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Australia's lauded Triple-A credit rating teeters on the edge with Standard & Poor's outlook changing from "stable" to "negative" — Gilchrist Clendinnen discusses the ramifications.

If you’ve gone anywhere near mainstream media lately, you’ve probably seen a lot of people talking very gravely about Standard & Poor's (S&P) recent change in outlook for Australia and how serious it is.

To recap, S&P are one of the largest global rating agencies and on 7 July, changed the outlook for Australia’s credit rating from "stable" to "negative".

This means that while Australia has kept its Triple-A rating for now, there is a real chance we will lose it over the coming months. The reaction from our politicians has been predictable. Chris Bowen has been busy telling anyone who will listen that whatever happens, it is definitely the Coalition's fault while Turnbull has been quick to point out that this just highlights how important his budget repair plans are. Indeed, a central argument of the Coalition's election campaign was that an elected Labor government would lead to Australia losing its Triple-A credit rating.

A credit rating is basically a judgement by the rating agency of how likely the borrower is to pay back its debts. The main credit rating agencies spend most of their time rating the debt of private companies but also provide ratings for government debt. Each rating agency uses slightly different metrics and philosophies but the main factors that are generally looked at when deciding upon credit ratings are things like budget deficits, total debt compared to GDP and economic outlooks.

The conventional argument from people concerned about a downgrade in Australia’s credit rating, is that it would cause a sharp increase in interest rates on Australian debt, as entities would demand higher returns when lending money to Australia due to the perceived higher risk. This, in turn, would put even more pressure on our budget bottom line, as more money would need to be spent each year simply paying down the interest on our national debt.

On the face of it, this seems like a logical argument. If you look at the yield on corporate bonds you can easily see that companies with Triple-A credit ratings (Microsoft for example) typically have much lower costs of debt than companies with lower ratings (like Rio Tinto). The problem with this argument, though, is that when it comes to sovereign countries like Australia, the relationship between credit ratings and bond yields is much less apparent.

In August 2011, S&P decided to downgrade America’s credit rating from Triple-A to Double-A+. Instead of bond yields increasing, they actually continued to drop over the next couple of months. For a more recent example, after the UK left the EU last month, its credit rating was also downgraded and once again, bond yields on UK bonds are lower now than before the Brexit vote.

The main reason for this lack of a relationship is the simple reason that sovereign countries like Australia, the UK and U.S. are incredibly unlikely to default on their own loans. Not only does the Australian government have multiple ways to raise revenues if it ever got into serious financial difficulty but as a country with complete control of its own currency, our government could literally print extra money if things got desperate. The entities that buy government bonds know this and therefore don’t pay much attention to the ratings various rating agencies give, when considering the yields at which they are willing to buy bonds.

Instead, as any bond trader will tell you, government bond yields are mainly affected by things like changes in interest rates and inflation.

Another more basic argument people make about why we should take S&P’s potential downgrade seriously, is that it is an indication from a highly respected organisation that we need to fix our deficit problem. Again, though, this argument does not stand up to scrutiny.

S&P is not some independent organisation of economic experts, it’s a profit driven company with a pretty chequered past. In the lead up to the Global Financial Crisis (GFC), S&P, along with the other major rating agencies, repeatedly gave Triple-A ratings to some of the most toxic subprime collateralised debt obligations (CDO) put together by the likes of Goldman Sachs. These ratings were instrumental in giving legitimacy to the subprime mortgage industry, allowing it to balloon in size without facing proper scrutiny.

Many people have made pretty convincing arguments that a large portion of the blame for the resulting GFC of 2008 can be laid squarely at the door of the major American rating agencies. To see these same rating agencies, not ten years later, wheeled out as authorities on the benefits of fiscal moderation is completely bizarre.

The potential implications of Australia running repeated deficits are complex and there are some sound arguments to be made about the importance of returning the budget to surplus over time. While our interest costs remain relatively low, the size of our total debt could potentially mean we have less viable responses should we face another global financial crisis.

However, to give such weight to the opinion of an entity as discredited as Standard & Poor, demonstrates a disquieting tendency we have of putting faith in external authorities when it comes to economic issues.

Australia is a sovereign country and therefore we should have the confidence to make decisions about our own financial destiny without outsourcing them to private American companies.

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