Friday, August 5, 2011

S&P: Dysfunctional Politics and their Price

S&P has now downgraded the US government from AAA to AA+, a historic downgrade. The effects of this downgrade will no doubt echo throughout the US and global economy.

Zero Hedge posts the full text of the S&P statement. Contrary to what you might read in some quarters of the media, the statement regarding the downgrade does not merely focus on the inadequacy of the recent debt deal to reduce the long-term debt. Instead, it offers a broader critique of the structure of American fiscal politics.

The statement hammers away at what it views as political gridlock. The battle over the debt-ceiling has exacted a considerable toll, in S&P's eyes:

We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process. We also believe that the fiscal consolidation plan that Congress and the Administration agreed to this week falls short of the amount that we believe is necessary to stabilize the general government debt burden by the middle of the decade....

The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year's wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability

Many wanted a "battle" over the debt-ceiling and hoped for more "battles" in the future; S&P suggests that this might not be a good idea for the long-term fiscal situation of the United States.

Though the report does vaguely ask for reforms to various entitlements, it mentions Republican intransigence on raising taxes multiple times. Unlike earlier reports, this new one, with its projections for an accelerating amount of federal debt, assumes the extension of all Bush tax cuts "because the majority of Republicans in Congress continue to resist any measure that would raise revenues, a position we believe Congress reinforced by passing the act." This report emphasizes tax hikes at the end, as well:

As our upside scenario highlights, if the recommendations of the Congressional Joint Select Committee on Deficit Reduction--independently or coupled with other initiatives, such as the lapsing of the 2001 and 2003 tax cuts for high earners---lead to fiscal consolidation measures beyond the minimum mandated, and we believe they are likely to slow the deterioration of the government's debt dynamics the long-term rating could stabilize at 'AA+'.
The report notes that other sovereign nations will have greater debts as a percentage of GDP for years into the future, but it still insists on downgrading the US:

When comparing the U.S. to sovereigns with 'AAA' long-term ratings that we view as relevant peers--Canada, France, Germany, and the U.K.--we also observe, based on our base case scenarios for each, that the trajectory of the U.S.'s net public debt is diverging from the others. Including the U.S., we estimate that these five sovereigns will have net general government debt to GDP ratios this year ranging from 34% (Canada) to 80% (the U.K.), with the U.S. debt burden at 74%. By 2015, we project that their net public debt to GDP ratios will range between 30% (lowest, Canada) and 83% (highest, France), with the U.S. debt burden at 79%. However, in contrast with the U.S., we project that the net public debt burdens of these other sovereigns will begin to decline, either before or by 2015.
So part of this analysis is based on long-term trends, an analytic assumption that may or may not be warranted.

Part of S&P's justification for the downgrade is premised on the fact that the economy is much weaker than was earlier thought. Ironically perhaps for some, this report may further damage the national economy by leading to an increase in various interest rates and heightening a sense of uncertainty in the nation's finances.

S&P makes the following recommendations for the United States: increase revenue, improve the economy, and ensure that government can fulfill its routine fiscal responsibilities. Those aren't exactly bad points. High-wire political knife-fights may make for riveting blogging and TV, but they do not always reflect the utmost of fiscal prudence. Perhaps the US government should not dance to the tune of (far from infallible) ratings agencies, but S&P does have a worthy point in this: in order for our government to work in the long term, it must have some kind of governable consensus. We must also have an economics anchored in reality and not in ideology, and a fiscal politics of compromise and empiricism instead of flamboyance and wrath.

1 comment:

  1. You forgot one other recommendation.

    Never vote Republican, ever. Not for dog catcher, not for mayor, and certainly not for congress.

    The Teahdists and the Clown Car party have managed what Al Queda couldn't pull off.

    Good job.