When will US debt be downgraded? By how much?

The once unthinkable prospect that US government debt might lose its AAA rating has suddenly become a real possibility. In fact, it now seems about as likely as not. The problem is not so much “can’t pay” but “won’t pay”. The US, like quite a few other countries, has some fairly serious fiscal imbalances, but they aren’t pressing in the short run, and there is plenty of capacity to raise additional revenue or cut spending so as to stabilise the ratio of debt to GDP at a sustainable level.

The problem is that even with a stable debt/GDP ratio the total value of outstanding debt keeps growing and the US Congress requires periodic votes to approve this. They are usually the occasion for some grandstanding, but this time the Republican majority of the House of Representatives is seriously threatening a refusal, unless the Democrats agree to massive (and still unspecified) spending cuts. The due date for raising the debt ceiling passed a while ago, but an actual default is being staved off by some sharp accounting tricks, which will apparently work until 2 August. The other day, to prove they are serious, the Repubs introduced a motion for an increase in the debt ceiling, with the express purpose of voting unanimously against it, which they did.

At this point, loud alarm bells have started ringing for the big ratings agencies, Standard&Poors and Moodys. They will have to decide, well before August, whether to downgrade US government debt and if so by how much.

The problem is essentially a political one. For anyone who is following the news, the fact that the US might default is obvious, and there is no reason (especially in view of their appalling performance leading up to the GFC) to think that the ratings agencies have any insights unavailable to the rest of us. But they have to make a choice and that choice will have significant financial, economic and political implications.

If the standard treatment applied to other governments were followed in this case, the downgrade would already have taken place. While it’s still more likely than not that some way of avoiding default will be found, the stated positions of the two sides are so far apart that there must be a significant probability, at least 10 per cent, that they will fail to agree. A security with a 10 per cent chance of defaulting in the next few months would normally be rated among the worst of junk bonds.

That’s not the whole story of course. Most of the time when bond issuers default, the bondholders’ money is lost for good. It seems nearly certain that even if default took place, the period in default would be short, and the US would pay interest and principal in full. Nevertheless, nearly certain isn’t certain, and once something as unprecedented as a default took place, anything could happen.

More importantly, the US government isn’t “other governments”. The ratings agencies are US firms operating in a US political context, and their actions will be governed by a mixture of concerns, starting with self-preservation, but also including a desire to influence US policy in a way favorable to bondholders as a group. In the medium term, that means support for a rapid return to budget balance or surplus, ideally through cuts in spending on the poor and middle class, but including tax increases if necessary.

The short run picture is more complicated. Avoiding default is presumably the main concern, but if that could be achieved by a Dem capitulation to demands for large spending cuts, so much the better. On the other hand, maintaining any kind of credibility requires a downgrade well before defalt actually takes place, and probably a series of downgrades as the deadline approaches. Even a single downgrade would throw financial markets into disarray (among other things, investors who are required to hold AAA assets would have to dump Treasuries and, presumably, buy the bonds of other governments). That in turn would place huge pressure on the Republicans. While the idea of “not raising the debt ceiling” polls pretty well, the reality of “destroying the US credit rating” probably won’t.

The most likely response seems to be an increasingly loud set of alarms about the need for a short-term agreement on the debt ceiling, combined (both becuase the agencies want it and because they need to placate the Repubs) with warnings about the need for a rapid return to fiscal rectitude. That’s not in fact what is needed (rather the US needs more stimulus now combined with a substantial increase in tax revenue in the long term), but it’s a message that will play well among the Serious People in Washington.

We’re already seeing this, with mid-July mentioned as crunch time. The problem is that the warnings may well not be enough. There’s no sign that the Repubs are willing to give an inch on tax increases. Agreeing to the cuts they want, with no tax increases would be politically suicidal for the Dems, which is not to say they won’t do it, but must raise the possibility of a breakdown.

20 thoughts on “When will US debt be downgraded? By how much?

  1. I highly recommend the film “Inside Job” about the GFC.

    It strongly suggests much more than simple incompetence on the part of the ratings agencies.

    Given that many of the players don’t feel restrained by normal laws/rules/economics etc., it seems as though the outcome, whatever it is, will be “unusual” and cause massive damage to those of us with net worth of less than $billions.

  2. This is very disturbing news. Well it’s not really news as it’s been coming for some time I suppose it would too much to hope that the US would restore some balance to its budget by reducing its insane level of military spending? Rhetorical question. Of course, that’s not going to happen.

    There is the old question of what does the biggest gorilla in the jungle do? And the answer is whatever it darn well likes. The US will do whatever is perceived to be in US interests which of course will be the interests of US corporate capital. I guess that the US would default rather than cut its military (the real cause of the overspend) or create hyperinflation at home.

    The rest of this decade will be very turbulent. The middle east will collapse in chaos. The US, EU and BRICs will hit the limits to growth and then we all will have to “pay the piper”.

  3. @conrad

    Of course its Canada. That type of death would not warrant an inquiry in the US, nor would it be front page news (or news at all), nor would it result in harsh words for the utility.

  4. “More importantly, the US government isn’t “other governments”. ”

    That’s the important point with the US. They don’t have a government, at least not in the ordinary understanding of other modern states. The executive doesn’t have the legislative power to operate as a government and the legislature doesn’t have executive powers and so is not a government either. As a consequence no-one is really responsible because it is never obvious to knuckle draggers who is to blame when government fails to do what obviously ought to be done.

    The problem is their much vaulted system of “checks and balances”. They have an 18th century governance technology copied on the then British system of a King executive balanced by a parliament and this ancient technology doesn’t work in the 21st century where a well functioning executive government is so much more important.

    Due to this systemic failure “[t]he once unthinkable prospect ” has been very thinkable for quite a long while. What really holds the US together is a succession of external “threats”. If there ceased to be perceived external ‘threats’, the variety of internal problems and lack of intrinsic cohesion would result in the Union quickly disintegrating.

    The real threat as they cease to remain “number one” is that either perceived threats will bankrupt their economy as they attempt to maintain military hegemony and collapse as the Soviet empire did before them for similar reasons. Or having not maintained that hegemony, they recognise the world is not such a threatening place, and the absence of threat imposed cohesion from outside, combined with their lack of intrinsic cohesion and many problems and divisions at home results in rapid disintegration and collapse.

    Either way, they are doomed.

    Lets hope their collapse doesn’t cause the rest of the world too many problems. Maybe we can step in when they do collapse with a ‘Marshal’ plan?

  5. There is a big overlap between Ron-Paul gold-buggery and the teabagger Republican Right who are now threatening a default.

    The pre-teabag Republican establishment wants to threaten default in order to destroy the welfare state, without actually following through on the threat, because they know that a US default will be a disaster for Wall Street.

    The extreme teabag Right, on the other hand, doesn’t care. They want a revolution that will bankrupt the government, destroy the Federal Reserve, and restore gold-backed currency. To the extent that they aren’t totally illiterate on economic matters, they go in for the Austrian metal-currency jive. Goldline is one of Glen Beck’s biggest advertisers. The fact that ending fiat currency would cause an unprecedented economic crisis in the country is a positive, not a negative: they desire a radical overthrow of the existing order.

    A lot of people look at America’s impossible-to-pay-off debt and think; something’s gotta give. But what would the resolution look like? I doubt it would look like a social-democratic government suddenly deciding to balance the books by scaling down defense spending and raising taxes. More realistically it would be resolved as follows:

    Teabag goldbug extremists take over congress. They believe that currency should be backed by gold, and that fiat money is an unsustainable ponzi scheme. They then turn this into a self-fulfilling prophecy by causing a default on America’s mega-debt. The value of the dollar goes to nothing; fuel prices skyrocket; hyperinflation takes over; the federal government goes bankrupt; and the American economy collapses. With the dollar no longer a safe investment, money pours into gold and other commodities. The goldbugs, obviously, make a killing on all that gold they’ve bought from Goldline and piled up in their basement (next to the boxes of ammunition) over the years. The whole thing is blamed on the Kenyan Antichrist and some post-Weimar teabagger freak becomes President of whatever wasteland survives the end of the fiat dollar.

    I suddenly feel like writing a novel but events might overtake me before I finish.

  6. The US has a shocking need for many more serious and capable people populating their congress following the Bush error, but if anything, the new intakes are worse and worse. There is no way their system of government can reform the influence of lobbyists, each pursuing their master’s profits, but in total ensuring ultimate destruction.

    Lets hope they go quietly. Sadly, we probably have much more to worry about with a US collapse than we did with the Soviet collapse. The US has a lot more military hardware that is very likely to go walkabout.

  7. This situation is so uncertain and so unstable it is nearly impossible to predict the datail of the calamity. What is pretty well certain is that there will be a calamity. America’s irrational responses to its problems ensures distaster. A US implosion (or explosion) will be no good for us. I hope the US can come back from the brink but my logical mind calculates it cannot.

  8. I think the yanks have their own Marshall plan Freelander, but it’s spelled different; if and when It happens, rather than collapse I think your knuckle-draggers would willingly coalesce around a strong military dictatorship.

    For all the fine rhetoric about democracy and freedom it’s as near as damnit to a fascist state already.

  9. Crisis can be adverted by countervailling tendencies, provided there is sufficient scope.

    The development of Africa and the Third World still has a long way to go.

    The problem is that the capitalist form of investment is not conducive to development of Africa as much as it is conducive to exploitation of Africa – including the so-called ‘locking-up’ of resources and brain-drains.

  10. Dear John,
    I think these arguments (like ‘debt ceiling/default’) first, carry way too much divisive and blinding emotional content (mainly fear) and are always framed illogically; and second, are in reality just meaningless distractions from what we really should be talking about. I think a real and pernicious disease in mainstream economic logic is exposed through an understanding of modern monetary theory (MMT), superficially discussed on this blog recently. Just as it took human beings a long time to work out where the rain came from, it is taking a while to work out how ‘magical’ (magnetic imprint magical) a fiat monetary system actually is. Once again I would recommend to interested minds to approach MMT rigorously and work through the logic. Then you will see how mainstream neoclassical theorists make climate sceptics look like geniuses. A sovereign government need not beg, borrow, labour, pray, plunder, prostitute itself, save or tax in order to spend – issuing its own sovereign currency it can never run out of its own ‘money’ nor bump its head on a ‘debt ceiling’! If it does do some of the aforementioned, it is for other reasons than topping up spending power. If it refuses to spend when external income is negative and the private sector is recessed and burdened with debt, then who else is there to spend? And spending = income and all the rest of it! There is a simple explanation of the sectoral balances here: What Happens When the Government Tightens its Belt? Part I and here What Happens When the Government Tightens its Belt? Part II The ratings agencies should be a matter for the DoJ.

    Distraction is a deeper problem!

    What exists in reality are human beings, the skin of the earth and its resources (earth, water and air) – and human values. These exist in real time and real space. The priority should always be the same in any sane world; the fundamental welfare of people and the planet. The monetary system is just an accounting record (magnetic imprints) and any debate about its mundane operation (which can be anything you want it to be) should be consciously framed in the context of these realities; never ever to be lost to sight.

    I am always amazed no matter who you listen to – (red ones, white ones, yellow ones, brown ones, black ones or any beautiful colour in between) – despite amazing cultural and social differences – most people just want a little bit of elbow room, a stable income (means) by which they can raise their families, and space to pursue their interests (learning). We are from this simple perspective a peace loving species – conflict exists only in a disturbed mind (history a record of just how disturbed). That does not mean that peace is not possible, if people use their intelligence constructively. People have wanted peace on this earth for a very long time because that is our core nature. Most of the time our so-called ‘world-leaders’ lead people away from their core nature (therefore, they are natural idiots, not leaders). Because we do need a monetary and political system we need to get priorities straight and we should Demand that.

    There is no cause greater than human life. There is no greater gift or challenge than the unfolding of a human life to reach its full potential, to speak with gratitude of fulfillment – and only through the richness of everyday experience. If this is a reason to be born and exist on this planet earth, albeit for an incredibly short time, then there is no ‘intelligence’ extant in wiping people senselessly and forever off the face of the earth in war (where human beings are manipulated into the horror of slaughtering their own species because of some idiot’s cause); or in the modern version allowing the financial sector to gamble with commodity prices or anything else for that matter, while real people starve to death as a consequence. This is not what it means to be human. Nor is there any sense in a government refusing to sustainably spend. People need resources to be distributed with sufficient equity to provide the simple basics of nutrition, clothing, shelter, health, education etc. whilst the environmental integrity of the planet and its ecosystems are maintained; and they need Peace in order to prosper. These are the fundamental issues that should be uppermost, forefront, and occupant of our outgoing attention!

    And this is what we should be passionately talking about – not endless mindless phoney political football soapies about how there are not enough resources in this world to take care of people (in this blog topic’s case not enough magnetic imprints for Main Street while Wall St. is part given, part pledged up to $20T of imprints with no debt ceiling in sight and little effect on the real economy) and the military budget expands effortlessly. The world still has exactly the same number of people and the same sustainable resources available, despite the magnetic imprints. There is absolutely no reason why these people and resources cannot be employed to heal most of the suffering – that is what we should be shouting about. We don’t need dud world leaders, predators or parasites in the driver’s seat; nor should we be distracted. It is within the power of ordinary people to tell them to shape up or ship out!

    The only people I see in this world trying to be as truthful as possible about reality (that is a real earth, real people, real resources, real life and real needs) are scientists: much of the political, religious and economic debate is pure toxic phantasy! The real path has always been the same: somebody with a little vision talks to somebody who is used to presenting it as ideas, and these are patterned and communicated to the people simply. Governments may have huge administrative and media power, but they cannot control the power to think! Clarity does not need a passport. Thinking is supposed to discriminate between what is real and what is not – and we always choose reality once the clouds are blown away. We need to choose our simple and fundamental human reality. That is what I believe at least, we should be talking about!

    So, far better to establish a real human discourse in my view; especially when MMT logically explains to me that debt ceilings and a US sovereign default is just fear obscuring reality. There is only one earth and only one human species. We each have only one life. I don’t think it helps to turn the realities of human existence into a soap opera – nor obscure those realities with endless dramas! Our human realities are in fact, quite simple.

    Cheers …

  11. Well, hear, hear, to that jrbarch !

    The pleasure I’ve derived from getting my head around MMT has been offset somewhat by the disturbance it caused to my previous comfortable acquaintance (albeit informal) with so-called orthodox economics: the need to balance the budget, NAIRU, EMH, sustainable debt/GDP ratios etc and all the rest of it.

    I’m now morbidly preoccupied with trying to work out why the bulk of the economics profession prostitutes itself to support policy that is clearly inimical to the interests of the people.

    When the President of the United States says this (quoted in one of your links):

    “Small businesses and families are tightening their belts. Their government should, too.”

    …and there’s barely a ripple of dissent, then you know that the dirty work of the neo-liberals is nearly done.

  12. The United Nations Department of Economic and Social Affairs just put out an update of their ‘World Economic Situation and Prospects 2011’. Interesting in it is a section titled “Global imbalances and the risk of a collapse of the dollar”. Given that there would be some reticence about even bringing the possibility up for discussion, the inclusion of such a section indicates significant concern.

    The update can be downloaded from:

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