Wednesday, 3 March 2010

Is the UK's credit rating important?

Nils Blythe at the BBC is asking 'Are credit rating agencies worth the fees they command?', to which my own answer is 'probably not, but everyone is watching these ratings so market participants have to take notice of them whether they believe in fairytales or not!'.

Clearly, the impact of a downgrade on UK government debt to anything but AAA would be very bad news for British taxpayers, just as it is proving to be very bad news to Greek taxpayers lately, but never moreso than after Gordon Brown has been on a rampant public spending binge on the nation's creditcard and he has no plans to stop any time soon. I have said this before, when Stuart Cheek brought up this topic quite some while ago now (and it is proving to be my most popular blog entry by the way, lots of people are finding that blog entry via Google searching for "stuart cheek", which is interesting... to me if not to you... :->).

To summarise what I said way back when, if you don't care to visit that linked entry above: if the UK's debt rating is reduced to below AAA grade, there will have to be a flood of forced selling from fund managers, many of whom are not allowed to hold anything but AAA rated securities in their portfolios. Bigger supply = smaller price. When it comes to bonds, smaller price = higher yield (AKA "higher interest rates"). I'm certain that someone will always be willing to part with cash to buy UK bonds, whatever their rating, but at what price (and therefore at what rate of interest) is the real question.

Moving onto the question of whether the UK government will ever actually *default* on any of its debt obligations -- most assuredly not. In the UK the government's debt is issued in the local currency, the Pound. The Pound is issued by the Bank of England within the UK governments sphere of control, and there is no theoretical limit to the number that can be issued at will. This is in stark contrast to the Greek situation, where they are a member of the Euro bloc, and therefore cannot issue more Euros at will to satisfy their debts. There is, however, a cost of issuing more Pounds, in that investors will lose confidence in your currency if they notice you are overprinting the stuff. That is when hyperinflation starts, and nobody in their right mind wants that to happen, not even most of the goldbugs.

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