Why should we care about the S&P downgrade? Some will say (and already have said) we should not care and for a lot of a good reasons. But none of those reasons change the fact that this is has been the number one story this weekend and will likely continue to be a top story throughout the week. The downgrade is important for the same reason Paris Hilton is famous, simply because she is (and somehow the similarities between the two don’t end there).
Many of those who will be criticizing the downgrade, and the S&P, will surely mention the 2 trillion-dollar mistake in their initial press release. One would assume that this would be a major hit to their credibility, but it isn’t really. Their credibility was damaged so much by their hand in the collapse of the mortgage market that there isn’t much left to damage. But this gives anyone who wants to be critical of the S&P downgrade yet another great talking point with which to disarm any notion that we should be taking a downgrade seriously. However, the mistake is irrelevant when it comes to the validity of the arguments made by the S&P about our fiscal situation. Without getting to deep into the weeds, the mistake was in how they calculated the baseline growth of the nation’s GDP. This changed some of their numbers, but as Kurgman points out – it’s a small amount in the grand scheme of these sorts of calculations.
The reason we should be taking the downgrade seriously actually has nothing to do with our credit worthiness. The economics of this are clear. The United States has no credit rating problem. We can rely on inflation (printing money) to take care of any debts. It is not a preferred option, but it works. So, let’s all get on the same page: The United States never has to default on any debt obligation ever. Our credit rating can never really be downgraded in real market terms as long as we remain as the world reserve currency. Despite the insistence of China, I have not heard anyone say that the position of the dollar as the reserve currency is at all at risk. As Warren Buffet said, in a way only he can, the United States should have a AAAA rating. Anything less simply doesn’t make sense if we’re actually talking about the credit worthiness of the United States. Hence the widespread confusion about the downgrade. While I partially surrender to that confusion, the rating included a very accurate portrayal of United State’s very big, and real, long-term fiscal problems. Most of their criticism is very difficult to argue against, and it’s a very public third-party (with no readily apparent self-interested motivation) declaration of disorder by people whom are taken seriously by a lot of other people. Even if you want to argue that they shouldn’t be taken seriously, the inherent impact of this kind of development is here to stay.
Firstly, this is a damn embarrassment to the United States and it’s probably going to hurt the markets on Monday. The downgrade is inherently important because of what it communicates to the world. This is a very big neon sign of further uncertainty in our markets, further economic degradation, and a continuation of market volatility. This is also scathing critique of the operation of the United States government (not dissimilar to my own). They are extremely pessimistic about the government’s ability to address our long-term debt problems, our economic growth problems, and the hardline political brinksmanship that was required to get even a very unsatisfactory compromise passed. Unfortunately I think their analysis is right, even if it does not justify lowering the rating. In any event, this is going to be the first and only thing on everyone’s mind – especially if you are an investor. If the markets do not go crazy in the next two days I will be shocked. We are in completely uncharted territory, and if I was heavily invested in the New York Stock Exchange I would be terrified by what’s going to happen after the opening bell rings tomorrow morning.
The downgrade is also important as a political event. Legislators, and the president in particular, are going to have to try to explain away this very negative development. They can try to discredit the S&P but people won’t listen. It should also impact the legislative agenda, but how is not clear yet. I suspect that most legislators will publicly agree that there is a debt problem, but once again we will fail to take any meaningful action. Tea Party folk will be energized by this and probably gain even more political steam. Getting the US back to a AAA credit rating will be one of the biggest talking points of the coming year, it is likely to be a conversation fraught with pseudo economics and frighteningly horrible ideas. But I could just be overly pessimistic.
(I hate how everyone is calling this a “wake-up call.” We’ve had innumerable amount of calls in the last decade. Are we hung over? We should be awake. The front desk is sick of giving us calls.)
Read more posts like this on my blog, Bootleg Insight.