America downgraded to AA+ for the first time in history. What happens next?
Americans are waking up to some unpleasant news this Saturday morning, we have been downgraded. Indeed, for the first time since 1917 Standard & Poor's has lowered our credit rating from AAA to AA+ (full text). Their outlook is negative, meaning that we could be lowered to AA if our situation worsens.
"If the US Government was a family, they would be making $58,000 a year, they spend $75,000 a year, & are $327,000 in credit card debt. They are currently proposing BIG spending cuts to reduce their spending to $72,000 a year. These are the actual proportions of the federal budget & debt, reduced to a level that we can understand."
Now imagine that this family suddenly gets labeled a deadbeat and unreliable. Where is the shock? Both political parties are completely ineffective at grasping and handling the seriousness of our financial situation, perhaps this will serve as a gentle reminder. (Quote comes from Dave Ramsey)
Point #2: S&P finds that the amount our Government spends is too excessive and highlights Social Security, Medicare and Medicaid as the primary culprits. Did you hear that? A liberal's head just exploded. In case you think that S&P is full of hot air, perhaps a visual aid?
In other words, what S&P is saying has already been known to us for quite some time. In fact the fiscal conservatives have been beating the drums on this for quite a while and why should this be a shock to anyone is really beyond me. It is also worth noting that the full text singles out Medicare which as you can tell by the chart is the biggest spender of them all.
So what happens next?
Now that we have accepted that this downgrade is deserved we can either start the blame game or determine what will transpire. ABC has already listed their five possible outcomes this morning, let us take a look.
ABC: The interest rates the government pays to finance the growing national debt will almost certainly rise as a result of the downgrade up to $75 billion in additional costs in the coming years.
ME: That is true and frankly much deserved. Due to the intervention by the Federal Reserve through QE2 and other mechanisms our treasury bonds have been artificially lowered. This was done to spur borrowing (which failed), but has also kept our debt payments very low. This had the effect of sidelining the issue of debt service because 200 Billion dollars annually for a country that makes 2.2 Trillion was not a big deal. These costs will rise and they have to rise. If rates rise sufficiently the debt service alone will start to eclipse every single other spending program. This really underscores how stupid and ineffective our Congress really is, because they have failed to address this critical issue.
ABC: The interest rates YOU and YOUR EMPLOYER pay will go up. Costs for borrowed money goes up, effectively raising the price of anything you're not paying for with cash.
ME: While the first point is guaranteed there is no guarantee here. Sure, most loans are tied to what happens on the bond market, but not directly so. Remember, one of the biggest problems that the Federal Reserve tried to overcome was the issue of banks refusing to borrow. By outright purchases of treasuries Bernanke hoped to lower rates and spur borrowing. Theoretically he achieved his desire although many argue that American bonds rose due to Europe and the rest of the world posing a greater risk that America. Regardless of the reason the lower rates did not materially improve lending because the economy was unable to absorb any additional borrowing. This critical point underpins the primary difference between the failed Keynesian policies of the Obama administration and the Austrian economic principles of people like Ron Paul, Rand Paul, Justin Amash and other minority voices of dissent.
ABC: Needless to say, increasing costs for consumers and businesses tends to slow their economic activity. Some estimates put a downgrade like this as likely to shave 1 percent off GDP. This slowing certainly increases the risks that the U.S. will have a second dip into recession. It also means less tax revenue, so the potential for additional debt increases.
ME: This is propaganda and fear-mongering using misdirection. It is true that higher rates could expedite the contraction of the economy, but it is also quite true that this contraction was coming anyway. The Dow Jones dropped 500 points last week, manufacturing slowed and unemployment suggested that our participation labor rates are lowest since 1984 - all of this happened before the downgrade. In fact, desperate voices in the media have already been requesting additional intervention from the Federal Reserve for weeks now because our economy *still* has not done the one thing it needed to do since 2008. To properly contract and purge the bad debt out of the system. Everything that Bernanke and Obama and now Boehner have done is to simply kick the can down the road by papering over losses. Sorry, this ponzi scheme cannot be sustained.
ABC: As the economy slows, expect the stock market to react. After all, investors buy shares to get a piece of growing profits. A slowing economy means profits grow less rapidly or go down. The relative value of a share of anything will go down. Some experts predict a downgrade could force stocks to sell-off by 6 percent to 10 percent in short order. That's another 1,100 points on the Dow.
ME: Recessions a.k.a. contractions cause the stock markets to decline, as discussed previously this was coming anyway. Nothing to do with the downgrade, everything to do with the years and years of reckless spending.
ABC: A slowdown in economic activity also means less demand for workers. The non-partisan group Third Way has published estimates that a simple 0.5 percent increase in interest rates could erase more than 640,000 jobs.
ME: Once again, ABC likes to engage in blame games instead of accepting reality. Recessions cause unemployment because economic contractions force bloated companies to downsize and lay people off, nothing to do with credit ratings. It will be very unfortunate if unemployment ticks up in a few months and the likes of ABC will blame it on the downgrade instead of the actual culprit - excessive spending.
Last Thoughts
I do not view this downgrade in a negative light and either should you. Consider what happened as a reminder of our failed policies and be grateful that at least some third party agencies (regardless of their previous mistakes) is now starting to sound the alarm. Although the alarm has been ringing by people like myself and many other more notable individuals the country has been asleep at the wheel. We did notice a resurgence in political activity in 2010 when many Tea Party individuals were sent to Congress, but the latest polls suggest that many Americans still do not 'get it'.
Polls are suggesting that Americans are confused as to what the best approach is in terms of solving our mounting debt, although they are reluctant to raise taxes they are equally reluctant to cut Medicare or Medicaid. People essentially are acknowledging the problem, but are refusing to let go of what they perceive to be their entitled share. Yet as you saw on the chart, leaving Medicare and Medicaid as-is cannot be. Truth is, spending almost a trillion on defense (2010) is hardly sustainable either, but really it goes beyond the numbers.
What we see on paper is the total Government revenues and expenditures, that is we see red ink. This red ink or the deficit is dubbed as the pressing issue, which it certainly is, but Government spending is far more sinister than just the deficit it creates. In fact you can significantly mitigate the deficit by confiscating more and more private wealth (until it runs out), but that does not solve the other looming issue. That is, Government spending creates massive distortions and damage to prices!
When I scream for cuts the screaming is not so much a desire to reduce deficits, but to return to real prices. If you look at every major Government program intervention you will find price distortions that spill out in the market causing damage to everyday working class Americans. This is what we must eliminate and this is what will finally create jobs, bring about capital formation and lower costs for *everything*. Some simple examples:
1965: Medicare/Medicaid enacted. Health care costs spiral out of control bringing about the HMO act, rise of crappy health insurance companies and mounting health care costs. Eventually leads to RomneyCare and ObamaCare. Massachusetts over the past several years has experiences the biggest price increase of any other states, unless ObamaCare is repealed prices will rise everywhere.
1979: Department of Education formed. Billions directed to education through federal programs creating layers of bureaucratic nonsense that were never needed in the first place. Expenses on education have risen every year until today and yet the results are standard with America showing lackluster results compared to every other modern country. Grants, loans and federal aid increased causing massive tuition hikes across the entire country resulting in a college tuition bubble. What once used to be affordable through simple budgeting and saving has become either an impossible dream for most or financial slavery.
1930s: FDR's legacy lives through his intervention in the housing markets with the creation of agencies that ultimately turned into Fannie and Freddie. For decades the US Government has intervened in guaranteeing, underwriting and directly providing paths toward home ownership. Whether it is Reagan's mortgage deduction credit or Clinton's CRA - our Government has spent money to encourage ownership. Result? Housing in some areas is completely and utterly not affordable and for many has turned into a disaster after the 2008 Housing crisis.
While there are plenty more examples the theme remains the same among those who fundamentally believe that the role of Government lies in protecting us and preserving our rights and freedom. As soon as those principles are abandoned and the chains of the Constitution are unshackled the path towards ruin begins. Whether it is Rome, Byzantine or Babylon the end result is the same. Perhaps this little warning shot will be all that is needed to drastically change course and embark on a journey of financial repair and responsibility.
We can only hope.
The reaction on the Internet seems to be one of shock and fear, but neither reactions are appropriate. Lets first examine some of the key points of the text to find out what S&P lists as their primary reason for this particular action.
The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics.
...and...
We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process. We also believe that the fiscal consolidation plan that Congress and the Administration agreed to this week falls short of the amount that we believe is necessary to stabilize the general government debt burden by the middle of the decade.Point #1: S&P finds the latest "debt deal" insufficient. To whom is this really a big surprise? Step back and consider the situation in pure numbers. Our annual deficit is 1.5 Trillion. The deal achieves to 'not spend' an extra 200 Billion a year. Most of the 'not spending' is done at a later time with a future Congress that may or may not pursue those plans. I use the term 'not spend' because no actual cuts were performed. Congress simply agreed to roll back some of the projected spending. It is insulting. Here is another beautiful example in terms that are easier to digest:
"If the US Government was a family, they would be making $58,000 a year, they spend $75,000 a year, & are $327,000 in credit card debt. They are currently proposing BIG spending cuts to reduce their spending to $72,000 a year. These are the actual proportions of the federal budget & debt, reduced to a level that we can understand."
Now imagine that this family suddenly gets labeled a deadbeat and unreliable. Where is the shock? Both political parties are completely ineffective at grasping and handling the seriousness of our financial situation, perhaps this will serve as a gentle reminder. (Quote comes from Dave Ramsey)
Point #2: S&P finds that the amount our Government spends is too excessive and highlights Social Security, Medicare and Medicaid as the primary culprits. Did you hear that? A liberal's head just exploded. In case you think that S&P is full of hot air, perhaps a visual aid?
So what happens next?
Now that we have accepted that this downgrade is deserved we can either start the blame game or determine what will transpire. ABC has already listed their five possible outcomes this morning, let us take a look.
ABC: The interest rates the government pays to finance the growing national debt will almost certainly rise as a result of the downgrade up to $75 billion in additional costs in the coming years.
ME: That is true and frankly much deserved. Due to the intervention by the Federal Reserve through QE2 and other mechanisms our treasury bonds have been artificially lowered. This was done to spur borrowing (which failed), but has also kept our debt payments very low. This had the effect of sidelining the issue of debt service because 200 Billion dollars annually for a country that makes 2.2 Trillion was not a big deal. These costs will rise and they have to rise. If rates rise sufficiently the debt service alone will start to eclipse every single other spending program. This really underscores how stupid and ineffective our Congress really is, because they have failed to address this critical issue.
ABC: The interest rates YOU and YOUR EMPLOYER pay will go up. Costs for borrowed money goes up, effectively raising the price of anything you're not paying for with cash.
ME: While the first point is guaranteed there is no guarantee here. Sure, most loans are tied to what happens on the bond market, but not directly so. Remember, one of the biggest problems that the Federal Reserve tried to overcome was the issue of banks refusing to borrow. By outright purchases of treasuries Bernanke hoped to lower rates and spur borrowing. Theoretically he achieved his desire although many argue that American bonds rose due to Europe and the rest of the world posing a greater risk that America. Regardless of the reason the lower rates did not materially improve lending because the economy was unable to absorb any additional borrowing. This critical point underpins the primary difference between the failed Keynesian policies of the Obama administration and the Austrian economic principles of people like Ron Paul, Rand Paul, Justin Amash and other minority voices of dissent.
ABC: Needless to say, increasing costs for consumers and businesses tends to slow their economic activity. Some estimates put a downgrade like this as likely to shave 1 percent off GDP. This slowing certainly increases the risks that the U.S. will have a second dip into recession. It also means less tax revenue, so the potential for additional debt increases.
ME: This is propaganda and fear-mongering using misdirection. It is true that higher rates could expedite the contraction of the economy, but it is also quite true that this contraction was coming anyway. The Dow Jones dropped 500 points last week, manufacturing slowed and unemployment suggested that our participation labor rates are lowest since 1984 - all of this happened before the downgrade. In fact, desperate voices in the media have already been requesting additional intervention from the Federal Reserve for weeks now because our economy *still* has not done the one thing it needed to do since 2008. To properly contract and purge the bad debt out of the system. Everything that Bernanke and Obama and now Boehner have done is to simply kick the can down the road by papering over losses. Sorry, this ponzi scheme cannot be sustained.
ABC: As the economy slows, expect the stock market to react. After all, investors buy shares to get a piece of growing profits. A slowing economy means profits grow less rapidly or go down. The relative value of a share of anything will go down. Some experts predict a downgrade could force stocks to sell-off by 6 percent to 10 percent in short order. That's another 1,100 points on the Dow.
ME: Recessions a.k.a. contractions cause the stock markets to decline, as discussed previously this was coming anyway. Nothing to do with the downgrade, everything to do with the years and years of reckless spending.
ABC: A slowdown in economic activity also means less demand for workers. The non-partisan group Third Way has published estimates that a simple 0.5 percent increase in interest rates could erase more than 640,000 jobs.
ME: Once again, ABC likes to engage in blame games instead of accepting reality. Recessions cause unemployment because economic contractions force bloated companies to downsize and lay people off, nothing to do with credit ratings. It will be very unfortunate if unemployment ticks up in a few months and the likes of ABC will blame it on the downgrade instead of the actual culprit - excessive spending.
Last Thoughts
I do not view this downgrade in a negative light and either should you. Consider what happened as a reminder of our failed policies and be grateful that at least some third party agencies (regardless of their previous mistakes) is now starting to sound the alarm. Although the alarm has been ringing by people like myself and many other more notable individuals the country has been asleep at the wheel. We did notice a resurgence in political activity in 2010 when many Tea Party individuals were sent to Congress, but the latest polls suggest that many Americans still do not 'get it'.
Polls are suggesting that Americans are confused as to what the best approach is in terms of solving our mounting debt, although they are reluctant to raise taxes they are equally reluctant to cut Medicare or Medicaid. People essentially are acknowledging the problem, but are refusing to let go of what they perceive to be their entitled share. Yet as you saw on the chart, leaving Medicare and Medicaid as-is cannot be. Truth is, spending almost a trillion on defense (2010) is hardly sustainable either, but really it goes beyond the numbers.
What we see on paper is the total Government revenues and expenditures, that is we see red ink. This red ink or the deficit is dubbed as the pressing issue, which it certainly is, but Government spending is far more sinister than just the deficit it creates. In fact you can significantly mitigate the deficit by confiscating more and more private wealth (until it runs out), but that does not solve the other looming issue. That is, Government spending creates massive distortions and damage to prices!
When I scream for cuts the screaming is not so much a desire to reduce deficits, but to return to real prices. If you look at every major Government program intervention you will find price distortions that spill out in the market causing damage to everyday working class Americans. This is what we must eliminate and this is what will finally create jobs, bring about capital formation and lower costs for *everything*. Some simple examples:
1965: Medicare/Medicaid enacted. Health care costs spiral out of control bringing about the HMO act, rise of crappy health insurance companies and mounting health care costs. Eventually leads to RomneyCare and ObamaCare. Massachusetts over the past several years has experiences the biggest price increase of any other states, unless ObamaCare is repealed prices will rise everywhere.
1979: Department of Education formed. Billions directed to education through federal programs creating layers of bureaucratic nonsense that were never needed in the first place. Expenses on education have risen every year until today and yet the results are standard with America showing lackluster results compared to every other modern country. Grants, loans and federal aid increased causing massive tuition hikes across the entire country resulting in a college tuition bubble. What once used to be affordable through simple budgeting and saving has become either an impossible dream for most or financial slavery.
1930s: FDR's legacy lives through his intervention in the housing markets with the creation of agencies that ultimately turned into Fannie and Freddie. For decades the US Government has intervened in guaranteeing, underwriting and directly providing paths toward home ownership. Whether it is Reagan's mortgage deduction credit or Clinton's CRA - our Government has spent money to encourage ownership. Result? Housing in some areas is completely and utterly not affordable and for many has turned into a disaster after the 2008 Housing crisis.
While there are plenty more examples the theme remains the same among those who fundamentally believe that the role of Government lies in protecting us and preserving our rights and freedom. As soon as those principles are abandoned and the chains of the Constitution are unshackled the path towards ruin begins. Whether it is Rome, Byzantine or Babylon the end result is the same. Perhaps this little warning shot will be all that is needed to drastically change course and embark on a journey of financial repair and responsibility.
We can only hope.
Comments
Post a Comment