When credit rating agency Standard & Poor revised its outlook on US sovereign debt from "stable" to "negative" a week ago, investors rushed to sell risky securities and buy gold, pushing the price up to a new all-time high of $1498.60 an ounce. European and American stock markets and oil prices were also hit.

The rating agencies have long been warning about Washington's inability to reduce the US deficit in the wake of the financial crisis, and have threatened several times to downgrade US debt. The trigger for the S&P move was the agency's belief that policymakers have yet to agree how to reverse fiscal deterioration and address long-term fiscal pressures.

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What does the S&P downgrade of US Treasuries mean?

S&P explained that its switch from a "stable" to a "negative" outlook means there is a one in three chance that it will downgrade its AAA rating of US sovereign debt within the next two years. Downgrading the world's number one economic power would have an enormous impact. In the author's view, S&P's move reflects anxieties about the global economy and global sovereign debt. It will not just impact the US economy and investment environment, but other countries around the world, including China.

In terms of capital markets, volatility on Wall Street will certainly affect China's A shares, so investors in the Chinese stock market should pay additional attention to risk.

Treasuries constitute the largest segment of US sovereign debt. And the Chinese government is the world's biggest buyer of US Treasuries. In order to mitigate risk, many investors have sold stocks and treasury bonds to buy gold. This will inevitably lead to a substantial decline in US Treasuries. Those who hold the most will lose the most, and continue to shoulder the greatest risk. China should diversify its $3 trillion holdings of foreign exchange reserves to spread the risk.

S&P's revised rating may also trigger a new round of dollar devaluation. This will mean not only the devaluation of China's foreign exchange reserves, but will also hit China's exports, as hot money inflows lead to faster yuan appreciation. The US Federal Reserve's second round of quantitative easing will end in June. If it decides on a new round this will boost global inflation and deal a blow to the world economy, especially China and other emerging market countries, which are already raising interest rates.

The S&P move is a wake-up call to China not to take credit risk lightly especially in the real estate market and local government finance. China's credit looks good from a statistical point of view. But it has not been tested by major domestic economic fluctuations. We should remember the credit crisis that followed the bursting of the Hainan real estate bubble in 1990s. And also recall Warren Buffett's famous quote: "It's only when the tide goes out that you learn who's been swimming naked."

(This article was first published in Chinese and translated by Li Huiru.)

Opinion articles reflect the views of their authors, not necessarily those of China.org.cn.