Fitch Downgrades US Credit Rating

Thank you for joining me. I'm Don Ma. Wall Street closed down on Wednesday, with S&P 500 and Nasdaq lower for a second straight day. And of course, Fitch downgraded the United States to AA+, from AAA, late on Tuesday. More on that in just a moment. July was the fifth straight month of gains for the benchmark S&P 500. Now, with markets entering a seasonally slow August, the Fitch downgrade offered an opportunity for investors to take a breather. Predictions are that investors will soon look beyond Fitch's downgrade and turn their focus to big tech company earnings due after the close on Thursday. And Amazon is expanding its footprint in healthcare. The company announced Tuesday its virtual clinic is now available in all 50 states and Washington, D.C. Amazon Clinic started operating last November. It offers customers 24-7 access to telehealth treatments on its website and app. Amazon Clinic currently does not accept insurance, so patients can see the cost before they start their visit. Other companies like CVS, Walmart and Walgreens offer similar services. Analysts say telehealth expanded during the pandemic, but recently the market growth has begun to slow down. Meanwhile, global firms from consumer goods giant Unilever to automaker Nissan and machinery maker Caterpillar have warned of slowing earnings in China. This is as the world's second largest economy loses its post-pandemic bounce. Here are the details. From consumer goods giant Unilever to automaker Nissan, global firms have warned of slowing earnings in China. That, as the world's second largest economy loses its post-health crisis bounce. Some sectors have enjoyed a continued rebound, such as luxury goods and dining. This has driven double-digit China sales growth for the likes of Starbucks and LVMH. Starbucks reported a 46% surge in comparable China sales last quarter, and Louis Vuitton owner LVMH reported a better-than-expected 17% rise in global second-quarter sales. But even those firms have stopped short of raising their China outlook, and consumer goods firms like Plot & Gamble, L'Oreal and Coca-Cola have taken a cautious stance. Last week, Unilever said it was seeing a historical low for consumer confidence in the country. Global automakers also face a tough environment. They now have to compete with increased competition from domestic rivals in China. Local car makers took a more than 50% share of the market in the first half of 2023 for the first time. Volkswagen cut its full-year sales target last week due to a sales dip in China, its top market. Even Apple, which reports earnings on Thursday, is likely to post flat iPhone sales in its third-largest market. And your car could be sharing your data, and California regulators want to put an end to it. Most cars today have sensors and cameras which track what's going on in and outside of the car. Insurance companies often use it to determine rates and track safe driving. But California's privacy regulator wants to review the privacy practices of the use of personal information from cars. It's something regulators in Europe are also looking into. The California Privacy Protection Agency will look at how the data is collected and decide whether companies are following state law on the use of that data. Meanwhile, major U.S. restaurant chains including Starbucks, Domino's, and Chipotle are automating their restaurants, from robotic grills to faster blenders with custom ice and milk dispensers. Starbucks said it plans to roll out a coffee-making machine in around 10% of its stores starting next year. Starbucks claims that baristas using the machine will be able to produce a drink with less time and fewer steps. Chipotle introduced a robotic prototype in July that cuts and peels avocados. The Colorado-based chain also rolled out a dual-sided grill which cooks 70% faster than the average employee. Last year, Domino's Pizza Enterprises announced an automated pizza prep device. A U.S. congressional committee on China is investigating asset management giant BlackRock. It's saying that the company was facilitating investments into blacklisted Chinese companies. The House of Representatives Select Committee on the Chinese Communist Party said the firm has facilitated the flow of American capital into companies the U.S. government had found guilty of fueling China's military advancement or human rights abuses. BlackRock, of course, denied any wrongdoing, saying it complies with all applicable U.S. government laws. Other asset managers including Franklin, Templeton, and Wisdom Tree also have funds or exchanged traded funds with Chinese assets, according to their websites. And Hugo Boss raised its sales and profit outlook on Wednesday as a brand revamp and marketing push helped the German-fashioned house overcome sluggish sector-wide demand in China and the United States. Here's a closer look. Hugo Boss raised its full-year outlook on Wednesday. It comes after the luxury fashion house reported second-quarter sales rose by a fifth. A brand revamp and marketing push helped the German firm overcome the sector's slow demand in the U.S. and China. Hugo Boss said business in EMEA and the Americas was helped by a pickup in tourism. While currency-adjusted revenue in China rose 56 percent from a year earlier, that made the Asia-Pacific region the strongest for the company. Group quarterly sales grew to $1.13 billion on a currency-adjusted basis. That was well up from $965 million a year earlier and roughly in line with analyst expectations. The company expects its annual sales to grow 12 to 15 percent and reach up to $4.6 billion. Hugo Boss had previously forecast growth of about 10 percent. It forecasts 2023 operating profit to grow up to a quarter to an upper limit of $461 million, again up from previous projections. Credit rating agency Fitch on Tuesday downgraded the U.S. government's top credit rating. And this is a move that drew an angry response from the White House and surprised investors. And this is coming despite the resolution of the debt ceiling crisis two months ago. Here's a closer look. Trust in the United States government repaying its debts is eroding. That's according to credit ratings agency Fitch, which downgraded its assessment of the United States on Tuesday. The agency justified the re-rating from AAA to AA+, because of an expected fiscal deterioration over the next three years. It also cited repeated down-to-the-wire debt ceiling negotiations that threaten the U.S. government's ability to pay its bills. In a statement, the agency said, quote, In Fitch's view, there has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025. Look, the only way American democracy can function is through compromise and consensus. The move comes despite the resolution of the debt ceiling crisis two months ago. Fitch had flagged the possibility of a downgrade in May and said after the crisis was resolved in June that it would finalize a review in the third quarter. U.S. Treasury Secretary Janet Yellen said she disagreed with the downgrade, calling it, quote, In a statement from Press Secretary Karine Jean-Pierre, the White House said, quote, It defies reality to downgrade the United States at a moment when President Biden has delivered the strongest recovery of any major economy in the world. Investors use credit ratings to assess the risk profile of companies and governments when they raise financing in debt capital markets. Generally speaking, the lower a borrower's rating, the more expensive it is for them to borrow. The move makes Fitch the second ratings agency to downgrade U.S. creditworthiness from the top AAA rating, after Standard & Poor's did so in 2011. Fitch said it shows the depth of harm caused to the United States by repeated rounds of contentious debate over the debt ceiling. After the announcement, the dollar fell across a range of currencies, stock futures ticked down and treasury futures rose. Yet several investors and analysts said they expected the impact of the downgrade to be limited. Others also expressed surprise at the timing. Eyes next will likely be on the last of the so-called big three credit ratings agencies, Moody's. It still has a AAA rating for the U.S. government. A Moody's analytics report from May said a downgrade of treasury debt would set off a cascade of credit implications and downgrades on the debt of many other institutions. And here to talk to me about Fitch downgrading the U.S. rating is Mark Hamrick, senior economic analyst at BankedRate.com. So Mark, maybe just help us put this into perspective. Just paint a picture for us. Obviously, one of the three major rating agencies is raising a bit of a question here about the U.S. fiscal position. And I think, if anything, the timing of this announcement from Fitch seemed a bit odd because it's referencing everything from the January 6th insurrection and uprising on Capitol Hill, which is two years in the rearview mirror. And even, you know, apparently alluding, if not just outright referencing some things that happened in the previous administration. And while there may be some people who take issue with what Fitch has done, I don't really think that there is a lot here that really surprises anybody in the sense of raising questions about the sustainability of U.S. debt and deficits. And this is something that two Federal Reserve chairs ago, Ben Bernanke, was talking about over a decade ago when we had a downgrade by S&P. And so to the degree that this could lead to more constructive conversations, more civil conversations about where the U.S. fiscal position ought to be, that could be a good thing. Do we have a high degree of confidence that all those discussions can be civil and constructive? Well, I guess what we'll say about that is let's see what happens. So in your opinion, do you think this downgrade of U.S. credit rating from Fitch, do you think this is justified? Well, that's a decision for them to make. I mean, they're a rating agency and that's their job. But I do think the timing is somewhat suspect. But I think at the same time, the long term observations aren't really necessarily things that many people would take issue with. We're talking about the rising level of debt to GDP that we have in this country that cannot continue to rise at this rate. The fact that taxpayers are bearing an increased burden with respect to just paying for interest on that debt. Oh, and by the way, we have interest rates that are the highest levels in many years. Now, we may be near peak rates. We'll see about that. The Federal Reserve very recently raising its benchmark rate once again and perhaps is ready to pause on the rate increases. That's another discussion. But, you know, I think that anything that can lead to, as I say, a constructive conversation, a debate, consideration about essentially where U.S. government spending is and the levels of debt and deficits that are associated with that. I think I think those are appropriate conversations to have, not only in the part of the American people, but on the part of the elected officials who are supposed to be doing, I would say, a better job, broadly speaking, than what they've been doing. Sure, sure. Of course. And we can get into that a bit later. But let me just get one quick reaction from you. This is a quote. In Fitch's view, there has been a steady deterioration of standards of governance over the last 20 years, including fiscal and debt matters, as you mentioned just now. What's what's your reaction to that? I think that that is a view that can be supported by some facts. And I'm laughing about it because it feels sort of blatantly obvious and it breaks down to all kinds of things, such as the fact that we had a debt ceiling standoff up until recently once again. And we were talking very in a very sober way, but seriously about the possible prospect of default on the government debt. And it felt as if this was as close as we've ever gotten in this country, which was why people like me and all sorts of other people, including I think most elected officials, were saying that that was an unacceptable alternative. And fortunately, let's say cooler heads prevailed and we moved past that. But here, as we're speaking once again, Don, there does appear to be a very real prospect of a federal government shutdown at the end of September, which is different than default. We're really talking about the fact that the government would simply need to shut down because it hasn't passed the necessary appropriations bills. That's minor league stuff compared to the seriousness of a default, because the latter, of course, is one where we'd be talking about a likely economic crisis where unfortunately we've weathered these temporary government shutdowns many times over the last decade or so. So I guess what I'll say is this continues to be sort of an experiment in action. And, you know, we've seen situations here where what used to be called regular order on the part of Congress, where hearings would be held on the budget, you know, and it would be passed a committee and then it would go on to the full chamber. Those kinds of processes really have broken down. And the fact that we really don't know what the spending plan is, you know, going farther out, that's not a way to run government. It's not a way to run business, not a way to run either of those two things. All right. And I think we should address if there is going to be a long term impact to this downgrade. I think we should start off with what has been the reaction in the stock market? I would say other than, you know, a kind of garden variety sell off as we speak, I would say there's been not much reaction at all. And I think the reason for that is, first of all, it's not our first rodeo with respect to a downgrade. We did have a rather severe reaction when this happened at the hands of Satterdan Poor's over a decade ago. But ultimately, everybody moved past that. And the government went about continuing to fund its business and moving on forward with debt and deficits as it did over those many years to come. And this just doesn't feel nearly as momentous as that event. For among other things, there we don't really have a pending crisis here in the coming days and weeks with respect to a default. All that is, you know, a couple of months in the past here. So I think the way to probably try to process this is to say, you know, Fitch appears to be trying to make a statement that our system of governance in the United States is sort of battered and bruised. We have had, I think, legitimate questions raised over the past several years about what is the health of our democracy in the U.S. and parts of that structure at times has felt a bit broken. And it's necessary to have a healthy system of law in a country that is based on the rule of law and an orderly government process. And it has been not as orderly as it was, as Fitch might have referenced some decades ago. But very much on almost no reaction at all in the financial markets. I think investors and participants are focused on what they've been focused on in the recent days and weeks. And that is an economic outlook that appears to be more solid than had been before. The soft landing thesis is sort of the most common base case right now, meaning that a recession or a severe downturn can be avoided between now and the end of the year, if not beyond that. And the discussion about whether the Federal Reserve, our own central bank, is close, if not at the end of its rate raising cycle. And we'll also be watching about the health of the job market in the coming days and not long after that, other measures of inflation. Speaking of how markets sort of shrugged this off to, so to speak, what do these ratings mean in the minds of investors? Well, I think that's what you're being told by the performance of markets, assuming that this performance sort of sustains itself. And that is we have not learned anything that we didn't already know about the challenges confronting the government and the U.S. fiscal position. And therefore, do we really think that the situation has changed materially in the coming days, weeks and months? No, I don't. I don't think that that is an assumption that is being made. And and that's not to be dismissive at all about the questions that are raised within, let's say, the text of that statement. We know the U.S. has some challenges. Spending is at an unsustainable level. Debt and deficits have been at unsustainable levels. Wasn't any more brought forward in the last 24 hours than what we had understood a week, a month, two months ago. You know, in investing, there is technicals and there are fundamentals. And what we're talking about right now is in the fundamentals category. So one would imagine it would impact markets. So why haven't we seen some catastrophic thing appearing? I think mainly, Don, because the U.S. continues to really be the least dirty shirt in the laundry when it comes to government debt. I mean, the Treasury bond is continuing to be the risk free asset that was seen in the past. And for sure, you know, we were talking about the debt ceiling not that long ago. We were wondering whether that risk free status could be threatened by a default or getting close to a default. But that did not happen. And if anything, the U.S. Treasury is having to issue all kinds of further debt because once we got past the debt ceiling, what can the government do? It can issue more Treasury paper. And that's what it's in the process of doing. And so we are in a high interest rate environment. But there are plenty of buyers for that debt. The government being the seller and buyers being everything from other countries, individuals, people who are just sort of balancing their portfolios out for their retirement savings, as well as, of course, institutional investors. And there's no indication that this downgrade on the part of Fitch has had a demonstrable impact on that. And even long term, this wouldn't have an impact. Well, we don't think so. It didn't in the S&P case. There was thought to have been a multibillion dollar impact over a period of time in the sense of, let's say, temporarily raising the cost to borrowing. But that doesn't seem to be the case now. All right. If we do get a consensus between the major rating agencies, would there be a bigger impact then, in your opinion? I think that would be a much more serious situation. And, you know, as I said, you know, this is sort of an experiment that is continuing to play itself out in real time. And you could almost say I don't want to say so far so good with avoiding, you know, the calamity that we were talking about a few months ago. But, you know, in the sense that Fitch just seems to have, without being a spokesman for them, to come out with this decision with odd timing. You know, I'm sure the other ratings agencies are taking note of this and making their own assessments about where they want to be. But obviously, so far, there hasn't been an event per se recently that has triggered those kinds of decisions on the other two being Moody's and S&P. All right. Thank you so much for your insight today, Mark. Thank you, Don. And finally, the Mongolian prime minister visiting the U.S. for the first time in five years. Resource-rich Mongolia has extensive deposits of rare earth minerals and copper. And the question is, can the U.S. reduce its reliance on Chinese critical minerals and source from Mongolia? Here to talk to me about this is Antonio Graceffo, China economic analyst. So, you know, I want to talk about the topic of U.S. reliance on Chinese critical minerals. The media question is, how do we diminish that? I want your thoughts on that. But but first, there's going to be a visit by the Mongolian prime minister to Washington today. Mongolia is resource-rich and it could want to position itself as a democratic partner for the U.S. So my question to you is, can the U.S. instead rely on Mongolia for critical minerals? OK, good morning. And yes, about Mongolia. So we consider Mongolia to be the island of democracy. It's the only democratic nation in that part of the world. Remember, they're sandwiched between China and Russia, which are both totalitarian. And then the nearest countries are the Central Asian republics, which do not have very high quality democracy. So that is the benefit of Mongolia. Mongolia is trying very hard to become a democratic partner of the United States. They consider the United States to be their best third neighbor because they only have two neighbors. So they consider U.S. the best third neighbor. Now, Mongolia is sitting on a lot of critical minerals and they are now in negotiations with the U.S. to be our new partner for that. And I think it's really good. I think it's a good sign politically because Mongolia is very much dependent on selling minerals and selling energy to China. And so this they're always looking for ways to diversify their business away from China and their dependency on China. So does Mongolia have enough resources to the degree where the U.S. can completely replace China? No, no, no. Ironically, the United States has enough resources that we could completely place China if we were to capitalize on those resources. So does the U.S. have an interest in strengthening this relationship with Mongolia? Oh, definitely. So the U.S. we hold some military exercises in Mongolia. We have some troops that are stationed there permanently, a small, you know, small group. So it's very important for the United States to be able to access Mongolia because it's between Russia and China. It's important for us strategically, politically, militarily. And of course, anything we can do to strengthen that tie is good. Also, Mongolia is extremely dependent economically on China, which then forces Mongolia to vote in favor of China in the U.N. And if we could reduce Mongolia's dependence on China economically, then it's more likely that Mongolia would vote their conscience, which as a rule, they tend to not like China, but they're just sort of forced to support China. How do you think China is going to react? Because it's sandwiched between China and Russia, right? So it's it's very in very close proximity. Is China going to be angered? Yes, of course. Anything that Mongolia does that China doesn't like, then they'll find some way to bring reprisals against Mongolia. When the Dalai... You know, the people of Mongolia are Tibetan Buddhist. And when the Dalai Lama visited Mongolia a number of years ago, China retaliated by closing the border for several months, which, of course, then causes shortages and lack of income in Mongolia. So anytime Mongolia does anything with the United States, Japan, South Korea, China will find some way to sort of punish them for that. So can Mongolia get around that? Why is it doing this now to strengthen relationship with the U.S.? So Mongolia can get around it if there were sufficient income generated by United States, Japan and Korea to replace the dependency on China. It is unlikely that that will happen unless Mongolia can move up the value chain. So right now they're selling coal to China. Well, they're not going to sell coal to the United States, Japan and Korea. Right. That just doesn't make any sense. It's too far away. So we'll have to find some other way to increase the revenue that they get per unit volume of whatever it is they're going to sell to us. So rare earth minerals are quite expensive. That could be one of the ways that, you know, if you sell one ton of rare earth minerals to the United States, you know, that equals how many, you know, probably thousands or hundreds of thousands of tons of coal sold to China. How do you think this relationship will look like after the Mongolian prime minister's visit? Well, I'm hoping that will intensify. Inevitably, what happens when we have these these meetings between U.S. leaders and Mongolian leaders, usually the U.S. will give them some sort of trade benefit that they'll agree to buy another 100 million dollars or 200 million dollars worth of stuff from Mongolia, or they might approve certain exports. Because there's other issues with Mongolia exporting is one, that they don't have that many products. And then number two, that the products are not approved. For example, the meat, you know, meat is one of the largest products in Mongolia after minerals. And the meat that is exported from Mongolia cannot get approval in the United States, Australia, Japan. It has a lot of trouble getting approved for human consumption. So and then there may be issues with cashmere, maybe issues with the with the leather. These are regulatory issues. So sometimes what the U.S. will do is we will reduce some of those regulatory barriers to trade to help increase the volume of trade between Mongolia and the United States. So if if the U.S. has Mongolia and it has resources at home, why is it still reliant on China for critical minerals? Problem with critical minerals is that, you know, they're called rare earth minerals, but they're not actually that rare. They're relatively common. The issue is that to mine them is very, very polluting because you have to remove a lot of earth, a lot of other waste materials in order to get a small quantity of rare earth minerals. So the United States has one of the largest deposits of rare earth minerals out in California. We only have one mine out there. And the problem is, number one, there's environmental regulations that prevent us from being able to effectively mine it. And then even after we mine it, we still send it to China for processing. So even if we're mining here to avoid relying on China, we're still relying on China because China does the processing. China has 90 percent of the world's processing capacity. So that needs to be bypassed. And the only way that can be bypassed is one, we'll have to reduce our regulations here, including climate restrictions. And number two, the government will have to fund the establishment of these processing and mining operations. In your words, maybe you can explain it. Is it worth it to wean off China in this topic? Definitely worth it for a number of reasons. I mean, just in general, we need to wean ourselves off of China. We're relying on a China supply chain, but rare earth minerals in particular are critical to defense technology, defense machinery, airplanes, advanced weapons, communications. So if we were to go to war with China, we would need these things. And of course, China would presumably refuse to sell them to us if we were in a war with China. So we need to be able to produce them domestically. Or the other option, which is probably the more viable option, is that, yes, the U.S. should step up our production, but then we should encourage our our allies in NATO and Canada and so forth. The AUKUS and the Quad have our defense allies also step up their production of rare earth minerals and refining of rare earth minerals. And I just want to point out, it's not even just a direct war with China. If China invades Taiwan and the U.S. gets involved, that could also result in what you just said. Right, exactly. So presuming if China invaded Taiwan and the war had had a look like the Ukraine war where the U.S. is not actually directly involved, but we're quite obviously involved supporting the other side. So we would be sending advanced technology to Taiwan, in which case China would refuse to sell us the rare earth minerals so that we couldn't manufacture that technology. What percentage of rare earth minerals is used for electric vehicles? Do you know this? We don't know the percentage. But what I do know is that with the rate of increase of electric vehicles and the rate of increase of the use of solar and wind energy, we need to increase our production by about 60 percent over the next 10 years, roughly through 2035. We need a 60 percent increase because these rare earth minerals are used in the turbines, the advanced magnets that are used in the electric engines and all of this. And of course, we're going to wean ourselves off of fossil fuel and meet climate goals that have been set by by the United States, by the international organizations and so forth. The only way to do that is we'll have to step up to green energy. And green energy is 100 percent dependent on or very much dependent on these rare earth minerals. And just a side question in terms of pollution, you know, making green energy technology versus using existing fossil fuel technology. Holistically speaking, which one pollutes more to the environment or maybe it's about the same? That's a really brilliant question. And it's one a lot of people don't want to address. So the issue with it, with the green technology, is that, number one, we're using batteries for everything. And, you know, batteries have a shelf life. Batteries are very polluting to dispose of. You know, the manufacture of things like wind turbines, solar panels is very polluting. And the way we have the system of carbon credits right now, if we outsource this pollution to China, then somehow we've met our climate goal. But at the end of the day, we're producing the earth is producing the same amount of pollution, whether we produce it in the U.S. or in China. So I think that the the green movement, the, you know, the alternative energy movement, people really need to sit down and do cost benefit through the entire chain of production, because the fact that we sent the manufacturing of solar panels to China doesn't mean that we've somehow saved the earth. Right. Because we're still producing the same amount of pollution. And that pollution may be more than running our cars on gasoline. And there's another aspect of this. There's another cost, which is on the human side. You know, in poorer countries, the labor laws are, let's say, very lenient. And sometimes they employ illegal child labor. Right. So one of the issues is that the rare earth minerals are often or any type of minerals, any type of raw materials often extracted from from either Africa or Asia, mostly in Africa. And so the child labor laws are essentially non-existent. Safety protocols are not there. Environmental protocols are not being met. And so these these mines are very polluting. They're very dangerous. And, you know, children working in them. Having said that, if we were to require somehow, if we had some sort of trans transnational enforcement of law, we were able to force, for example, Nigeria or whatever the country is where where they're mining these things right now. Niger just just had a coup and Niger is rich in uranium. Now, if we force Niger to adhere to our standards, well, then it would become expensive to mine in Niger and it might not make sense to mine there. So it might make sense to mine here in the United States, which is beneficial to us. But then it also means that this these jobs and this revenue and so forth would be lost to the country of Niger. All right. Just one final question. And let me just bring it back to the beginning topic of Mongolia. Just briefly, what kind of leverage does China have on Mongolia? So Mongolia's economy is considered the single most resource dependent economy in the world, and it is very close to 100 percent of the economy of Mongolia is resource dependent. And the reason why is that if the mines were to close tomorrow, everything else would disappear, the banks, the coffee shops, whatever. So it's easy to look at it and say, well, the resources are 70 percent because that's the mining. It's like, no, because everything else is dependent on the mines. The mining products, 80 to 90 percent of those are being sent to China. So this really means that the entire Mongolian economy is dependent on China. Wow. The entire economy. That's very eye opening. But thank you so much for your insight today, Antonio. OK, thanks for having me.