Forget the rating number itself - even if everything just shifts down one grade and the relative difference between them remains the same, what’s being said is that there is additional risk in lending money for U.S. Treasuries. That risk will have to be priced. If that leads to additional risk pricing on all other currencies, then that could simply kick off a worldwide recession or worldwide stagflation or something similar.
Forget the S&P for a minute, and just think about the U.S.'s situation - it has to continue to borrow somewhere in the neighborhood of a trillion dollars per year, without paying any of it back. Where is this money going to come from? China’s GDP is only about 5.8 trillion dollars per year. It simply cannot fund the U.S.'s appetite for debt. Japan is pulling its yen home to pay for reconstruction after the earthquake/Tsunami, and is also borrowing money like crazy. Europe is largely in the red and borrowing money as well.
It looks to me like an unstable situation waiting for some minor or major crisis to kick the apple cart over and expose the rotten carcass underneath. China has been stimulating its economy and overbuilding its infrastructure, and is due for its own asset bubble to pop. If that happens, what then? What if oil goes to $200/bbl?
It’s one thing to borrow money to fund a necessary war like WWII, where once the war is over you can go back to a low-cost model of government and pay back the debt. But when the debt is being absorbed by entitlements that are growing yearly with no end in sight, the market is going to tolerate a much lower debt level. How much lower, we don’t know. By the time we know, it will be too late and the crisis will be here. That’s how these things happen.
This is really what the S&P is warning about. They’re trying to knock some sense into the politicians and the U.S. public before it’s too late. But instead, people are just shooting at the messenger and acting as if borrowing 9% of the country’s entire gross domestic product every year to pay off citizens who have been promised too much can continue indefinitely, or at least for a long enough time that the problem can be ignored for a while. I think that’s madness.
In an earlier message I said that U.S. tax revenues should come back to 18-19% of GDP once the economy recovers. What if it doesn’t recover? What if this is an ‘L’ shaped ‘recovery’ and the U.S. is about to go into its own ‘lost decade’? This is an outcome that I consider to be quite likely, actually. A peer-reviewed economics paper last year looked at the cost of debt to GDP growth, and concluded that debt loads over 90% of GDP could cost a country 1-2% of GDP growth. The U.S. is about there right now. So if the historical 3.5% long-term growth turns into 1.5% until the debt is lowered, then the U.S. can’t grow its way out of the problem, and the deficit will continue to hover where it is unless spending is cut and/or taxes are raised.
Unfortunately, spending cuts and tax increases both tend to slow down growth, so this is not going to be an easy thing to fix. And each day that passes without something being done makes it even harder.
As for tax increases, the problem with that is that there’s no will to really raise taxes on the side of the Republicans or The Democrats. Some of you talk about the Bush tax cuts as if you can solve this problem by rescinding them. What you won’t say is that Obama has no intention of letting all the Bush tax cuts expire. He wants to make the tax cuts permanent for the lower and middle classes, and only expire them for the rich. But that’s not much money - at most about 70 billion dollars per year - less than 5% of the current deficit. Obama’s plan to reduce the deficit this way is not credible, and everyone knows it.
In the meantime, the cost of the new health care plan has gone up again, as HHS has given 6.7 billion dollars back to seniors to ‘ease the pain’ of Medicare cuts baked into the plan (cite). That’s 10% of the ‘savings’ from the tax cuts on the rich, gone with the stroke of a pen without anyone even noticing.
There’s the first place to start - repeal Obama’s health care plan before it has a chance to kick in and permanently change health care markets. Leave some of the taxes and spending cuts in place that were supposed to go towards funding it, and apply it to the deficit instead. That’s the most painless fix, since no one yet is relying on that money. It’s also more than a trillion dollars over ten years, or a little less than double what you’d get from increasing taxes on the rich. Maybe you do that too, and apply the money to the deficit. Then you cut ag subsidies, cancel the High Speed Rail projects and claw back that 50 billion, and institute other cuts across the board in government services.
Couple that with some regulatory reform to lift the weight of regulations off the economy and get it moving a bit better, and come up with a plan to reform entitlements in a credible way, and maybe you’ll buy enough time from the credit markets to attack the deficit in a more gradual and less painful way.
The current budget projections show that within five years the U.S. will be paying more than $500 billion dollars per year in interest on the debt. That is money that is taxed out of the economy every year, and which can’t be used for funding space programs, or retirement plans, or infrastructure investment. It is a giant dead weight on the economy. It will slow your growth. Within a couple years after that, you will be spending more on interest than you do on the military. Soon thereafter, the combination of interest and Medicare expenditures will absorb the entire budget of the United States government.
This is not a distant scenario. You’re already feeling the leading effects of this particular freight train. We’re seeing increasing numbers of economic shocks and small crises. Things are becoming just a little bit more risky and unstable. It’s time to get your act together and stop squabbling.
For you military hawks who don’t want the military cut: It’s time to start thinking of the debt as just as big a threat to security as any other nation right now. You want to take a holistic view of national security and recognize that the U.S. is losing a lot of bargaining power through its increasing commitments to foreign creditors. Military program spending has to be prioritized a little differently if it means gaining more financial credibility and stability. Reasonable cuts to the military have to be put on the table - even if that means scaling back in Afghanistan and pulling some soldiers out of places like Korea, Okinawa, and Germany.
:eek: 
