TEETERING ON THE BRINK

The USA has managed, as expected, to avoid a default after congressmen finally agreed a bill on 2 August raising the ceiling on public debt. The bill was passed and quickly signed into law by President Obama. The default prevention plan envisages an immediate reduction of so-called "discretionary spending" worth around a trillion dollars over 10 years.

Both defence and non-defence costswill be reduced. According to the bill, the limit of the public debt will be increased by at least $2.1 trillion, thus eliminating the need to raise the ceiling further before 2013. Under the agreements reached, a conciliation commission will be set up consisting of members of both chambers of Congress, which will look for waysof cutting government spending.

Spending will be cut by $917 billion. The second wave of cuts totalling $1.5 trillion is expected in late 2011 and further "cost-cutting" after the next presidential election in2012. According to Barack Obama, the USA has not seen such reductions in public spending since Eisenhower. Justifying the situation, the president tried to show that it was not so pessimistic: "Government spending will be reduced, but the level of reductions will still allow us to create jobs, care about education and scientific research."

But Obama's confidence has not spread to the decisions of international rating agencies. The decision by Standard & Poor's (S&P) to downgrade the US rating, which immediately resonated with stock, commodity and currency markets around the globe, came as a shock. Most have lost much of their growth - indices are hitting many-year lows, capital is being frantically moved between assets, while gold is breaking all price records.

Rating shock

So, on 5 August, shortly after the law was passed to raise the US debt limit, the international rating agency Standard & Poor's downgraded the US credit level from "AAA" to "AA+" against the background of problems with the government debt ceiling. The outlook on the US rating was defined by S&P as "negative". This means that in the next year or so the country's credit rating may fall further.

In Washington, the S&P decision was, of course, described as an"error".A harshly-worded statement was made by the White House'schief economic adviser, Gene Sperling."The magnitude of their error combined with their willingness to simply change on the spot their lead rationale in the press release once the error was pointed out was breathtaking.It smacked of an institution starting with a conclusion and shaping any arguments to fit it."Sources in the US Treasury told Reuters news agency that the S&P calculationswere $2 trillion out. After discussions with the Treasury the agency still confirmed the downgrade and said the Treasury's comments did not influence the decision.

According to the ratings agency, it has reached the reasonable conclusion that it would be difficult for the US authorities to take control of the growing budget deficitagain. S&P repeatedly warned of a possible downgrade of the US credit rating if Congress and the Obama Administration could not present credible plans to reduce the deficit.

Despite the S&Pdecision, the other two ratings agencies, Moody's and Fitch, have preserved the USA's top credit rating. However, some negative trends can be traced in their assessments too.

Meanwhile, despite negative forecasts, Barack Obama said in a special press statement that the USA is still a reliable place to invest. "Markets continue to confirm that we remain among the most reliable places in the world in terms of creditworthiness. We have always been and will be a country with the AAA rating, but our main objective is to reduce the budget deficit in the long run," Obama said.

But his reaction could hardly have been more different from the stock and commodity markets which have responded to the shocking decline on many fronts. Thus, on the first day of trading after the publication of the S&P decision stock indices in Asia and the Middle East plummeted, oil prices on world markets were significantly lower, while gold prices set a new record by surpassing $1,700 per ounce.

The decision by Standard and Poor's has caused concern in Azerbaijan. According to a representative of the State Oil Fund (SOFAZ), "the recent decline of the US economy, the debt crisis in several European countries have created a volatile situation in global financial markets and reduced the yield of fixed-income securities to the lowest level ever." However, the source noted, the bulk of the fund's resources is invested in short-term securities with a fixed income. "Diversification of investments by currencies, credit ratings and regions have minimized the impact on the portfolio of possible shocks on financial markets. At the same time, SOFAZ continues to consider new types of investment instrumentsto increase profitability," the fund's representative said.

Second wave of crisis in the offing?

Meanwhile, international experts have again raised the issue of a second wave of the global economic recession which could hit the world in the coming years.

According to the head of the department on oil markets at the US market research firm Energy Security Analysis (ESAI), Rick Mueller, the lowering of the US credit rating will have serious consequences for the global economy. Mueller said Treasury bonds serve as the main financial instrument in the world, so any doubts regarding their solvency will be very detrimental to economic growth, especially when the economy remains relatively fragile after the 2008-2009recession.

"Of course, the downgrade has occurred at a time when financial markets and advanced economies are still very fragile. Excessive uncertainty can easily contribute to a further decline in stock prices. In the worst-case scenario, this could spark another financial crisis which will lead to further recession in the USA and Western countries," says a report by English Capital Economics.

Nevertheless, Capital Economics believes that all the negative reaction in the markets to the US downgrade will be temporary. At the same time, the loss of the US "AAA" credit rating is a clear sign that the global financial crisis will still be felt for many years to come.

Meanwhile, the previously pessimistic International Monetary Fund has started to make encouraging predictions after the arrival of new president, Christine Lagarde. For instance, Lagarde believes that the fulfillment of commitments assumed by heads of the eurozone countries at the 21 July summit, as well as the US decision to reduce the mid-term budget deficit are critical elements in global financial stability. The IMF headwelcomed the statement from finance ministers and central bank governors of the "big seven", whereby G7 countries agreed to make efforts to achieve stability in global stock markets and pointed to the negative impact of excessive market volatility on the global economy.

In fact, the most tangible support for the US"at a difficult moment" was provided by France. French Finance Minister Francois Baroinsaid his country "has full confidence inthe stability of the US economy".The statement was made despite earlier statements by the Indian minister of finance and economic experts from China who expressed serious concern at the situation. As is evident from the world media, such support is not accidental.According to London traders,there are rumours of an impending downgrade of France's credit rating.

CDS quotes on French national debt (the cost of insurance against default) increased by a record 9 per cent in one day. The European Central Bank (ECB) announced after emergency consultations that it was launching "active pursuit" of a program for the purchase of government bonds in Italy and Spain to prevent them from defaulting.

Meanwhile, as a result of the news about the possible collapse of one of the biggest French banks, Societe Generale, and the lowering of the credit rating of the second biggest economy of the Euro-zone, the exchange rate of the single European currency has fallen too, as have European stock marketsin general. The value of Societe Generaleshares  has fallen by 22.5 per cent. According to observers, the developments on European markets can be viewed as the beginning of speculative games against the Euro, which began with undermining the position of France. Europeanleaders have daily talks on the near-critical situation in an attempt to prevent a collapse of the Euro-zone.

With this in mind, it would be premature to say that the threat of a global recession has been averted - the situation changes almost every hour. But clearly, no-one needs a new crisis today. The world is already preoccupied dealing with the problems of unemployment, food supply and other social issues. New economic shocks could spark off mass unrest in countries hitherto considered developed and stable, which would entail much more serious consequences than the collapse of markets.