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Posts Tagged ‘Standard & Poors’

Long-Term Downgrade for a Short-Term “Problem”?

In Debt Ceiling, Economy, Federal Deficit, Standard & Poor's USA Downgrade on August 9, 2011 at 11:56 pm

Eugene Robinson happens to be one of my favorite liberal columnists because he writes with flair and tends to be ideologically consistent.  Whereas many writers are predictably partisan hacks, Mr. Robinson is willing to take on President Obama and the Democrat Party when he believes they are wrong. 

I take exception, however, with two points in today’s column. [1]   

Mr. Robinson says the downgrade has Republican “footprints” because he thinks S&P is afraid the GOP will force a default.  He says, “This isn’t the rationale that S&P gave, but it’s the only one that makes sense”.  Many on the Left are trying to blame the downgrade not on the party in power but on Republicans (see: https://econscius.wordpress.com/2011/08/07/jay-carneys-4-trillion-lie/).  Never mind S&P’s own words about the growing debt or their repeated warnings in recent years, warnings issued before there even was a Tea Party (see https://econscius.wordpress.com/2011/07/28/us-aaa-credit-rating-downgrade-was-expected/).

If Mr. Robinson believes S&P based – or should have based – its decision not on the growing US debt but on a near-term Republican “threat” to default, then why downgrade the long-term debt to “AA+” and keep the short-term debt at “AAA”?  Isn’t it the shorter term debt supposedly at risk of Eric Cantor?  Why worry about the 30 year T-bond and not the one year T-bill?  Mr. Robinson quotes S&P, “A new political consensus might (or might not) emerge after the 2012 elections.”  True; so why worry more about who will be in Congress 20 or 30 years from now?  

We do not know how fast the deficit will grow; we might bump up against the Debt Ceiling faster than expected, possibly before the 2012 elections if the economy dips into another recession.  Many financial commentators are predicting a new recession. [2] [3]   S&P specifically says, “we believe [the Debt Ceiling] act provides sufficient clarity to allow us to evaluate the likely course of US fiscal policy for the next few years.” [4]   The short-term “AAA” rating was affirmed even with John Boehner on the loose in the Capitol?  Wow.

Secondly, Mr. Robinson disputes the merit of any downgrade, saying:

“There is no plausible scenario under which the United States would be unable to service its debt. If political gridlock were to persist, our government would be able to pay bondholders with a combination of tax revenues and funds raised by selling more Treasury bills. And in the final analysis, as Alan Greenspan noted Sunday on “Meet the Press,” the United States “can pay any debt it has because we can always print money to do that.” [1]

Yes, it is true the US can pay bonds out of current tax receipts or just “print money”. [5]  But there is a massive risk to printing money.  Firing up the government printing press debases the currency a la Weimar Germany.  

Running the printing press would be a short-term solution.  US government debt is a series of hundreds of outstanding debt issues.  Approximately every week, a series of Treasury debt matures and needs to be replaced with a new issue.  Treasury bills mature in less than one year. [6]  As of 7/31/11, the public held $1.5 Trillion of T-bills. [7]  All mature in the next 12 months and needs to be rolled over into new Treasury debts.  Other, older series of Treasury notes and long-term Treasury bonds mature regularly throughout each year, too.  For example, 30 year Treasury bonds issued in fall 1981 mature in coming months. 

If the US government decided to inflate away debt obligations by printing money, the US Dollar would decline in value.   That would lose investor confidence.  This would precipitate a crisis:  investors would soon enough refuse to buy new issues of Treasury debt at anything like current low rates, if at all.  Imagine yourself as China, lending to the US in the expectation of receiving US Dollars for your debt upon maturity.  If your interest and principal started being paid with rapidly depreciating Dollars created out of thin air, would you want to keep lending?  You’d demand higher interest rates, if you lent at all.  Alternatively, you might be willing to lend, but only in bonds denominated in Chinese Yuan.  You know the US government cannot inflate the Yuan, because the US printing press cannot print Yuan.  Amusing as it would be, I cannot picture Timothy Geithner changing out the US Mint’s printing blocks with Chinese characters.

Running the printing press is not a feasible bond payment option. 

[1] http://www.realclearpolitics.com/articles/2011/08/09/a_downgrades_gop_fingerprints_110861.html

[2] http://www.marketwatch.com/story/get-ready-for-great-recession-20-2011-08-08?link=home_carousel

[3] http://www.marketwatch.com/story/how-to-brace-your-portfolio-for-another-recession-2011-08-05?link=kiosk

[4] http://www.standardandpoors.com/servlet/BlobServer?blobheadername3=MDT-Type&blobcol=urldata&blobtable=MungoBlobs&blobheadervalue2=inline%3B+filename%3DUS_Downgraded_AA%2B.pdf&blobheadername2=Content-Disposition&blobheadervalue1=application%2Fpdf&blobkey=id&blobheadername1=content-type&blobwhere=1243942957443&blobheadervalue3=UTF-8

[5] Note that Mr. Robinson is actually stating one reason a “default” was unlikely no matter what happened in the recent Debt Ceiling controversy:  the government could have paid bond interest first out of tax revenues.  

[6] T-bills mature in less than one year.  Notes mature in 1-10 years and T-bonds mature in more than 10 years.

[7] http://www.treasurydirect.gov/govt/reports/pd/mspd/2011/opds072011.pdf

Picture from Wikipedia commons.

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Paul Krugman, Can You Spare the Chutzpah?

In American Recovery & Reinvestment Act (Stimulus), Federal Deficit, Government Spending, Obama Administration, Standard & Poor's USA Downgrade on August 8, 2011 at 9:42 pm

Paul Krugman today mocks Standard & Poor’s downgrade of the United States credit rating and accesses blame for the rating cut. [1]   Mr. Krugman says, “And please, let’s not have the usual declarations that both sides are at fault.  Our problems are almost entirely one-sided.” 

I held my breath a moment… wouldn’t this be the perfect place for Mr. Krugman to own up to his long advocacy of even larger deficit spending?  Alas, there’s no humility from Mr. Krugman, only chutzpah. [2]

Mr. Krugman predictably blames the “extremist right” and goes about making light of S&P.  Apparently it was the “extremist right” that demanded a trillion-dollar Stimulus program, Obama’s payroll tax cuts and the creation and continuous expansion of myriad other government spending programs the past 70 years?  Even the most cursory look at the history of the Public Debt shows neither party is blameless, but Mr. Krugman is too partisan.

Be that as it may, it is true S&P was too generous with ratings in the run-up to the financial crisis of 2008 and there is an argument S&P was late to drop the USA’s rating in 2011.  But Mr. Krugman shows chutzpah in making light of the rating drop to “AA-“.  I assume Mr. Krugman understands what rating systems are all about.  The top rating of “AAA” is intended for only the most pristine credits.  “AA+” is a good rating, just not as good as “AAA”.  The USA would have to drop another nine notches to “BB+” to be in speculative (so-called “junk”) territory.  The ratings scale works down to “C” and “D” (default).   Any honest person will admit the financial position of the United States has weakened and the country is not as creditworthy as it once was.  An “AA+” credit is still expected to repay the debt but is a bit riskier than an “AAA” credit.

Mr. Krugman is intelligent but occasionally careless.  Consider his statement: “It’s true that we’re building up debt, on which we’ll eventually have to pay interest.”  Eventually?  While rates are low today, we are paying plenty of interest.   US government interest expense was $414 billion in Fiscal 2010. [3]  Then again, this is the same Paul Krugman who also writes of “a trillion here or a trillion there” like a trillion is inconsequential.  In the rarefied spending air of a massive deficit advocate like Mr. Krugman, perhaps $414 billion is hardly anything at all.  After all, it rounds down to $0 Trillion.

Mr. Krugman said the 2009 Stimulus program was too small and he actually criticized the Obama Administration for its supposedly punctilious policies.  In his own words:

“The good news is that the American Recovery and Reinvestment Act, a k a the Obama stimulus plan, is working just about the way textbook macroeconomics said it would …  The truth, which is that the stimulus was too little of a good thing.” [4]

“it was obvious from the beginning [Obama’s Stimulus] was too small.” [5]

“Those of us who say that the stimulus was too small are often accused of after-the-fact rationalization: you said this would work, but now that it hasn’t, you’re just saying it wasn’t big enough. The quick answer to that accusation is that people like me said that the stimulus was too small in advance” [6]

“myself included, actually argued that the plan was too small and too cautious …. for the inadequate size of the stimulus plan” [7]

“[the Obama Stimulus] wouldn’t have been enough to fill the looming hole in the U.S. economy” [8]

Mr. Krugman got less deficit “Stimulus” spending than he had demanded, meaning he favored even greater debts than we actually have now.  But he has the chutzpah to ignore his own culpability and instead blames the messenger (S&P) and then blames the downgrade on, of all people, the Tea Party Republicans!  This is the same Tea Party caucus who has held partial power in the US House for a mere seven months and actually advocates cutting the deficit more than either Democrats or traditional Republicans.  Such chutzpah, Mr. Krugman!

 

[1] http://www.nytimes.com/2011/08/08/opinion/credibility-chutzpah-and-debt.html?_r=2&src=me&ref=general

[2] For the benefit of those not familiar with chutzpah: “Chutzpah (pronounced /ˈhʊtspə/) is the quality of audacity, for good or for bad, but it is generally used negatively. The word derives from the Hebrew word ḥuṣpâ (חֻצְפָּה), meaning “insolence”, “audacity”, and “impertinence” http://en.wikipedia.org/wiki/Chutzpah

[3] http://treasurydirect.gov/govt/reports/ir/ir_expense.htm

[4] http://www.nytimes.com/2009/11/02/opinion/02krugman.html

[5] http://blogs.abcnews.com/george/2010/09/krugman-spend-more-tax-less-almost.html

[6]  http://krugman.blogs.nytimes.com/2010/07/28/how-did-we-know-the-stimulus-was-too-small/

[7] http://www.nytimes.com/2009/03/09/opinion/09krugman.html

[8]  http://www.nytimes.com/2009/02/09/opinion/09krugman.html?ref=paulkrugman

Pictures from wikipedia commons.

When $3.5 Trillion was $3.5 Billion!

In Economy, Federal Deficit, Government Spending on August 6, 2011 at 12:48 am

In Fiscal 2009, the US government spent $3.52 Trillion [1].

In Fiscal 1926, the US government spent $3.58 Billion ($43 Billion in 2009 Constant Dollars). [2] 

If a picture can be worth a thousand words, perhaps there is insight available when looking at page 317 of the 1947 Statistical Abstract of the United States (pictured below). 

Note federal spending actually contracted in the Roaring Twenties, even as the economy boomed.   We tamed the severe Depression of 1920-1 not with massive deficit spending stimulus but with spending cuts. [3]

Even FDR’s 1930s federal government lived in penury compared to today.   In 1940, last year before our entry to WWII, the United States spent merely $9.1 billion ($140 billion in 2009 Constant Dollars).

I am not implying we do not get some value for the additional trillions we spend each year today, but the questions are: (1) are we getting good value for the money and (2) can we afford it?  Tonight, S&P’s ratings downgrade suggests the answer to #2 is no.

Statistical Abstract of the United States, 1947, pg. 316

[1] http://www.cbo.gov/ftpdocs/120xx/doc12039/HistoricalTables%5B1%5D.pdf

[2] A useful Constant Dollar Calculator can be found, using your tax dollars by the way, at: http://data.bls.gov/cgi-bin/cpicalc.pl?cost1=3584988&year1=1926&year2=2011

[3] http://en.wikipedia.org/wiki/Depression_of_1920%E2%80%9321

US “AAA” Credit Rating Downgrade Was Expected

In Debt Ceiling, Economy, Federal Deficit on July 28, 2011 at 4:32 am

Go to fullsize image

We cannot say we were not forewarned about a possible drop in the S&P rating for sovereign debt of the United States from the gold standard of “AAA”.   Back in April 2011, S&P cut its outlook on US debt from “stable” to “negative” on account of the mounting deficit.

I think the current political battle over raising the Debt Ceiling will end with an eleventh hour deal but the Federal Government’s credit rating may be cut, anyway, even with a deal that avoids a default.  Mr. Deven Sharma, president of Standard & Poor’s, told a US House subcommittee the US would need to work out a deficit reduction package of about $4 trillion over the next decade for the nation to keep its “AAA” rating. [1]  The Boehner and Reid deals now on the table fall well short of $4 trillion and President Obama’s original request was for a Debt Ceiling increase with no deficit reduction at all.

If the rating is dropped from “AAA”, there will be much partisan blame over who caused it.  The good news is a drop to “AA+” is hardly a high risk rating, putting the USA at the same rating as Belgium.  There will be short-term portfolio churn as some pensions and money market funds require holdings to be “AAA”.  Other buyers are likely to step up for US debt, though probably at slightly higher yields.  Nevertheless, the blow to American prestige will be enormous. 

Do not blame the ratings agencies who are simply messengers of the bad news.  The fact is a ratings downgrade becomes inevitable when servicing the debt becomes more risky.

Do not let politicians mislead you into thinking a ratings downgrade unexpectedly popped up out of nowhere.  We have been warned many times the past three years as seen in this sample of headlines:

“S&P says pressure building on U.S. “AAA” rating,” Reuters, Sept. 17, 2008 [2]

“Moody’s Says U.S. Debt Could Test Triple-A Rating”, New York Times, March 16, 2010 [3]

“Moody’s and S&P Alert US About Credit Rating”, New York Times, January 14, 2011 [4]

“U.S. Warned on Debt Load: S&P Signals Top Credit Rating Is In Danger, Stoking Political Battle on Deficit”, Wall Street Journal, April 17, 2011 [5]

“Analysis – United States gets closer to losing its AAA rating”, Reuters, July 25, 2011 [6]

May we be forewarned about what may happen in the future.  There are many notches below “AA+” a profligate United States may gradually be cut to.  Most ominous is how continuous growth in the deficit relative to GDP exposes the US to higher interest rates whenever the rate environment turns up.  The deficit then grows as the debt used to pay that interest is added onto old debt.  A 3% increase in average interest costs on a $15 trillion debt amounts to $0.45 trillion in new interest expense each year.  Most 30-year bonds will not adjust any time soon, but short-term T-bills roll over every month, reseting to the latest interest rates.  

 

[1] http://www.csmonitor.com/Business/2011/0727/US-debt-downgrade-is-possible-not-inevitable

[2] http://www.reuters.com/article/2008/09/17/us-usa-rating-sandp-idUKN1752966920080917

[3] http://www.nytimes.com/2010/03/16/business/global/16rating.html?adxnnl=1&ref=moodyscorporation&adxnnlx=1311824019-0Pn17TP47seMxuN11WzntQ

[4] http://www.nytimes.com/2011/01/14/business/economy/14place.html?_r=1&ref=standardandpoors which refers to Moody’s report: http://graphics8.nytimes.com/packages/pdf/business/AaaSovereignMonitor-January2011.pdf

[5] http://online.wsj.com/article/SB10001424052748704004004576270693061767996.html

[6]  http://uk.reuters.com/article/2011/07/25/uk-usa-debt-downgrades-idUKTRE76O0DE20110725

No Check For Grandma? Where’s the Social Security Trust Fund?

In Economy, Obama Administration, Social Security on July 18, 2011 at 3:39 am

President Obama is threatening Social Security checks may not go out in August because of his dispute with Congress over raising the Debt Ceiling. 

As pointed out in yesterday’s Wall Street Journal editorial page, how can this be possible when Social Security has a Trust Fund? [1] The Social Security Administration (“SSA”) website reports an impressive Trust Fund balance of $2,669,215,081 as of June 30, 2011 [2].   What happened to your money?

Haven’t we been told by the editors of the New York Times, Paul Krugman and others that the Trust Fund is solid as a rock and people are “peddling nonsense” to imply otherwise? 

Back in 2005, the New York Times said:

“At a recent press conference, Mr. Bush exaggerated the timing of the system’s shortfall by saying that Social Security would cross the “line into red” in 2018…. If you had a trust fund to pay your bills when your income fell short, would you consider yourself insolvent?”

“In suggesting that 2018 is doomsyear, [Bush] is reinforcing a false impression that the trust fund is a worthless pile of I.O.U.’s – as detractors of Social Security so often claim.” [3]

Just last year, the Times’ strongly opinionated columnist Paul Krugman opined:

“So where do claims of crisis come from? To a large extent they rely on bad-faith accounting. In particular, they rely on an exercise in three-card monte in which the surpluses Social Security has been running for a quarter-century don’t count — because hey, the program doesn’t have any independent existence; it’s just part of the general federal budget — while future Social Security deficits are unacceptable — because hey, the program has to stand on its own.”

“It would be easy to dismiss this bait-and-switch as obvious nonsense, except for one thing: many influential people — including Alan Simpson, co-chairman of the president’s deficit commission — are peddling this nonsense.” [4]

How can Mr. Krugman and the New York Times editors square their confidence in the strength of the SSA Trust Fund against President Obama’s “I cannot guarantee that those checks go out on August 3”?   Is the President just playing a game or is the Trust Fund really empty?

The possible absence of Social Security checks results from an unusual structure.  If you have a private sector pension or 401(k), your retirement funds are set aside in a segregated account and the funds are invested in stocks and bonds. 

The Federal Government receives payroll and regular taxes every day and makes accounting entries for Social Security receipts vs. Social Security payouts.  SSA built up an excess of payroll tax receipts over payouts as working Baby Boomers paid in for decades.  This accounting entry comprises the Trust Funds. [5]

The issue with August’s Social Security checks is the Trust Fund is not invested like a normal pension.  Every dollar of Trust Fund surplus is invested in US Treasury obligations, meaning the Trust Fund was already spent for the general use of the Federal Government. [6]  Despite New York Times claims to the contrary, the SSA Trust Fund holds $2.7 Trillion in IOUs.

US government debt has traditionally been such a safe IOU it was called the “risk-free asset” back when I took Finance classes.   Still, even before the current Debt Ceiling controversy, trillion Dollar annual deficits led ratings agencies like Standard & Poor’s in May 2009 to issue warnings about a possible downgrade of US debt. [7]  

Grandma’s Social Security check could be held up not only in August but again in the future after the current Debt Ceiling crisis is settled.  The SSA Trust Fund is simply a very large claimant on future tax receipts of the US Treasury.  The New York Times misunderstood how safe the Trust Fund supposedly is as we now have the spectacle of an American President threatening Social Security payments may not be made on account of the supposedly separate matter of the federal budget deficit.  There is no lockbox; there is no firewall between Social Security and the overall budget.  SSA is not quite “separate”; it is linked to the overall fiscal health of the US government.

Ida May Fuller with the first Social Security check. Source: Wikipedia Commons.

[1] pg. A12, 7/16/11 print edition or http://online.wsj.com/article/SB10001424052702304521304576446250270069780.html?KEYWORDS=trust+fund

[2] http://www.ssa.gov/cgi-bin/investheld.cgi

[3] http://www.nytimes.com/2005/01/10/opinion/10mon1.html?ex=1263099600&en=24a380642da9ba1b&ei=5090&partner=rssuserland

[4] http://www.nytimes.com/2010/08/16/opinion/16krugman.html?adxnnl=1&adxnnlx=1310953732-DNwzINppkFOQn5GdGjvUXQ

[5] Technically there are two Trust Funds: Old Age Survivor (retirement) and Disability.

[6]  http://www.ssa.gov/oact/progdata/fundFAQ.html#n1

[7] http://www.huffingtonpost.com/2009/05/27/moodys-us-governments-aaa_n_208298.html