Now that the downgrade of the United States credit rating has finally come to pass after S&P pushed through a drop on August 5th to AA+, the entire global economy will be looking hard at their US holdings and have to make some difficult decisions going forward. These decisions could very well lead to direct buying of US debt by the Fed, all out monetization, and little choice but to implement QE3 on or before the August Federal Reserve meeting at Jackson Hole.
The downgrade by S&P of the US credit rating will automatically have reverberating effects in Asia, Europe, and the United States. Every nation and bank that holds US debt, US paper, or interest bearing products will be taking the time to study each one, assess their exposure, and then make determinations on whether it is economically feasible to continue to hold onto that debt, or purchase more in the future. These decisions, especially by European interests that are entrenched in a credit crsisis of their own with Ireland, Greece, Spain, and Italy, may cause a chain reaction which leads to a massive dumping of our treasuries on the open market, or limit dealers from future purchases as they seek more sound investments.
In either case, the Federal Reserve would be forced to purchase any and all paper that comes into the US bond markets, and at a time when the US government intends to sell an additional $2 Trillion in new debt now that Congress has passed legislation raising the debt ceiling.
There are also many repercussions for the American people now that the US has been downgraded from its AAA+ status. Interest rates on mortgages and other borrowing is expected to go up, even if the Fed continues to hold interest rates at the banks discount window near 0. Other factors that are sure to affect Americans is a rise in price inflation as the FED would need to begin a larger program of debt monetization and money printing to make up for the losses incurred from foreign interest in buying US debt. In fact, a report on August 6th by the Hindu Business Line out of India estimates that their economy may gain, even as the US falters on the inflation front due to the downgrade.
The US dollar is now expected to depreciate, leading economists concur, but, unlike during 'normal times', this would have a beneficial impact for India.
This is because the 'new normal' would see the falling dollar bring international commodity prices also down. In normal times, the impact would just be the opposite; cheaper dollar turning asset classes traded in the greenback affordable to aspire for, driving up their prices in the local currency.
But the 'new normal' is such that the downgrade would lead to interest rate hikes in the US and slow down the investment cycle there, badly impacting demand for commodities including crude oil.
Lowered international commodity prices would be the best thing for India to happen, since the inflation bugbear stomping around the economic landscape has been feeding on what has come to be known as 'imported inflation'. – Hindu Business Line
This depreciation in the dollar, coupled with the dropping interest in foreign purchases of US debt going forward will lead the Fed to have little choice but to massively monetize, and implement a QE3 program that will make QE2 look like a drop in the bucket. Deflation to a country that carries massive outstanding debt obligations is a pre-cursor to absolute default, thus paving the way to hyperinflate to ensure that current and future debt can be paid for.
Now that the threats of a US downgrade to our credit rating have become reality, the global economy will be taking the next week to digest just what this means to their current US debt holdings, and the future value of purchasing more. The results of this will lead inevitably to the Fed choosing a course of monetization and QE3, and the American people will soon feel the absolute effects of this policy.
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