From the December 13, 2009 Sunday Times (London)
December 13, 2009
by Irwin Stelzer
It took the current administration less than a year to reduce the United States from the country with a currency that is considered a safe haven during international storms, to one that is warned by a rating agency that unless it mends its profligate ways it will lose the triple-A credit rating it has had since US government debt was first assessed in 1917. Who would have thought when Barack Obama took the oath of office some 11 months ago that Greece, Britain, and America would attract the attention of the rating agencies in the same week.
But here we are, caught in what consultants at the Lindsey Group call an “attack on the sovereigns”. Greece was downrated because its fiscal deficit is 12% of GDP, and the European Central Bank is tired of buying its banks’ paper. Ireland and Spain, which also have deficits equal to 12% of their GDP, were put on credit watch. America is in the 12% club, but being America, with a currency that central banks and others still hold and want to hold in huge amounts, was granted a reprieve.
Our “public finances are deteriorating considerably ... [and] the question of a potential downgrade of the US is not inconceivable”, says Pierre Cailleteau, managing director of the sovereign risk group at the Moody’s rating agency, but such a move is not imminent.
Steven Hess, US analyst at Moody’s, says: “If no policy changes are made, in 10 years from now we would have to look very seriously at whether the US is still a triple-A credit.”
Of particular concern are the projected increases in healthcare and social security (pension) costs. “The combination of the medical programmes and social security is the most important threat to the triple-A rating over the long term,” says Hess.
Desmond Lachman, resident fellow at the American Enterprise Institute, a Washington think tank, believes the grace period granted by the market might be as short as three to four years. He says a downgrade would send “a really bad signal to foreign investors”. The Congressional Budget Office reckons that the federal government will run deficits of more than $1 trillion in each of the next five years, and overseas investors who are funding about half of that deficit are increasingly nervous.
This matters. If overseas investors’ enthusiasm for American IOUs wanes, the interest rates we have to pay to persuade foreigners to buy our debt will rise. That means higher mortgage rates, not exactly what the doctor ordered for the troubled housing sector, and higher charges to entrepreneurs hoping to obtain credit with which to expand, creating jobs. A downgrade of the American government’s credit would also make it difficult or impossible for pension funds, insurance companies and other institutions to buy American bonds, driving interest rates still higher, and halting an already slow, drawn-out recovery in its tracks.
Like so much else these days, all depends on policy. Nothing is written. It is for elected politicians to decide. They are vote-maximisers, and will calculate whether such a scenario is more threatening to their futures than the hard steps necessary to rein in spending and avoid a downgrade. If the government engineers “a credible fiscal consolidation” — cuts the flow of red ink, in ordinary language — America’s triple-A rating is secure. It comes down to whether you believe that this and subsequent administrations are likely to do a u-turn and ditch profligacy for prudence.
On current evidence, that does not seem likely. Having discovered that the bank bailout programme (Tarp, for Troubled Asset Relief Program) will cost $200 billion less than originally thought, the president is proposing that most of the money be spent. Never mind that the bulk of the $787 billion original stimulus package has yet to be spent. Or that the government will hit the statutory debt ceiling next week, setting off an acrimonious debate on the mounting deficits that are so worrying the voters.
The president wants to use most of what he considers “found money” to stimulate jobs: tax breaks for small businesses, more infrastructure spending, incentives for homeowners to weather-proof their homes, grants to states such as his own cash-strapped Illinois. A mere $200 billion is no big deal these days, but the president’s decision is symbolic of his attitude towards the red ink he is spilling across the nation’s ledgers. He is rather like a man who decides that he is too deeply in debt to afford a new car, and then uses the “saving” from sticking with his present vehicle — money he never had — to finance a round-the-world cruise.
More important is what the rating agencies are about to witness. The Democrats’ healthcare plan, costing more than $1 trillion, is about to become law. Legislation going through Congress will reduce the independence of the Federal Reserve Board, increasing congressional oversight. That means politicians who fear the jobs market is not improving rapidly enough will press the Fed to keep interest rates low, and continue to buy up the IOUs pouring from the Treasury to cover the deficits.
A costly energy bill is next on line.
Meanwhile, the off-balance-sheet liabilities of the federal government are rising — the debts of troubled states, underfunded pension plans, the unbooked obligations to an ageing population. These skeletons are always uncovered when a nation’s finances come under close scrutiny. The government is on the line for a lot more than the official balance sheet shows.
In short, the outlook is not brilliant. The policy changes the rating agencies are looking for are nowhere in sight. But Moody’s might be looking for relief in all the wrong places — the Oval office, the halls of Congress, the offices of government bureaucrats. Policy might remain unchanged, but the great, energetic, entrepreneurial American private sector just might cope with the burdens being placed on it by the nation’s political class, and launch a new decade of rapid growth. It always has in the past. Unfortunately, the past is not always prologue.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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