“You can’t always get what you want,” says Mick Jagger, “but if you try sometime, you might find, you get what you need.” Congress got neither with the deficit reduction plan passed last Monday. Instead, it got what it deserved on Friday as Standard and Poor’s dropped the United States sovereign debt to AA+ from AAA. Global markets responded quickly, with the Dow Jones Industrial average shedding approximately 7%, Tokyo losing 5.5% (4% on Friday alone), and London down almost 11%. This is hardly good news. However, several prominent market analysts are saying the credit rating cut isn’t necessarily bad news, either.
Last Monday, Congressional leaders announced a bipartisan plan to reduce the long-term federal deficit and increase the debt ceiling to avert a default on U.S. Treasury securities. The deal promises over $900 billion in long-term cuts now and a mandate to cut another $1.5 trillion by the end of this year. How is this additional $1.5 trillion to be decided? The bill authorizes a bipartisan “super-committee” to identify future cuts. It’s rather apparent that taxpayers and investors have little patience in additional committees, however super they may be. If the treasury got a dime every time legislators authorized a new committee, we probably wouldn’t be in this mess (Zing!). The $2.1 trillion package fell well short of the $4 trillion analysts say is required to put U.S. debt on solid ground. In short, Congress did the minimum to get by and passed the buck on further down the road. Standard and Poor’s called the deal out for the turd it was and downgraded the government’s credit rating.
So why isn’t this bad news? Because investors don’t need to wait for the rating agencies to recognize a turd when they see one. All of the aforementioned markets fell steadily throughout the week in reaction to the deal itself, so no one was really shocked by the time the downgrade was actually announced. Markets have continued to decline thus far today, but treasuries have rallied as global investors continue to seek safety in American assets. Gold is also up over $1700/oz. due to the flight to safety, but exchange rates have only marginally weakened between the Dollar and other major currencies.
According to Vassili Serebriakov, currency strategist at Wells Fargo, “One of the reasons we don’t really think foreign investors will start selling U.S. Treasuries aggressively is because there are still few alternatives to the Treasury market in terms of depth and liquidity.” Only four other nations – Canada, France, Germany, and United Kingdom – have AAA ratings. France and Germany are both tied to the Euro, which is far less stable than the Dollar due to debt crises in Greece, Ireland, and Spain. Neither Canada nor the U.K. have debt to satisfy demand for global currency reserves.
The downgrade to AA+ is a major blow to American prestige, but still signifies a very low risk of default to investors. The Oracle of Omaha, Warren Buffett said on Friday that he would rate American debt at “quadruple-A” if such a rating were available. So speaketh the Oracle: “If nothing else takes place, meaning, if all other variables hold and there isn’t say, a new problem in Europe, it won’t make any difference. The U.S., to my knowledge, owes no money in currency other than the U.S. dollar, which it can print at will. Now if you’re talking about inflation, that’s a different question.”
If any good can come from the situation, Congressional leaders will take the message that they need to take long-term deficit more seriously than they have thus far. Remember, the downgrade was caused by congressional inaction. It’s specious to blame the tumble on the ratings decline when the decline was a simple response to fiscal inaction on the part of the U.S. government. I predict markets will recover as quickly as they collapsed if (and this is a big if) Congress can put forth a credible deficit plan to clean up their fiscal act over the next 10 years. In the meantime, don’t expect the sky to fall on the American economy.
Tanner has spent the last four years not only gaining insight into the macroeconomic trends that produced the Great Recession, but also learning how to restore his own finances from losses during the 2007 housing market collapse. Having gained experience from both academia and the school of hard knows, Tanner is uniquely qualified to interpret the impact of macroeconomic happenings on your wallet.
When not pontificating on all issues financial, Tanner enjoys pontificating on all issues non-financial. Contrariety is among his more heavily indulged vices. He also enjoys cycling, music, wine, literature, sports, and traveling anywhere he will be tolerated. He currently resides in Des Moines, Iowa. Besides blogging, he hopes to one day work in economic policy analysis, either at a think tank, government agency, consulting firm, or non-profit organization.
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