Us Downgrade

On August 5th, 2011 Standard and Poor's downgraded the United States from AAA to AA+, but despite the downgrade the other two major credit rating agencies (Moody's and Fitch) preserved their AAA rating for the U.S. This downgrade does not seem justified because the United States has made it clear they are looking to cut costs, as evidenced by the $2 trillion worth of spending cuts offered by the Administration. This truly just seems like a brash reaction from S&P due to the debt ceiling debate. Yes the talks extended much longer than desired, but to downgrade the US because their "effectiveness, stability, and predictability of American policymaking have weakened" is a little premature. What is interesting, but not that surprising, is the initial reaction in the bond market. On August 9th, 2011 10-year Treasuries yield dropped to a then-record low of 2.28% (now currently 1.787%) and yields on long-term municipal bonds dropped below 4%. This could be taken as a slap in the face to Standard and Poor's, and clearly the market disagrees with S&P.

The stock market has taken quite a beating since the downgrade, but this is a panicky reaction and should not reflect solely the state of the economy. The underlying danger, however, would be if yields rose because the Federal government would have increased borrowing costs. These increased borrowing costs would trickle down to state governments, commercial businesses, and individuals (in the form of mortgage interest rates). It seems obvious this would ultimately lead the United States into a double dip recession, if we are not currently in one that is.

To fight these potential problems, the Fed has implemented a program called Operation Twist. The policy involves selling $400 billion in short-term Treasuries in exchange for the same amount of longer-term bonds, starting in October and ending in June 2012. This move is not to pump more money in the economy, but rather to lower yields on long-term bonds and keep short-term rates little changed. The purpose of Operation Twist is straightforward: push down interest rates on everything (mortgage rates, business loans, etc.) to promote borrowing and spending by businesses and individuals. There is uncertainty about Operation Twist's effectiveness because interest rates have been at historic lows for sometime now and there is still not much borrowing and spending to show for it. Additionally, the Fed could lose money on longer-term Treasuries because inflation could outpace the interest rate over time, cutting into the returns on the bonds.

Since China is America's largest foreign lender, about $1.2 trillion of US Treasuries, there is fear about what would happen if they dumped those Treasuries on the open market. This should not be a concern because China's economy strives on exporting cheap goods, and the Yuan would gain in value if China sold/stopped buying US Treasuries. This would slow