(Lack of) Credit Ratings by Country

On 05/20/2011, in Economics, by Jordan Wilson
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Countries continue to finance their activities through deficit spending, resulting in substantial accumulated debt.

This devalues the worth of a country.

As with individuals, high debt results in poor credit ratings as the risk of default increases. This can have a significantly negative effect on a country and its residents. 

Increasing Interest Rates

To attract lenders who will purchase government debt, countries need to increase interest rates offered. This compounds debt problems as an ever increasing amount of debt repayment involves interest expense.

In your own life, simply look at your mortgage if you have one. What percentage of your monthly payment goes to interest? Probably much more than goes to principal.

Also, increased interest rates funnel down to domestic borrowers as well. Your car loan becomes more expensive. A company must pay more to finance expansion. The more money spent on interest, the less disposable income for you and the company. Not a good thing for your lifestyle and for growing the domestic economy.

Depreciating Currency

Another issue with poor credit ratings is a lack of demand for your currency. Even offering high interest rates may not attract sufficient investors. Would you lend money to Zimbabwe regardless of the return offered? Not too likely. With less demand for a currency, one will see currency devaluation.

Some people believe that a weak currency is a positive. Especially if you are a country that exports products or is seeking investment in the country itself. The thought is that countries who export goods provide economic stimulation for companies in the exporting industries. This trickles down throughout the country as a whole, which is beneficial.

True.

Strong Currencies Are Best

But I believe that a strong currency greatly outweighs a weak currency. A strong currency shows that you are an economically solid country. That will allow the country to better withstand periodic economic downturns, unexpected issues such as earthquakes, or use its strong financial position to improve internal infrastructure or social conditions.

While a weak currency may help exporting industries (at least in the short-term), most countries are not wholly exporters. Much of most larger, developed nations involves domestic production and consumption. Often inputs into domestic production involves foreign materials. A weak currency does not assist in these areas. A strong currency may be preferential for domestic industries.

Also, a strong currency makes imported goods more attractive. This provides more purchasing options for consumers which enhances customer satisfaction. And over time, it may enhance domestic production as internal companies must become more efficient to counter lower priced foreign products. Another benefit for the consumer (although possibly not for the domestic producer).

As an investor, strong currencies are also preferred.

Say you invest USD 1000 in a foreign currency when it is equal to your own. It offers a one year return of 10%. If the exchange rate remains at par, at the end of one year you will receive USD 1100 after conversions. If the foreign currency appreciates by 15% over the year, you will receive USD 1265 after conversion.

But if the foreign currency depreciates 15% over the year, you will only receive USD 935. Despite the 10% return in the foreign currency, you will have lost money on the investment.

As an investor, exercise caution when investing in foreign currencies. Unless the rates offered justify the risk, be careful when investing in potentially weak currencies. You may find the returns are not what you expected.

The following chart shows the credit ratings and financial position of many countries.

As you can see, there are a lot of countries with significant problems.

The only positive is that countries who are merely weak seem strong against some of their brethren.  As the old saying goes, in the land of the blind, the one-eyed man is king.

Original posted at this link.

Mint.com Personal Finance

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