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.

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23 thoughts on “S&P being silly again

  1. Stubborn Mule Post author

    Ramanan a key question here is whether a failure to meet the requirements of that IMF Article, however unpleasant that may be, constitutes default on a debt obligation. I would not have thought so and certainly I don’t see that scenario forming part of S&P reasoning.

    P.S. I should assure you that you do not sound like an extremist at all!

  2. Michael Michael

    One of your best posts ever. Congratulations.

    Perhaps you should bugger off to Europe more often!

    Question: will any mainstream media organisations do any of this kind of analysis, or will they all just photocopy an S&P press release and piss off down the boozer?

  3. Magpie

    Although I am in no position to argue against Ramanan on this subject, and I do tend to side with Stubborn on this, I believe ultimately both sides are missing the point.

    S&P’s “warning” seems (at least to me) to have very little to do with economic theory and a lot to do with politics. As Stubborn said: why that warning precisely now and not during the 1980s or 1990s?

    I apologize in advance, but I need to be candid on this: it seems naïve to overlook that, at this moment, the US Congress is discussing a debt ceiling (I know, Stubborn did mention it), the 2012 federal budget and the Republicans are hell bent on implementing a series of measures that benefit big wigs big time (i.e. tax cuts), at the expense of the rabble (i.e. eat shit, people).

    We also know that President Obama has not shown himself to be particularly combative and resolute in his policy stance.

    Now, call me cynical, paranoid or whatever, but as hopeless as S&P have shown themselves to be in their role of assessing default risk, they are not complete morons and they can perceive the effect their outburst has in politics. Is it beyond them to count on that effect to tilt the balance of the Congress discussions in their (and the Republicans’) favour?

    In fact, it would not be the first time big financial institutions have done precisely the same kind of thing. I can think of at least the IMF doing that (and before anyone asks, yes, there is research on that and I can post a link to it if required).

    So, economic theory (and simple, garden variety reason) has little to do with this, at this moment. But it is far from being entirely irrelevant.

    If I understand Stubborn’s point: at this moment the main threat the US economy confronts is a very weak “recovery”, not a generalized default perception (as evidenced by the bond market, mentioned by Stubborn). As I see it, the US is balancing itself on a knife’s edge. If Mr. Ryan succeeds (with a little help from his S&P friends) the US might fall on the wrong side of the edge.

    Now, that could actually trigger the default crisis S&P is warning about.

    Well, let me close in a hopefully humorous note: as there are all sorts of terrorism (old-fashioned, biological, nuclear, cyber) I am wondering, is it too far fetched to imagine a “financial terrorism”?

    In which case, I just hope the usual national security experts in the US are moderate and don’t start asking for anyone’s head, before a fair trial.

    Okay, maybe it wasn’t that humorous, but at least I tried. :-)

    PS: I agree with Michael^2, that’s a damn good post. It’s just that reason is not the problem here.

  4. Zebra

    Excellent post. The other common misconception, happily propogated by the media, is that the Chinese, as substantial buyers of US government bonds in recent years, have the same status and rights as bank lenders. A bond is a minimalist loan at best and in this case comes with no covenants or liens over US assets if not repaid. The idea that the US government could not have supported such a large deficit without Chinese assistance is ridiculous. If the US bonds had not been bought by the Chinese they would have been bought by someone else, albeit at a higher coupon.

    Even if the Chinese decide to sell all their US bonds en masse this will drive up the yield (down the price), but only effect the coupon on newly issued bonds. It won’t affect the ability of the US to repay existing bonds by 1 cent. In fact it would put additional pressure on the Chinese govt to appreciate the renminbi so unlikely to benefit them. After all keeping the renimbi down was one of the main reasons the Chinese bought the US bonds in the first place!

    The Chinese cannot forclose on the US if bonds are not paid so pretty irrelevant who holds them as they are “bearer bonds”. The US is under no obligation to it’s bond holders other than to pay the agreed principal and interest on time.

    And if Uncle Sam decides to default there is not a damn thing (I’m slipping into character here) the Chinese can do about it, apart from decide not to buy any more. End. Of.

  5. Ramanan


    Yes I agree with you and not the reason of the S&P.

    What I am saying is that the article I quoted may lead to embarrassments for the US government in refinancing its debt should foreign official sectors rush in to “cash in” their dollars – as in use convertibility. This happened around 1971 when Nixon suspended Gold convertibility (which was the US’s undertaking, not binding) and I think Britain asked for conversion of the dollars through Article VIII, Section 4.

    So if I were a rater, it will be difficult for me to continue saying that the US should be rated AAA, because of the scenarios I present.

    The US is a strong nation but let us take the case of a weaker nation where foreign official sectors are big creditors, though in the currency of the debtor. A run to conversion can force the debtor State to do something crazy such as intentionally defaulting – though this blurs the distinction between ability and willingness.

  6. Ramanan


    Also re automatic stabilizers, it may not work the way it is usually presented. The budget deficit is equal to the private sector net saving plus the current account balance. The present fiscal policy can be called relaxed instead of expansionary.

    Whatever the case, the budget deficit is at least equal to the current account deficit which is around 3-4% of GDP. Add to that the private sector net saving which can be assumed to be positive. Since the flow of deficit adds to the stock of debt, the public debt keeps rising.

    The automatic stabilizers work this way. Lets start with some level of public debt relative to gdp in a closed economy. If the government has an expansionary fiscal policy, it may lead to a higher deficit initially but as tax receipts increase, the government starts running into a primary surplus even though it is making no attempt to do so. Add growth and inflation complication and we can start to see in more detail how this works. One situation is a primary surplus but a negative total surplus. The quantity which “converges” is the debt/gdp.

    However this is not guaranteed in the case of an open economy. An expansionary policy leads to a higher demand and hence higher imports and a widening of the current account deficit. (The causality is from current account deficit to the budget deficit but from fiscal policy to increase in the trade deficit).

    To put it simply, this is because if the US goes into a fiscal expansion, the income of the private sector increases and people will purchase more imports.

    So automatic stabilizers are not so straightforward for the case of the open economy.

  7. Stubborn Mule Post author

    Michael Michael travel may have been a factor: still suffering from jet-lag, I wrote this post at 4am.

    Magpie I am quite happy to be quoted in your blog. While you may be right about a political dimension, I still think that S&P are also have a gap in their understanding. Unless I have missed something, everything I have read from them focuses on debt and deficit ratios and fails to make any distinction between nations like the US, UK and Australia which control their own currency and those such as EU members which do not and are present a real risk of sovereign default.

    Ramanan you are certainly correct that consideration of an open economy is complex and the budget deficit is an outcome of what the public and external sector balances generate. Still, I think it is still fair to say that a scenario in which the Fed feels compelled to start a significant tightening cycle, thereby pushing up interest servicing costs on government debt, is most likely to arise in the context of a strengthening economic which would tend to reverse the deficit situation. That, of course, is a problem the US would like to have.

  8. Magpie


    Well, it’s definitely hard to prove an eventual political motivation, up to the standards of criminal justice.

    Short of having a signed confession, I can’t see any other way. And even in that case, there could still be doubts: was that the only motivation?

    But we’re not talking about criminal justice here.

    Further, your doubt (i.e. they don’t understand other ways out of debt) assumes a lot of ignorance from them, for it doesn’t take much effort to find instances of normal people, outside MMT circles, perfectly able to grasp the basic idea: just these days the BBC’s Paul Mason included these lines in his spoof/scoop piece:

    “Yeah, but there’s a problem. They’re about as close to being a ‘true SOVEREIGN’ as you could get. Their currency’s pretty crucial to the global economy and THEY CAN PRINT IT.”

    “So they’re NOT PEGGED TO THE DOLLAR?”

    “They are the dollar. The country’s called AMERICA.”

    “Yikes. I see the problem. Technically speaking this America place prints the global currency of last resort so IT CAN INFLATE AWAY ITS OWN DEBTS, devalue the currency, impose the cost o’ crisis onto everybody else.”

    “Yeah well that’s what they did last time.”

    Think about it: is it more reasonable to assume nobody at S&P understands the above?

    So, one may make allowance for ignorance/incompetence from them (to the extent one cannot prove their guilt); but the case seems pretty weak, to me.

  9. Magpie

    Yet another reason why the ignorance thing doesn’t explain the rating agencies’ behaviour (h/t Rortybomb): rating agencies consistently rate public debt as riskier than reasonably justified.

    So much so that in “July 2008, the Connecticut Attorney General office sued the ratings agencies over what they found as a consistent undervaluing of public debt.”

    Here’s the Connecticut Attorney General’s Office press release:

    And here’s Rortybomb’s post:

  10. PFH007

    Unfortunately, although I have read the post a few times I am still unclear about a few things. That may because of an excess of seasonal chocolate or a lack of understanding of some basic economic issues or both.

    From the MMT perspective it seems there no role at all for rating government debt for countries like the US and Australia because they can always avoid default if they really want to by printing money (no necessarily negative connotations are intended by that term).

    When I heard that S&P had reduced their rating on the US I did not interpret it to mean that they literally thought the US would default but instead that they considered the outlook for US debt has become riskier.

    By this I assumed they were referring to the likelihood that the demand for US government debt was likely to be lower in the future with the result that the price of bonds would fall and yields would increase.
    My impression from reading the post is that you would disagree with S&P on either view, both the risk of actual default or that there is a increasingly negative outlook for US government debt that would warrant a rating downgrade.

    As to the risk of actual default your point about the inability of a country where the government is the monopoly issuer of a free-floating currency to run out of money is correct but I would not want to be the politician trying to explain that to Alan Jones.

    With regard to the outlook for US government debt I understand that you are sanguine on that front because the Federal Reserve has the capacity keep both long term and short term interest rates low. The impression I got was that you view that the only limiting factor on interest rate policy should be inflation. If inflation stays low the Fed Reserve is free to keep pushing interest rates (short and long) down.
    Surely, one of the lessons of the last decade was that forcing interest rates down (when inflation is low) to stimulate economic activity produces a broad range of poor investment and resource allocation decisions across the economy.

    Plus I am not sure that Japan is a good argument that governments, even the currency monopoly issuer kind, can issue lots of debt with limited downside. Wasn’t a key factor in Japan that allowed the government to issue debt at low cost, the unique cultural tendency of Japanese households to stow away high levels of savings in very low yield accounts at their local post office. This source of cheap funds was then applied to the purchase of vast quantities of Japanese government debt.

    The impact, on the price of Japanese bonds, as aging Japanese households start to run down their saving accounts, will be interesting but in any event the savings performance of US households over recent decades is very un-Japanese. The savings performance of US households would seem to reflect normal expected behaviour when interest rates are held down to discourage household saving and encourage debt.

    It will be interesting to see what happens when QE2 draws to a close. Considering the size of the Fed Reserve’s purchases during QE2 it seems likely that the absence of the Fed will make a difference. With short term US rates still bouncing along the floor it seems unlikely that Mr Benanke will tolerate a rise in longer terms rates. Some form of QE3 seems unavoidable and thus I tend to agree that the outlook for US Government debt is unlikely to be negative. This is probably why the bond market is also quite sanguine.

    While all this money printing and low interest rates may not result in inflation how can we be confident that the US (and other countries pursuing low interest rates policies) are not simply encouraging the same sort of dysfunctional investment and resource allocation decisions that characterised the last two decades.

    It would be interesting to see what would happen if interest rates (short and long term) were increased to a level that encouraged a reasonable level of domestic saving. The rates in Australia seem reasonably close to that level.

    7%-8% for 12 month term deposits feels about right. Saving up $100K is hard work for most workers and $7,000- $8,000 per annum interest seems a reasonable reward for that effort.

    I think it is time for more chocolate eggs!

  11. Stubborn Mule Post author

    PFH Generous though you are being to S&P with your reading of their announcement, unfortunately it doesn’t stand up. S&P are very specific that their ratings indicate relative probabilities of default and not the outlook for investment returns. They emphasised this during senate hearings in the US on their role in the financial crisis. There were some securities (many with high ratings, up to AAA), which performed very badly during the crisis because no-one wanted to buy them and many wanted to sell them. So, while some of these securities did not end up experiencing a default, many investors suffered poor returns selling them during the crisis. S&P, Moodys and Fitch repeatedly emphasised that the ratings should in no way be interpreted as a sign that an investor would see good returns from a bond (you can see some of the footage in the movie Inside Job and, I am sure, plenty more on youtube).

    As for Japan, I should emphasise again that I do not bring the Japanese experience up as something the US should emulate, but simply to point out that high interest rates, currency collapse and inflation are not inevitable consequences of high levels of government debt. You point to the propensity of the Japanese to save and some have used this to suggest that the Japanese experience was unique. In fact, it was part of Japan’s problem: Japan suffered what Richard Koo described as a “balance-sheet recession”. The reason low interest rates can stimulate an economy is because it makes borrowing more attractive, but if individuals and businesses are intent on paying down debt or saving rather than borrowing regardless of the level of interest rates, then there’s not much monetary policy can do. The US has been going through an period of deleveraging (although I do not expect it to last as long as Japan), and as long as the private sector is a net saver and the current account is not positive, the government sector will inevitably be in deficit. Attempting to turn that deficit around amounts to trying to force the private sector to run a deficit, and so increase its debt.

    Your concern about low rates encouraging dysfunctional investment is a reasonable one, but that sort of response is fairly visible. Prior to the GFC, there was very strong growth in margin lending balances in the US, not to mention growth in leverage structured products (sub-prime CDOs for example). It is something that the Fed and other regulators can and should be on the lookout for. However, that sort of investment tends to be associated with periods of high confidence, and I would be surprised to see excessive growth in leveraged investment in risky assets to emerge before economic conditions begin to improve, at which point interest rates should go up again.

  12. Magpie

    Although I agree completely with you on the 3 matters treated in your response to PFH007, maybe it would be interesting to insist in a point PFH007 also addressed:

    “When I heard that S&P had reduced their rating on the US I did not interpret it to mean that they literally thought the US would default but instead that they considered the outlook for US debt has become riskier.

    “By this I assumed they were referring to the likelihood that the demand for US government debt was likely to be lower in the future with the result that the price of bonds would fall and yields would increase.”

    Let’s leave aside S&P’s meaning.

    And let’s assume PFH007’s interpretation (as stated in the last paragraph, above): S&P is envisaging a state where demand for US federal government bonds diminishes autonomously, perhaps due to a kind of “saturation”.

    In that case, bond prices could fall and yields would increase, as PFH007 states.

    According to MMT, irrespective of what the US government did, could demand for US federal government just fall?

  13. pfh007

    I think i best check out that testimony as I am now curious as to what S&P and their brethren claim is the practical purpose of their ratings and what if any steps they are taking to avoid a future situation where they had rated turkeys as triple A.

    I can understand, in the context of congressional hearings, denying that your old snake oil product promised any actual benefit but surely they would be now taking the Rocky and Bullwinkle line ‘This time for sure…….’

    It seems like generating ratings is nice work if you can get it!

    I am not so sure that the dsyfunction of low interest rates is all that visible. Generally the commentary tends to be that low interest rates are great unless they cause a rise in inflation. Absent an inflationary consequence they should be kept as low as possible.

    I guess what I am suggesting is that even in a low inflation environment caution should be taken in forcing down interest rates short or long. In other words central banks should give more consideration as to whether manipulating saving behaviour through the manipulation of interest rates (particularly low rates) may have significant undesirable consequences.

    We may be leaning too heavily on interest rates as a lever of economic policy and thereby causing new or maintaining existing imbalances.

    but i am now clearly off the topic of S&P – and typing on an ipad is very fiddly – so goodnight and have a great holiday!

  14. Zebra

    ph007 and others. In should be pointed out that the way S&P rate sovereigns and CDOs is quite different. For soveriegns each rating represents a subjective opinion as to the ability of country to repay interest on it’s debt under varying adverse economic conditions. A ‘AAA’ rating means that a country could repay under all but the harshest economic downturn. For CDOs and structured products in general they take an acturial approach and attempt to work out the probability of default. This usually means looking at the probability of default of the individual assets eg. mortgages. This can be done on the basis of historical default probabilities of which there is a lot of data, unlike say AAA rated sovereigns defaults of which there has been none. The second factor for CDO ratings is the probability of joint default. A AAA rated CDO will only default if there are a lot of mortgages defaulting at about the same time as opposed to spread out over say 10 years. This is known as “correlation” and is fiendishly difficult to predict partly because if the probability of one thing defaulting is low then the historical probability of two of them defaulting is much lower so less historical evidence. In the case of mortgages the mistake they made was underestimating the extent of systemic default risk – they used to assume that in the US that mortgages defaulting in say Denver were uncorrelated with mortgages in say New York. The GFC showed that the probability of a systemic collapse in the US mortgage market was much higher than expected. As indeed was the probability of individual defaults due to what was essentially documentation fraud. The fact that there was a general economic downturn is less of a problem as it can be factored in by using increasingly harsher scenarios of underlying default. In that sense the model performed as expected. It is not so much the ratings model they used but the inputs into it. GIGO as they say. Needless to say the GFC joint default experience is the new benchmark for future ratings of CDOs.

  15. Zebra

    @stubborn – re ratings based on market value vs default probability I am reminded of CPDOs circa 2005/6. These were essentially rated on the ability of the product to generate the necessary returns to repay at maturity. I think it was generally accepted (Janet Tavikoli was an early Cassandra on this, check out her eponymous website) as the point when S&P jumped the shark on structured credit ratings.

    BTW you may remember Perry from DB Sydney in the ’90s. He was in charge of S&P structured credit rating business in the UK in the ’00s.

  16. Stubborn Mule Post author

    Magpie with one important caveat (more on that in a moment), then the usual rules of supply and demand do apply to bonds and if S&P’s actions, concerns about Europe, political commentary all have the potential to reduce demand for bonds, pushing up yields (if, that is, buyers in bond market pay attention to these things, rather than focusing on the potential inflationary outlook and the expected response of the Fed to this outlook, which tends to be the way things go after initial blips in the wake of media announcements). Even so, it is worth keeping in mind that US government bond yields are near historical lows, so some increase in yields is hardly something to get too alarmed about. So, what is the caveat? It is that there is one super-player: the government (taking that to include its agent, the Fed) which can furnish both supply (new issuance) and demand (through programs such as QE or simply regular market operations) that can swap other participants. Thus, the usual rules don’t really apply as the government can always change the balance of supply and demand and move interest rates.

    PFH007 to be fair (in a limited way) to S&P and the other ratings, when assigning sovereign credit ratings, they have never made any statement to the effect that their ratings indicate that the bonds would be a good investment or not. There are too many other factors driving interest rates (and hence bond prices and returns) than simply sovereign solvency, which is what the ratings opine on.

    One final point: at the heart of this post is fiscal policy rather than monetary policy. Monetary policy is a blunt, one-size-fits-all tool, while fiscal policy can be far more targetted. In this post and others I am arguing that misguided notions of budget constraints and sovereign risk should not constraint governments from intelligence use of fiscal policy. Whether interest rates should be kept low is a really independent question. The main link is that payment of interest on bonds is one component of fiscal policy (because you end up directing expenditure to whoever owns bonds).

  17. Magpie


    Thanks for the reply.

    Yes. I agree with that.

    Besides, as you already pointed out, it hasn’t happened yet, by any spontaneous combination of psychological factors.

    Ironically, it’s the politically motivated fear-mongering that could trigger this scenario. However, even then, at least in theory, the Government could still confront the crisis, if it was allowed.

  18. PFH007

    Hi Stubborn
    Not sure if the first post made it – if it did please delete it.

    Yes, monetary policy is a blunt tool but one which many governments do not appear to have lost any enthusiasm for leaning on.

    I watched a few videos of Mr Koo explaining his ideas ( unfortunately his books are not available as ebooks!). He explained how at even zero percentage interest people whose liabilities exceeded assets but had cash flow were not borrowing as they wished to pay down debt – good for the debtor but no good for the macro economy.

    Yet despite the apparent ineffectiveness of low interest rates the BOJ has persisted with very low interest rates. Essentially they continue to subsidize the zombie-like debtors who are paralyzed by their debts, and penalize savers with low interest rates, rather than raise rates and push some of the debtors into bankruptcy. This would allow the assets of the economic concerns that are liquidated to be acquired by debt free companies.

    Yes I know this sounds like hard love but fiscal and other policies could be used to ameliorate the adjustment process. Perhaps including some of the job guarantee concepts that MMT talk about – though they sound quite complicated to apply in practice.

    Considering the role easy money played in getting Japan and other countries into the present situation I remain skeptical of the usefulness of the weaning the junkie approach.

    Some monetary cold turkey with fiscal and other policy support may be what the patient requires.

    Iceland might prove an interest study into whether short term pain in the context of the social safety nets provided by modern government may be better than a protracted period of Japan style de-leveraging. After watching a Panorama Episode on Ireland I do not envy the debt burden that the Irish State has signed its people up to pay.

  19. Magpie


    And speaking about Ms. Tavakoli, whatever happened to last year’s foreclosure crisis v2.0?

    If I remember well, she called it “the greatest fraud in the history of capital markets”, or something.

    I seem to recall she was referring to faulty underwriting practices, among other things.

  20. Jimbo Jones

    Great thread guys. As Magpie said above the current issue is a political one in the face of an entrenched structural fiscal deficit in the US. Caused of course by the Bush income tax cuts coupled with increased coverage in Medicare and Medicaid, but exacerbated by annual health care costs which represents currently circa 17% of the Federal Budget increasing way above and beyond the rate of inflation. Only to get worse in a wasteful system dominated by private players with an expectant baby boomer demographic squeeze to come. Actual health care outcomes in the US lag way behind other OECD nations in the US which will only increase the difficulty in bending the health care cost curve. We could be in the midst of electioneering posturing at the moment with Congressional and Presidential elections to come but health care cuts are seen as electoral suicide in the States with strong poll dissaproval of any cuts to Medicare and tax cuts are still (despite all the economic evidence to the contrary) core Republican party dogma. It is clear that even a reformist candidate like Obama who wanted to be above the fray of Washington politics had to appease strong interest groups (i.e the Health Insurers and Pharma companies) in order to just get his health care bill through, watered down without the single payer/public option that in most nations is central to their health care system and kick backs for the special interest groups. It is also clear that in Obamas recent budget that entitlement reform was not tackled, instead we again see a politcal strategy wherein he seeks a negotiated almost House led outcome in response to the lessons learnt in the Clinton administration. So in this context is the Ryan plan all that we can hope for? Capping medicare and implementing further tax cuts?

    So even in a Fed manufactured benign interest rate setting, these structural concerns will not be solved by the return of employment growth in the US, but only through serious entitlement reform and taxation mix changes (i.e. increases on the rich or broadening the base of say corporate taxation). Do we see the current partisan poltical impasse in the US solving these big complex issues in the medium term? Particularly bearing in mind that the future automatic stabliser effects may not be as strong if another jobless recovery takes place and the middle class is further squeezed by rising health care costs and the entrenchment of accelerating income inequality? Lets also be clear that the bond vigilanties will also punish a continued political impasse, and any real chance of a rejected increased debt ceiling, by punishing bond yields upwards. Even the US Fed’s balance sheet has limits and so it cant just buy bonds forever. Its crazy to think that the 10 year treasury bond is still only paying around 3%, it doesnt take much in the current world of finance for a crisis of confidence to manifest itself with mass selling of T-bonds and therefore a further structural nail to the coffin on the US fiscal position through increasing interest payments. The US forever printing money in the context of a recovering economy is un-fathomable and probably against the Fed’s charter. In these ways therefore I think for once S&P perhaps has taken a crtical view on the US fiscal position and started questioning how the US can avoid impending fiscal meltdown if the current trajectory continues in the light of politcal impasse. Perhaps Obama’s second term, when usually Presidents preside for the sake of legacy as opposed to re-election, may see the US making some tough but necessary health care and fiscal decisions.

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