August 24, 2011
The NYT reported on S&P’s downgrade of Japanese government debt to the 4th highest level. It explained the downgrade by noting Japan’s continued weak growth, political problems and concerns about deflation. These are factors that might concern the Japanese public when they vote for their leaders, but it is difficult to see what they have to do with bondholders holding Japanese government debt.
Bondholders are presumably worried about whether they will get paid back. None of the issues raised in this discussion have any direct bearing on whether Japan’s government can repay its debt. In fact, since the debt is denominated in yen, it would be difficult to understand how Japan would be unable to repay its debt, unless it forgets how to print yen.
In fact, the concern about deflation undermines one of the arguments that is occasionally made in the context of the U.S. downgrade, that S&P is concerned about inflation eroding the value of the debt. While this story never made sense in any case, if Japan sees deflation then bondholders will actually be repaid in yen that are worth more than the yen they lent. (The credit rating agencies are not in the business of making inflation forecasts. Furthermore, if an increased risk of inflation was the basis for its downgrade then S&P should have downgraded all dollar denominated debt regardless of the issuer.)
It is important for the media to analyze the basis for these downgrades since there are serious questions about the competence of S&P and the other credit rating companies. They rated hundreds of billions of dollars of subprime mortgage backed securities as Aaa. They also gave top investment grade ratings to Lehman, Bear Stearns and AIG until their bankruptcies (or bailout in the case of AIG).
Given their abysmal track record, it is entirely plausible that there is no basis for their downgrades of sovereign debt. There certainly cannot be a prima facie assumption that they have any idea what they are doing.
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