Meanwhile, the US government continues to borrow around 40 cents for every dollar it spends, while the economy is hardly growing and unable to generate the needed revenues to sustain its fiscal path.S&P cited two reasons for the downgrade: 1) the fiscal consolidation plan agreed to be around $2 trillion in deficit reduction over the next 10 years falls short from containing the debt growth over the medium-term. 2) the extended political debate regarding raising the debt ceiling underscored the gap between the political parties. These indicate that measures needed to restrain the growth of public debt, such as raising taxes and entitlement reforms were less likely to be adopted than S&P had initially envisioned.The S&P's decision was not a total surprise, but the surprise in the accelerated timing since the July 14th announcement when S&P put the US on CreditWatch negative, hinting that a downgrade was imminent over the next few months. Apparently, the announcement shortened the time period in which S&P wanted the political parties to agree on deficit reduction, with an ambitious $4 trillion debt reduction target. As the deficit reduction plan, which was passed last week, was significantly less at $2.4 trillion, a downgrade seemed unavoidable.The Saudi economyThe impact of the S&P's downgrade of US's credit on Saudi Arabia economy will come through three channels. The first is through its impact on crude oil demand and prices. Triggered by worries of a new economic decline or a double-dip recession in the US, the world's largest oil consumer, this would greatly undermine global energy demand. In addition, recent concerns that Europe's debt crisis could spread to Italy, the euro zone's third-largest economy, accentuated fears of a vicious new global economic downturn. Oil prices sank more than $10 a barrel last week, highlighting just how quickly commodity markets can swing in the peak of a crisis, and continued to sag below $80 a barrel.Apparently, the NCB report said drop in prices reflects the market's revision to expected demand growth. On Monday, Light sweet crude for September delivery, fell $2.08, or 2.56 percent, to the level of $79.23 a barrel. Meanwhile, Brent North Sea crude for September delivery dropped $1.21 or 1.17 percent to $102.53. More volatility in oil prices can be expected in the near-term as financial investors reduce their long positions on the back of risk aversion and the uncertain global economic outlook. However, the NCB believes, that the fall in oil prices may be nearing an end. This would be especially true if the Fed steps up its purchases of US government bonds. However, even if oil prices fall below the $80 a barrel level, Saudi Arabia will not have a great impact as the Kingdom enjoys a large reserve to meet its planned spending.The second channel of impact on the Saudi economy is through the US dollar. The US dollar response against most currencies will likely follow broader market developments. As equity and commodity markets keep falling globally, investors are likely to cut long positions in equities, and commodities. These are mainly funded by short US dollar, so whether or not the safe-haven status of the US dollar is impaired over the long-term, a downward shock to markets is likely to be US dollar positive in the near term. There are contradictory forces at work with the pull down from the credit rating and the push up from an equity market disturbance, for as stocks are sold and dollars are bought. Although this is positive for the US dollar in the short-term, once things settle down, as noted earlier, the downgrade would have a negative impact on the US dollar. Meanwhile, there may be other concerns in FX markets that the euro AAAs are not strong, given the economic issues facing the euro zone. While investors instinctively may want to sell US dollar and buy euro, the euro sovereign issues do not look better because the US' looks worse. With the impact of S&P's downgrade being positive on the US dollar in the short-term, it is unlikely to raise the level of imported inflation in the kingdom, especially that commodity prices are falling. However, weaker US dollar in the long term, due to the S&P's downgrade, may eventually contribute to higher imported inflation, the report said.The third channel of impact is through the official holdings of US treasuries, which is believed to constitute the majority of the Kingdom's net foreign assets, currently amounting to $492 billion. The downgrade is actually more of a referendum on the dollar rather than US treasuries, due to the fact that US's ability to pay its debt obligations remains a fundamental certainty because the dollar remains the world's reserve currency and the US government can continue to print money to fund its obligations. Therefore, holders of US treasuries like Saudi Arabia should not be concerned that they may not receive interest payments on US bonds. However, the value of those payments will essentially decline, given the fact that with more dollars in circulation due to the printing presses, the value of each dollar by definition declines. Given that the Kingdom is keeping much more than enough to maintain the peg of the Saudi riyal to the US dollar, it is advisable that the Kingdom should opt for diversifying future excess revenues away from US Treasuries into other real assets across different currencies and regions, the NCB report said.US Treasury marketDespite the S&P downgrade, treasuries trading strengthened, with the prices of long-term treasuries soaring to high levels and accordingly yields falling further. In fact, the yield on the 10-year Treasury benchmark fell to a record low of 2.034 percent on Aug. 9. Demand for treasuries is going strong till date, with investors submitting $2.99 in bids for every dollar of the $1.26 trillion sold this year, exceeding the $2.26 in bids for every dollar of debt sold during the budget surplus years between 1998 and 2001. This is also partly due to speculation that the Fed might buy longer duration treasuries. One cannot rule out that that the US Treasuries have been driven by the changing perceptions about monetary policy, and also fears of a new euro zone sovereign debt crisis. Nonetheless, the flattening yield curve is the opposite of what one would expect if the markets concurred with S&P's downgrade. The US Treasuries remain the flight to quality asset class of choice, and we do not believe that recent S&P's decision will change that in the near to medium term, the report added.It has been for some time believed that based on fiscal stance alone, the US was no longer a triple A rated sovereign. But the credit rating of a country is not a function of its fiscal stance only, let alone for a country like the US. In the case of US, two factors are of remarkable importance, which include the political weight and the reserve currency status. It is true that political system in recent months has demonstrated gridlock, diminishing its political will, but the status of the US dollar as the global reserve currency will continue to provide the US with a significant advantage no other economy enjoys.In addition, the lack of immediate credible alternatives will keep the rest of the world highly de- pendent on the US treasury market. The two biggest bond markets after the US are the Japanese and Italian bond markets. Japanese yields have been low and are now far lower than the US's and in addition Japan's fiscal position is significantly worse than that of the US. In Italy, the fiscal stance has been worsening, with its debt/GDP ratio far exceeding that of the US debt/GDP ratio. Notably, despite its fiscal challenges, the US economy is more positioned to recover than either of these two economies. Emerging markets, on the other hand, do not offer trustworthy alternatives as their bond markets beside being small, their currencies are in general not fully convertible, and their political and legal institutions are non predictable.The financial industryThe near-term impacts of S&P's downgrade expected, as noted above, to be minimal for the US bond markets. “We do not anticipate forced selling of US treasuries from any major investor base. Foreign central banks maintain a large share of their FX reserves in US treasuries because it is the deepest and most liquid bond market. But, international funds that limit their investments to “AAA” rated bonds may dump the US holdings, causing the US dollar to depreciate. Yet, mutual fund investment guidelines do retain some flexibility regarding the handling of such matters,” the NCB said in its report,In the US banking system, where US treasuries are benchmarks for lending and collaterals, the impact could be more disruptive. That is especially true in the interbank "repo" market, where banks swap bonds for cash to balance their books in the short-term. To mitigate the impact on banks, the US Treasury quickly issued a ruling on Friday stating that the risk weight of US debt in their reserves would not change despite the downgrade, thus banks should not be forced to sell. Moreover, given that major US banks are several notches below AAA, a single- notch downgrade should not lead to downgrades in the credit ratings of banks. Assuming that this occurred, additional collateral requirements believed to be manageable, the NCB report said.Similarly, insurance companies are also unlikely to be forced to sell as the National Association of Insurance Commissioners (NAIC) has already de-emphasized credit ratings for regulatory capital requirements. Meanwhile, the impact may be seen on institutions, which rely on the US government guarantee for their bonds, like heavily indebted home lenders Freddie Mac and Fannie Mae. Their borrowing costs may rise, and that would spill over into higher mortgage costs and possibly bank lending rates for the consumers.The US dollarThe size of the US economy and its treasury market and the dollar's status as a reserve currency make it impossible to find a historical parallel for the current situation. However, being the world's reserve currency, the US dollar now appears inconsistent with an AA+ rating. The longer-term effects are driven primarily by whether international markets will eventually also downgrade the US. Consequently, the biggest impact should be through the effect on the US dollar as a reserve currency. Theoretically, the downgrade should raise the borrowing cost of the government, to rates higher than other AAA countries like Germany. This, in turn, should push down the dollar's value relative to other currencies of strong economies.With China alone holding more than $1.2 trillion worth of US debt and Japan, $900 billion any questioning of US's ability to pay its debts should unnerve the global financial system. Foreign investors have supplied nearly 40 percent of non-financial credit creation in the US over the past few years. Ultimately, the downgrade could increase diversification away from the US assets. Therefore, an increase in the pace of diversification should have a negative impact on the dollar and also would be an economic drag on the US, as domestic savings would have to rise to pick up the slack, the NCB report said.