IMF, Asia Weigh Impact of US Credit Rating Downgrade

The International Monetary Fund (IMF) has warned against a downgrade in US credit rating even as US Secretary of State Hillary Clinton, who is on an 11-day tour of Asia, sought to reassure the region that the US$14.3 trillion debt ceiling will be raised.

Let me assure you, we understand the stakes,” Clinton told business leaders in Hong Kong on July 25. “We know how important this is for us and how important it is for you.”
“I am confident that Congress will do the right thing and secure a deal on the debt ceiling and work with President Obama to take the steps necessary to improve our long-term fiscal outlook,” she added.
Republicans and Democrats have been at loggerheads over how and by how much to raise the debt ceiling by August 2. Without that authority, the US Treasury has warned, the federal government will not be able to borrow more money to service its obligations.
The US could well default on some of its debts. That, in turn, will cause the credit rating agencies to downgrade America’s triple-A credit ratings.
“A downgrade will be very damaging for both the U.S. economy and the rest of the world,” Rodrigo Valdes, senior advisor in the Western Hemisphere Department at the IMF, said in a July 25 conference call.
“There are effects in the functioning of repo markets; other securities would be downgraded at the same time; most likely effects on interest rates; stock markets, etcetera,” he said. “But the extent of those effects, I think, is very difficult to predict with certainty . . . This will be the first time that this happened so nobody really knows what will be the true effects.”
"The clock is ticking, and clearly the issue needs to be resolved immediately," Christine Lagarde, the IMF's newly appointed chief, said the next day. "Indeed, an adverse fiscal shock in the United States could have serious spillovers on the rest of the world. But more fundamentally, a credible fiscal adjustment plan is needed sooner rather than later."
Lagarde warned that the US could be facing "another jobless recovery." This is why the IMF advises against fiscal consolidation, a course of action that the so-called Tea Party wing of the Republican Party is advocating, at this time – "even as we stress the importance of getting a fiscal consolidation plan agreed soon," Lagarde stressed. "We've also recommended active labour market policies to stem the rise in structural unemployment, and measures to ease adjustment in the housing market (for example, mortgage relief)."
Among the most worried in Asia are governments with huge foreign currency holdings, most of them in US dollars. China is estimated to hold US$609 billion in US dollar assets, three-fifths of its US$3.2 trillion in foreign-currency reserves. Most of Japan’s US$1.1 trillion in reserves and Korea’s US$300 billion in reserves are also in the US currency.
Because of the massive amounts involved, governments and investors do not really have a lot of option but to park their assets in the greenback. The other international currencies – euro, yen, Swiss franc – are not as liquid.
Clinton and other US officials have been making private and public assurances to America’s debtors in Asia and elsewhere, but governments and investors basically can do nothing but hope that America's bickering politicians, who are jockeying for advantage in next year's elections, really do get their act together.

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