Wednesday, July 27, 2011

The Debt Limit & Downgrade- So What?

Occasionally, CNBC co-host Gary Kaminsky will say something simple and insightful when others miss the point. He did so earlier this week on David Faber's noontime program.

When asked about the potential impact of a rating agency downgrade of US debt, Kaminsky said that it didn't really matter, because nobody believed the US is a AAA credit anymore, and the downgrade is already priced in. Not because of the debt limit debate, but because of the nation's profligacy.

I believe Kaminsky is entirely correct and echoes my sentiments in this post from earlier this month,

"Druckenmiller contends that no serious change at all in federal spending and disposition regarding its habits would be the worst outcome. And if the GOP rushes to capitulate after a government shutdown, there won't be such change. Obama will declare political victory, many Tea Party voters will be disgusted with the GOP.

But if Obama faces a GOP House whose members are willing to force a shutdown and, then, after it is clear there won't be capitulation, an ordered payment of federal obligations, while some functions are shuttered, everyone- global investors, voters, onlookers- will understand that things have changed.

In the meantime, the US would have lost its AAA rating. No matter which party gained relatively greater power among Congress and the White House in 2012, a return to borrowing and spending for new programs would no longer be an option. Interest rates would be too high on Treasuries to borrow much more money, if investors would even lend it. Slow economic growth and joblessness would make higher taxes on anyone a non-starter.

In short, a default now will bring forward what I believe would be the eventual outcome of political business as usual in Washington, which will continue without a default.

Whether it's this group of Republicans, or another, after a brief return to Democratic control of the House, Senate, and Oval Office, and the final orgy of unaffordable deficit spending, it will likely now take some catastrophic event such as a credit rating downgrade and default to wake up Washington politicians to what is understood by many American voters and most global investors, to wit, no small change in American federal government fiscal policy will suffice any longer."

Just this morning, I heard a fund manager from Loomis Sayles say essentially the same thing.

What seems to escape the grasp of many pundits, and certainly Congress and the president, is that America doesn't have an inalienable right to a AAA credit rating, even as it debauches its currency and has spent, for most of 80 years, more each year than it receives in tax receipts.

Ironically, sophisticated capital markets combined with a dearth of investment alternatives post-WWII to leave the dollar and US Treasuries in the position of becoming the world's reserve currency.

Much like Rome after the fall of Carthage, the US has been, in the long run, ill-served by the absence of competitors to it as a reserve currency and general free world economic superpower. We've gradually picked up momentum, post-WWII, spending and promising to spend, on entitlements, consistently more than tax receipts were funding. It took about three-quarters of a century, but we've finally exhausted the investment appetites of the rest of the world for our securities.

On recent fiscal policy course, the US has become a discredited government. If the Fed weren't artificially pegging rates so low, and monetizing Treasuries' borrowings to the great extent that it is, does anyone really believe interest rates on Treasuries would be so low, or that the dollar wouldn't be even cheaper?

An official rating cut from AAA for America is warranted, debt limit agreement, or not.

One pundit predicted a partisan 'blame game' among federal elected officials.

Well, American voters need only look in the mirror for whom to blame. They consciously elected and re-elected generally inept spendthrifts since 1932, then wonder why the country has amassed so much net external debt.

It's time for Americans to wake up to the consequences of their poor political choices for the last eight decades.

And when the rating downgrade happens, the resulting increased funding costs will help put a stop to excessive spending and bad tax policies, only from outside, uncontrollable forces, rather than internal, political ones.

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