On the S&P downgrade of the US sovereign credit rating

I have been off the grid for a full 24 hours now so I haven’t seen commentary on the S&P downgrade yet. But here are a couple of thoughts.

The confidence trick of fiat currency is the belief of citizens that the government issuing the currency will manage its finances in a way that promotes general “life, liberty and prosperity”. If confidence erodes, tax evasion will rise, citizens will begin surreptitiously using other media of exchange to transact and inflation and currency depreciation will spiral out of control.

In my view, that confidence in the US has already been eroded. This is why the dollar value of gold and other precious metals is rising. As I said in April, the recent government shutdown standoff and debt ceiling fiascos say “the risk of default is real – and that doesn’t sound like the hallmarks of a AAA-rated country, more like the hallmarks of a banana republic.” If S&P wants a reason to downgrade the US sovereign debt rating, this is it.

Do I think this is a big deal? No. This move had been telegraphed for weeks. Moreover, the prospect of a double dip recession and a potential lost decade of debt deflation in the US is infinitely more important. The recent rally in Treasury securities tells you that. Clearly, the US is on an unsustainable path economically and politically, with its foreign wars, bailouts, shutdowns, and debt ceilings. And the massive unfunded liabilities from Medicare and Social Security will to set up a nasty political contest down the line between an activist voting senior population and everyone else about the allocation of real and financial resources in the US – that much is clear.

What we should be concerned about is the government response to the loss of faith in its credit. What does government plan to do to right the ship politically and economically to prevent a lost decade and probable further downgrades?

  1. Demetri says

    But Edward, don’t you believe that the reason why confidence has been lost in the dollar has more to do with all the various forms of deficit spending that we have engaged in (including the bailouts) than it is the result of economic weakness?

    1. Edward Harrison says

      When looking at the benefits of economic policy ex-post you should see a high debt to GDP number as a de facto indication of the ills of poor economic policy (socialization of the losses of private gains or misallocation of resources). Budget deficits are the result of an ex-post accounting identity. In plain English this means that the deficits are the effect and not the cause.

      I would reiterate what I said here:


      The ‘stealth’ default of Dollar depreciation and inflation is always a risk if real resources are malinvested as they are in the US. The US economy is very unbalanced, with a disproportionate share of S&P500 earnings coming from the financial services sector. The US cannot go on artificially propping up its financial services and auto sectors ad infinitum without its taking a toll on long-term growth and bloating debt-to-GDP ratios.
      Right now, underemployment is 17% as measured by the government’s broadest unemployment measure. With so much idle human capital and with capacity utilization rates in industry still below long-term averages, inflation is not yet the short-term worry. Government should be focused on aiding the economic recalculation that is on-going in order to prevent dead-weight economic loss as people out of work lose skills. If it isn’t, American wages will lag behind CPI and commodity price gains.
      Any country that issues substantially all of its debt in a currency it creates cannot be forced to default. It can only default because it chooses not to pay for political reasons. Unless the US economy restructures, deficits will continue due to a dearth of aggregate demand. Perpetual trillion dollar deficits will be met by permanent zero rates at the Fed. PZ means attractively low interest rates for as long as possible.
      The political reasons in the U.S. are a real risk which necessitates higher bond yields. There is a real possibility the U.S. could default.
      Trillion dollar annual deficits add up, and eventually produce a stock of debt that can become unmanageable.
      As such, the United States is not a AAA credit in the way Switzerland or Germany is.

  2. Dave Holden says

    That confidence trick isn’t helped when Mitch McConnell states (as quoted by The Economist):

    “McConnell proudly declared the strategy “a new template”. “In the future”, he added, “any president, this one or another one, when they request us to raise the debt ceiling, it will not be clean any more…we will go through the process again and see what we can continue to achieve.””

    1. David Lazarus says

      Yet do we really think that will happen. If it is a GOP president then I doubt that we will see such measures. The problem for the US is that with its fixation on not raising taxes it has guaranteed itself being downgraded. It will take some time. Though with the recovery relying on a fraction of the weapons that the government could wield it means that it will struggle to resolve its issues.

      1. Dave Holden says

        The only reason that won’t happen to a GOP president is because as Bill Maher puts it “we have one party with no brains and one party with no balls”.

  3. Bernard says

    McConnell wont hold the President hostage if he is Republican. that’s a non sequitor.
    the Republicans only go after Democratic Presidents, even though Obama is a Democrat in name only.

    now that we know the Democrats won’t ever stop the Republicans and their aims for the Government/Society, it seems counterproductive to elect Democrats any more, unless of course the Democrats stand up to the Republican, which i haven’t seen in my lifetime, other than the first Black President/Clinton, lol. and Clinton actually fought back. Imagine Obama fighting back. Never to happen.

    all these wonderful ironies still won’t stop the slide into deeper banana republicanism, though.

    the debasement of our dollar by the Republican Congress and Presidents, explains the downgrade by S&P of the Government, and is why we won’t ever get out of this mess. these so called leaders of the One Party/Two Sides are working hand in hand to rip us off.

    as long as Taxes can’t be raised, thanks to the Elite’s control of Congress, America’s economic future is bleak. and so is the dollar. Value only comes when there is some worth behind our economy/dollar.

    to watch the Eurozone fall apart for different reasons is sad as well, although the dynamics of the “theft” may be somewhat different, the end result is the same for the average European. Trickle Down Economics. at least in Europe there is a chance of disunion from the Euro, which might allow for new currencies to resurface with some real value behind it. Unless all the Euro states agree to financial and political solutions, the Euro too is cooked.

    but the Political parties in America have been actively destroying the dollar and the country. their main goal, it seems.

    here in America, the successful destruction of our Society by the Republicans has a long history, going back at least to Reagan and his “Government is the Problem” mantra that helped the Looters pick off, one by one, all the safeguards/Laws enacted to keep society functioning.

    the continual referencing of Social Security as an entitlement is also part of the theft.
    our forced buying into retirement insurance/SS has now been turned into an entitlement, like Medicare or Medicaid. no mention of the fact that working Americans have put money into this “Retirement Fund” upon entry into the job market. Government now is the Problem, thanks to Reagan and his legacy.

    this mischaracterization of our retirement fund as an “entitlement” enables the Looters to steal it that way, along with their theft of Medicare. mostly to cover their wars and bailouts.

    1. David Lazarus says

      Also to call them unfunded when they have not collected the premiums for them. Unfortunately I do not see much future for the US long term. Its electorate are like turkeys voting for thanksgiving. The only thing that will save America is fear of a competing economic system that made them see sense in the depression. With communism out of the frame the republicans are dismantling union rights and voting rights.

  4. Henri Myllyniemi says

    We will see how the treasury market react.

    “From the wells of disappointment
    where the women kneel to pray
    for the grace of God in the desert here
    and the desert far away:
    Democracy is coming to the U.S.A.”

    Leonard Cohen knows how to fit a small bit into this mess. Stay out (or if you can afford it, stay short) off equity market. March 2009 would be alike this level, though now there is not a thing to revive.

    QE3? More massive EFSF for Europeans? It helps for a while. How long can the can roll?

    Things will crash. The only problem is that no one knows when it comes. Staying short can cost, but then again: so does cost doing nothing?

  5. Douglas says

    “The massive unfunded liabilities from Medicare and Social Security?”

    The Congressional Budget Office and Social Security Board of Trustees concluded that income (payroll tax and interest) and assets (bonds) are sufficient to pay full benefits through 2037. After that date income would cover 75%. Implementing a flat payroll tax in place of the current regressive tax (removing the payroll tax lid so that wealthier Americans pay the same rate as the rest of the country) would allow for 100% payments.

    The 2011 report of Medicare’s trustees finds that Medicare’s Hospital Insurance (HI) trust fund will remain solvent — that is, able to pay 100 percent of the costs of the hospital insurance coverage that Medicare provides — through 2024; at that point, the payroll taxes and other revenue deposited in the trust fund will still be sufficient to pay 90 percent of Medicare hospital insurance costs.

    The Medicare problem is drugs and outpatient care like tests and physicians. Reducing the cost of drugs is not difficult. Permit the government to negotiate the same low cost medicines the rest of the world enjoys. One long term solution for physician cost would be to gradually adopt the European system using specialists as consultants with GPs providing treatment. As Europe demonstrates every doctor does not have to be a high cost specialist. Specialists in Europe (where I live) are quite well to do. GPs not so well off but every bit as good as their American counterparts.

    US medical care is the most expensive in the world yet based on outcomes is ranked anywhere from 16th to 32nd in the world. Exorbitant US health care costs are the real problem and are not restricted to Medicare. Simply reducing Medicare coverage sweeps the real problem under the rug. Go to Europe and see how France, for example, delivers the world’s #1 rated health care at roughly 60% of the US cost.

    1. David Lazarus says

      Exactly spouting incorrect facts so that they can dismantle these programs does seem to be very short sighted. If they do dismantle these programs they clearly have no intentions of running the country when these facts are exposed.

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