It took the Obama administration less than a year to reduce the United States from the country with a currency that is considered a safe haven when international storms threaten, 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 U.S. government debt was first assessed in 1917. Who would have thought when Barack Obama took the oath of office some eleven months ago that Dubai World, Greece, the UK, 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 â Attack on the Sovereigns â . Greece was downrated because its fiscal deficit is 12% of GDP, and the European Central Bank is tired of buying its banks â paper. Ireland and Spain, which also have deficits equal to 12% of their GDP, were put on negative credit watch. America is a member of the 12% club, running a deficit every bit as large relative to its GDP as Greece, Ireland and Spain, but being America, with a reserve currency that central banks and others still hold and want to hold in huge amounts, was granted a reprieve. Although our â public finances are deteriorating considerably â . [and] the question of a potential downgrade of the US is not inconceivable â , says Pierre Cailleteau, chief international economist at Moody â s, such a move is not imminent. Moody â s US analyst, Steven Hess, says, â If no policy changes are made, in ten years from now we would have to look very seriously at whether the U.S. is still a triple-A credit. â Of particular concern are the projected increases in health care and Social Security costs. â The combination of the medical programs and Social Security is the most important threat to the triple-A rating over the long term. â
Desmond Lachman, resident fellow at the American Enterprise Institute, thinks the grace period granted by the market might be as short as three-to-four years. He says a downgrade would send â a really bad signal to foreign investors. â The Congressional Budget Office (CBO) reckons that the federal government will run deficits of over $1 trillion in each of the next five years, and overseas investors who are funding about half of that deficit are increasingly nervous, as the Chinese made clear to President Obama during his abortive visit to Beijing.
This matters. If overseas investors â enthusiasm for U.S. IOUs wanes, 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 U.S. government â s credit would also make it difficult or impossible for pension funds, insurance companies and other institutions to buy U.S. bonds, driving interest rates still higher, and halting what anyhow promises to be a 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-maximizers, and will calculate whether such a scenario is more threatening to their political futures than the hard steps — such as increasing the retirement age — necessary to rein in spending and avoid a downgrade. If the government engineers â a credible fiscal consolidation â — cuts the flow of red ink, in ordinary language — America â 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 bail-out program (TARP, for Troubled Asset Relief Program) will cost $200 billion less than originally thought, the president is proposing to Congress 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 have voters so worried.
The president wants to use most of what he considers â found money â 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 â s decision is symbolic of his attitude towards the red ink he is spilling across the nation â 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 â saving â 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 â $2.5 trillion health care plan is about to become law. Legislation wending its way through Congress will reduce the independence of the Federal Reserve Board, increasing congressional oversight. That means politicians who fear that the jobs market is not improving rapidly enough will pressure the Fed to keep interest rates low, and continue to buy up the profusion of IOUs emitting 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 aging population, funds needed to prevent systemic risk. These skeletons are always uncovered when a nation â s financial condition comes 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 â 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 prove capable of coping with the burdens being placed upon it by the nation â 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 M. Stelzer is a contributing editor to THE WEEKLY STANDARD, director of economic policy studies at the Hudson Institute, and a columnist for the Sunday Times (London).
