THE RATINGS AGENCIES BECOME EVEN MORE USELESS
Last December I warned that the ratings agencies were likely to downgrade the credit rating of the USA. And this morning they went ahead and slapped a “negative” rating on US credit:
“On April 18, 2011, Standard & Poor’s Ratings Services affirmed its ‘AAA’ long-term and ‘A-1+’ short-term sovereign credit ratings on the United States of America and revised its outlook on the long-term rating to negative from stable.
…Our ratings on the U.S. rest on its high-income, highly diversified, and flexible economy, backed by a strong track record of prudent and credible monetary policy. The ratings also reflect our view of the unique advantages stemming from the dollar’s preeminent place among world currencies. Although we believe these strengths currently outweigh what we consider to be the U.S.’s meaningful economic and fiscal risks and large external debtor position, we now believe that they might not fully offset the credit risks over the next two years at the ‘AAA’ level.The U.S. is among the most flexible high-income nations, with both adaptable labor markets and a long track record of openness to capital flows. In addition, its public sector uses a smaller share of national income than those of most ‘AAA’ rated countries–including its closest peers, the U.K., France, Germany, and Canada (all AAA/Stable/A-1+)–which implies greater revenue flexibility.
Furthermore, the U.S. dollar is the world’s most used currency, which provides the U.S. with unique external flexibility; the vast majority of U.S. trade flows and external liabilities are denominated in its own dollars. Recent depreciation of the currency has not materially affected this position, and we do not expect this to change in the medium term.
Despite these exceptional strengths, we note the U.S.’s fiscal profile has deteriorated steadily during the past decade and, in our view, has worsened further as a result of the recent financial crisis and ensuing recession. Moreover, more than two years after the beginning of the recent crisis, U.S. policymakers have still not agreed on a strategy to reverse recent fiscal deterioration or address longer-term fiscal pressures.”
As I stated back in December, this is nothing short of absurd:
“Of course, the USA has no foreign denominated debt and can create currency at will. The issue of solvency is a non-issue for a nation such as the USA which is the supplier of its currency in a floating exchange rate system. In a very low inflation environment the USA needs to focus more on price stability and the ratings agencies would help everyone out if they didn’t contribute to the fear mongering that the USA is going bankrupt. Nothing could be further from the truth.”
There is simply no such thing as the USA not being able to meet its financial commitments. We could devolve into a hyperinflation, but that is a very different phenomenon than insolvency & S&P does not touch on this topic. Unfortunately, S&P appears to make no real distinction so it’s clear that their analysis is entirely off base to begin with. They are acting as though the US government is akin to a household. That analogy simply does not apply to the USA.
The worst part, is that this is all likely to throw gasoline on the austerity fire. S&P is seen as a credible outfit (despite discrediting themselves during the financial crisis, but hey, this is Wall Street and we’re always willing to welcome someone into our homes who only just recently robbed us) so the lawyers in Congress are likely to use this as a good excuse to dig their heels in over the debt ceiling and spending. And not surprisingly, it is the credit rating agencies, via their own ignorance, who are likely contributing to what has the potential to be a disastrous economic outcome….
I agree absolutely that S&P is absurd, but I think you have carried the US can have deficits as far as the eye can see (or forever) because of MMT is also an untenable situation. The problem (as I have pointed out) is that these deficits are used to generate asset bubbles and huge malinvestment rather than for productive purposes. As a result, this nonsense from all the MMT’ers and Koo that we should generate deficits forever until the economy recovers is mostly useless and impractical. As far as Koo’s argument that Japan would have been evern worse off w/o deficits, it is a stupid argument – who says that where they are now is such a good place to be anyway? What if they had moderate levels of liquidation and let all those bubbles burst in a methodical fashion – perhaps they would have been in a better way now.
You ahve carried the MMT torch far too much and given them way too much credit – its an elegant mathematical/accounting theory and an accurate representation of the current monetary system. Its nothing more!
I would recommend that you read http://www.creditwritedowns.com – Ed Harrison is very much in agreement that MMT is the right way to think about the operations of the fiat monetary system, but he has rejected its policy implications.
Controlled liquidation of debt and asset bubbles is the way to go. Otherwise, all we are doing is build more bubbles.
Haris,
You must not be very familiar with my work because I called for “controlled demolitions” of the banks. I am very aware of the malinvestment effects. That is why I wrote so extensively on the homebuyers tax credits, cash for clunkers and many of the other spending policies that were so misguided.
I talk to Edward at CW quite a bit. We are remarkably similar in terms of our perspectives.
As for Koo, the balance sheet recession math is quite simple. Someone has to fill the spending gap or output collapses. It’s that simple. Now, if you want to talk about the benefits of a recession then be my guest. I believe there are many benefits to recession. However, this is not your average recession. This has the potential to be far worse. And I think govt has a duty to ensure that depression does not occur. Especially when the risk of depression is largely due to their own misguided prior actions….
True, recessions will cause output to collapse. However, if there is huge malinvestment in the system, then they should be allowed to fall (not collapse). I realize that instant liquidation can cause a depression, not calling for that, but controlled liquidation should be allowed to happen. Just propping up the current system with out of control govt deficit spending (especially when you know that a majority of that spending is usurped for wholly unproductive purposes) seems like altogether a stupid thing to do.
Someone needs to step up and take the pain for future prosperity, but alas Bubble Ben and Geithner will just do whatever it takes to help Obama get re-elected in 2012, that being the sole purpose of their jobs. Obama – I thought he was going to be a leader, alas he is just yet another politician running to get re-elected. He invoked Lincoln while running, what a joke, he will be consigned to rubbish in Presidential history, not be anywhere near the top as Lincoln is.
“What if they had moderate levels of liquidation and let all those bubbles burst in a methodical fashion – perhaps they would have been in a better way now.”
Purge the rottenness from the system! Has history not taught us anything? We went through that in the 30′s and it was pretty goddamn ugly. If you think things are bad today, I shudder to think what it would be like for America with 25% unemployment. Perhaps that is acceptable in some people’s worlds, but I’m not into supporting idealogical positions at such a cost, even if I get to keep my job. Markets often fail, and as inefficient as gov’t intervention can be, the alternative in modern industrial economies can be a whole lot worse.
What would happen if out of ignorance Congress voted against an increase in the debt ceiling?
What if, out of wisdom, Congress voted against an increase in the debt ceiling?
DH & Prescient,
Jinx, you owe eachother a coke.
It would be a disaster. It would either require massive spending cuts or it would result in a default. It would be an economic calamity that made the financial crisis look like a walk in the park….
I am a human.
And yeah, TPC, agreed there. But I think that a line needs to be drawn now, and that is a pledge among politicians to do SOMETHING SUBSTANTIVE.
And I don’t care about the short term, I agree with everything you said, hell we need more short term stimulus in my book.
But the elephant/donkey in the room is the long term entitlement picture. That MUST BE ADDRESSED or we are all headed down a road of misery and serfdom.
prescient11.
SS entitlement is about shift of 1 to 2 % of GDP to the seniors – nothing to get worked up about. Medicare is worse, but the problem is emphatically NOT the program itself but ouor broken healthcare system. Eliminating MC doesn’t solve the problem (and actually makes it worse) but shifts it. And at some point something will have to give. As Jamie Galbraith quipped:
“And if health care does get that expensive, and we’re paying 30 percent of GDP while everyone else is paying 12 percent, we could buy Paris and all the doctors and just move our elderly there.”
Cullen,
This note from Koo a few months ago sums up the situation nicely;
http://www.scribd.com/doc/48072696/Koo-2-2
My favorite quote,
“Last week Standard & Poor’s announced a downgrade of Japan’s sovereign debt. The news was heralded as a major shock to Japan in the overseas press, but the resulting sell-off in JGBs was brief and ultimately negligible. One reason for the market’s muted response to the downgrade was that Japanese bond market participants have grown used to this kind of behavior by Western rating agencies. Several years ago, Moody’s repeatedly lowered Japan’s credit rating to the point where, for a time, it was considered less creditworthy than the African nation of Botswana. In the end, however, the only party harmed or embarrassed by this action was Moody’s.The nightmare scenario envisioned by the analysts did not come to pass. No other agency followed Moody’s lead, and the agency eventually was forced to raise Japan’s rating several times even though nothing had changed. The upgrades had as little effect on the market as the downgrades had previously.”
Botswana has a higher credit rating than Japan. Kinda like packaged Alt-A’s are AAA. Ignorance abounds.
One would think they would have learned after they kept downgrading Japan…
Haris07
There’s lots to agree with there, but I think you may not be aware of Cullen’s prescriptions or recommendations
1. He recommended Nationalizing the banks (debt reduction)
2. Stop supporting asset bubbles (anti QE2)
3. Malinvestments are bad.
4. Reduce the financialization of the economy (which has contributed mightily to asset bubbling)
re MMT is “an elegant mathematical/accounting theory and an accurate representation of the current monetary system Its nothing more!”
Well, that’s a lot better than the alternative belief systems that seem to be driving policy decisions.
MMT is NOT a system to pick winners and losers (based on someone’s idea of what is moral or right). That is politics, and the marketplace.
All he asks for is that everyone start with an accurate representation of the current montary system. And go from there.
Right Roger. MMT is descriptive. Not prescriptive.
Fair enough, Roger and Cullen. In reading Koo, Randall, Marshall etc. the overarching idea that I walk away with is “we are in a bad economy, there is significant slack in labor and capital, so there can be no inflation. Ergo government should spend away till we get full inflation”. There are 2 problems with this:
1. If govt spending was efficiently channeled to full employment, God bless them all, lets do it! Alas, it is actually “captured” along the way by the banking system and others for malinvestment.
2. Even with significant slack, due to speculation of because foreign central banks maintaining their peg with the USD forced to print more local currency, it is causing significant increase in select commodities which in turn causes real pain.
So, it is causing “inflation” in the wrong places – commodities and asset inflation in risky assets.
Haris,
We’ve been very critical of the actual policy attempts at stimulating, and have mostly proposed tax cuts instead of trusting policymakers to spend on the right things in the current environment. We were against the TARP from the very beginning in fall 2008. We have published extensively on the problems with traditional Keynesian stimulus.
My favorite part is that the USD and US Tsys are rallying today….
I KNOW!!! Oh the irony is that a flight to safety is the same damn thing that was just downgraded that is causing all the “panic”…
I am looking for big time rallies in the equity markets coming up, and I would not be caught dead shorting this market for more than a day.
I believe commodities should have a nice rally too.
Cullen, to be fair, S&P noted:
“Our ratings on the U.S. rest on its high-income, highly diversified, and flexible economy, backed by a strong track record of prudent and credible monetary policy. The ratings also reflect our view of the unique advantages stemming from the dollar’s preeminent place among world currencies.”
Although you are certainly correct that “There is simply no such thing as the USA not being able to meet its financial commitments,” the way we meet said commitments is the key. We may meet them in a way which is “un-credible monetary policy,” and the way we meet them might damage the “dollar’s preeminent place among world currencies.”
-KD
Covering their ass. “The USA is extremely strong, but we are still worried (insert blah blah blah here for 10 pages)….”
Cullen:
Assuming we should always keep our AAA rating due to our ability to create money out of thin air (As God created the world, with words), what do you suggest as a credible rating for our economy?
What characteristics would it need to meet?
And, what ratings would you give if we don’t meet various characteristics?
Don Levit
I wouldn’t rate a country like the USA. It’s nonsensical. The credit rating agencies sell financial products. In this case, they sell their research on sovereign credit. That research is useless. But people pay big bucks for it (because they think it matters) so S&P is happy to oblige. It’s just another case of Wall Street shenanigans.
Actually, Mosler made the argument that ratings agencies *should* downgrade the credit rating of the U.S. based on “willingness to pay”
.
http://moslereconomics.com/2011/03/25/the-ratings-agencies-should-downgrade-the-us-government/#comments
Warren is mocking the political idiocy on display….and rightfully so.
I was aware- just providing some morbid humor
Ok, Mr. Roche, I agree the ratings agencies are the wolf that cried wolf x oo. No credi(t)bility. With respect to MMT, however, it ‘seems’ as if proponents have inferred there are no hard “stops” to endless monetization. Maybe I am beginning to understand; hyperinflation is a hard ‘stop’? Is perhaps S&P saying, in MMT parlance, we’ll force the hand because hyperinflation is, in effect, a hard stop? Is this not a defacto default? Also, did you see where the Saudis are cutting production due to supply gut? Has QE so distorted S&D that commodities are reflecting purely monetization? (As I claim, commodities ARE the gold standard). Please elaborate vis a vis MMT. Surely it can’t be that an asset swap is nothing more than asset swap.
Defacto default, sure. But if we’re going to have a grown up discussion regarding hyperinflation then let’s first understand the basic premise of that discussion. Most people, in worrying about traditional forms of solvency, entirely miss the points in this discussion that matter….
My point is, there is a huge difference between hyperinflation and traditional insolvency. They are very different animals.
Ducksoup,
I would posit an additional thought for your consideration regarding oil and true S&D. QE is a red herring, except for psychology I suppose. The real question that the endless bubble callers continue to fail to answer, is what is the supply/demand equation and how is the dollar’s value eventually going to reflect the insane fiscal structure the US finds itself in.
The BRICS countries have already announced that they are phasing out USD in their trades and will trade with each other in their own currencies.
How many damn WARNING BELLS need to be rung here?
The better question is why does the S&P still exist? They should have been reorganized along with the damn banks…
I think we’ll look back on this day and event as “the” catalyst that sealed our fate into following the trajectory of 36/38.
IN the Q&A SnP was asked about debt monetization.
Q: What does credit risk mean when the borrower can monetize its own debt?
A: In the US, or any other central bank country, S&P has always thought that it is very short sighted to say government can not default if US can print its way out. Counterintuitively, US should never have to levy any taxes and just monetize all deficits. That is not a credible or realistic alternative to levying taxation. The short answers is that in longer term, if deficits continue to rise, this impairs the credit standing of a government including the US.
Considering taxation is the glue that binds the system…it’s clear that S&P doesn’t get it. There’s no such thing as monetization for a nation that issues its own currency, exists in a floating exchange rate system and has no foreign denominated debts.
Cullen:
If taxation is the glue that binds the system, shouldn’t there be some minimal relation between taxation and expenses?
Currently, taxes cover about 60% of expenses.
Don Levit
Are you saying there is no relationship between taxes and spending?
Why is even the suggestion of “nationalizing the banks” such a third rail? If the banks were nationalized then the interest payments on loans would go back to Uncle Sam. Student Loans were supposed to be a “give away”, so our kids could get a great education even if their parents were broke…why were banks even involved?
My understanding of what the MMT explainers have said is that Taxes, the selling of Treasuries, QE (the Fed in effect buying treasuries), are needed to keep control of the fact that “deficit spending” (e.g. Uncle Sam putting money into the economy), is inherently a currency dilution, however our currency leaks away via the negative balance of payments and interest taken by the banks (etc.). So we always need more money coming from the Governement than being taken in just to keep the currency pool full. So I don’t understand why Cullen says QE is always bad, and the Chinese have ruined their economy?
I quote “RXXT60″ one of your best PRAG commentors (He writes and explains way better than me):
03/14/2011 at 8:50 PM
RXXT60
Henry C.K.Liu says that when humans figure out that money can be debt free, that will be the
equivalent of figuring out the world isn’t flat. Henry is a chartalist, and China dials him up for advice.
Yes, MMT folks are making an honest attempt at defining our modern system as it evolves. Their
notions of using government as employer of last resort (ELR) is a moral attempt at moving our money
forward.
Personally, my ideal system would be the 1930′s Chicago plan with some blend of ELR and clearing
banks. With a system like this, the fraudsters would have nowhere to hide, and the system would not
easiy go out of equilibrium. The Chicago plan absorbs the FED into the treasury. The treasury then
can issue vertical money debt free. Horizontal bank credit money goes away, and becomes real
money. The horizontal banks become 100 percent reserve, so they only loan out money that already
exists. Money pops into being only by way of the treasury, so in effect there is only vertical money.
The borrow short to lend long problem can be taken care of with mutual fund type operations.
Clearing banks, or bancor types systems, can bring political control over the exchange rate. In other
words, if a good leaves your country, your account is credited up, and when an import comes in your
account is credited down. Money doesn’t leave the economy, it is insulated by the clearing bank. That
means your money circulates only in your economy. If a trading country becomes mercantilist, they
will be penalized for having too high of a trade imbalance. Yes, Keynes was a bit radical. You can
then control better for the total money supply than we do today.
The FED lost control of the money supply volume with the rise of non banking finance, like GE
capital and others. So, the FED only controls for interest rate windows. This is a potential danger to
us, as the huge unkown volumes of dollars overseas can come flooding home if we fall out of reserve
status. The big thing to remember is that money is a fiat of the law. It is not gold, or something
magical. Money is codified into existence by the law.
No, I am saying taxation must be a minimal percentage of spending to be relevant.
Otherwise, the glue becomes porous.
100% would be fine with me.
Don Levit
I am no fan of the ratings agencies, but I find it quite reasonable to put the US on negative watch. Even though there will be no de facto default, there is an increasingly likelihood that investors in US Treasuries will be paid back in devalued dollars. If you are a foreign investor, then that is germane to your net return on your investment. Higher interest rates are also a possibility, which would mean that your return relative to future alternatives is lower. Hence there is a rising risk to an investment in US government bonds. Why is this so controversial?
This thread is a lot of hoopla over nothing…
The diminutive, Standard & Poor, is nothing more than a credit rating agency and a bad one at that….
Nevertheless, even its lowest rating does not confirm in anyway whether or not, the underlying entity is solvency or insolvent…
Compare the PIGS rating and yield to that of the US Treasury and one will find the appropriate credit rating…
BTW, nun of the PIGS have gone bankrupt either…