On the S&P Downgrade

The decision by Standard & Poor’s to downgrade U.S. government debt reflects its own failings as a credit rating agency.  It says nothing about the creditworthiness of the U.S. government.

The Treasury Department revealed that S&P’s decision was initially based on a $2 trillion error in accounting.  However, even after this enormous error was corrected, S&P went ahead with the downgrade.  This suggests that S&P had made the decision to downgrade independent of the evidence.

It would be difficult to find any basis for questioning whether the United States will be able to repay its debt.  With investors willing to hold trillions of dollars in long-term U.S. debt at interest rates well below 3.0 percent, the financial markets certainly do not seem to share S&P’s concern.  It is also noteworthy that interest rates fell in the wake of S&P’s decision, providing further evidence that the markets do not take S&P’s assessment seriously.

It is also striking that the downgrade comes in the wake of an agreement that would actually lower the country’s projected debt burden.  If S&P was actually looking at the prospects for the U.S. debt it seems that the more obvious point at which to have made the downgrade would have been last December when Congress and the president agreed to extend the Bush tax cuts.  It is difficult to understand how a decision to increase indebtedness does not lead to a downgrade, while a decision eight months later to reduce indebtedness does.

The country’s long-term budget projections do show excessive deficits.  However these are driven in large part by projections of explosive growth in private sector health care costs.  The Congressional Budget Office’s projections imply that in 2030 the cost of providing care in the private sector for an 85-year old will be more than $40,000 a year (in 2011 dollars).  Health care costs of this size would impose a crushing burden on the economy regardless of how they are divided between the public and private sector.  Remarkably, S&P never mentioned health care costs as a concern in its lengthy downgrade statement.

Of course, since U.S. debt is payable in dollars, and the U.S. government controls the printing of dollars, it is not clear what a downgrade could even mean.  As long as the U.S. government knows how to print dollars, it will always be able to make the interest and principal payments on its debt.

Clearly the S&P downgrade was not based on the economics of the country’s debt.  S&P has a horrible track record of incompetence in the housing bubble years — they gave Lehman Bros. AAA rating just before its collapse — and the accounting scandals of the stock bubble years.  This downgrade should be seen in this light.  It is not a serious assessment of the nation’s fiscal condition.

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C.  He is the author of several books, including False Profits: Recovering from the Bubble Economy.  The statement above was issued by CEPR on 8 August 2011.  Cf. “It’s apparently hard to get economic news at the Washington Post.  How else can one explain the fact that it explains the movement of markets over the weekend only in reference to S&P’s downgrade of U.S. debt and completely ignores the debt crisis in Europe that could lead to the collapse of the euro?  The latter threatens the same sort of freeze up of the financial system that we saw in the wake of the Lehman bankruptcy.  It is likely that markets were more concerned about this prospect than the downgrade by one of the three major credit rating agencies. . . .  It also would have been worth noting that S&P’s downgrade of Japan’s debt in 2002 had no noticeable impact on Japanese interest rates.  The government can still borrow long-term at interest rates just over 1.0 percent. . . .  [N]o one believes that Japan is anywhere close to defaulting on its debt.  And, because of the deflation over this period, bondholders are getting repaid in yen that are worth more than the yen they lent” (Dean Baker, “No One Told the Post about the Euro Zone Crisis,” Beat the Press, 8 August 2011).

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