When Standard & Poor's took away the United States' prestigious triple-A rating in August, it sent stock markets into a tizzy. Concerns surfaced about whether the country was heading right back into recession. Moody's reaffirmed the U.S.'s AAA but gave the country a negative outlook, due to the continually rising debt. (To read more on debt ratings, check out The Debt Ratings Debate.)
TUTORIAL: Credit Crisis
A surprising number of countries still have a triple-A rating; Denmark, Canada, France, Singapore, the Netherlands, Australia, Sweden, the United Kingdom, Switzerland, Norway, Austria and Germany all still maintain their AAA rating. However, the rating agencies have concerns about several of those countries and we may be seeing more downgrades in the coming year.
Let's compare a solid AAA country (Canada) with two that may be in trouble.
Despite being America's largest trading partner, Canada did not get dragged down into the 2008 quagmire that was the sub-prime mess. Canada's tighter regulations on banks and a more centralized banking system meant that the shady sub-prime mortgages that the United States was handing out like party favors did not exist. The country's overall debt is only around 34% of its gross domestic product (GDP), thanks in large part to aggressive balanced budgeting and debt reduction, especially in the late 1990s. Canada's triple-A rating is unlikely to change as its economy is strong and the country is resource-rich.
France, on the other hand, is in serious trouble. Although its economy is strong overall and it has an economic leadership position in the EU, France's debt is spiraling out of control. It rose from an already high 68% of GDP to 84% from 2008 to 2010. Deficit spending is rising and austerity programs put into place to cut the budget down have not yet shown significant results. France's largely socialist society is resisting budget cuts. Adding to France's woes is the fact that it is a large holder of U.S. debt, so, if the United States defaults, France may plummet with it. Hooking into the euro also leaves France without an important monetary policy tool: the ability to print money. So far, S&P has affirmed France's stable outlook but, if growth turns negative, that may change.
The U.K.'s real estate crash and financial toppling in 2008 rivaled that of the United States. Although no longer under a labor government, its deficit spending continues to rise and is now at 76.5% of GDP. England's austerity measures included removing most subsidies from post-secondary schools, which made tuition skyrocket, resulting in violent rioting in the streets. Coupled with a drastic cut to tax credits for children and working families, the measures destroyed consumer confidence and the U.K. may be looking at recession in the next couple of years. Economic growth has slowed significantly and the country is now a net importer of energy - a resource it used to drive GDP with. One benefit that the U.K. has over France is that it still controls its own monetary policy for the most part. S&P has recently expressed concern over the state of the U.K.'s banking system but have left their triple-A rating in place for now.
The Bottom Line
The next two years will continue to be volatile for many countries as they try to reign in their debt and avoid recession in the process. America's inability so far to devise a comprehensive debt reduction or revenue raising plan has sent ripples of concern around the world, and economies that are tied to that of the United States may be in for some more rough weather. (For more read Understanding Interest Rates, Inflation And The Bond Market.)