “The world may not come off its
axis, but it would wobble,” said Jan Randolph, director of sovereign risk at independent consultancy
IHS Global Insight. “Until now, American bonds have been seen as what is called ‘benchmark
sovereign debt’, the one against which all the others are judged.”
Were the ratings agencies to cut America’s creditworthiness from AAA to AA, banks and other
prudent institutions would still be allowed to count American bonds as top-quality assets for
regulatory reasons, he said. The pain would be felt further down the chain.
“One result would be that corporate and individual borrowers who had used American bonds as
security may well find themselves asked to provide more bonds as collateral for the same amount of
borrowing,” said Randolph. “That would mean a tightening of credit conditions.
“A second, longer-term effect would be to accelerate an investment shift by countries such as China
away from sovereign debt, and American debt in particular, and towards physical assets, such as
commodities or mining operations in countries such as Australia.”
So America’s reduced credit rating could make it harder for all Western countries to borrow -
ominous in light of the British government’s continuing need for large-scale funding.
As with the acrimonious talks on reducing the annual budget deficit, the chances of agreement on
cutting the national debt are hugely reduced by a deeply divided political scene that comes as a
shock to the British observer accustomed to believing all sides in Washington shared a pro-business
consensus and saved their ideological spats for “cultural” issues such as gun control or abortion.
Maybe in the past, but in 2011 the economy itself is now part of the “culture wars”, with Tea Party
Republicans refusing to countenance tax increases to reduce borrowings and Democrats who refuse
to support any plan that would rely mainly on spending cuts.
Anyone who listened in on the early Congressional skirmishes on the public finances in April will not
find the current crisis especially surprising.
Lurking behind the issue of American bonds is the even larger question of the role of the dollar. If the
former have provided the bedrock for debt markets, the greenback has been the “anchor currency” -
the reserve asset of choice for central banks and corporate treasurers alike.
It is said that two-thirds of world trade is dollar-denominated and 99 per cent of those trades are
cleared on Wall Street. But this status has allowed America to borrow itself into precisely the crisis
that is now breaking. If you print the world’s money, you can run up debts galore - until your creditors
have finally had enough.
In other words, the key role of the dollar has helped to undermine the key role of American
bonds.Now bonds are taking the dollar down with them. And with vital commodities such as oil,
agricultural products and gold priced in dollars, they can only become increasingly expensive.
Nor, given the respective, grave problems of their issuing nations, is either the euro or the yen in any
position to replace the dollar anchor.
Without that anchor, we are all drifting into chilly and uncharted waters. As John Connally, America’s
then Treasury Secretary, told the world in 1971: “The dollar is our currency but it is your problem.”