Weeks of political gamesmanship that fell far short of the Obama administration’s early promises of deficit reduction have cost the U.S. government the top-notch credit rating it has held for almost a century.
Standard & Poor’s announced Friday night that it was cutting the AAA credit rating to AA-plus, saying it was “pessimistic about the capacity of Congress and the administration to leverage their agreement this week into a broader [deficit cutting] plan that stabilizes the government’s debt dynamics any time soon.”
The credit rating agency, which suggested another downgrade was possible within two years, was scathing in its rebuke of the U.S. political class after Sunday’s $2.4-trillion (U.S.) deficit reduction deal. It stated that that the “brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective and less predictable.”
The humbling downgrade, which leaves the United States with a lower rating than Canada, capped a tumultuous week on global stock markets. The dive reflected a loss of investor faith in the ability of politicians and central banks in the developed countries to fix the underlying structural problems in their economies.
The two other leading credit rating agencies, Moody’s Investor Services and Fitch Ratings, have already confirmed they intend to, for now, maintain the U.S. top-tier rating.
It is unclear what impact S&P’s move will have on U.S. interest rates, which are currently at rock bottom levels. A lower credit rating typically requires borrowers to pay a higher rate. But yields on U.S. Treasury bonds are at historic lows; investors consider them among the world’s safest investments.
S&P’s move, which came after the close of stock market trading, followed the Obama administration’s reported attempts to challenge the agency’s math. President Barack Obama was not likely aware of the agency's intentions when he addressed an audience of U.S. veterans on Friday morning - he was briefed by officials later in the day - but his deameanour betrayed the gloomy economic mood.
“What I want the American people and our partners around the world to know is this: We are going to get through this,” a subdued President offered, suddenly looking every bit his 50 years and a day.
But S&P’s report underscores a harsher truth. The U.S. President is hobbled by a political system that saps what little power he and Congress have to restore economic confidence.
European leaders are similarly hamstrung by dysfunctional political systems. Their attempts to contain the euro-zone debt crisis have repeatedly come up short because the measures needed to comfort financial markets exceed the tolerance of voters.
On both sides of the Atlantic, “you’re caught between the politicians feeling as if they are making a heroic effort, pushing the boundaries of what they regard as politically possible, and [the fact] that it doesn’t come near to what is economically necessary,” explained Sebastian Mallaby, a Washington-based senior fellow at the Council on Foreign Relations.
On Friday, Italian Prime Minister Silvio Berlusconi, whose country could be the next overleveraged European nation to seek a bailout, sought an emergency meeting of G7 finance ministers. But it is unlikely they can fix in one gathering what countless previous summits have been unable to repair.
Global stock markets have cratered because, after weeks of debating, dissecting and diagnosing what ails their respective economies, U.S. and European policy makers have not been able to bring themselves to administer the bitter medicine they have all acknowledged is needed.
So, what’s the cancer? In a word, debt.
The developed countries have too much of it. The most overleveraged nations – Greece, Ireland and Portugal – have already become wards of their wealthier European neighbours.
Italy and Spain could be next. When European leaders unveiled their latest Greek bailout package two weeks ago, conceding that holders of Greek government bonds would need to take a haircut on their debt, they failed to insulate Italy and Spain from the contagion of a potential debt restructuring.
European leaders, Mr. Mallaby says, “had loudly, openly and repeatedly declared what it would take” to protect Italy and Spain, notably a massive expansion of the €440-billion European Financial Stability Facility, or bailout fund. But the politics of expanding the EFSF is difficult; voters in richer nations resent having to pay the tab for rescuing weaker cousins.
The internal politics of the most indebted nations are tougher still. The austerity measures demanded in exchange for a bailout have sent Greek citizens into the streets.
Mr. Berlusconi promised on Friday to move faster to eliminate the country’s budget deficit. But whether he will be able to, given the country’s fractured political system and certain voter resistance to spending cuts and tax increases, is anyone’s guess.
The resolution, for now, of the U.S. debt-ceiling stand-off has not provided any comfort to investors, either.
For weeks, Mr. Obama suggested the debt-ceiling negotiations would spur the U.S. political class into finally addressing the elephant in the room – unsustainable public pension and health insurance programs that are set to send the country’s debt above $20-trillion (U.S.) within a decade.
But the relief investors felt at seeing the stand-off end was soon displaced by their realization that the deal’s $2.4-trillion in cuts – all subject to repeal by a future Congress – came up short. Financial markets had been conditioned by Mr. Obama’s own advisers to look for a debt-ceiling deal that would slash the U.S. by deficit by $4-trillion over 10 years.
S&P’s verdict was swift and brutal. But it will not make tackling the problem any easier.
Despite the purported Tea Party zeal for deficit-slashing, few Americans are willing (or indeed able) to absorb cuts to their Medicare or Social Security benefits. The disconnect is encapsulated in the oxymoronic Tea Party mantra: “Keep your government hands off my Medicare.”
In short, the credit rating agencies have an easier job than the politicians.