Monday, August 8, 2011

AA+ Has Never Looked So Bad

Last Friday, one of the major ratings agencies, downgraded U.S. Treasury Bonds for the first time ever.  This was not a complete surprise, I was one of many that were speculating about it last week.  What surprised me was their reasoning.  Standard & Poor's downgraded us for political reasons.  They wrote in their report on the downgrade, 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."  Furthermore they argued, "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."

I would remind S & P that our nation has had debt to income ratios higher than this one with more political strife (U.S. Civil War) and we have always managed to pay it all down in a timely fashion.  Not that I think S&P is being completely foolish.  I simply reject their rationale.  The reason that we should be downgraded is not because of political troubles, but rather because of our central bank interfering with Treasury Bond markets with fantastic amounts of new dollars as indicated in Charts 4 & 5 of Did We Kill the Golden Goose.

George Mason University economics professor, Tyler Cowen, was on NPR this morning, saying that blaming S&P is a distraction.  Cowen says that we were on the verge of defaulting on our debt.  He argues that we need to have a combination of spending cuts and tax increases, and that any notions that we can do it with simply one or the other is foolish.  It is a fantastic amount of debt that we have accrued, $14.5 trillion.  Clearly we need to get this under control and balance our budget again.

Tyler Cowen

If Cowen is correct that we need to take a balanced approach to tackle a problem this large.  How should we do it?  There is quite a bit that can be cut out of the Federal Budget (still).  Surely not from any agency that might give me a job, but y'know... other parts of the budget.  We still give enormous amounts of subsidies, rebates and refunds for all manner of special interest groups.  All of that could easily be cut out, as it is unhelpful in a macroeconomics sense.  This would all help make our tax code more easily understandable, and would not skew our incentives which then skew our price signalling process.

All of this reminds me of an old argument about why a nation should not go into debt in the first place.  David Ricardo wrote that nations should not go into debt to stimulate demand because consumers understand that even if their tax rates are not high now, they will be raised later to pay for the debt.  His argument is that they save the extra money to pay it in taxes later.  This has come to be called the Ricardian Equivalence.

David Ricardo

Today's United States probably shines as a beacon against that idea.  It seems that most Americans haven't any notion that we would ever have to balance our budgets and pay down our debt.  Naturally, we can continue to do this, as long as we have individuals, firms, or nations willing to purchase our debt.  We've had such a long ride of everyone having a high demand for our debt, that it seems that Americans have been enabled to forget that we have to pay this all back.  So perhaps Ricardo's supposition that all citizens internalize the debt and save to pay it down later hasn't taken into account such a long period of holding debt.  Ricardo probably couldn't imagine anyone giving anyone else a $14,500,000,000,000 loan!  So perhaps Ricardo's theory is a bit off the rails, but he isn't likely to worry about it.  He's been resting in peace for 200 years, and we'll be the ones working to pay off this enormous sum.

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