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Wednesday, 3 February 2010

Why bother about the Rating Agencies?

The media have carried repeated stories that Rating Agencies have threatened to downgrade UK government debt.
It is well recognised that the government has 'prevented a slump' by spending huge amounts of money, much of which has been borrowed. The government has printed and sold billions of poundsworth of bonds every month: and so far there have been buyers, though the rates of interest attached to the bonds are much higher than the 0.5% official bank rate. Some government bonds yield 5% or more annually to their owners; and so far [since 1695] all bonds have been paid off in full on the due date. This still looks a pretty good deal.

But what if the value of the pound goes down seriously against other currencies? The government could offer an even higher rate of interest, but the money in which it is paid would be worth less to foreigners; and the bonds would progressively become worth less in foreign currency on the dates when they are cashed. So foreigners would be well advised to avoid British government stocks if such a devaluation was expected.

The agencies were utterly useless in their rating of bonds and businesses during the bubble that preceded the credit crunch: they have lost any right to be taken seriously by anybody. But they are big businesses stuffed with supposedly clever employees, who all want to keep their high earnings. So they desperately need to make a few right calls that will convince investors that they merit having attention paid to their predictions. If they call 'wolf' on the British economy too soon, they will add to their discredit; but if they call too late they will again prove their incompetence. Their call on Britain matters even more to them than it does to the viability of UK national debt: so there is a real issue here.

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