MarketWatch commentator Paul B. Farrell has just penned a typically entertaining op-ed on why the US is headed for an even greater world of trouble come 2011. Among other things, entitlement spending is going to spiral upwards given the imminent retirement of the baby boom generation. Throw in stagnant wage growth for almost an entire decade with a collective unwillingness to contemplate tax increases and the US is in a fiscal bind of enormous proportions that will only grow. I have few difficulties with Farrell's bleak prognosis: the US is the world's biggest economic basket case and it is dragging the rest of the world down the sinkhole care of such mindless actions as continually funding America's huge external deficits no matter what. Who is dumber, the fool running unsustainable deficits or those allowing the fool to run unsustainable deficits year in, year out? My response, of course, would be the latter. Given a collective unwillingess to stop allowing the US to behave badly, the rest of us get what we deserve. Garbage in, garbage out. Globalization is, at best, subprime.
Something that Farrell and others keep recycling though is this idea that American sovereign debt will be downgraded from AAA in the near future. Again, we are talking about two different things. You do not need to convince me that US Treasuries are utter rubbish given America's unquestioned strategy of running even more massive deficits to solve the problem caused in the first place by, er, running large deficits. However, that American sovereign debt should be downgraded is different from believing this debt will be downgraded. Those quantitatively inclined can probably use models such as Cantor-Packer to simulate what America's debt rating ought to be going forward.
As an IPE scholar, I am inclined to believe that no amount of red ink will make the major credit rating agencies--S&P, Moody's, and Fitch's--downgrade US debt. The reasons are political-economic. With the exception of Fitch's, these are all US-based firms. When push comes to shove, they will try to protect the national interest, provided not-too-subtle nudges from Sammy. For instance, American authorities have sole discretion for classifying these entities as nationally recognized statistical rating organizations (NRSROs). If American authorities catch wind of an impending downgrade, it is child's play to kick them out of the US credit rating business entirely by removing this designation (despite these being American firms). Being disqualified to rate a significant portion of dollar-denominated debt would endanger credit rating agencies in a way that the Asian financial crisis and the credit crunch failed to do.
In many ways it's very ironic. NRSROs can badly misjudge sovereign debt of LDCs and financial weapons of mass destruction all they want and get away practically scot-free. But, issue an accurate assessment of Uncle Sam's fiscal depravity and there will be hell to pay. Hey, it's an unfair and messed up world, but it was that way long before I got here.
Bottom line: chronic US deficits don't matter--if you're a major credit rating agency. That's one of the rules of the game.