The U.S. credit downgrade: 4 predictions

What does Standard and Poor's controversial decision mean for Wall Street investors, Main Street Americans, and beltway politicians?

A German trader
(Image credit: REUTERS/Kai Pfaffenbach)

Stocks dropped sharply in the U.S. and around the world on Monday, as investors reacted to the news that Standard and Poor's had stripped the federal government of its top-notch AAA credit rating for the first time in history. In a "remarkably blunt" statement explaining the unprecedented downgrade to AA+, the ratings agency said it no longer considers U.S. Treasury bonds to be an essentially risk-free investment because Washington is running up mounting deficits with no real plan to reduce them. What ramifications can we expect from the downgrade? Here, four predictions:

1.The economy will plunge into another recession

The Dow Jones Industrial Average plummeted more than 500 points by mid-afternoon on Monday. With the threat of a double-dip recession looming, says UBS markets strategist David Cassidy, as quoted by Australia's Herald Sun, the downgrade, which threatens to send interest rates higher, has torpedoed everyone's sense of well-being and sent stocks into a nosedive. That only worsens the "negative feedback loop," making another recession more likely than ever.

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2. Our lawmakers will shape up — or be shipped out

Members of both political parties should view this downgrade "as a last-chance wake-up call," says The Baltimore Sun in an editorial. We have no choice now but "to reject both far-right and far-left doctrine on the deficit. Neither a hard line on taxes nor entitlements is what the nation needs right now." If our leaders can't grow up and achieve "genuine compromise," maybe in 2012 voters will "put centrist pragmatism back in the nation's capital."

3. Despite the downgrade, treasury bonds will remain the "gold standard"

In this topsy-turvy economy, every investment has become riskier, say Min Zeng and Cynthia Lin at The Wall Street Journal. As one big-time trader put it, "Double-A-plus is the new triple-A," and U.S. Treasury bonds remain "the world's gold standard." Japan and China, which both own massive amounts of U.S. debt, won't be dumping their holdings. If anything, nervous investors might snap up U.S. debt because it's less risky than everything else, which will send interest rates down, not up.

4. S&P's credibility will be shot

This is "amateur hour" at S&P, says Paul Krugman at The New York Times. The Treasury Department put out a fact sheet showing that S&P analysts overshot deficit projections to the tune of $2 trillion, something "real budget experts" would never have done. These guys clearly don't even understand "basic analysis of budget estimates." Really, Krugman says, S&P is "the last place anyone should turn for judgements about our nation's prospects."

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