US Debt Downgrade May Have Chinese Connection

Standard & Poor’s recent downgrading of the US credit rating is being billed in the media as a major blow to the economic credibility of the nation and to the future election prospects of President Obama, but there are some special interests that appear to have benefited from that black mark on the US currency.

Those beneficiaries include the parent company of S&P as well as a Republican senator and aspiring vice presidential candidate who played a key role in the recentdebt-ceiling negotiations that engulfed Congress and the White House in turmoil over the summer.

On Aug. 5, S&P, a subsidiary of McGraw-Hill Cos., lowered its assessment of US long-term debt, cutting its rating from a top-notch AAA to a slightly less-favorable AA+ (the only major rating agency to do so) and in the process sent shock waves through world markets.

Within days of that action, another event occurred that was barely covered in the mainstream media.

The Chinese currency, the yuan, spiked suddenly in value, reaching in a few days a17-year high against the dollar. And this was not an unexpected result in the wake of S&P’s downgrading of US debt, according to some economists, given that China holds $1.2 trillion in U.S. Treasury notes and as much as $2 trillion more in US dollars — all of which became less valuable in the wake of the credit downgrade.

The Dow Jones news service reported on Aug. 1, four days prior to S&P’s downgrade, that an economist with a major Chinese state-run think tank was predicting just such a spike in the value of the yuan (also known as the renminbi, or RMB) should the US credit rating be slashed.

From that report:

“Countries all around the world would be less willing to hold dollars [if US debt is downgraded], resulting in a greater flow of capital to emerging markets, including China. China will experience great pressure to let the yuan rise faster, which will likely compel the PBOC [People’s Bank of China] to act,” Zhu said. [Emphasis added.]

And, as the chart at right shows, the yuan did spike upward dramatically in the days immediately following the S&P downgrade of US debt on Aug. 5.

There are other factors (including Federal Reservepolicy that has weakened the dollar) putting upward pressure on the yuan, which the Chinese government had already begun to pump up slowly prior to S&P’s downgrade. But that downgrade arguably was a major trigger event leading to the yuan’s sudden spike to record value within days of the downgrade.

A sharp rise in the value of the yuan works to the advantage of US companies (and their Chinese business partners) seeking to sell products and services in China. A stronger yuan provides Chinese consumers with more buying power.

In the reverse, a stronger yuan also disadvantages Chinese exporters, whose products become more expensive in the US, which also works to the advantage of US companies seeking to sell their US-produced goods to American consumers.

Overall, at least in the short-term, US consumers will likely suffer with a higher yuan, since prices of Chinese-made goods will tend to rise at the retail level for them; however, long-term, new jobs could be created if US manufacturing strengthens as a result of the upward price pressure on Chinese imports into the US.

Money As Politics

S&P’s decision to drag down the US credit rating was made in the wake of a brutal, partisan battle in Washington over the US debt ceiling, which was essentially held hostage by that brinksmanship until the last possible minute, Aug. 2, when a budget deal was finalized between the Republicans and Democrats that resulted in the lifting of the nation’s debt ceiling.

The rating agency’s rational for downgrading US debt boiled down, in the main, to the future uncertainty that was made manifest due to the debt-ceiling battle royal.

“The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed,” S&P stated in an Aug. 5 press release explaining its decision to downgrade US debt. “The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year’s wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge.”

But what was not mentioned in the S&P press release was the fact that the rating agency’s parent company, McGraw-Hill Cos., has a major, and growing, presence in the Chinese market, according to its latest 10K filing with the U.S. Securities and Exchange Commission. As a result, it would appear to be among the US companies that stands to benefit from a sharp rise in the value of Chinese currency, which seems to create at least the perception of a conflict of interest for the rating agency.

From McGraw Hill’s most recent 10K report to the SEC, filed in February of this year:

Over the next five years, it is estimated that emerging markets will account for as much as 75 percent of the world's economic growth. As a company at the intersection of education and financial information, McGraw-Hill will have a growing role in helping those economies develop the two forms of capital they need for sustained expansion — human capital and financial capital. Already, international sales account for 29 percent of our total revenue, with key markets such as India and China growing rapidly.

… McGraw-Hill has witnessed China's remarkable growth firsthand, having entered that market more than two decades ago. Therefore, it was fitting that for Standard & Poor's 150^th anniversary, S&P hosted in July [2010] the “Future of Finance” forum in China, in collaboration with the Chinese Academy of Social Sciences (CASS). Mr. [Harold] McGraw [chairman, president and CEO of McGraw Hill Cos.] shared the podium with (left to right) Wu Xiaoling, Member of the Standing Committee of the National People's Congress (NPC) and Vice Chairman of the Financial and Economic Committee of NPC; Wang Zhaoxing, Vice Chairman, China Banking Regulatory Commission (CBRC); and Li Yang, Vice President, CASS.

As part of its expansion into key global markets like China, McGraw-Hill deployed a highly successful, blended IT vocational English course. In July, Mr. McGraw interacted with students at a vocational center in Beijing.

Narco News contacted McGraw-Hill in New York for comment for this story, but company officials did not provide a response prior to press time.

Politics of Business

Two Republican US senators, both conservative but not viewed as Tea Party hardliners, played important roles in the debt-ceiling negotiations with the White House.

Senate minority leader Mitch McConnell, who is married to former US Labor SecretaryElaine Chao (whose father founded a shipping company that does business with China), as late as July 19 of this year made it clear that he was backing the Republican effort to hold out on making a deal with the White House over the debt ceiling, seemingly fueling the very type of partisan bickering that led to S&P’s downgrade.

From a July 19 blog penned by McConnell:

No one, not even the President [Barack Obama], can claim to support the status quo anymore, even when he does.

But, of course, winning the debate isn’t nearly as important as achieving the reforms that are needed to convince the world that we’re actually serious about getting our fiscal house in order.

That’s why Republicans continue to hold out for significant reforms. And that’s why we’ll continue to fight for serious, long-term reforms this week. [Emphasis added.]

One of McConnell’s chief advisors on those debt-ceiling talks was Ohio Sen. Rob Portman, who served as budget director and earlier as US Trade Representative during the George W. Bush administration. Portman is a rising star in the Republican Party and considered a possible Republican vice presidential candidate. McConnell has appointed Portman as one of just three Republican senators to serve on a special deficit-cutting committee created as part of the recent debt-ceiling compromise.

Portman, ironically, seems to have predicted the S&P downgrade, or at least expected it, while at the same time taking a hard line toward China’s efforts to keep its currency artificially low against the dollar.

A July 24 story in the Columbus Dispatch reports that Portman was “warning fellow members of Congress that even if the debt ceiling is raised, it’s likely the U.S. credit rating will still be downgraded because of existing debt.”

On July 29 of this year, Portman stated the following in a press release issued by his office:

“Opening markets to increase American exports and vigorous enforcement of trade laws go hand-in-hand. Gaining fair access to over 1 billion Chinese consumers is crucial for Ohio’s small businesses and farmers,” said Portman, who initiated the first-ever legal case to be litigated and won against China before the World Trade Organization because of China's unfair treatment of U.S.-made auto parts. “When countries such as China use unfair tax and trade laws to put U.S. companies at a disadvantage, our government must aggressively fight to change these policies.”

A few months earlier, in May, Portman issued another press release, in which he stated “China needs to allow their currency to appreciate more quickly” and a month earlier, he was quoted in a Dow Jones story saying, “I think China is manipulating their currency.”

So it seems clear that Portman has strong feelings about the nature of the Chinese economy and its currency, which seemingly dovetail with the interests of his constituent US corporations that are doing business in China. That might explain, in part, why individuals from McGraw-Hill Cos. donated $22,600 to Portman’s Senate bid in the 2009/2010 cycle — the most given in aggregate to any Congressional candidate by McGraw-Hill officials during that period, according to the government transparency group the Sunlight Foundation.

McGraw-Hill Cos. chairman, Harold McGraw, personally contributed $7,200 to Portman’s Ohio Senate campaign during the same period. Federal Election Commission records show. McGraw also is a major proponent of expanding the US business relationship with China and serves on the board of directors of the pro-China trade-lobbying group the US-China Business Council — which represents some 220 US companies that do business with China.

Portman, prior to taking office as a Senator in January 2011, worked for Squire, Sanders & Dempsey LLP, an international law firm that has offices in Beijing, Shanghai and Hong Kong.

The law firm’s Web site offers the following description of the services it offers to companies and individuals seeking to do business in Chinese cities such as Shanghai:

The lawyers of Squire Sanders’ Shanghai office have the needed expertise and insight to advise investors on the prospects that await them – in Shanghai and beyond.

Our Shanghai lawyers offer astute and creative counsel across many borders in antimonopoly, competition, trade and regulatory including customs matters; corporate transactions, finance and governance including M&A; environmental, health and safety; intellectual property; labor and employment including trade union matters; real estate and construction; and tax and benefits.

Portman, who earned more than $500,000 in salary and bonuses in 2009 while at Squire, Sanders & Dempsey, worked in the law firm's transactional and international trade practice. Squire, Sanders & Dempsey also does work in the municipal bond market, and in that capacity, its line people have worked with Standard & Poor’s professionals as part of the finance teams for those bond issues — such as a $12 million tax-exempt bond issue put together in July through the California Municipal Finance authority.

Although there is no evidence that Portman met with or otherwise discussed the US credit rating with Harold McGraw, or with officials from McGraw-Hill, prior to the S&P's downgrade, it appears that Portman, given his extensive trade and business experience, should have been aware of the possible implications that a downgrade might have for the Chinese currency and economy, and for US corporate interests engaged in doing business with China.

And it is clear, that as part of their mutual interest in Chinese affairs, Portman and McGraw’s paths have crossed in the past. In fact, in 2006, while serving as US Trade Representative, Portman attended a luncheon at the White House honoring the Chinese president. Also at that luncheon were McGraw and his wife, Nancy; as well as Chao, then Secretary of Labor.

That same year, McGraw presented Portman with an award at the ECAT Trade and Investment Leadership Awards dinner.

Narco News contacted both McConnell and Portman’s offices in Washington, D.C., seeking comment for this story. Neither office returned calls prior to the deadline for this story.

Political Capitol

Again, there is no evidence that McGraw-Hill officials, Portman or McConnell in anyway conspired or otherwise acted improperly to influence a downgrade of the US credit rating in order to benefit their business or corporate constituents' financial interests. At issue here, though, seems to be the question of whether a rating agency such as S&P, as a matter of US national interest and security, should be put in the position of judging the credit rating of the nation when even a perception of a conflict of interest exists.

S&P officials might argue that there is an impenetrable firewall between the rating agency and its corporate parent, but given the rating agency's past performance during the housing crisis, in which it was accused, due to financial pressures, of issuing overly-glowing ratings reports on what later proved to be toxic investment instruments, any claim of an ability to exercise complete arms-length judgment by S&P officials might be open to question.

From an April 2011 article in the Nation describing S&P’s alleged failures during the toxic-asset crisis:

The dereliction of Standard & Poor was spelled out in detail by the blistering report recently issued by the Senate Permanent Subcommittee on Investigations, chaired by Senator Carl Levin. Levin’s hearings last year established why the supposedly disinterested analysts at S&P took a dive for the bankers and handed out inflated ratings for toxic assets. They did it for the money, as witnesses acknowledged. The rating agencies are paid by the banks to do their ratings. If they refuse to stamp newly issued securities with AAA labels, the bank will take its business elsewhere. The firm loses income; executives get smaller bonuses.

In any event, any possible connection between S&P’s decision to downgrade US debt and those who might benefit from an increase in the value of Chinese currency triggered by such a downgrade, even if it is only a perception of a conflict of interest, should be fodder for Congressional hearings, where the power of the subpoena can be exercised and where all parties have the opportunity to present their arguments — and where, in theory, sound policy and law is crafted in the interest of all the people of this nation.

And it appears there is a movement toward such a moment, with recent media reports indicating that U.S. Rep. John F. Tierney, D-Mass., is now calling for hearings on the S&P downgrade while the Senate Banking Committee also, reportedly, has launched a probe into the matter, according to an unnamed committee aide.

Stay tuned…..

NOTE: For those not up to speed with high finance but are interested in an understandable, if a bit dry, explanation of the dynamic relationship between US debt and Chinese currency, check out the following video clip.