In early August parents begin preparing for the start of another school year. Sales are on for school supplies, and the kids are getting bored. It’s time to get them back in the classroom pursuing straight As.
A grade of B, however, is a good showing. Under the traditional grading system a letter grade of B means “good” performance, deserving of merit.
In the financial markets today, it looks as if a B grade might mean even better performance. Some governments with lower grades on their debt are rewarded with lower interest payments.
The grading system for government debt is operated by the credit rating agencies. Three large agencies — Fitch, Moody’s and Standard and Poor’s — account for almost all government debt credit ratings.
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On Friday, Standard and Poor’s downgraded the U.S. government’s debt from the highest AAA rating to AA+.
By their own standards, credit agencies expect debts with lower ratings will pay higher interest rates since the risk of default is higher. That is not always the case.
A decade ago Japanese government debt was downgraded from AAA to AA. Over this period, the annual interest rate on 10-year Japanese government bonds ranged between 1 percent and 2 percent. Over the same time period, U.S. government notes and bonds averaged 5 percent annually.
Standard and Poor’s currently gives Korea a grade of only a single A. Nevertheless, the interest rate on 10-year Korean government debt fell from around 8 percent in 2001 to just 4 percent today, very near what the United States pays.
Canada lost its AAA rating in 1994 and regained it in 2001. Yields on Canadian bonds initially jumped to 9 percent from 7 percent but then steadily dropped to less than 6 percent by 2001. Since 2004, long-term Canadian government bonds paid lower interest rates than the United States despite the same rating.
Even with all the problems in Greece, Spain and other member countries, the weighted average of 10-year government bonds for the euro area has been at or below the U.S. rate for the past decade. Spain’s credit rating is holding at AA despite being named as the next potential crisis country.
Back in the United States, the credit agencies are saying that Treasury notes and bonds may be downgraded even though the president and members of Congress have reached an agreement to raise the debt limit and avoid default. Apparently, the political agreement does not do much to lower the amount of government debt outstanding and its expected growth rate.
The federal government already has debt outstanding that amounts to more than two-thirds of the nation’s annual income, or gross domestic product. A household with this level of debt undoubtedly receives a credit score that would prevent them from further borrowing. Perhaps the government debt rating system is beset by grade inflation.
It looks as if the full faith and credit of the United States is still meritorious. The Treasury market remains the most liquid and active in the world.
A grade of B is unlikely to change anything.
PETER CRABB Professor of finance and economics at Northwest Nazarene University in Nampa