By Steven K. Beckner

(MNI) – As Group of Seven officials confer over the implications of
the downgrade of U.S. debt, much of the focus is on the implications for
Europe, not just the United States, Market News International is told.

Although by no means unexpected, Standard & Poor’s Friday night
action to strip the U.S. government of its triple-A rating is creating
shockwaves around the world this weekend in dread anticipation of the
reopening of financial markets in Asia Sunday night.

Not only has the premier ratings agency downgraded U.S. government
debt for the first time, there is a real risk it could do so again. And
a number of European nations are in line for more of the same.

It’s bad enough that the debt has been downgraded. That could mean
higher borrowing costs not only for the U.S. Treasury, but also for
millions of Americans if bond buyers bid up their yields.

But this may not be the end of the process. In addition to
downgrading U.S. debt a notch to double A-plus, S&P is calling the
outlook for “negative.” The Treasury calls the action unwarranted and
“flawed” — an allegation which the firm has defended itself against.

S&P says the recently enacted debt deal has removed any immediate
perceived default threat, but says “the political brinksmanship of
recent months” shows U.S. policymaking “becoming less stable, less
effective and less predictable.” It faults Republicans and Democrats for
agreeing on only “modest” discretionary spending cuts while delaying
action on more comprehensive measures.”

If a second $1.5 billion in deficit reduction is delivered, it
warns of “a possible further downgrade.”

But there are broader repercussions for troubled Europe for the G-7
to discuss.

Europe is already reeling from the Greek debt crisis, which
threatens to spread to Italy, Ireland, Portgual and Spain. The European
Central Bank reluctantly resumed buying the debt of some of those
nations Thursday in an effort to reduce the wide yield spreads relative
to Germany and to prevent an economically destructive domino effect.

The S&P downgrade and threat of further downgrades potentially adds
to financial turmoil and economic headwinds in Europe and elsewhere.

Even before the downgrade, U.S. stocks had plunged well in excess
of 10% in recent weeks — a market correction that could further slow
consumer spending by destroying household wealth. If borrowing costs
were to rise as well, there could be more damage to the sluggish U.S.
economy.

An exacerbation of America’s economic woes would hurt
export-oriented nations in Europe and elsewhere — quite aside from the
risk of another worldwide financial crisis.

It is not clear what the G-7 can do or are prepared to do, however,
given the extraordinary measures they have already taken.

The United States has undertaken massive fiscal stimulus to spur
growth and reduce unemployment. But not only has it failed to work, it
has led directly to the downgrade in question. So more fiscal stimulus
is off the table.

The Federal Reserve has provided unprecedented monetary stimulus of
its own. It has held the key federal funds rate near zero since December
2008 and has bought more than $2.3 trillion in securities to push down
long-term rates.

There is reluctance to resume buying assets or “quantitative
easing,” but Fed Chairman Ben Bernanke has said it is an option if
economic weakness persists. He has also said the Fed could cut the rate
of interest it pays on excess reserves (the IOER) and/or tinker with its
“forward guidance,” i.e. the pledge to keep the funds rate
“exceptionally low … for an extended period” to make clear that the
period will be even longer than previously assumed.

The Fed’s policymaking Federal Open Market Committee will surely be
discussing these and perhaps other options at a scheduled meeting
Tuesday.

Following a better than expected July employment report that
stemmed the stock sell-off Friday morning, most Wall Street Fed watchers
said they expected the FOMC to leave monetary policy unchanged. But if
there is disorderly market activity early next week, the FOMC may feel
forced to act.

The Fed has already taken one modest step in conjunction with other
U.S. financial regulatory agencies.

Noting late Friday that S&P had lowered the rating of U.S.
government and federal agency obligations, they issued the following
guidance to banks, savings associations, credit unions, and bank and
savings and loan holding companies (collectively, banking
organizations):

“For risk-based capital purposes, the risk weights for Treasury
securities and other securities issued or guaranteed by the U.S.
government, government agencies, and government-sponsored entities will
not change.”

“The treatment of Treasury securities and other securities issued
or guaranteed by the U.S. government, government agencies, and
government-sponsored entities under other federal banking agency
regulations, including, for example, the Federal Reserve Board’s
Regulation W, will also be unaffected,” the joint statement added.

As always the Fed and other major central banks stand ready to
inject emergency liquidity into turbulent financial markets. Beyond
that, it is unclear what the G-7 can constructively do beyond publicly
vowing to cooperate to preserve stability.

Unfortunately, the G-7 authorities go into this crisis with their
resources strained and their credibility tarnished.

** Market News International **

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