Saturday, 14 January 2012

Public or private downgrade

According to BBC News,

The cut in the so-called sovereign ratings of governments is likely to lead to most other borrowers domiciled in the same countries - including banks and companies - being downgraded.

Although the move has been widely expected, it is still likely to make it somewhat more difficult and expensive for borrowers from those countries to raise money, including for the governments themselves.

Is this true? And if so, how does it work?

Why should the creditworthiness of individuals and private companies be connected to that of governments?

I can only assume that it's a feature of our corrupt caricature of capitalism. If the government struggles to borrow, it will struggle to spend, which may impact company profits and personal incomes. And in extremis, a government that struggles to borrow will have a harder time bailing people out.

I can imagine something similar happening in the private sector. If the economy in a certain town is heavily reliant on a single company or industry, the prosperity of the residents, and their creditworthiness, is tied up with the viability of the dominant employer. If the industry goes pop, a thriving community may turn into a ghost town, with various bankruptcies and foreclosures along the way.

The problem, then, is twofold:
  1. All sectors of our economy - household, corporate, and government - are overly reliant on credit
  2. Governments, over the course of the last century, have become the biggest of big players.

If we are to achieve stability and prosperity, we need to kick our addiction to cheap credit and government pork.


It occurs to me that there may be another factor at work: psychological inertia. The long-standing wisdom has been that government debt is safer than other forms. Why risk your money with competing entrepreneurs, when you can invest in an organisation that confiscates the profits of the winners? What's happening with these downgrades is an overdue recognition that government debt isn't as safe as previously thought. But it could be that investors haven't yet re-evaluated their standing rule that government debts are safer than private debts. Or perhaps some have, but they are basing their choices on the path of the herd.

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