Monthly Archives: April 2011

S&P being silly again

The debt rating agency Standard and Poor’s (S&P) has placed their rating of the US on negative outlook. What this means is that they are giving advance warning that they may downgrade their rating of the US from its current AAA level (the highest possible rating). Their actions were motivated by concern about “very large budget deficits and rising government indebtedness”.

To me this shows that S&P do not have a good enough understanding of macroeconomics to be in the business of providing sovereign ratings. How can I doubt such an experienced and reputable organisation as S&P? Well, keep in mind that this is the same agency which maintained investment grade ratings for the likes of Bear Stearns, Lehman Brothers and AIG right up to the point where these firms were on the brink of collapse (while it was only Lehman that actually failed, that was only because the other two were bailed out). Likewise, it is the same agency which assigned investment grade ratings to sub-prime CDOs and other structured securities many of which only ended up returning cents in the dollar to investors during the global financial crisis.

Of course many commentators are very nervous about the growth in US government debt (notably, the bond market seems far more sanguine) and typically assert, with little justification, that growing government debt will lead inevitably to one or more of:

  • a failure of the government to be able to meet its debt obligations,
  • rising inflation as the government seeks to deflate away its debt (and interest rates will rise in anticipation of this future inflation), and
  • a collapse of the currency as the government seeks to devalue its way out of the problem.

Before considering how likely these consequences really are, it is important to emphasise that while there is a widespread tendency to label all of these as a form of “default” by the government it is only the first of the three, a failure of the government to make its payment obligations, that the S&P rating reflects.

In fact, I do not consider any of the three consequences above to be inevitable. The quick and easy counter is to point to Japan. As its government debt swelled to 100% of gross domestic product (GDP) and beyond, it never missed a payment, would have loved to generate a bit of inflation but consistently failed year after year and, while its currency has its ups and downs, the Yen remains one of the world’s solid currencies. While I certainly do not think that the US should aspire to repeat Japan’s experience over the last couple of decades (I would hope for a better recovery for them), this point should at least dent the simplistic assumption that default, inflation or currency collapse follow rising government debt as night follows day.

Since it is only a true default that is relevant for the S&P rating, it is worth considering more specifically how likely it is that the US government will be unable to honour its debt obligations. Regular readers of the blog will know that I regularly make the point at the heart of the “modern monetary theory” school of macroeconomics, namely that in a country where the government is the monopoly issuer of a free-floating currency, the government cannot run out of money. If your reaction to that is “of course they can print money, but that would be inflationary!”, ask yourself why that did not happen in Japan and then remind yourself that even if it did happen, it is not relevant to the S&P rating.

There is one important caveat to this monopoly issuer of the currency argument. While it certainly establishes that the US government will never be forced to default on its debt, it is still possible that it could choose to default. This choice could come about in a dysfunctional kind of way since the US imposes various constraints on itself, in particularly a congress legislated ceiling on the level of debt the government may issue. So it is possible that a failure of congress to agree to loosen these self-imposed constraints could end up engineering a default. Now that is a more subtle scenario than the one that S&P is worried about, but since it is possible, it is worth considering how serious debt-servicing is becoming for the US government. To make a comparison over time meaningful, I will take the usual approach of looking at the numbers as a proportion of GDP. Taking the lead from a recent Business Insider piece*, the chart below shows US government interest payments as a share of GDP rather than the outright size of the debt. This has the advantage of taking interest rates into account as well: even if your debt is large, it is easier to meet your payment obligations if interest rates are low than if they are high.

US federal government interest payments as a share of GDP

So the interest servicing position of the US government has actually improved of late and is certainly much better than it was in the 1980s and 1990s. So why is S&P reacting now? I would say it is because timing is not their strong suit (and they do not really understand what they are doing). Ahh, you say, but what happens when interest rates start going up? Since the US Federal Reserve controls short-term interest rates and of late, through its Quantitative Easing programs, has been playing around with longer-term interest rates as well, the US government is in a somewhat better position than a typical home-borrower, and interest rates will only start to rise once economic activity picks up again. Then the magic of automatic stabilisers come into play: tax receipts will rise as companies make more profit and more people are back at work, and unemployment benefits and other government expenditure will drop and the growth of government debt will slow or reverse.

So, there is no need for panic. Once again, the rating agencies are showing that we should not be paying too much attention to them. After all, as they all repeatedly said in hearings in the wake of the financial crisis, their ratings are just “opinions” and not always very useful ones at that.

Data Source: Federal Reserve of St Louis (“FRED” database).

* As Bill Mitchell, @ramanan and others have noted the Business Insider chart, while looking much the same as my chart, has the scale of the vertical axis out by a factor 10.


This is a quick post to reassure regular readers that I have not given up the blog. The hiatus between posts has been due to travel. Seasons in Australia are not as distinct as they are in Europe and when I lived in England (many years ago) I always found the arrival of Spring the most striking illustration of this difference. True to my recollection, the European Spring put on an excellent show for this trip to England and Italy.

Wandering the streets of Rome, I came across a street called Via De’ Burro. While a burro is not exactly a mule*, it is a close enough relation to remind me that I was neglecting the blog and to inspire a quick photograph.

My family and I were not the only ones enjoying Spring in Rome. It had been many years since my last visit to Italy’s capital and I am convinced that there are more tourists there than ever. Perhaps good weather, a week of free museum admission and the lead-up to Easter were conspiring to swell visitor numbers, but I can only imagine that the crowds would be larger still by summer time. The photograph below shows the square in front of the Trevi fountain and I cannot help thinking that, while tourism is a big industry for Australia, we don’t really know what it means to be a serious tourist destination!

Of course, no trip to a non-English speaking country is complete without coming across bizarre English translations. The sign in the photo below was in the window of a restaurant near our hotel. What it means remains a mystery as it certainly did not tempt me to try their cuisine.

As well as Rome, the Italian leg of the trip took in Venice. Spring is an excellent time to visit Venice: excellent weather and not at all stinky!

Venice’s famous “Bridge of Sighs” was under renovation and partly shrouded in scaffolding. But I was able to photograph another Bridge of Sighs, named with a nod to the Venetian original. Before Italy, we spent some time in England and spent a beautiful Sunday morning punting down the river Cam in Cambridge. The bridge in Venice connects the court rooms in the Doge’s Palace to the prison cells and the name supposedly derives from the sighs of prisoners getting their last glimpse of freedom through the windows of the bridge. The connection of the bridge in Cambridge to the original is simply that both are covered stone bridges, regardless of how dim a view students of St John’s college may have taken of their studies at times.

Travelogues are not the usual fare here at the Stubborn Mule, so stay tuned for a return to more typical content soon!

* Thanks to Magpie for reminding me that while “burro” is donkey in Spanish, in Italian it means butter!