- The Washington Times - Sunday, August 7, 2011

ANALYSIS/OPINION:

Standard and Poor’s went straight to the heart of the matter on Friday in a first-ever downgrade of the U.S. AAA credit rating. It found that the “effectiveness of American policymaking and political institutions has weakened” and that the fiscal plan “falls short of what would be necessary” to stabilize debt. Ouch.
 
Contrasting the U.S. with AAA countries such as the UK and Germany, S&P said it expects debt-to-GDP ratios there to peak around 2015 but continue to worsen here. S&P kept France in the AAA category, leaving the U.S. in the ditch. Double ouch.
 
Citing a $2 trillion “error” in S&P’s debt projections, the white house reaction was to shoot the messenger in a desperate effort to avoid this being labeled the ‘Obama downgrade’. On Friday, Treasury convinced S&P to use CBO’s “baseline scenario” which assumes discretionary spending grows slower than nominal GDP. Good luck with that.  It’s a big stretch given Washington’s ability to inflate the baseline, double count spending cuts and go back on previously agreed cuts. S&P had been assuming faster spending growth, a baseline that I think is closer to reality because it incorporates Congress’s bias toward more spending and the possibility of occasional recession-related bursts in spending.
 
The Administration’s misdirection strategy may have worked. The August 6 New York Times and Time Magazine stories emphasized the change in S&P’s ten-year debt projections instead of highlighting the U.S. fiscal mess.  Many news stories profiled the S&P employees involved in the rating rather than S&P’s multi-year track record warning the U.S. about its fiscal deterioration.
 
The reality is grim.  Even after lowering its assumptions about federal spending growth, S&P projects marketable government debt in 2015 at $14.5 trillion, 79% of GDP.  Debt would grow to over $20 trillion in 2021, 85% of GDP including state-and-local debt.
 
In the real world, the U.S. fiscal deficit and the debt-to-GDP ratio depend heavily on GDP growth rates. They are weak now and hard to predict, leaving a good chance that the debt-to-GDP ratio is heading toward 100% of GDP, much higher than either version of the S&P projections.
 
The problem is that our current federal spending system has few effective controls. The Constitution was amazingly farsighted but didn’t envision a government so successful and jaded that it could ever borrow $100 billion much less $20 trillion as now envisioned.
 
Washington benefits from more spending and doesn’t want it to stop. Making matters worse, an offshoot of the flawed 1974 Budget and Impoundment Act makes it a felony for executive branch officials to spend less than Congress appropriates no matter how wasteful or misguided a program.  
 
By negotiating with Vice President Biden and then each other, fiscal conservatives missed an opportunity this summer to restrain spending. The administration opposed spending restraint almost to the end. That is the heart of the S&P complaint.
 
My previous pieces on this page have advocated replacing the current dysfunctional debt limit with true spending restraint. To grow fast and create private sector jobs, we need a glide path to a permanent debt-to-GDP ceiling much lower than current levels. Rather than a debt default, it should use escalating penalties on government to force discrete decisions on spending cuts including entitlements. The compromise to use commissions and unworkable across-the-board sequester is typical Washington responsibility ducking. S&P saw through the dodge in its downgrade, expressing skepticism that the super-committee would cut spending and that the sequester would be implemented.  
 
In the near-term, markets should take the downgrade in stride. It wasn’t a surprise, and other ratings agencies such as Moody’s and Fitch have maintained their U.S. ratings at the highest grade. S&P chose to release the rating on Friday after the market close, reducing its impact. The U.S. fiscal deterioration spelled out in the S&P downgrade has been underway for years, and it’s unlikely that the S&P opinion will cause new revelations.  Many funds categorize U.S. Treasuries as riskless without reference to the bond rating, limiting the impact on yield.
 
In the longer-term, the downgrade will be expensive unless it helps force an improvement in Washington’s spending patterns. Instead, the U.S. is likely to continue ultra-loose spending and monetary policies, with a harmful impact on the dollar, investment in the U.S., GDP growth and employment. There’s the risk that this downgrade is just the first in a series (as is often the case). Perhaps most costly, it’s another clear marker for investors that the U.S. is in economic decline.

David Malpass, president of Encima Global and chairman of GrowPAC, was deputy assistant Treasury secretary in the Reagan administration.


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