This move will, as today’s WSJ notes, “force traders and investors to reconsider what has been an elemental assumption of modern finance” — that is, that America is economically unsinkable. The strange thing about America is that, no matter what the credit rating agencies say, its ability to borrow cheaply will continue to be driven by the sheer volume of Asian savings. Xinhua, China’s state newspaper, put it well last week. “The US debt market is the only market that can absorb China’s rapidly growing foreign-exchange reserves,” it said. This is one of the core problems of global economics: the sheer volume of Asian savings is encouraging Western debt.
It doesn’t pay to admit it, but America is borrowing so much for a simple reason: because it can. In the old days, a S&P downgrade would spike American gilt yields and send a shock through the system. This time, the US Treasury can moan about S&P’s maths and say the market will speak for itself. And China’s $1 trillion bank of American debt notes will keep growing. As Caldwell writes in this week's magazine, this option is certainly open; "But this is drink-till-you-fall-down economics, a suggestion that one should keep imbibing debt as long as one can 'handle it'."
So where does that leave George Osborne? Unlike Caldwell, he hasn't been arguing that high spending is an ill in itself. He has not made the moral or the economic case for lower spending, making himself vulnerable to Ed Balls' attacks (of which there is another one today, in the Guardian). Osborne's argument has been to blame the markets, and say that Britain has no choice. That the likes of S&P have a gun to Britain’s head: if we don’t cut, they shoot (and cut our AAA rating, just as America’s has been cut).
America will probably get away with it; and, if so, Osborne will be in difficulty. The left, in Britain and America, are already arguing that an AAA rating doesn't matter. I suspect America's borrowing ability will not be crippled now that S&P has it at AA, so Osborne will be asked: what's the big deal? If America can survive a downgrade, why should Britain fear one so? The credit rating agencies fired their gun, it's a blank.
Of course, the dollar’s status as the world’s reserve currency brings with it the Chinese demand, whatever S&P says. The Chinese can, however, happily live without sterling IOU notes in their massive, ever-expanding vaults. These same credit rating agencies will now be asking if Britain, like Italy, has fallen into a high-debt, low-growth trap. A UK downgrade would hit us far harder. This will be the only argument Osborne can make, but it may sound like technocratic waffling.
Osborne can hardly soften his cuts further. remember, is cutting total spending by less over four years than Obama is doing in 2011-12 alone. Inflation and tax rises are dragging the UK economy, and the 2 per cent growth that seemed likely looks like 1.5 per cent now. More tax and more debt-financed state spending — Labour's Plan B — is unlikely to improve things. Osborne had best come back from holiday with a Plan A+. It looks like Britain is going to need it.