08 August 2011

Guardian: Financial crisis - full force of US downgrade is felt around the world

The Guardian comments that recent events have changed the US as an unassailable economic superpower. The US decline leaves China tipped as the next economic superpower, while pressure on US bonds is set to affect the eurozone crisis.

Following a week when an estimated $3tn (£1.8tn) was wiped off the value of world shares, Friday's downgrade of America's cherished AAA rating to AA+ by Standard & Poor's is set to cause more turmoil on global markets and potentially jeopardise Europe's attempts to solve its own financial crisis.

With currency markets, particularly the dollar, expected to come under pressure, and US bond yields almost certain to rise, this could have the knock-on effect of raising borrowing costs in the eurozone at a time when Spanish and Italian bonds in particular have seen yields soar.

For decades, the interest rate on American debt has been known as the "risk-free rate", because a US default was as close to impossible as anyone in financial markets could imagine, and all other bonds were priced relative to America's. Now that the markets have been forced to think the unthinkable, it is not at all clear what happens next. While Standard & Poor's verdict on the US is a humiliating blow, it merely raises the distant fear of a future default, while for Italy and Spain that risk is much more immediate. When the crisis reached Rome, it finally became impossible for Europe's leaders to write off the turmoil in bond markets as a problem of the "periphery" – little Greece, Ireland and Portugal.

As German officials told Der Spiegel this weekend, Italy's economy simply looks too big to rescue, certainly by the current bailout fund, the European Financial Stability Facility (EFSF).

The eurozone has repeatedly drawn back from the brink over the past three years, but a default by Italy or Spain would pose a threat to the single currency's existence.

Full article

© The Guardian