Looking Ahead To America’s Next Credit Downgrade

unemployment benefits

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Former Fed nominee and Nobel Laureate Peter Diamond spoke to Bloomberg News about how he sees the economic difficulties the United States faces. His view is that America faces a jobs crisis in the here and now and that deficit reduction is a longer-term problem. Like Marc Chandler, Diamond believes an infrastructure public works program is a big part of the jobs and demand problem. Expect a proposal of this sort from the President in the Fall.The line the Obama Administration has taken to the deficit discussion dovetails with this thinking. I agree with this. As I wrote two years ago:

I argued that the United States faced a policy dilemma in avoiding debt deflationary forces while maintaining fiscal prudence. The reality is that President Obama faces political constraints in Washington right now regarding budget deficits. He is not likely to get another stimulus package through the Congress unless he can credibly demonstrate a longer-term deficit reduction outlook. In my view, this necessarily means changes to Social Security and/or Medicare.

    –Means of deficit reduction: Medicare and Social Security

Liberals will resist this, just as conservatives will resist any tax increases or military spending cuts. Everyone knows the deficit issues are almost entirely about military and entitlement spending.

Meanwhile, despite under-employment percentages in the mid-teens and the looming threat of a double dip recession, the US is moving toward immediate cuts to discretionary spending as a result of a threat to refuse to pay its financial obligations.

This is exactly the dysfunctionality that got the US sovereign debt rating downgraded. And yet, we hear from both the left and the right that the downgrade was unwarranted – for completely different reasons of course. This is the rationalisation of economic nationalism.

If you look at Japan, which is ousting its 7th Prime Minister in 5 years and is looking to cut spending by 10%, it is clear that depressionary credit crises lead to political dysfunction and a worsening fiscal picture that results from the conflicting priorities which emanate from that dysfunction.

In the US, I fully expect zero policy traction on military and entitlement issues and further brinkmanship on the smaller discretionary spending issues because that’s how political posturing about fiscal responsibility works best. Further, I expect the infrastructure ideas to fail, due to obstruction from Republicans. This will result in a double dip recession, an increase in unemployment and a fall in asset prices, weakening the fiscal outlook further. Therefore, I expect further ratings downgrades from all the ratings agencies in due course as a result of this train of events.

This article originally appeared at Credit Writedowns >