Emperor’s New Clothes – An Independent Assessment

Reminiscent of a Stasi leg-breaking, Argentina persecuted economists for publishing inflation estimates that exceed the banana republic’s official estimates.  Encouraged by those soul-mate vaqueros, Italian politicians started a regulatory shootout with S&P and Moodys for publicly saying a downgrade may result from Italy’s excessive levels of sovereign debt.  The spaghetti western ended a few days later, when Prime Minister Berlusconi agreed to balance the budget a year faster than planned, and rush through welfare and labor market reforms – tacitly acknowledging the excess debt S&P and Moodys and everyone else could see.  Berlusconi had tried to delay the austerity until after the 2013 election, sound familiar?  Official action was prompted not by an independent assessment, but by the big money consequences of the European Central Bank refusing to buy Italian bonds in the market.  Big money often trumps independent assessments.

 

In July 2011 Egan-Jones downgraded US credit.  Unlike other credit rating agencies, Egan-Jones ratings are paid for by investors, not by debt and equity issuers.  In early August, S&P also set US credit at an AA+ rating.  Excessive debt was part of the downgrade, but S&P says the conclusion “was pretty much motivated by all of the debate about the raising of the debt ceiling.”  Predictably, the machetes started swinging at S&P.  

 

The US Treasury attacked a $2T error in assumptions.  S&P responded; “In taking a longer term horizon of 10 years, the U.S. net general government debt level with the current assumptions would be $20.1 trillion (85% of 2021 GDP). With the original assumptions, the debt level was projected to be $22.1 trillion (93% of 2021 GDP).”    And there were threats to “investigate” S&P because it said the debt deal did too little to slow the growth in entitlements.  As well, there was legitimate criticism of S&P’s role in the housing crisis.  But, proving S&P’s point, both political parties vigorously blamed the other for the downgrade.

 

Some took the independent assessment on its merits and voiced acceptance of the earned downgrade.  At least one analyst said the new rating would eventually cost consumers a 0.7% hike in loan interest – big money.  Others offered thoughtful comments on paths forward.  Mohamed El-Erian notes that US debt needs “de-levering” but unlike Europe, we have no liquidity problem.  In his Aug 1 post, he says we need to remove impediments to sustained economic activity — including the functioning of the housing and labor markets, better worker retooling and retraining, enhanced education systems, more bank lending, and improved infrastructure.  We could inflate our way out of debt or reduce it through years of financial repression (as the Federal Reserve is already doing), but ultimately, we will be forced into austerity involving both spending and tax measures.   

 

American consumers face a rough period.  We need to ignore the political stylists and reign in the fashion tastes of spendthrift politicians using the public’s credit card.

 

Alan Daley is a retired businessman living in Florida.  He follows public policy issues from the consumer’s perspective

 

 

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