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?