Recent news hints that agencies like Standard and Poor’s, Moody’s and Fitch may downgrade their ratings of U.S. Treasury bonds. This is not good news, but it is fundamentally different from a decline in an individual’s credit score, a Dun & Bradstreet rating of a small business or a rating given by these same agencies to bonds issued by corporations, cities or states.
It is even different from these agencies downgrading the debt of Greece, Paraguay or the Netherlands. So if they do act, take the news with a grain of salt.
This is not to dismiss our nation’s fiscal problems. They are severe. But they also have been 30 years in the making. Moreover, we are not yet out of the worst financial sector crisis in 80 years. Having gotten to where we are by following bad policies for decades, the question now is one of choosing the least bad option rather than some abstract ideal.
Start by putting things in a historical context. The ratio of gross national debt to gross domestic product is rising at a rate that scares investors and ratings agencies. It was higher only at the end of World War II. But then the ratio fell continuously from 121 percent of GDP in 1946 to 33 percent in 1981. It then reversed course and began to rise for the first time in peacetime history and doubled to 67 percent by 1996. It then fell, dropping nearly 11 percentage points in five years. Since then, it has risen. As of Wednesday, it is at 92 percent.
Given that background, why is a ratings agency downgrade for U.S. Treasury bonds any different than it would be for the city of St. Paul, the state of North Dakota or Xcel Energy?
There are two reasons. First, the U.S. dollar remains the world’s reserve currency, the one in which nearly all other nations of the world choose to hold foreign exchange reserves. And its only competitor for this role, the euro, has problems that are even deeper than those of the dollar. Second, virtually all of the U.S. national debt is denominated in our own currency. We can always make principal and interest payments simply by creating more dollars. There never need be a default in the formal sense of telling some set of bondholders they don’t get their money back.
St. Paul doesn’t print its own currency. Nor does Xcel Energy. And, since 1999 at least, nor do Portugal, Ireland, the Netherlands or any other of the original eurozone countries. The need to repay in money for which someone else controls the printing press imposes rigid constraints on others from which the U.S. Treasury remains exempt.
The danger for bondholders, the target clientele for ratings such as these, thus is not that they will not get back the dollars due them but rather that the greenbacks they do get won’t have much buying power.
The broader danger to society as a whole is the damage to output, employment and household income that would result from an inflationary expansion of the money supply to service the national debt. This danger is substantial. But we should have been thinking about it for years. Economists certainly have been sounding the warning for nearly as long as I have been in the business, even though we were heeded only for a brief period in the 1990s.
So the fundamental problems that our continued fiscal mismanagement poses are real. But the opinions of the ratings agencies remain peripheral. These businesses exist to generate valuable information for private investors. Want to know if you should buy a bond that Roseville issued to build a public school? You don’t have to spend hours poring over years of Roseville Public Schools financial statements. Just look up the ratings of the bonds and you get a pretty good idea of the level of risk.
The same is true for small countries like Portugal, Paraguay or the Netherlands. Few in-vestors have the resources to follow the details of such nations’ public finances, so analysis from Moody’s or SP is useful. They don’t have a monopoly on evaluating these nations’ fiscal positions, but they still add some value.
The situation is different for a nation as large as Germany, the United Kingdom, Japan or, especially, the United States. Thousands of professional economists follow U.S. public finances and macroeconomic policies on a daily basis. So do tens of thousands of analysts working for financial firms on Wall Street and around the world. And so do millions of sundry pundits and punters, paid and unpaid. It is the collective judgment of all of these on the short- and long-run fiscal prospects of our country that is the most relevant rating, not some collection of letters assigned by out-of-repute ratings companies.
Ultimately, the question is political rather than economic. The United States remains one of the richest countries in the world both in terms of physical assets and income generating potential. The idea that we somehow are so impoverished we cannot pay our debts is preposterous. Total federal tax revenues in FY 2010 dropped to 15 percent of GDP, the lowest level since 1949. When our grandchildren and great-grandchildren look back at this era in U.S. history, they will shake their heads at our foolishness.
© 2011 Edward Lotterman
Chanarambie Consulting, Inc.