America financial domination ending as a new World order emerges

• From: The Australian
• August 08, 2011 12:00AM

The decision by ratings agency Standard & Poor's to downgrade the US's credit rating from AAA to AA+ with a negative outlook is another powerful indicator that the world order is changing, perhaps faster and more profoundly than some Western governments have grasped.

THE decision by ratings agency Standard & Poor's to downgrade the US's credit rating from AAA to AA+ with a negative outlook is another powerful indicator that the world order is changing, perhaps faster and more profoundly than some Western governments have grasped.

Such ignominy would have been unthinkable two decades ago after the Berlin Wall was torn down and the wealth and strategic might of the biggest economy the world has ever seen looked unassailable.

The downgrade is significant not only because of the size of the US economy, but because, around the world, US Treasury debt is such a widely held investment, with 46 per cent foreign-owned, compared with 1 per cent in 1945. China, the largest foreign holder of US Treasuries, rubbed salt into the US's wounded pride with a tart rebuke to put its house in order to safeguard Chinese dollar assets. Just how negative, or mild, the impact of the downgrade on markets, capital flows and US borrowing costs remains to be seen, but it has compounded economic gloom.

While hotly contested by the US Treasury and some US economists, the decision by S&P, which might not be matched by other agencies, was no surprise given the nation's soaring $14 trillion debt and the counterproductive brinkmanship between Republicans and Democrats that produced an agreement just in the nick of time last week to lift the debt ceiling and avoid a default.

 

Any pundit, however, who seizes on the development to predict the long-term, ongoing decline of the US, or to advise a move away from market-based economics towards centralism and bigger government, is deluded. To the contrary, the downgrade underlines the importance of fundamental economic principles and demands that Barack Obama, and both sides of American politics, as well as other debt-ridden nations, respond with unflinching resolve to rebuild their budgets and restore prosperity.

 

Margaret Thatcher's observations that "the state has no source of money other than the money people earn themselves" and that "prosperity will not come by inventing more and more lavish public expenditure programs" have never been more relevant. Of all nations, the US is better placed than any to work its way back to economic health because it was built on enterprise and is more deregulated than most economies. A vast amount remains to be done but, arguably, the process is at least under way with the spending cuts agreed last week and a good boost in new jobs.

 

As a road map, the US and debt-ridden European governments should look to Australia and Canada, which lost their AAA ratings in recent decades and had them restored through the determined pursuit of good economic policies. S&P removed Australia's AAA rating in 1986 and restored it in 2003.

It is no coincidence that in the intervening years the Hawke-Keating governments modernised the economy, lifted productivity, enacted financial deregulation and competition policy, and the Howard government advanced labour market reform and, in its early budgets especially, imposed strict fiscal discipline to retire debt. Canada restored its AAA rating over 10 years from 1992 through stringent spending cuts.

The US cannot remain tardy about economic reform, but the necessary cuts will be all the more difficult because of the magnitude and importance of defence spending. But the price of shying away from medium-term pain for long-term gain would be too high to contemplate. S&P has put the US on notice that its rating could be downgraded further within two years if progress is not made in cutting its huge deficit. Japan, which lost its AAA rating in 2001, has since sunk to AA-, with a colossal 225.8 debt-to-GDP ratio.

The US downgrade will not impact on Australia's AAA rating, one of 17 in an elite group that includes Britain, Singapore, Germany and France. Our performance is due to good management by both sides of politics in the 1980s, 90s and early 2000s, and the good fortune of a once-in-a-century resources boom. But we can't take our luck for granted.

The US's predicament should be a stern warning to the Gillard government and the opposition. Big-spending, waste and irresponsible populism have no place in an increasingly unpredictable world order.