Credit Rating Cliffhanger


Everyone involved in the debt ceiling debate, from conservative Republicans to President Obama, has warned about the looming threat of a credit rating downgrade from Moody’s and Standard & Poor’s.  A downgrade would significantly increase the already tremendous cost of servicing the national debt, which already costs the American taxpayer over $400 billion per year.

Will the debt ceiling compromise reached over the weekend save Uncle Sam’s credit rating?  A Fox Business report says S&P and Moody’s are still pondering our fate:

The U.S. avoided a fiscal crisis with an eleventh hour debt ceiling deal, and the markets are recovering from its fainting spell that the U.S. might default for the first time in the nation’s history.

But the credit-ratings agencies are waiting on the details of the deal, and may stick to their guns that the $2.4 trillion in promised cuts fall short of the $4 trillion they demanded in a “credible” plan to ward off a downgrade by one notch to double A from triple-A.

Both Moody’s Investors Service and Standard & Poor’s tell Fox Business they can’t immediately comment on the U.S. debt deal because the details of the cuts are still being hammered out. Both have asked for $4 trillion in cuts over the next decade. 

A little back-of-the-envelope math reveals that $2.4 trillion is much less than $4 trillion.  In fact, since $2.4 trillion in deficit reduction is a best-case figure from the debt ceiling deal, and the actual total will most likely be closer to $2 trillion, we’re looking at roughly half of what Moody’s and S&P said they needed to see from a “credible” plan.

Let me put it this way, credit analysts: none of those details you’re “waiting to see” will make the package better at deficit reduction.

“More cuts are needed to stabilize” the U.S.’s annual budget-deficit-to GDP ratio, S&P tells Fox Business, now at more than 9%. Both cite the worrisome fact that the U.S. credit markets face the retirement of the baby boomers putting added stress on Social Security and Medicare, and as health reform will enroll potentially 16 million uninsured on Medicaid, and another 16 million on new,state-run health insurance exchanges subsidized by the federal government.

The International Monetary Fund has said that a healthy ratio for countries is 7.5%.

Actually, according to an April report from Zero Hedge, the United States will hit a deficit-to-GDP ratio of 10.8% in 2011, which is comparable to basket-case Ireland.  Getting from 10.8% to 7.5% will require a whole lotta “stabilizing.”

If Moody’s and S&P were at all serious in their earlier warnings, they cannot possibly preserve America’s credit rating after a deal offering a mere $2.4 trillion in deficit reduction.  Fox Business reporter Elizabeth MacDonald looks ahead to what might happen if our AAA status is revoked:

A downgrade doesn’t necessarily mean borrowing rates would rise drastically higher. The U.S. still enjoys safe haven status, and can print dollars. Yields on the ten-year note struggled to stay above 3.5% and actually broke down below 3% during the height of the crisis. Bond markets notably focus on inflation risk—the story now is deflation, which means the U.S. can still borrow at teaser rates for now.

Same goes for Japan. Moody’s stripped Japan of its triple-A in 1998 S&P followed in 2001. Japan was hit with further downgrades ever since. Yet although it has the heaviest debt burden in the world, Japan still borrows at rock bottom rates, thanks to deflation and the loyalty of its savers who own most of its debt, unlike the U.S., which relies on foreign buyers like China. 

[Emphasis mine.]  Is it just me, or does that last sentence deflate the reassuring tone of the previous paragraphs?

The big credit agencies don’t really want to downgrade the United States, a borrower so huge that it exists on a different plane than other world governments.  The resulting disruption to the financial markets would be bad for business.  Nobody wants to say “no” when the eight-hundred-pound drunk in the red-white-and-blue top hat pounds the bar and demands another round.

Contrary to popular belief (and I feel safe in describing this as the “popular belief”) the government doesn’t just conjure funds out of thin air when it decides to spend a trillion dollars a year in excess of revenue.  Broadly speaking, it can finance that spending in two ways: borrow money at interest, or print big piles of dollar bills.

Those who would loan the United States the money it needs for deficit spending cannot conjure funds out of thin air, either.  There is only so much credit available in the world.  America is soaking up a rapidly growing amount of that credit.  Under the most optimistic reading of the debt ceiling compromise, we’ll gobble up another $10 trillion over the next 10 years.  How much does that leave for everyone else, and how close does it bring us to the moment when – AAA credit rating or not – the world has no more cash to lend Uncle Sam?

When we reach that moment, there will be no choice but to either devalue the currency by printing a tsunami of dollars and triggering hyperinflation, or adopt the kind of “austerity” measures that have filled other nations’ capitals with flaming cars.  Austerity will be much harder after another decade of madcap spending has made Americans even more dependent on the government than they already are.

Moody’s and S&P are giving the United States enough second chances and sweet deals to call their professionalism into question.  If they settle for $2 trillion in debt reduction when they said a minimum of $4 trillion was needed, they will not only make themselves look foolish, but contribute to creating the kind of existential financial crisis they’re supposed to help investors avoid.