Friday, April 22, 2011

S&P's Rating Folly

On Monday April 18th, the S&P credit rating agency lowered its outlook on the United States to negative citing the deficit and a political climate unlikely to produce agreement on a debt reduction path.  The stock market fell over 200 points before recovering to 140 points down, the dollar rose in value, and Treasury bond interest rates fell as the market professionals rejected the outlook as meaningless.  The next day the New York Times ran eight short reactions by commentators which were overwhelmingly of the opinion that the rating change was unwarranted and economically unjustified.  One of the commentators, Yves Smith, on her blog followed up with a post noting other comments and dismissing the idea that China would stop buying US Treasuries by citing Michael Pettis' public blog post on US interest rates and the effects of Chinese inflation and policies of which I had a week earlier written in detail from his earlier and more extensive private newsletter.

Paul Krugman was quick to point out that when Japan lost its triple A credit rating in 2002 it had no lasting negative effect on Japanese bond rates (notice in the just linked chart that Japan has a fiat currency and the other countries do not).  The S&P was criticized for its failure to understand that a fiat currency nation does not have the same credit, inflation, and solvency risks of a country which does not have a sovereign fiat currency.  Marshall Auerback also used the Japanese comparison as well as citing Bill Mitchell's, who has written extensively on budget deficits, observation that it is not logical to assume insolvency default when a nation has sovereign debt denominated in its own currency.  The only possible default of a sovereign fiat currency nation is a political decision to default.  The S&P concern about budget deficits was quickly shown as out of perspective if not warped.  If the United States risked default, then all debt in US dollars would be at risk; yet, the S&P warning did not address that obvious issue.  Even the big banks know the United States is not even close to being broke if one just considers US household net worth in comparison to government debt..

Besides continuing Michael Pettis' observations that US debt funding is not dependent on foreign government policies, Yves Smith also noted that the actual S7P statement contained a section on additional risks which cited the risks of the US financial sector to be higher than 2008 and the potential costs of the US government bailing out the financial sector again to be 34% of GDP as opposed to 26% estimate in 2007.

Bruce Bartlett observed that the only possibility of the US defaulting would be if Congress made the political decision to not raise the debt ceiling. In fact, the United States may be the only country in the world which has a legal debt ceiling and it has some asking why the United States would not be better off economically without a debt ceiling.  Still there are those who politically find the deficit politically advantageous and those who are under the mistaken belief that US debt is economically unsustainable. The sad fact is that the world has not yet recovered from the 2008 financial crisis and it is still in dire need of global economic growth which is not going to come from an austerity driven recession.  While budget deficits should always be reviewed for efficiency gains in the delivery of publicly desired services and for private pressures, such as the astronomical increase in healthcare (including insurance) costs, the primary cause of the current deficit is the financial crisis and the worst thing that could happen is to derail economic growth with austerity.  What this all means is what the politicians have been ignoring and what the financial sector wants ignored is that, until unemployment is brought down and not purposefully used to hold interest rates down, the economy will never be normal again and the financial sector will be larger and larger and dictate its "too big to fail" mantra as the purpose of government with the people relegated to essentially serf status.

The ratings agencies discredited themselves in the financial crisis by aiding and abetting the financial sector's massive financial fraud, which caused the financial crisis, and the S&P warning is now lighting the fires of the debt vigilantes, which deflects public opinion from the failure to create meaningful financial reforms which would  prevent another financial crisis and the failure to prosecute the highly paid and highly placed financial managers who not only caused the financial crisis but profited from it at the public's expense, and is stoking the austerity fires which could ensure the next economic crisis.

The ratings agencies primary clients are the big banks.  The US financial "reforms" have not addressed the problems in the credit ratings agencies business model.  Yet, the public world wide depends on their ratings in evaluating the revenue constrained debt of US local and state government and the eurozone member nations.  In 2010, the EU proposed tightening credit rating agency rules to increase the availability of rating analysis information and transparency in response to ratings which fueled bond vigilante's profits and increased European credit insurance and debt costs.  In response the ratings agencies threatened to black out Europe and not provide credit ratings for debt issuance and rating the credit worthiness of European nations.  These 2010 proposed EU rules have yet to be adopted.

Bottom line, the United States is not anywhere close to insolvency and a fiat currency sovereign nation with sovereign denominated debt cannot default unless it politically chooses to do so.  Worse, the current deficit problems are financial crisis driven and the US has done little yet to correct high unemployment.  Austerity would derail economic growth and foster unemployment.  Just look at the failure of austerity in the eurozone and the increasing social disturbances and growth of political extremism.

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