Years ago, someone assigned a name to the countries whose prospects looked especially bright and to which investors should turn their attention. Brazil, Russia, India, and China, collectively became known as the “BRIC” countries.
Not to be outdone, someone with a little too much time on his (or her) hands came up with an acronym for those European countries which are in financial trouble. The acronym: PIIGS. The countries? Portugal, Italy, Ireland, Greece and Spain.
Greece has been the leader of this dubious group, with Standard & Poors (S&P) downgrading the country’s debt back in January of 2009. Only recently has Greece’s debt situation become a full-blown crisis, with traders taking bets on how much more likely Greece is to default on (ie: not pay) its debts. As the risk of loaning the country money has increased, so has the interest rate demanded by lenders to the country. By January of 2010, when Greece borrowed another $8 billion Euros (about $11 billion) for five years, it had to pay a whopping 6.1% interest per year. Compare that with the U.S., which pays about 2.5% to borrow money for five years!
With its deficit in excess of 12% of GDP (Gross Domestic Product, the total value of all the goods and services the country produces), Greece was digging a hole so big it was hard to ignore. However, after seeing how harsh the markets can be, Greece’s Prime Minister, George Papandreou, took dramatic steps to reign in the country’s deficit, including cutting the pay of government workers and raising taxes. These difficult moves are said to have gotten Greece’s deficit down to 8% of GDP. Still, this is far above the 3% limit that every European Union (EU) member country has agreed to observe. Incidently, Greece is not alone in the EU, as several other members are also blatantly exceeding this deficit ceiling.
Now, on March 23, 2010 comes word that Fitch Ratings has downgraded the debt of Portugal one notch, shining the harsh light on a second European country. Yet, with the focus on Europe and the questionable future for the Euro as a currency, the biggest pig of all has mysteriously evaded the spotlight. Its deficit this year will be more than 10% of its GDP, making it a bigger offender than Greece. It is a member of no union. As such, there is no requirement that it demonstrate any discipline. Without anyone or anything keeping it in check, its deficits and debt are exploding. We are talking, of course, about the U.S. of A.
Why does it not seem as though the U.S.’ situation is as bad (or worse) than the above-mentioned European nations? There can only be two explanations: 1) all three credit rating firms believe the U.S. truly is different and will one day call on unidentified powers to reduce its deficit without wrecking the economy, or 2) they are under tremendous political pressure to avoid downgrading the U.S.’ creditworthiness.
Interestingly, the markets may finally be doing what the ratings agencies should have been. All investors are free to assess the fiscal (ie: financial) situation of the United States and make their own judgments about how risky it is to loan it money. Collectively, investors are the market. And the market, it seems, is finally speaking. On March 24, 2010, the U.S. announced that it was borrowing $42 billion for five years. Formally, it was “issuing 5-year Treasury notes”. Investors would only loan the U.S. the money if it agreed to pay 2.6% per year in interest as opposed to the 2.5% they were earning before. While this may not seem like a lot, it is actually a big, abrupt move that may signal more such increases in the future. With the US needing to borrow a total of $1.4 trillion this year, the market will have plenty of chances to speak.
Conclusion: What can you, as a teen investor, take away from this article? The debt of the United States is currently rated the highest possible (ie: AAA) due to the unwillingness of the ratings companies to give it a realistic rating. Don’t take this rating as a sign that the troubles of the U.S. are relatively minor and can be dealt somewhere down the road. They can’t. They require immediate attention.
Can you answer?
1. What are the BRIC countries and what do they have in common?
2. What are the PIIGS and what do they have in common?
3. Which of the PIIGS seems to be the worst of the bunch?
4. What is gross domestic product?
5. Under what limit are European Union members supposed to keep their annual deficits?
6. What do investors do when they perceive that lending money to a country has become riskier?
7. Which of the PIIGS recently had its debt downgraded?
8. Identify two of the three big bond rating agencies.
9. Which country’s deficit in percentage terms is now larger than that of Greece?
10. Provide a rationale for why the ratings agencies have not downgraded the country.
11. Explain how the market “speaks” with regard to the risk of lending countries money.