How I Learned to Stop Worrying and Love the Debt
On August 5, 2011, the credit rating agency Standard and Poor’s downgraded the status of the United States’ long-term credit rating from AAA to AA+. Riots immediately broke out nationwide, Texas seceded from the Union, and California broke off and sank into the sea.
A little background might be in order. Standard and Poor’s – one of the three most prominent credit rating agencies in the United States – had been threatening since April to downgrade the credit rating of US Treasury bonds. A lower credit rating means that the borrower is less likely to pay off their debt – a scary prospect with over ten trillion dollars of outstanding US bonds. Usually a downgrade means that the borrower will be forced to pay higher interest rates to be able to continue borrowing at all.
So when S&P announced the first downgrade of the United States’ credit rating since 1917, politicians everywhere were quick to declare it a national catastrophe – caused, of course, by the greed and recklessness of their opponents across the aisle.
Republican presidential candidate Michele Bachmann was quick to lay the blame squarely on the Obama administration, claiming that “President Obama is destroying the foundations of the US economy one beam at a time.” Republican Speaker John Boehner framed the conflict along even more sharply divided party lines: “Republicans have listened to the voices of the American people and worked to bring the spending binge to a halt…the Democrats who run Washington remain unwilling to make the tough choices required to put America on solid ground.”
Democrats have done their best to blame the Republicans as well. Senate Majority Leader Harry Reid used the downgrade to snipe at the Tea Party, referring to “hardliners who have already ruled out the balanced approach that the markets and rating agencies like S&P are demanding.” Through all the mudslinging, it took most of us a while to realize that the world had not, in fact, come to a grinding halt.
The real fear was that the credit downgrade might raise the cost of financing the US debt. Normally, if Treasury bonds stop seeming like safe investments, investors would demand higher interest rates to compensate for the increased risk. An interest rate hike would make it more expensive for the United States to borrow money, and drive the deficit up even further.
In the case of the United States, however, it’s a little more complicated. The United States has been the safest bet in the bond markets for almost a century, and has overwhelming financial influence on the rest of the world. The dollar is the most widely held foreign reserve currency in the world. In short, in the Atlantic City casino that is the international stock market, Treasury bonds are the safest bets in the house. Investors tend to view any shift in US debt as a sign of larger instabilities within the economy, so after S&P announced the downgrade investors bought up all the relatively safe US debt they could lay their hands on. The buying spree drove interest rates down so far that on August 15, only ten days after the announcement, the yield on the ten year T note dropped to 1.99%, an all-time low.
But let’s ignore for a second the fact that the credit rating reduction did exactly the opposite of what it was predicted to do, and talk about the downgrade itself. Immediately following S&P’s disclosure of the downgrade, Treasury officials pointed out basic math errors in the calculations that they used to predict long-term US debt, resulting in approximately two trillion dollars to the predicted debt. S&P acknowledged the mistakes, but refused to reconsider the rating. Add that to claims from the Department of Justice that S&P has been under investigation for improperly inflating the ratings of junk bonds prior to the current recession, and you start to get a different view of the situation. Call me an anti-capitalist revolutionary, but I think that we might want to hesitate before trusting the economic analysis of suspected criminals who make trillion dollar typos.
Meaningless or not, the credit downgrade does raise a couple serious questions. Is the long-term debt a problem? The short answer is that it might be. No one really knows. Does this new rating mean that the government is anywhere close to a credit default? There’s a simple answer to that: no. It’s easier now than ever before for the United States to borrow and to put that money to work: creating jobs, building up infrastructure, and reshaping the American economy. Heck, we should even look into buying some beachfront property. I hear Greece might be selling.