It is not that difficult to discover who is the most concerned about Standard & Poor's recent downgrade of the United States' coveted AAA credit rating.
The People's Bank of China owns more Treasury bonds than anyone. All of a sudden, the liquidity of the U.S. Treasuries market no longer looks so appealing for the $1.5-trillion treasury bonds or so of foreign reserves owned by the People's Bank of China.
China, like most of the U.S.'s foreign creditors, wants serious action on cutting Washington's monstrous budget deficit. But the political gridlock between the Republican dominated Congress and the Democratic administration, which has stood in the way of serious deficit reduction, may become a permanent feature of the U.S. political system. Who's to say Americans don't elect another hung jury to Washington after next year's presidential election?
More important, even if Americans can come to a rare political consensus and agree to cut government spending and raise tax rates would the tough fiscal medicine demanded by the credit rating agencies actually do what it is intended to do? Can fiscal restraint reduce deficits in barely growing economies?
Runaway federal spending and unfunded tax cuts are only part of the legacy of Washington's deficit. Faltering economic growth is not an innocent bystander here. During the first half of the year, the U.S. economy hardly grew despite the benefit of both fiscal stimulus and quantitative easing. How is the U.S. economy likely to perform when neither are no longer around?
Even more challenging, what happens if Washington actually took deficit reduction seriously and started to chop spending and raise taxes like the distressed PIIGS in Europe are being forced to do? As the Greeks can tell you, these policies do not exactly boost GDP growth. In fact, it seems the more the PIGs cut, the more their deficits grow as their economies and their tax bases continue to shrink.
Without the continued support of the People's Bank of China, the U.S. can't finance its fiscal deficit any more than Greece, Portugal or now even Italy and Spain can finance theirs. And as I have argued before in this blog, the days of China slavishly financing Washington's huge budget deficits are drawing to a close.
The loss of America's AAA credit rating brings us that much closer to the day when the People's Bank of China doesn't show up at the Treasury auction. Their absence in the future, more than any proclamation by any credit rating agency will be the real downgrade that awaits the U.S. Treasury market.