Double-Dip Recession? How Our Dysfunctional Political Class Has Made Another Grueling Collapse Far Likelier

Just a few short months ago, few analysts would say publicly that the American economy was likely to slide into another grueling period of recession. That's changed.
By Joshua Holland, AlterNet
Posted on August 10, 2011


The single bright spot in this anemic “recovery” had been steadily rising stock prices. Although the market staged a modest rally on Tuesday, news of the debt ceiling deal was followed by a massive sell-off in stocks – the S&P 500 saw its biggest one-day drop in more than a year the day the deal was announced. After losing $14 trillion in household wealth in the crash, Americans' nest eggs had rebounded to some degree, but whether their 401(K)s and investment accounts hold their value in the coming months remains to be seen.

The outlook for the economy is extraordinarily bleak. But we've pulled ourselves out of deep recessions before. What's different now is the profound, tea-party stained dysfunction plaguing our political class. As I wrote recently, if the economy does end up contracting in the near future, it will be a recession driven by the “age of austerity” embraced by Washington – and the contractionary policies it has ushered in.

That scenario appears more likely today. Just a few short months ago, there were very few analysts who would predict that the American economy stood a decent chance of sliding into another period of grueling recession. The consensus held that while we were recovering far too slowly in light of the depth of the crash, we were nevertheless on the rebound. But that thinking has changed. Last week, former Treasury Secretary Larry Summers estimated that there was a 33 percent chance of the economy once again falling into recession – the dreaded “double-dip.” Other economists put the likelihood a bit lower, but researchers at the Federal Reserve tell us that, since World War II, about half of the times the economy has grown as slowly as it has in the first half of this year, a recession has followed within twelve months.

For the majority of Americans, the official end of the last recession was merely an abstraction – it in now way reflected the profound economic pain tens of millions of working people continued to feel. Since 2009, when the wonks at the National Bureau of Economic Research (NBER) set the official end of the Great Recession, the unemployment rate has edged down tick, but most of that was due to people giving up and dropping out of the workforce. The share of the population that has a job today is about the same as it was in the early 1970s, before women entered the workforce en masse.

Housing prices bottomed in 2009, then had a brief and sputtering recovery, before hitting a new low early this year, well after the official end of the recession. Around one in four homeowners with a mortgage still owe more on their properties than they're worth, and the foreclosure crisis continues unabated. New business creation has ground to a halt, people are running up credit card debt to make ends meet and new grads aren't leaving home to start out on their own.

High oil prices have squeezed already strained household budgets -- consumer spending dropped in June and “consumer confidence” about the future plunged in July. The Japanese Tsunami caused supply disruptions, the eurozone is a mess and China's economy is slowing – with our trading partners slumping, we certainly won't see an export-led boom anytime soon.

The slump in demand for companies' goods and services remains our core problem, and that problem will only be magnified as the last of the stimulus funds dry up, the temporary payroll tax break expires and extended unemployment benefit run out later this year. Without more help from Washington, states and municipalities are expected to shed 450,000 public sector jobs next year.

Last year, with the private sector economy continuing to slump, an analysis by Moody's Analytics found that almost one in five dollars in American consumers' wallets came from one government program or another. The public sector has already seen deep cuts, and that trend will only worsen with Washington's relentless focus on deficit reduction. Without those dollars, there will be fewer consumers demanding American companies' goods and services, and the private sector will continue to have little incentive to hire. Although the cuts in the debt reduction deal are “backloaded” to some degree, $70 billion in cuts will hit before the end of next year, which will cost the economy hundreds of thousands of jobs, resulting in more people out of work, missing mortgage payments and not spending much money.

And they're not done. In downgrading America's debt last week, S&P relied on some dodgy economi analysis, but its view of the political situation is spot-on: the GOP's absolutism is making governing next to impossible. Not only are all revenue raises effectively “off the table,” in all likelihood any significant effort to kick-start the economy is as well. Senator Jim DeMint, R-South Carolina, said that the debt ceiling was simply “round one” in a 15-round brawl over spending and “entitlements.” If their position were that we need to pay down the debt as soon as unemployment drops below 7 percent and the housing market stabilizes, it wouldn't be an entirely insane position. Doing so in this economic climate is ideologically driven madness.

And the real danger is that we'll get into a disastrous kind of feedback loop if the economy starts contracting. That would certainly lead to higher deficits, as tax revenues sank to new lows and the demand for anti-poverty services grew. The deficit hawks will use that rising deficit to call for more cuts, and without some new engine of private sector growth emerging, we'll stay stuck treading water. We've already lost a decade – after the dot-com bust, median incomes only surpassed those in 1999 during one year – 2006 – and have only declined since then.

In his book, Collapse, Jared Diamond looked at a bunch of societies that had seen their physical climates change and tried to determine what made some die out while others persevered. It wasn't the severity of the change, or its speed that was the determining factor, but the foresight of those societies' leaders – their ability to properly diagnose the problem and adapt – to come up with proactive solutions to the problems they faced. The economic woes we're suffering are man-made, but we may look back on the era in which American prosperity collapsed and see the same kind of stubborn refusal to acknowledge reality as a proximate cause.

Progressive Groups Unveil 'Contract For The American Dream'

Tuesday, August 9, 2011 by Huffington Post
by Sam Stein

WASHINGTON -- In the wake of the deal to raise the nation's debt ceiling, widely viewed as yet another setback for the progressive community, advocacy groups on the left are redoubling efforts to change the political narrative.

S&P's decision to downgrade the United States' debt and the market selloff that followed has only emboldened those voices who believe the main structural problem plaguing the economy has less to do with debt and more to do with a lack of economic growth.

On Monday afternoon, MoveOn.org and Rebuild the Dream announced a campaign to build up a popular movement that could match (if not surpass) the debt reduction crowd in both size and energy. And they have borrowed a concept from former House Speaker Newt Gingrich (R-Ga.) as their organizing principle.

The campaign, led by Van Jones, President of Rebuild the Dream; Justin Ruben, Executive Director of MoveOn.org; and Rep. Jan Schakowsky (D-Ill.), among others, is debuting a new Contract for the American Dream. They describe it as "a progressive economic vision crafted by 125,000 Americans … to get the economy back on track." Its debut will involve a nationwide day of action, as well as an ad in The New York Times to run sometime this week, organizers said.

The basic premise of the campaign is that America isn't broke, it's merely imbalanced. In order to stabilize the economy, politicians should make substantial investments in infrastructure, energy, education and the social safety net, tax the rich, end the wars, and create a wider revenue base through job creation.

"Many of our best workers are sitting idle, while the work of rebuilding America goes undone," reads one bullet point of the Contract. "Together, we must rebuild our country, reinvest in our people and jump-start the industries of the future. Millions of jobless Americans would love the opportunity to become working, tax-paying members of their communities again. We have a jobs crisis, not a deficit crisis."

The name of the campaign is, of course, a reference to the Contract for America that Gingrich authored in the run up to the 1994 congressional elections. In the context of the current debate in Washington, the principles it promotes resemble a liberal pipe dream more than an actual outline for potential legislation. President Obama and Democratic leaders in Congress have, after all, been openly willing to throw entitlement reforms into the debt reduction discussion. And the notion that this Congress will decide to make future stimulus-like investments ignores Republicans' complete dismissal of such measures.

And yet, if you look at the specific suggestions, there is overlap between what the Contract advocates and what the president has endorsed -- mainly on the transportation and clean energy fronts. More than that, the Contract fills the obvious need for liberal advocacy groups to build a popular movement in support for their ideological side of the debt debate, something that has been clearly and at times painfully missing as a counterpoint to Washington's current obsession with austerity.

Read the full Contract below:

ContractDream

What the S&P Downgrade Really Means

The S&P Downgrade
By PAUL CRAIG ROBERTS

On Friday, August 5, the credit rating agency, Standard & Poors, downgraded US debt from AAA to AA+.

Gerald Celente’s view that S&P’s downgrade of the US Treasury’s credit rating reflects a loss of confidence in the political system was confirmed by the rating agency itself.

S&P explained the downgrade as the result of heightened political risks, not economic ones. The game of chicken over the debt ceiling increase and the GOP’s ability to block tax increases indicate that “America’s governance and policymaking is becoming less stable, less effective, and less predictable”

The reduction in the government’s credit rating to AA+ from AAA is a cosmetic change. It remains a very high investment grade rating and is unlikely to have any effect on interest rates. It is revealing that despite the downgrade, US bond prices rose. It was stocks that fell. The financial press is blaming the stock market decline on the bond downgrade. However, stocks are falling because the economy is falling. Too many jobs have been moved offshore.

Interest rates could fall further as investors flee into Treasuries from the euro because of sovereign debt worries, flee equity markets as they continue to tumble, and as large banks charge depositors for holding their cash. Indeed, the latter policy could be seen as an effort to drive people with large cash holdings out of cash into government bonds. Japan has a lower credit rating than the US and has even lower interest rates.

More hard knocks are on their way. As the economy weakens and the economic outlook darkens, new deficit projections will elevate the debt issue.

The psychological effect of the S&P’s downgrade is likely to be larger than its economic effect. Many will see the downgrade as an indication that America is beginning to slip, that the country might be entering its decline.

There is no danger of the US defaulting on its bonds. The bonds are denominated in US dollars, and dollars can be created without limit. Moreover, the problem with the debt is less with the size of the national debt, which remains a lower percentage of GDP than during World War II, than with the large annual budget deficits. If equities continue to fall, if flight continues from the euro, if bank fees drive people out of cash, it is possible that the inflows into Treasuries can finance, for awhile, the large annual deficit, removing the need for the Federal Reserve to monetize the deficit via Quantitative Easing.

On the other hand, the weakening economy, given traditional policy views, will likely lead to a renewal of debt monetization or QE in an effort to stimulate the economy.

Continued debt monetization threatens the dollar. Investors will move out of Treasuries and all dollar-denominated assets not because they fear default, but because they fear a fall in the dollar’s exchange value and, thus, a fall in the value of their dollar holdings.

Debt monetization can cause domestic inflation (and imported inflation for those countries that peg to the dollar) as, and if, the new money finds its way into the economy. This has not happened to any extent so far in the US, because the banks are not lending and consumers are too indebted to borrow. But the fall in the dollar’s exchange value results in higher prices of many imports. So far the inflation that the US is experiencing is coming from the declining exchange value of the dollar. However, there is little doubt that asset prices, such as those of Treasuries and stocks, have been inflated by the Fed’s monetization of debt.

To flee from the dollar, there must be someplace to go. There are not alternative currencies large enough to absorb the dollars, especially with China pegged to the dollar and the euro experiencing troubles of its own because of the sovereign debt crises in Greece, Spain, Ireland, Portugal, and Italy. Dollar flight has driven up the prices of bullion and Swiss francs. Despite the Swiss government printing francs to absorb the dollar inflow, the franc continues to rise in value. As of time of writing, one US dollar is worth only about 76 Swiss centimes or cents. In 1966 there were 4.2 Swiss francs to the dollar or 420 centimes to the dollar.

The rise in the franc is crippling Switzerland’s ability to export. The loss in the dollar’s exchange value from dollar creation causes other countries, such as Japan and Switzerland to inflate their own currencies in order to hold down their rise. The Fed’s dollar policy has resulted in Russian leader Putin declaring the US to be a parasite upon the world and the Chinese to call for other countries to control how many dollars can be printed.

In other words, the US policy is seen as adversely impacting other countries without doing any good for America.

What I have explained can be comprehended within existing ways of thinking. Within this way of thinking, as the debt ceiling imbroglio made clear, the policy choices are between eliminating Social Security and Medicare or eliminating wars and low tax rates on the mega-rich in order to eliminate the annual budget deficits that are threatening the dollar’s exchange value and enlarging the national debt.

However, it is often the case that more is going on than traditional thinking can know about or explain. It is always a challenge to get people’s thinking into a new paradigm.
Nevertheless, unless the effort is made, people might never comprehend the behind-the-scenes power struggle.

A half century ago President Eisenhower in his farewell address warned the American people of the danger posed to democracy and the people’s control over their government by the military/security complex. Anyone can google his speech and read his stark warning.

Unfortunately, caught up in the Cold War with the Soviet Union and reassured by America’s rising economic might, neither public nor politicians paid any attention to our five-star general president’s warning.

In the succeeding half century the military/security complex became ever more powerful. The main power rival was Wall Street, which controls finance and money and is skilled at advancing its interests through economic policy arguments. With the financial deregulation that began during the Clinton presidency, Wall Street became all powerful. Wall Street controls the Treasury and the Federal Reserve, and the levers of money are more powerful than the levers of armaments. Moreover, Wall Street is better at intrigue than the CIA.

The behind the scenes fight for power is between these two powerful interest groups. America’s hegemony over the world is financial, not military. The military/security complex’s attempt to catch up is endangering the dollar and US financial hegemony.

The country has been at war for a decade, running up enormous bills that have enriched the military/security complex. Wall Street’s profits ran even higher. However, by achieving what economist Michael Hudson calls the “financialization of the economy,” the financial sector over-reached. The enormous sums represented by financial instruments are many times larger than the real economy on which they are based. When financial claims dwarf the size of the underlying real economy, massive instability is present.

Aware of its predicament, Wall Street has sent a shot across the bow with the S&P’s downgrade of the US credit rating. Spending must be reined in, and the only obvious chunk of spending that can be cut without throwing millions of Americans into the streets is the wars.

Credit rating agencies are creatures of Wall Street. Just as they did Wall Street’s bidding in assigning investment grade ratings to derivative junk, they will do Wall Street’s bidding in downgrading the US credit rating. Wall Street might complain about downgradings, but that is just to disguise that Wall Street is calling the shots.

The struggle between the military/security complex and the financial sector comes down to a struggle over patronage. The military/security complex’s patronage network is built upon armaments factories and workforces, military bases and military families, military contractors, private security firms, intelligence agencies, Homeland Security, federalized state and local police, and journalists who cover the defense sector.

Wall Street’s network includes investors, speculators, people with mortgages, car, student, and business loans, credit cards, real estate, insurance companies, pension funds, money managers and their clients, and financial journalists.

As the financial sector has over-extended and must shrink, Wall Street is determined to have access to public funds to manage the process and determined to maintain its relative power by forcing shrinkage in its competitor’s network. That means closing down the expensive wars in order to free up funds for entitlement privatization and to keep the dollar’s role as reserve currency. Wall Street realizes that if the dollar goes, its power goes with it.

What insights can we draw from this analysis?

The insight that it offers is that although economic policy will continue to be discussed in terms of employment, inflation, deficits, and national debt, the policies that are implemented will reflect the interests of the two contending power centers. Their struggle for supremacy could destroy the rest of us.

Wall Street opened the game with a debt downgrade, implying more are to come unless action is taken. The new Pentagon chief replied that any cuts to the military budget would be a “doomsday mechanism” that “would do real damage to our security, our troops and their families and our military’s ability to protect the nation.”

Will Americans be so afraid of terrorists that they will give up their entitlements? Will false flag terrorist events be perpetrated in order to elevate this fear? Will Wall Street provoke crises that are perceived as a greater threat?

From whom do we need greater protection than from Wall Street and the military/security complex and from our government, which is the tool of both?

A National Debt Of $14 Trillion? Try $211 Trillion

All Things Considered
by NPR Staff - August 6, 2011

Listen to the Story

When Standard & Poor's reduced the nation's credit rating from AAA to AA-plus, the United States suffered the first downgrade to its credit rating ever. S&P took this action despite the plan Congress passed this past week to raise the debt limit.

The downgrade, S&P said, "reflects our opinion that the fiscal consolidation plan that Congress and the administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics."

It's those medium- and long-term debt problems that also worry economics professor Laurence J. Kotlikoff, who served as a senior economist on President Reagan's Council of Economic Advisers. He says the national debt, which the U.S. Treasury has accounted at about $14 trillion, is just the tip of the iceberg.

"We have all these unofficial debts that are massive compared to the official debt," Kotlikoff tells David Greene, guest host of weekends on All Things Considered. "We're focused just on the official debt, so we're trying to balance the wrong books."

Kotlikoff explains that America's "unofficial" payment obligations — like Social Security, Medicare and Medicaid benefits — jack up the debt figure substantially.
Laurence J. Kotlikoff served as a senior economist on President Ronald Reagan's Council of Economic Advisers and is a professor of economics at Boston University.
Courtesy of Boston University

Laurence J. Kotlikoff served as a senior economist on President Ronald Reagan's Council of Economic Advisers and is a professor of economics at Boston University.

"If you add up all the promises that have been made for spending obligations, including defense expenditures, and you subtract all the taxes that we expect to collect, the difference is $211 trillion. That's the fiscal gap," he says. "That's our true indebtedness."

We don't hear more about this enormous number, Kotlikoff says, because politicians have chosen their language carefully to keep most of the problem off the books.

"Why are these guys thinking about balancing the budget?" he says. "They should try and think about our long-term fiscal problems."

According to Kotlikoff, one of the biggest fiscal problems Congress should focus on is America's obligation to make Social Security payments to future generations of the elderly.

"We've got 78 million baby boomers who are poised to collect, in about 15 to 20 years, about $40,000 per person. Multiply 78 million by $40,000 — you're talking about more than $3 trillion a year just to give to a portion of the population," he says. "That's an enormous bill that's overhanging our heads, and Congress isn't focused on it."

"We've consistently done too little too late, looked too short-term, said the future would take care of itself, we'll deal with that tomorrow," he says. "Well, guess what? You can't keep putting off these problems."

To eliminate the fiscal gap, Kotlikoff says, the U.S. would have to have tax increases and spending reductions far beyond what's being negotiated right now in Washington.

"What you have to do is either immediately and permanently raise taxes by about two-thirds, or immediately and permanently cut every dollar of spending by 40 percent forever. The [Congressional Budget Office's] numbers say we have an absolutely enormous problem facing us."

S&P head: Agency may downgrade U.S. again

By David Edwards - RAW Story
Sunday, August 7th, 2011

The head of Standard & Poor's sovereign ratings said Sunday that the agency may downgrade the U.S. again.

"Given the economic and political situation in the U.S., which will we see, an upgrading back to AAA or further downgrades?" Fox News' Chris Wallace asked David Beers.

"We have a negative outlook on the rating and that means we think that the risk currently for the rating are to the downside," Beers said.

While explaining what the U.S. could do to get its AAA rating back, the S&P official mentioned entitlement cuts but ignored the agency's call to raise revenues.

"Does any compromise have to have entitlement reform and revenue increases to be credible?" Wallace wondered.

"The key thing is, yes, entitlement reform is important because entitlement is the biggest -- are the biggest component of spending and they are the part of spending where the cost pressures are greatest," Beers replied.

"The White House as you know is not happy with this decision and they have accused S&P of amateurism. They went through your numbers and found a $2 trillion overstatement of what the debt would be and when they pointed that out to you, you simply changed the rational and continued to downgrade the debt," Wallace noted.

"That is a complete misrepresentation of what happened," Beers claimed. "Here we are talking about highly technical assumptions about projecting budget base lines far in the future. We made the motifications that we did after a conversation with the Treasury, it doesn't change the fact that in our estimation, that even with the agreement of Congress and the administration this past week, that the underlying debt burden of the U.S. government is rising and will continue to rise, most likely, over the next decade."

"The haste with which S&P changed its principal rationale for action when presented with this error raise[s] fundamental questions about the credibility and integrity of S&P's ratings action," Treasury assistant secretary for economic policy John Bellows wrote last week.

White House chief economic adviser Gene Sperling added that S&P's actions "smacked of an institution starting with a conclusion and shaping any arguments to fit it."

"The magnitude of their error combined with their willingness to simply change on the spot their lead rationale in their press release once the error was pointed out was breathtaking," he said.
Beers told Wallace that he did not expect "that much impact" from the downgrade when the global markets open on Monday.

Watch this video from Fox's Fox News Sunday, broadcast Aug. 7, 2011.

Second U.S. recession could be worse than the first

(Call it what it is...the beginning of a depression. If we used math instead of some 9 member panel of economists, the math would show we are 3 years into a depression. That panel of economists says we're in a recovery--HA!--jef)

By Kase Wickman - RAW Story
Sunday, August 7th, 2011

A second recession, what many are calling the double-dip recession, could be on its way, economists warn. And should it come, it will probably be even more devastating than the previous period of economic woe. 

“It would be disastrous if we entered into a recession at this stage, given that we haven’t yet made up for the last recession,” Conrad DeQuadros, senior economist at RDQ Economics, told the New York Times.

The Standard and Poor's downgrade of the U.S.'s credit rating bodes ill for the world's financial markets as well as the domestic market.

President Barack Obama, once the debt deal with Congress to avoid a debt default was struck, announced a pivot to focus on jobs.

"I'll continue also to fight for what the American people care most about: new jobs, higher wages and faster economic growth," Obama said in a statement to press after the debt deal was passed last week.

While the working age population has grown 3 percent in the past four years, the economy has 5 percent fewer jobs -- or 6.8 million less than four years ago. The U3 Unemployment rate stands at 9.1 percent.

Economists don't think another stimulus package will do the trick, either.

“There are only so many times the Fed can pull this same rabbit out of its hat,” Torsten Slok, the chief international economist at Deutsche Bank, told the Times.

Downgraded Anyway...( 3 articles)

Sunday, August 7, 2011 by Richard D. Wolff
The S&P Downgrade of US Debt: What it Means
by Richard Wolff

 

Much verbiage is piling up on this issue. Yet, it matters little that the two other giant rating agencies did not downgrade US debt as S&P did. It is likewise unimportant that all those agencies deserve the bad reputations won when their over-rating of securities burst in the collapse of 2007 and took an already unbalanced economy into deep recession. Nor does the downgrade impose major cash costs anytime soon.

The S&P downgrade is important because it clarifies and underscores two key dimensions of today’s economic reality that most commentators have ignored or downplayed. The first dimension concerns exactly why the US national debt is rising fast. There are three major reasons for this:

(1) major tax cuts especially on corporations and the rich since the 1970s and especially since 2000 have reduced revenues flowing into Washington,
(2) costly global wars especially since 2000 have increased government spending dramatically, and
(3) costly bailouts of dysfunctional banks, insurance companies, large corporations and the economic system generally since 2007 have likewise sharply expanded government spending. 

With less tax revenue coming in from corporations and the rich and more spending on defense/wars and bailouts, the government had to borrow the difference. Duh!

The second dimension concerns the “deal” just agreed between President Obama and the Republicans in Congress. That deal promises further major increases in the national debt in the years ahead. That is because it does not alter any of the three major debt causes listed above. The political theatrics of the two parties reflect the money/power of the corporations and the rich, keeping their tax cuts, subsidies, and government orders untouched. Instead, the two parties pretend concern about the debt, debate only how much to cut government spending on the people, and focus on the 2012 election.

S&P downgraded the US national debt because these economic and political dimensions of the US today guarantee a worsening of the nation's debt. Thus, a basically political problem is looming for those lenders who purchased and now own the debt obligations of the US (i.e. Treasury securities). The political problem is this: how long will the mass of Americans accept not only an economic crisis bringing unemployment, home foreclosures, reduced real wages and job benefits, but now also cutbacks in government supports? When will the political backlash explode and how badly may it impact the creditors of the US?

When might that backlash demand that the people’s taxes stop going to pay off creditors (corporations, the rich, and foreigners) and be used instead for public services that the people need? Exactly that political danger for creditors prompted the rating downgrades for the debts of Greece, Portugal, etc. The same danger has now reached our shores and confronts our nation'a creditors.

S&P decided – for reasons good and bad, noble and venal – to say what any reasonable observer knows (given that such backlashes hurting creditors have often happened in recent history). Creditors need to worry about the combination of economic crisis, growing inequalities of wealth, income and power, and political dysfunction that now defines the US. The risks of backlash against creditors rise with the national debt. Not to worry is irrational and dangerous for them. And for us?

 ++++++++++++++

Saturday, August 6, 2011 by Huffington Post
How to Think About Standard and Poor's Downgrade
by Dean Baker

 

Standard and Poor's downgrade of U.S. government debt captured headlines across the country and around the world. It is a newsworthy event, but primarily as another colossal failure by a major credit rating agency.

First, it is worth mentioning the important background here. S&P, along with the other credit rating agencies, rated hundreds of billions of dollars of subprime mortgage backed securities as investment grade. They were paid tens of millions of dollar by the investment banks for these ratings. We know that concerns were raised by their own people about the quality of many of these issues. This was at the least astoundingly incompetent. It was quite possibly criminal.

This raises the question of whether S&P fears an investigation and possible prosecution. In such circumstances the desire to curry favor with powerful politicians could certainly influence their credit rating decisions. There are also rules affecting the credit rating agencies in the Dodd-Frank financial reform bill. The desire to have these rules written in a favorable way could affect the credit rating agencies' decisions. It would be nice if we could just assume that the credit rating agencies make their rulings on an objective assessment of the evidence, but we can't.

Let's look at the evidence. S&P made a big point of citing the fact that the debt deal did almost nothing to slow the growth of Medicare and other entitlements, obviously alluding to Social Security. S&P surely knows that Medicare's cost growth is driven by projections of explosive growth in private sector health care costs. The projections it relies upon from the Congressional Budget Office show that the cost of providing health care to an average 65 year-old in the private sector will be almost $20,000 (in 2011 dollars) a year by 2030. Of course, this will make Medicare unaffordable if it proves true, but this projected explosion in health care costs will be devastating for the U.S. economy even if we eliminated Medicare and other public sector health care programs altogether.

If S&P were being honest, it would have written about the need to fix the U.S. health care system. Instead it talked about the need to cut Medicare. Of course, if U.S. health care costs were comparable to those in any other country in the world, then we would be looking at massive surpluses in the long-term, not deficits.

The reference to Social Security also cannot be supported. The program is financed by its own designated tax. Under the law, if benefits exceed the money raised by the tax, then they are not paid. If S&P assumes that Social Security will add to the deficit in future years, then they are assuming that Congress will change the law in a way that no one is now proposing.

It is also worth noting that the projected increase in Social Security as a share of GDP over the next 30 years is 1.6 percent. This is roughly the same as the increase in the annual military budget since the days before September 11th. An unbiased credit rating agency would not be highlighting one increase while ignoring the other.

There are other problems with the S&P downgrade. U.S. government debt and its derivatives (e.g. the $5 trillion of mortgage backed securities issued by Fannie Mae and Freddie Mac) are the backbone of the U.S. financial system and indeed the world financial system. If U.S. debt is in fact less creditworthy, then all the banks and financial companies that rely on its value should also be less creditworthy. Yet, we didn't hear of J.P. Morgan, Goldman Sachs and the rest being put on the watch list for a downgrade. Why not? Perhaps this is because S&P doesn't take its own rating seriously.

Finally, what does the risk of default on U.S. government debt mean? The debt is issued in dollars. That means it is payable in dollars. The U.S. government prints dollars. This means that if some reasons the government was unable to tax or borrow to raise the money to pay its debt then it could always print it. This may carry a risk of inflation, but S&P is not in the business of making inflation predictions, they are in the business of assessing the likelihood that debt will be repaid. (Of course if they are worried that inflation will erode the value of U.S. debt, S&P would also have to downgrade all debt denominated in dollars everywhere in the world.)

In short, there is no coherent explanation that can be given for S&P's downgrade. This downgrade was not made based on the economics. We can only speculate about the true motive.

+++++++++++++++

Saturday, August 6, 2011 by The New York Times

S&P and the USA: Right's 'Madness' and Agency's Ineptitude Led to Downgrade

by Paul Krugman 

NEW YORK - OK, so Standard and Poors has gone ahead with the threatened downgrade. It’s a strange situation.
 
On one hand, there is a case to be made that the madness of the right has made America a fundamentally unsound nation. And yes, it is the madness of the right: if not for the extremism of anti-tax Republicans, we would have no trouble reaching an agreement that would ensure long-run solvency.

On the other hand, it’s hard to think of anyone less qualified to pass judgment on America than the rating agencies. The people who rated subprime-backed securities are now declaring that they are the judges of fiscal policy? Really?

Just to make it perfect, it turns out that S&P got the math wrong by $2 trillion, and after much discussion conceded the point — then went ahead with the downgrade.

More than that, everything I’ve heard about S&P’s demands suggests that it’s talking nonsense about the US fiscal situation. The agency has suggested that the downgrade depended on the size of agreed deficit reduction over the next decade, with $4 trillion apparently the magic number. Yet US solvency depends hardly at all on what happens in the near or even medium term: an extra trillion in debt adds only a fraction of a percent of GDP to future interest costs, so a couple of trillion more or less barely signifies in the long term. What matters is the longer-term prospect, which in turn mainly depends on health care costs.

So what was S&P even talking about? Presumably they had some theory that restraint now is an indicator of the future — but there’s no good reason to believe that theory, and for sure S&P has no authority to make that kind of vague political judgment.

In short, S&P is just making stuff up — and after the mortgage debacle, they really don’t have that right.

So this is an outrage — not because America is A-OK, but because these people are in no position to pass judgment.