Yesterday’s breathless anxiety-inducing headline was that Standard & Poors, the rating agency, has issued a “negative outlook” warning on US sovereign debt, claiming that the US, in comparison with other countries with a top AAA credit rating, has “very large budget deficits and rising government indebtedness and the path to addressing these is not clear to us”. S&P warned that there was a “a one in three chance that the US could lose its AAA rating in two years because of its mounting debt.”
The ratings firm–one of three global companies that Wall Street relies upon to establish the credit ratings of companies and nations around the world–said its analysts had “little confidence” that the Obama administration and the divided Congress would reach any agreement on a deficit-reduction plan before the next national election in the fall of 2012, and that they doubted that any such plan would be adopted until after 2014, two whole Congressional elections away.
So far, the other two ratings agencies, Moody’s and Fitch Ratings, have not followed suit. Moody’s issued a statement saying, ““Moody’s rating for the US is Aaa and remains stable,” though the company warns that “an upward debt trajectory and increasing fiscal pressures could increase the likelihood of an “outlook change” within “the next two years.”
Meanwhile, Fitch Ratings, which unlike Moody’s and S&P, is based in Europe, took an even more sober stance, saying, “In Fitch’s opinion, the likelihood of the U.S. government failing to honor its financial obligations and in particular make due and full payments on U.S. Treasury securities is extremely low. Ultimately, the recognition of the dire consequences of failing to raise the debt ceiling in a timely manner will prevail over differences on the more fundamental issue of how best to place U.S. public finances on a sustainable path over the medium- to long-term.” Fitch goes on to add, “The brinkmanship over the debt ceiling and the 2011 budget will be resolved…Fitch does expect that the tough choices on tax and spending will be made – as is starting to be seen at the state and local level – that are necessary to place public finances on a sustainable path.” Unlike S&P and Moody’s, Fitch’s analysts note the critical point that “The U.S. ‘AAA’ status is underpinned by the flexibility and dynamism of its economy, as well as the exceptional financing flexibility that derives from the U.S. dollar’s role as the world’s predominant reserve currency.”
Investors took the bad S&P news in stride. US equities markets reacted to the report by dropping by 2%, before recovering a bit, and ending up down 1.2-1.3% for the day. The usually fairly skittish equities markets have fallen farther than that on reports that Gen. Muammar Qaddafy was risking sunburn or a bullet in the head riding around Tripoli in an open jeep, or that Portugal, one of the smallest countries in Europe, was in danger of default.
At least one economist burst out laughing on hearing about the S&P announcement. “They did what?” exclaimed James Galbraith, a professor of economics at the University of Texas in Austin, who formerly served as executive director of the Congressional Joint Economic Committee. “This is remarkable! It certainly will confirm the suspicions of those who have questioned S&P’s competence after its performance on the mortgage debacle.”
S&P, as well as the other two big ratings firms, all notoriously failed completely to spot the looming disaster of the banking collapse and financial crisis, and famously issued A ratings to mortgage-backed securities that later proved to be virtually worthless paper, as well as to the banks that had loaded up on the financial dreck.As Galbraith explains it, “US debt consists of bonds issued in US dollars, which I assume the S&P analysts know. How can the US possibly default on its own currency? The obligation is in nominal dollars, which is to say when the bond retires, the US issues a check in dollars to cover it.”
Since the US prints its own currency (or actually just issues electronic payments to create new money) whenever it needs it, as Galbraith puts it, “As long as there is diesel fuel to power up the back-up generators that run the government’s computers, they will have the money to back their own bonds.”
Anticipating such a criticism, S&P issued a FAQ sheet about its decision, and in answer to the question of how a country could default on bonds issued in its own currency, writes, “We consider having the world’s reserve currency to be a strength to the U.S. government’s credit profile. However, there can be reserve asset demand for the currency of a sovereign that is experiencing a weakening of its credit profile, as in the case of Japan (AA-/Stable/A-1+), which Standard & Poor’s downgraded most recently in January 2011.”
This however, just dodges the question, because after all, the Japanese yen is not a reserve currency. Oil, for example, is not priced in yen, it is priced in dollars. Third world countries, when they issue debt not in their own local currency, generally use dollars, not yen, except for instance when they are funding a project involving Japanese companies.
So what’s going on here?
There would seem to be only two possibilities:
Either S&P has been pressured by powerful Republicans and/or Wall Street Bankers to issue this warning, in order to add to national hysteria about the national debt and win more drastic cuts in social programs, or S&P is simply blowing it again.
“Political shenanigans cannot be ruled out,” says Galbraith. “That’s what lawyers would call the ‘rebuttable presumption.’ After all, who benefits? The Republicans and perhaps the banks. But of course the other possibility is that S&P doesn’t know what it’s talking about, and after their disastrous missing of the mortgage bubble, that’s quite possibly what it is.”
The Obama administration, for its part, has reacted with surprising restraint to the S&P bombshell, saying only that the administration expects to reach an agreement with Congress over how to reduce the nation’s debt. Mary Miller, assistant treasury secretary for financial markets, for her part said that S&P “underestimates the ability of America’s leaders to come together to address the difficult fiscal challenges facing the nation.”
How pathetic is that? How about a call for the SEC, or the Federal Reserve or the Attorney General to investigate whether S&P was improperly pressured to issue its absurd “negative warning”? How about a call in the Senate for hearings to look into any such possible improper political pressure?
I’m not suggesting that there are no consequences for the failure of the US political system to pay for the nation’s trillions of dollars in wars, or for its preference over the last 30 years to hand tax cuts to corporations and the rich while continuing to encourage corporations to shift their investments abroad, taking the nation’s jobs with them. There will surely come a reckoning. But it won’t be in the form of default.
As Prof. Galbraith notes, the US can continue to print money to repay its debts, because they are denominated in the same currency.
The problem will come when the dollar starts to seriously erode against other currencies because too much of the currency has been put into circulation. When that happens, there may be a shift away from the dollar as the world’s “reserve currency.” Looking further, one could then imaging the US being unable to issue debt to foreign investors, because they would no longer want to be left holding dollars, and the US would have to either drastically reduce its debt, or borrow in foreign-denominated debt–say Yen or Euros or Renminbi.
That future may come, but what S&P is talking about–a risk of default on current US debt–is simply absurd, and does raise questions about behind-the-scenes pressure from some nefarious actors on the right anxious to do away with Medicare and Social Security before today’s Baby Boomer population becomes the biggest retirement and Medicare-entitled voting bloc–both numerically and proportionally–in the nation’s history.