Could post-Brexit Credit Downgrades save Britain from the next Crash?

v2-bank-of-england-pa

After last Thursday’s decision by the British public to leave the European Union (a decision which I endorsed and stand by), reports emerged in the press almost immediately of the imminence of a downgrade in the UK government’s perceived creditworthiness. And sure enough, several downgrades have occurred in the days since the referendum. First to act was ratings agency Moody’s, who assigned a negative outlook to Britain’s Aa1 rating on government debt the day after the referendum. Shortly afterwards, Standard & Poor’s downgraded the British government’s creditworthiness from AAA to AA+, while Fitch went even further, downgrading the government’s credit rating to AA. Significantly, S&P has also, in the past few hours, downgraded the credit rating of the EU itself from AA+ to AA.

Grim sounding stuff, upon a cursory glance, and certainly perfect headline content for the many doomsayers and pro-EU commies of the fourth estate. However, the long-term implications of such downgrades might not be as negative as we’re all being led to believe. Indeed, increasing doubtfulness of the government’s creditworthiness could help to cushion the blow for Britain somewhat, when the next crash inevitably arrives.

First of all, these downgrades theoretically make it more difficult for the British government to sell bonds to private investors, and hence more difficult for it to borrow money, which to me at least makes the downgrades a positive, almost regardless of their other consequences. With UK public sector debt at over 80% of GDP and Osbourne still failing to achieve even his own lax targets for reducing the deficit, I’m pretty sure that if fire rained from the sky and Beelzebub ascended from hell to eat Mark Carney’s legs, I would still hail the event as a positive if it made it more difficult for the government to borrow money. One might argue that the downgrades actually won’t affect the total amount that the government can borrow, because even if they dissuade private investors from buying government bonds, the Bank of England can theoretically pick up the slack by simply buying government bonds with money created out of thin air. However, with interest rates at record lows since 2009, the threat of high inflation might prevent the bank from completely offsetting a reduction in demand for government bonds, and so it’s possible that the total amount of money the government can borrow may indeed decrease.

However, far more important is the fact that these downgrades may help to deflate the government debt bubble which we are currently living through, and which will in all likelihood be the cause of the next crash. In the aftermath of the Dot-com crash of 2000-2001, central bankers’ pursuit of artificially low-interest rates encouraged speculation and a scramble to borrow and invest, during a time in which the economy should have been allowed to readjust and learn the lessons of the crisis it had just been through. Instead of allowing the Dot-com bubble to fully deflate so that the economy could start building on a solid foundation again, they merely rolled the bubble over into another section of the economy: housing. The reason why housing became the area of the next bubble was because it was seen as an extremely safe area of the economy, with  relatively predictable rates of expected return, and only a small chance of failure. When the housing bubble finally did burst, central bankers made all the same mistakes again that they had in 2000, sledgehammering interest rates into the earth’s mantle and consequently causing a scramble to invest in the area that had replaced housing as the universally accepted “safest” investment in town: government debt. However, with Puerto Rico facing an historic debt default just this very week, and many other countries not far behind, the signs are beginning to emerge that the government debt market of today is just as “safe” as the housing market of 2006 was.

If the above is true, and if we really are on the verge of a government debt crash that will dwarf the housing crash just as much as the housing crash dwarfed the dot-com crash, then we should all be thanking the ratings agencies for trying to steer UK investors away from becoming more heavily invested in government debt. Will it completely shield us from the effects of the crash? Absolutely not. But we can at least assume that, come the crash, the British public and its institutions will likely find themselves at least somewhat less heavily invested in the failing government bonds than they would have been, had they retained their unimpeachable AAA ratings.

So thank you again to the British public for voting for Brexit, and thank you to Moody’s, Fitch, and S&P for downgrading your assessment of our government’s creditworthiness; in exchange for a little short-term uneasiness, you may have put Britain in a stronger position to weather the coming storm, perhaps without even having realised it.