Investment rating firm Egan-Jones cuts US credit rating due to QE3

September 17, 2012

Wall Street may be euphoric over the Fed‘s new QE3 scheme, but they’re only looking at the short term bump that the stock market is getting.

The true adults in the financial world are very much concerned. The rating firm Egan-Jones went against the conventional wisdom last week and downgraded the US credit rating specifically because of QE3. This story was not widely reported because much of the world’s attention was focused on a Middle East in flames due to protests at US embassies across the Islamic world.

The rating agency on Friday downgraded its credit rating for the U.S. to AA- from AA, citing the Fed’s latest round of stimulus. From Egan-Jones:

[T]he FED’s QE3 will stoke the stock market and commodity prices, but in our opinion will hurt the US economy and, by extension, credit quality. Issuing additional currency and depressing interest rates via the purchasing of MBS does little to raise the real GDP of the US, but does reduce the value of the dollar (because of the increase in money supply), and in turn increase the cost of commodities (see the recent rise in the prices of energy, gold, and other commodities). The increased cost of commodities will pressure profitability of businesses, and increase the costs of consumers thereby reducing consumer purchasing power. Hence, in our opinion QE3 will be detrimental to credit quality for the US…. From 2006 to present, the US’s debt to GDP rose from 66% to 104% and will probably rise to 110% a year from today under current circumstances; the annual budget deficit is 8%. In comparison, Spain has a debt to GDP of 68.5% and an annual budget deficit of 8.5%. 

While Egan-Jones is not as widely known as S&P or Moody’s, there are those on Wall Street who say they have the best track record in recent years of all the ratings agencies.

Note that undermining the value of the dollar, which is what Egan-Jones says QE3 will do, is very positive for gold investments for two reasons:

1. Gold is priced in dollars, so a decline in the value of the dollar tends to push the price of gold higher.

2. Because the dollar is currently considered the world’s reserve currency of choice, gold is a natural rival to the dollar. When the dollar weakens, investors naturally gravitate to gold investments.