May 28, 2009
In the last week the news that has
roiled financial markets on both sides of the Atlantic was a warning
from Standard & Poor's, the credit rating agency, that the UK could lose its AAA credit rating, the highest bond rating and one that is held by 18 governments worldwide.
The British pound fell, and then the contagion spread to the United States, with investors dumping US Treasuries on fears that the US could be next. The selling drove interest rates on the benchmark 10-year Treasury note from 3.15% up to 3.45% over the next two days - the highest in six months.
S&P's warning was seen by many as an indication that both the UK
and the US governments will have to reign in deficit spending or face
financial disaster up the road.
But is this really what anyone
should be worried about? The first question that comes to mind is why
anyone would take the analysis of S&P seriously. The credit rating
agency, along with Moody's and others, played a significant role in
helping to create and spread the global financial crisis by giving AAA
ratings to highly risky and sometimes worthless assets backed by bad
mortgage loans. They seemed oblivious not only to the $8tn housing
bubble but also to the shoddy practices in mortgage origination and
mostly everything else that a normal person asked to make these
judgements should have taken into account.
In a US congressional
hearing that examined the ratings agencies' contribution to the
financial crisis, one congressman read aloud a correspondence between
S&P employees in which they said they would rate a deal "even if it were structured by cows".
from S&P's questionable credibility, the deficit hawks who have
seized on their analysis have the economics wrong. The overwhelming
economic urgency facing the UK, the US and in fact most of the world,
is not a problem of expanding debt. The problem is that these
governments have enacted fiscal stimulus packages that are much too
small to compensate for the fall-off in private spending during the
The UK stimulus is only about 1.4% of GDP,
despite the fact that its government budget deficit is expected to
reach as much as 11% of GDP this year. Most of the difference is
attributable to the costs of bailing out the financial system, and
there is a good argument that way too much has been wasted compensating
The same is true for the United States. Our fiscal
stimulus in 2009 and 2010, if we take into account the cutbacks in
state and local government spending, is about $126bn per year, or 0.9% of GDP.
This is just a fraction, perhaps not even a tenth, of the decline in
spending that we can expect from the collapse of the housing bubble. At
the same time, our government has spent hundreds of billions of dollars
on bailouts like that of AIG.
Although taxpayers in both
countries have been ripped off and should demand that some of this
money be clawed back, the debt in both countries is still manageable.
S&P projects that the UK debt will grow from 49% of GDP today to
97% in 2013. The government - which is probably more reliable than
S&P - projects 76%. Either way, this should not discourage anyone
from pushing for an increased fiscal stimulus as the economic situation
Likewise for the United States, where
the non-partisan congressional budget office projects an increase in
the federal debt held by the public from 40.8% last year to 71.4% in
2013. It is worth recalling that the United States had a public debt of
109% of GDP in 1946, as it began the "golden age" of its historically
most rapid economic growth over the ensuing 27 years - growth that
resulted in broadly shared prosperity, unlike that of the last three
The CBO projections also show that, despite the sharp
rise in the US budget deficit from 3.2% of GDP in 2008 to 13.1% for
2009, net interest payments on the debt have actually fallen, from 1.8%
to 1.2% of GDP. This is a very low interest burden and of course is due
to the fall in interest rates. The same is true for the UK. In the US,
the interest burden is projected to rise after 2013, but that is mostly
due to projected increases in interest rates.
standards of future generations in the US and UK will be determined not
by the amount of debt that we accumulate during this recession, but by
the productivity, capital stock and skills embedded in the economy that
they inherit. We would be foolish to let the bond ratings agencies, or
the narrow financial interests that they represent, convince
politicians that they must cut spending or raise taxes before a
sustained recovery is entrenched.
© 2023 The Guardian
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