Thoughts, essays, and writings on Liberty. Written by the heirs of Patrick Henry.

August 5, 2011

SP Lowers the U.S. Debt Rating

by tarran

The Standards and Poor rating service has downgraded the U.S. Federal Government’s bonds to AA+ status. This action long overdue does not go far enough.

To understand the meaning of this, we should first understand the meaning of the S&P ratings.

The ratings indicate several things:
1) The likelihood of a default – the debtor failing to make interest payments owed to the people who purchased the bonds.

2) The likelihood that the bond holders will recover some of their losses after a default.

3) How quickly the debtor’s financial condition could deteriorate causing them to slide into default.

In the pdf explaining their rating system, S&P has a very interesting table showing the default rate associated with organizations based on their classification. As one would expect, in the past thirty years no AAA organization has defaulted, nor has any organization that is rated AA+.

In their press release explaining the downgrade, S&P makes the following points:

• The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.
• More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.
• Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics any time soon.
• The outlook on the long-term rating is negative. We could lower the long-term rating to ‘AA’ within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case
• The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short ofwhat, in our view, would be necessary to stabilize the government’smedium-term debt dynamics.
• More broadly, the downgrade reflects our view that the effectiveness,stability, and predictability of American policy making and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned anegative outlook to the rating on April 18, 2011.
• Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics anytime soon.
• The outlook on the long-term rating is negative. We could lower thelong-term rating to ‘AA’ within the next two years if we see that lessr eduction in spending than agreed to, higher interest rates, or newfiscal pressures during the period result in a higher general governmentdebt trajectory than we currently assume in our base case.

In essence, the S&P rating agency is implying that since the recent debate about raising the debt ceiling was immaturely handled, they are now more pessimistic than they were this spring. This strikes me as and excuse to give plausible deniability to the accusation that for years they have been rating the U.S. government much more favorably than is appropriate by any objective manner.

The fact is that over the past few decades, the U.S. government’s long-term fiscal condition has been steadily eroding, and the legislature has shown no willingness to seriously tackle the issue.  Unsurprisingly any legislator who broaches the topic of reducing any of the major sources of spending, medicare, social security, millitary spending,  corporate subsidies, etc risks being voted out of office by an electorate whipped into a frenzy about an attack on the elderly, the poor, our allies, etc.

The rating agencies, having been granted a monopoly on ratings by the U.S. government, have been loath to bite the hand that feeds them, to risk the wrath of the legislature by frankly describing the terrible financial outlook for the U.S. government. At this point the AAA rating has become a joke; there is no way that the U.S. government can pay back the loans. There is no ideological chasm between the Republicans and the Democrats.  Both parties support massive welfare spending, high taxes, and massive plundering of the productive bits of the economy.  I am increasingly of the opinion that the debt fight was a kabuki theatre engaged in by the Democrats and the Republican leadership in order to end the Tea Party threat to the metastasizing state.  The Teaparty were the grownups announcing that the party has to stop, and the political parties’ leadership were the petulant teenagers plotting to keep things going a little longer.

At this point U.S. government bonds are a very bad thing to buy. The interest the U.S. government is offering is pathetically low.  Inevitably, to attract buyers, the government will have to raise the interest rate. Once they do this, prices in the secondary market for the older low-yield bonds will collapse.  The interest payments needed to service the outstanding debt will increase, and the U.S. government will be in even worse financial shape.  It’s possible that the Federal Reserve will buy the bonds itself, using newly printed dollars, much like the central bank of Zimbabwe.

Unfortunately too many retirees have invested in U.S. government bonds, expecting that the income from the bonds would provide a reliable, dependable source of income. Either they will be screwed by the inevitable default, or they will find their income’s purchasing power destroyed by inflation.

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  • Phil

    Having done your analysis, do you have any suggestions?

  • Dr. T

    He already suggested not buying U. S. government bonds. If you mean suggestions for reducing the national debt, the answer is simple: reduce the size, scope, and powers of the federal government to those originally enumerated in the Constitution.

  • Phil

    Dr. T, I couldn’t agree with you more. But I’m at a loss as to how to bring the ultimate answer about. After retirement I decided to take government very seriously. I spent practically my whole day, each day, learning all that I could about the current issues, proposed bills, regulatory agencies, etc., etc. After analyzing an issue I would write (what I thought to be) reasoned commentary, with suggestions as to how to legislate, to my representatives in Congress and to the President. This went on for a few years. What I learned was that the ins and outs of the federal government have become so entangled and complex that no single individual has a hope of understanding the “system”. Also, that our representatives and the President do not and cannot understand the system. Furthermore they have no interest in hearing ideas from any source other than their aides and handlers. Hence my question about suggestions.

  • tkc

    Phil, I would suggest that a system that tries to govern 300 million people must be decentralized. No single person, or say, 535 people, could accurately predict the needs and wants of so many people. They’ll never get it right due to the limits on information.
    If they tried they’d have to be omni-present. Government everywhere, all the time. Care to take a wild guess as to where that road goes?

  • Phil

    tkc, I agree wholeheartedly. Do you think that there may be a path to get out of this seemingly inevitable result?

  • Phil

    All but a few walk-ons to this web site appear to agree that federal government’s proper purpose is to secure our natural rights. All other purposes are ancillary.
    Most, also, appear to agree that the ninth and tenth amendments should be recognized to mean what they say: i.e. very limited powers of the federal government.
    Please, could one of the “Contributors” begin a topic devoted to discussing a step-by-step means to get the country back to, or at least close to, that ideal?

  • tkc

    Phil, the cynic in me has pretty much taken over. What needs to happen won’t because their is too much political/economic pain to pull it off. There is just no will on the side of the welfare/warfare state to limit the government and to put the fiscal house in order. I’m becoming more and more convinced that there is no way out and that the country will collapse.

    After all, look at what is going on in London. I could see that happening here.

  • http://www.thelibertypapers.org/author/tarran/ tarran

    Phil, I think Ron Paul and a few others have written book length treatment of how we could unwind things.

    In the end, though, they are all politically unfeasible as everyone here seems to recognize.

    I don’t think things will collapse in fire. Americans are too peaceable for that. In the end, I think we will see a collapse like that of the Soviet Union or ancient Rome, where people just start ignoring the dictates from Washington, and a few decades later the stars and stripes will no longer be flown anywhere.

    Depressingly, I think this collapse will take away the one benefit of the U.S. constitution. The continent spanning free trade zone that was the United States. I think we will see significant barriers to interstate commerce as the federal government becomes weakened. Here in Massachusetts, for example, the craft breweries came close to being legislated out of business by a law requiring them to buy half their agricultural supplies from in-state farms.

    Thus, I think that in the troubled times ahead, we have to evangelize freedom. We can’t merely shriek that big government sucks. We also must persuade people that little government is good.

    How you do that, whom you prozletize, etc all depends on your particular circumstances. I don’t advise trying to recreate the pre WW-I federal government. It’s a futile, uphill battle. Rather than row the canoe against the currents of history we should go wit the flow and steer the boat to avoid the worst of the rapids ahead.

    As technology advances, people’s material wealth will become greater, and the impetus justifying socialism will become less and less. In the future, the case for liberty will become easier to make, not harder. On the other hand, the statists and collectivists will have a harder and harder time justifying their desire for control. So talk up freedom (as opposed to talking down the state) and open the eyes of those around you to the possibilities or a freer life.

  • Phil

    tarran, I appreciate your thoughts. I’ll definitely look at more of Ron Paul’s books to see if I can find what I’m looking for. What I have in mind (and should have stated before) is something like the Contract with America for the 104th House. It was simple, readable, and bulletized. The voters fundamentally bought into it.
    I am probably one of the very, very few folks who actually recall hearing the 1940 Republican convention on the radio in which Wendell Willkie was nominated. I tell you that in order to illustrate how long I have been interested in the federal government. During my entire adult life I have tried to “evangelize freedom”. It appears to have had little affect. Thus my hope for an agenda that can be read and understood and will appeal to the electorate.

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