## Saturday, August 06, 2011 ... /////

### RIP: Standard & Poor's AAA rating of U.S. bonds (1917-2011)

In November 1917, the Bolsheviks ignited their October Revolution and overtook Russia. They were ultimately successful despite the attempts of some forces that tried to stop them.

Czechoslovak Legions grabbed about one-half of Siberia. Here they proudly pose above some hunted down Bolsheviks in Vladivostok: picture roughly from 1917, too. But maybe it's 1920 - departure from Vladivostok.

Well, the Soviet Union and communism didn't last forever. They began to quickly disintegrate about 20 years ago.

In the same year, physicists became familiar with the first serious calculations using Einstein's new general relativity. Schwarzschild actually found his solution already in 1915. He died because of some infection acquired during his World War I service.

Meanwhile, in the same year of 1917, the United States were given their AAA rating from Standard & Poor's - one of the Big Three (and Big Two, with Moody's) rating agencies today. Has America decomposed just like the Soviet Union? Not quite. Instead, what has happened is that in agreement with the recommendations of TRF, one byte on their computers was changed from "A" to "+". The rating went down from AAA to AA+, after 94 years, with a (still) negative outlook.

Everyone who is watching - and trying to project - the fiscal situation of the U.S. government must have known that such a reduction of the rating is a natural decision. The rating agency recently announced that spending cuts lower than \$4 trillion will mean a reduced rating - and the cuts were just one-half of it. And the reduction shouldn't really be a big deal. It's like when you were a schoolkid and all your grades were A/1 and suddenly you got your first B/2. Of course, my first B/2 was from sports in the first semester of the high school. ;-) Needless to say, my sports A/1 at the basic school was often a result of a special treatment.

The reduced rating should have been expected, it is in principle unspectacular, but my guess is that many people will react hysterically - as if the event were comparable to the collapse of the Soviet Union. It surely isn't. It is million times smaller an event. The comparison of the fall of regimes and the reduced rating reminds me of the joke about two dogs in the animal hospital. "What are you doing here?" one of them asks. "Well, they're going to euthanize me because I have attacked our neighbor. And what about you?" - "I jumped on my mistress and played with her a little bit." - "So will you also be euthanized?" - "No, she asked the doctors to polish my claws."

America's bonds don't deserve the AAA rating anymore. I surely agree that the situation of the U.S. is vastly better than the situation of Greece (today) but I would say that it is comparable to the situation of an average Western EU country. But the average rating of the EU countries isn't AAA, either. The fiscal situation of the U.S. is clearly worse than e.g. that of Germany (at least in 2011).

If I were in one of the central banks, I would actively try to financially ruin all the "traders" and "investors" who always join the first mass hysteria and start to sell "everything". The existence of these people on the markets - whether they're acting in this way because they're uncontrollable emotional cowards or because they made a risky investment they couldn't really afford or because they actively want to benefit out of the mass hysteria by strengthening it - is behind a big portion of the volatility and problems of the contemporary world economy. Such people have no business to remain among the rich people who influence the dynamics of the markets. They screw the markets and the way for the government to protect the markets is to do everything they can to make these people broke.

If prices go down - and prices of stocks went down in the last days and weeks for pretty much no good reason - it is a reason to buy because the stocks are cheaper. The people who think in the opposite way are idiots and they should lose their buttocks - but they don't because their number has become so large that they can distort the basic logic that a lower price means cheap. Traders are literally being rewarded for acting irrationally - or for pretending to behave irrationally (which is what hedge funds often do).

As a central banker, I would create special funds that would buy stocks and bonds, and when they drop below some sensible level given by a 1-year average minus 2-3 sigmas, I would buy them up. One could even design some rather strict algorithms. Those assets could be sold when the stocks get 2-3 sigmas above the normal. At any rate, I think it's obvious that if there's a role for the government and central banks, they should try to regulate things, and buying things that got excessively cheap and selling things that got expensive is a natural way to regulate the system that even normal profit-seeking traders should do much of their time. Governments and central banks may want to do such things in a systematic way.

Other kinds of interventions always look less natural to me.

So we will see whether the markets will amplify their chicken-little behavior.

What I really hate is that much of the markets seems to be composed of idiots who are no longer capable of distinguishing different assets. They can only distinguish "being hysterical" and "being optimistic" (about everything). This is just so deplorable. People often talk about the domino effect which is just a piece of communist propaganda. One domino falls so other dominoes will also fall. The communist propaganda says that everyone is so interconnected, so the safety and prices of everything are de facto equal, and all this utter garbage.

Except that their fates are not linked. The world economy doesn't resemble domino in any non-trivial way. Every kind of asset has its independent value, the influence of "adjacent" market players is small and the influence of those "behind them" is already negligible in most cases, the stability of every company and every financial institution is an independent quantity, and many pairs of companies actually have their fate negatively and not positively correlated - you know, it's because they're competitors.

If someone nuked the U.S. and completely erased it from the map, it would be sad but a majority of the world could continue without much change. The Greek financial problems are problems of Greece, a few players that hold the Greek bonds, and almost no one else.

When the interest rates on Spanish or Italian bonds grow from 6 to 6.3% or something like that, it is pretty much a non-event even for these two countries. But it should be a complete non-event for the rest of the world. Even if Spain and Italy went completely bust - and this won't happen anytime soon - America and lots of other countries would be unaffected. Everyone primarily has a responsibility for himself.

If a growth of the interest rates of some not-key-countries' bonds by 0.3% is enough to spark a 10% drop in the market across the world - and the world economy is 2 orders of magnitude bigger than Spain and Italy combined, you may be sure that the idiots must inevitably dominate all the transactions. A reasonable contribution to the change of the price of generic assets in the world should be close to 0.3% / 100 = 0.003%.

Meanwhile, the subjects who are the primary drivers of the hysteria - such as the Greek government and the Greek people - act as if there's no problem with them. Do you think that the society favors improvement of things if those who are deeply in red numbers are being rewarded and those who are in black numbers suffer? This is what's happening - not only because of socialism that has penetrated into various governments and international organizations but also because of the socialism inside many of us. And the socialism inside us may be even more toxic.

Could people please stop spreading the outrageous communist garbage about domino effects and the interconnectedness of all the players in the economy? Well, I know that this is probably too much to ask.

Far left attacks the rating agency

The far left pundits apparently realize that it's the Democratic Party, and not the G.O.P., that is mainly responsible for the recent dramatic deterioration of the U.S. fiscal situation. That's why they don't criticize the G.O.P. but the rating agency itself: Washington Examiner.

So they try to make a big story out of a numerical error in a justification of the reduced rating. That's cute to find such an error (2 trillions) but it's not really going to affect the decisions which have been obviously thought about for quite some time and without big numerical mistakes.

A crackpot economist, New York Times columnist, and Nobel prize winner Paul Krugman even said "After the mortgage debacle, they really don't have that right." Well, they have this right even in North Korea and in the U.S., they really have the obligation to impartially evaluate such things - and the U.S. government is no exception. Apparent imperfections of their estimates in the past can't change anything about the fact that they remained the leaders in their industry and it is their duty to do exactly what Paul Krugman thinks they're not allowed to do.

Later, Krugman even retweeted a message from his fellow crackpot blogger named Atrios: "Apparently we're supposed to care about what some idiots at some corrupt organization think about anything." - Well, not at all. You are not supposed to care about the empirical data at all. Everyone realizes that with the feces in your skull, you're not able to do so - so you're not supposed to do so, either.

In reality, one may praise Standard & Poor's for their polite discourse. Five days ago, Vladimir Putin said that America is a parasite on the world economy, through the dollar monopoly and export of its own problems to the world. Today, Chinese media celebrated that the era of America's easy borrowing is finally over (full text). ;-)