In one very important sense, the Standard & Poors downgrade of the United States credit rating is spot on. The debt ceiling debacle that preceded the ratings action showed an extraordinarily destructive political culture at work in Washington. To take the Federal Government within inches of default for no apparent reason was beyond infantile and warranted a re-rating of sovereign risk. S&P basically downgraded all of Washington. From the S&P rationale:
We have changed our assumption on this because the majority of Republicans in Congress continue to resist any measure that would raise revenues, a position we believe Congress reinforced by passing the act.
I am not terribly fearful that the downgrade will have an immediately damaging effect on markets. The downgrade was telegraphed and contingency plans will be in place. The Federal Reserve has already neutralised much of the impact with an ongoing commitment to Treasuries as collateral, as well as offering a string of funding lines for those that suffer a hiccup. As well, Moodys and Fitch still offer a AAA rating.
The fallout from the downgrade is at once less obvious and far more damaging. What matters most is that the rerating was of a discredited leadership by an institution whose own credibility remains stuck firmly in the S-bend. Who can, or should, forget the rating agencies disgraceful behaviour in the years leading up to the GFC. S&P and its peers were responsible for a Himalyan sized pile of AAA ratings that, as one analyst put it, could have been issued by cows. The importance of the downgrade is that it was administered to a discredited government by a discredited watchdog institution. Both of whom now appear, to my eye, to be even further discredited.
Indeed, if anything, the importance of the downgrade is better captured by the events that transpired following the announcement. The US Treasury examined the S&P rationale and discovered a $2 trillion arithmetic error. The US government’s future fiscal position was to be $2 trillion better than S&P had calculated. S&P paused for a few hours after the US Treasury challenge then admitted its mistake and went ahead with the downgrade anyway.
The symbolism is pointed. What matters most about the downgrade is the discredit it showers upon the current iteration of the liberal democratic market system. We now face the ludicrous circumstance in which the United States government holds the same credit rating as New Zealand, a lower rating than Microsoft, despite issuing its own currency (the world’s reserve), being able to raise taxes when it chooses, owning a printing press and possessing no fewer than eleven nuclear-powered aircraft carriers (ten of which are Nimitz class). Yet it has neither the nous, wherewithal or power to see off a failed company.
Precisely the same dance is transpiring across the pond in Europe. There, as we know, the ratings agencies have been tormenting European nations with downgrades as politicians squabble over how to restore liquidity to their various bond markets. This morning we have a mad scramble by European leaders to catch up, again.
Liberal democracy is now at war with the market that it spawned and both are losing. The war is working on three fronts and each merges with the other to form one giant battlefield. The three are ideas, markets and politics.
The last thirty years of global economic policy has been dominated by a blend of Keynesianism and libertarianism. That has resulted in two very large changes to national economies.
First, we now have a global financial market that is vast, fast moving and integrated. It has very few internal mechanisms of control. It relies on asset inflation, momentum and sentiment for strength.
Second, this system has been complimented by the national Keynesian urge to stimulate whenever economic growth stalls. Increasingly over the last fifteen years, that stimulus has also taken on the job of bailing out the underlying financial system whenever its excesses periodically peak. This has undermined the most important and final hurdle in the rampaging market’s way: fear of failure.
The underlying financial system has crossed borders and shifted savings from surplus countries to Western consumers. In doing so it has created an enormous pile of private debt. The same underlying system has also fed easy money to governments, who have returned the favour by borrowing and spending whenever economies have taken a blow. This has created an enormous pile of private debt. The culmination of which was the GFC, when the entire shaky edifice came crashing down. It was again saved by governments but its credibility was fatally damaged. Consumers across the Western world turned about face, shunned debt and began saving money as fast as they could.
Now, the Austrian school of economic ideas is rising. Rightly enough, it’s notions of creative destruction, capital misallocation and purging the system of excesses each business cycle suddenly makes sense. Except for one small problem. It’s too late. Bringing austerity to economies with giant debt-loads only makes those debt-loads more difficult to service. Nonetheless, the Austrian banner has been taken up by politicians on both sides of the Atlantic. A new breed of Brown Shirt politics has emerged in which government debt is viewed as an intrinsic evil. These political forces demand austerity at all costs. The inappropriate application of these ideas by the political process is clouding the role that government should play in regulating the private economy. Government itself is now losing credibility.
The conclusion of it all is a loss of faith in liberal democratic market structures generally. That is the real problem and its slowly but surely engulfing global markets.
Perhaps this morning some politicians are beginning to sense the earth moving beneath their feet with hastily convened G7 and other meetings. Such efforts may stimulate a new rally. Somehow, however, I doubt it will be more than crisis management, as it has been from the beginning.
What the world needs is s new Bretton Woods. A new global agreement on how to balance debt management against growth objectives and how to do so in a new framework that returns stability, transparency and credibility to the global financial market. But if nations can’t even do that internally, what hope is there that they can do so in concert?
To help you understand and prepare for the outcomes of this Crisis of the West, today we offer a MacroBusiness special. Each of the senior bloggers has prepared his view of the likely direction and fallout of events. Delusional Economics presents his take on the European end-game. The Unconventional Economist examines China’s growth model and its global linkages to determine its fate if (when) the Western powers slide back into recession. The Prince and Q Continuum offer a paradigm through which to view equity markets and the great volatility ahead. Deus Forex Machina looks at the growing currency chaos and diagnoses where the Australian dollar fits. Finally, I have a piece despairing at the absolute failure of the baby boomer controlled Australian media to understand what is going on. I hope you enjoy the special and it brings you greater prosperity in troubled times.