China's Glass House

Every time the United States issues a public statement over the abuses of human rights in China, this achieves little more than the satisfaction of “playing the humiliation card.”  From that point of view, one can sympathize with China’s desire to play a similar humiliation card in response to the news that Standard & Poor (S&P) has downgraded our credit rating from AAA to AA+.  Here is how BBC News reported the “official” Chinese statement:

China, the world's largest holder of US debt, had "every right now to demand the United States address its structural debt problems and ensure the safety of China's dollar assets," said a commentary in the official Xinhua news agency.

"International supervision over the issue of US dollars should be introduced and a new, stable and secured global reserve currency may also be an option to avert a catastrophe caused by any single country," the commentary said.

However, once the short-term satisfaction of the Chinese has elapsed, we might want to put things in a clearer perspective.  We can begin with the observation that China’s own credit rating is AA-.  It would be nice to explain why this should be the case, but this would require penetrating two rather thick layers of opacity.

The most important is that neither S&P nor any other credit rating institution has ever been particularly transparent when it comes to explaining their results.  This is nicely summarized in the Wikipedia entry for “Credit rating” as follows:

The credit rating represents the credit rating agency's evaluation of qualitative and quantitative information for a company or government; including non-public information obtained by the credit rating agencies analysts. Credit ratings are not based on mathematical formulas. Instead, credit rating agencies use their judgment and experience in determining what public and private information should be considered in giving a rating to a particular company or government.

Thus, the accusations of an unnamed Treasury Department spokesman accusing the S&P result of being a “judgment flawed by a $2tn error” are academic.  We know neither which numbers were considered in the rating process, how each of those numbers was weighted, nor how any of that “qualitative” information contributed to concluding that the AA+ rating was the most appropriate.  After all, one qualitative factor may have been that S&P just wanted to take both the Legislative and Executive branches of our Government to task on the grounds that their handling of the debt ceiling legislation amounted to dereliction of duty.  In other words this is nothing more than S&P playing a humiliation card of its own in the wake of the humiliating blunder they had made that led up to the economic crisis.

Then there is the Chinese side of the story.  The fact is that there is very little, if any, transparency in just about anything currently taking place in China’s financial sector.  Remember, most of us never heard the word “audit” used in conjunction with Chinese finances until the first such audit was conducted last June.  Thus, one reason why China may have a lower rating than the United States is that S&P analysts have little to work with in setting that rating and may have to rely on the educated guesses of the best hand-picked consultants they can find.

Last Tuesday I asked whether or not it made sense for an entire country to have a credit rating in the first place.  That was probably a bit extreme.  If a country is going to sell bonds, then anyone purchasing those bonds should be provided with some level of risk assessment that represents how likely it will be that the promised return on investment will actually get delivered.  This should matter to any of us, but it really matters to those who buy bonds in quantities way above the pay grade of the rest of us.  Sometimes we can benefit from the wisdom of those purchases through a bond fund, but the rest of the time it amounts to a private decision to turn a pile of money into a bigger pile of money.  In either case, if it looks like our investment may not return as expected, we usually have the option of selling it, which is one way of saying that we have lost confidence in the source institution.

However, when that country is an entire government, it is unclear that the consequences of such a sell-off would be.  I remember cashing in all of my savings bonds during the Vietnam War, but I knew that this was little more than a symbolic gesture that made me feel a bit better about my own position on that war.  China may be right that global markets need a better reference standard than the United States dollar.  However, that will not be an easy transition to make;  and it will be even more difficult to consider the consequences of the shift.

So what can we take away from the current state of play?  We can probably sympathize with the Chinese desire to pay back the United States for humiliations over their human rights record (no matter how much we feel that those issues of human rights are significant).  We can also sympathize with the Chinese call for international supervision, but will it do any good?  We already have supervising agencies on an international scale;  and they are controlled by a greedy oligarchy of the rich and mighty who care little about those of us who see money only as a means for maintaining food, clothing, and shelter.  Then we have the United Kingdom crowing about its own AAA rating as a vindication of its decision to put austerity before any stimulus policy that would put its citizens back to work.  Ultimately, we are one with those Egyptians who gathered in Tahrir Square and the Israelis camped out on Boulevard Rothschild;  like them we face the possibility that we no longer have a future in the world those oligarchs have made.