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Reactions to the Credit Downgrade

Standard & Poor's officially took away their AAA credit rating for the United States yesterday. Anticipation of this likely was the cause of the large drop in the market on Friday, and when markets reopen on Monday there will likely be another drop. Growing fears that the United States recession is about to take a downturn and be worse than before, on top of the Euro crisis, are making people jittery. The Eurozone crisis is making people even more upset than before because Italian Prime Minister Silvio Berlusconi has ruled out calling for early elections to get him out of office and allow a new government to solve their debt debacle. All in all, though, I don't think any of the reactions to the credit downgrading were all that surprising.

China: A lot of saber-rattling about changing the world reserve currency away from the dollar and telling the USA that it is fiscally insane, all-the-while ignoring their own impending crisis. "China, the largest creditor to the world's sole superpower, has every right to demand the United States address its structural debt problems and ensure the safety of China's dollar assets," said the Chinese government. I think there was something tongue-in-cheek on the superpower comment. China also said that the United States needs to stop letting its domestic electoral politics hold the global economy hostage. The U.S. government ought to have responded with something nice about liberty and rights and politics and such, but President Obama seems to agree with China's view on government administration.

President Obama: The president is, true to form, standing behind a microphone and blaming partisanship in Congress for the credit downgrading. "Both parties have to work together on a larger plan plan to get our nation's finances in order." Too bad the Democrats insisted that there be no further discussion of the debt ceiling until after the 2012 elections.

Secretary Geithner: The Secretary of the Treasury is mulling quitting his job as some conservatives demand his resignation for things like saying in April that there is "no risk" at all of a credit downgrade. The Treasury, for its part, is officially disputing the logic behind the downgrade. Okay. Good luck with that.

GOP Candidates: A lot of blaming Obama for everything and not making any suggestions on how to solve our debt problem other than the typical vague talking points.

Europe: British Prime Minister David Cameron, German Chancellor Angela Merkel, and French President Nicholas Sarkozy all happen to simultaneously be on vacation this weekend. Really. That's Europe for you.

Friends: Japan, South Korea, and Australia all said everyone else is overreacting, they're keeping an eye on the situation, and economic cooperation between nations should remain strong right now. Australia was also quick to point out that the other two international credit rating agencies still have the United States at AAA.

All-in-all, I'm with Australia and Japan on this one insofar as people are overreacting to the downgrade and placing too much importance on what S&P thinks of the United States. As hypocritical as the Chinese complaints are, they have very good points about the United States reaching a point where we must realize we cannot borrow our way out of problems anymore. Additionally, ignoring the plunge in the stock market for a moment, the bond markets in the United States and Europe are offering far more cause for concern. But our government, despite this tumult surrounding us, will not sit down and figure out a way to solve the problem. As Pete points out below, we need a new person in the White House if there is to be any hope of averting disaster, and whoever that person is needs to be able to have a conversation with the American public about why we need true reform.
Categories > Economy

Discussions - 12 Comments

"Standard & Poor's officially took away their AAA credit rating for the United States yesterday. Anticipation of this likely was the cause of the large drop in the market on Friday."

Doubtful, in fact the deficit reductions measures were the main cause of the market fall this week, but not because they weren't large enough, but because they were too large. The CBO certification of 2.1 Trillion in cuts insures that ceteris paribus there will be that much less money in the economy to float around and end up as E so as to justify a larger P multiple.

The Dow actually gained on Friday and the S&P and Nasdaq were rather flat. Technical resistance for the indexes came back(not sure the extent to which this matters.)

The market did okay on Friday because the unemployment number was ok (or better than expected, on diminished expectations.)

Also Fluor (FLR) reported good earnings, in part because they are really a great play on the reconstruction of Japan, albeit if we cut $1 out of defense this hurts the sector they are loosely in (on the literal rebuild side).

CF industries which sells fertilizer did outstanding, in part because if you have all sorts of floods in the Midwest and you have to plant corn late, you need to buy the special seeds (50 day corn) from them or Monsanto, and you probably need to use more fertilizer. So this was not suprising, except that it did beat analysts.

Ever since April, multiple firms have been talking about eliminating the requirement of AAA, and boards of directors approved policies which would prevent them from undertaking forced selling.

Actually the raiting for monetarily sovereign nations is at least functionally inconsequential.

If you look at Japan who is rated AA the yield on those 10 years stand at 1.08%....this is a lower yield than any of the AAA's including Germany.

Everyone of importance in the EU (i.e. the French and Britts who have higher Debt to GDP ratios(than the U.S.), are forced by virtue of not being monetarily sovereign (by the EU) to confront the issue of deficits, so the ratings agencies project that these nations will do something, thus they get to keep AAA.

Geithner is actually right, the downgrade was dishonest in so far as it mentioned both willingness and ability to pay. The treasury is simply disputing the factual claim that it doesn't have the ability to pay, and argueing that the downgrade occured because Congress demonstrated a lack of willingness to pay. But for the debt ceilling...Geithner is right.

Again this "lack of willingness" is born of a serious macroeconomic misunderstanding about Monetary Finances.

It is not even clear to me that the biggest problem isn't folks who think we have a problem, and insist on thinking about the federal government as if it was a state gov. or even a government like France or Germany under the Euro.

I kind of think there will be a drop on Monday and that the next week will be bad, but this bearishness is just because stocks are valued in future dollar revenue streams. So I agree on Market direction, but pretty sure I disagree about the reason.

I will also point out that Ohio average gas prices did decline from $3.69 on Thursday to $3.625 currently and I am giving myself 9 more hours to hit my Saturday target of $3.61. Obama's role=?= caveing on the debt reduction/ceilling increase ( a macro event of significance.)

I don't think either Obama, Reid or the Republicans have been at all clear about what the problem or disaster is that we need to avert.

I would be happy to hear it, but bear in mind I am not all that scared of large numbers.... for example we have 612 Trillion dollars worth of currency and credit derivatives, that is a big number that dwarfs the 115 Trillion in unfunded liabilities.

So there is actually I think a misguided political consensus represented by the democrats who think the solution is higher taxes and by republicans who think the solution is less spending. Both of which are essentially deflationary policies...(takes money out of the economy)

So you have the market deflating as a consequence.
My bearish reasoning is more direct and analytically precise. The market inflates (or rises on expectations of higher future revenues denominated in dollars, and deflates or falls on expectations of lower future revenues denominated in dollars.)

You have a 2.1 trillion dollar event with a clear direction and you are trying to talk around it.

@JL: "The CBO certification of 2.1 Trillion in cuts insures that ceteris paribus there will be that much less money in the economy to float around and end up as E so as to justify a larger P multiple."

You are assuming that if the federal government doesn't tax away private wealth that those who earned it will place it under a mattress or lock it up in a safe in their attic rather than spending it or investing it. The small business owners (who may be worth >$250k/year but because of the cost of running business takes home much less than that) and the larger companies whose money you want the government to tax will know how to better and more efficiently spend that wealth than the federal government. Ma and Pa Kettle know if they need to save a bit or are ready to hire another employee, and the Mid-West Grocery Market Chain knows if it needs to close a store and save up some cash for a couple quarters or if they're ready to open a new branch in Smithville. These are the things that stimulate an economy. Any economy, but especially the world's largest, is a massively complex system and no enlightened individual or group of enlightened individuals can ever hope to control it. Seeing that we're short of philosopher kings in Washington (our Lord and Savior the President of the United States notwithstanding), throwing that much money into the economy does nothing but waste it on unproductive things like buddy hook-ups and all those embarassing research projects and pet projects in individual congressional districts. How did the last stimulus work out?

"I don't think either Obama, Reid or the Republicans have been at all clear about what the problem or disaster is that we need to avert."

Our debt is now at 100% of our GDP. This is the point at which it becomes possible we will enter a debt spiral like the PIIGS. Do you think that their financial difficulties are imaginary? The "we're America, we can't default" line isn't an argument. Our interest rates will be raised to untenable levels and no one will be able to bail us out. That is the road to massive inflation (and right after QE1 & 2).

@ROB: "The president is, true to form, standing behind a microphone and blaming partisanship in Congress for the credit downgrading. "Both parties have to work together on a larger plan plan to get our nation's finances in order."

This is because he's never actually led and doesn't know how.

"... because Italian Prime Minister Silvio Berlusconi has ruled out calling for early elections to get him out of office and allow a new government to solve their debt debacle."

Part of the reason is that, while Berlusconi still has some small hope of solving the debacle, the opposition has no hope at all.

Do you remember the Spring of 2008, and pictures of stacks of garbage 20 feet high and 200 feet long all over the streets of Naples? That was the crowning glory of Romano Prodi's wonderful 'center-left' administration.

If Berlusconi leaves office, those same 'centre-left' incompetents will get back into power -- with dire results, not only for Italy, but for the whole of Europe.

The essence of this debacle is vote-buying -- our representatives spend spend spend because that's the way you stay in office. Taxing to meet those spending numbers seldom gets anyone re-elected.

Solution? Two words: Term limits. Three terms in the house, 1 in the senate, 2 for POTUS. And NO PUBLIC UNIONS, EVER.

Our political cycles should be longer: four years for any office, with no one holding a given office for more than eight years in twelve.

Jerry Springer of all people was once Mayor of Cincinnati. His last campaign was for Governor of Ohio in 1982. He was buried in the Democratic primary after running a TV ad saying people could have various sorts of service cuts or they could have a new state income tax to pay for the services; the state's finances meant one or the other.

He was asked why he got out of politics: "I didn't want to do it as a career... If you're doing it to put bread on the table, you'll say anything." People permitted to run for office should be in middle age at least, i.e. drawn from the ranks of those who have spent at least fifteen years building a career. Recent experience suggests the minimum age for the Presidency should be about 60.

If term limits were effective, California would have balanced its budget years ago, but it hasn't. Instead, it is governed by men and women with short-term horizons and more so by career bureaucrats, judges and even legislative staffers. Why deprive the government of capable people? The problem is not people serving too long simply, but the means by which they perpetuate themselves which, too often, are blatant vote buying and gerrymandering. The right people must be in control for long enough to reform budgetary practices. That won't happen with one big electoral blow or clean sweep. It takes a long time, as Tea Parties (who are a godsend) need to learn, as did Goldwater, Reagan and Gingrich followers in the past.

It is indeed unfortunate that the United States cannot, at the moment, handle its social programs and economy as well as China can. However, until the 13th amendment is repealed or we start making political prisoners**, we simply won't be able to adopt their solution of having "reform through labor" as a way to keep costs down while making a profit. But who knows? Tomorrow *is* another day, so there is always "hope" yet.

**I assume we aren't. I'd hate to be wrong. "Prisons without walls", and all....

You all can speculate and comment as much as you want on this subject, but there is one fact that cannot be denied.

Barack Hussein Obama is a lame duck president.

Well, Richard, I notice that NOT having term-limits hasn't made Congress more likely to take the long view or indeed to attend to the welfare of the country. And gerrymandering is part and parcel of the problem of career politicians.

I'll admit there is no single solution to the problem, but I also know that, whether on the Right or Left, career politicans begin to act like kings over time. Even the best grow arrogant and lose contact with the people.

California has pieces of institutional architecture which produce gridlock, not present elsewhere. (Required supermajorities for tax increases, for example). Public employee unions also have the run of the place, a situation which antedated the advent of term limits. It is also the most severely gerrymanderred state in the country.

If I am not mistaken, their term limits provisions allow members of the legislature to alternate between houses, so you have some retention of personnel you would not otherwise have.

That is New York's legislature, in spades. (They have passed a budget this last year, however, and our fiscal deficits are no worse than average).

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