By: Dr. Mike Campbell
Perception of risk is a very strange thing. Few of us would quail at the idea of having a CAT scan for medical reasons but hardly any of us would volunteer to have stood within a mile and a half of the Hiroshima atomic bomb blast – but the radiation dose received from the two events is the same. It is the same with financial risk. The US government bonds have the highest rating possible; triple A, meaning that an investor purchasing US debt is highly unlikely to suffer a default. As a consequence of this, the yield that America must pay on its bonds is comparatively low. This is just as well since the US deficit is set to exceed $1.5 trillion in the current financial year.
The interest on a US government 10 year bond is currently 3.37%; whilst not all US debt is funded through bonds and shorter bonds have lower interest rates, it does indicate the cost of borrowing to the US. 1% of $1 trillion is $10 billion, so US borrowing is an expensive business in real terms, even if the proportion of US GDP represents means that it is affordable.
Ratings agency Standard and Poor’s has voiced concern over the US Federal government’s ability to tackle the deficit, citing a lack of bi-partisan agreement. As a consequence, they have changed the outlook on the long-term US credit rating from stable to negative. This could lead to a downgrading of US credit rating within the next two years and would force up the yield on US bonds, making the cost of borrowing rise. Loss of confidence (even marginal) in the ability of the US to honour its debts could have major consequences to global financial markets since confidence is a commodity more precious than gold on global markets.