Fisher Investments Editorial Staff
Deficits, US Economy, Politics

The Scarlet Letter

By, 04/19/2011

Story Highlights:

  • S&P affirmed the US’s AAA long-term credit rating, but revised its outlook to “negative.”
  • They cited current fiscal worries, but the crux of that issue is mostly entitlement spending.
  • US debt costs remain low relative to history and very affordable.

In Nathaniel Hawthorne’s The Scarlet Letter, maligned adulteress Hester Prynne was forced to wear an embroidered scarlet “A” as a public shame. Monday, the US was faced with a threat of its own scarlet “A” (or make that “AA+”), as Standard & Poor’s downgraded the US’s long-term credit rating outlook from “stable” to “negative.” This wasn’t a rating downgrade—they affirmed the US’s sterling AAA long-term and A-1+ short-term sovereign credit ratings. However, citing government budget risks, they gave the US a one-in-three chance of losing its AAA rating within two years.

But the threat of a downgrade hardly means one is written in stone. S&P wants the US to devise a credible plan to address fiscal imbalances within two years. Their beef is what they view as a gulf between current Republican and Democratic budget plans, making America’s outlook dimmer than “key peers” like Germany (way lower deficits) and the UK (firmer austerity plans). Interestingly, despite S&P’s finger-wag, yields on US Treasuries (all maturities) fell and the dollar rose on Monday—rather the opposite of what many would have expected.

Or perhaps not. After all, the US has the deepest capital markets, and the dollar is still considered the safest, most liquid reserve currency. And though Republicans and Democrats nit-picked their way to a budget consensus this year based on cuts to mostly discretionary items—the big budget busting items (and those S&P is most concerned about) are all mostly entitlements. But entitlements aren’t true debt. (An important distinction: Read more here.) They can, at any moment, be legislated away. This is much more a political problem, not a fiscal one. Canceling social security abrogates no contract, though it undoubtedly annoys constituents politicians covet.

A very important point perhaps S&P misses: America can easily afford its debt—borrowing costs relative to GDP remain low. Debt interest payments as a percent of GDP were higher the entirety of the 1980s and 1990s—sometimes double what they are now. Yet, the 1980s and 1990s weren’t disastrous. The reverse! They were overall terrific times for the economy and capital markets. If our total debt level increased 50%, we’d still be below levels seen for most of those two decades. Or, interest rates could rise 200 basis points, and we’d still be at levels that weren’t problematic in the past.

We certainly don’t think endlessly adding debt is good idea. At a point, too much debt would indeed become problematic—but it’s not clear what that point is, and given how affordable US debt is currently, that level is still a long ways off. What’s more, a bloated government sucks capital from more productive avenues, like entrepreneurs and innovators.

Also remember, ratings agencies don’t have perfect or even particularly good economic forecasting track records. Could S&P be falling prey to political rhetoric? Possibly. Moody’s disagrees with their assessment, but either way, proclamation by any ratings agencies should be taken with a grain of salt. 

A diminished opinion of America’s outlook by one (by-no-means-infallible) credit agency tied to what may or may not happen over the next two years doesn’t change current facts. Heck, the threat of a downgrade could goad political consensus to push through unpopular measures like spending cuts and possibly higher taxes. However, in the here and now, US (and global) economic indicators have been largely expansionary—and that likely continues this year, no matter how any credit agency feels about it.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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