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August 8, 2011

U.S. Debt Downgraded, Now What? (Guest Posts)

By Ilene

On Friday, August 5, Standard and Poor’s downgraded U.S. debt from AAA to AA+, and assigned a negative outlook to U.S. debt. In its press release, S&P directly addressed the contentious squabbling on Capitol Hill, and the clumsy spectacle of Obama, Boehner and the upstart Tea Party faction of the Republican party wrangling over the raising of the debt ceiling, a process that had previously been routinely approved as a matter of course.

Bruce Krasting asked and answered,
“What to make of the move by S&P? I will tell you that I was surprised that it happened this weekend. I expected that S&P would have given the US till November to sort things out. From the news reports, it appears that the White House and Treasury were equally unprepared for this to happen now. Some thoughts:

“It looks as if the US is going to have a split rating. (AAA {equivalent} by Fitch/Moody’s, and AA+ by S&P.) If this were a high-grade corporate credit, the split rating status would make no difference in how the underlying bonds trade. I doubt that the S&P action will have a different (lasting) consequence.”
China is the largest holder of U.S. debt, and the S&P’s downgrade presented an opportunity for the Chinese government to sharply admonish the U.S. government through the state-run Xinhua News Agency:
“The U.S. government has to come to term with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone... China, the largest creditor of the world’s sole superpower, has every right now to demand the United States to address its structural debt problems and ensure the safety of China’s Dollar assets.”
Xinhua suggested that the U.S. slash its “gigantic military expenditure and bloated social welfare costs” and accept international supervision over U.S. Dollar issues.

Theoretically, the downgrade might make U.S. debt less attractive to the rest of the world, and might cause China to stop buying so much of it. However, Michael Pettis, finance professor at Peking University’s Guanghua School of Management, argues that this is very unlikely.
“Is the PBoC going to stop buying USG bonds?  ...if the US defaults, it will be mainly a technical default that will certainly be made good one way or the other. Since the PBoC doesn’t have to worry about mark-to-market losses, unlike mutual funds, I think for China this is largely an economic nonevent.
"Remember that the PBoC does not purchase huge amounts of USG bonds because it has a lot of money lying around and doesn’t know what to do with it. Its purchase of USG bonds is simply a function of its trade policy.”
In examining the S&P's move, it's natural to wonder about its motives - politics, money, or just a desire to (finally) do the right thing? A separate question is whether the U.S. deserves an AAA rating or not. Those who find fault with the S&P's downgrade, should consider that second question as well.

Lee Adler of the Wall Street Examiner discussed the overall health of the economy, as measured uniquely in food stamps.
“Total food stamp recipients rose by 1.1 million in May. That represented a dramatic acceleration from the recent rate. Enough QE2 had trickled down from December to April to slow the growth rate of people entering the program to about 100,000 per month. The last time we saw an acceleration of this magnitude was in September 2008. That was at the beginning of the 2008 crash in the stock market and economy.

“This rise in food stamp use,...... [and] a sharp drop in government withholding tax receipts in May, suggesting the return of the recession that had been hidden by the government’s propping of the markets and economy. I had repeatedly warned that it appeared that the economy had suddenly gone into free fall beginning in May. This data on the food stamp program tends to confirm that.”  (See chart below, note the number of people on food stamps is inverted.)

[Note:  This is an edited version by EconMatters from author's original post]

Related Reading:
U.S. Should Downgrade S&P
A U.S. Sovereign Credit Downgrade Is No Laughing Matter

About The Author - Ilene is the editor and affiliate director at Phil's Stock World with a fascination with the markets.  She also maintains a blog at Phil's Favorites.  (EconMatters author archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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