Thoughts on the Downgrade: S & P Got It Partially Correct

After a tumultuous week in the markets, Standard and Poors decided to add to the anxiety by announcing that they would be stripping the United States of its AAA rating. Mind you, this is the same company that gave AAA ratings to mortgage backed securities that eventually turned out to be worthless. There are many questions people are asking regarding the downgrade, what follows may answer a few of them.

First, S & P erred in some of their calculations regarding debt accumulation, but regardless they still cling to a belief system that is pre-1971 (pre-gold standard) and thus continue to compound their errors. The S & P stated:

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.

So, in effect, S & P feels that the United States needs to cut deficits in order to avoid a debt spiral and the potential default on US Treasuries. This rationale for downgrading the US Credit Rating (while keeping Germany’s AAA) is baseless. The United States can always pay its bills that it accumulates in its own currency. Default is not a possibility in terms of the US ‘ability’ to pay. In other words, the US ALWAYS has the ability to pay its Dollar obligations as it is the monopoly issuer of such currency.

Despite what you may hear on television, the United States is not like a household. A household CANNOT print US Dollars (legally) and thus for a household to pay its debts it must accumulate the currency in which its debts are denominated – The United States has no such constraint. The United States always has the ability to pay as it can always issues its own currency. Clearly, S & P does not understand this concept.

But, S & P does get their downgrade rationale correct when they state:

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.

In other words, one or both parties using the threat of default to further their own agenda could affect the WILLINGNESS of our country to pay its dollar based obligations. Ability and Willingness are two different things – on the willingness front we just learned that in fact the US has a problem and it stems from the debt ceiling and the threat to not pay US Dollar obligations if one political party doesn’t get what they want.

Before this last debt ceiling fiasco the world believed that the US would always be willing to raise its debt ceiling in order to avoid any sort of default, yet that assumption came under severe distress when neither party could come to an agreement and both parties used the threat of default (taking the nation hostage) to further their own agenda. As it turned out, only one party actually got anything out of the deal and this will embolden that party to hold the nation hostage once again when it can’t get done what it needs to get done in the normal course of business. Its a real shame and because of this the “willingness”, not the “ability” of the United States to make good on its promises is up in the air – thus the downgrade.

S & P was right to downgrade based on willingness and wrong to downgrade based on ability – we always have the ability.

As for the calls for Geithners resignation…well, he should have resigned in disgrace a long time ago, he has been an unmitigated disaster – but losing our AAA credit rating is not due solely to Geithner, he wanted a straight up or down debt ceiling vote (though he has also called for Austerity). Whether the S & P would have downgraded without the debt ceiling fiasco is not known, the company is dysfunctional and it is anyone’s guess – but it was the political parties (and one in particular) that showed the world that perhaps the US wasn’t serious about its obligations.

How will this affect the markets? The consensus is they will go down, but the downgrade alone has zero real affect on the economy. Interest rates are not determined by some group of invisible vigilantes, our borrowing costs will not go up because of the downgrade. Japan had the same thing happen to them and their rates dropped….in fact you might do well checking out their borrowing rates – next to zero across the spectrum (they don’t have a debt ceiling). So, yes, the markets might fall (or they might not), but the affect of the downgrade in real terms is nada. However, the perception of the affect may be severe – we are about to find out.

Both parties are at fault in this downgrade and both should be ashamed for how they treated Americans during the debt ceiling.

See my two previous posts on the Debt Ceiling:

Trillion Dollar Coin

Reagan on the Debt Ceiling

Scott Dauenhauer CFP, MSFP, AIF

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