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Downgrade, Default, and the Messy Economic Situation

12:00 AM, Apr 23, 2011 • By IRWIN M. STELZER
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So the sovereign debt of the American government has been downgraded. Not last week by Standard & Poor’s, which merely put it on negative watch. But last November, by Dagong, China’s rating agency, which down-rated it from AA (its highest rating) to A+, and rated its outlook “negative.” Of course, the folks at Dagong had special reasons of their own: The Chinese regime, sitting on $1.2 trillion of U.S. government IOUs, wants to warn that it might stop buying Treasuries if we threaten to pay our debts in depreciated dollars.

Federal Reserve

But the Chinese regime also used the occasion to take a few swipes at “the serious defects in the US economic and development management model”—those inherent contradictions of capitalism that so disturbed Karl Marx—and to argue that America’s problems cannot be solved by a move by their agreement to allow the renminbi to rise from the undervalued level at which they have been maintaining it—a policy they are reviewing since it is contributing to the inflation that is causing the regime such difficulties.

Not that S&P was acting out of some sudden flashing of a danger signal by its economic model, if it has one. The rating agencies have been widely criticized for lavishing AAA ratings on securities backed by subprime mortgages, and missing the fact that Greece’s fiscal condition is more than a little different from Germany’s. So here was a chance to issue a warning: If it proved prescient, if the president and the Congress could not bring the deficit under control, the S&P raters could indulge in a “we warned you.” And if the politicians do finally move to rein in the Obama deficits, they can say, “We frightened them into action.” Win-win for the agency, which also avoids another charge of sleeping at the switch should things turn ugly on the deficit scene.

There is, of course, no possibility that we will default on our debt, as that term is generally understood. But there is a real possibility that we will pay our creditors back in trillions of newly printed dollars of shrunken value. After all, in the face of a deficit that clocks in at or close to double digits, President Obama submitted a budget for next year that actually increased spending and the deficit. Now a born again deficit cutter, he has since abandoned his own budget. No surprise: his reading of the political tea leaves tells him the voters want the deficit brought under control, although they are quite uncertain just how they want that done. A new poll shows that 44 percent of all voters definitely intend to vote against the president next year, 37 percent say they definitely will vote for him, and 18 percent are undecided. In a head-to-head poll with Mitt Romney, generally regarded as the most plausible Republican candidate—even though The Donald trumps him in polls of Republican voters—Obama’s 15-point lead in January has shriveled to a single percentage point.

So the president, now on a national tour to raise the $1 billion he says he needs to finance his reelection campaign—a trifle when you consider that we will spend twice that much on candy this Easter season. And he is promising to bring the deficit under control largely by taxing the rich, sometimes referred to as “millionaires and billionaires.” Unfortunately, there aren’t enough of those to make a dent in the deficit even if they are hit with a 100 percent tax rate. Meanwhile, the Paul Ryan-led Republicans say they will close the budget gap by converting Medicare, the government health care plan, into a subsidized insurance-cum-voucher system for future entrants into the system, a truly sensible proposal, but too easily demagogued to be counted on to win voter enthusiasm.

Squabbling notwithstanding, we are on track to a quasi-resolution in the next month or so. The government will soon hit the legal limit of its borrowing power, and it will take a congressional vote to allow it to borrow more. Otherwise, we will default after a few budgetary tricks to conceal our inability to pay our bills and the interest on our massive debt, which is now estimated by the International Monetary Fund to be “worse than some troubled European countries.” Obama, who when in the Senate voted against lifting the then much lower debt ceiling because that would demonstrate an absence of “leadership,” now wants the ceiling raised, no strings attached. The Republicans are busily attaching strings to their vote to raise the ceiling, and Treasury secretary Tim Geithner and Vice President Joe Biden are shuttling back and forth from the Hill to the White House to fashion a compromise. Which they will: neither party wants to be tagged with the label of defaulter in chief.

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