How worried should Australia be about the warnings from the Vampire Squid (sorry, Goldman Sachs) about the possibility of losing our prestigious triple-A credit rating?
If the warning, issued yesterday, had been made a decade ago or in the 1990s, the hue and cry from the financial press (which was much bigger then anyway) would have deafening. And the Financial Review did give it detailed coverage. But really, who cares?
Well, Joe Hockey will, for one. The fact that Wayne Swan secured a third triple-A credit rating for Australia has always rankled with the Coalition; it stuck in the craw that the markets so egregiously refused to play along with its narrative of manifest Labor incompetence. To suffer a downgrade would redouble that pain and further wreck the Coalition’s claims to fiscal competence. “Who lost the triple triple-A rating?” Labor would ask incessantly.
Beyond egos, though, it’s not clear that losing a rating notch would have any particular negative impact. Indeed, it might have some positives. Losing the rating might even have a kind of liberating effect on policymakers, allowing them to see Australia’s debt problem in the long-term perspective that it merits, without obsessing over whether fiscal policies that are necessary for current macroeconomic conditions — somewhat stimulatory, though less so than during the height of the financial crisis — might damage our rating.
And then there’s the current realities of a low-yield world — as Reserve Bank Governor Glenn Stevens pointed out earlier this week, we face a medium-term future of low nominal yields and rising risks for those hunting for yields, so anyone offering higher-than-expected yields will be swamped with money. That is what happened to Australia from around 2011 to 2013, when the dollar was at parity with the greenback or higher. That is what we are again starting to see in the past few days, with the dollar jumping form 76 US cents to more than 80 US cents yesterday and today. If a downgrade knocks the value of the Aussie dollar lower, all the better: the Reserve Bank (which doesn’t place much value in ratings anymore) and exporters, as well as the government, would be very happy.
If the AAA rating were hit, yes, yields on Australian government bonds, banks and other issuers would rise, but then they would get flattened by the wall of money looking for high yield — the demand for Aussie bonds and bank debt would drive down the dollar and those yields. That is what has happened to the likes of the United States, France, Austria and other major developed economies to suffer a downgrade from the likes of S&P in recent years.
The second-order problem invoked in relation to a downgrade is the effect on banks: the thinking (from the likes of Financial Inquiry head David Murray) goes that if the Commonwealth were downgraded, it would have less capacity to bail out Australia’s major banks in the event of another financial crisis or major slump. This in turn would drive up the banks’ borrowing costs. It’s a logic that reflects, in a reverse way, what happened in Ireland: the need to bail out Irish banks wrecked the Irish government’s budget, forcing it to go cap in hand to the EU and the International Monetary Fund. The lower the capacity of the sovereign to help, the greater the risk to those it can help. But the likely impact on bank borrowings would be limited, again, by the amount of liquidity available around the world.
In any event — and this is presumably the lesson that Murray wants us to draw from it — the real solution there is to remove the implicit guarantee that underpins Australian banks by strengthening bank capital requirements that would enable them to withstand a financial crisis without government intervention. This is one of the core recommendations of the Murray inquiry and an approach that’s supported by the Reserve Bank and the Australian Prudential Regulatory Authority. And that’s what the banks are eager to avoid.
The history of Standard & Poor’s downgrades suggest they mean very little these days. Countries such as the US, Austria and France have all been downgraded, and the loss of the AAA rating has not mattered one jot. For that matter, Australia survived the downgrades of the 1980s and recovered. We’re not in the ’80s and ’90s anymore. The new reality of a low-yield world means credit ratings don’t matter if you offer economic stability and avoid the junk status of places like Greece.