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A year later, S&P downgrade of U.S. looks like a dud

By Paul Wiseman

Associated Press

Published: Sunday, Aug. 5 2012 7:06 a.m. MDT

Bond investors are demanding punishingly high interest rates from Spain and Italy. They fear that Spain can't afford to rescue its troubled banks and its debt-ridden regional governments. And they worry that Italy can't generate the economic growth and the tax revenue necessary to keep up with the cost of caring for its aging population.

The larger worry is that financial pressure will eventually force countries like Spain and Italy to abandon the euro currency. The breakup of the 17-country eurozone could cause financial chaos as countries replaced sturdy euros with local currencies of dubious value.

So investors have fled Europe for the safety of U.S. Treasurys.

The Federal Reserve has also helped blunt the impact of S&P's downgrade. Under its Operation Twist, which began last year and will continue through the end of 2012, the Fed has been selling its holdings of short-term Treasurys and buying $667 billion in long-term Treasurys, pushing long-term yields lower.

Investors also shrugged off S&P's warning because the rating agency doesn't know anything they don't. "S&P has no monopoly on wisdom," says Nigel Gault, chief U.S. economist at IHS Global Insight. "The market will make its own judgment on U.S. debt ... Ultimately, the pressure (to bring the federal debt under control) will come from the markets, not from the rating agencies."

But Gault reckons that S&P might have done some good by sounding a warning and focusing attention on the need to tackle America's debt. "I suppose (S&P) laid down a marker and perhaps made it more likely that we won't forever kick the can down the road," he says.

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